By Prof. M.H. Jawahirullah,
(Following is a summary of the doctoral thesis on ‘Performance Evaluation and Assessment of Service Quality in Islamic Banks: A Study with Special Reference to Bank Islam Malaysia’ by Prof. M.H. Jawahirullah, president of Tamilnadu Muslim Munnetra Kazhagam (TMMK). The thesis was declared as highly commended at the public viva-voce examination held by the University of Madras on 29th April. Prof. M.H. Jawahirullah is faculty member at the Department of Commerce, Islamiah College, Vaniyambadi)
Islamic Banking and finance: an introduction
Islamic Banking and finance is an innovation of the world in present times. India has largely remained on the outer fringe of the development of Islamic Banking and finance. Except for those countries where Islamic banking is being introduced on an economy wide scale, most Islamic Banking institutions have been established in the private sector.
In view of the on-going processes of liberalization and globalization, restructuring of the banking sector is long overdue. Introduction of Islamic Banking in the private sector shall boost private commercial banking in India. India has lately adopted the policy of opening up the banking sector and many foreign banks are now operating in India. India should learn from the experiences of Singapore and could invite more foreign capital to the country if it allows not only foreign Islamic banks but also conventional commercial banks to open Islamic windows as have been done in several European countries. The Indian Banks Association (IBA) has also appealed for allowing Islamic Banking in India. IBA Chairman M.B.N. Rao has gone on record saying “it (Islamic banking) is an idea, whose time has come. The IBA will study the concept, but will wait for the regulatory framework by the RBI to run it.”
Required amendments in Indian banking laws to facilitate Islamic Banking
In view of the fact that Islamic financial techniques are not based on interest, Islamic Banking has a special relevance for micro credit institutions in satisfying financial needs of weaker sections of Indian society. Indian banks are regulated by the Indian Banking Regulation Act, 1949, The Reserve Bank of India Act, 1935 and The Negotiable Instruments Act and Cooperative Societies Act, 1866. None of these laws admit the possibility of an interest free bank. Hence these laws will have to be amended significantly to admit such a possibility and to evolve a suitable system of regulation and control. The following sections in the Banking Regulation Act have to be taken into consideration while amending the Act or enacting a new legislation permitting Islamic Banks in India:
Section 21 of the Banking Regulation Act requires payment of interest on Saving Bank Account deposits. This section should be amended to permit Al Wadiah — Saving Account in which the deposits do not receive any interest but receive Hiba (gift) in case the banks use the funds at its own risk. Section 21 of the Banking Regulation Act disallows products like Mudarabah (trust financing) where the bank can invest the money in equity funds (in India, equity exposure is determined by a separate set of rules), and the client has complete freedom in the management.
Sections 5, 6 of the Banking Regulation Act indicate the forms of business a banking company can undertake, and does not allow any kind of profit-sharing and partnership contract like Musharakah (for project finance and SME credit)— the basis of Islamic Banking.
Section 9 of the Banking Regulation Act prevents the bank from owning any sort of immovable property other than for private use. This section thus prevents banks from introducing Ijarah (Leasing) under which Islamic Banks finance equipment, building or other facility for the client against agreed rental while owning the asset. Besides the usual curbs on acquiring immovable property, under the current Indian laws offering Islamic Banking products may not be bankable due to stamp duty, central sales tax and state tax laws that will apply depending on the nature of the transfer. In markets like the UK, there is separate law that makes it possible to launch Islamic Banking products. Singapore and Sri Lanka have amended their Banking Regulation Act to accommodate Islamic Banking products. Singapore has also amended its taxation laws to solve this problem. The Banking Regulation Act even disallows an Indian bank from floating a subsidiary abroad to launch such products, or offering these through a special window. Thus, in India Islamic Banking experiment is impossible without a new law (or multiple amendments to the Banking Regulation Act).
One way of amending the laws would be to maintain the current legislation with regard to conventional banks but to specifically enact laws applicable to Interest free Islamic Banks. The new legislation will have to expressly allow the regulatory authority the ability to deem a bank capable of interest-free operations. Once that authority has deemed a bank capable of interest-free operations, current legislation will no longer apply and a new set of laws will apply. Those new laws will govern their activities and subject them to the regulatory body. The regulatory body would assist in establishing and enforcing auditing and accounting standards, ensuring transparency in the dealings of interest-free banks and ensuring compliance with liquidity standards. The regulatory body, in conjunction with industry experts, could also look into some form of deposit insurance for account-holders and some form of a rating agency to judge the efficiency and managerial competency of the newly-developing interest-free banks helping to ensure the stability of the parallel interest-free banking network being set up.
Why India should permit the establishment of Islamic Banking?
Modern secular countries like Britain, United States, Singapore and Srilanka have successfully accommodated Islamic Banking and Islamic Banking products within their banking system.
In Britain the U.K. Financial Services has successfully resolved a number of regulatory issues including the problem of Deposits in Islamic Banks. This has enabled not only the setting up of Islamic Bank of Britain but also has enabled renowned banks to offer Islamic financial products.
In the United States the flexible approach of the regulatory authorities has permitted two types of Islamic financing vehicles: Ijara and Murabaha.
Singapore has been systematically reviewing its policies to ensure that Islamic finance is not disadvantaged vis-à-vis conventional finance. Singapore’s existing regulatory framework with suitable refinements has facilitated the development of Islamic finance in Singapore. Where there are specific risks or impediments, rules have been refined to address these specific areas. It is to be specifically pointed out here that Islamic Banks, Takaful and retakaful companies or Islamic capital markets players interested to operate in Singapore need not apply for a separate category of license; that is, the same licensing regime as that for conventional financial institutions will apply. Singapore has also amended its taxation laws to accommodate Islamic Banks and Islamic financial products.
Sri Lanka has also amended its Banking Act to accommodate Islamic Banking.
On the grounds of attracting capital as well as respecting the sentiments of the minorities Britain, United States, Britain, Singapore and Sri Lanka has facilitated either Islamic Banks and/or Islamic financial products.
The Indian Banking sector has been opened considerably in the past decade or so and openness to interest-free banks is a reasonable next step. Islamic Banking is one way to better provide the disadvantaged Muslim minority (among others) with the tools it needs to improve its situation. The potential benefits of allowing Islamic Banking include decreased economic disparity between the Muslim minority and the rest of the nation, better integration of that Muslim minority, and increased national economic growth. By creatively accommodating the ideological differences of its Muslim minority, and keeping an open mind about interest-free banking, India can position itself to reap these potential benefits. The government of India can grow one step closer to actualizing the spirit of “garibi hatao” (poverty alleviation) by reforming its banking sector and allowing the establishment of Islamic Banks.
Launching Islamic Banks in India has definite advantages
Firstly, providing acceptable Bank mediated avenue of Investment, savings of those who avoid interest based investments on religious grounds can be mobilized.
Secondly, an increase in the number of financial products available in the market is good for all concerned.
Thirdly, domestic interest free financial institutions will facilitate inflow of interest free foreign private investment.
Lastly, it will allow reputed banks to market interest-free financial products, or even open ‘Islamic Windows.’