ISLAMIC BANKING

Chapter-1

1)

Islamic Banking An Introduction

Modern banking system was introduced into the Muslim countries at a time

when they were politically and economically at a low ebb, in the late 19th century. The main banks in the home countries of the imperial powers established local branches in the capitals of the subject countries and they catered mainly to the import export requirements of the foreign businesses. The banks were generally confined to the capital cities and the local population remained largely untouched by the banking system. The local trading community avoided the foreign banks both for nationalistic as well as religious reasons. However, as time went on it became difficult to engage in trade and other activities without making use of commercial banks. Even then many confined their involvement to transaction activities such as current accounts and money transfers. Borrowing from the banks and depositing their savings with the bank were strictly avoided in order to keep away from dealing in interest which is prohibited by religion. With the passage of time, however, and other socio-economic forces demanding more involvement in national economic and financial activities, avoiding
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the interaction with the banks became impossible. Local banks were established on the same lines as the interest-based foreign banks for want of another system and they began to expand within the country bringing the banking system to more local people. As countries became independent the need to engage in banking activities became unavoidable and urgent. Governments, businesses and individuals began to transact business with the banks, with or without liking it. This state of affairs drew the attention and concern of Muslim intellectuals. The story of interest-free or Islamic banking begins here. The first modern experiment with Islamic banking was led by Ahmed El Najjar in the Egyptian town of MitGhamr when in 1963; a saving bank based on profit sharing was set up. The experiment lasted until 1967 by which time where nine such banks in the country. These banks neither charged nor paid interest, but invested the funds collected in trade and industry, either directly or in partnership with others and shared the gains made with their depositors. The world's first Islamic bank was founded back in 1975, it is only in the last five years or so that Islamic finance has surged. Sniffing opportunity, conventional banks are now scrambling to set up Shari'a-compliant operations; and there has been a flurry of all-Islamic start-ups, from full-service investment banks to specialist advisory firms. Products have moved beyond lending, insurance and investment funds to include sukuk, hedge funds, currency swaps, and more. In the 1970s, a number of Islamic bank came into existence in the Middle East, e.g., The Dubai Islamic Bank (1975); the Faisal Islamic Bank Of Sudan (1977), the Faisal Islamic Bank Of Egypt(1977) and the Bahrain Islamic Bank, to mention a few.
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In most countries individuals and private organizations took the initiative for establishment of interest free banking. But in Iran and Pakistan, the government took such initiatives. Even in India, there was a proliferation of interest free saving and loan societies in the 1970s.

1.1) Concept of Islamic banking

The concept of Islamic Banking has been derived from a verse of the Holy Quran that says, Allah has allowed trade and prohibits Riba(interest or usury).. Islamic Banking is based on the principle of sharing profit and loss from trading and commercial activities and the prohibition of loans. Interest is considered to be unfair, exploitative and unproductive according to the Islamic laws. According to the Holy Quran the three principles that define general trading and commerce include: Risk taking (ghrom) Work and effort (kasb) Responsibility (daman) These three elements constitute the principles of general business today, where profit are created with an equivalent counter value. For e.g., in the retailing business, the retailer purchases goods from the wholesaler at $20 per unit and sells it retail at $30. The profit margin of $10 usually signifies the work and effort (kasb) component in the business. This is the imputed his skills and knowledge to promote the sale as well as buying from supplies at lowest cost. He is also risking (ghrom) his capital as there is no guarantee he can sell the goods at a profit for example, purchasing 1,000 units will cost him $20,000. He stands to lose his money capital if people stay away
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from the goods due to changes in taste and preferences, economic slowdown, natural calamities, etc. finally, he is responsible (daman) for any defects found in the goods sold. By way of warranties, customers can return defective goods in exchange can return defective goods in exchange for news ones. Based on the above, it is fair to say that profits created from trading contain the element of risk, work and responsibility. The trader deserves the profit because he has fulfilled the tripartite principle of trading. Riba, on contrary, is illegitimate because it is created without fulfilling the above three principles. The bank is not risking its capital, because all loans are collateralized. It is also not liable for any adverse outcome befalling the borrower. Islamic banking products should be able to make evident the three elements of risk, effort and responsibility to claim legitimacy. Otherwise, the religious labeling is inaccurate and may fail to reflect the morality of Islamic banking business. Islamic banking products are so designed hat it is able to make evident the three elements of risk, effort and responsibility to claim Shariah legitimacy. The banks can thus earn profits only from three areas, namely: trading leasing and by direct financing in profit- and loss sharing contracts. Different instrument are devised to earn profit in any of these ways. However, the condition of these transactions must conform to the Islamic laws.

1.1) Brief History

Islamic banking had its beginning from small-scale interest-free savings bank which were created in Egypt in 1963. These banks were not overtly Islamic for the fear of offending the political authorities. These saving banks did not pay interest to
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the depositors nor they charged any interest from their borrowers, investing mainly in trade and industry. The banks depositors were paid a share of the profit of the borrowers; hence they were acting more like saving and loan institution rather than commercial banks. The Nasr social bank, established in Egypt in 1971, was created as an interest-free commercial bank, but still without specific reference to Islam. Finally , in 1974 the Islamic development bank (IDB), as an intergovernmental bank aimed at proving development funds or projects in less well-off member countries. The IDB provides fee-based financial services and profit-sharing financial assistance. The IDB operations, which are free of interest, are explicitly based on Shariah principles. After that gradually other Islamic banks came up in the Middle East, South East Asia, Malaysia and even in Philippines and India.

1.2) Features of Islamic Banking

It emerges that all this that Islamic banking has three distinguishing features;

It is interest free It is multi-purpose and not purely commercial It is strongly equity-oriented.

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The literature contain hardly any serious criticism of the interest free character of the operation, since this is taken for granted , although concerns have been expressed about the lack of adequate interest free instruments. The multi-purpose and extra commercial nature of the Islamic banking operation does not seem to pose intractable problems. The abolition of interest makes imperative for Islamic banks to look for other instrument, which render operation outside the periphery of commercial banking avoidable. It has been argued that the replacement of predetermined interest by uncertain profit is not enough to render a transaction, since profit can be just as exploitative as interest.

1.1) Principles
Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of Riba (usury). Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah). In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments. However, the fact that it is profit cannot be made explicit and therefore there are no additional penalties for late payment. In order to protect itself against default, the bank asks for strict collateral. The goods or land is registered to the name of the buyer from the start of the transaction. This arrangement is called Murabaha. Another approach is EIjara
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wa EIqtina, which is similar to real-estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid). Islamic banks lend their money to companies by issuing floating rate interest loans. The floating rate of interest is pegged to the company's individual rate of return. Thus the bank's profit on the loan is equal to a certain percentage of the company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka. Further, Mudaraba is venture capital funding of an entrepreneur who provides labor while financing is provided by the bank so that both profit and risk are shared. Such participatory arrangements between capital and labor reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, resulting in a balanced distribution of income and not allowing lender to monopolize the economy.

1.2) Banking Operation

There are five categories of operating Islamic bank:1. The Islamic Development Bank 2. The banks which operate in countries where the whole banking system is supervised by religious bodies (like in Pakistan) 3. The banks which operate, co-exist with commercial banks ( like in Jordan, Egypt, Malaysia)
4.

Islamic banks also exist in non Muslim countries where authorities do not recognize their Islamic character.
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Islamic banks, which exist in non-Muslim countries whose monetary authorities, do recognize their Islamic character (for instance, the Faisal International bank (FIB) based in Copenhagen, Denmark, registered under the Danish Banking Supervisory Board).

1.1)

Conventional Banking: Differences and Similarities

Both banking systems are financial intermediary institutions. Current and

demand deposit accounts are the same as in the conventional banking system in the sense that the deposits are guaranteed (but interest is not payable). The financial intermediation banking is based on the concept of borrowerlender and isolation of depositors (surplus category) from investors and those seeking finance for their projects (deficit category). In such form of banking, depositors do not consider the risk of the end lenders; they only take the risk of end lenders whom it has separated from sources of money, whereas the institution of Islamic banking is based on the concept of Mudarabah i.e., partnership in profit where capital and management may join together to create value. As far as financing is concerned, like conventional banks, these banks are also in the business of financing trade and services, primary form of lending such as loans with service charges apart from the business of no-cost loans where each bank is expected to set aside a part of its funds for no-cost loans to the needy i.e., small farmers, producers, entrepreneurs etc. These banks, like conventional banks, also provide services like moneytransfer, bills collection etc., at a cost where the banks own money is not involved.
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The conventional banker works as a risk manager as is considered with all types of risk such as credit, market, interest rate, legal and other risks. The Islamic banker has got one added risk to manage which may be called Shariah is observance risk. One major difference between the two forms of banking is in the handling of delinquency and default. When a debtor/borrower delays payment of debt, interest will accrue on his delayed portion till the borrower ultimately defaults, and is incapable of repaying his debt. Such interest will compensate for the lost business. But this cannot be done in Islamic banking system because it is considered as usurious. This is a loss-making preposition for the Islamic banks because they will not be compensated for the lost profit.

The main sources of the banks funds consist of the accounts available to the customers are: Demand Deposit Account (Current or Checking Accounts) Savings Account General Investment Account Special Investment Account In savings deposit the customers deposit earn no interest and the investment is in the form of profit sharing. Hence, positive rate of return is not guaranteed. The depositor will not receive any premium if the bank incurs a loss on its investment projects. Term deposits (both Short-term and Long- term) earn a certain rate of return

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based on the banks profits and on the deposit maturity. Table 1 gives a list and purpose of the various instruments. Some conventional banking activities are not conducted by Islamic banks this include transactions involving interest in all forms; bonds, bank deposits, and certificates of deposits and the discounting of commercial paper. Most Islamic banks also forbid the purchase of stocks in companies dealing with interest (including western).

