To introduce Islamic Finance and Banking in India, we have to: (1) Undertake regulatory changes in the Indian Banking Acts, and (2) Create awareness among Muslims and Indians as a whole.
While analysing the regulatory changes, two important documents of the government and two important developments from the public-private participation have to be studied in detail and analysed in depth.
WORKING GROUP REPORT OF RBI
This is the only serious attempt by RBI on the feasibility of the Islamic Banking in India. The 51-page report titled “Report of the working group to examine financial instruments used in Islamic Banking” was prepared by Reserve Bank of India, Department of Banking Operations and Development, Central Office, Mumbai in July 2006. The working group was headed by Mr. Anand Sinha, Executive Director, RBI.
According to RBI, this report is an internal research work for their own consumption and done in routine way to enhance the knowledge level within organisation, and report of such groups are generally not placed in the public domain. The group was constituted in June 2005 and within a year in July 2006 it submitted its report. After two years of correspondence with RBI, we were able to get it for the first time in April 2009 through Right to Information Act (RTA) 2005.
LEGAL OPINION
The Group also sought legal opinion from the Legal Department of Reserve Bank of India.
The Legal Department observed that Islamic Banking has different modes of financing and in most of these kinds, the bank involves itself in the trading or business activities of the borrower or will be based on equity participation of the bank, which is very much unlike the conventional banking. In Bai’-Mu’ajjal, the bank resorts to purchase and resale of properties, which is not permissible as per the provisions of Sections 8 and 9 of Banking Regulation Act, 1949. The equity participation in the form of joint venture is one of the major forms of financing (Musharakha) whose permissibility will have to be examined in each case in the light of restrictions contained in Section 19 (2) of Banking Regulation Act, 1949. Further, risk sharing forms the basis of all Islamic financial transactions in the place of charging interests on loan amount.
In terms of provisions of Section 6 of Banking Regulation Act, 1949, in addition to the business of “banking”, banks are permitted to engage in business as prescribed under clauses (a) and (o) thereof. In the case of Islamic banking, the very business of “banking” itself involves the bank in active trading, purchase and resale of properties and investment etc., which is not permissible under the Banking Regulation Act, 1949.
Section 5(b) of the Banking Regulation Act, 1949 defines “banking” to mean “the accepting for the purpose of lending or investment of deposits of money from public, repayable on demand or otherwise”. Thus, “banking”, contemplates inter alia, lending of deposits of money from public, but in Islamic Banking, the bank accepting deposits of money from public is not engaged in lending or the pure financial activity in the conventional manner, but is engaged in equity financing and trade financing (Musharaka and Mudaraba), i.e. taking risk of sharing profits or losses as against lending (where there is no risk of loss and only profit in the form of interest at a specified rate). Therefore, the banks doing Islamic banking would not be doing “banking”, to that extent, as contemplated in Section 5 (b) of Banking Regulation Act, 1949.
As regards the regulatory aspects, there may be constraints as the bank rate, maintenance of CRR and SLR as per the provisions of Banking Regulation Act, 1949 etc., involve the concept of interest. The issues of liquidity shortage or surplus may have to be handled differently in the case of Islamic banking, since ban on interest rules out resort to the money market and the Central Bank.
All these bring out to the fore that the concept of Islamic banking should be dealt with as an absolutely different sector with separate norms to address the specific structure and contents of the financial instruments in Islamic banking.
In view of the above, if the banks in India are to be allowed to do Islamic banking, appropriate amendments are required in Banking Regulation Act, 1949 and separate rules and regulations may have to be framed to permit them to do the business in view of the special characteristics of financing they adopt.
Thus, in the current statutory and regulatory framework, it would not be feasible for banks in India to undertake Islamic banking activities in India or for branches of Indian banks abroad to undertake Islamic banking activities there.” (Page No. 47, 48 & 48A).
