The term ‘bank’ originates from the Italian word ‘banco’ meaning bench. During the renaissance, moneylenders carried out most of their transactions over these benches, and since then they have become symbolic of banks, and other financial functions. Banks today follow a similar system to that of moneylenders back in the day, which involves charging interest on deposits. However, over the years many different forms of banking have evolved. Some of which refrain from following the mainstream guidelines of finance and seem to originate from religious teachings. Islamic banking is one such financial institution, which is steadily gaining popularity. But before delving into the reasons for Islamic Banking’s increasing acclaim it is important to understand the system on which this structure functions.
The ethics and regulations of Islamic Banking stem from Shariah also known as Fiqh al-Muamalat. As the Sharia considers the charging or paying of Riba or interest as a sin, the organization is established on a value based system. In simpler terms, no interest is charged for any transaction that occurs in Islamic Banks. Instead of benefiting from dividends, this system makes profits by other means. Profit sharing as well as having joint ventures are some of the ways in which the banks keep the money flowing.
Here, some terms are essential in understanding the system better. First is Musharaka, this implies that the bank and the client get into a joint venture, where the profits and losses are to be shared by both the parties. Similarly for buying assets, such as houses, or land, the bank follows a slightly different version of Musharakah, called the Ijara. Ijara is where the bank buys the given assets on behalf of the client and then leases it to them. The client then continues to pay the amount in installments. Once the entire price is paid the ownership is then transferred to the client. However, the client is not obligated to buy the property at any given point of time, and can choose to sell the asset before the lease collapses. In such a case, the bank can sell the property on behalf of the client and share the profits with them.
Despite these technicalities and intricacies of Islamic Banking, it is crucial for one to realize that this financial system is deeply entrenched in religious guidelines. Investments in the fields of adult entertainment, alcohol and gambling is strictly prohibited. As the receipt and payment of interests is a sin, Islamic Banking is extremely mindful of its resources. Hence, trading in debt is not allowed, and most of the transactions are referred to the religious heads for consultation. A thorough investigation is always carried out prior to lending out money, so that a calculated risk takes place.
Islamic Banking in recent times
As per the World Islamic Banking Competitiveness report by Ernst and Young (E&Y), assets of Islamic Banking have seen a steady rise of 17% per annum. For any financial institution this is a huge achievement. But one would be gravely mistaken to think that the report was solely based on Muslim majority countries. Ever since the 2012 financial crisis, many Western nations appear to have taken to the notion of Islamic Banking. Companies such as J.P Morgan, are incorporating this system in their organization in order to reach a larger audience. Even if many countries have not formally accepted this form of banking, Islamic Windows act as a small scale version of the larger system in order to serve the population. However, the way this system plays out in every nation is quite different. Islamic banks have become an essential part of many predominantly Muslim majority countries. Hence, it is crucial to take a look at the various ways in which Islamic Banking has carved a niche for itself in the economies of these nations.
Saudi Arabia
With the holy pilgrimage center of Mecca falling under its reign, Saudi Arabia has been a hub for Islamic ideas for a long time. Considering its predominantly Muslim population, it will not be surprising if Saudi Arabia was to emerge as one of the main nations for Islamic banking. According to sources, there are 12 licensed commercial banks that are functional in Saudi Arabia. Out of which four of them are fully Sharia compliant and the remaining 8 offer a mix of Sharia compliant as well as conventional banking products and services. As of 2017, the assets generated from these four banks alone was 157.2 billion dollars, making Saudi Arabia as one of the biggest consumers of the Islamic banking industry. According to the EY estimate of 2016, the Islamic banking assets were 51.2% of Saudi Arabia's total. Currently the value of the assets owned by Islamic banks are more than that of conventional banks in the nation.
One of the main Sharia compliant banks that is emerging in the market is the Al Rahji Bank. With assets amounting up to SR 338 bn ($90.1bn), this company serves as a tough competition for the other conventional banks. Despite the rising trend of the Sharia compliant banking systems, the Saudi Arabian Monetary Authority (SAMA) has not put in place any special regulations for these banks. Islamic banks are allowed to consult their own board for introducing new forms of products and services that can be approved by the nation’s Central Bank. Due to these differing systems of management, banking activities are sometimes called into question. For instance, in 2014, the National Commercial Bank (NCB) was criticized by the religious heads of the nation. A plan by NCB was reviewed by the Sharia board in order to completely transform it into an Islamic Bank.