Table 1 : An Alternative System

Accounts Purpose

Nominal Value Guaranteed

Profit

Risk Nature

Demand Deposit Accounts

To keep the Yes excess liquidity available demand on

None

None

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Savings Account

A precautionary deposit, profit may also earn some

Yes

Not guaranteed

Low

General Investment Account

The holder profit

deposit Yes earns

From investment in Projects share in activities all

High

Special Investment Account

Available wealthy clients

to Yes

Negotiated amount

High

These pure Islamic banking products are very similar to venture capital finance, in western banking terminology, or non-recourse project finance and equity investments. Hence it involves investing and not lending and therefore on a anathematic basis it is similar to the Germany, Japanese and Spanish banking system rather than the British or American system. Over the years Islamic financial products have become more diversified to include variable rate equity based mechanism as well as hedging instruments that strengthen the risk management capabilities of the Islamic banks.
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In the area of regulation, the Accounting and Auditing Organization for Islamic Financial Institutions(AAOIFI) was established in 1991 by several major Islamic financial institutions to regulate international accounting and auditing standards for the industry it promulgates on Islamic financial institutions; it does, however, work closely with respective central banks and governments. Today, Islamic banking is estimated to be managing funds of US$200bn annually . its clientele is not only confined to Islamic countries but are also spread over Northern Africa, the Far East, India, Europe and United States. Banks from all over the world, which include western banks like HSBC, Citigroup and UBS are moving fast to a secure a place in the market. With the coming in of such western institutions some widely held misconceptions about Islamic banking being conducted exclusively within the Muslim community have come to an end. It is estimated that more than 250 Islamic institutions are operating worldwide.

Chapter- 2 Islamic Banking as An Alternative banking Concept

The concept of Islamic banking evolved on the basis of Shariah principles. While in conventional banking, interest is acceptable; in Islamic banking interest in any form is strictly prohibited. The alternative banking concept is being promoted by Islamic development bank which undertakes all development activities of any conventional development bank like World Bank.

2.1) Foundations
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The basic principle of Islamic banking originate in the axioms of justice and harmony with reality and the human nature. The most genuine and plain definition of financing is that it is the provision of factors of production as well as goods and services without requiring an immediate counterpart to be paid by the receiver. For instance, a laborer finances the employer by waiting until the end of the month for getting compensation for the working hrs given throughout the month, and the real capital owner finances that entrepreneur by waiting until the sale of production to get a portion of the net outcome. Islamic financing is no more than that in its full, plain and direct sense. Islamic finance is a name for providing factor of production, goods and services for which payment is deferred so simple and so straight forward. This is the essence of Islamic banking practices. Islamic banking provides financing in the form of equipment, machinery, and other producers and consumer goods for deferred payments. It also provides means of payment as producer principal in projects on the basis sharing the actual real life outcome of a production process. In lending, the lender gives real goods to the borrower against the motional right, called debt. Hence lending changes the nature of what is owned from real balance to a legal commitment, which is purely an inter personnel concept. However direct investment does not seem to be favored by traditional banks. Quoting a recent article in the World Bank Research Observer.

2.2) Operations of Islamic banks

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Contemporary Islamic banks have been founded on the banking model that existed in Europe and North America, with regard to their main layout, departmental structure and their basic function of mobilizing financial resources and using them to finance those who are in need for investable funds. The difference lies in the area of modes of financing that are in the case of Islamic banks, derived from the Islamic system and structured within the Islamic legal framework. 2.2.1) Fund Mobilization Resources are mobilized from shareholders and saving owners. Shareholders own the banks net equities while saver participate in the ownership of the banks investments. In other words, saving is mobilized on the basis of sharing rather than interest based lending. In Islamic banks, deposits agreement is a contract to provide funds that will be managed by the banks on behalf of the owner, as an appointed agent. They are more of agency or deputation contracts in which depositors authorize the bank to invest their funds and share the return with them. In case of loss, the financial burden falls on funds owners and the bank would have lost it s efforts that went without compensation. The Islamic banking has usually two categories of deposits: 1. Investment deposits that share in the return of investment operation in proportion to the amount of deposit and on the basis distributing the net return on a contracted ratio. Islamic banks usually differentiate between long and short run investment deposit committed for longer period.

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2. Demand Deposit which are guaranteed and represent liabilities and they do not earn any return

2.2.2) Fund Utilization

Islamic banks use available funds by means of three major categories of financing modes: sharing modes, sale modes and leasing modes. None of them has any interest component.

2.2.3) Fund Sharing Modes

The principle is simple as much as its natural. The Islamic banks provide financing to projects on the expectation of a share in the return. There are two of application of this principle: full partnership and non-voting partnership or financing. In full partnership, the bank would be represented on the board of executive director and would share in formulating policies and managerial decisions, while in non-voting financing, Islamic banks fully entrust managerial decision making to the user of funds.

2.2.3.a) Sales Modes

The idea of sales modes of financing is also simple. The bank would be asked to buy the goods and give them to users against future repayments. The simplest of them is derived from regular sales contract. Where the bank sells the real goods, equipment and machinery to their users at an agreed upon marked-up price. All sale based modes can end up in one lump sum deferred payments or in installments spread throughout a certain period of time.

2.2.3.b) Leasing Modes

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As practical is leasing companies and recently in many traditional banks leasing modes can have a variety of forms with fixed or variable rents declining or fixed ownership, operational or financial, along with different conditions regarding the status of leased asset at the end of the lease period.

2.1) Growth of Islamic banks

A quick reading of Islamic history tells us that practices of certain forms of banking activities go back as early as 1200 years ago in Baghdad, Damascus, Fez and Cordoba. Deposits in current accounts and use of checks were well known in these Muslims cities at that early date. Also, inter-city money transfers were a known practice between cash depositors and practitioner Banker who also used to be money exchangers at the same time. However, the early contemporary Islamic banks , the wall street journal comments that if its present rate growth continues, within ten years they are expected to handle around 40 to 50% of total saving of the Muslim world. On the average, about 30% of the funds were allocated to trade, 19% to industry, 13% to the service, 12% to real estate and 9% to the agriculture.

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This diversity in sectorial financing seems to be significant in terms of the dominance of a specific economic activity within each region and development and application of Islamic financing instruments compatible with the economic need of the region.

2.2) Islamic banking as a new choice 2.4.1)Islamic Banks and Banking Community
Nowadays, most Muslim countries have Islamic banks operating within their banking community, under the supervision and control of their respective Central banks. Some countries have only one Islamic bank which is , of course a disadvantage because it deprives the prospective clientele from the benefit of competition . Few countries have also switched to Islamic banking system. Although the nature of Islamic banking transaction requires special attention from Central Banks and Monetary authorities, the relationship between them have gone reasonably smooth, effective and constructive. As we noticed earlier, Islamic banking operation have their own characteristics both on the financing and resource mobilization sides. Their application does not
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require bankers pr customers to have a particular religion, ethnicity or language. Their success or failure depends only on managerial ability to provide competitive services.

2.4.2)Islamic Banking as an Alternative Approach

One might wonder whether Islamic banking and finance is an alternative approach to modern banking. In fact, the banking business is no more than a possible means to satisfy the need of society according to the prevailing condition and circumstance. Those needs should always govern the means not be its subject. The most important development in modern banking is the art of mobilizing funds for investment. In contrast, Islamic banking is a system that provides financing and attracts savings on the basis of profit/loss sharing. One may have to think positively of such a scheme. By waiving the interest factor, we find an alternative vehicle to provide financing on a different basis, which should be judged on it own merit. Economists have proven that the wider the freedom of choice the higher the level of social welfare in addition, wider choice implies greater respect of human rights. When an alternative concept such as Islamic banking is introduced a new choice is open to market with obvious economic and social benefits. Introducing Islamic banking as a new choice has also further benefits related to the advantages it provides to fund user. Commodity and service producer would certainly appreciate equal opportunities for obtaining capital based on the merit of the business rather than on their personal credit worthiness alone.

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Therefore, we would like to recommend strongly to the western world that all obstacles remaining in the way of establishing Islamic banks in their countries be removed.

2.1) Challenges and Prospects

The biggest challenges Islamic banks have faced from their very beginning is how to narrow the gap between the Islamic banking model and its application, in other words, between theory and practice. Islamic banks have been trying hard to meet those challenges through several means, the first is to work for better understanding of the concept upon which their operations are based. This has been a success to the extent that now traditional bankers are mostly co-operative and accommodating. Central banks have also come forward with new ideas of better methods for supervision and control to suit the operation of Islamic banks. Another means is to train their staff in his new form of banking and press for more banking and financial innovation which are necessary for the new modes of finance. Fortunately, financial engineering has come in handy with bold and new

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ideas in finance, which made the Islamic model so much more applicable. Innovation in this regard did not come exclusively from Islamic banks. Nonetheless, many challenges still remain not the least to the predominance of Murabaha ( sale mode) in the operation of some Islamic bank, as well as the relative scarcity of short-term Islamic institutions. The prospects of Islamic banking and finance will depend extensively on the ability of Islamic banks to continue facing challenges with resourcefulness and creativity in addition to being worthy of trust and understanding.

Chapter- 3 Islamic Banking and Development

3.1) Developmental Characteristics of Islamic Modes of Financing

The essential characteristics of Islamic modes of financing is their direct and undetectable link to real or physical transactions. Sharing modes are only possible for productive enterprises that involve real life business that increase quantity or improve quality or enhance usability of real goods and services and by doing that such business generate a return that can be distributed between the entrepreneur and the financier. In other words, Islamic financing is purely a real-life, real-goods financing. No financing can find its way to the Islamic system without passing through the production and/or exchange of real goods and services.
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In contrast with traditional methods, Islamic financing not centered only around creditworthiness and ability to loans and return. The key word in Islamic financing is worthiness and profitability of the project and the exchange of goods and merchandise, while the ability to recover the financing principal becomes the result of profitability and worthiness of the project itself. Consequently, the nature of Islamic financing makes it exclusively restricted to the construction, establishment and expansion of productive project and to the exchange and trade of commodities. Whether it is done by means of sharing, sale or lease contracts, Islamic financing is bound by the extent of transaction in good market. The Islamic modes of financing, by virtue of their very nature, are incompatible and inapplicable for debt rescheduling, debt swap, financing of speculative cash balances, inter-bank liquidity speculative transfers and other purely monetary activities that make a substantial part of contemporary activities of traditional bank.

