INTEREST FREE BANKING-COMPLEMENT FOR INDIAN ECONOMY Author Name: Sameera Afroze Affiliation: Assistant Professor, Aristotle PG College Paper Title: Interest Free banking, complement for Indian Economy Paper Track: Islamic Banking. Phone: 8686092482 Email: sameeraafroze@gmail.com Abstract Some sections of Indian society have remained financially excluded for religious reasons that preclude them from using banking products with an element of interest. Interest free banking has been prevalent in various countries as Shariah or Islamic banking. Islamic or Shariah banking is a finance system based on the principles of not charging interest, which is prohibited under Islam. Islamic financial institutions are successfully doing business in more than 75 countries. It has been estimated that the total Islamic finance industry including mutual funds, non banking companies, leasing, real estate investment and stock market investment are in the range of US $ 2trillion. The present paper focuses the need of interest free banking in India, its benefits to Indian economy and all the sections of the society, and suggests measures to overcome the challenges. Keywords: Interest free banking, Shariah banking, Islamic finance, Islamic banking, India. Introduction: Islamic banking is an activity that is consistent with the principles of Shariah and its practical application through the development of Islamic economics. Shariah regular banking in that it prohibits earning of interest (or riba) through the business of prohibits the fixed or floating payment or acceptance of specific interest of fee for loan of money. It is different from lending. Islamic banking has the same purpose as conventional banking system but 2
functions in accordance with the principals of Shariah, known as Fiqh al-muamalat. Islamic Shariah law prohibits engaging in activities or transactions that are considered harmful to people, society or the environment. This ethical approach is at the core of Islamic banking and avoids transactions involving usury, interest, speculation, gambling, or industries contrary to Islamic values. So for investors that share these principles, irrespective of religion, Islamic finance provides a range of options. Islamic banking offers a plethora of products for customers or investors looking to participate. The last decade has seen a sharp rise in Islamic banking services, which are starting to offer a real and attractive alternative to the sort of financial services most people have grown used to, across the Middle East, Africa, and Asia. Islamic banking has grown to become a prominent means of financial management, while it is also emerging in Western economies that have not typically been associated with it in the past. In addition Islamic finance has an inbuilt anti-crisis mode, which is perhaps one of the most compelling reasons why Islamic finance is so relevant to investors across the globe. For a world reeling from the aftereffects of the global financial crisis, Islamic banking offers a steadier, safer approach. This is reflected in the in-depth screening process that eliminates companies deemed too risky because of excessive leveraging. The partnership structure of Islamic financing prompts both parties to be mutually responsible thus protecting individual investors. While profit is encouraged, it is just one of the reasons to participate in economic activity with community welfare taking equal, if not higher precedence. Money has no intrinsic value except as a medium of exchange and transactions have to be backed up by real assets and activities. Indeed, in the aftermath of the global financial crisis, many proponents of Islamic banking pointed out how institutions offering these services tended to be far more resilient to the crisis than those at the heart of the crisis. The IMF produced a report in 2010 that showed how Islamic banking institutions contained the fall out of the crisis by having lower leverage and no investments in risky, non-shariah-compliant products. 3
Literature Review: Jeet Singh and Preeti Yadav (2013) studied the growth and potential of Islamic banking in India and stated that Islamic banking has been misunderstood in India as a religious charitable venture restricted to the poverty-ridden and economically downtrodden Muslim community. They suggested tha it would help India to fill the inequality, promote social well being and wealth generation activities. Dusuki and Abdullah (2007) in Malaysia found that religious factor is not the main criteria for banking selection. They found that competent and knowledgeable personnel, followed by friendly personnel and service quality as their main patronage factors. A study on perception of non-muslims towards Islamic banking in Kuala Terengganu conducted by Mahamad and Tahir (2010) found low acceptance among the non-muslim community towards Islamic Research Methodology: The research is basically based on secondary data, which has been collected from the various web sites, different journals, annual reports, periodicals banking as an alternative over conventional banking. They found that Islamic banking was able to attract more non-muslim customers if Islamic banks can fulfill their selection criteria of banking, which was quality of services provided. Objectives: To understand the concepts of interest free banking. To identify the need, scope and potential of interest free banking in India. To study the current status of Interest free banking in India and across the globe. To highlight the potential of interest free banking services for solving socioeconomic problems in India. To suggest ways and methods for successful implementation of interest free banking as a separate window in various commercial banks. magazines and weeklies published by the various research companies, Islamic Institutes & colleges and consultancies, various Islamic banks reports and also the analyst organizations. 4
