Mint:Dinesh Unnikrishnan : Mon, Oct 15 2012. 11 24 PM IST
Central bank asked to examine the possibility of making interest-free model part of India’sRs.75 trillion banking system
Reserve Bank of India governor D. Subbarao said last week
that the apex bank was holding talks with the government on
how existing laws can be restructured or amended ‘so that
they are in conformity with Islamic banking’.
Mumbai: India may be closer to allowing Islamic banking than ever before with the central bank and the finance ministry discussing ways in which rules need to be changed to allow the interest-free practice that’s compatible with Shariah law.
Demands by Muslim groups over the past few decades to allow the method have thus far been stalled because of concerns over incompatibility and fears that it could be used as a conduit for terror funding.
Reserve Bank of India (RBI) governor D. Subbarao said last week that the apex bank was holding discussions with the government on how existing laws can be restructured or amended “so that they are in conformity with Islamic banking”. RBI has thus far maintained that Islamic banking is not feasible in India as existing regulations do not permit interest-free banking.
The finance ministry recently wrote to RBI asking it to examine the possibility of making the interest-free model part of India’s Rs.75 trillion banking system
.
Interest isn’t allowed under Shariah law as it’s equated with usury; instead, lenders get a share of any profit made by the borrower, while having to absorb any losses.
The finance ministry’s communication to RBI followed a meeting with the National Commission for Minorities (NCM) in June, a constitutional body headed by former chief information commissionerWajahat Habibullah.
NCM asked the apex bank to take a fresh look at Islamic banking. Following this, the National Committee on Islamic Banking (NCIB), a non-profit body, submitted an action report to RBI in this regard. Mint has reviewed these documents.
The NCIB report argues that it’s not necessary to change banking laws to implement interest-free products, though tax laws would need to be amended.
“The only area where a change is necessary is the tax laws, as they do not match with the sale and investment-based contracts offered by participator banks such as wakala (agency contract), murabaha(trust-based sale), musharaka (joint venture),” said H. Abdur Raqeeb, convenor, NCIB.
Supporters of Islamic banking say its implementation will lead to money coming in from organizations that can only make Shariah-compliant investments. Critics say it will destabilize the secular nature of the country’s banking system by imposing the laws of one religion, besides facilitating terror funding.
D.K. Mittal, financial services secretary, declined to say whether the government was considering any change in laws to facilitate Islamic banking, saying it’s a “larger issue”.
An email to RBI asking about the steps being taken to study the proposal was unanswered.
“At this stage, the government has not made up its mind on whether Islamic banking is feasible in the country,” a senior member of Parliament said on condition of anonymity. “But certainly, there is a push from influential quarters to bring it in the country.”
Islamic banking based on Shariah law is known as participatory finance, or interest-free banking in some countries. The collection or payment of interest and the funding of businesses engaged in alcohol, pornography and weapons of mass destruction, all considered haraam (unlawful) in Islam, are prohibited.
Unlike conventional banking, which treats customers as debtors and creditors, in Islamic banking, the customer is an investor in the bank’s business.
“Our (existing) banking system is based on the philosophy that money must become more money (by accruing interest) as time passes. One can imagine why people who benefit from that do not want any other model to enter this system,” said Nejatullah Siddiqui, an economist.
India has 26 public sector banks, 20 private banks and 41 foreign banks. The total assets of the 40 listed banks, as on 31 March, stood at Rs.71.64 trillion. But half of the country’s population still does not have access to formal financial services and are dependent on informal money lenders.
Both the government and RBI are promoting financial inclusion programmes to bring the unbanked population into the formal system. But for some Muslims, a banking system not compliant with the Shariah may be an issue. A Shariah-compliant option could encourage them to become part of the banking system. India has about 170 million Muslims.
Globally, Islamic banking is common in West Asian countries, the UK, Japan and Singapore. The global market for Shariah-compliant assets reached $1.3 trillion in 2011 from $509 billion in 2006, according to the UK Islamic Finance Secretariat, a part of TheCityUK, an independent body in London that promotes the UK’s financial services industry.
Shariah-compliant Sukuk Bonds, or debt instruments equivalent to securities in the conventional banking system, are also common in the Islamic banking system.