RAGHURAM RAJAN COMMITTEE REPORT
Let us turn towards the report of the Committee on Financial Sector Reforms (CFSR) of the Planning Commission, GOI to prepare a report on the next generation of Financial Sector Reforms. The Committee consisted of 12 members, who were called by Dr. Raghuram Rajan, “some of the finest financial and legal minds of the country” and the report was an awesome display of true public-private partnership.
The committee consulted 16 virtual members and 38 relevant players in the financial sector arena. A preliminary draft report was placed in the public domain (website) for comments. The committee received a large number of comments directly and through the press. Several individuals and institutions both within and outside the country placed the comments as well as submitted personally to the committee for including Islamic Finance and Banking in the report. Upon these submissions and representations the following recommendation was included in the final report of the CFSR which is as follows:
“Another area that falls broadly in the ambit of financial infrastructure for inclusion is the 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 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.”
(Chapter 3: Broadening Access to Finance, Page: 35)
SHARI’AH COMPLIANT INVESTMENT PRODUCT FOR HAJJ PILGRIMAGE
The recommendations of a high level committee set up by Prime Minister’s office, chaired by Mr. Rahman Khan, Deputy Chairman, Rajya Sabha is under the consideration of Government of India favouring a Shari’ah-compliant mutual fund to provide investment option to the Muslim community was submitted in July 2006. The PM has constituted a Committee of Secretaries headed by the Cabinet Secretary to look into the suggestion of this high level committee. The Committee had specially recommended a Shari’ah Compliant Investment Scheme to fund Hajj Pilgrimage as in Malaysia. Malaysia had set up a pilgrimage fund and formed a board called TABUNG HAJI.
KERALA SHOWS THE WAY
Recently, the Government of Kerala launched a Shari’ah-compliant financial institution and wished to establish it by 2010 with the objective to grow into a full-fledged Global Islamic Bank. This institution will be started with a share capital of Rs.1000 crores and the Kerala State Industries Corporation will have 11% share and remaining 89% from private investors. Already Ernst & Young has given a feasibility report and the financial institution will be set up on the basis of recommendation of that report. Additional study is being done through Ernst & Young to analyse the implication of the Central, State and Municipal taxes for this Islamic financial institution.
INTERACTION WITH DEPUTY GOVERNOR, RBI
When it was learnt that RBI is considering discussion on 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 following important documents. According to the Deputy Governor: RBI, which has plans to increase the reach of banking system to more people, will welcome to introduce interest-free banking, provided the Government takes a decision.
OVERVIEW
The need and necessity of interest-free Islamic finance and banking has to be spread among the Muslims, common people, religious scholars, businessmen, bankers, politicians, and other stakeholders.
Among Muslims, criticism has been raised against the banking approach itself. Some allege that it is nothing but the changes of nomenclature only. Some other question its capability to meet all the financial requirements of modern day economy. Some go further to say that the whole 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 in international 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 for Islamic Finance and Banking.
Justice Mufti Muhammed Taqi Usmani mentions in An introduction to Islamic Finance: “Islam, being a practical way of life, has two sets of rules: one is based on the ideal objectives of Shari’ah which is applicable in normal conditions, and the other 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 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, misunderstanding among majority community 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 ethics and Socially Responsible Investment (SRI). It has to be showcased that 40% customers in Islamic banks in Malaysia are Chinese of other communities and also in UK, 20% customers are Non-Muslims.
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 based may bring banks closer to their clients and to the true spirit which should mark every financial service,” the Vatican’s official newspaper, L’ Osservatore Romano said.
Recently, France has amended its laws to issue SUKUK of one Billion Euro.
Post 9/11, oil money has stopped being invested in U.S and is looking for a safe investment destination, and India could well be that destination given its safe economic scenario, huge market, skill and educated labour and good growth rate.
Modern, secular and industrialised countries like Britain, Singapore, Hong Kong and Japan have become hub of Islamic finance and banking. If London, Tokyo, Singapore and Hong Kong can become hub and house of Interest-free Islamic finance and banking, why not Mumbai and Cochin?