Islamic Banking in India: What is Islamic banking, in which you get loan without interest
Pakistan is currently surrounded by economic difficulties from all sides. It is unable to get a loan from the IMF. Inflation and unemployment are at their peak. It has become difficult for a large section of the people to even arrange for two meals a day. Amidst all these challenges, the Central Bank of Pakistan has announced to move towards Islamic banking. State Bank of Pakistan (SBP) Governor Jamil Ahmed recently said that his country’s goal is to eliminate interest transactions from its banking system under Sharia law by 2027. Pakistan wants to run the banking system completely under Islamic law.
Now the question arises, what is Islamic banking? How does it work without taking or giving interest? How did it start and what is its condition in India? Let us know the answers to all these questions:
What are Islamic banks?
These are banks that work according to Sharia law. The biggest difference between them and traditional banks is that of interest. Normal banks deposit their customers’ money and pay interest on it. If a customer takes a loan from them, he has to return the principal amount along with interest. But, Islamic banks neither give interest to their customers on deposits nor do they charge interest on loans.
In fact, usury is considered ‘haram’ in Islam. This is the reason why Islamic banks stay away from it. Islamic banks give loans on the basis of good behavior. The loan taker has to return only the principal amount, with some conditions. No interest is charged on it.
In Islamic banking, the bank plays the role of a trustee of funds, that is, the caretaker of money. Anyone can deposit money in the bank. He can also withdraw it whenever he wants. If the bank makes a profit, then it also gives a part of the profit to the customers as a gift. But, in case of loss, along with the banks, the customers also have to bear the loss.
Under which rules do Islamic banks work?
Islamic banking revolves around certain principles – such as Mudarabah, Wadiah, Musharaka, Murabah and Ijara. Mudarabah means sharing the profit and loss among themselves, for example, if an Islamic bank makes a profit, it will share it among all its customers. In case of loss, everyone will have to bear the loss together. Wadiah means safeguarding the money, that is, it is the bank’s responsibility to protect the money deposited.
Musharaka means doing halal business by helping each other. Similarly, Murabah is a kind of sales contract, in which both the buyer and the seller agree to pay a price higher than the market price for the goods being sold. Finally comes Ijara, which is leasing an immovable property. This is the biggest source of income for Islamic banks.
Islamic banks have to take care of halal and haram. They do not have to invest money in any business that is prohibited in Islam. Such as drug and illegal arms trade or prostitution and pornography. Investing money in shares of companies considered haram in Islamic finance is also not allowed.
People of any religion can open accounts in Islamic banks. These banks do not work as religious institutions, but as financial institutions. In Malaysia, about 40 percent of the customers of Islamic banks are non-Muslims. There are many alternatives to conventional banks, yet people trust Islamic banks more.
How do Islamic banks work?
Now it is natural to ask that how does a bank that does not take or pay interest pay its employees and how and from where are its other expenses met. Actually, Islamic banks use the ‘back door’ to earn money. Earning interest is prohibited in Sharia, but not earning profit. With the money that Islamic banks have, they mostly buy immovable property, for example – houses, shops or a piece of empty land. By leasing this out, they earn profit and their business continues.
For example, a customer comes to a traditional bank to take a loan to buy a house or a car. The bank will give the money after completing the paperwork. You will become the owner of the house or car by buying it and then you will have to pay installments with interest. But the way Islamic banks work is completely different. If someone goes to them to take a loan for a house or a car, the bank itself will buy that thing and give it to him.
How Islamic Banks Make Money
Islamic banks make installments equal to the price of the house or car. But, the ownership right in this is with the bank, so it charges rent from the customer. Now suppose there is a house worth one crore and you bought it by making a down payment of 20 lakhs, then the bank will own 80 percent of the house and you will own 20 percent. You will also have to pay 80 percent rent. As you keep repaying the loan, your ownership right will increase and the rent will keep decreasing. In the end, the house will be completely yours.
A big difference between the two banks is the risk of ownership. For example, after purchasing goods by taking a loan from a traditional bank, you will become its owner. If there is any damage to that goods, then you alone will have to bear the burden. The bank will recover the entire amount including interest from you. But, in an Islamic bank, the ownership is joint, so the bank also bears the burden of loss along with you. This philosophy is the foundation of Islamic banks.
When and how did Islamic banking start?
The modern form of Islamic banking started in the 1960s. Mit-Gamer Savings Bank of the United Kingdom is considered the first Islamic bank, which was established in 1963. Mit-Gamer gave loans to businesses with a profit-sharing model. Initially, most Islamic banks were opened in Muslim countries, but in the 1980s, they started opening in Western Europe as well. Governments like Iran and Sudan have also adopted this banking model and now Pakistan is also moving forward in this direction.
Currently, around 500 banks and two thousand mutual funds around the world follow Islamic principles. The website of the State Bank of Pakistan states that Islamic banking is growing at the rate of 15 percent annually and Islamic financial institutions are working in some form or the other in about 75 countries of the world.
What is the state of Islamic banking in India?
The first Islamic bank in India opened in Kochi, Kerala in 2011. The state government has an 11 percent stake in it. Former RBI governor Raghuram Rajan was very interested in Islamic banking. The government was also taking initiatives in this direction. But then, due to legal complexities, Islamic banking was shelved.
In response to a question in 2016, the central government told the Lok Sabha that the government wanted to promote Islamic banking because it could bring a lot of investment from Gulf countries. RBI had also formed an internal committee for this. But, its suggestions were not implemented because major changes would have to be made in the law for this.
However, the Muslim community is constantly demanding the government to promote Islamic banks. They say that this will bring those Muslims into the banking system, who are currently away from it due to religious reasons. Also, it will help in connecting Muslim youth with employment.
Q&A
Question: Which is the first bank in India?
Answer: Bank of Hindustan. This bank was established in the year 1770, but it was closed after 50 years of operation.
Question: How many banks are there in India?
Answer: Currently, there are a total of 34 nationalized banks in India. Of these, 12 are Government of India banks and the remaining 22 are private sector banks.
Question: How many types of banks are there mainly?
Answer: Four types – Central Bank, Commercial Bank, Cooperative Bank, Regional Rural Bank.
Question: Which is the highest earning bank in India?
Answer: Central Bank of India. It had assets of Rs 3.69 trillion as of FY 2021.
