ISLAMIC BANKING

MEANING

Islamic banking refers to a system of banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic.

Sharia prohibits the payment or acceptance of interest fees for the lending and accepting of money respectively, (Riba, usury) for specific terms, as well as investing in businesses that provide goods or services considered contrary to its principles (Haraam, forbidden).

While these principles were used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that a number of Islamic banks were formed to apply these principles to private or semi-

private commercial institutions within the Muslim community.

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HISTORY

During the Islamic Golden Age, early forms of proto-capitalism and free markets were present in the Caliphate. Where an early market economy and an early form of mercantilism were developed between the 8th-12th centuries, which some refer to as "Islamic capitalism.

A vigorous monetary economy was created on the basis of the expanding levels of circulation of a stable, high-value currency (the dinar) and the integration of monetary areas that were previously independent.

A number of innovative concepts and techniques were applied in early Islamic banking, including bills of exchange, the first forms of partnership (mufawada) such as limited (mudaraba), and the earliest forms of capital (al-mal), capital accumulation (nameal-mal), cheques, promissory notes trusts (see Waqf),startup companies, transactionalaccounts, loaning, ledgers and assignments.

Many of these early capitalist concepts were adopted and further advanced in medieval Europe from the 13th century onwards.

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ISLAMIC DEVELOPMENT BANK

IDB Headquarters in Jeddah, Saudi Arabia Islamic Development Bank (also known as IsDB), is a multilateral development financing institution located in Jeddah, Saudi Arabia. It was founded by the first conference of Finance Ministers of the Organization of the Islamic Conference (OIC), convened 18 December 1973. The bank officially began its activities on 15 Shawwal 1395H (20 October 1975). There are 54 shareholding member states.[1] On the basis of paid-up capital, the main shareholders of the Bank are from these countries:

Saudi Arabia Sudan Kuwait Libya Turkey UAE Iran

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Egypt Indonesia Pakistan

The IsDB is also a United Nations General Assembly observer

Functions
Principal shareholders of the IDB shown in green. The functions of the Bank are to participate in equity capital and grant loans for productive projects and enterprises besides providing financial assistance to member countries in other forms for economic and social development. The Bank tries to foster the economic development and social progress of member countries and Muslim communities in non-member countries individually as well as jointly in accordance with the principles of Shari'ah or Islamic jurisprudence. Adhering to Islamic principles forbidding usury, the Bank provides interest-free loans primarily for infrastructural projects with socioeconomic benefits.The Bank is authorized to accept deposits and to mobilize financial resources through Shari'ah compatible modes. It is also charged with the responsibility of assisting in the promotion of foreign trade especially in capital goods, among member countries; providing technical assistance to member countries; and extending training facilities for personnel engaged in development activities in Muslim countries to conform to the Shari'ah. Shari'ah compatible practices include:

Loan Leasing Installment Sale Istisna'a

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Equity Participation Lines of Financing

The unit of account of the bank is the Islamic Dinar. The Bank's financial year is the lunar Hijri year. The official language of the Bank is Arabic, but English and French are additionally used as working languages.

Membership
The present membership of the Bank consists of 56 countries. The basic condition for membership is that the prospective member country should be a member of the Organization of the Islamic Conference (OIC), pay its contribution to the capital of the Bank and be willing to accept such terms and conditions as may be decided upon by the IsDB Board of Governors.

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MODERN ISLAMIC BANKING

The first modern experiment with Islamic banking was undertaken in Egypt under cover without projecting an Islamic imagefor fear of being seen as a manifestation of Islamic fundamentalism that was anathema to the political regime.. This experiment lasted until 1967 (Ready 1981), by which time there were nine such banks in the country .In 1972, the Mit Ghamr Savings project became part of Nasr Social Bank which, till date, is still in business in Egypt. In 1975, the Islamic Development Bank was set-up with the mission to provide funding to projects in the member countries. The first modern commercial Islamic bank, Dubai Islamic Bank, opened its doors in 1975. In the early years, the products offered were basic and strongly founded on conventional banking products, but in the last few years the industry is starting to see strong development in new products and services. Islamic Banking is growing at a rate of 10-15% per year and with signs of consistent future growth.] Islamic banks have more than 300 institutions spread over 51 countries, including the United States through companies such as the Michigan-based University Bank, as well as an additional 250 mutual funds that comply with Islamic principles. It is estimated that over US$822 billion worldwide sharia-compliant assets are managed according to The

Economist. This represents approximately 0.5% of total world estimated assets as of 2005. According to CIMB Group Holdings, Islamic finance is the fastestgrowing segment of the global financial system and sales of Islamic bonds may rise by 24 percent to $25 billion in 2010.

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Interest-free banking as an idea

Interest-free banking seems to be of very recent origin. The earliest references to the reorganisation of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposition by Mawdudi in 1950 (1961).2 Muhammad Hamidullahs 1944, 1955, 1957 and 1962 writings too should be included in this category. They have all recognised the need for commercial banks and the evil of interest in that enterprise, and have proposed a banking system based on the concept of Mudarabha - profit and loss sharing. In the next two decades interest-free banking attracted more attention, partly because of the political interest it created in Pakistan and partly because of the emergence of young Muslim economists. Works specifically devoted to this subject began to appear in this period. The first such work is that of Muhammad Uzair (1955). Another set of works emerged in the late sixties and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors.3 Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in 1972, First International Conference on Islamic Economics in Mecca in 1976, International Economic Conference in London in 1977 were the result of such involvement. The involvement of institutions and governments led to the application of theory to practice and resulted in the establishment of the first interest-free banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process.

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The coming into being of interest-free banks

The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a group of Muslim businessmen from several countries. Two more private banks were founded in 1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In the same year the Kuwaiti government set up the Kuwait Finance House.However, small scale limited scope interest-free banks have been tried before. One in Malaysia in the mid-forties4 and another in Pakistan in the late-fifties.5 Neither survived. In 1962 the Malaysian government set up the Pilgrims Management Fund to help prospective pilgrims to save and profit.6 The savings bank established in 1963 at Mit-Ghamr in Egypt was very popular and prospered initially and then closed down for various reasons.7 However this experiment led to the creation of the Nasser Social Bank in 1972. Though the bank is still active, its objectives are more social than commercial.8, 9 In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 interest-free banks have come into being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well: in Denmark, Luxembourg , Switzerland and the UK. Many banks were established in 1983 (11) and 1984 (13). The numbers have declined considerably in the following years. In most countries the establishment of interest-free banking had been by private initiative and were confined to that bank. In Iran and Pakistan, however, it was by government initiative and covered all banks in the country. The governments in both these countries took steps in 1981 to introduce interest-free banking. In Pakistan, effective 1 January 1981 all domestic commercial banks were permitted to accept deposits on the basis of profit-and-loss sharing (PLS). New steps were introduced on 1 January 1985 to formally transform the banking .
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OPERATION IN ISLAMIC BANKING

T includes the discussing the Islamic banking operation and examines in depth the steps of Islamic financial transactions. It also provides insight into methods of control and supervision on Islamic banks. Responsibilities,risk management and challenges facing Islamic banks will be discussed in depth. Islamic Banking Operations It also designed for new entry and mid level Staff who need to understand the operations and transactions in Islamic banking and for experienced staff who need to update their skills and knowledge. Islamic Financial Transaction Contracts. Islamic Banks, their functions and responsibilities. Financial Transactions in Islamic Banks. The main Challenges facing Islamic banking operations The role of Islamic Banks in economic Development Control and Supervision on Islamic Banks Control and Supervision on Islamic Banks: Case Study : Risk Management in Islamic Banks

