INTRODUCTION TO THE CONCEPT OF ISLAMIC BANKING AN INDIAN PERSPECTIVE

INTRODUCTION TO THE CONCEPT OF ISLAMIC BANKING AN INDIAN PERSPECTIVE

1.1 INTRODUCTION

Islamic banking is popularly known as Interest free banking, originated in Egypt around the year 1963. It has grown at the rate of 15% per annum and today, it accounts for about USD300 bn in assets and projected to reach USD 1 trillion by the end of 2014. Ever since its inception in an Egyptian hamlet, Islamic banking has never looked back. An Islamic Development Bank was established in Jeddah in 1975 and a number of commercial banks such as the Dubai Islamic Bank, the Kuwait Finance House and the Bahrain Islamic Bank also came into existence in the 1970s and 1980s. The banking system in Pakistan and Iran is also Islamized to a large extent. Now there are about 203 Islamic Financial Institutions including banks. Besides these exclusive Islamic Financial Institutions, some banks in the West serve the Muslim community in accordance with their religious principles. Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba (usury). Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah). 1.2 LITERATURE REVIEW Presently in India, Islamic banking is confined to the co-operative sector. Only 10-15 Islamic banks with deposits of about Rs 75 cr are operating all over the country in various states. They are actually non-banking finance companies (NBFCs), which work on no-profits-no-loss basis. Islamic banks by and large cater to the needs of local area except a few that operate across districts or states. These banks do not function under banking regulations. They are licensed under Non Banking Finance Companies Reserve Bank Directives 1997 RBI (Amendment) Act 1997. RBI has also introduced a compulsory registration system. (This extract is from an article published in Sify Finance October, 2005) In India, with the world's second largest Muslim population of 154 million, the lack of Islamic banking is a barrier to the flow of substantial funds into the market. "There is at least Rs5,000 crore of unclaimed interest in Kerala alone. People prefer to put their money in gold or jewellery, which is the worst kind of investment from an economic point of view," says Shariq Nisar, CEO, Bearys Amanah Investment. There are atleast 300 Islamic societies which accept deposits and lend money, but can't make a business of it because of the Shariah's prohibition of interest. And they are not able to convert themselves into banks because the government will not permit any form of banking without interest. Some of them have collected more than Rs200 crore in interest-free deposits, but they do not have any avenue to invest that money. (This extract is from an article published in DNA November 9, 2008)

With Islamic finance industry at its infancy in India, a lot of misconception has been creeping in such considering this banking system exclusively for Islam followers. But the sources from around world says that some of the banks that are operating in Malaysia and Baharain, which are considered to be the hub for Islamic banking has more of non Islam followers as their customers. ( This is an abstract taken from an article published in The Mille Gazette , July issue 2006) The Indian banking system is losing a staggering Rs2-3 lakh crore annually, due to the delay in introducing Islamic banking laws, analysts say. K Rehaman Khan, deputy chairman of Rajya Sabha added that once the system is recognized, savings of the Muslim community would only make Indian banking richer and stronger. (This is an abstract taken from an article published in June issue of The Financial Express, 2006)

1.3 NEED OF THE STUDY

In India Islamic banking has not been legally employed. Its presence is only in the NBFCs. Even though international banks like HSBC and Standard Chartered bank are pressurizing the government to implement Islamic banking in the banking system of the country, its papers are still in pipeline. Moreover there are 4400 companies that are Shariah-complaint, which is the highest in comparison to Malaysia or Pakistan. India has an Islam following population of 150million which definitely is a potential market for Islamic banking if implemented in India. But there is already news around the nation that Islamic banking is not suitable for a nation like India which is a secular state with very religion conscious people. And some experts states that the Islamic banking will fail in India since the name of the banking system will create misconception in the minds of the people. It is necessary to know the opinion of people regarding the implementing Islamic banking in India. Hence a study is to be done in order to find the attitude and opinion about Islamic banking in India.

1.4 STATEMENT OF THE PROBLEM Islamic banking command assets base of $2 trillion across the world. In India, with the world's second largest Muslim population of 154 million, the lack of Islamic banking is a barrier to the flow of substantial funds into the market and its presence only in Non Banking Financial Sector and not in the regular banking business. Even though there are similarities to conventional banking it cannot be carried out in the similar lines since it has alliance to the Islam religious principles. But the strategy to enter must be very effective since its presence in India is in an infancy stage. Thus this study will provide an insight into the areas of concern that has to be dealt with when adopting Islamic banking in India. And to understand the attitude and acceptance of people if Islamic banking is adopted in India. The title of the study - Introduction to the concept of Islamic banking an Indian perspective

1.5 OBJECTIVE OF THE STUDY

To study the acceptance of interest-free banking in Mangalore, India. To find the awareness level of interest-free banking among people in Mangalore, India. To determine the prospect of Islamic banking in India. To understand the attitude of the people on introduction of Islamic banking in India. To understand the problems in implementing Islamic banking in India.

1.6 SCOPE OF THE STUDYThis study will provide an insight to existing bankers and new Islamic banks to form strategies and to adopt informative decisions for implementing Islamic banking in India. This study on Islamic banking will give bankers an insight on their prospective clients.

1.7 RESEARCH METHODOLODY

1.7.1 Type of study:The type of study that was carried out was both exploratory and descriptive Researches. The Exploratory research gave an insight into Islamic banking in India, and descriptive research helped in measuring various parameters.

1.7.2 Sources of data: The sources of data were primary sources and secondary sources.

1.7.3 Method of collecting primary data: The information required was collected through questionnaires, by using a survey or descriptive research method.

1.7.4 Sources of secondary data:Secondary data means data that are already available i.e. they refer to the data which has been collected and analyzed by someone and can save both money and time of the researcher if it is complete and not outdated. Secondary data sources are as follows:

News paper articles: The Hindu, Economic Times, Financial Express, Indian Express.

Journals: ICFAI Journal, Indian Journal of Finance, Infosys finacle etc.

Websites: www.surveymoney.com, www.survio.com, www.studymode.com, www.slideshare.com etc.

YouTube: 1.What Is Your Opinion On Islamic Banking? Sheikh Imran Hosein (http://www.youtube.com/watch?v=W1zbdg64nAI ) 2. Dr Subramanian Swamy explains Islamic Banking in India etc. (http://www.youtube.com/watch?v=fTyFmlQOmIU)

1.7.5 Type of survey: A sample survey was carried out.

1.7.6 Sampling Unit:The sampling units were Bankers, Students, Entrepreneurs, Professionals, Govt. employees, Pvt. Employees, & others.

1.7.7 Sample size:The sample size considered for the study was 60 & which also includes the sample of Muslims & Bankers.

1.7.8 Tools for data collection: A structured questionnaire was formulated and given to a respondent which was the tool that was utilized for data collection along with the secondary data collection. The questionnaire was formulated in such a way as to have a very few open ended questions to make it easier for analysis of data. Each questionnaire was distributed and collected by the researcher in person.

1.7. 9 Analysis & Interpretation of data:The data obtained from all respondents was analyzed & presented systematically through tabular & graphical representation so as to reach the desire end.

1.8 LIMITATIONS OF THE STUDY

The main limitation of the study was that Islamic banking is only an emerging concept hence the sample may not truly represent the population.

Further due to limited time constraint the sample size was 100 only. But efforts were taken that it represents the population.

The coverage of study was limited to Mangalore alone and the result of this may not truly represents the whole of the country.

The study is restricted only to an introductory stage; it doesnt involve the deeper perspective.

1.9 CHAPTER SCHEME The study was divided into five chapters and presented accordingly,

Chapter 1: Introduction to the topic This chapter will include the introduction, statement of the problem, need, objective, research methodology, literature review, scope, limitation of study.

Chapter 2: Theoretical Framework This chapter will include the concepts, definitions & related issues of the topic.

Chapter 3: Service Profile This chapter will comprise the details about banking industry, scope, growth, opportunities, challenges, PEST.

Chapter 4: Analysis and interpretation in this chapter the data collected from the respondents will be tabulated and the analysis will be done with the help of statistical tools.

