By Aniket Raina*

Introduction

The term Islamic Finance (or Islamic Banking) refers to financial ventures that are undertaken in strict conformity with Islamic Law (hereinafter referred to as Shariah i.e., the legal code of Islam). As opposed to its conventional counterparts, Islamic Finance inherently possesses specific key conditions including and not limited to the banning of the collection and payment of riba (interest), and prohibition of activities including maysir (gambling) and gharar (of unknown risk). In short, any financial activities deemed haram or against Islam’s virtues are prohibited. The idea that steers this form of ethical investing rests on the fundamentalistic Islamic tenet that money has no intrinsic value within itself, thereby, cannot be used to acquire(through selling) more money at a profit and is to be used for Shariah accommodating purposes only. According to a report, over 500 Islamic Banks are spread across 72 countries(primarily Middle East-North African and Asian) and are anticipated to witness an 8% yearly average growth until 2025 and up to 4.95 trillion dollars in revenue.

How Islamic Finance Works?

Islamic economics lays forth that all human desires are not endorsed and by extension, Islamic Finance, are to be governed in a systematic manner that doesn’t transgress Shariah. The key principles in place are as follows:

1. Every transaction must hold a definitive purpose and should encompass real material value.
2. The parties that enter into a contract have to share profit and loss; one side cannot bear undue and inequitable influence over the other. By extension, this principle has come to encapsulate the need for existing assets and the preservation of property before entering into an asset-based transaction.

Additionally, there exist 5 contracts to Islamic Finance:

1. Mudarbah is a type of partnership wherein a party called the rabb-ul-mal gives money to the other party, the mudarib for exclusively investing said funds in the desired organization.
2. Musharakah is a joint enterprise wherein both parties agree to pool resources and share profits at an agreed ratio. In some cases, both Mudarbah and Mushakarah are combined to allow both parties to perform an extended role in their contract.
3. Murabahah typically refers to a two-step contractual sale of a commodity with a defined profit and against an adjourned form of payment. The client first initiates an order transaction of a commodity through a bank and then purchases the commodity from a supplier and sells it to the client at the agreed profit, after which the client makes a lump sum payment to the bank.
4. Ijarah is similar to renting out a specific asset or commodity. In this scenario, the leaser who is the bank can rent out the said asset for a defined period until the maturity of the contract and payments are made in full by the lessee.
5. Salam is a form of contract that entails a sale wherein the seller agrees to supply a desired commodity to the buyer at a later date in exchange for an advanced payment for the price of a commodity. This proved beneficial for both parties as the seller could obtain funds quickly whereas the buyer could usually pay less than what would have normally been paid for at a physical market. A fatwa is normally sought from a Shariah scholar to ensure the activity to be pursued by an Islamic Bank per contract is Shariah compliant.

Complications in the Indian Banking & Legal Sphere

In 2008, Raghuram Rajan, former governor of the Reserve Bank of India (RBI) put forward the proposal for the introduction of Islamic Finance in his report on the Financial Sector and thoroughly recommended interest-free banking as beneficial for the lower strata of the population that otherwise does not have sufficient financial security. This was picked up again in the 2015-16 RBI report to the Central Government outlining the need for the introduction of interest-free window banking services to a specific demographic who are financially excluded due to religious reasons. Currently, there is no deadline in place for the formal nationwide introduction of Islamic Finance after the RBI noted that there already exist ‘wider and equal opportunities to citizens in regards to banking service in a reply to an RTI in 2017. In another scenario, the High Court of Jammu and Kashmir (J&K) had closed a PIL filed in 2018 by an NGO that sought to pursue the introduction of Islamic Finance in J&K due to it being deemed unfeasible by the government.

Moreover, the Banking Regulation Act, 1949 which governs banking firms and activities would have to be amended to accommodate interest-free banking activities as Section 5(b) of the Act leaves an umbrella definition that can include financial activities that are not considered tantamount to Shariah. While the majority of the contracts offered under Islamic Finance bear some resemblance to existing Indian contracts (for instance Sukuk which have come to be known as Islamic bonds for Shariah-compliant assets), the lack of an existing regulation that governs the acquisition and management of funds for Islamic Banks is the focal problem at hand. Additionally, the absence of penetration into the Indian financial sphere in comparison with the conventional banking system would leave investors facing Return on Investment (ROI) issues as both profit and loss are shared in specific contracts in the form of equity-based financing. A review would have to be made into non-Islamic countries opening up Islamic banking houses such as American Finance House LARIBA in the US and how such countries can equate their domestic banking services and needs with that of Islamic Finance. States such as Kerala have begun with the implementation of Islamic financial services in the form of a non-deposit taking NBFC, Cheraman Financial Services Ltd. Further examination would have to be made into whether Islamic Finance can exist within the context of NBFCs per Section 45-I(f) of the Reserve Bank of India Act, 1934.

An overarching issue in connection can cause concern, specifically, the Uniform Civil Code (UCC) as it aims to implement common personal laws irrespective of caste, religion, etc. Moreover, the Shariah-trained scholars require extensive consideration of a financial transaction before issuing a certificate that asserts its compliance with Shariah. On top of an already increasing scarcity of Shariah scholars and not being able to keep up with industry demand, there may be differing views on what would comply as Shariah compliant and in a country as legally diverse as India, this problem would multiply many times over. 

Conclusion

To conclude, Islamic Finance acts parallel to the personal laws of Muslims, and any potential legislation that seeks to legitimize the Shariah-compliant institution on a nationwide scale would have to move in tandem with their respective religious sentiments. If ever instituted as part and parcel of the Indian Banking System, Islamic Finance needs to follow a ‘Bottom-Up’ approach. What this means is that at the grassroots level, those who would not have maintained secure access to steady finance otherwise can benefit through circumvention of traditional banking limitations. As confidence in the industry grows, further legislation and regulations can be implemented that seek to corroborate the vision of Indian Banking Regulations while keeping the intrinsic principles of Islamic Finance.

*Aniket Raina is a 3^rd year law student at Amity Law School, Noida.