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ISLAMIC ECONOMICS JURISPRUDENCE

Islamic economics refers to the body of Islamic studies literature that "identifies and promotes an economic order that conforms to Islamic scripture and traditions," and in the economic world an interest-free Islamic banking system, grounded in Sharia's condemnation of interest (Riba). The literature originated in "the lates 1940s, and especially" after "the mid-1960s." The banking system developed during the 1970s. Islamic economic literatures' central features have been called "behavioral norms" derived from the Quran and Sunna, zakat tax as the basis of Islamic fiscal policy and prohibition of interest In Shia Islam, some scholars such as Mahmoud Taleghani, and Mohammad Baqir al-Sadr, have developed an "Islamic economics" emphasizing the uplifting of the deprived masses, a major role for the state in matters such as circulation and equitable distribution of wealth, and ensuring participants in the marketplace are rewarded for being exposed to risk and/or liability.

Islamists movements and authors generally describe an Islamic economic system as neither Socialist nor Capitalist, but a "third way" with none of the drawbacks of the other two systems.
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To some degree, the early Muslims based their economic analyses on the Qur'an (such as opposition to riba, meaning usury/interest), and from sunnah, the sayings and doings of Muhammad. Perhaps the most well known Islamic scholar who wrote about economics was Ibn Khaldun (1332140) who is considered a father of modern economics. Ibn Khaldun wrote on economic and political theory in the introduction, or Muqaddimah (Prolegomena), of his History of the World (Kitab al-Ibar). In the book, he discussed what he called asabiyya (social cohesion), which he sourced as the cause of some civilizations becoming great and others not. Ibn Khaldun felt that many social forces are cyclic, although there can be sudden sharp turns that break the pattern.] His idea about the benefits of the division of labor also relate to asabiyya, the greater the social cohesion, the more complex the successful division may be, the greater the economic growth. He noted that growth and development positively stimulates both supply and demand, and that the forces of supply and demand are what determines the prices of good He also noted macroeconomic forces of population growth, human capital development, and technological developments effects on development. In fact, Ibn Khaldun thought that population growth was directly a function of wealth. Other important early Muslim scholars who wrote about economics include Abu Hanifah, Abu Yusuf (731-798), Ishaq bin Ali al-Rahwi (854931), al-Farabi (873950), Qabus (d. 1012), Ibn Sina (Avicenna) (9801037), Ibn Miskawayh (b. 1030), al-Ghazali (10581111), al-Mawardi (10751158), Nasr al-Dn alTs (12011274), Ibn Taimiyah (12631328) and al-Maqrizi.

Post-colonial era
During the modern post-colonial era, as Western ideas, including Western economics, began to influence the Muslim world, some Muslim writers sought
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to produce an Islamic discipline of economics. Because Islam is "not merely a spiritual formula but a complete system of life in all its walks", these writers believed that it should logically follow that Islam also had its own economic system unique from and superior to non-Islamic systems.To date, however, there have been no agreement as to the methodological definition and scope of Islamic Economics. In the 1960s and 70s Shia Islamic thinkers worked to develop a unique Islamic economic philosophy with "its own answers to contemporary economic problems." Several works were particularly influential,

Eslam va Malekiyyat (Islam and Property) by Mahmud Taleqani (1951), Iqtisaduna (Our Economics) by Mohammad Baqir al-Sadr (1961) and Eqtesad-e Towhidi (The Economics of Divine Harmony) by Abolhassan Banisadr (1978)

Some Interpretations of Property Rights, Capital and Labor from Islamic Perspective by Habibullah Peyman (1979).

Al-Sadr in particular has been described as having "almost single-handedly developed the notion of Islamic economics"In their writings Sadr and the other authors "sought to depict Islam as a religion committed to social justice, the equitable distribution of wealth, and the cause of the deprived classes," with doctrines "acceptable to Islamic jurists", while refuting existing non-Islamic theories of capitalism and Marxism. This version of Islamic economics, which influenced the Iranian Revolution, called for public ownership of land and of large "industrial enterprises," while private economic activity continued "within reasonable limits." These ideas helped shape the large public sector and public subsidy policies of the Iranian Revolution.

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In 2008 an economist and former adviser to Tony Blair, Tahir Iqbal, resolved the existing issues in Islamic economics of both providing a fully shariah compliant Islamic political economy (including the problem of government borrowing and mortgages) in his book "what is the sound of an invisible hand clapping", published by maison mascara books. The foundation of this was the quard al hasana (good debt)which when introduced with zakat on all assets sets in place a new framework that solves boom and bust and implies that poverty itself could be stopped using Islamic economics.

Property
The Qur'an states that God is the sole owner of all matter in the heavens and the earth. Man, however, is God's viceregent on earth and holds God's possessions in trust (amanat). Islamic jurists have divided properties into three categories:

Public property State property Private property

Public property Public property in Islam refers to natural resources (forests, pastures, uncultivated land, water, mines, oceanic resources etc.) over which all humans
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have equal right. Such resources are considered the common property of the community. Such property is placed under the guardianship and control of the Islamic state, and can be utilized by any citizen, as long as it does not undermine the right of other citizens over it. Some types of public property can not be privatized under Islamic law. Muhammad's saying that "people are partners in three things: water, fire and pastures", has led some scholars to believe that the privatization of water, energy and agricultural land is not permissible. Other types of public property, such as gold mines, were allowed by Muhammad to be privatized, in return for taxes to the Islamic state. The owner of the previously public property that was privatized has to pay zakat and, according Shiite scholars, khums as well. In general the privatization and nationalization of public property is subject to debate amongst Islamic scholars. Public property thus, eventually, becomes state or private property State property State property includes certain natural resources, as well as other property that can't immediately be privatized. Islamic state property can be movable, or immovable, can be acquired through conquest, or peaceful means. Unclaimed, unoccupied and heir less properties, including uncultivated land (mawat), can be considered state property. During the life of Muhammad, one fifth of military equipment captured from the enemy in the battlefield was considered state property. During his reign, Umar (on the recommendation of Ali) considered conquered land to be state property, instead of private property (as was usual practice). The reason for this was that privatizing this property would concentrate resources in the hands of a few, and prevent this property from being used for the general good of the
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community. The property remained under the occupation of the cultivators, but the taxes collected on it went to the state treasury. Muhammad said "Old and fallow lands are for God and His Messenger (i.e. state property), then they are for you". Jurists draw from this the conclusion that, ultimately, private ownership takes over state property. Private property There is consensus amongst Islamic jurists and social scientists that Islam recognizes and upholds the individual's right to private ownership. The Qur'an extensively discusses taxation, inheritance, prohibition against stealing, legality of ownership, recommendation to give charity and other topics related to private property. Islam also guarantees the protection of private property by imposing stringent punishments on thieves. Muhammad said that he who dies defending his property was like a martyr. Islamic economists have classified the acquisition of private property into three categories: involuntary, contractual and non-contractual. Involuntary means are inheritance, bequests, and gifts. Non-contractual is acquisition involves the collection and exploitation of natural resources that have not previously been claimed as private property. Contractual acquisition includes activities such as trading, buying, renting, hiring labor etc. A tradition attributed to Muhammad, with which both Sunni and Shi'ite jurists agree, in cases where the right to private ownership causes harm to others, then Islam is in favor of curtailing the right in those cases. Maliki and Hanbali jurists argue that if private ownership endangers public interest, then the state can limit the amount an individual is allowed to own. This view, however, is debated by others.