3.2) Social Commitment of Islamic Banking

The religious ideas on which Islamic banks are based are so integrated with ethical and moral values to the extent that these new institutions that are called Islamic banks cannot detach themselves from socio-moral consideration even if they try , especially that their own environment including both staff and client, expects from them such socio-moral commitment and always measure them. Many Islamic banks also establish social funds especially designed for relieving economic hardship of the poor and needy. The early Zakahdues on shareholders equities as well as many investment depositors who give their consent
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to the banks management for the deduction and distribution of Zakah annually usually finance this funds. Moreover, many Islamic banks contribute to research and community development and assign sometimes-substantial amounts for these objectives. Additionally, many Islamic banks usually work within a traditional banking environment, and have working relationship with traditional banks. According to the Islamic Shariahs earned interest cannot be considered an income and it is to be disposed of to the poor in the way that does not directly benefit the bank. Hence, those Islamic banks that happen to earn interest spend them on benevolent social activities. In other words, while profit maximization is equally essential to the Islamic banks as other business, the underlying philosophy of these institutions is conducive towards social commitment and activities that usually cannot be interpreted by the motive of profit maximization.

3.3) Developmental activities of the Islamic Development Bank (ISDB)

Islamic development banks have to board areas of financing: project construction and expansion and trade operation. Project financing includes transport and communication , gas, electricity, water and other public utilities, agriculture and agro-industries, industrial and mining projects, social services and other developmental projects in addition to technical assistance provided for the purpose of project preparation, inception and feasibility studies. Trade financing covers both inter member countries trade and import of member countries from the rest of the world.
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The IDB has established a close contact with Islamic banks in different countries in order to meet the financial and developmental needs of its member countries. The IDB plays the role of a promoter and coordinator between the IBD and Islamic banks have resulted in launching institutions and preparation of studies on subject like liquidity management and other related matters, medium and long term investment as well as on new financial instruments. The IDB has in collaboration with indigenous entrepreneur setup Islamic banks in different members countries. Apart from equity participation, the IDB provides assistance and help in development of procedures manual for the operations of the banks another cooperative efforts having far-reaching consequences is the pilot project to make the capital structure and financing of companies having interestbearing debts compatible with the principles of Shariahs. IDB is also making strenuous efforts to contribute to the capacity building of Islamic banks and to mobilize them to co-finance project.

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Chapter- 4 Islamic Banking : Modes of Financing

Islamic banking has found acceptance from many section of the society for its interest free and non-exploitative nature. However, there is a growing dispute between the two major modes of financing available under this system
(i)

Profit and loss sharing modes Fixed returns mode

(ii)

True modes of financing

An Islamic bank is a financial institution which identifies itself with the spirit of Shariah, as laid down by the Holy Quran and Sunnah, as regards its objective, principles, practices and operations. To replace interest, the ideal mode of financing under the Islamic banking system is financing on profit and loss sharing (PLS) basis. To safeguard the interest

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of depositors/investors, these types of loans, as a matter of policy, do not constitute a significant source of financing by Islamic bank. The bulk of financing by Islamic banks has to be equity oriented. In these modes of financing, the losses are shared by the financier along with the entrepreneur in the ration of their respective capitals. The profit are however, shared in an agreed ratio. While designing an alternate to interest based system, it was realized that large scale resorting to PLS system of Islamic banking could pose serious risks and hazards to Islamic banks due to widespread tendency to adopt unethical account practices to conceal true profit, high rate of illiteracy and host of other reasons.

Financing on PLS basis

The Real alternate to interest on loans in an Islamic framework is financing on

PLS basis a shift from debt- based transaction to investment based funding on PLS system of Islamic banking in a conducive environment would not only ensure a healthier financing portfolio and of course higher rate of return to depositors but would also lead to optimum allocation of resources for overall economic growth welfare of the society, individually and collectively. It is however, accepted that banks allowing financing on PLS basis are exposed to risk of losses as even a profitable company may sustain genuine loss due to various factors even beyond their control. In actual practice however, we find that traders and industrialists, etc. generally earn substantial profit with the funds of a large number of depositors but they do not
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share these profits with the banks for onward passing on the share to be depositors. The injustice can be avoided if banks accept deposit on PLS basis according to its true spirit and also allow bulk of financing on the same basis. This will bring prosperity in the society, as a large number of depositors will be receiving higher rate of return on their deposits. In the Islamic banking system, the concept is that of ratios in which profit and losses are shared instead of fixed, predetermined interest and mark-up/ profit rates. The issue of possible injustice due to inflation and recession, in money lending transaction, was settled by Islam over 1400 years ago, as PLs system absorbs the impact of inflation as regard the sharing of operational results are concerned. A glaring example is that of partnership where there is no dispute between partners due to high inflation or otherwise.

Model Islamic Bank

It is important that the requisites for total implementation and success of

Islamic in a country, include re-shaping the society restructuring of the economic system and re-framing of the laws according to the dictates of Islam. The most important and the difficult task however is the reformation of society which has to be undertaken as ongoing process. We therefore, need to change our priorities and at least as much emphasis should be laid on improving the ethics, honesty and values of the society as is being done for expansion of Riba free banking. This will then create a conducive environment for more and more financing under profit and loss sharing system Islamic banking.
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In view of the position explained here in above and consideration the real difficulties in presently adopting the PLS system of Islamic banking for bulk of the financing for trade, industry and agriculture, it is felt that the need of the hour is to establish Model Islamic banks is an also GCC countries as also in other Islamic countries where a large number of interest free banks have been operating for number of years. The Proposed Model Bank would be a commercial bank. While the objective of the bank would be to earn profit, it would identify itself with the Shariah as regards objectives, principles, practices and operations. The Proposed bank would undertake all normal banking business as in done by the interest based banks but the provision of Shariah would be kept in view at all times. The Proposed Model bank would accept deposits investment on PLS basis. It would develop risk- bearing but competitive products for deposits investments where in depositors investors are given reasonable assurance of higher return as also safety of their funds. The sponsor directors of the proposed model bank should be Muslim scholars, jurists, chartered accountants, economists, banker and investors. All these person should be men of integrity and of highest reputation. They should also have unshakeable faith and commitment in the Islamic banking system. It is sincerely believed that the proposal of Model Islamic bank is not only feasible but is the need of the hour. The successful operational results of this bank would also motivate the existing Islamic banks to enhance their share of financing on PLS basis.
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Modes of financing
Banks adopt several modes of acquiring assets or financing projects. But they

can be broadly categorized into three areas: investment, trade and lending.

4.1) Investment financing:

This is done in three main ways: i) Musharaka (Partnership Finance) Where a bank may join another entity to set up a joint venture, both parties participating in the various aspects of the project in varying degrees. Profit and loss are shared in a pre-arranged fashion. This is not very different from the joint venture concept. The venture is an independent legal entity and the bank may withdraw gradually after an initial period. ii) Mudarabha( Entrepreneurial Finance) Where the bank contributes the finance and the client provides the expertise, management and labour. Profits are shared by both the partners in a pre-arranged proportion, but when a loss occurs the total loss is borne by the bank. iii) Financing on the basis of an estimated rate of return Under this scheme, the bank estimates the expected rate of return on the specific project it is asked to finance and provides financing on the understanding that
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at least that rate is payable to the bank. (Perhaps this rate is negotiable.) If the project ends up in a profit more than the estimated rate the excess goes to the client. If the profit is less than the estimate the bank will accept the lower rate. In case a loss is suffered the bank will take a share in it.

4.2) Trade Financing:

This is also done in several ways. The main ones are: i) Mark-up Where the bank buys an item for a client and the client agrees to repay the bank the price and an agreed profit later on. ii) Leasing Where the bank buys an item for a client and leases it to him for an agreed period and at the end of that period the lessee pays the balance on the price agreed at the beginning an becomes the owner of the item. iii) Hire-purchase Where the bank buys an item for the client and hires it to him for an agreed rent and period, and at the end of that period the client automatically becomes the owner of the item. iv) Sell-and-buy-back

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Where a client sells one of his properties to the bank for an agreed price payable now on condition that he will buy the property back after certain time for an agreed price.

v) Letters of credit Where the bank guarantees the import of an item using its own funds for a client, on the basis of sharing the profit from the sale of this item or on a mark-up basis.

4.3) Leasing Financing:

Main forms of Leasing are: i) Loans with a service charge
Where the bank lends money without interest but they cover their expenses by levying a service charge. This charge may be subject to a maximum set by the authorities.

ii) No-cost loans Where each bank is expected to set aside a part of their funds to grant no-cost loans to needy persons such as small farmers, entrepreneurs, producers, etc. and to needy consumers iii) Overdrafts Also are to be provided, subject to a certain maximum, free of charge.

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4.4) Deposit Accounts:

All the Islamic banks have three kinds of deposit accounts: current, savings and investment. i) Current accounts Current or demand deposit accounts are virtually the same as in all conventional banks. Deposit is guaranteed. ii) Savings accounts Savings deposit accounts operate in different ways. In some banks, the depositors allow the banks to use their money but they obtain a guarantee of getting the full amount back from the bank. Banks adopt several methods of inducing their clients to deposit with them, but no profit is promised. In others, savings accounts are treated as investment accounts but with less stringent conditions as to withdrawals and minimum balance. Capital is not guaranteed but the banks take care to invest money from such accounts in relatively risk-free short-term projects. As such lower profit rates are expected and that too only on a portion of the average minimum balance on the ground that a high level of reserves needs to be kept at all times to meet withdrawal demands. iii) Investment account

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Investment deposits are accepted for a fixed or unlimited period of time and the investors agree in advance to share the profit (or loss) in a given proportion with the bank. Capital is not guaranteed.

