Scope of Islamic Banking

By Durgesh Desai

Islamic banking is a type of a banking system which is in accordance with the Sharia law that prohibits paying any interest or fee for renting money. It also has rules about the type of businesses where money can be invested. These businesses have to function according to the principles of Islam. So investments cannot be made in companies or projects that deal with alcohol, drugs, war weapons etc.

Banking without interest

It is quite difficult to imagine any banking system functioning without paying or receiving interest on any transaction, but in Islamic banking, there is a concept of profit and loss sharing where banks invest the deposited money in Shariat compliant businesses and divide the profit and loss equally or as per the terms agreed with the depositor. Therefore Islamic banks act as a sort of equity funds. Islamic banks also provide many products like Musharaka (resources are equally shared), Mudarbah (finance provided by one party and expertise by the other) etc.

Islamic Banking in the World

The IMF in April 2015 endorsed the Islamic financial system saying that it could provide a safer alternative to conventional modes of finance. Islamic banking is common in Islamic countries and is starting to grow in other non – Islamic countries as well. The UK was the first non – Islamic country to issue license to the Islamic Bank of Britain which is in accordance with the Sharia law. The Dow Jones had started an Islamic Market Index in 1999 which had only Shariat compliant companies listed on it.

Islamic Banking in India

The RBI is mulling over the idea of introducing an Islamic window in conventional banks in India. This could help attract huge funds from Gulf countries and other investors who want to invest only in Shariat compliant businesses. It would also help in financial inclusion among the members of the Indian Muslim community who possibly shied away from investing in conventional banks due to its non – compliance with Sharia Law. State Bank of India had launched an Islamic equity fund in December 2014 with the mandate to only invest in Shariat compliant companies. To open an Islamic window in banks, the Banking Regulation Act needs to be amended. This will require Parliament’s approval which could be difficult in light of the political nature of this subject.  Islamic Banking offers an alternative investment option for investors. It would help broaden the Indian financial system.



By Garima Singhal & Vishnu Pillai


Reserve Bank of India’s bimonthly report in March revealed that the deposit growth in the fiscal year 2015-16 has slipped to 9.9%, the lowest in the last five decades. India is an economy, which is considered as saving centric, and the country’s banking system provides the depositor with one of the highest interest rates ranging from 4.5%-7.5% on time and demand deposits (up to Rs. 1 Crore). Inflation has seen a downward trend and the economy is moving towards faster growth. In spite of all these reasons, Indian banks are facing liquidity crunch due to low deposit growth that has also led to an increase in the credit-to-deposit ratio to 77.6% in March 2016 from 76.5% in the previous year.

In all this debate, the question arises why deposits in banks are so important for India’s growth and if the nation is really growing at a high growth rate then why are deposits in the banking system decreasing to such a large extent?


                              Figure 1: Growth in bank deposits (in %), Source: RBI


India is a developing country rapidly moving towards better technology and efficient ways of working. Similarly is the financial market of the country, which is currently in its growing phase. A financial market is a market where direct trading takes place in equity, bonds, currency, commodities etc. Here the investors and people in need of funds meet directly without the need of intermediary like banks. As the financial market of the nation grows and become more efficient, the need for banking sector becomes less important. However, in India where financial markets cope with the problem of adverse selection and moral hazard, banks play an important role in transferring funds from investors to borrowers.

Moreover, banks work on the principle of spread, which is the difference between the interest paid on deposits and interest earned on loans. As deposit growth falls and demand for the loans increases, banks need to increase the rate of interest on their deposits resulting into less spread for banks and reduction in profitability.

Also, with the current credit-to-deposit ratio of 77.6%, banks are lending 77.6 rupees for each of Rs. 100 of deposit. As banks need to maintain other reserves under CRR and SLR, lending such a high amount can lead banks to run into a liquidity shortage, which is not a favorable situation for the banking system as a whole.

