Why Islamic Banking in India?

Since the mid 70s Islamic banking and finance has expanded to about 70 countries encompassing most of the Muslim world; about 55 developing and emerging market countries and 13 other locations around the world, including Australia, Bahamas, Canada, Cayman Islands, UK and Switzerland.

In 1974, the Organization of Islamic Countries (OIC) had established the first Islamic bank called the Islamic Development Bank or IDB. The basic business model of this bank was to provide financial assistance and support on profit sharing. By the end of 1970, several Islamic banking systems had been established throughout the Muslim world, including the first private commercial bank in Dubai(1975), the Bahrain Islamic bank(1979) and the Faisal Islamic bank of Sudan (1977).

The most pivotal fact on which Islamic banking rests upon is the prohibition of interest based earnings or “Riba”. Muslims believe that profit should be based on efforts ; while moneylenders make money with negligible efforts by using the tools of Interest. Their earnings increase while they sit idle.

Islamic banking also prohibits investment on activities considered haram or sinful, according to sharia. Thus, projects involving alcohol, tobacco, pork products and pornography are all forbidden. The system also condemns gambling and speculative activities. It should also be mentioned that Islamic banks keep their doors open to all irrespective of religious differences.

India's current laws obstruct the establishment of Islamic banking – The Banking Regulation Act (1949) prohibits the operation of banks on a profit-loss basis (5b), and thus forbids “murabaha” & 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, there is no reason for these regulations not to be amended. The purpose of regulations is to ensure smooth and standardised operations, not vet business models; the market will be the best judge of the efficiency and pitfalls of Islamic banking.

Experts argue that Islamic banking will mobilise enormous capital held by devout Muslims who sparingly participate in the conventional market. The Raghuram Rajan Committee on Financial Sector Reform (2008) also considered interest-free banking, and by 2013, the global market for sharia-compliant assets has risen to $1.6 trillion. Specifically for India, this means institutional money from the Middle East and Southeast Asia, as well as private wealth held by Indian Muslims in and out of the country. Given the number of Indian expatriates in these regions, Islamic banking holds an enticing opportunity for fuller market capitalisation. Sharia-compliant schemes have already shown promise in India - Tata Core Sector Equity Fund, launched in 1996, was tailored to assuage Muslim inhibitions on riba. Furthermore, it would be an added bonus if Islamic banking reduces dead-end investments in gold and jewellery.

“The non-availability of interest-free banking products results in some Indians, including those in economically disadvantaged strata of society, not being able to access banking products and services due to reasons of faith.”

- Raghuram Rajan

Islamic Banking has the potential to create new financial products which can be safer than the existing products. One probable product could be debentures with modified or no coupon rates. Many orthodox Muslim businessmen are still self-financing their businesses; Islamic banking can help in including all these people in the nation’s growth by expanding their horizon of businesses. The current population of Muslims in India is 177 million, which is 13% of the total population of India; countries like Pakistan and Indonesia have population of 173 million and 246 million as per 2012 census. Though the percentage figure seems low in India, countries which have implemented Islamic Banking serve as a lesson for targeting the correct segment of population to reap the benefits. This would also promote the entry of foreign currency and investments into India from the Islamic countries across world.

On the flip side, devising a regulatory framework satisfying both Islamic and conventional banking systems would be a challenging task for RBI. Educating the people about the new banking system would be tough, given the low awareness levels of conventional banking system. Another challenge is the common perception among the people of other communities in India against Islamic Banking. There is a serious dearth of Islamic banking experts in India who can manage the banks in the current competitive environment. Nevertheless, the interest-free solutions of Islamic Banking could restore equilibrium in Indian society by providing succour to debt ridden farmers, labourers and other marginalized groups. Hence, Islamic Banking is a potential tool for financial inclusion.

Aftab Anjum
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