Chapter- 5 Islamic Banking : Current Practices and Challenges

Islamic banking practices have been widely accepted by many Muslims customers both in Muslims and non Muslims countries, there are certain operational challenges faced by modern Islamic banks. Interest free banking popularly referred to as Islamic banking, tracing back its origin in Egypt around the year 1963, has grown at the rate of 15%. Ever since its inception in a tiny Egyptian village Islamic banking has never looked back. Financial intermediation based on the concept of interest may not promote humanitarian goals such as full employment, equitable distribution of income and wealth and economic stability. Islamic banking and finance is largely based on the concept of profit and loss sharing modes.

5.1) Rational reason behind prohibition of interest

The interest system is perceived to be incapable of allocating available liquid funds among firms and activities in the society according to considerations of efficiency, productivity and growth. An Islamic system based on profit /loss sharing financing methods would an efficient substitute in principle.

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The interest system maintains a pattern of income distribution, which is based towards wealthy individuals, and large business that can afford to pay and receive interest. An Islamic financial system on the other hand, justifies an income distribution pattern that promotes economic efficiency, productivity and other actual factors contributing to the total value added. The interest system contributes to passive behavior to develop among people who possess liquid funds since the availability of excess funds acts as a deterrent from participating in risk financing. Prohibition of interest does not affect savings / investments or mobilization of funds as it is based on the religious principles and is considered more ethical by the religious people.

Reasons for the rise in Islamic banking in non Muslim Countries

Besides Islamic or predominantly Muslim countries, Islamic banking is attracting tremendous attention in countries that are considered to be strictly secular or with minuscule Muslim population such as the UK, Germany, Switzerland, Luxembourg, etc. One does wonder why these countries are attracted to Islamic banks. But there is a strong economic sense in it. Firstly, these countries are financially developed. Markets in these countries are saturated. So, they are always on the lookout for products and range. Secondly, though their Muslim population is not as big as in many other countries, these are people of high net worth. They are mostly professional and businessmen settled in these countries for a better lifestyle. So, it pays to serve them. And thirdly, most of the top most financial institutions are MNCs operating in all parts of the world including over 55 Islamic countries, these
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institutions are offering financial services, so it is convenient for them to offer these services in their home country also. These institutions also have an eye on the petrodollars flows, which are moving very fast from the developed countries to emerging markets. So, to check the outflow of petro-dollars from these countries, it is necessary that they offer Islamic options in their home countries too. Most of the large western financial institutions have their own Islamic subsidiaries or Islamic windows or products aimed at their Islamic clientele. The importance of Islamic banking is also evident by the decision of major stock exchange such as Dow Jones and FTSE to offer Islamic indices. Statistics from the international association of Islamic banks suggest that assets managed by Islamic banks have grown quite substantially during the last few years.
5.2)

Implementation Challenges
Most of the challenges of Islamic banks are related to the age and size of the

institutions comprising this sector. Relatively, their age and size is very small, therefore, the biggest and most important challenge for Islamic banking is its regulation. Most of the Islamic financial institutions are grown spontaneously. Consequently, there is no central organization, which can guide or regulate these institutions. Another big hurdle for Islamic banking is lack of adequately trained manpower. Most of those working at present have switched from conventional banking to the Islamic one. They are experienced in banking operational, but their understanding of Islamic banking or its underlying concept is fairly poor. Moreover, the roots of Islamic banking lie in ethical concerns. Unless, the overall ethical standards of the society are fairly high, it is difficult to implement Islamic banking concepts in the fullest sense.
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The moral hazards related to under over reporting of profits / loss is another issue. At the same time, refusal of depositors to accept losses in case of genuine reverses suffered by Islamic banks has also posed a big challenge to the industry. Some technical and market related risk can also be considered as serious challenge for Islamic banking institution , as the major market for Islamic banks are in third world countries whose undeveloped financial and communication infrastructure poss a big challenge to the growth of these institutions.

5.3) Short coming in current practice

The current practices under three categories: deposits, modes of financing (or acquiring assets) and services. There seems to be no problems as far as banking services are concerned. Islamic banks are able to provide nearly all the services that are available in the conventional banks. The only exception seems to be in the case of letters of credit where there is a possibility for interest involvement. However some solutions have been found for this problem -- mainly by having excess liquidity with the foreign bank. On the deposit side, judging by the volume of deposits both in the countries where both systems are available and in countries where law prohibits any dealing in interest, the non-payment of interest on deposit accounts seems to be no serious problem. Customers still seem to deposit their money with interest-free banks. The main problem, both for the banks and for the customers, seem to be in the area of financing. Bank lending is still practiced but that is limited to either no-cost loans (mainly consumer loans) including overdrafts, or loans with service charges only. Both these types of loans bring no income to the banks and therefore naturally they are not that keen to engage in this activity much. That leaves us with investment financing and trade financing. Islamic banks are expected to engage in these activities
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only on a profit and loss sharing (PLS) basis. This is where the banks main income is to come from and this is also from where the investment account holders are expected to derive their profits from. And the latter is supposed to be the incentive for people to deposit their money with the Islamic banks. And it is precisely in this PLS scheme that the main problems of the Islamic banks lie.

5.4) Problems in implementing PLS scheme

In the over half-a-decade of full-scale experience in implementing the PLS scheme the problems have begun to show up Table 1 shows the term structure of investment by 20 Islamic Banks in 1988. It is clear that less than 10 percent of the total assets goes into medium- and long-term investment. Admittedly, the banks are unable or unwilling to participate in long-term projects. This is a very unsatisfactory situation. Table 1: Term Structure of Investment by Islamic banks, 1988 Term Structure of Investment by 20 Islamic Banks, 1988 Type of Investment Amount* % of Total Short-term 4,909.8 68.4 Social lending 64.2 0.9 Real-estate investment 1,498.2 20.9 Medium- and long-term investment 707.7 9.8 The main reason of course is the need to participate in the enterprise on a PLS basis which involves time consuming complicated assessment procedures and negotiations, requiring expertise and experience. The banks do not seem to have developed the latter and they seem to be averse to the former. There are no commonly accepted criteria for project evaluation based on PLS partnerships. Each single case
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has to be treated separately with utmost care and each has to be assessed and negotiated on its own merits. Other obvious reasons are: a) such investments tie up capital for very long periods, unlike in conventional banking where the capital is recovered in regular installments almost right from the beginning, and the uncertainty and risk are that much higher, b) the longer the maturity of the project the longer it takes to realize the returns and the banks therefore cannot pay a return to their depositors as quick as the conventional banks can. Thus it is no wonder that the banks are averse to such investments. Small scale businesses form a major part of a countrys productive sector. Besides, they form a greater number of the banks clientele. Yet it seems difficult to provide them with the necessary financing under the PLS scheme, even though there is excess liquidity in the banks.

5.5) Future of Islamic Banking

There is no centralized institutions from where one can get the exact size of Islamic banking in terms of deposits/ assets, etc. however, estimates suggest that the overall Islamic finance industry, which includes Islamic banking, non- banking, mutual funds, leasing, real estates, stock market to the charitable financing institutions, has grown manifolds during the last two decades. Taking into account 15% annual growth of the industry during the last decades, even a conservative estimates will put the Islamic finance size beyond $ 1,000bn. One estimate suggest that the global size of the Islamic economy to be around 2.5% of the total global economy and 12% of the developing economy. A large
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number of Muslim also live in many secular countries like India, UK, USA and other Asian , South African countries. As a whole, Muslims comprises approximately 1/5th of the total world population. Conservatively, if it is assumed that Muslims on an average have half the resources per capita as compared to their non Muslim brethren, still 1/10th of the world resources are with Muslims. Of this, even if 50% Muslims are interested in any kind of Islamic countries. One obvious fact remains, that many kind of Islamic countries are still under-banked due to their inhibition in dealing with interest based banking. According to one western observer, the growth in Islamic banking and finance is primarily driven by the fact that Muslims during the last 15 to 20 years have built significant wealth that necessitates banking services, they are inhibited in fully participating in conventional finance operation due to the fact that usury is a very serious sin in Islam. Consequently, in view of many leading authorities, this market will be responsible for managing at least 50 to 60% of the total saving of Muslim world wide in 8 to 10 years time.

5.6) Islamic banking in other sectors

A. Equity Funds Islamic investment equity funds market is one of the fastest growing sectors within the Islamic financial system. Currently there are approximately 100 Islamic equity funds worldwide. The total assets managed through these funds currently exceed US$5 billion and is growing by 12-15% per annum. With the continuous interest in the Islamic financial system, there are positive signs that more funds will

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be launched. Some western majors have just joined the fray or are thinking of launching similar Islamic equity products. Despite these successes, this market has seen a record of poor marketing as emphasis is on products and not on addressing the needs of investors. Over the last few years, quite a number of funds have closed down. Most of the funds tend to target high net worth individuals and corporate institutions, minimum investments ranging from US$50,000 to as high as US$1,000,000. Target markets for Islamic funds vary, some cater for their local markets e.g Malaysia and Gulf based investment funds. Others clearly target the Middle East and Gulf regions, neglecting local markets and have been accused of failing to serve Muslim communities. Since the launch of Islamic equity funds in the early 90's, we have seen the establishment of credible equity benchmarks by Dow Jones Islamic market index and the FTSE Global Islamic Index Series. The website failaka.com monitors the performance of Islamic equity funds and provide a comprehensive list of the Islamic funds worldwide. B. Involvement in non banking activities

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It is due to historical reasons that banks have evolved purely as a financial institution. They are suited to attract money, keep it in safe custody, lend it under safety, invest it profitably and enjoy the capacity to create the means of payment. A bank has to maintain a balance between income, liquidity and flexibility. While allocating its funds it has to be meticulously sensitive about the factors like capital position and rate of profitability of various types of loans, stability of deposit, economic conditions, influence of monetary and fiscal policy, ability and experience of banks personnel and credit needs of the area. So far these banks thrive on a fixed rate of return a portion of which is passed on by them to the depositor. Thus the entire effort of a bank is directed towards money management and it is not geared to act as an entrepreneur, trader, industrialist, contractor or caterer. Traditional banks do perform a certain amount of project evaluation when granting large medium- and long-term loans. But doing such detailed evaluation as would be required to embark on a PLS scheme, such as determining the rates of return and their time schedule, is beyond the scope of conventional banks. So is the detailed accounting and monitoring necessary to determine the actual performance. Chart of Other non Banking activities of Islamic Banking

Under Islamic banking these exercises are not limited to relatively few large loans but need to be carried out on nearly all the advances made by the bank. Yet, widely acceptable and reliable techniques are yet to be devised. This is confounded by the fact that no consensus has yet been reached on the principles. Both the
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unprecedented nature of the task as well as the huge amount of work that need be done and the trained and experienced personnel needed to carry them out seems a daunting prospect. C. Training Of Staff In 1994, the Institute launched a program of lectures in the field of Islamic finance. The program proved to be highly popular and attracted audiences from highly prestigious financial, legal, accounting, business and academic organizations. The aim is to diffuse and disseminate information about developments in the Islamic financial system, to exchange views, share experiences and to highlight the opportunities and problems associated with the Islamic financial system.