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Market Islam accepts markets as the basic co-ordinating mechanism of the economic system. Islamic teaching holds that the market, through perfect competition, allows consumers to obtain desired goods, producers to sell their goods, at a mutually acceptable price. The three necessary conditions for an operational market are said to be upheld in Islamic primary sources:

Freedom of exchange: the Qur'an calls on believers to engage in trade, and rejects the contention that trade is forbidden.

Private ownership Security of contract: the Qur'an calls for the fulfilment and observation of contracts. The longest verse of the Qur'an deals with commercial contracts involving immediate and future payments.

Islamic insurance
Some Muslims believe insurance is unnecessary, as society should help its victims. Muslims can no longer ignore the fact that they live, trade and communicate with open global systems, and they can no longer ignore the need for banking and insurance. Aly Khorshid demonstrates how initial clerical apprehensions were overcome to create pioneering Muslim-friendly banking systems, and applies the lessons learnt to a workable insurance framework by which Muslims can compete with non-Muslims in business and have cover in daily life. The book uses relevant Quranic and Sunnah extracts, and the arguments of pro- and anti-insurance jurists to arrive at its conclusion that Muslims can enjoy the peace of mind and equity of an Islamic insurance scheme.

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Interest
The Quran (3: 130) clearly condemns what it calls by the Arabic term "riba," usually translated "interest": "O, you who believe! Devour not riba, doubled and redoubled, and be careful of Allah; haply so you will prosper."

Debt arrangements
Most Islamic economic institutions advise participatory arrangements between capital and labor. The latter rule reflects the Islamic norm that the borrower must not bear all the cost of a failure, as "it is God who determines that failure, and intends that it fall on all those involved." Conventional debt arrangements are thus usually unacceptable - but conventional venture investment structures are applied even on very small scales. However, not every debt arrangement can be seen in terms of venture investment structures. For example, when a family buys a home it is not investing in a business venture - a person's shelter is not a business venture. Similarly, purchasing other commodities for personal use, such as cars, furniture, and so on, cannot realistically be considered as a venture investment in which the Islamic bank shares risks and profits for the profits of the venture.

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Money changers
Due to religious sanctions against odious debt, Tamil Muslims have historically been money changers (not money lenders) throughout South and South East Asia

Natural capital
Perhaps due to resource scarcity in most Islamic nations, this form of economics also emphasizes limited (and some claim also sustainable) use of natural capital, i.e. producing land. These latter revive traditions of haram and hima that were prevalent in early Muslim civilization.

Welfare
Social welfare, unemployment, public debt and globalization have been reexamined from the perspective of Islamic norms and values. Islamic banks have grown recently in the Muslim world but are a very small share of the global economy compared to the Western debt banking paradigm. It remains to be seen if they will find niches - although hybrid approaches, e.g. Grameen Bank which applies classical Islamic values but uses conventional lending practices, are much lauded by some proponents of modern human development theory.

Islamic stocks
In June 2005 Dow Jones Indexes, New York, and RHB Securities, Kuala Lumpur, teamed up to launch a new "Islamic Malaysia Index" a collection of 45 stocks representing Malaysian companies that comply with a variety of Sharia-based criteria. Three variables (the total debt of an indexed company, its total cash plus interest-bearing securities and its accounts receivables) must each be less than 33% of the trailing 12-month average capitalization, for
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exampleIslamic bonds, or sukuk, use asset returns to pay investors to comply with the religions ban on interest and are currently traded privately on the overthe-counter market. In late December 2009 Bursa Malaysia announced it was considering enabling individuals to trade Shariah- compliant debt on its exchange as part of a plan to attract new investors to the securities

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PRINCIPLES OF ISLAMIC BANKING

An Islamic bank is based on the Islamic faith and must stay within the limits of Islamic Law or the sharia in all of its actions and deeds. The original meaning of the Arabic word sharia was 'the way to the source of life' and it is now used to refer to legal system in keeping with the code of behaviour called for by the Holly Qur'an (Koran). Four rules govern investment behaviour: a. the absence of interest-based (riba) transactions; b. the avoidance of economic activities involving speculation (ghirar); c. the introduction of an Islamic tax, zakat; d. the discouragement of the production of goods and services which contradict the value pattern of Islamic (haram). Riba

Perhaps the most far reaching of these is the prohibition of interest (riba). The payment of riba and the taking as occurs in a conventional banking system is explicitly prohibited by the Holy Qur'an, and thus investors must be compensated by other means. Technically, riba refers to the addition in the
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amount of the principal of a loan according to the time for which it is loaned and the amount of the loan. While earlier there was a debate as to whether riba relates to interest or usury, there now appears to be consensus of opinion among Islamic scholars that the term extends to all forms of interest. In banning riba, Islamic seeks to establish a society based upon fairness and justice (Qur'an 2.239). A loan provides the lender with a fixed return irrespective of the outcome of the borrower's venture. It is much fairer to have a sharing of the profits and losses. Fairness in this context has two dimensions: the supplier of capital possesses a right to reward, but this reward should be commensurate with the risk and effort involved and thus be governed by the return on the individual project for which funds are supplied. Hence, what is forbidden in Islamic is a predetermined return. The sharing of profit is legitimate and that practice has provided the foundation for Islamic banking. Ghirar Another feature condemned by Islamic is economic transactions involving elements of speculation, ghirar. Buying goods or shares at low and selling them for higher price in the future is considered to be illicit. Similarly an immediate sale in order to avoid a loss in the future is condemned. The reason is that speculators generate their private gains at the expense of society at large. Zakat A mechanism for the redistribution of income and wealth is inherent is Islam, so that every Muslim is guaranteed a fair standard of living, nisab. An Islamic tax, Zakat (a term derived from the Arabic zaka, meaning "pure") is the most important instrument for the redistribution of wealth. This tax is a compulsory
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levy, one of the five basic tenets of Islam and the generally accepted amount of the zakat is one fortieth (2.5 per cent) of Muslim's annual income in cash or kind from all forms of assessed wealth exceeding nisab.Every Islamic bank has to establish a zakat fund for collecting the tax and distributing it exclusively to the poor directly or through other religious institutions. This tax is imposed on the initial capital of the bank, on the reserves, and on the profits as described in the Handbook of Islamic Banking. Haram A strict code of 'ethical investment' operates. Hence it is forbidden for Islamic banks to finance activities or items forbidden in Islam, haram, such as trade of alcoholic beverage and pork meat. Furthermore, as the fulfilment or materials needs assures a religious freedom for Muslims, Islamic banks are required to give priority to the production of essential goods which satisfy the needs of the majority of the Muslim community, while the production and marketing of luxury activities, israf wa traf is considered as unacceptable from a religious viewpoint. In order to ensure that the practices and activities of Islamic banks do not contradict the Islamic ethical standards, Islamic banks are expected to establish a Sharia Supervisory Board, consisting of Muslim jurisprudence, who act as advisers to the banks.