Global rating agency Standard and Poor’s, in a 13 October report, said Islamic banking could help ease funding constraints in the infrastructure sector.
“The growing and deepening market for Islamic financing is a key reason why we think this market is worth considering for the infrastructure sector,” it said. “We also believe that infrastructure projects are a logical fit for Islamic finance, which is governed by Sharia and predicated on asset-backing and shared business risk.”
Concerns
There is strong resistance against the prospect of Islamic banking in India.
“The fundamental issue is we cannot have two laws in the same system. It doesn’t make sense,” saidSubramanian Swamy, economist and president of the Janata Party.
Madan Sabnavis, chief economist at rating agency Care Ratings, holds similar views.
“Pricing is important for any market to function and interest is what determines the price value of a commodity,” he said. “Questions arise on how does one determine the critical efficiency parameters, level of bad loans and capital adequacy of such institutions... I do not believe a parallel system can exist.”
Swamy, a long-time critic of the model, also worries that Islamic banking “can open channels for terrorist organizations to channel money into India”, and that “since such organizations will encourage only Muslim customers, the international Muslim organizations (may) want to use this as a tool to encourage people to convert to Islam.”
Swami moved the Kerala high court in 2009 against the inception of a financial institution, Al Barakah Financial Services Ltd, that was to be run on Islamic banking principles backed by the state-owned Kerala State Industrial Development Corporation (KSIDC). The high court dismissed the petition in early 2011. KSIDC has an 11% stake in Al Barakah, which is yet to start operations, while the rest is held by a few non-resident Indian businessmen.
Sabnavis also said “chances of terrorists using this channel can also not be ruled out... The fact is that nobody will be able to monitor where this money is coming from and its ultimate end-use”.
Habibullah refutes this argument. “It is stupid to think Islamic banking will facilitate funding channels to terrorist organizations. It is simply another form of banking being done in other countries and is one more option to the people in India.”
“Terrorist money can come in anyway, even with or without Islamic finance,” said Thanveer Mohiddeen, chief operating officer, Alternative Investments and Credits Ltd, or AICL, a Kerala-based non-banking financial company (NBFC) that began operations in 1999 in accordance with Shariah principles. “Indian Muslims are financially backward and Islamic finance can change this scenario.”
RBI in April barred AICL from providing further finance, charging the firm with not complying with its fair practice code for NBFCs that requires them to declare the interest rate at which they lend to borrowers. AICL moved the Bombay high court in May against the RBI order cancelling its licence. As of March, AICL had a loan book of Rs.7 crore. The case is still pending in the high court.
Regulatory reluctance
The apex bank’s discomfort with the Islamic banking model may not change despite all the recent activity.
In 2007, an RBI-appointed working group under then executive director Anand Sinha that was examining the financial instruments used in Islamic banking, said that under existing regulations it was not feasible for banks in India to undertake Islamic banking or to allow their branches to carry out Islamic banking operations abroad.
In 2008, though, the Raghuram Rajan committee on financial sector reforms suggested implementing interest-free banking in the country.
“The committee recommends that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system... it would be possible, through appropriate measures, to create a framework for such products without any adverse systemic risk impact,” the panel said.
It also pointed out that as certain faiths prohibited financial instruments that involved interest payments, a section of Indians was unable to access banking products and services. “This non-availability also denies India access to substantial sources of savings from other countries in the region,” it said.
“The model of Islamic banking can be implemented (in India) only when regulations are conducive,” saidAshvin Parekh, partner, financial services, at global consultancy Ernst and Young India, adding that it was premature whether it can be misused. “The right approach is that right KYC (know your customer) disclosures are put in place to avoid misuse.”
Comments:
Safiya Mubarak
Interest free finance 'll helps speed development of the country,it says by expert economists.Than why it is getting 'goslow ' for implementation
nrparwani
If the working group appointed by the RBI in 2007 came to a conclusion that it was not feasible for banks in india, under the existing legal framework, to undertake islamic banking or to allow their overseas branches to carry out islamic banking abroad, how can it be done now, as the the banking regulation act has not been amended since then ? If allowed, it might provide an easy legal channel for terror funding, given the slack monitoring system obtaining in the country.