Chapter 6 CASE STUDIES 6.1) Islamic Banking Potential Impact : Case Study on India Islamic banking in India
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The period from 1930s to 1974 is characterized by theoretical writings on Islamic economics and banking, which can be term as the foundation period of Islamic banking. A country, which can rightly claim to have played a pioneering role in the development of Islamic economics and finance, is India. It not only produced some of the most prominent scholars of the Islamic financial world but also played a very catalytic role in the practice of Islamic finance. An analysis of the literature on the subject reveals that during the first of the 20th century, almost half of the total literature available in the world was in the URDU language, and the rest being either in English or in Arabic. In English the first ever book on the subject was by Indian professor. Some other works that are considered milestones in the development of present day Islamic economics are also by Indian scholars. A graduate of Allahabad University has the distinction of publishing the first ever work exclusively devoted to the subject of Islamic banking. Endeavors to establish interest free financial institutions in India precede the writing on this issue. The first such attempt on this issue can be traced to the beginning of the cooperative movement in the country in the 1890s at Patni Cooperative Credit Society (1939) of Gujarat is still continuing its business. Northern India, which can boast of having the largest number of Muslim funds in the country today, has the distinction of establishing the first Muslim fund in the country in 1940. According to the information I collected, there are not less than hundred such Muslim funds in the country with interest free deposits about Rs.1200mn. Bombay, the financial capital also used to have some of the finest Islamic financial institutions in the country. But the crises among NBFCs in the late 1990, which saw the closure of over 45,000 finance companies, had its effect on some of the
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citys most prominent Islamic finance companies. And after the tragic event of Barkats liquidation in May 2000, Islamic financial activities in the city came to the halt. However, before being liquidated Barkats along with some others had succeeded in convincing the Tatas to launch a mutual fund targeted primarily at Muslim investor. The current prospectus of Islamic banking and finance in the country can be seen from two angles. Firstly , the internal demand and secondly the external supply. Internal demand arises particularly from the huge Muslim population between 130 15 mn ( the second highest Muslim populated country in the world). High awareness of Islamic financial products and high saving of the community give another indication of the huge potential for Islamic finance in the country. From the supply side also Islamic finance has a huge potential in India. High Net worth Indians (HNIs)working in the Middle East are flush with petrodollars. The Indian economics is the one of the fastest growing economy of the world. It has the potential to grow at the rate of over 8% for the next 50 years; however what it lacks is proper infrastructure. Once India opens its market to Islamic and other Islamic financial institutions in the Middle East and elsewhere to invest in India. The Government of India too seems to be quite aware of the benefits of these institutions coming to India and may be because of this it has recently constituted a Committee of expert under the RBI to look into the matters of Islamic banking.

Facts and fictions about Islamic banking in India:

It is unfortunate that our financial sector regulators, bankers and professional have failed to see the prospects of Islamic Banking in India, thats why RBI or any other committee have yet to visualize the scope of Islamic banking in India. So far
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Islamic banking has been considered as a mere religious matter for Indian Muslims and thus it is not allowed with a fear of financial segregation, a threat of parallel banking system for RBI along with any hidden fear for SCBs to lose Muslim depositors. There has never been any public committee analyzing the impact of Islamic banking in India because Muslims of India were never so evocative about features of Islamic banking in India while the other community members had no background to conceive this concept to required level for projecting its utility for Indian economy. Off Course the concept of Islamic banking is driven by ethics of Islam, but it has more economic utility compared to its religious vigor which needs some genuine study by professionals having basic knowledge of Islamic banking and expertise on Indian economy because Islamic banking carries more advantageous features to boost real sector economy compared to financial sector. It is a need of the hour that Indian government should constitute a committee on public domain to study and analyze the economic significances of Islamic banking for the Indian economy.

Economic analysis of Islamic Banking in India:

Islamic banking may not be allowed just for a community as a religion based banking business, but it should be allowed after thorough study of its potential to resolve our real economic problems. The report by Sinha Committee was incomplete and thereafter still we have to find any report on economic viability of Islamic banking and its impact on inclusive growth. We have to remove the prejudices about Islamic banking and need to study it as a core economic issue irrespective of its base driven form Islam.

Future leaders of Islamic banking in India:

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There might be a prejudice among top bankers that since Islamic banking originates from Islam, Muslims might take a lead in Islamic banking and their supremacy in banking sector may not be sure after Islamic banking. However the reality may be far different from the fiction. Indian Muslims are hardly capable to hold major shares of Islamic banking business in India as they lack required infrastructure, financial depth, banking creditability to attract the general depositors and investors under Islamic Banking. Islamic banking is not a childrens game. It requires even better professional expertise compared to conventional banking because it deals more with commercial projects than mere monetary credit and debit transactions. Indian Muslims may feel privileged in terms of Islamic ethics required for Islamic banking but they certainly lack professional efficiency to manage modern commercial banking on Islamic ethics. Our leading nationalized bank (SBI) is somehow reaching to that expertise which may be required to manage a complex banking project such as Islamic banking, but they have to hire services of experts on Islamic Banking. The RBI code of conduct to SCBs putting thrust on SMEs is reflecting the need of advanced commercial banking in India which would be focus under Islamic Banking. The performance by SBI has been best among nationalized banks to lend commercial credits. But still majority of unorganized sector workers who are non-bankable due to collateral problems are actually needing equity finance instead of debt finance. All the difference among nationalized banks operation and Islamic banking is the mechanism of credit and deposits. Under Islamic banking mechanism thrust would be on equity deposits and credits while interest charged would be replaced by profit margins on commercial credits and interest expended

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over deposits would be replaced by dividend on equity finance with deposits mobilized as equity deposits by banks. It is expected that with introduction of Islamic banking in India, the first choice of depositors and investors would be nationalized banks as despite contradiction of interest, Indian Muslims have a confidence in nationalized banks. To ensure security of deposits majority of Muslims depositors would prefer to join Islamic banking managed by nationalized banks. However it is expected that Foreign Investors looking to invest in India through Islamic banking, would prefer to have services of foreign banks. As far Indian Muslims are concerned, they have to make hard efforts to find their place in managing Islamic banking in India because they lack required financial depth; infrastructure and more importantly they have poor credibility among the depositors and investors due to some past failures of financial institutions. Beside to take political, social, religious and diplomatic advantages, Islamic banking is more desired for Inclusive growth of India. It is all important to evaluate probable impact of Islamic banking in different segments of Indian economy. Every segment is expected to enjoy its benefits. (i) (ii) The 150 millions Indian Muslims would enjoy their religious rights in banking sector with provision to get rid of interest which is strictly prohibited in Islam. With introduction of Islamic banking, the UPA government may get advantage to please the second largest community of India who are somehow uncomfortable with linking of recent terrorist attacks with only Muslim community or in other words by hearing the terminology of Islamic terrorism.

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(iii)

With introduction of Islamic banking, Indian government will gain diplomatic advantages to make financial dealings with Muslim dominated nations especially to attract trillion dollars of equity finance from gulf countries.

(iv)

The operation of Islamic banking will allow the Muslims to work with majority community in banking sector which is not found in proportion to their population share so far, because RBI has just 0.78% Muslims and SCBs have just 2.2% Muslim employees. Similarly Muslims have a poor employment rate in NABARD and SIDBI because every where financial institutions are dealing with interest and Muslims do not like to work with interest based banking and financial institutions. It is a major factor causing financial exclusion of Indian Muslims. With Islamic banking this exclusion may be removed and it would definitely help us build civil society economy. Islamic Banking is rated as one of the urgent needs of Indian economy as it is

the only banking mechanism which seems to arrest the liquidity and inflation problem along with allowing GDP growth with adequate share in all segments. The increased percentage share in GDP by agriculture or manufacturing industry, or per capita income growth is just not indicative of true inclusive growth. For real inclusive growth, we have to ensure increase in income and employment status of workers at all segments. Empirical evidences reflects that though India has registered better growth rate in recent years, the number of poor living below poverty line has increased in our country. It may be noted that the household consumption is directly related to household income which has declined in recent years; while corporate savings are directly related to income of corporate sector which has increased. Thus we may conclude that with better GDP growth rate in recent years, our corporate sector has
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snatched the fruits of growth, while majority of work force have failed to enjoy the fruits of development. The prime economic advantages of Islamic banking could be as following

Islamic Banking and Financial Inclusion

Though we do not have any survey to compare community wise financial exclusion in India, the primary study of data available through Sachar Committee report reflects that still around 50% Muslims are financially excluded and banking is inversely related to concentration of Muslim Population. The reason is just prohibition of interest in Islam and thus wherever Muslims are concentrated; they find means practicing interest free banking through societies and NBFCs. With inception of Islamic banking it is expected that Muslims will join Islamic banks which will remove their financial exclusion.