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Profit-sharing agreements Although the restriction against the use of interest might seem to be a binding constraint upon expansion, Islamic banks and financial institutions have in fact grown rapidly. Table 1 sets out the number of banks, paid up capital, total deposits and total assets of these Islamic banks, classified by region. It shows that the total assets of these reporting banks amounted to US $155 billion in 1994, with employment in excess of 220,000 (data supplied by the International Association of Islamic Banks). If the paying and receiving of interest is prohibited, how do Islamic banks operater It is necessary to distinguish between the expressions 'rate of interest' and 'rate of return'. Whereas Islam clearly forbids the former, it not only permits, but rather encourages, trade. In the interest-free system sought by adherents to Muslim principles, people are able to earn a return on their money only by subjecting themselves to the risk involved in profit sharing. As the use of interest rates in financial transactions is prevented, Islamic banks are expected to undertake operations only on the basis of Profit and Loss Sharing (PLS) arrangements or other acceptable modes of financing. Mudaraba and musharaka are the two profit-sharing arrangements preferred under Islamic law. Mudaraba A mudaraba can be defined as contract between at least two parties whereby one party, the financier (sahib al-mal), entrusts funds to another party, the entrepreneur (mudarib), to undertake an activity or venture. This type of contract is in contrast with musharaka. In arrangements based on musharaks there is also profit-sharing, but all parties have the right to participate in managerial decisions. In mudaraba, the financier is not allowed a role in management of the enterprise. Consequently, mudaraba represents a PLS
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contract where the return to lenders is a specified share in the profit/loss outcome of the project in which they have a stake, but no voice. In interest lending, the loan is not contingent on the profit or loss outcome, and is usually secured, so that the debtor has to repay the borrowed capital plus the fixed interest amount regardless of the resulting yield of the capital. Under mudaraba, the yield is not guaranteed in profit-sharing and financial losses are borne completely by the lender. The entrepreneur as such losses only the time and effort invested in the enterprise. This distribution effectively treats human capital with equally financial capital. Musharaka Under musharaka, the entrepreneur adds some of his own to that supplied by the investors, so exposing himself to the risk of capital loss. Profits and losses are shared according to pre-fixed proportions, but these proportions need not coincide with the ratio of financing input. The bank sometimes participates in the execution of the projects in which it has subscribed, perhaps by providing managerial expertise. Figure 3 illustrates the elements. Mudaraba and musharaka constitute, at least in principle if not always in practice, the twin pillars of Islamic banking.The two methods conform fully with Islamic principles, in that under both arrangements lenders share in the profits and losses of the enterprises for which funds are provided and shirkah (partnership) is involved. The musharaka principle in invoked in the equity structure of Islamic banks and is similar to the modern concepts of partnership and joint stock ownership.

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Two-tiered mudabara For banking operations, the mudaraba concept has been extended to include three parties: the depositors as financiers, the bank as an intermediary, and the entrepreneur who requires funds. The bank acts as an entrepreneur when it receives funds from depositors, and as financier when it provides the funds to entrepreneurs. In other words, the bank operates a two-tier mudaraba system in which it acts both as the mudarib on the saving side of the equation and as the rubbul-mal (owner of capital) on the investment portfolio side.

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FUNCTIONS OF ISLAMIC BANKING

The functions of the Bank are to participate in equity capital and grant loans for productive projects and enterprises besides providing financial assistance to member countries in other forms for economic and social development. The Bank tries to foster the economic development and social progress of member countries and Muslim communities in non-member countries individually as well as jointly in accordance with the principles of Shari'ah or Islamic jurisprudence. Adhering to Islamic principles forbidding usury, the Bank provides interest-free loans primarily for infrastructural projects with socioeconomic benefits. The Bank is authorized to accept deposits and to mobilize financial resources through Shari'ah compatible modes. It is also charged with the responsibility of assisting in the promotion of foreign trade especially in capital goods, among member countries; providing technical assistance to member countries; and extending training facilities for personnel engaged in development activities in Muslim countries to conform to the Shari'ah.

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SOURCES OF FUNDS
Besides their own capital and equity, Islamic banks rely on two main sources of funds, a) transaction deposits, which are risk free but yield no return and, b) investment deposits, which carry the risks of capital loss for the promise of variable. In all, there are four main types of accounts: Current accounts Current accounts are based on the principle of al-wadiah, whereby the depositors are guaranteed repayment of their funds. At the same time, the depositor does not receive remuneration for depositing funds in a current account, because the guaranteed funds will not be used for PLS ventures. Rather, the funds accumulating in these accounts can only be used to balance the liquidity needs of the bank and for short-term transactions on the bank's responsibility. Savings accounts Savings accounts also operate under the al-wadiah principle. Savings accounts differ from current deposits in that they earn the depositors income: depending upon financial results, the Islamic bank may decide to pay a premium, hiba, at its discretion, to the holders of savings accounts. Investment accounts An investment account operates under the mudaraba al-mutlaqa principle, in which the mudarib (active partner) must have absolute freedom in the management of the investment of the subscribed capital. The conditions of this account differ from those of the savings accounts by virtue of: a) a higher fixed minimum amount, b) a longer duration of deposits, and c) most importantly, the
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Special investment accounts Special investment accounts also operate under the mudaraba principle, and usually are directed towards larger investors and institutions. The difference between these accounts and the investment account is that the special investment account is related to a specified project, and the investor has the choice to invest directly in a preferred project carried out by the bank.

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USES OF FUNDS
ISLAMIC BANKS Cash & balances with other banks TRADITIONAL BANKS Cash & balances with other banks Loans Sales Receivables (murabaha, Salam, Istisnaa) Mortgages

Investment securities

Financial leases

Investment in real estate Musharakah financing Securities Mudaraba financing

Investment in real estate

Investment in leased asset

Inventories Murabaha)

(including

goods

for

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ISLAMIC BANKING IN NON MUSLIM COUNTRIES

The modern commercial banking system in nearly all countries of the world is mainly evolved from and modelled on the practices in Europe, especially that in the United Kingdom. The philosophical roots of this system revolves around the basic principles of capital certainty for depositors and certainty as to the rate of return on deposits. In order to enforce these principles for the sake of the depositors and to ensure the smooth functioning of the banking system Central Banks have been vested with powers of supervision and control. All banks have to submit to the Central Bank rules. Islamic banks which wish to operate in nonMuslim countries have some difficulties in complying with these rules. We will examine below the salient features. Certainty of capital and return While the conventional banks guarantee the capital and rate of return, the Islamic banking system, working on the principle of profit and loss sharing, cannot, by definition, guarantee any fixed rate of return on deposits. Many Islamic banks do not guarantee the capital either, because if there is a loss it has to be deducted from the capital. Thus the basic difference lies in the very roots of the two systems. Consequently countries working under conventional laws are unable to grant permission to institutions which wish to operate under the PLS scheme to functions as commercial banks. Two official comments, one from the UK an the other from the USA suffice to illustrate this. Sir Leigh Pemberton, the Governor of the Bank of England, told the Arab Bankers Association in London that:
o

It is important not to risk misleading and confusing the general public by allowing two essentially different banking systems to operate in parallel;
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A central feature of the banking system of the United Kingdom as enshrined in the legal framework is capital certainty for depositors. It is the most important feature which distinguished the banking sector from the other segments of the financial system;

Islamic banking is a perfectly acceptable mode of financing but it does not fall within the definition of what constitutes banking in the UK;

The Bank of England is not legally able to authorise under the Banking Act, an institution which does not take deposits as defined under that Act;

The Islamic facilities might be provided within other areas of the financial system without using a banking name.

