Islamic Banking in India: Need of the Hour
The development of Islamic banking in India is a realization of the needs of the public
seeking an alternative banking system that is both capable of delivering sound banking/
financial services and compliant with Shariah (Islamic creeds).
As a matter of fact, in India the development of Shariah compliant financial institution
had started well before the establishment of few most prominent Islamic financial
institutions the worldwide. But due to certain legal and other hassles, these institutions
could not grow beyond a certain limit and those who grew could not sustain themselves
at that level for a longer time.
Therefore there was always felt a need to regulate financial institutions catering to the
religious, financial and social requirements of Indian Muslims in a way that depositors of
these institutions are assured of the viability and stability of these institutions besides it
also helps bring more and more of their money into formal banking institutions of the
country. No doubt religious reasons are one of the biggest hurdles for Indian Muslims to
avoid keeping their money in the formal banking institutions that are perceived to be
usurious and so irreligious.
A huge chunk of Indian Muslims even avoids serving in financial institutions of the
country. That is why we see that Muslims participation in banking services is even less
than Muslims selection in Indian Administrative Services (IAS) that is considered to be
most prestigious competition in India. Muslims non-participation in country’s formal
banking institutions has not only hampered their economic prospects but also blocked a
huge chunk of money belonging to Muslim community to participate in the National
Sometimes this is construed as Muslim unwillingness to participate in the economic
development of the country. It is the responsibility of the policy makers in the country to
understand the real cause of the problem. Ministry of Finance’s advice to RBI to draw a
roadmap for Islamic banking in the country (as reported in certain sections of the media)
is a right step in the right direction. This, apart from bringing Indian Muslims into
country’s financial stream will also bring a lot of big financial players from the middle-
east to participate in the developmental efforts in India, particularly the infrastructure
No doubt this may require some changes in country’s present banking regulation but the
large economic and social benefit that will accrue will serve in our national interest. The
nature of Islamic banking and finance is such that it automatically avoids speculation,
gambling and other such unethical practices. In addition there are other goals and
objectives which will subserve the national aim to achieve growth with social justice. We
shall mention these in the subsequent chapters of this memorandum.
Throughout the world Islamic banking has shown rapid development in terms of total
assets. Not only in the countries that are predominantly Muslim but also in the countries
that are strictly secular like UK, USA, Germany, Sweden etc. and with meager Muslim
The memorandum defines the position, vision and strategic initiatives required in
developing Islamic banking in India . The vision of Islamic banking development in the
country is defined as follows:
“The establishment of a competitive and efficient Islamic banking that complies with
prudential banking principles, and significantly support real sector activities through
profit and loss sharing in the spirit of justice, brotherhood and good deeds to promote
the well-being of the nation”.
It is an established principle that the government wishes to help in the development of
the economically backward sections. Muslims are extremely backward socially as well
as economically. The main reason for this is their reservations about interest dealings.
Since they form an important part of the nation, it is necessary to provide them as well
as other interest averse sections with an alternative to the present banking system. This
will lead to speeding up of the development process for the country as a whole.
If an interest-free bank is allowed to be established in India , it can operate viably. It can
attract sufficient deposits and grow at respectable rate. It could also be able to make
ends meet. This paper outlines the specific enabling actions of government required for
its establishment and viability. It also analyze and proves that despite the special nature
of the bank and certain provisions governing it, its establishment need not lead to any
inequity vis-à-vis conventional banks. The ends of government policy in respect of
control of credit and direction of the economy will also be easily achieved by resorting to
slightly different instruments and methods of control.
Riba means increment or increase. In the context of business, it refers to an
unearned increase in an exchange contract without offering anything in return
that is recognizable in Shari ‘ah . Interest on money-lending is the most
Riba common kind of riba; it’s strongly condemned in the Qur’an in several verses.
Examples of riba include interest on bank loans and credit cards, gains from
trading bonds or other debts, and interest earned on saving and other deposit
Is a form of contract between the capital provider and a skilled entrepreneur
whereby the capital provider would contribute capital to an enterprise or
activity, which is to be managed, by the entrepreneur as the Mudarib (or labour
Mudarabah provider). Profits generated by that enterprise or activity are shared in
accordance with the terms of the Mudarabah agreement whilst losses are to
borne solely by the capital provider unless the losses are due to the Mudarib’s
misconduct, negligence or breach of contracted terms.
Musharakah is a contract between the Islamic Financial Institution and a
customer to contribute capital to an enterprise, whether existing or new, or to
ownership of a real estate or moveable asset, either on a temporary or
permanent basis. Profits generated by that enterprise or real estate/asset are
shared in accordance with the terms of Musharakah agreement whilst losses
are shared in proportion to each partner’s share of capital.
Diminishing Musharakah is a form of partnership in which one of the partner
promises to buy the equity share of the other partner gradually until the title to
the equity is completely transferred to the buying partner. The transaction
starts with the formation of a partnership, after which buying and selling of the
equity take place between the two partners. The “buying and selling” is
independent of the partnership contract and should not be stipulated in the
partnership contract since the buying partner is only allowed to give only a
promise to buy. It is also not permitted that one contract be entered into as a
condition for concluding the other.