As a result of all these factors, deposits have become a crucial component in the banking system to facilitate the smooth flow of funds from investors to borrowers.


                  Figure 2: Prime Lending Rate in India from April 2015 – March 2016,



In countries like India and China people tend to save more for the future than consuming today. As a result of this saving habit of citizens, the Indian economy was hit to a lesser extent during the Financial Crisis of 2008, but what has led to the reversal of this trend in current times? Though there is no sure answer for this question, few factors explain the reversal to some extent.

In the past when the country was facing a double-digit inflation, banks were providing high-interest rates on deposits, to reduce the impact of inflation on people’s savings. But as inflation eased, interest rates on deposits have not reduced in the same proportion providing people with a higher real rate of interest. This has resulted in people earning same returns with fewer funds parked in the banks. This could have resulted in the reduction of deposits in banks.

Moreover, the behavior of present generation is changing, as people want to fulfill more of their present demands than saving for the future. The availability of various insurance schemes in the market to face future uncertainties has made this task of present consumption more attractive, preventing people from worrying about future thereby saving less.

Second of all, as the financial market in the country is growing and becoming more efficient, new and better products like Mutual Funds, Equity Traded Funds, Bonds, Real Estates etc. are becoming available to people to earn more profit with the same amount of money invested. Also, the returns provided by these investments are far above the inflation rate resulting in more returns in nominal as well as in real terms. Another reason for the growing popularity of financial products is the liquidity they provide. As a result, people who are willing to take risks to earn higher profits are moving towards these products rather than parking their funds in banks.

Another reason that can also be considered as one of the factors for falling deposits growth is an increase in the maximum limit under the Liberalized Remittance Scheme. Under this scheme, the RBI defines the maximum permissible amount that Indians can remit to other countries. The maximum amount under this scheme has been raised to $250,000. As a result of this, people have started sending more money to their parents, children or relatives in foreign countries instead of saving them in bank accounts. This can be validated from the fact that the transactions under this scheme have seen a jump from $106mn to $449mn from May 2015 to Feb 2016.

The largest factor that is contributing to this rise is the amount sent by parents to children who are studying abroad. This shows that our education system is not only incapable of retaining its talent but also is one of the major causes of money leaking out of the economy.

The points discussed above identify the fact that people presently are reluctant to put money in banks. But what if in the previous years the funds deposited by people was just higher deposit growth than normal rate and presently that trend is only getting reversed to attain its normal pace. This can be inferred from the fact that during the period of Financial Crisis, markets were facing great uncertainty and the economy was experiencing double-digit inflation. People were losing jobs and were more focused on saving to secure their future consumption as much as possible, which led to very high growth in deposits. As the economy recovered from recession over the years and inflation rates have fallen, people have reverted to their actual rate of spending bringing the deposits growth down.

The other factor that is more perplexing is that in the situation when deposit growth is at its all-time low, currency in circulation is seeing a high growth of 14.6% as compared to 11.32% growth over the previous year.

In the scenario where not only advance ways of doing banking are coming up every day resulting in improvement in efficiency of transactions but also schemes like Pradhan Mantri Jan Dhan Yojana(PMJDY) which are trying to put ideal money into circulation by opening up bank accounts, high growth in currency in circulation despite fall in bank deposits raises questions. Though this increase can be described by few factors, actual reasons remain uncertain.

Elections could be seen as one of the reasons for the rise in currency, as it is a phase where a large amount of money is spent by political parties for funding their campaigns and to lure the voters by offering them cash. The rumor of each voter in Tamil Nadu getting somewhere between Rs.3000 to Rs.6000 during the Assembly Election in April – May 2016 added fuel to this fire. Even Mr. Raghuram Rajan hinted this as a possible reason for an increase of Rs. 50,000 crores more money in the hands of the public than what was expected by the Central bank. Another interesting fact that came to light during this period was that the amount of money with the people had not only increased in the poll-bound states but also the neighboring states.

