ISLAMIC BANKING:

PROSPECTS &
CHALLENGES
Brennen College Seminar
27 October 2014
PA Shameel Sajjad
Director Zirva Institute of Islamic Finance
Outline
The Inherent Problem with Conventional Banking
The Alternative of Islamic Banking
Challenges Posed by the Law in India

The Inherent Problem with
Conventional Banking
The Instrument of Interest
The concept of interest presumes the usage of capital as a
factor of production and claiming a reward for the usage like
the other factors of production vis a vis land, labour and
organization.
But in reality capital is not an original factor of production.
It is only a means to acquiring other factors of production.
This is evident from the fact that capital cant go directly into
production like other factors but will be used only in the
procurement of any of the other factors of production that
can be directly used in the process of production.
This argument is supported by several economists including
Ludwig Heinrich Edler von Mises (1881 1973); the world
renowned philosopher, Austrian School economist,
sociologist, and classical liberal It is true that majority of
the economists reckon money among production goods.
Nevertheless, arguments from authority are invalid; the proof
of a theory is in its reasoning, not in its sponsorship; and with
all due respect for the masters, it must be said that they have
not justified their position very thoroughly in the matter.


The concept of the right to interest on
capital creates the necessity for securing the
capital loaned and the interest thereupon.
Securing this right and ensuring repayment of
capital and payment of interest cant depend
upon the financial destiny of the enterprise.
This makes the whole mechanism of
conventional banking collateral based even
for risky enterprises.
With the existence of collateral as an essential
condition for lending, conventional banking system
can never become inclusive.
Rather it becomes exclusively reserved for the
sections of population who are relatively well off
with some asset base (which can be offered as a
collateral).
This reality can be verified in the Indian context from
the statistics issued by the Reserve Bank of India.
The number of loan accounts constituted only 14 per cent of
adult population - In rural areas, the coverage is 9.5 per cent
against 14 per cent in urban areas.
The extent of exclusion from credit markets can be observed
from a different view point. Out of 203 million households in
India; 89 million are farmer households. 51.4 per cent of farm
households have no access to formal or informal sources of
credit while 73 per cent have no access to formal sources of
credit.
However after 1991, the share of non institutional sources has
increased; specifically, the share of moneylenders in the debt
of rural households increased from 17.5 % in 1991 to 29.6% in
2002.
The financially excluded sections largely
comprise marginal farmers, landless labourers,
oral lessees, self employed and unorganised
sector enterprises, urban slum dwellers,
migrants, ethnic minorities and socially
excluded groups, senior citizens and women.
Source: Text of speech by Smt. Usha Thorat,
Deputy Governor, Reserve Bank of India at the
HMT-DFID Financial Inclusion Conference 2007,
Whitehall Place, London, UK on June 19, 2007.


For India, financial inclusion has become a key
policy concern as there are over 600 million
citizens who lack basic banking and financial
services.
In India, financial exclusion has strong linkages
with poverty and is predominantly
concentrated among the vast sections of
disadvantaged and low income groups.

One of the important factors behind rising farmer
suicides in the countryside is the lack of access to credit
from banks and institutional sources and the inability to
repay due to loss of crops.
In the early 2000s, India launched a massive drive to
bring most of its population under the formal banking
system.
However, 90% of the 100 million accounts opened under
the plan are unused and close to half of Indias 1.2
billion-strong population still dont have bank accounts.

The number of the Indian poor constitutes
33% of the global poor, which is pegged at 1.4
billion people.
According to World Bank estimate, India had
456 million people or about 42% of the
population living below poverty according to
the new international poverty line of US$ 1.25
per day.
If the international poverty line is slightly
raised from the US$ 1.25 /day to US$ 2 / day
the scenario is further disheartening.
Based on that measurement, India had 828
million people, or 75.6% of the population
living below the poverty line surpassing the
sub Saharan Africa, considered the worlds
poorest region with 72.2% people without
US$ 2 / day.

Key Facts and Figures
41% of the population in India is unbanked.
40% is unbanked in urban areas.
61% is unbanked in rural areas.
Only 14% of the population have loan
accounts.
9.5% in rural areas.
14% in urban areas.
203 million households in India
147 million households in rural areas
89 million are farmer households.
51.4% of farm households have no access to formal
or informal sources of credit.
73% of farm households have no access to formal
sources of credit.
Share of money lenders in debt finance has
increased.
The Islamic Alternative
By taking out the interest out of the process of financial
intermediation Islamic baking has strong nexus with actual
production and distribution on the ground.
Money as such doesnt have a right to earn. The right to
positive revenues is an entitlement which is granted by
partaking the risks and uncertainties of productive activities.
When this maxim is established collateral will have no
significant role as far as financing for productive activities are
concerned.
This is because there is no binding responsibility on the
entrepreneur to guarantee the repayment of the capital and
interest. The binding responsibility is to share the revenue /
profit of the venture.
As soon as this happens the focus shifts to inherent capability
of the venture to generate profits which will depend in turn
on a number of factors like demand for the commodity /
brand, capability of the entrepreneur, quality of management,
sincerity of the entrepreneur etc.
Thus a financial atmosphere is established in which the asset
backing of the clients of the bank will be of little use to the
bank and the rich and the poor will be on a level playing field;
a scenario where the richness of the rich will no longer be a
privilege and the poverty of the poor will no longer be a an
obstacle.
Thus Islamic banking is a transition from
aristocratic / feudal / undemocratic banking to
democratic banking for the masses.
For the bank its positive returns will be worked
out on the basis of the Portfolio theory. That is
even after the due diligence exercised before
investing in projects if some projects fail they will
be made up by the success of other projects.


