Islamic Banking Adv & Dis

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Problems and Prospects of Islamic Banking

in India Road Map Ahead

By H Abdur Raqeeb,

Banking institutions have emerged as very necessary for everyone, poor as well as rich. It is

needed to deposit and protect the saving however meagre it may be. Poor labourers, construction

workers and others migrating to the urban centres of the country from remote corners must have

access to banking to transfer their earning to the families in far off places. Also several socialinitiatives, welfare programmes and schemes of the government both state and central do require

bank accounts of those targetedbelow poverty line segmentsto receive money safely in theiraccount. Also credit is provided to people through banks. All these requirements have made

banking an inevitable part of life of todays men and women.

Even after forty years, since nationalisation of the banks about 60% population do not haveaccess to formal banking and only 5.2 % of villages have bank branches. Marginal farmers, land

less labours, oral lessees, self employed and unorganised sector enterprise, ethnic minority and

women, Aam Aadmi of our great country continue to form the financially excluded class. The

financial exclusion of a large segment of the population has far-reaching implications for thesocio-economic and educational uplift of the masses. These financially excluded classes would

not hesitate in sharing a return on their investment but they often find itdifficult to meet the demand of a pre determined return unrelated to the yield. If finance isavailable without the burden caused by pre-determined interest rates, it will be a welcome

development for the marginalized and also especially for SMEs. Interest-free IslamicBanking can fill up this gap.

For Muslims, as per the Sachar Committee report based on census 2001 data, the percentage of

household availing themselves of banking facilities is much lower in towns and villages where

the Muslim population is high. This is due to a certain mindset prevailing in the banking sector

which has categorized Muslims and Muslims dominated areas as NegativeZones as documented in Sachar report. Prohibition of interest and thus for reasons offaith Muslims are away from the conventional banks as referred to in the report of the Committee

on Financial Sector Reforms CFSR of the Planning Commission headed by Dr.Raghuram Rajan

Interest Free Banking

In the absence of an alternative to the convention based on interest, in the state of Kerala whereMuslims make up around 25% of the population of Kerala, which was 31.8 million according to

the 2001 Census, it is reported that thousands of crores earned in interest is kept in suspended

accounts, as believers do not claim it. Muslims both rich as well as those employed in the Gulfinvest their money on gold and real estate which are not productive investments. They also

indulge in lavish spending in marriages and other rituals and many of them fall into trap of bogus

financial institutions lose their hard earned money.


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Therefore there is a strong case to have an alternative system based on equity instead of the debt

based banking system catering and caring to the unbanked segments more specially of themarginalized and minorities -particularly Muslims in the country

Government Initiative

RBI Working Group

In 2005, Government of India asked Reserve Bank of India to examine Islamic banking

instruments and constituted a Working Group headed by Mr. Anand Sinha, Chief Manager,Department of Banking and Operation and Development along with senior Bankers from SBI,

ICICI and Oman International Bank that came up with its report in 2006 which said: In the

current statutory and regulatory framework it would not be possible for banks in India to

undertake Islamic Banking activities and concluded that if the banks are allowed to do Islamicbanking appropriate amendments are required in Banking regulations Act 1949.

National Workshop

After the GOI announcement that Islamic banking is not feasible in India, several interactive

sessions were held by ICIF, one of them was a National Workshop on Road Map onIslamic banking in Sept 2006, which was participated by prominent National andInternational Islamic experts and bankers. It passed resolution that Islamic Banking is relevant in

the 21st century and India may implement the same by obtaining inputs from the global examplein UK, Malaysia and Singapore. It also chalked out a plan of action as well.

CFSR-Planning Commission Recommendation

In August 2007, Govt. of India under the Planning Commission constituted a high levelcommittee on Financial Sector reforms (CFSR) under the chairmanship of Dr. Raghuram Rajan,former chief economist, IMF along with other eleven members who are the finest financial and

legal minds in the country.

CFSR submitted its final report in Sept. 2008 to Prime Minister with the specific

recommendation of interest free banking in the country:

Another area that falls broadly in the ambit of financial infrastructure forinclusion isthe provision of interest-free banking. Certain faiths prohibit the use of financial instruments that

pay interest. The non-availability of interest-free banking products (where the return to the

investor is tied to the bearing of risk, in accordance with the principles of that faith) results insome Indians, including those in the economically disadvantaged strata of society, not being able

to access banking products and services due to reasons of faith. This non-availability also denies

India access to substantial sources of savings from other countries in the region.