But if we were to believe the above reasoning then didn’t we have more states going for elections last year? Why didn’t the level of deposits fall in the last year or the year before it during the elections? Or is it that the states that went to polls last year (Bihar, Delhi- 2015) or in 2014 (Parliament, Maharashtra, Haryana, Andhra Pradesh, Jammu & Kashmir, Jharkhand) had a better follow-up of electoral policy than the states that had elections this year (Kerala, Tamil Nadu, Assam and West Bengal).

Another factor which gives rise to the possibility of high currency in circulation is the rise in service tax from 12.36% to 14% and with the introduction of the Swachh Bharat cess and Krishi Kalyan cess, it reaches to 15%. Because of this rise, people may be seen as reluctant to put large sums in banks due to increase in transactions costs or ATM charges. Though the cost may be lower on transaction basis but combined cost may result in keeping people away from depositing in banks. Moreover, with the rise in service tax people may be more willing to pay for services in cash instead of through bank accounts as transactions from accounts are recorded whereas cash payments cannot be traced and can be used as a means of saving tax.

All this presents one side of the picture that concludes that people are not depositing at the same rate as of before but there is a second angle to the picture. What if people are still saving at the same rate but they do not have enough income to save which is leading to the fall in deposits growth?

The data based on Quarterly Employment Survey (QES) of  the number of jobs created in select eight industries shows that the number of jobs generated in 2015 is only 135,000 which are very low as compared to that of jobs created in 2014 that were 421,000. This fact puts another problem in picture that though the economy is growing at a rate of 7.4% currently it is facing difficulty in translating the growth into increased jobs to accommodate the growing workforce of the country. Moreover, in the rural area the fall in income due to crop failures caused by two successive droughts is aggravating the problem. This has resulted in farmers losing their crops and worsening the situation in both urban as well as rural areas.


                Table 1: Changes in employment in selected sectors (in lakh numbers)

                                                       Source: Labour Bureau

The actual reason for such a high fall in growth of deposits is still unknown. In a scenario, where the economy is booming and with the pressure from industry to reduce the interest rates is continuously growing, banks will be required to reduce the interest rate on their deposits as well so as to maintain their Net Interest Margins (NIMs). However, as banks are already facing the problem of lower deposit growth, reducing deposit interest rate may make the situation worse forcing banks to face a highly constrained situation from both low deposits as well as high loan demands. Therefore the banks will be required to come up with schemes that can give investors attractive payoffs to deposit money in the bank and to focus on making the banking system more robust so as to not only reduce the growing NPAs but also control the increasing growth of currency and inject back the money which is currently out of the system.

Post March 2016, the deposit growth has increased in banks. So this fall in deposits growth in FY2015 may be considered as one time phenomenon but if such a trend continues to persist in the future, banks should not only focus on finding the root cause of such a high decrease but also try to find new avenues to earn its income so as to bear the brunt of its reduced NIMs.


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Dugal, I. (2016, April 1). The curious case of rising currency in circulation. Retrieved September 29, 2016, from Money,

Bhattacharya, S. (2016, April 15). India’s job growth lowest since 2009: Where are the jobs PM Modi? Business. Retrieved September 29, 2016, from

Das, S., & Nayak, G. (2016, April 7). Article: Banks in a fix as deposit growth hits 50-year low, loan disbursement rises – the economic times. Retrieved September 29, 2016, from

Bureau, O. (2016, April 12). “Higher spending, remittances hurting deposit growth.” Retrieved September 29, 2016, from Money & Banking,


Dr. Urijit Patel’s Contribution to Economic Development of India

AUTHOR- Nimisha Khattar

Popularly known as the Inflation Warrior, Dr. Urijit R Patel, has been associated with RBI since 2013. He has played a key role in formulating and shaping the monetary policy of India. With his appointment as the new RBI Governor, we can expect the government to continue with the existing macroeconomic policy.