It is not only the religious heads of the nation that are vouching for this form of investment. A considerable section of the population too, seems to be leaning towards the same idea. Many feel comfortable with Islamic Banking as it is also compatible with their religious beliefs. But this is just one of the reasons as to why Islamic Banks have managed to expand so exponentially over a decade. A percentage of the economic growth is contributed by the credits and revenues earned from the banking sector. Due to the increasing profits of Sharia compliant banks, they too have a fair share in Saudi Arabia's economy. The Islamic financing credits in 1990 was SAR 15,536.18 million. However, as of 2015, this number has increased up to SAR 308,651.39 million. This steady rise in credits from the Islamic Banking sector has perfectly aligned itself with Saudi’s no-oil revenue policy.
Malaysia
This Muslim majority nation, located in south east Asia, experiences a slightly modified version of Islamic banking. Islamic banks were introduced in the early 1970’s. This eventually led to the setting up of the first commercial Islamic bank in 1983, licensed as Bank Islam Malaysia Bhd (BIMB) under the Islamic Banking Act (IBA). Since then, 16 Islamic banks have been permitted. Considering the ethnic diversity in the population, conventional banks are equally present. Unlike the Islamic financial institutions in the gulf countries, Malaysia has managed to make a mark of its own in this sector by modifying some of its regulations. One such reform includes the introduction of Sukuk or Islamic bonds. In 1990, Malaysia was the first country to issue a Sukuk with an issue size of RM 125 million. During the government's attempts to promote Islamic banking in the early 1990’s, they established the Islamic Interbank Money Market in 1994. This was one of its kind, and was instituted to counter the liquidity issue faced by the banks. Looking at the success rate of this policy, in 2005, Bank Negara called upon conventional banks to open Islamic windows.
The financial crisis of 2008, drew the international focus towards Islamic banking, which had relatively suffered less. This newfound attention proved to be a game changer for the Islamic financial sectors in Malaysia as well. Today, as one of the top three nations that hosts the world's largest Islamic banking industry, the Sharia compliant system is flourishing immensely in the nation. This can be seen in the altered asset values over the decade. In 2006, the total value assets of Malaysia's commercial and Islamic banks was RM 904.54 billion. By the end of 2009, these numbers changed to RM 1364.664 billion, out of which Islamic banks had contributed RM 224.938 billion. These figures themselves speak volumes about the growing Islamic finance. However, it is hard to determine how the Sharia compliant banking system has impacted the economic growth of the nation. Yet, the future of the system in Malaysia looks promising.
Iraq
As a state that is constantly mired with political instability, it is hard to imagine that Islamic Banking might have any prospects in the nation. But according to analysts, the future of the Islamic financing sector seems assuring, despite the internal conflicts. Considering the influence of terrorist groups and the presence of the United States’ forces in the region, the economy is greatly affected. Islamic Banks were first introduced in the 1980's, but started gaining momentum only in the late 1990’s. Over the past decade, this sector has experienced a steady growth. In 2011, a small step was taken towards the development of the Sharia compliant system.
The Central Bank of Iraq approved the opening of Islamic windows in the state owned banks, Rafidain Bank and Rasheed Bank. This announcement was accompanied by Iraq's Ministry of Finance and Central Bank declaring that Islamic banking services were to be provided to major banks, for which a plan worth $42 million was set in place. As of today there are 11 Islamic banks operating in Iraq.
What makes Islamic Banking more appealing to the Iraqi population is the religious affinity. Apart from that the government too, plays a crucial role in maintaining the status of such institutions. With the toppling of the government in 2003 and the dipping oil prices, the economy has taken a great hit. However, Sharia compliant banks do not seem to have been affected negatively. Like the Elaf Islamic Bank, a 14-year-old Baghdad-based Islamic bank, managed to increase its profit by a third in 2015. Its competitors Cihan Bank and National Islamic Bank also saw positive business trajectories. Currently the Islamic Banks account for up to 1.5% of the total Iraqi bank assets, which amounts up to 3 tn dinars ($2.55 bn). The Iraqi Central Bank speculates that these numbers are to rise by 6%, provided the political and economic environment improve. According to Boston Consulting Group, the investments in the Sharia compliant banking industry are only going to increase in the coming years. Even though, many companies are apprehensive of exploring their avenues in Iraq due to the ensuing unpredictability, many Islamic Banks can be seen collaborating with international Islamic Banks. It is very likely that Sharia compliant banking systems would take over the banking structure in the nation.