Syed Zahid Ahmad
Because in 2005-6 that working group had taken use of internet instead of direct interection with any Islamic banker to study Islamic banking, their observation was different. After that report RBI is approached by Islamic bankers and at last they understand the system and doing the corrections without referring earlier report. Have you find any Islamic bank involved in any terror funding? Only true knowledge can make your understanding better. There is no scope of terror in Islamic banking.
(Edited by author 1 day ago)
reply to nrparwani
lamba
you might be right but there have been too many crimes by the peoples for the other s to believe any of it.
reply to Syed Zahid Ahmad
Farooque Shahab
I commend Mr. Dinesh Unnikrishnan on authoring such an informative news article, giving all the shades of views and without passing any value judgment on any one of them. I am myself a practicing conventional banker and have seen shar'ia compliant banking in operation, from close quarters. I'll like to list out concerns, challenges, expectations, etc. associated with the shar'ia compliant banking and my own take on them.
1. How Islamic is the popularly peddled Islamic banking?
Jury is still out. Cognoscenti confirm the current form of Islamic banking is at best an effort to move as close to shar'ia compliant banking as is possible, in the present situation. They are miles away from being Islamic and should better be called Alternative Banking, Participative Banking, etc. Puritans will never like it to be called Islamic Banking.
At its worst, it is a shar'ia clone of conventional banking. The same mannequin draped in another dress.
I vote in favour of the former.
2. Introducing Islamic Banking in India is simply vote bank politics, minority rather Muslim appeasement.
On closer scrutiny, any one can see that it cuts both ways. Whichever ruling party introduces it in India, whether rightist, leftist or so called centrists, will definitely like to take mileage out of it and why not? It is their job. They may get some advantage as well. But, whichever party is in opposition will raise the bogey of vote bank politics and wean away a few of the ruling party's voters to themselves. No star gazer even can say what political dividend will the initiative pay. So, it is better that India decides on introducing Interest free banking on its economics and not politics. A difficult decision, of course!
FSA OF UK, US FED OF USA, MAS OF Singapore, Banque De France of France, etc. allows Islamic Banking in France. I do not think that any one of them has ever been accused of introducing Islamic Banking in their geographies for appeasing Muslims or for their votes. Had they wanted votes from Muslims, taking this decision would have been far more difficult for them. The fact that there was no politics involved in their decision made their life much simpler, much simpler than that of the lifes of RBI Guv or the FM or PM of India.
3. Does it make a lot of economic sense for the country? A view is that it is more of a hype and post introduction of Islamic Banking, nothing substantial is going to happen.
I personally know a few of the CEOs of banks, including Islamic banks in Middle East and have talked to them. They are of the view that Middle East investors will make significant investments in Indian market, if their religious sensibilities are taken care of. And it is conventional wisdom as well. Post 9/11, a lot of GCC investments flew back from the west to their region, which led to boom in their backyard. Spill over that went to North Africa and China also did a lot of good for these two geographies. India was bypassed mostly on account of absence of shar'ia compliant investment products/banking. And the finance & banking professionals, the world over, know that ME investors carry the highest liquid surplus, in their portfolio. Another issue is that unlike western investors, who are more interested in short term portfolio investment, their investment horizon is a little longer, say 1-3 years. They are more attracted to real sector than financial. However, India needs more investments in infra sector, which by nature is longish. How to mould these investors' appetite from short & medium to long term will really be the challenge for finance professionals, once GoI and RBI together enable them to attract ME investors by allowing Alternate/Islamic/Shar'ia compliant banking.
I will post the sequel of my comments later.
I Q Khan
Kudos to Mr. Subba Rao and Team for the leadership and foresight demonstrated.
It makes both Financial and Political sense to implement these measures.
Thanks to the critics as it will strengthen the system
Tasneem Ataullah
A very good article displaying all the sides of Islamic Banking. Finance without interest must surely be implemented, as it leads to real assets and ultimately real development of the country. When well-experienced economist agree to this fact, then why is the implementation still at a slow pace?