An Economist from Yale University, Dr. Patel, believes that in order to make India a country characterized by stable growth, inflation needs to be in control. Dr. Patel has brought about many significant changes. Adopting Consumer Price Index as the base, instead of Wholesale Price Index, for measuring inflation in an ‘inflation targeting approach’ was one revolutionary reform.

Dr. Patel has been a great critic of the excessive government spending and subsidies. Time and again, he has emphasized the need for a discipline in fiscal expenditure. In order to control inflation, since the degree of correlation between monetary policy and fiscal policy is high, the greatest contribution by Dr. Patel has been to keep inflation in the targeted rate bracket of 4% ± 2% in the recent years.

Apart from his contribution in controlling the inflation by increasing the interest rates and reducing fiscal expenditure, one of the smart moves that Patel committee came up with was setting up a team of six members instead of one alone, for deciding the policy rates. This has led to minimization of risk and has helped in making the process a democratic one.

Considered as an owl (a symbol of wisdom) by the ex-RBI Governor, Dr. Raghuram Rajan, Dr. Patel had been advising central government on some major issues as well – like the development of debt market, growth of foreign exchange market and the banking sector.

Thus, it can be concluded that Dr. Urijit Patel’s contribution played a massive role in the economic development of India and going by the logic of keeping repo rate higher than the CPI, as remarked by him in the committee recommendation, let’s also keep our faith in the owl higher and stronger.

Asset Quality Review – Pros and Cons

By – Vishaka Sivanainar

The RBI implemented “asset quality review” (AQR) as a component of their annual financial inspection (one-off exercise) in order to gauge the true efficiency and health of Indian banks. AQR was implemented by RBI governor Raghuram Rajan because he believed the Indian banking system required “deep surgery”. AQR diminished the profits of most public banks and several private banks.

The pros and cons of AQR can be easily understood with the help of an analogy. University XYZ publishes the results of students below the 10th percentile on the notice board. The aim of this practice is to point out the defaulters and ensure that they follow stricter academic discipline in the future. The display of marks negatively motivates the students to work harder. The weaker students begin to recognize their flaws at an earlier stage. However, since the university is new it might not be the right time to implement this policy. If this were to be made an annual exercise, it would actually bring down the goodwill of the university.

Similarly, AQR is carried out to ensure credit discipline is maintained among banks. The defaulters are highlighted and this information is made public. The negative exposure that the banks receive will affect their stock prices in the share market which is an indication of the lowering of public confidence. Higher provisioning leading to lower earnings will make the banks reluctant to lend. The process might lead to capital shortfall which would call for infusion from the government. Since India is a growing economy it is improbable to allow AQR to become an annual practice because it would be an unfair representation of the Indian banking system.

However, this tool has myriad benefits as well. Banks were given too much forbearance in comparison to other corporates, with stringent regulations their activities would be tracked meticulously. The implementation of aforementioned norms would lead to banks being more prudent. Banks will start recognizing stress early with respect to loan repayment and can adjust the terms accordingly.

Despite the noteworthy cons, we may conclude that AQR would be a boon to the banking industry and Indian economy. It would result in the improvement of governance, sustainable and profitable promotion of economic growth. It would also increase transparency, which will allow the public to better understand and trust their banks.

Rockstar Rajan – The Last Monetary Policy Review

By Sachit Modi

On August 9, 2016, Dr. Raghuram “Rockstar” Rajan, who is set to end his 3-year term on September 4, released his last monetary policy review. The RBI Governor, who has reduced the benchmark policy rate by 1.5% since January last year, decided to keep it static in his final review, owing to the inflationary trends. He also stated that, in order to achieve the Liquidity Neutrality goal, RBI will continue to pump funds into the market, as and when the need arises. This article gives few of the major highlights from the review.