Chapter 5: Summary of Findings, Conclusions and suggestions This chapter will include the summary of findings obtained from the inferences and the conclusions will be made with respect to the findings.

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2.1 INTRODUCTION

Islamic banking is a new phenomenon that has taken many observers by surprise. The whole banking system has been Islamized in both Iran and Pakistan. In addition, there are some thirty Islamic banks in operation in other parts of the globe, including the Jeddah-based Islamic Development Bank (IDB) but excluding numerous non-bank Islamic financial institutions.

Islamic banking refers to a system of banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the payment of fees for the renting of money (Riba, usury) for specific terms, as well as investing in businesses that provide goods or services considered contrary to its principles (Haraam, forbidden). While these principles were used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that a number of Islamic banks were formed to apply these principles to private or semi-private commercial institutions within the Muslim community.

The World Islamic Banking Conference held annually in Bahrain since 1994 is the unique platform internationally recognized as the largest and most significant gathering of Islamic banking and finance leaders in the world. 2.1.1 Evolution of Islamic Banking: The first modern experiment with Islamic banking was undertaken in Egypt under cover, without projecting an Islamic image, for fear of being seen as a manifestation of Islamic fundamentalism. The pioneering effort, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in l963. This experiment lasted until l967 (Ready l98l), by which time there were nine such banks in the country. They functioned essentially as saving- investment institutions rather than as commercial banks. The Nasir Social Bank, established in Egypt in l97l, was declared an interest-free commercial bank, although its charter made no reference to Islam or Shariah (Islamic law).

The IDB was established in l974 by the Organization of Islamic Countries (OIC), but it was primarily an inter-governmental bank aimed at providing funds for development projects in member countries. The IDB provides fee- based financial services and profit-sharing financial assistance to member countries. The IDB operations are free of interest and are explicitly based on Shariah Principles.

In the seventies, a number of Islamic banks, both in letter and spirit, came into existence in the Middle East, e.g., the Dubai Islamic Bank (l975), the Faisal Islamic Bank of Sudan (l977), the Faisal Islamic Bank of Egypt (l977), and the Bahrain Islamic Bank (l979), to mention a few. The Asia-Pacific region was not oblivious to the winds of change. The Philippine Amanah Bank (PAB) was established in l973 by Presidential Decree as a specialized banking institution without reference to its Islamic character in the bank's charter.Islamic banking made its debut in Malaysia in l983, the first Islamic financial institution in Malaysia was the Muslim Pilgrims Savings Corporation set up in l963 to help people save for performing hajj (pilgrimage to Mecca and Medina). In l969, this body evolved into the Pilgrims Management and Fund Board or the Tabung Haji, as a non-bank financial institution. The success of the Tabung Haji, however, provided the main impetus for establishing Bank Islam Malaysia Berhad (BIMB) which represents a full-fledged Islamic commercial bank in Malaysia. BIMB has a complement of fourteen branches in several parts of the country. Plans are afoot to open six new branches a year so that by l990 the branch network of BIMB will total thirty-three (Man l988).

Reference should also be made to some Islamic financial institutions established in countries where Muslims are a minority. There was a proliferation of interest-free savings and loan societies in India during the seventies (Siddiqi l988). The Islamic Banking System (now called Islamic Finance House), established in Luxembourg in l978, represents the first attempt at Islamic banking in the Western world. There is also an Islamic Bank International of Denmark, in Copenhagen, and the Islamic Investment Company has been set up in Melbourne, Australia.

2.1.2 Principles of Islamic Banking: In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments. However, the fact that it is profit cannot be made explicit and therefore there are no additional penalties for late payment. In order to protect itself against default, the bank asks for strict collateral. The goods or land is registered in the name of the buyer from the start of the transaction. This arrangement is called Murabaha. Another approach is EIjara wa EIqtina, which is similar to real estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid).

An innovative approach applied by some banks for home loans, called Musharaka al-Mutanaqisa, allows for a floating rate in the form of rental. The bank and borrower forms a partnership entity, both providing capital at an agreed percentage to purchase the property. The partnership entity then rent out the property to the borrower and charges rent. The bank and the borrower will then share the proceeds from this rent based on the current equity share of the partnership.

At the same time, the borrower in the partnership entity also buys the bank's share on the property at agreed installments until the full equity is transferred to the borrower and the partnership is ended. If default occurs, both the bank and the borrower receive the proceeds from an auction based on the current equity. This method allows for floating rates according to current market rate such as the BLR (base lending rate), especially in a dual-banking system like in Malaysia.

There are several other approaches used in business deals. Islamic banks lend their money to companies by issuing floating rate interest loans. The floating rate of interest is pegged to the company's individual rate of return. Thus the bank's profit on the loan is equal to a certain percentage of the company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka. Further, Mudaraba is venture capital funding of an entrepreneur who provides labor while financing is provided by the bank so that both profit and risk are shared. Such participatory arrangements between capital and labour reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, resulting in a balanced distribution of income and not allowing lender to monopolize the economy.

And finally, Islamic banking is restricted to Islamic ally acceptable deals, which exclude those involving alcohol, pork, gambling, etc. Thus ethical investing is the only acceptable form of investment, and moral purchasing is encouraged.

In theory, Islamic banking is an example of full-reserve banking, with banks achieving a 100% reserve ratio However, in practice, this is not the case, and no examples of 100 per cent reserve banking are observed. Islamic banks have grown recently in the Muslim world but are a very small share of the global banking system. Micro-lending institutions founded by Muslims, notably Grameen Bank, use conventional lending practices and are popular in some Muslim nations, especially Bangladesh, but some do not consider them true Islamic banking.

However, Muhammad Yunus, the founder of Grameen Bank and microfinance banking, and other supporters of microfinance, argue that the lack of collateral and lack of excessive interest in micro-lending is consistent with the Islamic prohibition of usury (riba).

2.1.3 Islamic Banking Terminology:

1) Bai' al-inah (sale and buy-back agreement)The financier sells an asset to the customer on a deferred-payment basis, and then the asset is immediately repurchased by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency. Some scholars believe that this is not compliant with Shariah principles.

2) Bai' bithaman ajil (deferred payment sale)This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. This is similar to Murabahah, except that the debtor makes only a single installment on the maturity date of the loan. By the application of a discount rate, an Islamic bank can collect the market rate of interest.

3) Bai muajjal (credit sale)Literally bai muajjal means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of murabaha muajjal. It is a contract in which the bank earns a profit margin on the purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price. (Deferred-payment sale)

4) Mudarabah (profit sharing)Mudarabah is an arrangement or agreement between the bank, or a capital provider, and an entrepreneur, whereby the entrepreneur can mobilize the funds of the former for its business activity. The entrepreneur provides expertise, labor and management. Profits made are shared between the bank and the entrepreneur according to predetermined ratio. In case of loss, the bank loses the capital, while the entrepreneur loses his provision oflabor. It is this financial risk, according to the Shariah, that justifies the bank's claim to part of the profit. The profit-sharing continues until the loan is repaid. The bank is compensated for the time value of its money in the form of a floating rate that is pegged to the debtor's profits.

5) Murabahah (cost plus)"Mudarabah" is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise. The investment comes from the first partner who is called "rabb-ul-mal", while the management and work is an exclusive responsibility of the other, who is called "mudarib". This concept refers to the sale of goods at a price, which includes a profit margin agreed to by both parties. The purchase and selling price, other costs, and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. This is a fixed-income loan for the purchase of a real asset (such asreal estate or a vehicle), with a fixed rate of profit determined by the profit margin. The bank is not compensated for the time value of money outside of the contracted term (i.e.,the bank cannot charge additional profit on late payments); however, the asset remains as a mortgage with the bank until the Murabaha is paid in full. This type of transaction is similar to rent-to-own arrangements for furniture or appliances that are very common in North American stores.6) MusawamahMusawamah is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. While the seller may or may not have full knowledge of the cost of the item being negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This difference in obligation by the seller is the key distinction between Murabaha and Musawamah with all other rules as described in Murabaha remaining the same. Musawamah is the most common type of tradingnegotiation seen in Islamic commerce.

