Potential of Islamic Banking India

Topics: Islamic banking, Bank, Fractional-reserve banking Pages: 11 (1853 words) Published: September 7, 2014



The basic principles on which the Islamic banks function are prohibition of Riba i.e. collection and payment of interest and prohibition of investment in organization involved in unethical and socially harmful activity. the profits earned by a bank from its activities and returns made by a bank to the depositors shall be (a) from sharing of risk in the project and (b) profit-share agreements and not pre-agreed fixed interest payments, which is considered as prohibited earnings because pre-agreed interest agreement has no sharing of risk of investment of money. In last few decades the Islamic bank has gained huge momentum. It is growing faster than any other subset of world banking; at 15 to 20 per cent a year (see McKinsey report (Exhibit1) for asset growth of Islamic bank as compared to conventional banks in selected few companies).The Economist estimates Islamic assets under management are worth $US700 billion ($1000 billion). This figure could hit $US1 trillion - by 2010. Now days the Islamic banking has become major point of discussion in India. Even RBI had appointed a committee to check the feasibility of Islamic banking in India. The India wants to achieve two objectives by offering Sharia compliant banking: a) Financial Inclusion of Muslims: Sachar committee report shows that the Muslims are financially exclude and they are not able to get benefited by the recent growth experienced by India. The report says that the condition of Muslims is similar to that of SC/ST’s. One of the measures of financial loss to Muslims is Credit/deposit ratio which is much lower than the national average. One such calculation is shown in Exhibit (2). In the state-wise analysis it is found that advances to the Muslims are lower than other minorities (Exhibit 3 shows the graph for few states which has high Muslim population). b) To attract capital from Gulf countries and other Muslims nations.

Banks broadly performs two functions:
1) Sourcing of fund
2) Investing the fund
Combined effect of these two transactions is profit generation which ensures the growth and sustainability of any bank. To analyze the future potential of Islamic bank in India we shall use the above model of banks. We would look whether there are enough sources of funds and possible avenues for investment in India which are Sharia compliant.

Sources of Fund: The main source of funding for banks will be a) Public deposits b) Special Investments c) a) Public deposits: Though both Muslims and non-Muslims can avail of Sharia compliant product, but generally the main target of the Islamic bank will be Muslims because it caters not only to their financial product need but religious need as well.

Muslims Depositor: India boasts of about 154 million Muslims. Dinar Standard estimates their total annual household income of $48 billion (Avg. Household Income x Avg. Household size x Population). Dr. Nisar estimates that there are over Indian Rs. 40 billion of funds to invest by Indian Muslims annually. The Muslims till now have been financially excluded. Their condition is described as similar to SC/STs by Sachar committee report. The lower involvement of Muslims in banking system of country could be because of any or combination of following reasons: Unavailability of Sharia compliant product

Unwillingness of the Lenders to lend to Muslims (It may be due to dearth of Collaterals available for getting loan) Financial constraints of the Muslims (Poor household Income) Financial illiteracy of the Muslims.

If Sharia product is made available first problem (a) is completely solved. Second problem (b) partly solved because the Sharia finance is basically equity financing

which does not seek collaterals. But it is yet to be found out which factors contribute to what percentage of the financial exclusion. But we can...
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