Business of nationalized banks would be increased:

So Indian Muslims are looking for Interest free banking to avail much needed credits for development which is possible through introduction of Islamic Banking in India. This may add at least approximately 60 millions Muslims to formal financial sector. Through this financial inclusion of Indian Muslims to formal sector Islamic Banks, it is expected that Indian nationalized banks may see additional savings worth 1,00,000 crores and credit worth over Rs. 2,00,000 crores which may help banks to gain higher rate of profits compared to their SLR. After successful operation of Islamic banks by our nationalized banks, private banks may also enter into dealing with Islamic banking.

Stock Market Capitalization

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Since Islamic banking focuses on equity deposits and finance, it is expected that Stock market will be the most preferred avenue for investments by future Islamic banks of India because currently it is our stock market which is attracting new investments under Shariah Finance schemes. With advanced art of technology for investment with liquidity and profitability, it is expected that majority of deposits with Islamic banks in India will be preferably canalized to stock market. It would be the safest and fasted mode of deploying equity funds. Thus Islamic Banks may add additional 6 million new D mat accounts with expected capital gain of Rs. 60,000 crores from domestic market and around 1 trillion US $ through Islamic Banks managed by foreign bankers in India.

Formal Sector Economic Agents

Under Islamic banking the formal sector economic agents like corporate firms listed with stock markets would be the first likely beneficiary of Islamic banking because their shares would be subscribed through investors at Islamic banks. All the companies listed in stock markets will have additional potential subscribers to genuinely subscribe their shares instead of mere trading stocks to gain for speculation.

Islamic banking will bring Revolution:

Islamic banking will allow the manufacturing and retail enterprise of unorganized sector and agriculture to obtain equity finance which would bring revolution in Indian economy because our majority of poor and vulnerable workers are associated to agriculture and unorganized sector that are not in a position to afford financial risks for capitalization which is required to increase their productivity and income levels. Their financial background is not encouraging SCBs to extend debt
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finance to them in lack of collaterals. While in case of Islamic banking the inadequate capital ratio in unorganized sector could be resolved through equity finance which might be a revolution is our agriculture and unorganized sector; with improved capital ratio, our poor and vulnerable workers associated with agriculture and unorganized sector might be able to compete with the formal sector workers with their enhanced productivity. This might induce our leaders to substitute grants and subsidies with financial institutions focusing on equity finance because self reliability is more important for growth which never comes through grant and subsidies but with successful utilization of equity finance. The stabilization fund for poor farmers and artisans may be utilized to experiment such finance with Islamic banking.

Islamic Banking and Public Finance:

Islamic banking may further help us mobilize capitals on equity base to meet the investment needs for irrigation, dams, roads, electricity, and communication projects along with other infrastructure where public finance is insufficient and debt finance may be cause deficit to the government. With Islamic banking raising equity funds would be easier for banks. We must not forget that over 50% of our rain fed lands need irrigation which need equity finance to reduce the credit costs. The total investment in infrastructure, in 200607 was estimated to be around 5% of GDP. It has to be 9% of GDP by 2011-12, it means that we would require Rs. 2,07,291 crores in 2006-07 and Rs. 5,74,096 crores by 2011-12 to finance our infrastructure. The total investment amounts to Rs 20,56,150 crore for the 11th five year plan. Of which Rs. 14,36,559 crores is supposed to be met from Public Investment wile Rs. 6,19,591 from private investments. Islamic banking through promoting equity finance from national and international markets may reduce this burden effectively with keeping
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public finance well under control and probably we may need not to worry about fiscal deficit as well. Since Islamic banks may also have managerial control over commercial financing, government might use banking units as source to mobilize taxes as well which might reduce mobilization costs for public revenue and increase margins for governments.

Islamic Banking and Indian Economy:

Viewing the probable multi dimensional positive impacts of Islamic banking on Indian economy, there are many reasons to smile for Islamic banking in India. It is helping our financial sector maintaining stability while helping real economic sector attain inclusive growth. The public finance would be much benefited through Islamic banking by generating investment funds on equity basis. Thus Islamic banking should be considered as a core economic need of the economy instead of viewing it as a religious matter for Indian Muslims. By any projections, it is expected that Islamic banking may help us mobilize business up to 5% our GDP with making due corrections in financial and real markets. Therefore it should be considered as a genuine economic need of the nation instead of considering it as religious, social or political issue. Hope all patriot Indians will flag green signal to Islamic banking as it is opening the doors towards faster and more inclusive growth An approach to 11th five year plan of India. Since we have no project or viability report on this issue, it would be better to form a committee on public domain to analyze Islamic banking and its impact on

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Indian economy before we take any action in this regard because a delay but careful step is far better than any hasty move with prejudice.

6.2) Islamic Banking and Its Potential Impact : A Case study on Indonesia
Islamic banking was introduced a little late in the largest Muslim Populated nation in the world Indonesia. Nevertheless, it has gained popularity and acceptance in a short span of time. This case analyzes the experience and the progress of Islamic banking in Indonesia with the help of the support offered by Shariah Bureau of bank of Indonesia. Since the representative of the Shariah Buerau of Bank Of Indonesia responsible for the supervision and development of Islamic finance will focus on the experience and progress of Islamic banking in Indonesia., I will focus on some questions about the impacts of that banking, particularly in rural areas, and aspects that the Bank Indonesia representatives will not focus on. Islamic banking is a worldwide phenomenon involving a variety of institutions and instruments, not one project or institution. In the past few decades, Islamic institutions and instruments have developed in many countries, including the United States. In certain countries Iran, Sudan, and Pakistan all or most financial intermediation conforms to Islamic law as defined by local authorities. All three of
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these countries also have banking authorities that govern the general level of charges and returns in the system and these are not usually market-governed systems. In most other countries, including Indonesia, Islamic transactions and institutions make up a small part of the total and must compete with conventional financial institutions There is even considerable Islamic banking in the United States. If the terms and conditions of Islamic transactions differ too much from those of conventional institutions they become hard to sustain. The terms and conditions of Islamic institutions therefore tend to converge with conventional ones. Islamic instruments are simply a narrow group of familiar financing instruments. Any transaction, with any distribution of proceeds, can be conducted as a lease, a sale, a partnership, a fee-generating transaction, or a loan. Islamic instruments generally avoid loans. Though the scheduled distribution of proceeds may be the same as for a conventional loan, the legal risk in case of default is often different in the different forms of financing. Those who promote Islamic finance often prefer partnership arrangements in which profits or turnover is shared because this conforms more fully to the goals of Islamic banking. One goal of Bank Indonesia in promoting Islamic banking is to increase the proportion of financing involving such sharing. Nonetheless, more than 80 percent of Indonesian Islamic financing is in fixed-term forms, mirroring the pattern throughout the world. Many involved in Islamic banking would like to minimize the differences between Islamic and conventional banking and thus they welcome fixed-term forms. However, because the instruments differ in some degree they typically require some adjustment from their conventional counterparts. For example, in Islamic
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transactions, the bank often holds the title of the property concerned. U.S. banking authorities have ruled this unobjectionable provided that title holding is only a matter of form to accommodate Islamic structures.

THE EXAMPLE OF INDONESIA

Indonesia, with the worlds largest population of Muslims, has come to Islamic or Shariah banking fairly late. Many of Indonesias Muslim leaders do not believe that commercial interest in its modern form is prohibited, although others do. After some false starts, Islamic financial institutions are developing rapidly and have the enthusiastic support of many young people and intellectuals. The work of the Shariah Bureau of Bank Indonesia demonstrates that Indonesia, especially in particular parts of the country, has considerable unmet demand for Islamic banking. Islamic banking in Indonesia has some unusual characteristics. Like most microfinance institutions in Indonesia, Islamic institutions, micro or otherwise, are generally private, for-profit institutions based on the intermediation of depositor funds secured on a competitive market. In this they are different from microfinance institutions in almost every other country in the world. They typically have no explicit social goal other than profit maximization and conformity with Islam, though in some cases a social element is present, as we will see. Social impacts are thus the result of the market impacts of the Islamic institutions.

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The lending of the various venture capital firms in Indonesia, the Modal Ventura, did support a number of agribusiness ventures on an Islamic, profit-sharing basis. The example is not necessarily an attractive one, however, because although repayment was frequently high, the profit-sharing element, in which low profits were reported, and the devaluation of the Indonesian rupiah led to the de capitalization of these venture capital firms. Islamic financial institutions in Indonesia include the Bank Muamalat Indonesia, which has been functioning since 1992, several new Islamic branches of regular commercial banks, one other newer commercial bank, 80 Bank Perkreditan Rakyat Shariah (BPRSsmaller banks limited to borrowing and lending in limited areas), and 2,470 BMT (of which a few are reported to be registered with the Ministry of Cooperatives and Small Business). The Islamic commercial banks and BPRS file frequent and detailed reports with Bank Indonesia and thus produce reliable and current statistics. This is not yet the case with BMT. The amount of funds in Islamic institutions has been growing rapidly, as the paper, The Blueprint of Islamic Banking in Indonesia, which is also being presented at this session, illustrates. Assets in Islamic banks have grown from US$52 million to US$302 million but still account for only 0.26 percent of assets in the banking system. The figure is somewhat higher if we exclude the considerable assets of conventional banks that represent government recapitalization bonds of one sort or another. Bank Indonesia has been moving to ensure that support institutions are developed for Islamic banks.

Bank Muamalat
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Bank Muamalats position as of December 31, 2002 (from quarterly reports posted on the Bank Indonesia website) can be seen in the following table.