7) Bai salamBai Salam means a contract in which advance payment is made for goods to be deliveredlater on. The seller undertakes to supply some specific goods to the buyer at a future datein exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver, or currencies based on these metals. Barring this, Bai Salam covers almost everything that is capable of being definitely described as to quantity, quality, andWorkmanship.

8) Ijarah thumma al bai' (hire purchase)Parties enter into contracts that come into effect serially, to form a complete lease/buyback transaction. The first contract is an Ijarah that outlines the terms for leasing or renting over a fixed period, and the second contract is a Bai that triggers a sale or purchase once the term of the Ijarah is complete. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed amount over a specific period. When the lease period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed to price.The bank generates a profit by determining in advance the cost of the item, its residual value at the end of the term and the time value or profit margin for the money being invested in purchasing the product to be leased for the intended term. The combining of these three figures becomes the basis for the contract between the Bank and the client forinitial lease contract.

9) Ijarah-wal-iqtinaA contract under which an Islamic bank provides equipment, building, or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.

10) Musharakah (joint venture)Musharakah is a relationship between two parties or more, of whom contribute capital to a business, and divide the net profit and loss pro rata. This is often used in investment projects, letters of credit, and the purchase or real estate or property. In the case of real estate or property, the bank assesses an imputed rent and will share it as agreed in advance. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, whilethe loss is borne by each partner strictly in proportion to respective capital contributions. This concept is distinct from fixed-income investing (i.e. issuance of loans).11) Qard hassan/ Qardul hassan (good loan/benevolent loan)This is a loan extended on a goodwill basis, and the debtor is only required to repay the amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor. In the case that the debtor does not pay an extra amount to the creditor, this transaction is a true interest-free loan. Some Muslims consider this to be the only type of loan that does not violate the prohibition on riba, since it is the one type of loan that truly does not compensate the creditor for the time value of money.

12) Sukuk (Islamic bonds)Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic equivalent of bond. However, fixed-income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are securities that comply with the Islamic law (Shariah) and its investment principles, which prohibit the charging or paying of interest. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets.

13) Takaful (Islamic insurance)Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss due to misfortunes. Takaful is based on the idea that what is uncertain with respect to an individual may cease to be uncertain with respect to a very large number of similar individuals. Insurance by combining the risks of many people enables each individual to enjoy the advantage provided by the law of large numbers.

14) Wadiah (safekeeping)In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when the depositor demands it. The depositor, at the bank's discretion, may be rewarded with Hibah as a form of appreciation for the use of funds bythe bank.

2.1.4 References to Riba (interest/usury) in Quran & Hadith:

Ribacan be roughly translated as Usury. Riba is forbidden inIslam and considered as a major sin. Simply, unjust gains in trade or business, generally through exploitation. The Qur'an deals with riba in 12 verses, the word appearing eight times in total, three times in 2:275, and once in 2:276, 2:278, 3:130, 4:161 and 30:39. Even we can get lot more references regarding to Riba/Usury in other Islamic texts.

In Quran:

Those who devour usury will not stand except as stand one whom the Evil one by his touch Hath driven to madness. That is because they say: "Trade is like usury," but Allah hath permitted trade and forbidden usury (Quran 2.275)

Allah will deprive usury of all blessing, but will give increase for deeds of charity: For He loved not creatures ungrateful and wicked (Quran 2.276)

O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers. (Quran 2.278)

ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may (really) prosper. (Quran 3.130)

That they took usury, though they were forbidden; and that they devoured men's substance wrongfully; we have prepared for those among them who reject faith a grievous punishment. (Quran 4.161)

That which ye give in usury in order that it may increase on (other) people's property hath no increase with Allah; but that which ye give in charity, seeking Allah's Countenance, hath increase manifold.(Quran 30.39)

In Hadith:

Jabir said that Muhammad cursed the accepter of usury and its payer, and one who records it, and the two witnesses, and he said: They are all equal. (Sahih Muslim, Book 10, Number 3881)

Narrated AbuHurayrah: Muhammad said: If anyone makes two transactions combined in one bargain, he should have the lesser of the two or it will involve usury. (Sunan Abu Daud, Book 23, Number 3454)

Jabir (RA) said that the Messenger of God (PBUH) cursed the taker of Riba, giver, the writer of it, and its two witnesses, and he said: 'They are all equal. (Sahih Muslim, 4177)

Abdul Rahman ibn Abdullah ibn Masoud (RA) said: The Messenger of God (PBUH) cursed the taker of Riba, the giver, the witness and the writer. (Sunan Abi Dawoud, 3543. Hadith Hasan 1)Narrated Ibn 'Umar: Muhammad said, "The selling of wheat for wheat is Riba (usury) except if it is handed from hand to hand and equal in amount. Similarly the selling of barley for barley, is Riba except if it is from hand to hand and equal in amount, and dates for dates is usury except if it is from hand to hand and equal in amount. (Sahih Bukahri, Volumn 3, Book 034, Number 379)

Muhammad declared the practice of riba worse thanzina, worse than "to a man committing zina with his own mother" (Recorded in Sunan ibn Majah)

2.2 SOURCES OF FUNDS

Besides their own capital and equity, Islamic banks rely on two main sources of funds, a) transaction deposits, which are risk free but yield no return and, b) investment deposits, which carry the risks of capital loss for the promise of variable. In all, there are four main types of accounts:

A. Current accounts: Current accounts are based on the principle of al-wadiah, whereby the depositors are guaranteed repayment of their funds. At the same time, the depositor does not receive remuneration for depositing funds in a current account. Rather, the funds accumulating in these accounts can only be used to balance the liquidity needs of the bank and for short-term transactions on the bank's responsibility. The Islamic banks provide the broad range of payment facilities - clearing mechanisms, bank drafts, bills of exchange, travellers cheques, etc. (but not yet, credit cards or bank cards). More often than not, no service charges are made by the banks in this regard.

B. Savings accounts: Savings accounts also operate under the al-wadiah principle. Savings accounts differ from current deposits in that they earn the depositors income: depending upon financial results, the Islamic bank may decide to pay a premium, hiba, at its discretion, to the holders of savings accounts. The savings account holders are issued with savings books and are allowed to withdraw their money as and when they please.

C. Investment accounts: The investment account is based on the mudaraba principle, and the deposits are term deposits which cannot be withdrawn before maturity. The profit- sharing ratio varies from bank to bank and from time to time depending on supply and demand conditions. In theory, the rate of return could be positive or negative. The conditions of this account differ from those of the savings accounts by virtue of: a) a higher fixed minimum amount, b) a longer duration of deposits, and c) most importantly, the depositor may lose some of or all his funds in the event of the bank making losses.

D. Special investment accounts: Special investment accounts also operate under the mudaraba principle, and usually are directed towards larger investors and institutions. The difference between these accounts and the investment account is that the special investment account is related to a specified project, and the investor has the choice to invest directly in a preferred project carried out by the bank.

2.3 USES OF FUNDS The mudaraba and musharaka modes, referred to earlier, are supposedly the main conduits for the outflow of funds from banks. In practice, however, other important methods applied by Islamic banks include:

A. Murabaha (mark up): The most commonly used mode of financing seems to be the 'mark-up' device. In a murabaha transaction, the bank finances the purchase of a good or assets by buying it on behalf of its client and adding a mark-up before reselling it to the client on a 'cost-plus' basis profit contract.

B. Bai' muajjal (deferred payment):Islamic banks have also been resorting to purchase and resale of properties on a deferred payment basis. It is considered lawful in fiqh (jurisprudence) to charge a higher price for a good if payments are to be made at a later date. According to fiqh this does not amount to charging interest, since it is not a lending transaction but a trading one.

C. Bai'salam (prepaid purchase):This method is really the opposite of the murabaha. There the bank gives the commodity first, and receives the money later. Here the bank pays the money first and receives the commodity later, and is normally used to finance agricultural products.

D. Istisnaa (manufacturing): This is a contract to acquire goods on behalf of a third party where the price is paid to the manufacturer in advance and the goods produced and delivered at a later date. Ijara and ijara wa iqtina (leasing). Under this mode, the banks buy the equipment or machinery and lease it out to their clients who may opt to buy the items eventually, in which case the monthly payments will consist of two components, i.e. rental for the use of the equipment and instalment towards the purchases price.