In the United States, Mr Charles Schotte, the US Treasury Department specialist in regulatory issues has remarked: There has never been an application for an Islamic establishment to set up either as a bank or as anything else. So there is no precedent to guide us. Any institution that wishes to use the word bank in its title has to guarantee at least a zero rate of interest -- and even that might contravene Islamic laws. Supervision and control Besides these, there are other concerns as well. One is the Central Bank supervision and control. This mainly relates to liquidity requirements and adequacy of capital. These in turn depend on an assessment of the value of assets of the Islamic banks. A financial advisor has this to say: The bank of England, under the 1979 Act, would have great difficulty in putting a value on the assets of an Islamic institution which wanted to
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Operate as a bank in the UK. The traditional banking system has much of its assets in fixed interest instruments and it is comparatively easy to value that. For example, if they are British Government instruments they will have a quoted market value; and there are recognised methods for valuing traditional banking assets when they become non-productive. But it is very difficult indeed to value an Islamic asset such as a share in a joint venture; and the Bank of England would have to send a team of experienced accountants into every Islamic bank operating in the UK as a bank under the 1979 Act, to try to put a proper and cautious value on its assets. Another financial analyst states: Even if a method could be found for assessing the risks to calculate the capital necessary, little comfort could be taken from the profitability which is usually relied upon to cover day-to-day losses arising from the banks business, because a substantial part of an Islamic banks portfolio is venture capital without any guaranteed return. It is evident then that even if there is a desire to accommodate the Islamic system, the new procedures that need be developed and the modifications that need be made to existing procedures are so large that the chances of such accommodation in a cautious sector such as banking is very remote indeed. Any relaxation of strict supervision is precluded because should an Islamic bank fail it would undermine the confidence in the whole financial system, with which it is inevitably identified. As Suratgar puts it There could be potential dangers for the international system, where the failure of such an institution could bring with it the failure of other
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Associated institutions, or of all the Western banking institutions which come closely tied to with such an operation. The question has engaged the attention of Central Banks in Muslim countries as well. But reliable satisfactory methods are still to developed. Tax regulations Another important consideration is the tax procedures in non-Muslim countries. While interest is a passive income, profit is an earned income which is treated differently. In addition, in trade financing there are title transfers twice -- once from seller to bank and then from bank to buyer -- and therefore twice taxed on this account decreasing the profitability of the venture. The Director of the International Islamic Bank of Denmark says: Tax laws are against the Islamic philosophy and pose the greatest difficulty. In most OECD countries Mudarabha is constrained by fiscal acts which define profits as an after tax item for the profit creator and a fully taxable item for the profit receiver.

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RISK MANAGEMENT IN ISLAMIC BANKING

The asset and liability sides of Islamic banks have unique risk characteristics. The Islamic banking model has evolved to one-tier mudaraba with multiple investment tools. On the liability side of Islamic banks, saving and investment deposits take the form of prot-sharing investment accounts. Investment accounts can be further classied as restricted and unrestricted, the former having restrictions on withdrawals before maturity date.

Demand deposits or checking/current accounts in Islamic banks take the nature of qardhasan (interest-free loans) that are returned fully on demand. On the asset side, banks use murabaha (cost-plus or mark-up sale), installment sale (medium/long-term prot-sharing modes murabaha), of nancing bai-muajjal (musharaka (price-deferred
1

sale),

istisnaa/salam (object deferred sale or pre-paid sale) and ijara (leasing) and and mudaraba). These instruments on the asset side, using the prot-sharing principle to reward depositors, area unique feature of Islamic banks. Such instruments change the nature of risks that Islamic banks face. Some of the key risks faced by Islamic banks are discussed below. Credit risk Credit risk is the loss of income arising as a result of the counterpartys delay in payment on time or in full as contractually agreed. Such an eventuality can

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underlie all Islamic modes of nance. For example, credit risk in murabaha contracts arises in the form of the counterparty defaulting in paying the debts in full and in time. The non-performance can due to external systematic sources or to internal nancial causes, or be a result of moral hazard (wilful default). Wilful default needs to be identied clearly as Islam does not allow debt restructuring based on compensations except in the case of wilful default. In the case of prot-sharing modes of nancing (like mudaraba and musharaka) the credit risk will be non-payment of the share of the bank by the entrepreneur when it is due. Market risk Market risks can be systematic, arising from macro sources, or unsystematic, being asset-or instrument-specic. For example, currency and equity price risks would fall under the systematic category and movement in prices of commodity or asset the bank is dealing with will fall under specic market risk. We discuss a key systematic and one unsystematic risk relevant to Islamic banks below. Mark-up risk Islamic nancial institutions use a benchmark rate to price dierent nancial instruments. For example, in a murabaha contract the mark-up is determined by adding the risk premium to the benchmark rate (usually the LIBOR). The nature of a murabaha is such that the mark-up is xed for the duration of the contract. Consequently, if the bench-mark rate changes, the mark-up rates on these xed income contracts cannot be adjusted. As a result Islamic banks face risks arising from movements in market interest rate. Mark-up risk can also appear in prot-sharing modes of nancing like mudaraba and musharaka as the prot-sharing ratio depends on, among other things, a benchmark rate like LIBOR. Commodity/asset price risk The murabaha price risk and commodity/asset price riskmust be clearly distinguished. As pointed out, the basis of the mark-up price risk ischanges in
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LIBOR. Furthermore, it arises as a result of the nancing, not the tradingprocess. In contrast to mark-up risk, commodity price risk arises as a result of the bankholding commodities or durable assets as in salam, ijara and mudaraba/musharaka. Note that both the mark-up risk and commodity/asset price risk can exist in a single contract. For example, under leasing, the equipment itself is exposed to commodity price risk and the xed or overdue rentals are exposed to mark-up risks Liquidity risk Liquidity risk arises from either diculties in obtaining cash at reasonable cost from borrowings (funding liquidity risk) or sale of assets (asset liquidity risk). The liquidity risk arising from both sources is critical for Islamic banks. For a number of reasons, Islamic banks are prone to facing serious liquidity risks. First, there is a qh restriction on the securitization of the existing assets of Islamic banks, which are predominantly debt in nature. Second, because of slow development of nancial instruments, Islamic banks are also unable to raise funds quickly from the markets. This problem becomes more serious because there is no inter-Islamic bank money market. Third, the lender of last resort (LLR) provides emergency liquidity facility to banks whenever needed. The existing LLR facilities are based on interest, therefore Islamic banks cannot benet from these. Operational risk Operational risk is the risk of direct or indirect loss resulting from inadequate or failed internal processes, people, and technology or from external events (BCBS, 2001, p. 2). Given the newness of Islamic banks, operational risk in terms of personal risk can be acute in these institutions. Operation risk in this respect particularly arises as the banks may not have enough qualied professionals (capacity and capability) to conduct the