The Bi-monthly Rates:

Repo Rate Reverse Repo Rate Cash Reserve Ratio Marginal Standing Facility Bank Rate Inflation Target Growth Forecast
6.5 % 6.0 % 4.0 % 7.0 % 7.0 % 5.0 % 7.6%

Inflation and Inflation Target

In June, the CPI-based retail inflation, driven by sharper-than-expected rise in the food prices (particularly vegetables and sugar), rose to 5.77 %, a 22-month high figure. Even though the market is expecting the food prices to increase further, the inflation target has been set by RBI at an optimist 5.0 % with an upside risk for Jan-2017. This has been kept in line with the RBI’s fixed target of bringing it down to 4.0 % in the next 5 years. The upper tolerance target of 5.0 % has been set by keeping in mind a strong expectation for a progressive monsoon and softening positions of oil and other commodities in the market. One thing to note here is that the inflationary trend is expected to be boosted by the contributions from the GST Bill and the 7th Pay Commission’s Housing Allowance. However, the governor is expecting the influence to be very minimal in the long-term.

Rate-cut Transmissions

The governor took a strong stance against the banks for passing on the rate cuts only modestly. Recently, the banks have been citing the upcoming $20 billion worth of Foreign Currency Non-Residents (FCNR) redemptions as the reason for the same. However, Dr. Rajan stated that RBI, with an efficient management plan and Open Market Operations (OMOs) to the tune of INR 80,500 crore, is well balanced to carry on the redemptions smoothly. This leaves the banks with no further reasons, ‘as of now’, to hold the cuts to themselves.


Overall, the RBI Governor’s valedictory policy was a hallmark of his term. This policy stands out as a unique document in terms of liquidity management, macroeconomic developments and pass-through of previous policy rate cuts to the lending rates.


By Ananya Biswas

The official announcement of Raghuram Rajan’s decision to quit as RBI governor has sparked strong reactions amongst the public and imminent industrialists. The timing of this move adds to the ongoing woes relating to the uncertainty of Britain’s exit from the European Union, unstable oil prices and delayed monsoons. There is a high possibility of this news adversely affecting the Indian rupee in the near term. His exit leaves the government with a herculean task of finding a new governor who is equally competent, sharp and pragmatic about reforming the Indian economy.

The recent letter addressed by Mr. Rajan to the RBI highlights all the reforms that have been brought about by the Governor and also veiled hints about the government’s reluctance to accept his second tenure. Mentioned below are few comparative measures which reflect the commendable work done by Mr. Rajan for the growth of the Indian economy (2013-2016 being the tenure):

Economy measures 2013 2016
Forex reserves 277,722.2 million dollars 338,979.3 million dollars
CAD as % of GDP 1.7% 1.1%
Inflation 10.92% 5.7 %


Economic reforms

Banking reforms

  •  Stabilizing the rupee which had plunged to an all-time low of 69 against the dollar in 2013 owing to stiff economic challenges and global volatility
  • Groundwork for on-tap bank licensing and licensing of differentiated banking entities to create a more diverse banking sector (Payment banks and NBFC’s)
  • New monetary framework focussing mainly on inflation targeting and changing the indicator from wholesale price index to retail inflation
  • Bringing in a universal payment interface which would play a major role in achieving the goals of universal electronic payments, cashless transactions and financial inclusion.
  • RBI cutting interest rates by 150 basis points thereby boosting liquidity in the market.
  • Sustainable structuring of stressed assets to address asset quality challenges at banks through Asset Quality Review.
  • Reduction of min daily maintenance CRR from 95% to 90% and narrowing the LAF corridor to 50 basis points.
  • Use of MCLR to decide lending rates by commercial banks so as to improve the monetary transmission mechanism.

All these reforms stabilized the banking industry which was in a vulnerable state. We hope our government selects a suitable candidate who can fill Mr. Rajan’s shoes. He / She must make sure that they maintain proper financial and price stability in the Indian economy which in turn will lead to a brighter future.