E. Qard hasan (beneficence loans):This is the zero return type of loan that the Holy Qura'n urges Muslims to make available to those who need them. The borrower is obliged to repay only the principal amount of the loan, but is permitted to add a margin at his own discretion.

F. Islamic securities:Islamic financial institutions often maintain an international Islamic equity portfolio where the underlying assets comprise ordinary shares in well run businesses, the productive activities of which exclude those on the prohibited list (alcohol, pork, armaments) and financial service based on interest income.

2.4 DIFFERENCES BETWEEN CONVENTIONAL BANKING & ISLAMIC BANKING

1. In a conventional bank, a customer is given finances by a contract of loan where the bank is creditor and the customer is debtor. On the other hand in Islamic banking, finances are given to a customer by a contract of sale i-e a deferred sale contract. In this contract, either bank itself buys goods or appoints the customer to buy on its behalf and later sells them to the clients with a mark up (cost plus an agreed profit margin). Payment is done in installments over a specific period of time. 2. Islamic banks earn their profit by trading and investment activities and this profit can be said legitimate as it involves risk and efforts as compared to conventional banks which earn their profit by financing the customers at a fixed interest rate.

3. Participation in partnership business is the fundamental function of the Islamic banks. So they have to understand their customer's business very well. Whereas lending money and getting it back with compounding interest is the fundamental function of the conventional banks.

4. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds are given to charity. On the contrary, conventional banks can charge additional money (penalty and compounded interest) in case of defaulters.

5. The nature of Islamic banking is not simply lending the money as experienced by a conventional bank, but it is involved in selling and buying the commodity. Thus the selling price which is a cost price plus the profit margin, which is the contracted amount. In conventional banking practice, interest is regarded as the price of loan.

6. Profit amount agreed once between the customer and an Islamic bank remains the same, e.g., in murabahah or cost plus profit is fixed at the time of contract and must be agreed upon by the customer. If customer is unable to pay on time, bank cannot ask for a higher price due to delay in settlement of dues. While interest rate is also prefixed at the time of contract would be either unchangeable or would change according to the Base Lending Rate (BLR) which is monitored by the central Bank.

7. Islamic banks cannot remain unconcerned about the nature of the activity for which they are financing. They cannot finance any business which is against the teachings of Islam. While conventional banks dont have to follow any limitations of religion and they may finance any profitable activity e.g., a gambling casino or an alcoholic manufacturing industry etc.

8. Many of the services provided by conventional banks that are not related to interest, are also performed by the Islamic banks in the same way e.g., letter of credits, collections, foreign exchange and financial advising etc .

2.5 LIMITATIONS OF ISLAMIC BANKING Islamic Banking is based on the concept of profit and loss sharing (PLS) is theoretically superior to conventional banking from different angles. However from the practical point of view things do not seem that rosy. In the over half-a-decade of full-scale experience in implementing the PLS scheme the problems have begun to show up.

I. Financing There are four main areas where the Islamic banks find it difficult to finance under the PLS scheme: a) participating in long-term low-yield projects, b) financing the small businessman, c) granting non-participating loans to running businesses, and d) financing government borrowing. Let us examine them in turn.

a) Long-term projects The term structure of investment by 20 Islamic Banks in 1988. It is clear that less than 10 percent of the total assets go into medium- and long-term investment There are no commonly accepted criteria for project evaluation based on PLS partnerships. Each single case has to be treated separately with utmost care and each has to be assessed and negotiated on its own merits. Other obvious reasons are: a) such investments tie up capital for very long periods, unlike in conventional banking where the capital is recovered in regular instalments almost right from the beginning, and the uncertainty and risk are that much higher, b) the longer the maturity of the project the longer it takes to realize the returns and the banks therefore cannot pay a return to their depositors as quick as the conventional banks can. Thus it is no wonder that the banks are averse to such investments.

b) Small businesses Small scale businesses form a major part of a countrys productive sector. Besides, they form a greater number of the banks clientele. Yet it seems difficult to provide them with the necessary. This has been particularly relevant for the construction and service sectors, which have large share in the gross domestic product (GDP). The service sector is made up of many small producers for whom the banking sector has not been able to provide sufficient financing. Many of these small producers, who traditionally were able to obtain interest-based credit facilities on the basis of collateral, are now finding it difficult to raise funds for their operations.

c) Running businesses Running businesses frequently need short-term capital as well as working capital and ready cash for miscellaneous on-the-spot purchases and sundry expenses. This is the daily reality in the business world. Often the clients need to have quick access to fresh funds for the immediate needs to prevent possible delays in the projects implementation schedule. According to the set regulations, it is not possible to bridge-finance such requirements and any grant of financial assistance must be made on the basis of the projects appraisal to determine type and terms and conditions of the scheme of financing.

d) Government borrowing In all countries the Government accounts for a major component of the demand for credit -- both short-term and long-term. Unlike business loans these borrowings are not always for investment purposes, nor for investment in productive enterprises. Even when invested in productive enterprises they are generally of a longer-term type and of low yield.

II. Legislation Existing banking laws do not permit banks to engage directly in business enterprises using depositors funds. But this is the basic asset acquiring method of Islamic banks. Therefore new legislation and/or government authorization are necessary to establish such banks. In Iran a comprehensive legislation was passed to establish Islamic banks. In Pakistan the Central Bank was authorized to take the necessary steps. In other countries either the banks found ways of using existing regulations or were given special accommodation. In all cases government intervention or active support was necessary to establish Islamic banks.

III. Re-training of staff The bank staff will have to acquire many new skills and learn new procedures to operate the Islamic banking system. This is a time consuming process which is aggravated by two other factors. One, the sheer number of persons that need to be re-trained and, two, the additional staff that need to be recruited and trained to carry out the increased work.

IV. Globalization of Financial Markets This is the second change I mentioned in the beginning. Financial markets the world over are integrated as never before. Money moves across national boundaries without cost and instantaneously. The few remaining exceptions are on the way out. In principle this change should be favorable to Islam which never cared much for national boundaries. In practice however it does pose problems for Islamic financial movement, for two different reasons. Firstly the home base of this new trend is the Middle East and South and South East Asia where the economies are small and financial system less sophisticated than in the developed countries. Secondly, Islamic financial institutions themselves suffer from smallness in size and very few of them operate in more than one country as the major players in the field do. The situation has changed with the entry of some major conventional financial institutions into the field. But that has made it harder for the older Islamic financial institutions, obliging them to consider mergers and consolidation. Globalization has increased the volatility of almost every financial variable, especially the exchange rates. It has also reduced the efficacy of national economic macro- management. The redress can only come through international agreements curbing speculation and regulating the financial markets. The insights of the Islamic financial movement relating to sharing modes of finance, commodity-linked financing like murabaha, and reducing the role of debt have great potential in this regard.

2.6 ISLAMIC BANKING IN INDIA India is considered to be one of the most desired economies since its growing rapidly with a legal framework which enables protection for the foreign investors. The Islamic banking sector commands an asset base of $3trillion across the world. It is commonly known as participatory banking in India and it has shown its presence in the cooperative sector this new trend in banking will help the poor and marginalized segments of the society, petty workers, small farmers, skilled persons and women encouraging saving as well as providing micro credit along with other macro banking operations. Thus suitable amendments should be made in the Banking Act.