Table 1. Bank Muamalats Quarterly Position Bank Assets Credit Deposits Nonperforming Loans (%) 4.8 6.6 8.1

Bank Muamalat Bank Mandiri Banking System

238 28,103 123,556

190 7,101 45,556

190 20,444 92,778

Bank Muamalats loans, according to its recent annual audited reports, are distributed among Islamic financial instruments as shown in Table 1. About two-thirds of the rupiah financing and half of the foreign currency financing are for less than one year. This is a high level of longer-term financing for a commercial bank. There is a trend toward Mudharabah. The average return on loans seems to be a little more than 10 percent, which is not high by Indonesian standards. Bank Muamalat splits gross revenues with borrowers, not net profit as in other Islamic institutions, and almost always insists on collateral. Its sharing, non-fixed term lending is thus easier for it to manage than it would be in some other countries.
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The bank made a profit when many Indonesian banks were losing money. It used to have a higher percentage of nonperforming loans, but the situation appears to be improving. The pattern of outside funds deposited in Bank Muamalat by instrument can be seen in the following figures, from a similar source to Table 2.

Table 2: Bank Muamalats Funds Deposited by Instruments Savings and Returns Mudharabah Time Deposits Securities Mudharabah Saving Deposits Wadiad Demand Deposits 1998 Amount 221 103 63 1998 Returns 28 23 7 3

The cost of outside funds seems to be roughly half that charged borrowers again somewhat low by Indonesian standards. Bank Muamalat reports that despite its relatively low payment of 1012 percent on deposits, while other banks were paying in the mid- 20s, the nominal amount of deposits declined by only 15 Graph1: Bank Muamalats Funds Deposited by Instruments percent. This reflects the strong customer loyalty enjoyed by all Islamic financial institutions. In recent months a number of banks have opened or announced that they will shift to Islamic principles or open Shariah branches, so competition for Bank Muamalat is likely to increase.
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Bank Muamalat has a specifically social focus, as noted in its 1998 annual report. Its mission is to become the catalyst for Islamic financial institution development, and enhance its role in small scale industry finance. Almost 17 percent of its lending goes to small and medium enterprises, which is above average for commercial banks. Bank Muamalat intends to selectively [distribute] its financing with emphasis on small businesses by using its Shariah financial institution network, which often have a savings and credit unit. Bank Muamalat is also one of three sponsors that conduct extensive training for BMT. The other training sponsors are the Indonesian Council of Muslim Intellectuals and the Majlis Ulema Indonesia (a group of Islamic scholars) of Yayasan Inkubasi Bisnis Usaha Kecil (Foundation for Incubating Small Businesses [YINBUK].

Bank Perkreditan Rakyat Shariah

The roughly 80 Shariah BPRS have Rp 80.5 billion in total assets. They were created as a legal category under the 1988 banking reforms. They are permitted to borrow and lend money but do not have access to the payments system, have lower capital requirements than commercial banks, and are subject to inspection by Bank Indonesia. BPRS have been growing rapidly although they still constitute a small portion of the total.

Bait Maal Wat TamwilIslamic Savings and Loan Cooperatives

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The BMT savings and loan cooperatives follow Islamic procedures as well. So far only a few of these are registered with the Ministry of Cooperation and Small Enterprise and are subject to its rules. The BMT, like the BPRS, more or less follow the general rules for savings and loan co-ops. The legal status of BMT, unless they are registered as cooperatives, is ambiguous, although the Ministry of Cooperatives and local governments often work with them. As of June 1998, there were 330,000 members in 2,470 BMT with Rp 187 billion in outstanding loans in this network. The BMT appear to be 100 percent lent up, with no liquid funds in bank accounts or cash.

KopontrenCooperatives Connected with Pesantren

The 1,500 Kopontren connected with Pesantren are registered with the Ministry of Cooperatives. Most of their savings units do not follow the Islamic system, although some are beginning to do so: One hundred to 300 of the Kopontren savings units are estimated to have shifted to Islamic banking. The Islamic financial institutions look on them as an important target market segment, but much of the Kopontren leadership does not want to identify solely with Islamic financial institutions. Because the Pesantren are mostly in rural areas, their cooperatives and credit are frequently connected with agriculture.

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6.3)

HSBC AMANAH CASE STUDY

ABOUT HSBC AMANAH:

HSBC Amanah is the global Islamic banking division of the HSBC Group, and was established in 1998 with the aim of making HSBC the leading provider of Islamic banking worldwide. With more than a hundred professionals serving the Middle East, Asia Pacific, Europe and the Americas, HSBC Amanah represents the largest Islamic banking team of any international bank. The HSBC Group is one of the largest banking and financial services organisations in the world. With operations in twenty OIC member states, no international bank is more widely represented in the Muslim world than HSBC. Nor has any made a greater investment in Islamic banking. Headquartered in London, the Groups international network comprises about 10,000 offices with almost 110 million customers in 77 countries and territories in Europe, the Asia-Pacific region, the Americas, the Middle East and Africa. With a rich history of community banking and a commitment to meet the particular needs of our diverse customers, we are the world's local bank.

VISION:
HSBC has a rich tradition of community banking, and HSBC Amanah was

established to serve the particular financial needs of Muslim communities. Our mission statement and corporate values reflect this vision.

The HSBC Amanah mission statement:

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HSBC Amanah is committed to Improving the lives of our customers worldwide by providing them with the highest quality Islamic banking solutions.

SERVICES OFFERED BY HSBC AMANAH Amanah Current Account

HSBC Amanah Current Account* is a relationship checking account available in AED, EURO, GBP and USD. It is designed to comply with Shariah (Islamic law) guidelines while also providing the regular convenience and security of a current account With a monthly minimum average balance of AED 5,000, EURO 3,000, GBP 3,000 or USD 3,000, it offers you: Free personalised cheque book to issue as many cheques as you need free of charge**

Free HSBC Amanah Gold/Classic Charge Card(s) for the 1st year***

Free international ATM Card giving you instant access to your account at any time through an extensive local and global ATM network A separate monthly Amanah Account statement to help you keep track of your transactions Other account related services to facilitate your transaction needs such as Autopay, Standing Instructions, Third Party Funds Transfers, Phone Banking, Internet Banking etc.

Amanah Non Checking Account

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When it comes to taking care of your investments, you need a trusted partner like HSBC Amanah. We understand your values first, then give you services and products that meet the highest global standards, reflecting our concern for your investments, and our belief in your ambitions and goals. HSBC is committed to providing financial services tailored to meet customer requirements across the world. At HSBC we understand your need for investment products that are fully compliant with principles of Islamic Shariah. The result: an innovative investment product that recognizes your values and offers you the financial solutions you require.

What is HSBC Amanah Term Investment?

It is a Shariah-compliant short to medium-term investment solution that allows

customers to earn returns in a Shariah-compliant manner. Your funds in this product will be invested in commodities (metals) which you will sell to the Bank on the basis of Murabaha contract - sale of assets at a cost plus stated profit

Features & Benefits:

Shariah-compliant short to medium-term investment opportunity with HSBC Free HSBC Amanah Gold/Classic Charge Card(s) for the 1st year* Flexibility to invest in Arab Emirate Dirhams, US Dollars, Euros or Pounds Sterling currencies Minimum Investment Amount of AED 25,000 US Dollars 10,000, EURO or GBP 10,000 Competitive Murabaha profit rates

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Option to automatically re-invest the investment amount and Murabaha profit for an additional term Option to avail a Shariah-compliant Amanah Current Account for your banking transactions

Amanah Premium Deposit Plus

Security plus growth in a Shariah compliant manner Shariah compliant product that offers the potential to earn profits linked to the

booming growth in emerging markets, in addition to offering principal protection, Then look no further than the Amanah Premium Deposit Plus. The Amanah Premium Deposit Plus is a three year term deposit designed to offer: 100% Principal protection Final profit linked to any positive performance of a basket of equally weighted BRIC stocks, determined at the end of the three-year term. Any profit paid at the end of the three-year deposit term will be equal to a participation rate of 100% of the increased performance of the basket with a maximum end of term profit capped at 25%, multiplied by the principal deposit amount.

The minimum deposit amount for the Amanah Premium Deposit Plus is AED 37,000 or USD 10,000. You cannot deposit any more money into your Amanah Premium Deposit Plus account once your application has been accepted. You can, however, hold more than one Amanah Premium Deposit Plus accounts should you wish to deposit further.
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Amanah Premium Deposit Plus has been approved by the HSBC Amanah Shariah Committee, an independent committee of Shariah experts of international repute.

Features:

Term: Three-year term Basket of stocks: Equally weighted basket comprising global companies operating in the BRIC countries Benefits: Amanah Premium Deposit Plus will pay a profit equal to a participation rate of 100% of the increased performance of the basket of shares with a maximum end of term profit capped at 25%, multiplied by the principal deposit amount.

Minimum deposit: AED 37,000 or USD 10,000 Closing date: 23rd July, 2008 or earlier if fully subscribed. Accounts are issued on a first come, first served basis. No advance notice of closure will be given.

Commencement date: 1st August, 2008 Early closure of offer: This offer may be withdrawn at any time before the closing date. Account maturity date: Third anniversary of the commencement date. The maturity date will be 25th July, 2011 and the final payment date is 1st Aug, 2011. Should this date fall on a holiday, the reading/maturity date will be taken as the next business day.

Charges: An agency fee of up to 15% of the surrendered amount will be charged only in the case of early withdrawal. However, the agent may waive
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part or the full amount of the agency fee at its sole discretion. In addition, the agent may also deduct such costs it may have to incur as a result of making an early payment. These charges will be deducted from the surrendered amount.

Withdrawals: If you want to withdraw your investment before the termination date, you need to write to your local HSBC Bank Middle East Limited branch. You should note that you may receive an amount less than your original deposit due to early withdrawal. Please refer to clause 3 & 4 of the Agency Letter for more information.

Principal Protection: The Amanah Premium Deposit Plus is structured to return the initial principal plus any profit, only at maturity i.e. three years, and the initial deposit amount may not be returned in full if the deposit is encashed before maturity

Amanah Portfolios
Shariah-compliant Amanah Portfolios offer you the flexibility to choose from three portfolios. You can invest in any one or a combination of two or three portfolios, spreading your investment amount to strike the balance thats right for you.

Portfolio Options
1.

