The Way Forward to Islamic Banking in India

By Riyazi Farook Islamic Finance News, 5th January 2007.

Islamic banking is the fastest growing concept the world over but has not caught on in India. There are currently a handful of foreign banks operating in the country which are offering Islamic banking products. These include Lloyds TSB, Citibank, Grindlays, Standard Chartered, HSBC and ABN AMRO, which are already operating interest free banking in several west Asian countries, Europe and the US. There are a few home-grown banks like ICICI and Kotak Mahindra which offer Islamic banking products as Indian banks become increasingly aware of the Islamic banking concept and confi dent of the huge potential market in India.

The resilience of the Islamic banking industry already seen in many parts of the world could progress further with the distinctive advantages which India can offer. A population of over 1.3 billion is certainly a massive market to tap. India has the capability to offer huge manpower and natural resources. Opportunities which India can offer are in the areas of technical and managerial talent, with the added benefi t of international experience, given the underlying strength of its economy in which the country has emerged as one of the fastest growing economies in the world.

At this juncture, Islamic banking in India is limited to the co-operative sector scattered in various states all over the country. Islamic banks in operation number less than 15, with deposits of about US$150 million. In reality, they are just non-banking fi nance companies (NBFCs) which function on the basis of profi t and loss. These so-called Islamic banks cater to the needs of their locality except for a few that operate across districts or states. As their sources of funds are limited and their existence is small scaled, they miss out on any economies of scale.

Islamic banks in India provide housing loans on the basis of coownership, venture fi nance on Mudarabah or profi t-sharing and Musharakah or equity participation and consumers’ loans. Some banks fi nance transport also on the Murabahah or mark up basis through hire purchase.

As for investments, the Islamic banks put their funds in government securities, small savings schemes or mutual funds and to a smaller extent, investment in shares of companies or the stock market. Conventional banks are showing preference to undertake this form of interest-free banking. However, the absence of a legal Islamic banking framework is making it diffi cult for scheduled commercial banks to manage this form of banking or even adopt the Islamic banking system in a small way. Islamic banks in India are not under the control of its banking regulations but are licensed under the Non Banking Finance Companies Reserve Bank Directives 1997 RBI (Amendment) Act 1997, operating on profi t and loss (Mudarabah) under Islamic principles. RBI has also introduced a compulsory registration system.

Even if banks are allowed to set up windows that offer Islamic banking services, they need to maintain cash reserves and a Statutory Liquidity Ratio (SLR) which involves interest. ettlement and clearing facilities are not available from these banks, therefore their inability to issue cheques.

There is an urgent underlying need to regulate the fi nancial institutions in India given such an immense market among Muslims. A regulated Islamic banking industry would offer the masses an avenue to channel their money into the formal banking system, be it conventional or Islamic.

Muslims in India have undoubtedly regarded religion as the biggest hurdle for them to deposit their money in the bank or to obtain funding for developing their businesses or ventures. A huge proportion of this population even avoids serving in fi nancial institutions. The nonparticipation of Muslims in India’s formal banking institutions has not only weighed down their economic prospects but also prevented a huge sum of money belonging to the Muslim community to participate in the national development. Islamic banking can certainly revolutionize the micro-fi nance sector in the country and become an advantage for the debt-ridden farmers in areas like Maharashtra.

The Indian fi nance ministry has advised the Reserve Bank of India (RBI) to draw a roadmap for Islamic banking in the country. This is a step in the right direction to tap both the local market as well as major fi nancial players from the middle-east.

Subsequent to this advice, RBI has taken the initiative to explore the feasibility of Islamic banking. A committee comprising senior bankers from the State Bank of India and other government and foreign banks and headed by Anand Sinha, chief general manager in charge of banking operations and development have tabled a feasibility study along with their recommendations. The fi ndings have yet to be made public.

Other initiatives towards Islamic banking in the country have been sporadic in the form of press briefi ngs, literature circulation and seminars. A recent move to get the government’s involvement in Islamic banking was the presentation to the fi nance ministry and RBI by Jamaat-e-Islami Hind (JIH), on the need to amend the RBI Act and launch Islamic banking in India. (JIH is one of the leading Muslim organizations based in Delhi).

A Bahrain-based private equity fund, with an amount of US$1 billion has expressed an interest to start an India-specifi c fund. Also fi rms like Abu Dhabi Investment, Qatar Investment Authority and Islamic Bank Finance House are looking at investing in India. This will all lead to the speeding up of the development process for the country as a whole.

Regulatory issues need to be put in place before Islamic banking can be introduced in India and its benefi ts can be enjoyed to the fullest.