The Indian banking sector has opened up considerably in the past decade or so and openness to interest-free banks is a logical next step. Islamic banking is one way to ameliorate the disadvantaged classes. The potential benefits of allowing Islamic banking include; decreased economic disparity between the haves and the have nots, better integration, and consequently accelerated economic growth. Even in the U.K. where the Muslim population is just 2 per cent, there is a full-fledged conventional Islamic Bank with four branches. Malaysia is the centre of Islamic Banking where against every conventional bank there is an Islamic Bank. Interestingly, the nine per cent Chinese population in Malaysia is also fulfilling their banking requirements by dealing with the Islamic Banks. In India, which has a huge Muslim population, by law cannot find Islamic Banks. Since it is difficult to form Islamic Bank, but Islamic Investment is a major part of Islamic Banking Industry. Malaysia has got not more than 200, whole of GCC has got not more than 300 companies. Out of 6000 listed companies almost 4400 companies are Sharia compliant. Some of the Islamic banking institutions(NBFC) in India: Al Ameen Islamic Financial & Investment Corp. (India) Ltd., Karnataka Bank Muscat International (SOAG) Al-Falah Investment Ltd

2.6.1 Major issues and constraints in Islamic banking:The biggest issue which is a permanent hurdle for Islamic banks operating in countries with interest-based banking is that they cannot function as banks unless powers of issuing cheques are given to them. They cannot be members of settlement/clearing house unless they accept two conditions regarding their liabilities and assets like conventional banks that have to keep fractional cash reserve with the central bank and statutory liquid assets in their assets. Thus banks in India have to maintain deposit account with the RBI over which they get interest. The SLR includes government and approved securities. A bank licensed by the RBI becomes part of the monetary system, which means it can create money by deposit generation through deposit acceptance. Since these assets are interest based, Islamic bank cannot hold them. Consequently, the central bank cannot act as the lender of last resort because such accommodation by the monetary authority is also interest based. Islamic banks cannot interact with conventional banks based on principles of interest. The last but not the least, Islamic banking has been constantly in short-term and medium-term operations though some of them are undertaking long-term finance also. It is understood that inability to evaluate projects profitability has tended to act against investment financing. Some borrowers frustrate the banks appraisal efforts as they are not reluctant to provide full disclosures of their business. Moreover, the borrowers do not observe business ethics which make it difficult to establish close bank-clientele relationship a condition for successful Islamic banking. As a result a number of Islamic banks have been closed during the recent years.

2.6.2 SWOT Analysis:

As per the SWOT analysis of Islamic Banking done below, it is clear that it faces many challenges in India. Banks will have to come out of religion set up and offer products of wider spectrum to wider audience.

Its a challenge to provide a solution that adheres to the basics of the Islamic finance concept and at the same time remains flexible enough to meet the demands of the changing environment. There is a need to advertise Islamic banking so that it could be used by Non-Muslims as well.STRENGTHIslamic Banking will unequivocally ameliorate the deplorable condition of the poor and marginalized segments of society. Banking products which comply with Islamic law are becoming increasingly popular, not only in the Gulf countries and far eastern states like Malaysia, but also in other developed markets such as the United Kingdom. Reputed banks like Standard Chartered, Citibank, HBSC are operating interest free windows in several West Asian countries, Europe and USA. There is a huge potential market in India for Islamic banking products.We have seen the fall of giants in the world of financial sector like Lehman Brothers in the aftermath of the US sub-prime mortgage crisis. Therefore, it is of paramount importance to be strict about credit rating system, to circumvent any chance of further bankruptcy. Since Islamic banking adheres to strict credit rating system and prohibits indebted economic agents to avail more debt finance, it could save our financial and economic enterprises from bankruptcy. Interest is strictly proscribed in Islamic banking. Principles of equity finance abhor financing the indebted enterprises thereby arresting the chances of bankruptcy togreat extends. Under Islamic banking, equity finance needs cost yield and pre-rating analysis of projects. It thus considerably subdues the mindless competition in financial sector to get more credit shares and tends to provide stability in the financial market.Islamic banks are unaffected by the subprime mortgage crisis. In fact, now many non-Muslim countries are turning up to Islamic banking as they are immune against such crisis due to inherent business ethics within Islamic banking.

Moreover, Islamic banking helps the weaker and hapless section of the society through various financial products. Islamic banking finances (through its Joint ventures, partnerships and leasing)are provided by investors or banks to the borrowers with a condition that financial risk is to be borne by the investors, and other risks to be borne by the borrower.The high powered Raghuram Rajan Committee draft Report as released on 7th April 2008, strongly suggested interest-free banking as a part of recommendations made for financial sector reforms. The Committee postulates that interest free banking is another area that falls broadly in the ambit of financial infrastructure. Certain faiths prohibit the use of financial instruments that pay interest.WEAKNESS Indian banking laws do not explicitly prohibit Islamic banking but there are provisions that make Islamic banking almost an unviable option. The financial institutions in India comprises of Banks and Non Banking Financial Institutions. Banks in India are governed through Banking Regulation Act 1949, Reserve Bank of India Act 1934, Negotiable Instruments Act 1881, and Co-operative Societies Act 1961.Certain provisions regarding this are mentioned below: 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.As regards to partnership by Islamic banks in a firm, the bank has to make sure that the manager does not avoid his responsibilities or obtain other non-pecuniary benefits at the expense of non-participating partners and ensure the veracity of the profit statements. Monitoring of data about firms in which Islamic bank invests would involve exorbitant cost.Islamic banking needs to introduce corporate governance with transparent accounting standards. It needs to perform detailed evaluation before embarking Profit Loss Sharing Scheme, which demand a pool of highly trained professionals. The imparting of professional training is costly. Detailed principles are still to be laid down and techniques and procedures evolved to carry them out. It is only after the satisfactory achievement of these that proper training can begin.Among the other disincentives from the borrowers point of view are the need to disclose his accounts to the bank if he were to borrow on the Profit Loss Sharing basis. However, many small-time businessmen do not keep any accounts, leave alone proper accounts. And large conglomerates do not like to disclose their real accounts to anybody. The widespread lack of business ethics among certain business community will be another major hurdle in the path of Islamic banking in India.The practices in use by the Islamic banks have evoked questions of morality. Some critics view Sukuk(Islamic Bond) as unIslamic in nature. Others criticize that financing through the purchase of clients property with a buy-back agreement and sale of goods to clients on a mark-up, involved the least risk and are closest to the old interest-based operations.Bai muajjal (sale with deferred payment) and Murabaha (cost-plus financing) are permitted in the Sharia under certain conditions. What is being done in many countries are fictitious deals which ensure a predetermined profit to the bank without actually dealing in goods or sharing any real risk. This is against the letter and spirit of Sharia.OPPORTUNITY India with a 20% Muslim population, the highest in a non-Islamic country andsecondhighest in the world offers huge opportunities to exploit. The size of the market will be very large as the Indian population is above 120 crore and Muslim population itself is about 20 crore and majority of them, in the name of religious faith, are looking for interest free banking and finance.It is pertinent to mention here that Islamic banking is not meant for Muslims only but non Muslims may also avail the benefit of it. And it is feasible to have a parallel banking system based on Sharia along with a conventional one.While Sharia compliant investment avenues are now becoming available in most countries, India has not seen large-scale development. To estimate the scope of Islamic investment opportunities in the Indian stock market, it is imperative to examine stocks that conform to Islamic Shariah principles Out of 6,000 BSE listed companies, approximately 4,200 are Sharia compliant.The market capitalization of these stocks accounts for approximately 61% of the total market capitalization of companies listed on BSE. This figure is higher even when compared with a number of predominantly Islamic countries such as Malaysia, Pakistan and Bahrain. In fact, the growth in the market capitalization of these stocks was more impressive than that of the non-Sharia compliant stocks.The software, drugs and pharmaceuticals and automobile ancillaries sector were the largest sectors among the Sharia compliant stocks. They constitute about 36% of the total Sharia compliant stocks on NSE. Further on examining the BSE 500 the market capitalization of the 321 Sharia compliant companies hovered between 48% and 50% of the total BSE 500 market capitalization.Another opportunity is mutual fund which is based on 100% equity. These funds are invested in different sectors like IT, automobile telecommunication, cement. In fact, Tata Mutual Fund made a pioneering attempt when, at the instance of the Barkat and some other Islamic financial group, it launched Tata Core Sector Equity Fund in 1996. This scheme was specially tailored keeping in view the Muslims inhibition of dealing with interest bearing and haram investments. This scheme surprised many by being able to raise Rs. 230 million from the public.THREATS Islamic banking could be a huge political issue. Certain parties might abhor the use of the word Islamic and could term it as anti-Indian. They might argue that the very concept of Sharia banking would go against the secular fabric of our country. We are already facing problems pertaining to Muslim Personnel Law and trying to implement Uniform Civil Code.Therefore, at this juncture, if we introduce Islamic banking in India, it will create more problems than solving the issue. Moreover, it may bring financial segregation in the economy. The compartmentalization of Sharia compliant and Non Sharia Compliant banking might be used by certain vested interest to communalize the finance sector in India.

