ISLAMIC BANKING IN INDIA

After discussing the different principles of Islamic banking, this is an attempt to explore the feasibility of Sharia banking in India. The rise of “interest” as a blood sapping social evil is alarming. To get rid of this menace and save the nation from the clutches of interest, suitable amendments should be made in the Banking Act. Indira Gandhi’s slogan, “Garibi Hatao” and “Roti,Kapda Aur Makaan” as enunciated by Zulfikar Ali Bhutto are still relevant today as it was in the early seventies. Yet even today, horrendous disparities exist between different segments of the Indian society. The majority of the unorganized sector; workers, semi-skilled persons, small farmers are all non-bankable. .Access to finance by the poor and the vulnerable groups is a prerequisite for poverty reduction and social cohesion. Such “financial apartheid" is one of the main causes of exclusion of the majority of the population in terms of growth. Government must provide the disadvantaged classes with the tools they need to improve their condition.The Indian banking sector has opened up considerably in the past decade or so and openness to interest-free banks is a logical next step. Islamic banking is one way to ameliorate the disadvantaged classes. The potential benefits of allowing Islamic banking include; decreased economic disparity between the haves and the have nots, better integration, and consequently accelerated economic growth. Government of India can leap a step closer towards the fulfillment of Indira Gandhi’s much cherished dream of “Garibi Hatao” by reforming its banking sector and allowing the establishment of Islamic Banks. 

To get a clear picture, let us analyze the position of Islamic banking in India on SWOT(Strength, Weakness, Opportunity and Threat) Scale. SWOT analysis will help us to logically examine the chances if this concept would flourish or flounder in India.  

STRENGTH

Islamic Banking will unequivocally ameliorate the deplorable condition of the poor and marginalized segments of society. Banking products which comply with Islamic law are becoming increasingly popular, not only in the Gulf countries and far eastern states like Malaysia, but also in other developed markets such as the United Kingdom. Reputed banks like Standard Chartered, Citibank, HBSC are operating interest free windows in several West Asian countries, Europe and USA.   There is a huge potential market in India for Islamic banking products.

We have seen the fall of giants in the world of financial sector like Lehman Brothers in the aftermath of the US sub-prime mortgage crisis. Therefore, it is of paramount importance to be strict about credit rating system, to circumvent any chance of  further bankruptcy. Since Islamic banking adheres to strict credit rating system and prohibits indebted economic agents to avail more debt finance, it could save our financial and economic enterprises from bankruptcy. Interest is strictly proscribed in Islamic banking. Principles of equity finance abhor financing the indebted enterprises thereby arresting the chances of bankruptcy to  great extends. Under Islamic banking, equity finance needs cost yield and pre-rating analysis of projects. It thus considerably subdues the mindless competition in financial sector to get more credit shares and tends to provide stability in the financial market. Islamic banks are unaffected by the subprime mortgage crisis. In fact, now many non-Muslim countries are turning up to Islamic banking as they are immune against such crisis due to inherent business ethics within Islamic banking.

Moreover, Islamic banking helps the weaker and hapless section of the society through various financial products. Islamic banking finances (through its Joint ventures,partnerships and leasing)are provided by investors or banks to the borrowers with a condition that financial risk is to be borne by the investors, and other risks to be borne by the borrower. This helps even the indigent and vulnerable to get finance at a no risk and cost basis, but definitely requires other credits like strong business proposal, rational planning, skilled hands and specialized art to attract the financier. Better business proposals succeed in fetching funds as opposed to the projects with comparatively poor propositions. Such inclusive growth will aggrandize   the Indian economy.  

A bank in India cannot raise deposits without promising a specified rate of return to depositors, but under Sharia, returns can only be determined post-facto depending on profit. Also banks have to maintain a Statutory Liquidity Ratio (SLR), which involves locking up a substantial portion of funds either as cash, gold or in government securities. Such cash will not get any return,  keeping it in gold is risky as it could depreciate and government securities come with interest.Moreover, Islamic banking can eliminate unaccountable economic activities, as every economic activity has to be financed through legal contract and physical verification of real assets under contract. There is no room for diversion of funds. Therefore, investment in consonance with Islamic banking principles will surely boost the engine of economic growth in our country.   

The high powered Raghuram Rajan Committee draft Report as released on 7th April 2008, strongly suggested interest-free banking as a part of recommendations made for financial sector reforms. The Committee postulates that interest free banking is another area that falls broadly in the ambit of financial infrastructure.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 in some 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 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. 

WEAKNESS 

Indian banking laws do not explicitly prohibit Islamic banking but there are provisions that make Islamic banking almost an unviable option. The financial institutions in India comprises of Banks and Non Banking Financial Institutions. Banks in India are governed through Banking Regulation Act 1949, Reserve Bank of India Act 1934, Negotiable Instruments Act 1881, and Co-operative Societies Act 1961.