Naeem
Its the matter of time that we can see in the near future, India approves Islamic banking. The reason is that everybody needs money (govt. also), the need will guide you to utilise the present world economic scenario. The studies say that ONLY Islamic Banks around the world didnt affect by the world economic slow down happened recentlty. more over, those banks are showing the considerable progress becuase of the inclusive policy of the system.
Why India cant practice this ?, if its giving benefits to the majority people who are still not accessible for the conventional banking system, what prohibits us to go with the Islamic banking? You can call it by any name if its name worries you. Interest Free Banking can be used rather than Islamic Banking.
Mr. Madan Sabnavis concerns that the parallel system (read Islamic Banking) cannot exist..!! Where this person is living..? All the gulf countries have got number of such banks working with good results and even performs better than conventional banking. , if you dont believe , ask Dr. R Seetharaman, CEO Doha Bank, Qatar. Apart from gulf countries, many countires support these banks as they are giving good results. UK,US, Japan, Germany, HongKong, Malesia, indonesia, to name a few...
Avoid persons like Subrahmanyan Swamy as he is not having any business with this. The point raised by Mr. Thanveer Mohideen, COO of AICL is right that terrorists can use any banking system no matter what system banks follow.
Chandru031
Muslims in India constitute around 17% to 18%. Majority of muslims find it difficult to accept 'Interest as Income', which is fundamentally against their religious beliefs. The impact of this is that, since there is no avenue for investment as per their belief, most of their earnings are never channelized productively into the mainstream economy. Result - The financial divide between Muslims and non-Muslims keeps increasing, creating & enhancing social tensions. Infact, bringing most funds into mainstream economy should shut or narrow the channels to involuntary terror funding. There is immense sense in introducing Islamic banking in India rather than hoisting boogies of terror funding, etc. After all, London is the hub of Islamic banking more than Dubai or any Islamic country & no terror funding seems to be aided by this? Introducing Islamic banking will uplift the livelihoods of millions of muslims, reduce the social divide and social tensions, enhance monitoring, attract much needed funds for infrastructure from many Islamic countries & uplift our economy. About time, we opened our eyes to this 'alternative channel' of investment.
M. Farooq Khan
Did the author cross checked what he wrote??
The heading suggest about INR 75 Trillion whereas supporting para talks about INR 75 Billion:
"The finance ministry recently wrote to RBI asking it to examine the possibility of making the interest-free model part of India’s Rs.75 billion banking system."Please get the facts right before publishing fairly important topic!
Nazeer Ataullah
Good article. Discusses what is Islamic Banking, opinions pros & cons. Thanks Dinesh and thanks for publishing. The irony is we are failing to introduce alternatives in our systems. Instead we argue negatively. I have a simple question: Does Dr. Raghuram Rajan do not know the pros and cons of Islamic Banking if implemented in India? Why does he recommends. Because he is an expert in Economics, studies this subject at global perspective. When a system is good to India, give a chance to accomodate otherwise we stand against our nation's development.
Farooq Khan
Interest free banking is The way of banking to save economy from regular recession as we are seeing in Europe after US . It should not be confused with religion except some strong fundamentals has been provided by Islam which whole world can take and use it in their day to day transactions. If UK can implement Interest free banking then why India can not do it as it Governance system is on foot step of UK . Indian Politician are misguiding people of India from right path. Farooq
Economicinitiatives
Any secular system cannot be against any religion so we cannot say that Indian banking is secular unless it create provisions to allow Muslims doing banking without avoiding their religious ethics . In a modern secular nation like india we need Islamic banking to let Muslims feel that they are part of the system and are not treated as second degree citizens
Why
If after all governments past and present have done for Muslims in India, you choose to be hateful, want to feel a part by only demanding and stick onto a label of 'second-class citizens', even introducing Islamic banking will do you no good. Secularism starts with realising that religion is NOT our only and most important identity and that it must ideally have no play in certain areas of life. You should be proud that India is perhaps the only country where muslims of all kinds are recognisedand coexist. If you still feel inferior, kindly ship out to a place that treats you better. FYI, Islamic academics themselves are divided over how islamic islamic banks. There's even a fatwa against it.
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