Interest Free BankingA Complete Social Responsible Banking

Dr. Abdul Majid Ansari,Dr. Sirajuddin H Chougle,

Dr. Mohammad Moghess, (HoD).Associate Professors, Department of Commerce,

Maharashtra College, Nagpada, Mumbai. 8

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Statement of scientific question addressed

1. Why Interest Free Banking is Complete Social Responsible Banking?

2. Why Interest Free Banking in India?3. How will it work? Or will it survive?

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Brief Description of Methodology

Secondary Source

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Why Social/Ethical deficit? Types of Banks Possibility of CSR

1. The banks based on only commercial principles

May or may not become socially

responsible2. The banks based on ethical/social plus commercial principles

Sure to become socially

responsible

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1. How Interest Free Banking is Complete Social Responsible Banking?

Finances only for fully social and ethical business.Works on the SHARIA (Islamic rules) principles:• No finance for:1. Alcohol/wine business2. Interest based business3. Drugs4. Speculation5. Lottery6. Black-marketing7. Hoarding8. Vulgar/ anti-social activities9. Prostitution10. Gambling11. Music and dance

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2. Why interest free banking in India?

Two major socio-economic problems:

• Social/Ethical deficit• Acute poverty (widening

gap between rich and poor).

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A Reason for widening gap between rich and

poor

INTEREST

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What’s wrong with interest?

• Interest system is not just. One party is assured returns (interest) and the other is left with uncertainty.

• Interest accumulates money in a few hands, resulting Rich becomes richer and poor becomes poorer.

• Interest based loans may create feelings like jealousy, selfishness, greed, misery, narrow-mindedness, and revenge.

• Capital itself alone is not a productive factor of production, unless combined with others.

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3. How will it work? Or will it survive?

Arguments against IFB:• Zero interest means infinite demand for loanable fund

and zero supply.• System would be incapable of equilibrating demand

and supply of funds.• Zero interest would mean no savings.• Zero saving means no investment and no growth.• There could be no monetary policy since instruments

for managing liquidity could not exist without a pre determined rate of interest.

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The Experts Speak

1. “While IFB is provided in a limited manner through NBFCS and co-operatives, the committee recommends that measures be taken to permit the delivery of interest free finance on a larger scale, including through banking system.”

(High level committee of planning commission of India, report submitted to chairman, Dr. Manmohan Singh, on 12th September 2008)

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The Experts Speak

2. “Another area that falls broadly in the ambit of financial infrastructure for inclusion is the provision of interest free banking.”

(Dr. Raghuram Rajan Committee. (financial sector reforms committee report)

3. “The ethical principles on which islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service”.

(The Vatican official newspaper L’Osservatore Romano, said in an article dated 5th march 2009.

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The Experts Speak

4. Islamic banking may be the solution to farmer suicide crisis in Vidarbha.

(M S Swaminathan, Father of Indian Green Revolution)

5. It (Islamic Banking) is an idea, whose time has come.

(MBN Rao, Chairman, Indian Bank Association, spoke in august 2007

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The arguments in favour:• IFB are for all and not only for Muslims.• There are 265 successful interest free banks in 40 countries with an asset of

$ 400 billion. • UK, Hongkong, Singapore and France have incorporated Islamic banking.• No fixed rate of interest does not mean zero returns on capital.• The return on capital is determined ex post and the magnitude of the return

on capital is determined on the basis of the return to economic activity. • This expected returns determine the investment.• The expected returns and incomes determine savings.• Positive growth is possible in such a system.• Monetary policy would function as in the conventional system, its efficiency

depending upon the availability of the instruments designed to manage the liquidity.

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Indian situation for Islamic Banking

• The first Islamic Bank with active involvement of the Kerala government is likely to start operations in Kochi very soon.

• Out of 6000 listed BSE companies, 4200 are shariah compliant• BSE has a shariah compliant index called BSE TASIS shariah 50

index.• Reliance Capital Asset Management has two Islamic Funds

which are managed from Malaysia.• Bechmark Asset Management launched India’s first shariah

compliant exchange traded fund on 4th February 2011.• Reliance Mutual Fund, UTI Asset Management, Way2wealth

and Edleweiss Mutual Fund are shariah compliant.

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Why interest is Haram (prohibited) in Islam?

1. Economic2. Moral3. Social

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If interest is banned

•Effects on Savers•Effects on Banks•Effects on government finances

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Why Conventional Banking may not be Complete Social Responsible Banking?

• It finances all types of business (social or anti-social).• By charging interest, it directly

helps in widening the gap between the rich and the poor.

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How do interest free banks work?

• On profit and loss sharing basis (principle of equity and justice) • Can collect deposits, directly invest in

business or give loan to businessmen on P & L basis.• Musharika (Partnership) and

Mudariba

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The Islamic Financial System, perfectly suitable for CSR

1. Trusteeship2. Care for Others3. Productive effort as a means of serving God4. Application of the Shariah Rulings5. Treating Wealth as a Means and not an End6. Proper Functioning of the Market7. Protection of Consumers8. No monopolies9. Zakat10. Qard-e- Hasana

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CONVENTIONAL BANKS INTEREST FREE BANKS

1. The functions and operating modes of are based on RBI guidelines.

1. The functions and operating modes are based on RBI guidelines and Shariah.

2. The investor is assured of a predetermined rate of interest.

2. It promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur).

3. It aims at maximizing profit without any restriction.

3. It also aims at maximizing profit subject to Shariah restrictions.

4. It does not deal with Zakat. 4. It has become one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre.

5. Lending money and getting it back with compounding interest is the fundamental function.

5. Participation in partnership business is the fundamental function.

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CONVENTIONAL BANKS INTEREST FREE BANKS

6. It can charge additional money (penalty and compounded interest) in case of defaulters.

6. These banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds are given to charity. Rebates are given for early settlement at the Bank’s discretion.

7. Very often it results in the bank’s own interest becoming prominent. It makes no effort to ensure growth with equity.

7. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity.

8. Borrowing from the money market is relatively easier.

8. Borrowing must be based on a Shariah approved underlying transaction.

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CONVENTIONAL BANKS INTEREST FREE BANKS

9. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations.

9. Since it shares profit and loss, the Islamic banks pay greater attention to developing project appraisal and evaluations.

10. Give greater emphasis on credit-worthiness of the clients.

10. Give greater emphasis on the viability of the projects.

11. The status of a conventional bank, in relation to its clients, is that of creditor and debtors.

11. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller.

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The challenge of adopting an Islamic Financial System

•The challenge of adopting an Islamic financial system •The challenges facing individual Islamic banks

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Suggestions and Recommendations

• Permission from the RBI is required.• Ethical aspects should be

highlighted.• Detailed need based Research and

Development should be undertaken.• Willingness to discuss various issues.

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Thanks a lot.

A dishonest rich businessman or organization is greater liability to a nation than a poor man or organization.