2.7 CONCLUSIONIslamic banking is at an incipient stage. The existing legal framework does not permit Islamic Banking in India. Only selective activities like equity investment is possible, while trade finance aspects like taking title to goods is not possible. A lot of amendments need to be carried out in the prevalent legal set up. Appropriate models need to be selected and implemented to suit societys diverse financial needs. And it is advised to refer Islamic Banking as Interest Free Banking so that it could be looked through the broad economic kaleidoscope and not a narrow religious prism.

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3.1 INTRODUCTION

The Indian banking has finally worked up to the competitive dynamics of the new Indian market and is addressing the relevant issues to take on the multifarious challenges of globalization. Banks that employ IT solutions are perceived to be futuristic and proactive players capable of meeting the multifarious requirements of the large customer base. Private Banks have been fast on the uptake and are reorienting their strategies using the internet as a medium The Internet has emerged as the new and challenging frontier of marketing with the conventional physical world tenets being just as applicable like in any other marketing medium.

The Indian banking industry is currently termed as strong, having weathered the global economic slowdown and showing good numbers with strong support flowing in from the Reserve Bank of India (RBI) measures. Furthermore, a report "Opportunities in Indian Banking Sector", by market research company, RNCOS, forecasts that the Indian banking sector will grow at a healthy compound annual growth rate (CAGR) of around 23.3 per cent till 2011.

Banking, financial services and insurance (BFSI), together account for 38 per cent of India's outsourcing industry (worth US$ 47.8 billion in 2007). According to a report by McKinsey and NASSCOM, India has the potential to process 30 per cent of the banking transactions in the US by the year 2010. Outsourcing by the BFSI to India is expected to grow at an annual rate of 3035 per cent. According to a study by Dun & Bradstreet (an international research body)"India's Top Banks 2008"there has been a significant growth in the banking infrastructure. Taking into account all banks in India, there are overall 56,640 branches or offices, 893,356 employees and 27,088 ATMs. Public sector banks made up a large chunk of the infrastructure, with 87.7 per cent of all offices, 82 per cent of staff and 60.3 per cent of all ATMs.According to the RBI, Indian financial markets have generally remained orderly during 2008-09. In view of the tight liquidity conditions in the domestic money markets in September 2008, the Reserve Bank announced a series of measures beginning September 16, 2008. Thus, the average call rate which was at 10.52 per cent declined to 7.57 per cent in November 2008 under the impact of these measures. Measures aimed at expanding the rupee liquidity, included significant reduction in the cash reserve ratio (CRR), reduction of the statutory liquidity ratio (SLR), opening a special repo window under the liquidity adjustment facility (LAF) for banks for on-lending to the non-banking financial companies (NBFCs), housing finance companies (HFCs) and mutual funds (MFs), and extending a special refinance facility, which banks could access without any collateral. Banking capital (net) amounted to US$ 4.8 billion in April-September 2008 as compared with US$ 5.7 billion in April-September 2007. Among the components of banking capital, non-resident Indian (NRI) deposits witnessed a net inflow of US$ 1.1 billion in April-September 2008, a turnaround from net outflow of US$ 78 million in April-September 2007. The reserve money lying with the RBI as on November 21, 2008 as per the January 2009 bulletin, is a total amount of US$ 179.28 billion and RBIs credit to the commercial sector stood at US$ 3.65 billion. Further, banks in India put up strong growth and profit numbers in the October-end-December 2008 period owing to high credit growth and easing of yield on government bonds. Top Indian banks have increased their earnings by almost 40 per cent year-on-year for the same period. According to latest Reserve Bank of India (RBI) data, bank credit grew by 24.6 per cent year-on-year as of December 19, 2008. The resulting credit growth was even better at 41 per cent during the April-end-December 2008 period. Deposits grew by 20.6 per cent as of December 19, 2008. The growth in advances reflects that the net interest income (NIM) too would indicate higher growth rate. RBI has taken a number of steps to lower the cost of credit in this quarter like cutting cash reserve ratio (CRR), the amount of funds banks have to keep on deposit with it, repo and reverse repo rate.The CRR rate, which had been reduced in December 2008, to 5.50 per cent, repo rate to 6.50 and reverse repo rate to 5.00, were further reduced CRR to 5 per cent, (its lending rate) repo rate to 5.5 per cent and reverse repo, at which it absorbs cash from the banking system, to 4 per cent in January 2009. Responding to these measures, banks have cut the prime lending rates (PLR). Further, according to several brokerage research teams, NIM may remain stable in the last quarter. For instance, a Motilal Oswal report on earnings preview reveals, "We expect margins to remain stable despite the PLR cut of 125-150 basis points (75 bps w.e.f January 1, 2009), as the banks have reaped the benefit of CRR cut (350 bps in December quarter) and have demonstrated their pricing power to corporate." According to brokerage Prabhudas Lilladhers preview report, among the banks, SBI, Bank of Baroda and Union Bank stand to gain the most on account of mark-to-market (MTM) reversals.Banks however, have to face the challenge of rising non-performing assets (NPAs) owing to the slowdown in exports and industrial production. Also, RBI has taken steps like one-time restructuring of real estate loans and second-time restructuring of loans given to other sectors to counter the NPA scenario.

3.2 SCOPE OF BANKING IN INDIA

The financial sector in India has become stronger in terms of capital and the number of customers. It has become globally competitive and diverse aiming, at higher productivity and efficiency. Exposure to worldwide competition and deregulation in Indian financial sector has led to the emergence of better quality products and services. Reforms have changed the face of Indian banking and finance. The banking sector has improved manifolds in terms of capital adequacy, asset classification, profitability, income recognition, provisioning, exposure limits, investment fluctuation reserve, risk management, etc.

Diversifying into investment banking, insurance, credit cards, depository services, mortgage financing, securitization has increased revenues. As large numbers of players in various fields enter the market, competition would be intensified by mutual funds, Non Banking Finance Corporations (NBFCs), post offices, etc. from both domestic and foreign players. All this would lead to increased sophistication and technology in the sector. Corporate governance would come into the picture and other financial institutions would have to reach global standards. Also the limit for FDI in private banks is increased to 74% and the limit for FII is 49%. There are many challenges ahead for the banking sector such as technology, consumer satisfaction, corporate governance, risk management, etc. and they are redefining their priorities, which are now focused on cost reduction, product differentiation and customer centric services. Some of the major players in this sector are HDFC, ICICI, HSBC, State Bank of India, Punjab National Bank, Ing Vysya, ABN Amro Bank, Centurion Bank, City Bank, etc.

