It was meant to be a unique experiment. As India decided to dabble with its first Islamic bank, to be registered as a non-banking finance company (NBFC), backed by the Kerala State Industrial Development Corporation, ?faith? was finally moving the mountain. In the pipeline were also the much sought Islamic bonds, ?sukuks?. Kerala?s finance minister, Thomas Isaac, had acknowledged, ?We need long-gestation funds to build airports, high-speed trains and expressways. Islamic finance promises unexplored potential in that context.? As a division bench of the Kerala High Court, in response to a petition filed by former Union minister Subramanian Swamy, stayed all further moves to set up an Islamic bank in the state, the context did take a U-turn on January 5.
Globally, Islamic banking is entering the financial mainstream even in Muslim-minority countries such as the US, UK and Germany. ABN AMRO, Barclays, HSBC, Deutsche Bank, Citi and Standard Chartered, are all vying to get a share in this $300-billion business, which has registered a 10-15% growth in the past 10 years.
KK Ali, CEO, Alternative Investments and Credits Limited, Cochin, reckons, ?Islamic banking is growing faster in secular countries in Europe and America. In Malaysia, more than 40% of the investors and 60% borrowers in Islamic banks are non-Muslims. One-fifth customers of Islamic Bank of Britain are non-Muslims.?
Javed Ahmad Khan, Associate Professor, Centre For West Asian Studies, Jamia Millia Islamia, author of Islamic Banking in India, Scopes & Challenges, advises that Islamic banks have to learn a lot from the modern, interest-based banks, especially on their managerial skills, financing tools and transparency standards. ?Today, conventional banks that are offering Islamic windows are much more attractive for investors in Muslim countries. If Islamic banks are allowed in India too, they would be more viable and trusted, especially if they run under the control of conventional banks, say the State Bank of India or any other established bank.?
Lost opportunity
Experts opine that non-availability of Islamic banking denies India access to sources of savings from other countries in the region and, coupled with the readymade market back home, it may become a case of a missed opportunity for India. Samir Bali, Partner, Financial Services, Ernst & Young, points outs, ?In FY09, FDI equity inflows from UAE were $257 mn and the UAE was among the top 10 investing countries for India. Islamic banking is likely to tap these funds further and boosting FDI inflows from the Gulf.?
A fact corroborated by Dr Rahmatullah, Vice-Chairman, All India Council of Muslim Economic Upliftment, ?During the financial crisis, Muslim investors in the Gulf were seeking opportunities to invest through Islamic financial products in emerging economies like India. Failing to get such opportunities in India, they are now parking their investments in Islamic banks of the UK and switching to other emerging economies like China, Taiwan, Indonesia and Malaysia. India is definitely missing billions of dollars in investment funds that could be mobilised in terms of Islamic investments.?
Given India?s growth story, ?Probably the only reason why investors from GCC and those from other Muslim countries are unable to take the initiative is because of lack of a Sharia-compliant market for FDI and FII. Individual and institutional investors need Islamic financial investment vehicles like Sharia-compliant mutual funds (halaal), Islamic bonds (sukuk) and Islamic insurance (takaful) to open up in India for investment. Also, the huge outlays required for infrastructure development, rural regeneration and other development projects needs huge foreign investment at reasonable cost, which is held back by intending countries because of the inability of the country to offer Shariah-compliant investment options,? opines MA Majeed, Dean, The Institute of Islamic Banking and Finance, Hyderabad.
Since 50% Indians are engaged in agriculture, Dr Rahmatullah suggests that Bai Salam could be a powerful financial instrument to empower farmers etc. It will help us increase agricultural exports as well. It allows for the future delivery of an asset/commodity at a lower cost, as the funds are made available at the start of the contract. Sukuk could also help mobilise interest-free financial resources for the government to develop the required infrastructure. It will also help us reduce the fiscal deficit.
Interest-free banking is beneficial for the under-banked and un-banked segments. Venkatramana Gosavi, AVP and Regional Manager, South Asia, Finacle, Infosys Technologies opines, ?For a country where a large part of the population still depends on agriculture and agro-based occupations, providing a financial product that is simple, convenient and cheaper will help bring a larger population under the formal financial/banking agenda. Mudarabha financing will be good as it is a partnership between the lender and the borrower, sharing risks together under the retail/SME banking, and considering the huge spend expected in the area of infrastructure, musharakah and ijaraha should work well.?
However, faith is not the only thing driving the Indian market. Prof Khan elaborates: ?Indian Muslims have been arguing that their downtrodden section can benefit through participatory financing (Islamic banking). However, there is no evidence to suggest as to how many would prefer this over conventional banking. There is no study to confirm that Islamic banking would be appealing even in a situation of the low rate of return compared to the interest-based conventional banks.?
He adds that Islamic investors from the Gulf are eager to participate in the growth of the Indian economy. Al-Rajhi Bank of Saudi Arabia, Dubai Islamic Bank, Kuwait Finance House and the Gulf Finance House of Bahrain are some of the leading participatory financing institutions that have already indicated interest in India.