Future of Islamic Banking in India
The subcontinent of India is a home to various religious and ethnic groups. Even though it is a Hindu majority nation, the largest minority is that of Muslims, with a population of around 182 million. In such circumstances, the inception of the notion of Islamic Banks will not be surprising. After the 2008 global recession, Raghuram Rajan, International Monetary Fund’s (IMF) former chief economist, suggested that Islamic Banking should be taken into consideration. This proposal was made in the report presented by the Planning Commission to the then Prime Minister, Dr. Manmohan Singh. Raghuram Rajan advocated for this change as he sought for an inclusion of all communities of India to pool into the credit system, so as to counter the issues of shortage of credit and financial services like savings and insurances. In hindsight this suggestion holds some credibility keeping in mind the damage that was done to the Indian economy due to the 2008 recession. However, this proposition was soon ruled out by the Reserve Bank of India (RBI). Whilst replying to an RTI (Right to Information) query in 2017, the Central Bank announced that it did not wish to pursue the idea of setting up Islamic Banks in India.
That being said, the debate about India accepting the Sharia banking system still continues. Many experts believe that introduction of Islamic Banking in India could not only solve the problem of inclusivity, but also bolster small and medium sized enterprises. According to Abdur Raqeeb, general secretary of the Indian Centre for Islamic Finance (ICIF), the introduction of Islamic Banking could make up for the inadequate labour capital ratio for informal sector workers associated with agriculture and manufacturing industries, through equity finance. This could prove to be beneficial for the agricultural sector of India as well as small scale industries. Given that Sharia banking is asset based, and profits based on speculation is prohibited, it reduces the risk of subprime investments, thus making it a safer option for investors. According to the International Monetary Fund, Islamic finance assets have grown at a double digit growth rate in the past decade from about $200 US billion in 2003 to $1.8 trillion at the end of 2013. This increase clearly indicates the hidden potential in the system.
The chances of India incorporating the interest free banking system appears to be bleak. RBI’s sudden shift in stance appears to be due to the political changes in the nation. Islamic banking in India first took roots in Kerala. However, in a turn of events BJP leader Subramanian Swamy approached the High Court in 2009 in order to stop the RBI from accepting the applications filed by Dubai based industrialists. This was not the only time that the BJP decided to intervene in the matter. The RBI approved State Bank of India’s Mutual Fund like proposal called Sharia Funds, was also cancelled due to the complaints raised by Subramanian Swamy. This decision was carried out under strict orders from the Prime Minister Narendra Modi. In an attempt to counter the issue of economic inclusivity raised by 2017 RTI inquiry, the Jan Dhan Yojana and Suraksha Bima Yojna was launched. This program was supposed to be open to all citizens of India. Along with the announcement, the minister of state for finance, Santosh Kumar Gangwar, also raised concerns against any ‘terrorist’ controversy in a Lok Sabha report.
Islamic banking has its own flaws in terms of problems in reporting of Non-Payable Assets, sharing of high risks with depositors, and getting more attuned to conventional banking with adoption of different nomenclature but with identical output and profile. The Islamic banking experts have said that the borrowing and even investments have been done through mediators thereby absolving itself of un-Islamic practices.
Given the shifting political trend in India, and the rise in Hindutva politics, the future of Islamic Banking in India seems bleak. With nationalist ideas on the surge, economic well being of the nation along with minority rights is being pushed out of the sight of the public. Given the performance record of the interest free banking industry, Islamic Banking could be a successful venture in India, considering its large population. As the system is open to both Muslims and non- Muslims, it could serve as a good opportunity for low income groups from multiple backgrounds to invest in. However, it might take a while before this form of banking sector finds any support in India, due to the political atmosphere in the nation.
(Pic Courtsey-Nick Pampoukidis at unsplash.com )
(Kritika Subroto Karmakar was research intern with Centre for Security and Strategy. She is currently student of global affairs at O P Jindal Global University.The views expressed are personal)