Islamic Banking and the Indian Economy

Islamic banking foraged into mainstream media as a tending tropic recently due to the RBI’s decision to revoke permissions to initiate this form of banking in the country. The decision came as a blow to the proponents of Islamic banking, who argued in favor of allowing Islamic banking stating that it attracts investments from the Middle-East region and also enables the 18 million Muslim population in the country to engage in banking activities. Those who opposed it did so on grounds of Islamic Banking being an unnecessary good for the economy. The move comes as an obvious victory for the latter.

Islamic Banking (IB) is a form of banking that is based on Islamic law. This essentially means that the bank can only operate within the purview of the sharia law, which derives from Islamic tradition. From the perspective of sharia law, there shall be nothing like charging an interest rate on the monetary transactions like deposits and loans. Sharia law considers usury or interest rates as immoral; money, under the law, only has a single function, that of acting as a medium of transaction. However, in modern times, money has become more than just a medium of transaction; it is something that has a value of its own. If interest rates are denounced, there would be no incentives for people to deposit money in banks. Banks will seize to earn money from transactions if they do not charge interest over loans. Considering the fact that any bank across the world finds more than half of its income from the interest payments upon its loans, the idea of denouncing interest seems quite disruptive.

Here is where Islamic banking differs from the formal banking structure that we see around us today. In Islamic banking, the bank does not charge a fixed interest rate. It charges either a certain amount as a service charge, or an amount from the individual in the form of a gift for ensuring the supply of monetary resources. The major difference between a sharia compliant institution and a traditional bank is that the sharia compliant bank depends heavily upon the trust and the faith that it builds with its customers. Traditional banks act more like a passive money lender that worry little about the borrower. In a nutshell, Islamic banking takes into consideration the ability and financial circumstances of an individual, while the traditional bank focuses more on the process of borrowing and repaying. Islamic banks are participatory organizations and the traditional banks are mere intermediaries.

The debate over whether India needs an alternative like Islamic bank is highly debatable. Those who support the Islamic banking argue that this will help the 18 million Muslims in the country to enter into the formal banking system. Many of them are reluctant to join the banking service since dominant banks charge interest rates, something that is opposed in Sharia law. Proponents staunchly believe that if the Islamic banking is planned and implemented in the country, it will help attract foreign investments from capital rich countries like UAE, Kuwait, Saudi Arabia etc. wherein the countries as well the investors are insisting on having financial dealings with Sharia-complaint financial institutions. Islamic banking will also enable the poor sections of the society to avail money without the hurdles and burdens of the interest payments.

Having said this, the banking sector in India is on the path of maturity. Given this momentum for the financial inclusion, the need for alternative banking may be contested.

-Contributed by Jiss Palelil

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