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Islamic nancial operations. Given the dierent nature of business, the computer software available in the market for conventional banks may not be appropriate for Islamic banks. Legal risk Legal risks for Islamic banks are also signicant and arise for various reasons. First, as most countries have adopted either the common law or civil law framework, their legal systems do not have specic laws/statutes that su pport the unique features of Islamic nancial products. For example, whereas Islamic banks main activity is in trading (murabaha) and investing in equities (musharaka and mudaraba), current banking law and regulations in most jurisdictions forbid commercial banks undertaking such activities. Second, nonstandardization of contracts makes the whole process of negotiating di erent aspects of a transaction more dicult and costly. Financial institutions are not protected against risks that they cannot anticipate or that may not be enforceable. Use of standardized contracts can also make transactions easier to administer and monitor after the contract is signed. Fiduciary risk Fiduciary risk can be caused by breach of contract by the Islamic bank. For example, the bank may not be able to comply fully with the sharia requirements of various contracts. Inability to comply fully with Islamic sharia either knowingly or unknowingly leads to a lack of condence among the depositors or hence causes withdrawal of deposits. Similarly, a lower rate of return than the market can also introduce duciary risk, when

depositors/investors interpret a low rate of return as breaching an investment contract or mismanagement of funds by the bank (AAOIFI, 1999). Displaced commercial risk This is the transfer of the risk associated with deposits to equity holders. This arises when, under commercial pressure, banks forgo a part of their prot to pay the depositors to prevent withdrawals due to a lower return (AAOIFI, 1999).
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Displaced commercial risk implies that the bank may operate in full compliance with the sharia requirements

RISK MITIGATION THROUGH TAKAFUL

Need for Takaful The underlying assets financed by Islamic banking contracts need to be Insured due to legal requirement e.g.Car Ijarah, Shipment of Goods etc. There is a major perception issue when these assets are insured using Conventional Insurance. In addition there is need for Life Insurance (in case of Housing Finance) and deposit protection (for savings & term deposits customers). Takaful is necessary to complete the cycle of Islamic Finance.

RISK MITIGATION
Murabaha Murabaha is a particular kind of sale where goods are sold to the customer by disclosing the cost price of the goods. Islamic banks assume asset risk during Agency period till the time goods are sold to the customer.

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In-Transit risk emerges during shipment of goods either from local or foreign suppliers. Islamic banks have to mitigate the risk by having Marine & in-transit Takaful. Ijarah Ijarah means to give out something on rent. It is analogous to the term leasing. Islamic banks assume ownership risk, right from the time of the purchase of the asset till the time ownership is transferred to the customer at maturity. Ijarah financing could either be for Corporate customers (Plant & machinery, Equipment, Commercial Vehicles) or Retail customers (Car, Motorcycl SBP regulations requires banks to get comprehensive Insurance for the vehicles/ Machinery financed through leasing. Takaful provides cover against loss due to accidents, theft, fire, natural calamities etc. The service levels, TAT and availability of Takaful in all areas where assets are leased is a challenge for Takaful companies. Diminishing Musharaka Islamic banks assume ownership of a asset which diminishes over time in favor of customer. Three components Joint ownership of the Bank and customer Customer uses the share of the bank and pays rent to the bank. Redemption of the share of the Bank by the customer

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Diminishing Musharaka o Financing could either be for Corporate customers (Plant & machinery, Equipment, Land & Building) or Retail customers (House Financing). o Takaful provides cover against loss due to accidents, fire, earthquake, natural calamities etc. o In case of House Financing, Life Takaful is required to cover the risk in event of death or disability of the customer Deposit Protection o Customers make deposit with Islamic banks on the basis of Mudaraba arrangement. Islamic Banks utilize those funds in the financing business and share profit with the depositors. o Depositors are at risk of earning lesser profits or loosing investment if the bank incurs loss in the financing business. o Islamic banks need Takaful cover to provide safety and protection to small depositors and increase confidence of the depositor in the Islamic banking system. Way Forward o As Islamic Bank grows need for Takaful will increase. o In terms of overall product scope, processes & turnaround time (TAT) Takaful should be comparable to conventional insurance. o Product range and pricing should be in line with the market. o Like Islamic Banking Takaful is also a knowledge based industry and hence there is a need to create awareness for market growth.

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ISLAMIC CAPITAL MARKET

In an Islamic capital market (ICM) market transactions are carried out in ways that do not conflict with the conscience of Muslims and the religion of Islam. Here, there is assertion of religious law so that the market is free from activities prohibited by Islam such as usury (Reba), gambling (maisir) and ambiguity (gharar). The ICM is a component of the overall capital market in Malaysia. It plays an important role in generating economic growth for the country. The ICM functions as a parallel market to the conventional capital market, and plays a complementary role to the Islamic banking system in broadening and deepening the Islamic financial markets

As the market became more complex and sophisticated, it needed supportive infrastructure so that the system could operate and function more efficiently and effectively. The SC's early initiative in setting up a dedicated Islamic Capital Market Department (ICMD) within its Strategy and Development Business Group was to provide the much needed infrastructure support. The mandate of
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the ICMD is to carry out research and development activities including formulating and facilitating a long-term plan to further strengthen the ICM in Malaysia.

ISLAMIC BANKING BUSINESS ACTIVITIES

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GUIDELINES ON CORPORATE GOVERNANCE FOR LICENSED ISLAMIC BANKING

Overview and Objective of the Guidelines
The primary objective of the Guidelines on Corporate Governance for Licensed Islamic Bank (the Guidelines) is to promote the adoption of effective and high standards of corporate governance practices by Islamic bank and Islamic bank holding companies. The Guidelines set out broad principles and minimum standards as well as specificrequirements for sound corporate governance, which are expected of Islamic banks and Islamic bank holding companies.

Importance of Corporate Governance

The adoption of sound corporate governance standards and practices ensures that Islamic banks are managed safely and soundly where risk taking activities and business prudence are appropriately balanced so as to maximise shareholders returns and protect the interests of all stakeholders. In a liberalised and more competitive environment where there is constant pressure for management to deliver required bottom-line, strong corporate governance becomes critical safeguards against all kinds of mismanagement and fraudulent activities. Effective corporate governance practices that enhance corporate accountability are key elements in the working of market discipline and transparency. Corporate governance is defined as the process and structure used to direct and manage the business and affairs of the institution towards enhancing business prosperity and corporate accountability with the ultimate objective of realising long-term shareholder value, whilst taking into account the interests of other stakeholders1. It involves a set of relationships between an institutions
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management, its board, its shareholders and other stakeholders2. As per the BIS Guidelines on Enhancing Corporate Governance for Banking Organisations, corporate governance involves the manner in which the business and affairs of an individual institution are governed by its board of directors and senior management, affecting how an institution: (i) sets corporate objectives, including generating economic returns to owners; (ii) (iii) (iv) runs the day-to-day operations of the business; considers the interests of recognized stakeholders3; aligns corporate activities and behaviours with the expectation that institution will operate in a safe and sound manner, and in compliance with the Shariah and the applicable laws and regulations; and (v) protects the interests of depositors.

