What is Sharia or Islamic Banking?

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New Delhi, Nov 21: The Reserve Bank of India has proposed opening of an Islamic Window in conventional banks for introduction of Sharia-compliant or interest free banking in the country. The proposal was taken up to ensure financial inclusion for those sections of society which remain excluded due to religious reasons.

The RBI said, "In our considered opinion, given the complexities of Islamic finance and various regulatory and supervisory challenges involved in the matter and also due to the fact that Indian banks have no experience in this field, Islamic banking may be introduced in India in a gradual manner."

What is Sharia or Islamic Banking?

What is Sharia or Islamic Banking?

Sharia banking or Islamic Finance is a principle by which all forms of interest is forbidden. This model works on the basis of risk sharing and the customer and the bank share the risk of any investment on agreed terms.

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The customer and the bank also divide any profits between them. There are five main categories within Islamic finances. They are Ijara, Ijara-wa-iqtina, Mudaraba, Murabaha and Musharaka.

Ijara: This is a leasing agreement where by the bank buys an item from the customer and then leases it back for a specific period.

Ijara-wa-Iqtina: While this is similar to Ijara, here the customer is able to buy the item at the end of the contract.

Mudaraba: Under this a special investment is offered by a financial expert in which the bank and the customer share the profits. Out here the customer runs the risk of losing money if the investment goes bad. The bank, however, not charge a handling fee unless there is a profit.

Murabaha: This is basically Islamic credit in which the risk is shifted to the borrower. Here the customer can make a purchase without having to take out an interest bearing loan. Here the bank buys an item and then sells it to the customer on a deferred basis.

Musharaka: This is an investment partnership in which the terms of profit sharing is agreed upon in advance. The losses are, however, pegged to the invested amount. Here the bank and the customer purchase the property together.

The customer must make monthly payments to the banks and also pay a monthly rental fee based on the portion of the purchase price the banks still own.

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