By Amjad Suri for TwoCircles.net
The issue of establishing Islamic banking (bank based on Shari’ah) in India is not new. Various efforts have been made to see it come through by some concerned Indian Muslims and non-Muslims but faced all sorts of challenges and oppositions due to differences in culture and religion, and as a result of lack of awareness about the system.
Growth
The global Islamic finance industry has been on an upward trajectory, evidenced by a compound annual growth rate of 17% for its assets between 2009 and 2013. The industry’s assets were estimated to be worth $1.87 trillion in 2014 from $1.79 trillion in 2013. In many majority Muslim countries, Islamic banking assets have been growing faster than conventional banking assets. There has also been a surge of interest in Islamic finance from non-Muslim countries such as the UK, Luxembourg, South Africa, and Hong Kong.
An estimated $1.5 trillion in capital moves around the Middle East, largely from oil prices. Recently, IMF established an external advisory group, comprised of standard setters for Islamic finance and leading international experts, to assist in identifying policy issues to enhance coordination with difference stakeholders in Islamic finance.In July 2015, the World Bank and the General Council for Islamic Banks and Financial Institutions (CIBAFI), the global umbrella of Islamic financial institutions, signed a Memorandum of Understanding (MoU) to help foster the development of Islamic finance globally and expand its use as an effective tool for financing development worldwide, including in non-Muslim countries. Many Middle Eastern investors are eager to capitalize on India’s growth story. Regulatory challenges and the government’s unfocused approach to Islamic finance is working against India’s potential in becoming a leading investment destination for Middle East investors.
Islamic finance contracts
The Islamic finance industry has developed a wide range of shariah-compliant financial products. “Ijarah” (Islamic leasing) is a contract of exchange which is popular due to its similarity to a conventional lease. Ijara contracts are used in project finance as well as in Islamic bonds.”Murabaha” (cost plus profit) is a contract of exchange based on sale-and-purchase contracts with a predetermined cost and profit. These contracts are used extensively in car and infrastructure financing. Manufacturing based financing uses “istisna” contracts whereby the funding party agrees to deliver a commodity or an asset at a pre-determined future time at an agreed pre-determined future time at an agreed price. Similarly, mudarabah (profit and loss) contracts is a contract of participation, a partnership where capital is provided, in cash or assets (no debt is accepted) by one party – the fund provider.
Regulatory challenges
The Raghuram Rajan Committee on Financial Sector Reform (2008) also considered interest-free banking specifically for India. With all these challenges and oppositions, a careful consideration of the Indian banking law impedes the formation of Islamic banking with the Banking regulation act (1949) bars banks on a profit and loss basis(5b) , forbids murabaha, or, the buying, selling, or barter of goods (8), impedes ijara, or, bars the holding of immovable property for a period greater than seven years (9), and requires the payment of interest (21).
However, Islamic banking in India is feasible within the ambit of the Indian banking regulations act(1949) due to the fact that it has been generally accepted the world all over that there is need for a re – thinking in the operations of the current financial system that led to the current global financial crisis. The stigma of association Islamic banking with sharia principles and terror financing is discarded on the basis that devastating effect of the global financial crisis on the giant financial institutions all over, Islamic banking system was marginally or not affected. Despite these challenges, Islamic banking will make headway if and only if it can address these challenges objectively.
RBI committee headed by Deepak Mohanty recommends “that commercial banks in India may be enabled to open specialised interest-free windows with simple products like demand deposits, agency and participation securities on their liability side and to offer products based on cost-plus financing and deferred payment, deferred delivery contracts on the asset side.The committee has also recommended that in the event that interest-free banking is allowed in India, the extant regulatory guidelines in respect of capital and liquidity as applicable in the case of commercial banks would have to be made applicable to those as well” (Ch. 5: Interest free banking, p.40).
The way ahead
Furthermore, while the global financial crisis wreak havoc on financial institutions around the globe, the Islamic banking system increased in their reserves as well as attracting new clients. Islamic finance is considered to be the main alternative source of finance and in principle actual model is related with private equity investments in conventional finance.
The regulatory challenges that may likely prohibit the successful establishment and management of Islamic banking in India and will be hindered by the current regulatory framework that supports conventional banking. This is because the current banking regulations (1949) is structure in the line of conventional financial system which is against Islamic banking. The step forward is for Reserve Bank of India is to either modify the existing framework banking regulations (1949) or introduce special framework for Islamic banking in order to provide adequate support for the establishment and operation of Islamic banking in India. The Reserve Bank of India had in February this year also sent a copy of the inter-departmental group to the Finance Ministry. The RBI technical analysis report said that work on formulating suitability and appropriate criteria for Islamic products in addition to what would be determined under Sharia.
In its annual report for 2015-16, the Reserve Bank had said that some sections of Indian society have remained financially excluded for religious reasons that preclude them from using banking products with an element of interest.
“Towards mainstreaming these excluded sections, it is proposed to explore the modalities of introducing interest- free banking products in the country in consultation with the government,” mentioned the report.
Challenges to Islamic banking can be addressed only through the help of Reserve Bank of India, religious bodies, and Islamic banking institutions by creating adequate awareness about the needs, objectives and the advantages of the institutions. Majority Muslims only know that Islamic banking is based on non-interest basis, while the majority of the followers of other faiths have little or no knowledge about it at all. This is a serious setback to Islamic banking in India thereby leading to unnecessary oppositions and lack of public acceptance. The Reserve Bank of India is really doing great in this aspect but still needs to carry it to the grassroot level, and any potential Islamic banking in islamic should also assist in creating awareness to enhance public acceptance of the institution. Islamic banking can survive in India by increasing its efficiency and performance.
The writer is a doctoral researcher on financial literacy based in the UAE