3.3 GROWTH OF BANKING IN INDIA

HDFC Bank and Axis Bank continue to remain as leaders of the private sector banks. Both the banks have maintained the advances growth and NIM. SBI, Punjab National Bank, Bank of India and Union Bank are expected to lead among PSU Banks. The State Bank of India is planning to open 1,000 new branches across the country to cover 100,000 villages in the coming FY 2009-10, according to the bank Chairman, Mr. O P Bhatt. The bank had decided to rope in 300 new customers every year for each branch using initiatives. According to Mr. Bhatt, the bank could get a record US$ 5.54 billion during December 2008, the highest amount collected by any bank in the country. Further, public sector banks (PSBs) on January 12, 2009 also decided to lower interest rates on bulk deposits and to offer a maximum rate of 7.5 per cent for one-year maturity. Earlier, on January 1, banks had lowered the interest rates on bulk deposits from 9.5 per cent to 8.5 per cent. According to the latest RBI data, growth in broad money (M3), year-on-year (y-o-y), was 19.6 per cent (US$ 151.04 billion) on January 2, 2009 lower than 22.6 per cent (US$ 141.82 billion) a year ago. Aggregate deposits of banks, year-on-year, expanded 20.2 per cent (US$ 133.08 billion) on January 2, 2009 as compared with 24.0 per cent (US$ 127.49 billion) a year ago. The growth in bank credit continued to remain high. Non-food credit by scheduled commercial banks (SCBs) was 23.9 per cent (US$ 102.78 billion), year-on-year, as on January 2, 2009 from 22.0 per cent (US$ 77.79 billion) a year ago. Scheduled commercial banks credit to the commercial sector expanded by 27.0 per cent (year-on-year) as on November 21, 2008, as compared with 23.1 per cent a year ago. Non-food credit of scheduled commercial banks expanded by 26.9 per cent, year-on-year, as on November 21, 2008, higher than 23.7 per cent a year ago.According to earlier RBI data, for the third quarter (September 26-December 27, 2008), total bank credit was up US$ 21.91 billion compared with a growth of US$ 22.91 billion in the same period a year ago. In the preceding quarter, credit had risen by US$ 26.50 billion. RBI data for deposits shows that for the Oct-end December 31, 2008 period, although deposit growth has slowed to US$ 25.99 billion against US$ 33.18 billion in the April-end to September, 2008 period, it was still stronger in the December 31 quarter period, 2008, as compared to the year-ago quarter when absolute growth was US$ 16.37 billion. Net banking capital amounted to US$ 4.8 billion in April-September 2008 as compared with US$ 5.7 billion in April-September 2007. Accounting for a part of banking capital, non-resident Indian (NRI) deposits showed a net inflow of US $ 1.1 billion in April-September 2008, increasing from net outflow of US$ 78 million in April-September 2007. Lending by banks also rose more than 76 per cent to Rs 2,80,000 crore (US$ 57.26 billion) during April-November 2008-09 from the same period a year ago, according to data available with the Reserve Bank of India (RBI). The Reserve Bank of India on January 21, 2009 fixed the Reference rate for the US currency at Rs 48.93 per dollar and the single European unit at Rs 63.70 per euro from Rs 49.12 per dollar and Rs 63.61 per euro, respectively.

On December 8, 2008, the repo rate and the reverse repo rate were reduced by 100 basis points each to 6.5 per cent and 5.0 per cent, respectively. In January 2009, the CRR has been further reduced to 5 per cent, repo rate to 5.5 per cent and reverse repo to 4 per cent.

3.4 OPPORTUNITIES AHEAD

Tap the Domestic Potentials:The countrys domestic savings today amount to approx. Rs. 4,00,000 Crores per year. This is expected to increase to over Rs. 10,00,000 Crores per year over the next 10 years, as our GDP increases from $ 400 billion to over a trillion dollars. The penetration of banking channels will have to increase in geometrical progression, to help fulfill Indias aspirations of becoming an economic superpower in the 21st century.

Improve Productivity through Updating Technology: Technology is actually the enabler, which can help the public sector banks overcome their natural limitations, improve productivity and efficiency, reduce transaction, processing and other costs, enhance the quality of service, and lead to increased access to their customers.

Convert ATMs to Service Centers: ATMs at present are just cash dispensing machines. They can be used to deliver a whole range of services from banking services, ticketing services, and retailing services. ATMs can be made into smart ATMs - using biometrics, to recognize customers by their voice, face, fingerprints or iris. In short, the new generation ATMs may be made into service retailing ports. This will change the very face of banking as well as retailing. Similar innovations can be introduced in various aspects like tele banking, home banking etc. If our banks acquire the global competency they now have opportunities expand their business on a quid pro quo basis in other countries.

3.5 CHALLENGES OF BANKING SECTOR

The banking industry in India is undergoing a major transformation due to changes in economic conditions and continuous deregulation. These multiple changes happening one after other has a ripple effect on a bank trying to graduate from completely regulated sellers market to completed deregulated customers market.

Deregulation: This continuous deregulation has made the Banking market extremely competitive with greater autonomy, operational flexibility, and decontrolled interest rate and liberalized norms for foreign exchange. The deregulation of the industry coupled with decontrol in interest rates has led to entry of a number of players in the banking industry. At the same time reduced corporate credit off take thanks to sluggish economy has resulted in large number of competitors battling for the same pie. Efficiency: This in turn has made it necessary to look for efficiencies in the business. Banks need to access low cost funds and simultaneously improve the efficiency. The banks are facing pricing pressure, squeeze on spread and have to give thrust on retail assets.Diffused Customer loyalty: This will definitely impact Customer preferences, as they are bound to react to the value added offerings. Customers have become demanding and the loyalties are diffused. There are multiple choices; the wallet share is reduced per bank with demand on flexibility and customization. Given the relatively low switching costs; customer retention calls for customized service and hassle free, flawless service delivery.

Misaligned mindset: These changes are creating challenges, as employees are made to adapt to changing conditions. There is resistance to change from employees and the Seller market mindset is yet to be changed coupled with Fear of uncertainty and Control orientation. Acceptance of technology is slowly creeping in but the utilization is not maximized. Competency Gap: Placing the right skill at the right place will determine success. The competency gap needs to be addressed simultaneously otherwise there will be missed opportunities. The focus of people will be on doing work but not providing solutions, on escalating problems rather than solving them and on disposing customers instead of using the opportunity to cross sell. Competition in retail banking: The entry of new generation private sector banks has changed the entire scenario. Earlier the household savings went into banks and the banks then lent out money to corporate. Now they need to sell banking. The retail segment, which was earlier ignored, is now the most important of the lot, with the banks jumping over one another to give out loans. The consumer has never been so lucky with so many banks offering so many products to choose from. With supply far exceeding demand it has been a race to the bottom, with the banks undercutting one another. A lot of foreign banks have already burnt their fingers in the retail game and have now decided to get out of a few retail segments completely. PSBs need to figure out the means to generate profitable business from this segment in the days to come.

3.6 PEST ANALYSIS

A. Political factors: Indian economy is not an instable economy but definitely the nature of the government has an impact on the various policies that get framed from time to time. The Reserve Bank of India is an autonomous body, with minimal pressure from the government that takes decisions regarding the banking operations and its monetary policy. It has given top priority for maintaining the price stability and for sustaining the rate of growth of the economy.

Earlier foreign players were not allowed in the country for operations but now the Indian government encourages foreign players in the banking sector and this has lead to the betterment of the services and products that are available in the market. . In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region

As per the latest updates it is said that Indian Government would allow 100% FDI in banking sector by 2009. Moreover the rules are being relaxed as compared to the earlier period as seen in March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (A private sector bank) to 10%. This is the first time an investor has been allowed to hold more than 5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by them.

B. Economic factors: Indian Economy has been experiencing an impressive growth in the recent years. The growth rate in output and employment has put some pressure on the level of inflation. The Whole Sell Prices Index (WPI) in the country as on 6th Jan 2007 has reached at 6.1 Percent. The present level of India inflation is considered as a challenge to the growing potentiality of the Indian Economy. The Gross Domestic Product in the country increased at an impressive rate of 9.2 percent per annum. The GDP Growth was mainly led by the fast rising industrial production as well as the growth in the services sector. The Tax Collections of the Government has increased, particularly the taxes such as Income Tax, Corporation Tax and the Service Tax. Tax collections from the new taxes such as Fringe Benefit Tax and Cash Transaction Tax have also increased With a GDP is 8.4% for 2007 and a growth rate of 8% over the past three years it is being one of the fastest growing economies of the world.

C. Social Factors: India is the second largest populated country with a population growth of 1.8%.Geographically its a large country with diverse culture and traditions. India is a country of diversities in itself. The cost of living of people has been increasing as compared to the earlier period of time especially with the boom of IT sector and the private sector. India has many languages and cultures in itself and the behavior of the consumers in that area depends on these factors that would be bonding them.

D. Technological Factors: India is said to have one of the booming IT sector in the recent past. India claims to be producers of the best intellects in technology. Apart from all this India implemented technology in almost all the sectors. In the banking sector there has been a lot of technological updations like mobile banking, internet banking, ATMs etc.

The Software Packages for Banking Applications in India had their beginnings in the middle of 80s, when the Banks, spurred on by RBI and the Rangarajan Committee Report, started computerising the branches in a limited manner.