The key to Islamic finance in India is to marry the existing Indian regulations with the Islamic law principles, without coming foul of either of them. This would involve a larger consensus building process, where all stakeholders will need to be taken into confidence, feels Keyur Shah, Partner, BSR & Co, Chartered Accountants. He adds, ?It is not that Sharia-compliant products cannot be issued in India at all. We have seen certain Sharia-compliant mutual fund schemes, some financial instruments issued by existing NBFCs etc. Thus, while there are amendments that would be required to the existing financial sector regulations in India in order to have a developed market for Islamic finance, even with existing regulations, Islamic finance can be undertaken to a certain extent. However, for this market to grow and achieve its full potential, clearly a change in thinking and regulations is needed.?
Restrained steps
The Raghuram Rajan Committee report, ?A Hundred Small Steps?, without using the term Islamic banking, advocated interest-free banking for India, highlighting the fact that certain faiths prohibit the use of financial instruments that pay interest, thereby necessitating such an alternative form of banking. Dr Rahmatullah says, ?While commenting over the draft report of the Raghuram Rajan Committee, we had the opportunity to interact with the panel in Mumbai, where we requested them to include recommendations for Islamic banking. Vijay Mahajan gave due attention to financial exclusion of Indian Muslims and also convinced other committee members to recommend Islamic banking for financial inclusion of Indian Muslims.?
However, in 2005, a working group was constituted by the RBI under the chairmanship of RBI Executive Director Anand Sinha to examine Islamic banking in India. A senior spokesperson from the RBI said on the condition of anonymity, ?It revealed that it will require legal changes in the current structure to bring in Islamic banking. So far, we have not received any requests from any banks to introduce the system.?
Not interested?
But the question is while France, the UK and other countries have opened doors for this multi-billion dollar business, why is India distancing itself? Bali says, ?The offering of Islamic financial services requires a review of the regulatory framework and is likely to entail significant modifications. Even western countries such as France and the UK have adopted Islamic banking and amended the regulatory framework to be conducive to Islamic financial services only in recent years. The offerings are impacted by several regulations, such as stamp duty, banking regulations Act, corporate and other tax regulations. Enabling full-fledged Islamic financial services in India entails a comprehensive review of the regulations applicable to these financial transactions and significant modifications to multiple acts and rules simultaneously.? He adds, ?The existing banking regulations have stipulations that may not be conducive to Islamic banking, such as payment of interest on savings deposits and charging of interest on advance, statutory liquid ratio requirements (the SLR portfolio to be maintained has to be interest yielding).?
This is a political issue and has to receive a political consensus, shares Robin Roy, Associate Director, PwC. ?Amendments will be in definition of ?what type of banking can commercial banks indulge in India?. Unless the tacit ?religious? connotation is resolved, acceptance could prove a challenge,? he says. A sentiment also echoed by MZ Rehman, CMD, TFS Group India, Mumbai, ?India is a secular country. Anything attached to any particular community or religion may create problem to the federal administration. Islamic banking is perceived as Muslim-sponsored banking because of the word Islam, rather than just another form of banking vertical ? ethical banking vertical. The government is trying to keep away from controversies. It is first trying to introduce Islamic investments, rather than jumping into Islamic finance and banking in the first instance itself. The second step will be creating Islamic funds and then other products.?
Islamic financial institutions have had a mixed run recently. In April 2009, the Dow Jones Islamic Market Indonesia Index posted its largest profit, gaining 18.13%, indicating how Islamic banking largely remained unscathed during the crisis. The market for Islamic bonds also took a hit when leading Muslim scholars found out that 80% of the global sukuk were haram (un-Islamic) because they comprised buy-back guarantees at par and issuance of sukuk dropped 40% in 2008. Roy says, ?In a globalised world, it?s difficult to be isolated. It would need very strong monitoring mechanisms, adding to the costs of compliance.?
Why India has not been able to keep up with this global phenomena is complex. As Ashraf Mohamedy, MD, Idafa Investments, Mumbai, says, ?We have strange sensitivities due to which arises a lack of political will. The Banking Regulation Act has no definition of banking outside the purview of interest-based transactions, whereas Islamic banking deals with profit and loss sharing. Accommodating such models within the banking system will need amendments. One major amendment required by the Union and state governments, especially in tandem with the Banking Regulation Act, is avoidance of double taxation in real estate transactions. Initially, India will see Islamic banks playing a bigger role in wholesale banking activities, which is already going on with SREI Infrastructure Finance and other players arranging for funds for large corporates in India on interest-free terms. The bigger problem is in penetrating the retail segment. Companies like ours can play a role in synchronising the efforts of such banks as a ?DSA? mobilising funds as well as loan disbursals, as they have grassroots-level presence in the retail side. When Islamic banking hits Indian shores, it will come with all the products?the good, the bad and the ugly.?