While interest-free banking is provided in a limited manner through NBFCs and cooperatives,

the Committee recommends that measures be taken to permit the delivery of interest-free finance

on a larger scale, including through the banking system. This is in consonance with the


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objectives of inclusion and growth through innovation. The Committee believes that it would be

possible, through appropriate measures, to create a framework for such products without any

adverse systemic risk impact. (Chapter 3: Broadening Access to Finance, Page: 72)

Why Islamic Banking?

The collapse of leading Wall Street institutions, notably Lehman Brothers, and the subsequent

global financial tsunami and economic recession, Islamic banking is seriously being considered

and has emerged as a possible alternative to the conventional banking because of the followings:

It is based on Ethical and Socially Responsible Investments (SRI) It aims at Equity and Justice and leads to poverty alleviation and It acts to new dimension to assets and actual projects aiming to support real economicgrowth instead of financial engineering.

It provides services to under banked populations ignored by conventional banks

Efforts Undertaken Meeting RBI & FM

When it was learnt that RBI is considering implementing a few recommendations of Dr.Raghuram Rajan Committee on Financial Sector Reforms (CFSR), ICIF contacted the Governor

RBI and sought an appointment to plead for the case of the recommendation of CFSR regarding

Interest-free banking. Accordingly a delegation of ICIF met the Deputy Governor Dr. K.C

Chakrabarty on September 11, 2009 and presented a memorandum along with the importantdocuments. RBI conveyed that it has no reservation regarding interest free banking but for that

an amendment in the Banking regulations has to be passed in the Parliament which can be done

by the Central government.

A memorandum was submitted to FM, Mr. Pranab Mukherjee to accept the recommendation of

CFSR committee on interest free banking and suitable legislative amendment. Several meetingsand interactions have taken place with the officials of the Finance Ministry and RBI in this

regard till now.


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In order to amend the Ranking Regulations Act 1949 and accommodate a level playing field for

Islamic banking, a bill has to be passed in Parliament. For this, Banking Amendment Bill hasbeen prepared and vetted by Dar Al Shariah, Dubai Islamic Bank and submitted to Parliament

secretariat by an MP to be undertaken as a Private Members Bill in the next session ofParliament.

Kerala & Islamic Banking

Another significant development has taken place in the state of Kerala. Govt. of Kerala under

KSIDC (Kerala State Industrial Development Corporation) has taken a courageous and

commendable step to form an Islamic Investment company named Al Barakah FinancialServices Company, an NBFC after an exhaustive feasible report undertaken by a reputed

international consulting firm Ernst & Young. This NBFC will be turned into a global Islamic

bank as soon as the RBI accommodates it after an amendment in the Banking regulations. Dr.

Subramaniam Swamy has submitted a petition in the High court to stop the participation of theKerala Government. Admission of his petition has put a hold on the proceedings for the time

being.

Misunderstanding

To bring Interest free Islamic Banking, misunderstanding and misinformation among the Muslim

masses as well as non-Muslims have to be removed. The need and necessity of interest freeIslamic finance and banking has to be spread among the Muslims, common people, religiousscholars, business men, bankers, politicians, and other stakeholders.

Among Muslims, criticism has been raised against the banking approach itself. Someallege that it is nothing but the changes of nomenclature only. Some other questions its capability

to meet all the financial requirements of modern day economy. Some go further to say that thewhole exercise is futile, with the macro level money creation process remaining the same, what

is attempted through so called innovative products is nothing but a cosmetic touch and even ininternational arena, Islamic banks have to price their investments on Global standards like

London Inter-bank Offered Rate (LIBOR) which are essentially interest based. These issues have

to be addressed properly by the Islamic scholars, finance experts and those who campaign forIslamic Finance and Banking.

Justice Mufti Muhammed Taqi Usmani, Chairman, AAOIFI (Accounting and AuditingOrganisationfor Islamic Financial Institutions) mentions in his famous book titled Anintroduction to Islamic Finance:Islam, being a practical way of life, has two sets of rules: one is based on the idealobjectives of Shariah which is applicable in normal conditions, and the second is based on some

relaxations given in abnormal situations. The real Islamic order is based on the former set of

principles, while the latter is a concession which can be availed at times of need, but it does not

reflect the true picture of the real economic order.

