Building blocks of Islamic banking

Posted: Monday, Aug 01, 2005 at 0000 hrs IST
Updated: Monday, Aug 01, 2005 at 0000 hrs IST

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: The Reserve Bank of India has appointed a committee to examine the feasibility and possibility of facilitating Islamic banking in India. Islamic banking is a recent concept, which is slowly replacing interest-based banking in many parts of the world. The Islamic finance is based and functions on the basis of a model which does not involve interest on lending as well as on deposit, and financial institutions like banks share both profits and losses from the business. The modus operandi of these banks are worth considering for an economy whether it is a secular or Islamic state.

Islamic banks use the principle of Almudarib-udarib, which means they mobilise financial funds on the basis of profit sharing and extend the same to the users on the same basis. There are two broad instruments for mobilising deposits and extending finance, viz. Mudarabah and Musharakah. In case of these instruments, the return cannot be fixed in advance and it is determined ultimately by the profits earned by the business. Whether they are depositors or bankers, they have to share profits as well as losses. Uarze-hasna is another instrument for deposit mobilisation and for extending finance. On this instrument, the bank does not pay dividend. They are like current deposits. In addition to deposits, an Islamic bank can raise resources by issuing equity shares. Equity shareholders participate in the management of Islamic banks. Let us have a little more explanatory analysis on Islamic instruments and their modus operandi to make the readers of an alternative model of banking. As mentioned above, Mudarabah, an instrument in Islamic banking is a contract between the bank and the entrepreneur (manager) or user of the capital. The bank in this case does not participate in the business and the profit is distributed between them, according to the ratios fixed in the agreement between both parties. The financial loss is borne by the bank and the entrepreneur (manager) bears the loss by not getting any return in compensation for the opportunity cost of his own labour and managerial work. Musharakah is a contract between the bank and entrepreneur. Here, the financier (bank) participates in the management and also shares the profit and loss. While profits are distributed according to an agreed ratio, the loss is borne in proportion to the share of each in the total capital. Murabahah is a sale contract with a profit mark-up. The client...

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