Amanah Defensive Portfolio: This portfolio is designed for investors who want a low to medium risk portfolio which invests in Shariah compliant fixed income funds and some exposure to Shariah compliant equity funds.

2.

Amanah Balanced Portfolio: This portfolio is for investors looking for medium risk growth potential from their investments through a greater
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concentration of equity holdings and a substantial exposure to fixed income instruments to help balance the risk.
3.

Amanah Growth Portfolio: This portfolio is primarily invested in equity funds. This provides investors the potential to earn higher returns than Amanah Balanced or Amanah Defensive Portfolio, in return for a greater degree of risk.

Amanah Personal Finance

Based on its Shariah compliant mechanism, HSBC Amanah Personal Finance offers you an Islamic alternative to a conventional loan. Shariah-approved and certified by HSBC Amanah Shariah Committee Features: Liquidity to meet genuine need of finance for permissible use Extended Finance Payment Terms up to 96 months* Discounted Agency Service fees Competitive Murabaha profit rates Zero down payment on your finance HSBC Amanah Current Account with minimum balance waived

Amanah Home Finance

Shariah approved and certified by the HSBC Amanah Shariah Committee Maximum lease period of up to 25 years for Villages and Townhouses You can apply on a single or joint basis Property age should be less than 10 years old
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A discount in the Ijarah profit rate will be offered to customers transferring their salaries to the Bank Competitive Ijarah profit rates reviewed and updated only once in every six months (on 01Jan and 01Jul every year)

Balance transfer from existing home finance provider at convenient terms Pre-approved HSBC Amanah Al Wafaa Gold Credit Card HSBC Amanah Current Account with minimum balance waived

Amanah Musataha:
HSBC Amanah provide Shariah-compliant solutions to the construction sector. HSBC understand financing requirements and provide project finance according to specific needs. Amanah Musataha covers various types of projects including residential and commercial. The product structure is flexible and consists of the following key benefits: Ownership of the land remains with you all the time Flexible pricing Flexible tenor Convenient lease rentals

Amanah Goods Murabaha:

Amanah Goods Murabaha is a Shariah compliant product that provides short-

to-medium term financing for your working capital requirements and purchase of assets. It involves the Bank purchasing goods/asset at your request and selling the same to you at a sale price on deferred payment basis. It is a Shariah requirement that the breakup of cost and profit in the sale price is disclosed.
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This product is designed to support your needs of local purchase requirements. Examples include financing of: raw materials spare parts, machinery/ equipment finished goods and other trading stocks shares

Main features:
Competitive pricing with the market 1-6 month tenor for working capital finances Longer tenors for purchase of machinery Simple documentation and quick turn-around time Various payment schemes

You will be appointed as HSBC agent to purchase the goods and negotiate the price and other specifications with your supplier

Conclusion
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Islamic banking is a very young concept. Yet it has already been implemented as the only system in two Muslim countries; there are Islamic banks in many Muslim countries, and a few in non-Muslim countries as well. Despite the successful acceptance there are problems. These problems are mainly in the area of financing. Islamic banking is the fastest growing financial sector in the world, with even conventional banks and financial institutions adding an Islamic window to their operations. The Islamic investment and banking arena need is modernization, through the development of more Islamic investment instruments and banking options that take into account the demands and exacting standards of the new age economy. With only minor changes in their practices, Islamic banks can get rid of all their cumbersome, burdensome and sometimes doubtful forms of financing and offer a clean and efficient interest-free banking. All the necessary ingredients are already there. The modified system will make use of only two forms of financing -- loans with a service charge and Mudaraba participatory financing -- both of which are fully accepted by all Muslim writers on the subject. Such a system will offer an effective banking system where Islamic banking is obligatory and a powerful alternative to conventional banking where both co-exist. Additionally, such a system will have no problem in obtaining authorization to operate in non-Muslim countries. The business of Islamic banking and finance is different. While Islamic financial institutions are more like universal banks that undertake various kind of fund based and fee based operations, the characteristics that sets them apart is need for Shariah compliance and promotion of Islamic banking

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The preceding discussion makes it clear that Islamic banking is not a negligible or merely temporary phenomenon. Islamic banking are here to stay and there are signs that they will continue to grow and expand. Even if one foes not subscribe to the Islamic injunction against the institution of interest, one may find in Islamic banking some innovative ideas, which could add variety to the exciting financial network. Participatory financing is a unique feature of Islamic banking, and can offer responsible financing to socially and economically relevant development projects. This is an additional service Islamic banks offer over and above the traditional services provided by conventional commercial banks More research and new Islamic financial instruments are required to have a fully operational Islamic financial system. Absence of adequate regulatory mechanism is yet another problem faced by the banking system. Islamic banking is based on fair principles of equity and justice. It is yet to gain global acceptance and is still in the developing stage. Broad basing the product portfolio and devising many more suitable financial instruments are prerequisites. Developing Shariah compliant liquid money market instruments , framing prudential rules to specific risk characteristics of Islamic financial contracts, development of internationally acceptable accounting standards and establishment of a global regulatory agency are priorities for the future. A sound Islamic financial system though a distant dream, is yet within reach.

FINDINGS AND RECOMMENDATIONS

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Though Bank Muamalat and the BPRS offer a full range of Islamic deposit and credit products, most Islamic credit in Indonesia has taken the form of trade finance though the proportion declines as the partnership or trust provision of working capital increases. Rates differ considerably between institutions and from time to time, but the average rates on Islamic credit often approximate those of other institutions. Although Bank Muamalat did not suffer as severely as many large banks from the financial crisis, it did require some management change and has begun healthy growth again. BPRS and BMT have been growing despite the monetary crisis. The BMT have mobilized a great deal of savings and provided financial services to a large constituency, many of whom have never been served before. They have a large prospective market and the advantage of building on the informal network created by the Islamic institutions with which they are associated as well as the moral sanction that comes with that affiliation. However, as largely unsupervised and unguaranteed institutions, many of which are run by relatively inexperienced personnel using new methodologies, they clearly present prudential dangers though not different in principle from those posed by all savings and loan cooperatives in Indonesia. Thus Islamic finance Enables financial services to an otherwise underserved group including small, rural, and agricultural producers; Furthers a social thrust to assist smaller producers and consumers and is often given in the context of a movement to assist them; but

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Requires some adjustment, mostly formal, of techniques and regulation to take account of Islamic values. Islamic finance, as part of a financial sector development strategy, ought to be encouraged, mainstreamed, and adjusted to. An IMF study on the matter concludes that Islamic finance should be encouraged by regulation and supervision that accommodate its forms while ensuring that their unfamiliarity is not exploited to defraud clients. Normal prudential and supervision norms should be adequate. The paper suggests a modified CAMEL (capital adequacy, asset quality, management, earnings, liquidity) system of banking supervision for Islamic banking. Special risks are the generally uncollateralized nature of Islamic banking and greater risks in the profit-sharing forms of lending. To the extent that Islamic banking is collateralized or does not engage in profit-sharing forms, the issues are less serious. Nonetheless, the Islamic banks are often more comfortable with specialized regulations and infrastructure that recognize their peculiarities. The BMT in particular need adequate supervision and some guarantee for their depositors, though not as elaborate as those provided commercial banks and BPRs. Islamic banking should be mainstreamed by maximizing the interaction between Islamic institutions and the rest of the financial system, subject to the constraints of Shariah. The financial system and its regulation should be adjusted as necessary to accommodate the other two thrusts. In the whole process of the project and by studying it deeply the researches is able to point out the following outcome which are as follows.
1)

Most of the challenges which the Islamic banks in India are facing are
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2) 3) 4) challenges. 5) 6)

The Islamic banks in India are not able to detect the challenges or the Thus , when the challenges grow robustly due to the negligence of the Islamic Bank of Malaysia have learnt from their mistakes by facing there As Islamic Bank of Malaysia is a large capital and infrastructure based Islamic banking in India was forced to give up their business due to the

problems at its initial stages. bank they are not been able to correct / solve by the management quickly.

banks are able to cope up with these challenges. increasing problems such as competition between other commercial banks , high NPA and many more.
7)

In spite of recognizing the power an d scope in the Islamic banking

sector in India the government is not making high level of improvement for its up liftment
8)

In spite of the large customer base the bank have and but the Islamic

bank of India tend to neglect the interest of that customers. 9) If the banks solved the problems without any delay and the banks would be at an advantage

QUESTIONS

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1)What is the basic concept of introducing Islamic banking in your bank?

2)Basically Islamic banking doesnt charge any interest. Does your bank charges any interest?

3)What are the actual differences in normal banking and Islamic banking operations?

4)What are the various types of accounts available In Islamic banking?

5)What are the modes of financing in Islamic banking?

6)How did u implement Islamic banking? (objectives)

7)What are the problems faced by your bank in Islamic banking?

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Bibliography & Webliography

Bibliography
Books/ Journals / Bulletins 1) Indian Banking Marching Forward 2) Indian Banking 2005 Special
3)

Subhi .Y. Labhi :- Capitalism in Medieval Islam", Journal of Economic History

4) Islamic Banking An Introduction 5) Islamic Banking Journal 6) A.L.M Abdul Gafoor :- Islamic Banking

Webliography
1)

www.islamicbanking.com

2) www.bankislam.com.home 3) www.rhbbank.com.home 4) www.islamicbanking/wiki.home

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Glossary
Al-Wadiah = safe keeping Bai'muajjal = deferred-payment sale Bai'salam = pre-paid purchase Baitul Mal = treasury Fiqh = jurisprudence Hadith = Prophet's commentary on Qur'an Hajj = pilgrimage Halal = lawful Haram = unlawful Ijara = leasing Iman = faith Mithl = like Mudaraba = profit-sharing Mudarib = entrepreneur-borrower Muqarada = Mudaraba Murabaha = cost-plus or mark-up Musharaka = equity participation Qard Hasan = benevolent loan (interest free) Qirad = Mudaraba
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Rabbul-mal = owner of capital Riba = Interest Shariah = Islamic law Shirka = Musharaka

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