10.10.

2005-Islamic Banking
What is Islamic banking?
Banking practiced as per the Shariah known as Fiqh al-Muamalat (Islamic rules on
transaction). The Islamic law prohibits interest (riba) both on loans and deposits. The
argument is that money is not commodity, and profit should be earned on goods and
services and not on the control of money itself. But Islam does not deny that capital as a
factor of production deserves to be rewarded. It however allows the owners of capital a
share in a surplus which is uncertain, contrary to the interest which is a fixed certain sum.

It operates on the principle of sharing both profits and risks by the borrower as well as
lender. As such the depositor cannot earn a fixed return in the form of interest. But
banks are permitted to offer incentives such as variable bonuses in cash or kind on these
deposits. The depositor in the conventional banking is risk-averse. In Islamic banking he
is provider of capital and equally shares the risk as the bank which lends his funds.

What are the products offered?

Investment finance is offered by these banks through ‘musharka’ where a bank
participates as joint venture partner in a project and shares the profits and losses.
Investment finance is also offered through ‘mudabha’ where the banks contribute the
finance and the client provides expertise, management and labour and the profits are
shared in a pre-arranged proportion, while the loss is borne by the bank (exclusively?).
Trade finance is also offered through a number of ways. One way is through mark-up,
where the bank buys an item for a client who agrees to repay the bank the amount along
with an agreed profit later on. Banks also finance on lines similar to leasing, hire
purchase and sale and buy back.
Consumer lending is without any interest, but the bank covers expenses by levying a
service charge. These banks offer a host of fee based products like money transfer, bill
collections and foreign exchange trading where the bank’s money is not involved.

Where is it practiced?
Islamic banks have come into being since the early 1970s. There are nearly 30 Islamic
banks all over the world from Africa and Europe to Asia and Australia. They are
regulated even within the conventional banking system. The whole banking system in
Iran has moved over to the Islamic system since the early 1980s and even Pakistan is
islamising its banking system. A number of European and American banks are now
offering Islamic banking products not only in Muslim countries, but also in developed
markets such as UK. The concept is also catching up in Malaysia and Dubai. In India
though there is no full fledged Islamic bank, there are NBFCs in Mumbai and Bangalore
operating on Islamic principles. It is also present in the form of cooperatives in various
parts of the country.

Advantage for developing economies

Experts say that with growing debts of several developed countries where bulk of the
borrowing goes to servicing the past debt and payment of huge interests, it could be an
alternative to conventional banking. Studies have shown that the rate of return is often
comparable and sometimes even higher than interest rates offered by conventional banks
to depositors.