Potential High Impact Areas for
Islamic Banking in India
Agriculture
"Slow agricultural growth is a concern for policymakers
as some two-thirds of Indias people depend on rural
employment for a living. Current agricultural practices
are neither economically nor environmentally sustainable
and India's yields for many agricultural commodities are
low. Poorly maintained irrigation systems and almost
universal lack of good extension services are among the
factors responsible. Farmers' access to markets is
hampered by poor roads, rudimentary market
infrastructure, and excessive regulation."
World Bank: "India Country Overview 2008"

"With a population of just over 1.2 billion, India is the worlds largest
democracy. In the past decade, the country has witnessed accelerated
economic growth, emerged as a global player with the worlds fourth
largest economy in purchasing power parity terms, and made progress
towards achieving most of the Millennium Development Goals. Indias
integration into the global economy has been accompanied by impressive
economic growth that has brought significant economic and social
benefits to the country. Nevertheless, disparities in income and human
development are on the rise. Preliminary estimates suggest that in 2009-
10 the combined all India poverty rate was 32 % compared to 37 % in
2004-05. Going forward, it will be essential for India to build a productive,
competitive, and diversified agricultural sector and facilitate rural, non-
farm entrepreneurship and employment. Encouraging policies that
promote competition in agricultural marketing will ensure that farmers
receive better prices."
World Bank: "India Country Overview 2011

Share in National Income: The contribution from
agriculture has been continuously falling from 55.1% in
1950-51 to 37.6% in 1981-82 & further to 18.5% in 2006-
07. But agriculture still continues to be the main sector
because it provides livelihood to majority of the people.
Largest Employment Providing Sector: in 1951, 69.5% of
the working population was engaged in agriculture. This
percentage fell to 66.9% in 1991 and to 56.7% in 2001.
However, with rapid increase in population the absolute
number of people engaged in agriculture has become
exceedingly large.

Islamic Banking Solutions to the
Farming Sector
Salam Advance Purchase of Crops
Muzaraa Share Cropping
Musaqath Crop Sharing for Maintenance
Infrastructure
The infrastructural requirement of India is US$ 1
trillion.
This cant be financed by government funding alone.
Islamic banks can issue sukuk to address this
requirement.
This will not introduce any additional debt burden on
the citizens of India.
We currently have a per capita debt of Rs. 33,000/-
The debt repayment for 2014/15 is seen at 1.397
trillion rupees.
Micro Medium and Small Enterprises
MSMEs are the real growth drivers in any
economy.
Overall finance gap in MSME sector is 32.5 trillion
rupees (MSME Census, RBI, SIDBI).
MSMEs largely require equity financing.
But the demands of listing and the competitive
conventional equity markets are not easily
accessible for them.
This vast need can be financed by Islamic banks
which rely on risk financing which is the essence
of the MSME sector.
Obstacles for the Introduction of
Islamic Banking in India
Section 5 (b) and 5 (c) of the Banking Regulation Act,
1949 prohibit the banks to invest on Profit Loss Sharing
basis -the very basis of Islamic banking.
Section 8 of the Banking Regulations Act (BR Act, 1949)
reads, No banking company shall directly or indirectly
deal in buying or selling or bartering of goods
Section 9 of the Banking Regulations Act prohibits bank
to use any sort of immovable property apart from
private use this is against Ijarah for home finance.
Section 21 of the Banking Regulations Act requires
payment of Interest which is against Sharia.

Operational Issues
SLR Requirements Banks have to invest at
least 25% of their NTDL (Net Demand and
Time Liability) in government securities.
CRR Requirements 6.5% of NTDL should be
deposited with RBI on which interest accrues.
Call Money Call Money Rate on Borrowing
from other banks which carries interest.
Repo Transactions Banks borrow from the
Central Bank which carries interest.
Raghuramrajan Committee Report
Chapter 3: Broadening Access to finance Page 35

While interest-free banking is provided in a limited manner through
NBFCs and cooperatives, the Committee recommends that measures be
taken to permit the delivery of interest-free finance on a larger scale,
including through the banking system. This is in consonance with the
objectives of inclusion and growth through innovation. The Committee
believes that it would be possible, through appropriate measures, to
create a framework for such products without any adverse systemic risk
impact.
THANK YOU!!


Contact details
shameelsajjad.pa@zirvabs.com
+91 9745 812 277

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Contact details
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+91 9745 812 277