Certain provisions regarding this are mentioned below

• Section 5 (b) and 5 (c) of the Banking Regulation Act, 1949 prohibit the banks to invest on Profit Loss Sharing basis -the very basis of Islamic banking.
• Section 8 of the Banking Regulations Act (BR Act, 1949) reads, “No banking company shall directly or indirectly deal in buying or selling or bartering of goods…”
• Section 9 of the Banking Regulations Act prohibits bank to use any sort of immovable property apart from private use –this  is against Ijarah for home finance
• Section 21 of the Banking Regulations Act requires payment of Interest which is against Sharia.

As regards to partnership by Islamic banks in a firm, the bank has to make sure that the manager does not avoid his responsibilities or obtain other non-pecuniary benefits at the expense of non-participating partners and ensure the veracity of the profit statements. Monitoring of data about firms in which Islamic bank invests would involve exorbitant cost. However, Islamic banks need to set up monitoring cell to keep them informed of the internal function of their joint venture. The implication is that banks and entrepreneur have to function very closely.

Islamic banking needs to introduce corporate governance with transparent accounting standards. It needs to perform detailed evaluation before embarking Profit Loss Sharing Scheme, which demand a pool of highly trained professionals. The imparting of professional training is costly. Detailed principles are still to be laid down and techniques and procedures evolved to carry them out. It is only after the satisfactory achievement of these that proper training can begin.

It is observed that inability to evaluate a projects’ profitability has tended to act against investment financing. Some borrowers frustrate the banks appraisal efforts as they are reluctant to provide full disclosures of their business. These exercises are not limited to relatively few large loans but need to be carried out on nearly all the advances made by the bank. Yet, widely acceptable and reliable techniques are yet to be devised.Moreover, the borrowers do not observe business ethics which make it difficult to establish close bank-clientele relationship - a condition for successful Islamic banking. Adverse selection has been one of the major impediments in the world of Islamic banking. 

Among the other disincentives from the borrower’s point of view are the need to disclose his accounts to the bank if he were to borrow on the Profit Loss Sharing basis. However, many small-time businessmen do not keep any accounts, leave alone proper accounts. And large conglomerates do not like to disclose their real accounts to anybody. The widespread lack of business ethics among certain business community will be another major hurdle in the path of Islamic banking in India. 

The practices in use by the Islamic banks have evoked questions of morality. Some critics view Sukuk(Islamic Bond) as unIslamic in nature. Others criticize that financing through the purchase of client’s property with a buy-back agreement and sale of goods to clients on a mark-up, involved the least risk and are closest to the old interest-based operations. Bai’ mu’ajjal (sale with deferred payment) and Murabaha (cost-plus financing) are permitted in the Sharia under certain conditions.What is being done in many countries are fictitious deals which ensure a predetermined profit to the bank without actually dealing in goods or sharing any real risk. This is against the letter and spirit of Sharia.  

OPPORTUNITY 

India with a 15% Muslim population, the highest in a non-Islamic country and  second  highest in the world offers huge opportunities to exploit . The size of the market will be very large as the Indian population is above 100 crore and Muslim population itself is about 15 crore and majority of them, in the name of religious faith, are looking for interest free banking and finance. It is pertinent to mention here that Islamic banking is not meant for Muslims only but non Muslims may also avail the benefit of it. And it is feasible to have a parallel banking system based on Sharia along with a conventional one.

After 9/11, most of these countries started pulling out their investments from the US and Europe because of the fear of freezing of assets. Another reason could be the slowdown in the economies of western countries. A growing Indian economy has created a huge enthusiasm among Islamic nations as it sees the unlimited opportunities it can avail. In fact, five Indian companies, Reliance Industries, Infosys Technologies, Wipro, Tata Motors and Satyam Computer Services figure in the Standard & Poor’s BRIC Sharia Index.

Eleventh Five Year Plan envisages inclusive growth with development in all sectors of economy. Islamic banking is an effective mechanism to subjugate the liquidity and inflation problems along with allowing inclusive growth. For real inclusive growth, we have to ensure increase in income and employment status of workers in all segments.

If Islamic banking is introduced, the inadequate labor capital ratio, for informal sector workers associated with agriculture and manufacturing industries could be resolved through equity finance, which might be a revolution in our agriculture and unorganized sector. With improved labor capital ratio, our vulnerable workers associated with agriculture and unorganized sector might be able to compete effectively with the formal sector workers. Thus Islamic Banking may financially empower majority of Indian workers.  

Islamic banking may induce our political leaders to substitute grants and subsidies with equity finance schemes through specialized financial institutions because equity finance allows access to credit without debts of borrowers. Equity Finance helps achieve self-reliability which never comes through grant and subsidies. Islamic banking should not be a religion based banking business, but could be profitably used to resolve our issues pertaining to economy. 

Moreover with introduction of Islamic banking, Indian government will certainly gain diplomatic advantages to make financial dealings with Muslim dominated nations especially to attract trillion dollars of equity finance from the gulf countries. This is more important after the fall of the titans like Lehman Brothers because it reflects the economic downturn in the west and the need of alternative sources of FDI for the Indian economy. India needs to provide a congenial economic environment to attract the financial inducement from the Gulf region. 

