ISLAMIC BANKING – Shattering the concept of Commercial Banking

I have been hearing about Islamic Banking for last over a decade but have been able to gather only some basic information.  Now  in August 2013, after the proposal for appointment of Raghuram Rajan has been cleared, it has come in fresh discussions as the new RBI Governor is considered to be a strong advocate of this concept.  The financial reforms commission headed by Rajan had even advocated Islamic banking.

Following the above, now it has been reported that Kerala Government has got a go ahead from Reserve Bank of India to launch a financial institution following the principles of Islamic finance.   The reports indicate that Cheraman Financial Services Limited (CFSL)  will be floated by Kerala State Industrial Development Corporation to function as a non banking finance company (NBFC).  The entity is likely to function as NBFC with an authorized capital of Rs 1000 crores, and has received clearances from RBI, SEBI and Wakf Board.  KSIDC will be the single largest shareholder in the company holding 11% shares whereas other individual shareholders can hold a maximum of 9% shares.

Before I share with our readers what I do not understand about this banking and the questions which needs some answers from our Muslim readers and / or people who have worked in Islamic countries , I will try to explain here what is Islamic Banking as understood by me. 

Islamic Banking in brief can be described as a banking activity that is consistent with the principles of sharia and its practical application through the development of Islamic economics. The foundation of Islamic bank is based on the Islamic faith and must stay within the limits of Islamic Law or the Shariah in all of its actions and deeds.

The literature available at present indicates that the major governing principles of an Islamic bank are:-

* No interest-based (In Islam is is called Riba) transactions i.e. neither the interest is paid to depositor nor it is charged from the borrower;

* No support to economic activities involving oppression (zulm)

* No financing to economic activities involving speculation (gharar);

* The introduction of an Islamic tax, zakat;

*No financing for the production of goods and services which contradict the Islamic value (haram)

The word "Riba" means interest, usury, excess, increase or addition, which according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money).    Riba is indeed deemed haram in Islam, for the reason that it is ‘unfairly’ exploitive in nature. It is ‘unfair’ because Riba requires the lender to return the borrowed money, plus an extra amount. This requires the borrower to work harder to return not just the principal, but also the interest or mark-up levied on the amount.