Alignment with Other Corporate Governance Codes

The broad principles, standards and requirements under the Guidelines are aligned with the principles enshrined in: I. II. The Islamic Code on Corporate Governance; The BIS Guidelines on Enhancing Corporate Governance for Banking Organizations; III. The IFSB Guiding Principles on Corporate Governance for Institutions Offering Only Islamic Financial Services (Excluding Islamic Insurance (Takaful) Institutions and Islamic Mutual Funds); and IV. Other international best practices on corporate governance.

Approach
The Guidelines are formulated based on the fundamental concepts of responsibility, accountability and transparency, with greater emphasis on the role of the board and management. The Guidelines highlight the principles of corporate governance
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that are translated into minimum standards and specific requirements. The Guidelines contain broad principles dealing with: (i) Board matters; (ii) Management oversight; (iii) Accountability and audit; and (iv) Transparency. The Guidelines should be read together with the Islamic Banking Act 1983 (IBA), the Companies Act 1965 and other relevant regulations, guidelines or circulars relating to corporate governance that Bank Negara Malaysia may issue from time to time.

Applicability
The Guidelines are applicable to the following institutions: (i) Islamic bank licensed under the Islamic Banking Act 1983 (excluding International Islamic Bank); (ii) Islamic bank holding company; and (iii) Any other institution specified by Bank. For Islamic bank holding companies, the following specific requirements under the Guidelines is applicable: (i) Establishment of Nominating and Remuneration Committee (including all requirements relating to the functions and responsibilities of the Nominating and Remuneration Committee); (ii) Requirements on independent directors (definition, responsibilities, composition, resignation and removal of independent directors); and (iii) Appointment of directors, Chairman and Chief Executive Officer To facilitate Bank Negara Malaysias monitoring and continuous assessment of financial groups, Bank Negara Malaysia may impose certain reporting requirements on Islamic bank holding companies as and when necessary.

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Compliance Requirements All Islamic banks are expected to: (i) comply and observe the Guidelines;

(ii) disclose in the annual report, any non-observance of the Guidelines and provide explanations and alternative measures taken to comply with the principles of the Guidelines; and (ii) With the coming into force of this Guidelines, the Guidelines on Directorship in the Islamic Banks

Legal Provision
These Guidelines are issued pursuant to section 53A of the IBA. Principle 1: Every Islamic bank should be headed by an effective board, which assumes specific responsibilities. The vision, strategy and corporate values of the Islamic bank should be clearly specified and understood Principle 2: There should be an effective board composition, with a strong independent element where no individual or small group of individuals should be allowed to dominate the boards decision making Principle 3: There should be a clear division of responsibilities at the helm of an Islamic bank, which will ensure a balanced and clear lines of role, responsibility, authority and accountability throughout the Islamic bank Principle 4: There should be a formal and transparent process for the appointment of directors to the board and the appointment of Chief Executive Officer Principle 5: Directors must be persons of calibre, credibility and integrity with the necessary skills and experience and be able to devote time and commitment Principle 6: Board should meet regularly and be duly furnished with complete and timely Information Principle 7: There should be a formal and an ongoing assessment of the effectiveness of the board as a whole, the directors and the Chief Executive Officer
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Principle 8: There should be a formal and transparent procedure for fixing the remuneration packages of board members, Chief Executive Officer and senior management and the remuneration policies and practices should be in line with the Islamic banks ethical values, objectives and culture Principle 9: Persons empowered with decision making authority (including directors) should exercise care to avoid situations that may give rise to a conflict of interest situation Principle 10: There should be clear separation between shareholders and management so as not to impede sound corporate governance Principle 11: There should be robust auditing requirements and the auditor, board and management need to maintain professional and objective relationships Principle 12: Islamic bank should engage in regular, effective and fair communication with shareholders/stakeholders Principle 13: Conducting corporate governance in a transparent manner can reinforce sound corporate governance Principle 14: Board is collectively responsible and accountable for the veracity of disclosures and management of risk.

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ISLAMIC BANKING IN INDIA- REALISING THE DREAM

The fact that India has the third largest Muslim population in the world after Indonesia and Pakistan may come as something of a surprise to many people, who wrongly assume that partition in 1947 effectively divided the Muslim and Hindu populations into separate nations the Muslim-dominated East and West Pakistan (now two states, Pakistan and Bangladesh) and the Hindu-dominated, secular state of India. There are approximately 156million Muslims living in India today, 13-14% of the population, although that percentage is much higher in some regions such as in Kerala and the disputed state of Jammu and Kashmir. There are, however, no Islamic banks in India and no conventional banks with Islamic windows. As Mr Lone points out in his article there are statutory and regulatory problems for anyone wishing to set up an Islamic bank in India, but perhaps more problematic is the highly emotional response of those opposing any changes to allow Islamic banking. The emotional issues, which are embedded in India's political history, will be much more difficult to address.

The Scope for Islamic Banking in India

Globalisation and the convergence of financial services mean that Indian banks will face an increasingly tough competitive environment, but there is tremendous scope for banks, particularly Islamic banks, because India needs major investment in its infrastructure. Islamic banking, however, has to be positioned as professional banking and not religion-based banking, which can have serious political implications and as a result the Indian regulatory authorities must be approached patiently and logically. That having been said, India does offer great promise for the development of Islamic financial services,

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not least because the Indian capital market is the most liberalised in the world and there is a good financial infrastructure. On the downside some experts feel that there is a shortage of Islamic banking expertise in the country and the general public are unaware of what Islamic banking has to offer. In response to the problem of lack of expertise, in July 2009 the Aligarh Muslim University (AMU) launched a course in Islamic banking and finance. Initially the university is offering a diploma course in Islamic banking and finance, but also plans to offer a masters' degree through the Department of Management Studies of AMU. There is no barrier to non-Muslims who wish to use Islamic financial services. Islamic finance is meant for all mankind, irrespective of religion and with its moral objectives of promoting fairness and social development, it may also provide a solution to the problems of unemployment and poverty in the community. In the Indian town of Maharastra more than 70 farmers committed suicide in 2008, because they had taken loans from banks to finance their grape crop, but due to unseasonal rain their crops were destroyed and they were not in a position to repay the principal amount with interest. Had there been a fullyfledged Islamic banking system in India, this may not have taken place.

The Stock Market

The lack of Shari'ah-compliant investment opportunities has discouraged Indian Muslims from investing funds, not only through the banks, but also through the stock market. The latter problem is being addressed by four asset management companies Reliance Mutual Fund, UTI Asset Management, Way2Wealth and the newly-approved Edelweiss Mutual Fund. Some of these organisations have already launched Shari'ah-compliant mutual funds and others are planning to do so.
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According to UTI sources, the fund house is likely to tie up with Mumbai-based Parsoli Corporation to launch their fund. The Shari'ah Board in Parsoli Corporation will certify the scheme and the Parsoli Islamic Equity index will be the benchmark for the fund. Reliance Money has already launched a Shari'ahcompliant portfolio management service for Muslim HNIs (High-Net-Worth Individuals) and Reliance Mutual Fund is close to filing its prospectus with the regulator to launch an Islamic fund. Company insiders say that the group is in an advanced stage of talks with an Islamic institution to launch the fund. As a next step, Reliance is also planning to launch its entire spectrum of financial services in a Shari'ah-compliant form. The motivation of these asset management companies is not altruistic in nature, enabling Muslims to participate in the stock market; their rationale for launching such funds in the Shari'ah space is purely commercial. The funds are eyeing scores of rich and religious Muslims, who do not invest in interestyielding instruments or non-Shari'ah-compliant stocks such as those with links to businesses involved in alcohol, cinemas, pork and other forbidden business activities.

