RBI says no to Islamic banking

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RBI has decided not to pursue a proposal for introduction of Islamic banking in the country. Replying to an RTI query, the central bank said the decision was taken after considering “the wider and equal opportunities” available to all citizens to access banking and financial services.

What is Islamic Banking?

  • Islamic or Sharia banking is a finance system based on the principles of not charging interest, which is prohibited under Islam.
  • Two basic principles behind Islamic banking are the sharing of profit and loss and, significantly, the prohibition of the collection and payment of interest by lenders and investors. Collecting interest or “riga” is not permitted under Islamic law.

How Do Islamic Banks Earn Money Without Using Interest?

In order to earn money without charging interest, Islamic banks use equity-participation systems. This means that if a bank loans money to a business, the business pays back the loan without interest, but it gives the bank a share in its profits. If the business defaults on the loan or does not earn any profits, the bank does not receive any profit either.

History of Islamic Banking

  • The origin of Islamic banking dates back to the very beginning of Islam in the seventh century. The prophet Muhammad’s first wife, Khadija, was a merchant, and he acted as an agent for her business, using many of the same principles used in contemporary Islamic banking.
  • In the Middle Ages, trade and business activity in the Muslim world relied on Islamic banking principles, and these ideas spread throughout Spain, the Mediterranean and the Baltic States, arguably providing some of the basis for western banking principles. In the 1960s to the 1970s, Islamic banking resurfaced in the modern world.

How this proposal started at RBI?

  • It all started in late 2008, when a committee on Financial Sector Reforms, headed by former RBI governor Raghuram Rajan, had stressed on the need for a closer look at the issue of interest-free banking in the country.
  • “Certain faiths prohibit the use of financial instruments that pay interest. The non-availability of interest-free banking products results in some Indians, including those in the economically disadvantaged strata of society, not being able to access banking products and services due to reasons of faith,” the committee had said.
  • Later, on the instruction of the central government, an inter-departmental group (IDG) set up in the RBI examined the legal, technical and regulatory issues for introducing interest free banking in India and has submitted its report to the government.
  • RBI had in February last year sent a copy of the IDG report to the finance ministry and recommended an “Islamic window” in conventional banks for gradual introduction of Sharia-compliant banking.
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