Principles of Interest Free/Islamic Banking: asset, and different forms of partnerships of which equity financing is the most desirable. Interest free banking is based on profit sharing principal. It is important to understand that Islamic Banking is based on a strong value system. It lays great emphasis on equity and investment in the real economy. Rather than providing a lucrative financial alternative to investing in the real economy, Islamic banking complements and strengthens the latter. One of the main principles of the Islamic finance system is the prohibition of the payment and the receipt of riba (interest) in a financial transaction. The term riba covers all forms of interest and is not limited to usury or excessive interest only. The most critical and significant implication of banning interest is the indirect prohibition of a pure debt security. The key point to bear in mind is that Islamic law doesn t recognize money and money instruments as a commodity but merely as a medium of exchange. Hence any return must be tied to an asset, or participation and risk-taking in a joint enterprise (such as partnerships). A pure debt security is replaced with an assetlinked security, direct financing of a real In addition to prohibition of riba, there are several other important provisions which may affect financial transactions. These include the prohibition of gharar (uncertainty or asymmetrical information), maysir (gambling, speculation), hoarding, as well as trading in prohibited commodities (for example, pork and alcohol). Instruments of Islamic Banking: Basic instruments include: cost-plus financing (Murabaha), profit-sharing (Mudaraba), leasing (ijara), partnership (musharaka) and forward sale (bay salam). These constitute the basic building blocks for developing a wide array of more complex financial instruments. Murabaha Trade with markup or cost-plus sale. The purchase of an asset is financed for a profit margin, with the asset purchased on behalf of client and resold at a predetermined price. Payment could be in lump sum or in installments and ownership of the asset remains with bank till full payments are made 5
Ijara Operational or financial leasing contracts. Bank purchases asset on behalf of client and allows usage of asset for a fixed rental payment. Ownership of the asset remains with the financier but may gradually transfer to the client who eventually becomes the owner (ijara wa iqtina). Mudaraba Trustee financing contract. One party contributes capital while the other contributes effort or expertise. Profits are shared according to a predetermined ratio and the investor is not guaranteed a return and bears any financial loss. Musharaka Equity participation contract. Different parties contribute capital and profits are shared according to a predetermined ratio, not necessarily in relation to contributions, but losses are shared in proportion to capital contributions. The equity partners share and control how the investment is managed and each partner is liable for the actions of the others. Sales contracts -Deferred-payment sale (bay mu ajjal) and deferred-delivery sale (bay salam) contracts, in addition to spot sales, are used for conducting credit sales. In a deferred-payment sale, delivery of the product is taken on the spot, but delivery of the payment is delayed for an agreed period. Payment can be made in a lump sum or in installments, provided there is no extra charge for the delay. A deferred-delivery sale is similar to a forward contract where delivery of the product is in the future in exchange for payment on the spot market. Sukuk Certificates of Ownership, Sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services, or (in the ownership of) the assets of particular projects. The returns on the certificates are directly linked to the returns generated by the underlying assets Current Status Of Interest Free Banking In India: Interest free or Islamic banks cannot function as a regular bank but are licensed under Non Banking Finance Companies Reserve Bank Directives 1997 RBI (Amendment) Act 1997, and operate on profit and loss based on Islamic principles. One of the important recommendations under financial infrastructure for inclusion by the CFSR was regarding the interest free banking in India.RBI in its annual report for 2015-16 has stated that some sections of the society have remained financially excluded 6