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According to research carried out by Dr. Shariq Nisar, Director, Taqwa Advisory and Shari'ah Investment Solutions, out of the 1000 NSE (National Stock Exchange of India) listed companies, 335 are Shari'ah compliant. The market capitalisation of these stocks accounts for approximately 61% of the total market capitalisation of companies listed on the NSE. In fact, the growth in the market capitalisation of these stocks was greater than that of the non-Shariah-compliant stocks.

Immense Opportunities
Perhaps, however, the effort will be worthwhile. Talha Sareshwala, chief finance officer of Ahmedbad-based Parsoli Corporation Ltd, has commented that with billions of dollars being deployed by devout investors only in those entities that are in conformity with Shari'ah laws, the opportunities are immense. Since some 13-14% of India's citizens are Muslims, Islamic finance is a domestic fund opportunity as well. Parsoli Corporation Ltd, listed on the Bombay Stock Exchange (BSE), is a non-banking finance company (NBFC) that specialises in channelling funds from domestic and non-resident Muslims into the Indian market. Islamic investments amounting to about $750 million (US) have already been made in the country's capital market and infrastructure sector over the past few months. Ashraf Mohamdey, chief executive officer of Mumbai-based Idafa Investments Private Limited, another Islamic investment institution in India, is of the opinion that almost 80% of Indian companies are Shari'ah compliant as far as their business in India is concerned, with only a handful being involved in activities such as gaming, casinos or alcohol production. Indian experts in the area of Islamic finance are working very hard to foster development of the industry in India and as 2011 began the Bombay Stock
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Exchange along with Taqwaa Advisory and Shari'ah Investment Solutions Ltd. (TASIS) launched a Shari'ah Index with 50 Shari'ah-compliant companies within the BSE 500. The index will be known as the BSE TASIS Shari'ah 50. These 50 companies are highly liquid and strictly adhere to Shari'ah norms. Dr. Sharique Nisar, Director of TASIS, said: BSE has the largest number of Shari'ah-compliant companies in the world, in fact more than the whole of the Middle East and Pakistan. There are many Shari'ah-compliant brokerage houses like Parsoli and Idafa in India, but a Shari'ah index with the leading stock exchange in India is a great achievement. DrShariqueNisar said that the index would provide Indian Muslims an opportunity to invest in Shari'ah-compliant shares and would bring in thousands of crores of rupees from the Gulf and other parts of the world. The challenge now is to ensure that potential investors in India and worldwide get to know about the index and the investment opportunities it offers.

New Developments
Islamic banking has been on the rise in the Asia-Pacific region, which now accounts for 60% of the global Islamic banking market. Despite its rise in the rest of the region, however, the penetration of Islamic banking in India has been low. This is especially surprising with India having approximately 156million Muslims, the third largest Muslim population in the world after Indonesia and Pakistan. The Celent report The Rise of Islamic Banking in the Asia -Pacific Region' attributes this primarily to a regulatory block, which allows Islamic banking to operate only in the form of a non-banking financial corporation. An amendment in the Banking Regulation Act of India, 1949 is required to allow the Islamic banks to formally operate as fully-fledged banks in India.

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The primary reason for the regulatory problem is the socio-religious nature of the Indian political scene. This is especially evident in the report of the Committee of Financial Sector Reforms chaired by Raghuram Rajan; this report was submitted to the Prime Minister of India in 2010. Although the report recommended principles based on Islamic banking, the term Islamic banking' was deliberately replaced by interest-free banking'. The committee recommended that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system. With this recommendation, the ball is in the government's court and it is up to it to come up with appropriate measures to introduce these products in the Indian banking sector. In parallel, however, a rebranding of the various Islamic banking products is needed to achieve widespread acceptance and serve its foremost purpose of financial inclusion. In addition to the regulations, some experts feel that the infrastructure for Islamic banking is not yet in place and steps must be taken in that regard.

The Rocky Road to Islamic Banking

In 2010 it looked as though the first Islamic bank in the country was about to be set up in Kerala with the active involvement of the Kerala government through the Department of Industries for Kerala. A high level meeting held at Kozhikode on August12 2010 approved a project report prepared by Ernst & Young. Kerala State Industrial Development Corporation (KSIDC), which is the designated agency for the formation of the bank, would hold an 11% stake in the proposed bank. According to government officials, it would be registered as a non-banking finance company, before being transformed into a fully-fledged Shari'ah-compliant bank. The project proposed to raise an initial capital of Rupees 500 crore (crore is 10million in the Indian numbering system) from leading non-resident Indians (NRIs) and Indian business houses. According to
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sources close to the development, leading NRI businessmen such as MohammedAli, MAYusufAli, CKMenon and other Kerala-based industrialists such as AzadMooppan had shown keen interest in the venture. Purely based on Shari'ah principles, the bank would avoid interest-based business activities. The proposed Kerala-based bank would invest funds in infrastructure projects and two instruments, bay' al-salam (deferred delivery) and instisna, have been identified for such investments. The bank would invest all its funds in wealth-generating investments and distribute profits to its shareholders. It would also set apart a social fund and provide interest-free loans to Gulf returnees to set up businesses or small scale ventures. The concept has widespread support among the Muslim community of the state, where a large number of affluent Muslims practice strict Shari'ah principles in business. A large proportion of these individuals do not have a bank account, so the formation of an Islamic bank would be good news for them. According to sources, the biggest challenge facing the Kerala-based bank will be the formation of a Shari'ah supervisory board due to the shortage of suitably qualified scholars. In 2010, however, a rather more immediate problem reared its head, when DrSubramaniamSwamy, president of India's Janata party and a former government minister, succeeded in putting the project on hold, issuing a writ in the High Court arguing that the involvement of government agencies in setting up an Islamic bank runs contrary to the secular principles enshrined in the Indian constitution. In February 2011 The Kerala High Court dismissed the writ, observing that they had no objection to KSIDC carrying on a business that was in accordance with Shari'ah law in addition to complying with the laws of the country. They also stated that, although the institution was based on
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religious principles, its motive was not to propagate religion and the state's participation in it was based on purely commercial reasoning. There are also moves in Jammu and Kashmir, India's most northerly state, where JamiatAhladith is planning to launch Islamic banking, but they will need the permission of the Indian government to do so. This state, however, has special status conferred by article 370 of the constitution and the state can pass the resolution for Islamic banking in the state legislative assembly with little modification from the central government, so there is an expectation that this state will also commence Islamic banking in the not too distant future. As this issue of NewHorizon went to press Turkey's Bank Asya were reported to be expecting the RBI to rule within 45 days on their application to open a branch offering Shari'ah-compliant lending facilities in India.

The Regulatory Position

Although an RBI (Reserve Bank of India) study group had rejected the concept of Islamic banking, it got the backing of the Raghuram Rajan committee on banking reforms. Commenting on the issue, DrDSubbarao, governor of the RBI, said that under the present Banking Regulation Act it was not possible to licence Islamic banks, because many of the banking principles in place are based on interest payments; separate legislation would be needed to make Islamic banking a reality. Apparently the RBI is now revisiting the issue and a decision is expected shortly.

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