Islamic Banking in the Offing

India is likely to have an option for Islamic Banking, initiated by Non-Banking Finance Companies (NBFCs). The development will be icing on the cake for those who evade depositing their money in traditional banks. Since there are strictures on usury-based lending in Islamic beliefs, Muslims oppose traditional banking. The proposed Islamic banking is meant to help draw more Muslims into the modern economy and tap their savings. The partners in this effort are various businessmen, including many non-resident Indians based in West Asia. The plan is to raise Rs 500 crore.

The finance ministry is also considering to introduce NBFCs in the country. “It is in early stage of discussion. The idea is to start with NBFCs so that they can gain experience and also issues regarding financing and the model of Islamic banking can be addressed,” said a finance ministry official. Islamic banking is based on the principle that money cannot be lent for receiving interest but it can be used to generate wealth through legitimate trade and investment in assets. There are some NBFCs that offer Islamic banking products but the business is not viable because of the rules. One reason is that because Islamic NBFCs work on lease-transaction and hire-purchase model, there is double taxation of benefits.

In 2006, an RBI committee had said Islamic banking did not fit into the country’s banking laws. The finance ministry says issues such as asset classification, accounting standards, capital adequacy and provisioning for bad and doubtful assets will have to be looked into.

“We can’t deviate from the basic principles of banking, but if there is a room for relaxation, it can be explored,” the finance ministry official said.

However, there is no dispute over the need for Islamic banking products. The Raghuram Rajan Committee on Financial Sector Reforms had earlier recommended the introduction of interest-free Islamic banking in India.

The Indian Centre for Islamic Finance (ICIF) recently made presentations to RBI and Finance Minister Pranab Mukherjee on issues restricting the growth of Islamic banking into the country.

“If finance is available without the burden caused by pre-determined interest rates, it will be a welcome development for all the marginalised sectors, and especially SMEs. Interest-free Islamic banking can fill this gap,” the Centre has argued.

The ICIF has also suggested that NBFCs should be allowed to float Islamic bonds to raise resources. “We will be working out the guidelines with RBI, to work out a set of exemptions that can be worked out specifically for Islamic NBFCs,” the official said.

The Kerala government is already in talks with Islamic Investment Company named Al Barakah Financial Services for setting up an Islamic NBFC with the support of Kerala State Industrial Development Corporation (KSIDC). RBI allows only four categories of NBFCs – Asset Financing Companies, Investment Company, Loan Company and Infrastructure Finance Company.

The Kerala High Court last week lifted stay on Islamic banking. It said that there is no problem in forming an Islamic bank if the procedures and permissions in this regard are adhered to, but neither the government nor its enterprises can associate with such an effort, the High Court said in an interim order. The order partly modifies a January 5 order, which had frozen the Kerala government-sponsored process of setting up an Islamic bank.

The Kerala High Court had issued an interim stay on the decision to help establish such a bank. The Kerala State Industrial Development Corporation (KSIDC) had been made the nodal agency for the project. The state government, KSIDC and Al Barakah Financial Services, a company formed to take the endeavour forward (in which KSIDC took 13 per cent stake), asked the HC to remove the January 5 stay. Al Barakah was formed as a non-banking finance company (NBFC), as the first step to have a bank which functioned in full compliance with the traditional Islamic code, the Shari’ah. Chief Minister VS Achuthanandan said the state government would decide what to do after a detailed examination of this development.

On the other hand father of Indian green revolution, M.S. Swaminathan said that Islamic Banking may be the solution to the farmer suicide crisis in Vidarbha. “The exorbitant lending rate charged by money lenders in Vidarbha has created a vicious cycle of debt and suicide in the region. Often we hear news about farmers committing suicide in the Vidarbha region. Islamic banking, which propagates zero interest lending, can hold the key to solving this crisis,” he said while speaking at Karuna Ratna award presentation function held in Chennai last week.