due to religious reasons. RBI has prepared and submitted a technical analysis report to the Finance Ministry regarding the proposal. The Reserve Bank of India (RBI) has come up with a proposal for opening of Islamic window in conventional banks for a gradual introduction of Shariah-compliant (interestfree) banking in the country. RBI s proposal is based on the basis of the recommendation of the Inter Departmental Group (IDG) and examination of various issues regarding the feasibility of Islamic Banking. Since Indian banks have no experience in this field, Islamic Banking is proposed to be introduced very gradually. Moreover, as funds received under the interest-free banking could not be mingled with other Prospects of interest free banking In India: India with a 15% Muslim population, the highest in a non-islamic country and second highest in the world offers huge opportunities to exploit. The size of the market will be very large as the Indian population is above 100 Crore and Muslim population itself is about 15 crore and majority of them, in the name of religious faith, are looking for interest free banking funds; Islamic banking has to be conducted under a separate window. India will soon have Islamic banking facilities with the Saudi Arabia-based Islamic Development Bank (IDB) set to start its India operations from Gujarat. During Prime Minister's visit to UAE in2016, the Indian Exim Bank had signed a with IDB for a MOU of $100 million line of credit to facilitate exports to IDB s member countries. IDB s main objective is to foster the economic development and social progress of member countries, as well as of the Muslim community, in accordance with principles of Shariah, Islamic law. The bank has 56 Islamic countries as its members. and finance. It is pertinent to mention here that Islamic banking is not meant for Muslims only but non Muslims may also avail the benefit of it. And it is feasible to have a parallel banking system based on Shariah along with a conventional one. Eleventh Five Year Plan envisages inclusive growth with development in all sectors of economy. Islamic banking is an effective mechanism to subjugate the liquidity and inflation problems along with allowing inclusive growth. For real inclusive growth, 7
we have to ensure increase in income and employment status of workers in all segments. Many Indian companies such as Reliance Industries, Infosys Technologies, Wipro, Tata Motors and Satyam Computer Services figure in the Standard & Poor s BRIC Shariah Index. The sustainable development of Islamic finance offers benefits for economic growth, reducing poverty and fostering shared prosperity. Islamic finance can significantly contribute to economic development, given its direct link to physical assets and the real economy. The use of profit- and loss-sharing arrangements encourages the provision of Suggestions: United Kingdom has set a benchmark for introduction of new laws to adopt Islamic banking and has been the world leader in interest free banking. The government and RBI should play an active role in educating the masses about interest free/islamic banking. If India adopts the concept of interest free banking whole heartedly it would attract huge amount of capital from financial support to productive enterprises that can increase output and generate jobs. The emphasis on tangible assets ensures that the industry supports only transactions that serve a real purpose, thus discouraging financial speculation It would be better in interest of the nation to evaluate the significance of interest-free banking in achieving targets like financial inclusion, inclusive growth, infrastructure finance, Credit-output and labour capital ratios in unorganized sector industries, Insurance for unorganized sector workers, improvising credit market, exports and future trading and facilitating the agriculture and Ignored Segments Of The Economy. GCC counties which can be utilized for infrastructure projects thereby contributing to economic development of the country. Interest free banking can help vulnerable groups such as agriculture and small & medium industries. Islamic Finance could lead to more entrepreneurship as venture capital funding and profit sharing is possible. It could also lead to more financial inclusion as those avoiding banks on grounds of faith might start using them. 8
Conclusion: Banking sector in India is currently going through a tough situation due to rise in bad loans or non performing assets, capital inadequacy and cyber crimes. RBI needs to redesign the financial products used under Islamic banking to make them fit for Indian banks without any religious conflict. It is better to use the term as interest free banking as labeling banking activities as Islamic might carry a real potential risk for misunderstanding or subtle segregation References: i. Jeet Singh; Preeti Yadav- -Islamic Banking In India - Growth And Potential, International Journal of Marketing, Financial Services & Management Research- ISSN 2277-3622 Vol.2, No. 4, April (2013). ii. Muhammad Hanif- (2011) - Differences and Similarities in Islamic and Conventional Banking, International Journal of Business and Social Science, Vol. 2 No. 2; February 2011. of communities and commercial activities. More than the terminology, what is more important is the strategy and concept of interest frees banking. Such a system will offer an effective banking system where Muslims in India may invest in pursuant to Islamic principles and the rest may have an alternative to interest bearing conventional banking. Both systems can co-exist. Let the people of the largest democracy decide democratically which one they should bank upon. iii. Dusuki, A. W., & Abdullah, N. I. (2007). Why do Malaysian Customers Patronize Islamic Banks, International Journal of Bank Marketing Vol. 25 No. 3, 2007 pp. 142-160 q Emerald Group Publishing Limited. iv. Khurram Aejaz Khan (2013), Emerging Islamic Banking: Its need and scope in India. v. http://economictimes.com. vi. http://www.islamicvoice.com. vii. http://www.icif.in viii. http://www.twocircles.net 9