Islamic Banking: Inclusion in the Indian Banking Sector

Abstract

Innumerable changes have been witnessed in the Indian banking sector since last six decades. Various generations of financial sector reforms has changed the face and complexion of the Indian Banking Sector which is adopting various innovative practices with the focus on inclusive growth. Islamic banking is one such practice which is being considered in full fledged manner which otherwise has been practiced in an informal way. Islamic banking has set its foot on the path of rapid growth throughout the globe and India could not be isolated from it, looking at immense potential. The 1st Ernst & Young World Islamic Banking Competitiveness Report 2011 presented at the 18th Annual World Islamic Banking Conference stated that Islamic banking assets with commercial banks globally will reach US$1.1 trillion in 2012, a significant jump of 33% from their 2010 level of US$826 billion. The conventional banking as practiced by the Indian banking sector in its present form does stand in the way of the principles of Islamic banking which prohibits transaction on the basis of interest and operate on profit and loss based on Islamic principles. Introduction of interest free banking will require a lot of changes in the Banking Regulation Act. Innumerable changes have been witnessed in the Indian banking sector since last six decades. From nationalisation in the 60's to liberalisation in the 90's this sector has been forging ahead as a significant element of the Indian Financial System. A well developed banking system is a pre-requisite for smooth and effective functioning of any economy. The basic function of the banking sector has been mobilising savings from the surplus entities and channelising them to deficit entities for productive purposes. These functions are based on the premise of interest rates, interest being given to depositor and interest being charged by the bank for lending. An alternate to this conventional banking system is Islamic banking which prohibits transaction on the basis of interest and operate on profit and loss based on Islamic principles. Islamic banking has set its foot on the path of rapid growth throughout the globe and India could not be isolated from it, looking at immense potential. The 1st Ernst & Young World Islamic Banking Competitiveness Report 2011 presented at the 18th Annual World Islamic Banking Conference stated that Islamic banking assets with commercial banks globally will reach US$1.1 trillion in 2012, a significant jump of 33% from their 2010 level of US$826 billion. Looking at the global recognition of Islamic Banking the RBI also weighed the option of introducing Islamic banking in the main stream of the Indian banking sector and constituted a committee in 2007 to examine the issues relating to Islamic banking. This can be the appropriate time for introduction of Islamic banking in India, when world is gripped under the impact of the subprime crisis, fallout of conventional banking based on interest and interest trap. Before discussing the convergence of Islamic banking into the mainstream banking sector it would be appropriate to highlight the concept of Islamic banking. In the following discussion Islamic banking and interest free banking are used interchangeably. CONCEPT OF ISLAMIC BANKING Islamic banking is a banking practice as per the Islamic principles, prescribed in the ‗Shariah' known as ‗Fiqh al-Muamalat' (Islamic rules on transaction). The Islamic law prohibits ‗riba' which means interest in Islamic discourse. It operates on the principle of sharing both profits and risks by the borrower as well as lender. The depositor, who unlike in the conventional banking system is risk-averse, is a provider of capital and equally shares the risks with the bank who lends his funds. . The basic principle of Islamic banking is the prohibition of Riba- (Usury - or interest)