However, Majeed cites that the socio-political compulsions in a sensitive matter and the complimenting factor of absence of a strong Muslim lobby urging implementation of the system appears to be another reason. ?Interestingly, the Muslim community desires only to be a beneficiary of the system and not a stake holder,? he says.
Observers opine that it is going to be more of a political decision than an economic one. As Dr Rahmatullah says, ?The government is looking for the right opportunity to take a decision. The urban cooperative banks in India have been incorporated through a separate legislation and Islamic banking could be allowed if the Parliament approves addition of a separate chapter in the Banking Regulation Act, 1949, to describe and deal with Islamic banking and finance.?
But there are some like Mohamedy who believe what?s in a name, ?Let?s call this alternative banking or ethical, participatory, interest-free, XYZ, anything that would not unsettle the sensitivities of the people at large. But the potential has to be understood by our leaders and the opportunity must be grabbed. The size of the opportunity is $1.2 trillion, including Islamic banking, equity investments and Islamic insurance. And it is growing at the rate of 20-30% year-on-year.
Please take a cue.?
In search of inclusive growth
H Abdur Raqeeb
The Kerala High Court?s stay on the proceedings of the newly-formed company based on Islamic banking principles by Kerala State Industrial Development Corporation (KSIDC), on a writ petition by former Union minister Dr Subramanian Swamy, is a blessing in disguise. It will definitely give an opportunity to the vast majority of our countrymen, Muslims included, to learn about the progress of Islamic finance and banking after the current financial tsunami in the West, and as a possible alternative to the exploitative and speculative, conventional financial system.
Al Barakah Financial Services Ltd (ABFSL) by KSIDC is only a non-banking financial company (NBFC) under RBI Act (2) of 1934, and is registered under the Company?s Act, 1956. It is not a banking activity as per Section 5 of the Banking Regulation, 1949, which has to be amended if the Islamic banking option has to be accommodated.
The apprehension that this company being based on Sharia laws would be beneficial to only Muslims and exclude the vast majority of the Indian population is ill-founded. Two of the director-promoters of Al Barakah are CK Menon, Chairman of Behzad Group, and PNC Menon, Chairman of Sobha Group. Even Ernst & Young, in a feasibility report, mentions in the target customer segment that it will provide financial services not only to Muslims but to all other communities as well. KSIDC has promoted this venture targeting the investments of large number of Gulf Muslim NRIs and HNIs who are not depositing their savings in conventional banks because of non-availability of interest-free option. After the successful launch of Al Barakah, the Kerala government was to issue sukuks (Islamic bonds) based on assets for future mega infrastructural projects.
Investors in the Middle East after 9/11 are looking towards India for safer investments on long-term infrastructural projects based on Shariah guidelines and, according to experts, trillions of dollars are awaiting to be invested. Last year, Prime Minister Manmohan Singh also spoke of the marriage between the finance of oil-rich Qatar and skill and opportunities of India.
The high-level committee on financial sector reforms of Dr Raghuram Rajan, former IMF chief economist, has recommended interest-free finance on a larger scale, including through banks, with the objectives of inclusion and growth through innovation.As an answer to the Anand Sinha Report of RBI, it referred to its possibility through appropriate measures to create a framework for such products without any adverse systemic risk.
India has the potential of an emerging market for Islamic banking, provided there is the political will, favourable change in the regulatory environment and increased awareness among Muslims and India as a whole. The option of the nomenclature to term it interest-free, non-interest, alternate banking can also be considered, provided these are Shariah compliant. It is high time an amendment in the Banking Regulations, 1949, is enacted in the Parliament and enforced by the RBI. Different models are available from the UK, Singapore, Japan and Malaysia. The regulators can choose one feasible to the Indian situation.
In a detailed discussion with the ICIF delegation, Dr KC Chakrabarty, Deputy Governor, RBI, said the RBI has launched special programmes to increase the reach of the banking to the people. In this context, interest-free banking will be welcomed as well, but for that the GOI should take a decision. Subsequently, in a meeting with FM Pranab Mukherjee, a detailed memorandum was submitted to accommodate Islamic banking in conventional regulations. Also, five options were furnished in the Indian context. Among them was a separate chapter exclusively dealing with all aspects of Islamic interest-free banking, as done in respect of cooperative banks in 1969, and for the department of non-banking companies in 1997, was supposed to have been favoured by the finance ministry. Recently, a delegation of MPs under the chairmanship of Deputy Chairman of Rajya Sabha, Rahman Khan, met Manmohan Singh, who assured them he would discuss the proposal of Islamic banking with the finance minister. It is expected the FM would incorporate the proposal of interest-free banking in the forthcoming budget speech. This will be a major step for inclusion of the minorities and marginalised segments of the country, as well as attracting investors from the Middle East to continue a growth rate of 8-10% and provide a roadmap to our march towards a developed country in the decades to come.
The writer is General Secretary,Indian Centre for Islamic Finance (ICIF)