A Murabahah contract refers to a sale contract whereby the Islamic Financial
Murabahah Institution sell to a customer at an agreed profit margin plus cost (selling price),
a specified kind of asset that is already in their possession.
An MPO contract refers to a sale contract whereby the Islamic Financial
Murabahah for the Institution sell to a customer at cost plus an agreed profit margin (selling price),
Purchase Orderer a specified kind of asset that has been purchased and acquired by the Islamic
(MPO) Financial Institution based on a promise to purchase from the customer, which
can be binding or non-binding.
Ijarah contract refers to an agreement made by Islamic Financial Institution to
lease to a customer an asset specified by the customer for an agreed period
Ijarah against specified instalments of lease rental. An Ijarah contract commences
with a promise to lease that is binding on the part of the potential lessee prior
to entering the Ijarah contract.
An Ijarah Muntahia Bittamleek (or Ijarah wa Iqtina) is a form of lease contract
that offers the lessee an option to own the asset at the end of the lease period
either by purchase of the asset through a token consideration or payment of
the market value, or by means of a gift contract, or by payment of lease
instalment during the lease period.
An Istisna` contract refers to an agreement to sell to a customer a non-existent
asset, which is to be manufactured or built according to the buyer’s
specifications and is to be delivered on a specified future date at a
predetermined selling price.
A Parallel Istisna` is a second Istisna` contract where a third party will be
Parallel Istisna manufacturing for the Islamic Financial Institution a specified kind of asset,
which corresponds to the specification of the first Istisna` contract.
A Salam contract refers to an agreement to purchase, at a predetermined
price, a specified kind of commodity, which is to be delivered on a specified
future date in a specified quantity and quality. The Islamic Financial Institution
as the buyers make full payment of the purchase price upon execution of a
Salam contract. The commodity may or may not be traded over the counter or
on an exchange.
A Parallel Salam contract refers to a second Salam contract with a third party
acquiring, from the Islamic Financial Institution, a specified kind of commodity,
which corresponds to that of the commodity specified in the first Salam
A non-interest bearing loan intended to allow the borrower to use the loaned
Qard funds for a period with the understanding that the same amount of the loaned
funds would be repaid at the end of the period.
Sukuk (certificates) represents the holder’s proportionate ownership in an
Sukuk undivided part of an underlying asset where the holder assumes all rights and
obligations to such asset.
Muqarada This technique allows a bank to float what are effectively Islamic bonds to
finance a specific project. Investors who buy muqaradah bonds take a share of
the profits of the project being financed, but also share the risk of unexpectedly
low profits, or even losses. They have no say in the management of the
project, but act as non-voting shareholders.
Wadi`ah An amount deposited whereby the depositor is guaranteed his/her fund in full.
Wakalah is an agency contract, where the investment account holder
(principal) appoints the Islamic Financial Institution (agent) to carry out on
behalf of the principal the investment for a fee or for no fee, as the case may
Muslim Economic Forum to Assists RBI on Islamic Banking
In the light of the recent advice by the Ministry of Finance to the Reserve Bank of India,
to draw a roadmap for introducing Islamic banking in the country, a meeting of Muslim
economists, financial experts, academicians and stock brokers was called on at Islam
Gymkhana Marine Lines, Mumbai on July 24, 2005, to discuss the matter and devise
ways and means to assist RBI in the task.
The meeting was chaired by the Former Executive Director, RBI, Mr. Abdul Hasib and
attended by about two dozen experts including Managing Directors of some of India’s
top Muslim financial institutions such as Al-Najib, Al Barr, Baitun Nasr etc. Managing
Directors, Idafa and Toss Financial Services Ltd. were also there to represent the stock
broking community. Some experts from India’s top financial institutions also made it to
attend the meeting.
In the light of some recent experiences, some speakers were pessimistic about the
possibility of Islamic banking in the country, whereas the other speakers were quite
enthusiastic about the development. The Chair, Mr. Abdul Hasib, while taking note of
both the views admitted that past experiences were not very encouraging. However, he
asked members not to let this opportunity go.
He also emphasized that under present circumstances establishing Islamic bank
immediately is beyond the reach of Indian Muslims unless some multinational Islamic
financial institution comes in to assist them, and that was not likely at least in the near
future. Being an Ex-RBI man, Mr. Hasib informed the members about some of the major
concerns that RBI could have and asked the participants to prepare themselves if they
want the RBI to address the issue seriously. He suggested that Muslims should
approach RBI with answers to all their major concerns and request the RBI to allow an
Islamic window at least in one of its public sector banks like SBI.
After a long discussion it was finally decided that a body called “Muslim Economic
Forum” should be established to look into the matter and assist the RBI in whatever
manner required. The Forum while formulating the memorandum shall seek the help of
various experts. All the participating members agreed to support the “Forum” in
whatever capacity they could.