The arrival of foreign and private banks with their superior state-of-the-art technology-based services pushed Indian Banks also to follow suit by going in for the latest technologies so as to meet the threat of competition and retain customer base.

The evolution of IT services outsourcing in the Indian banks has presently moved on to the level of Facilities Management (FM). Banks now looking at business process management (BPM) to increase returns on investment, improve customer relationship management (CRM) and employee productivity.

For, these entities sustaining long-term customer relationship management (CRM) has become a challenge with almost everyone in the market with similar products.

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Analysis, interpretation and inference of data are the central steps in the research process. The goal of analysis is to summarize the collected data in such a way that they provide answer to the question that trigged the research. It is also a method of finding meaning and relationship between given facts to interpret and inference the same. In interpretation is search for broader meaning of research findings. An analysis is not complete without interpretation and inference.

The chapter aims at presenting the result of study in a simple descriptive measure in the form of simple tables, and charts. It also aims at picking out the essential results of study. The entire chapter has been divided in to several sub heads so as to facilitate the understanding of studies.

This is an attempt to analyze, interpret and infer the data gathered from the respondents. The questionnaire is highly concentrated on Bankers and Muslims. And it also considered the other respondents say, Students, Govt. employees, Pvt. Employees, Research Scholars, NRIs.

PARTICULARS FREQUENCY PERCENTAGE

Male4270

Female1830

Total 60100%

Table 4.1: Gender of the respondents

Interpretation & Inference:It can be interpreted from the above table that 70% of respondents are male and 30% of the respondents are female.Thus we can infer from the study that majority of the respondents are male members. The above analysis can also be shown in the form of following Chart 4.1:

Table 4.2: Educational qualification of the respondents PARTICULARS FREQUENCY PERCENTAGE

P U0__

U G915

P G3965

Other1220

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that 65% of respondents are post graduates, 15% of respondents are under graduates, 20% of respondents are belong to other category which include CA & Lawyers.Thus we can infer from the study that majority of respondents 80% are graduates and post graduates, consist of Bankers & students. The above analysis can also be substantiated with the help of following Chart 4.2:

Table 4.3: Occupation of the respondents PARTICULARS FREQUENCY PERCENTAGE

Bankers1220

Students1525

Research Scholars 610

Lecturers915

Service/Business Sector1220

NRIs610%

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that 20% of the Respondents are Bankers & service or business men; 10% of the respondents are research scholars & NRIs; 15% are Lectures and 25% of the respondents are Students.Thus we can infer from the study that, the study is equally concentrated on all sectors. The above analysis can also be substantiated with the help of following Chart 4.3:

Table 4.4: Respondents awareness about Islamic Banking

PARTICULARS FREQUENCY PERCENTAGE

Yes60100

No0----

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, all respondents are aware about the concept of Islamic Banking.Thus we can infer from the study that, the respondents are familiar with this topic because the questionnaire is placed only to those respondents who are well aware to the topic. The above analysis can also be substantiated with the help of following Chart 4.4:

Table 4.5: Opinion on - Islamic Banking System is better than Conventional Banking System

PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree2745

NO/ Disagree2135

Cant say/ Neutral1220

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 45% of the respondents feels that Islamic banking is better than Conventional banking, where as 35% said No & 20% said cant say.Thus we can infer from the study that, most of the respondents like Islamic banking because of interest free transaction. The above analysis can also be substantiated with the help of following Chart 4.5:

Table 4.6: Economic welfare through Islamic bank

PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree3050

NO/ Disagree2440

Cant say/ Neutral610

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 50% of the respondents feels that Islamic banking will lead to economic welfare, where as 40% said No & 10% said cant say.Thus we can infer from the study that, it will bring economic welfare because Islamic banks not invest its fund in prohibited (Haram) products. The above analysis can also be substantiated with the help of following Chart 4.6:

Table 4.7: Present Islamic banking is true to the teachings of Islam PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree2440

NO/ Disagree610

Cant say/ Neutral3050

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 50% of the respondents are neutral regarding to the question, where as 40% said yes & 10% said no.Thus we can infer from the study that, there is lack of knowledge regarding to the teaching of Islam among the respondents. The above analysis can also be substantiated with the help of following Chart 4.7:

Table 4.8: Islamic banks to be governed by Shariah regulations

PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree1830

NO/ Disagree3660

Cant say/ Neutral610

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 60% of the respondents says that Islamic banking not to be governed by shariah regulations, where as 30% of respondents are agreed to the statement & 10% are neutral.Thus we can infer from the study that, Islamic banking not to be governed by Shariah regulation and it must be governed by Banking Regulation Act by RBI. The above analysis can also be substantiated with the help of following Chart 4.8:

Table 4.9: Will it Charge interest through indirect way

PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree2440

NO/ Disagree1830

Cant say/ Neutral1830

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 40% of the respondents says that Islamic banking charge interest through indirect way, where as 30% of respondents are disagreed to the statement & 30% are neutral.Thus we can infer from the study that, Islamic banking may charge interest through indirect way by misguiding its customer. The above analysis can also be substantiated with the help of following Chart 4.9:

Table 4.10: Conventional banks can also offer services provided by Islamic banks

PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree3355

NO/ Disagree1220

Cant say/ Neutral1525

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 55% of the respondents says that Conventional banks can also provide services of Islamic banks, where as 20% of respondents are disagreed to the statement & 25% are neutral.Thus we can infer from the study that, The Conventional banks can also offer services of Islamic banks by introducing separate Islamic financial section in each of its branches. The above analysis can also be substantiated with the help of following Chart 4.10:

Table 4.11: Removing societys inequality and improving standard of living

PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree1830

NO/ Disagree2745

Cant say/ Neutral1525

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 45% of the respondents says that Islamic banks will not remove inequality and improve standard of living, where as 30% of respondents are agreed to the statement & 25% are neutral.Thus we can infer from the study that, The Islamic banks may not remove and improving standard of living in the society. The above analysis can also be substantiated with the help of following Chart 4.11:

Table 4.12: Major Risk involved in Islamic banking PARTICULARS FREQUENCY PERCENTAGE

Increase anti-national activities & leads to social conflicts1525

Confuse in banking system1830

Against to the constitution & banking act1220

Time consuming1220

Other Risk35

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 30% of the respondents says that the Islamic banking system is most confusing one, 25% of the respondents say that it will increase anti-national activities and leads to social conflicts, 20% of the respondents say it is against to the countries constitution and against to banking regulation act, 20% says it is time consuming, 5% of the respondents gave other risks.Thus we can infer from the study that, majority of the respondents say it is confusing system of banking. The above analysis can also be substantiated with the help of following Chart 4.12:

Table 4.13: Benefits from Islamic banking PARTICULARS FREQUENCY PERCENTAGE

Huge cash inflow1525

Economic benefit to the nation915

Benefit to the particular class of people2440

Reforming the existing banking system915

Other benefits35

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 40% of the respondents says that the Islamic banking will benefits the particular class of people, 25% of the respondents say that it will leads to huge cash inflow, 15% of the respondents say it is benefit to the nations economy, 15% says it will reform the existing banking system, 5% of the respondents stated other benefits.Thus we can infer from the study that, majority of the respondents say that the particular class of people will be benefited from Islamic banking system. The above analysis can also be substantiated with the help of following Chart 4.13:

Table 4.14: India is ready for the implementation of Islamic banking

PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree1220

NO/ Disagree3050

Cant say/ Neutral1830

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 50% of the respondents says that India is not ready for the implementation of Islamic banks, where as 20% of respondents say yes & 25% are neutral.Thus we can infer from the study that, India is not ready to implement the Islamic banks because of the various factors. The above analysis can also be substantiated with the help of following Chart 4.14:Table 4.15: Will you use Islamic banking services in future

PARTICULARS FREQUENCY PERCENTAGE

Yes/Agree1220

NO/ Disagree3050

Cant say/ Neutral1830

Total 60100%

Interpretation & Inference:It can be interpreted from the above table that, 50% of the respondents says that they will not use the Islamic banking services in future; where as 20% of respondents say they will use it & 25% are neutral.Thus we can infer from the