Living under constraints, the Islamic banks are mostly relying on the second set of rules;

therefore, their activities could not bring a visible change even in the limited circle of their


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operations. However, if the whole financing system is based on the ideal Islamic principles, it

will certainly bring a discernible impact on the economy . (Page 24)

In the plural and secular country like ours, misunderstanding among majoritycommunity has to be addressed; Islamic banking is not just for Muslims. It is only a mechanism

for financing business without providing debt. It is also to be focused that it is based on ethicsand Socially Responsible Investment (SRI). It has to be show cased that 40% customers in

Islamic banks in Malaysia are Chinese of other communities and also in UK, 20% customers areNon Muslims.

Ms. Perrine Fiorina of CELENT, Strategy consulting for financial institutions, talks of

Promising Future of Islamic Banking thus:

In addition to the large and untapped Muslim population, Islamic Banking is currentlybeginning to attract Non-Muslim customers, who are interested in alternative way of banking.

Indeed, a growing number of Non-Muslims are turning to Islamic Banking as customers spooked

by turmoil in the western banking system increasingly see the sector as a safe and moreconnected to the real economy. In my opinion, Islamic banking will benefit from this new

customers interest and grow even more quickly than it recently did .

Even Vatican has offered Islamic Finance principles to Western banks as a solution for

worldwide economic crisis. The ethical principles on which Islamic Finance is basedmay bring banks closer to their clients and to the true spirit which should mark every financial

service the Vaticans official newspaper, L Osservatore Romanosaid.

Recently, France has amended its laws to issue SUKUK Islamic Bonds based on

assets-of one Billion Euro.

Post 9/11, oil money has stopped being invested in U.S and is looking for a safeinvestment destination, and India could well be that destination given its safe economic scenario,

huge market, skill and educated labour and good growth rate.

Among the intellectuals, scholars and politicians, a doubt is lurking in the mindwhether banking operations are feasible without the base of interest.

As Dr. Hussein Hamid Hassan, Chairman, Shariah Board, Dubai Islamic Bank has saidConventional banks have since inception, had only one product, that is loan with

interest, Shariah has unlimited products to suit every customer and every project under anycircumstances .

Various products with Arabic words have to be suitably presented in the prevailing banking

terms and the reasons why they are preferable to the conventional banking products and practices

provided as they are based on real economy rather than financial engineering in conventionalbanking has to be suitably highlighted.


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Modern, secular and industrialized countries like Britain, Singapore, Hong Kong and Japan have

become hub of Islamic finance and banking. If London, Tokyo, Singapore and Hong Kong canbecome hub and house of Interest free Islamic finance and banking Why not Mumbai and

Cochin?

10-Point Programme of Action

A 10-point programme of action is suggested to this august house for consideration and serious

follow up to make the dream of Islamic Finance and Banking become a reality which will change

the face and fortune of the community as well as the country, if Almighty wills.

1. Interest free Islamic banking is emerging as a possible alternative to conventional Finance and

Banking Know why?

2. Start discussion in our circle & make it an integral part of our all programmes.

3. Bring out special issues and supplements in the print media, create space for discussion inelectronic media, usage of internet to share the latest development & progress

4. To remove Misconception among Non-Muslims that interest-free banking is not only for

Muslims, a group of strong supporters among them- Abu Talibs has to be included in our efforts

to spearhead this great cause.

5. Create awareness among Muslim Scholars, Students and the General Public by using

Juma Sermons, Conferences, seminars, etc.

6. Human Resource Development Skills & Spirits, Competence & Character specific

to Islamic Shariah Fiqh ul Muamilat and modern finance and banking has to beproduced.

7. General awareness in Media lobbying for Islamic Banking, Takaful IslamicInsurance, Sukuk Islamic Bonds.

8. Conduct seminars & symposiumContact B-Schools, Professional associations, etc.

9. Create political willcontact & convince MPs of all parties to enable amending BankingRegulation act, 1949 in Parliament.

10. Planning for Islamic Micro finance & Mega Private Islamic Banks when permission granted.

(H Abdur Raqeeb is Convener, National Committee on Islamic Banking & General

Secretary, Indian Centre for Islamic Finance (ICIF). The paper was presented at Islamic

Investment and Finance conference on March 28, 2010 at India Islamic Cultural Centre in

New Delhi)

Documents

Islamic Banking Adv & Dis