On the
eve of Eid al-Fitr, or the end of the month of Ramadan, we refer to an article
we featured in our February Policy Desk Note on Islamic Banking in India
In
Islam, interest is considered to directly contribute to inflation and
inequality while money has no intrinsic value and is considered to be only a
unit of exchange. Banking which is consistent with the principles of Sharia (Islamic
law), such as the prohibition of Riba (Interest in excess of
compensation for the time value of money) is known as Islamic banking.
Islamic finance is based on the principle of
assuring fair play and risk-sharing between the debtor and the creditor.
Instead of paying interest, banks typically share profits accumulated by their
Investments in Halal businesses with their clients as Hibah (gift)
on top of their deposits. Two interesting products which are based on these
principles include:
I. Mudarabah
- A form of trustee financing where one party makes the investment on
behalf of the other which is in turn responsible for the management and work.
This results in risk-sharing as one party is risking it’s money while the other
is risking it’s time and effort. This could be considered similar to Venture
Capital.
II. Murabah
- A fixed-asset loan in which the selling and purchase price, profit
margin and other costs are clearly stated and agreed upon by both parties prior
to the agreement. The profit margin is compensation for the time-value of the
bank’s money. In case of a late repayment, the bank is not allowed to charge
any fines.
India
has the largest Muslim population for a secular nation and holds huge potential
to use Islamic banking. Under Islamic Microfinance models, MFIs directly
invest in their client’s projects and share profits.
However,
there are significant challenges to its adoption in India. The
Banking regulation Act of 1949 requires the declaration of an interest rate
from banks and opponents say Islamic banking could be exploited politically as
well as used to attract funding from Gulf coast countries for terrorist
organizations; although, the latter opinion would simply be an excuse for poor
regulation on part of the central bank.
The
Sachar Committtee, commissioned in 2005 to report on the latest social,
economic and educational conditions of the Muslim community of India, stated
that approximately 50% of Muslims in India are financially excluded. It’s here
that the potential of Islamic banking lies. If countries such as France, UK,
Singapore and China can accommodate their financial systems to Islamic banking,
India, with a Muslim population of over 160 million Muslims could consider the
same.
Here is an article featuring some recent
developments in the sector, where venture capital firms compliant with Sharia
law are trying to fill this gap in the market.
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