Islamic scholars have defined market instruments in length and they have permitted with some conditions to have investments in stock market .Certain broad criteria are:

• The company’s activities should not include liquor, pork, hotel, casino, gambling, cinema, music, interest bearing financial institutions, conventional insurance companies, etc.
• The total interest bearing debt of the company at any point in time should remain below one third of its average market capitalization during the last twelve months.
• Its aggregate of account receivables should remain below 45% of total assets.
• If company has any interest bearing income it should not be more than 10% in any condition.

 While Sharia compliant investment avenues are now becoming available in most countries, India has not seen large-scale development. To estimate the scope of Islamic investment opportunities in the Indian stock market, it is imperative to examine stocks that conform to Islamic Shariah principles "Out of 6,000 BSE listed companies, approximately 4,200 are Sharia compliant. The market capitalization of these stocks accounts for approximately 61% of the total market capitalization of companies listed on BSE. This figure is higher even when compared with a number of predominantly Islamic countries such as Malaysia, Pakistan and Bahrain. In fact, the growth in the market capitalization of these stocks was more impressive than that of the non-Sharia compliant stocks. The software, drugs and pharmaceuticals and automobile ancillaries sector were the largest sectors among the Sharia compliant stocks. They constitute about 36% of the total Sharia compliant stocks on NSE. Further on examining the BSE 500 the market capitalization of the 321 Sharia compliant companies hovered between 48% and 50% of the total BSE 500 market capitalization.”(Source: www.islamicequity.co.in) 

Another opportunity is mutual fund which is based on 100% equity. These funds are invested in different sectors like IT, automobile telecommunication, cement. In fact, Tata Mutual Fund made a pioneering attempt when, at the instance of the Barkat and some other Islamic financial group, it launched Tata Core Sector Equity Fund in 1996 . This scheme was specially tailored keeping in view the Muslims’ inhibition of dealing with interest bearing and haram investments. This scheme surprised many by being able to raise Rs. 230 million from the public.  

Moreover, large number of Muslims who are considered unworthy of credit by commercial banks would welcome Islamic banking. People prefer to put their money in gold or jewellery, which is the worst kind of investment from the economic point of view. Some Islamic societies in India accept deposits and lend money, but can't make a business out of it because of the Sharia's prohibition of interest. And they are not able to convert themselves into banks because the government will not permit any form of banking without interest. Some of them have collected crores in interest-free deposits, but they do not have any avenue to invest that money, 

THREATS 

Islamic banking could be a huge political issue. Certain parties might abhor the use of the word “Islamic” and could term it as anti-Indian. They might argue that the very concept of Sharia banking would go against the secular fabric of our country. We are already facing problems pertaining to Muslim Personnel Law and trying to implement Uniform Civil Code. Therefore, at this juncture, if we introduce Islamic banking in India, it will create more problems than solving the issue. Moreover, it may bring financial segregation in the economy. The compartmentalization of Sharia compliant and Non Sharia Compliant banking might be used by certain vested interest to communalize the   finance sector in India. Such questionably sane but unquestionably dangerous trend must be prevented with full might. 

Conclusion

Islamic banking is at an incipient stage. The existing legal framework does not permit Islamic Banking. Only selective activities like equity investment is possible, while trade finance aspects like taking title to goods is not possible. A lot of amendments need to be carried out in the prevalent legal set up. Appropriate models need to be selected and implemented to suit society’s diverse financial needs. Islamic Bank of Britain, Islamic banks of Thailand, Singapore and USA may be glaring models for Indian bankers. The reputed domestic and international banks along with the collaboration of RBI should be involved in the process of determining and implementing Islamic Banking products. 

The importance and relevance of Islamic banking in India in the context of "Financial Tsunami" that has taken place in recent times further enhances the need of Sharia banking. Also the political parties need economic rationality to convince majority of voters that Islamic banking is not being introduced to please Muslim voters but to genuinely boost faster and inclusive growth for the Indian economy. Obnoxious politics in the name of religion must be avoided. I personally believe to refer ‘Islamic Banking’ as ‘Interest Free Banking’ so that it could be looked through the broad economic kaleidoscope and not a narrow religious prism. 

With only minor changes in their practices, Islamic banks can get rid of all their cumbersome and sometimes doubtful forms of financing and offer a clean and efficient interest-free banking. Participatory financing is a unique feature of Islamic banking, and can offer responsible financing to socially and economically relevant development projects. This is an additional service that Islamic banks offer over and above the traditional services provided by conventional commercial banks. Such a system will offer an effective banking system where Muslims in India may invest in pursuant to Islamic principles and the rest may have an alternative to interest bearing conventional banking. Both systems can co-exist. Let the people of the largest democracy decide democratically which one they should bank upon. The young sapling of Islamic banking must be nurtured by the Government so that the country may reap the benefit of its fruit in the coming period.

Article by Syed Burhanur Rahman, Attorney,New Delhi