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RBI shows interest in no-interest banking. What does it mean?

RBI has proposed the opening of an ‘Islamic window’ in banks to ‘gradually’ introduce Sharia-compliant banking in India.

November 25, 2016 1:59:47 am
sharia banking, islamic banking, rbi, reserve bank of india, sharia banking india, interest free banking india, sharia banking for muslims, banking for muslims There has been a surge of interest in Islamic finance even in non-Islamic countries, says the World Bank. (Source: Reuters)

What exactly is Sharia banking?

Sharia banking refers to banking activity that conforms to Islamic law or Sharia. The fundamental principle of Islamic finance is the rejection of usury, along with the requirement that there must be no engagement in immoral businesses. Usury is seen as the levying of unreasonably high interest rates while lending money. Interest is Riba, which in its current interpretation, covers all interest — not just excessive interest. Under Islamic law, a Muslim is prohibited from both paying and accepting interest. Thus, Sharia banking means money can only be parked in a bank without interest — and this money cannot be used for speculative trading, gambling, or trading in prohibited commodities such as alcohol or pork.

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What is the rationale for Sharia banking?

The concept is aimed primarily at devout Muslims who do not participate in the conventional banking system due to religious restrictions, including not taking credit from banks to expand businesses. There is no recent data on the number of Muslims who have bank accounts, but the Sachar Committee report released in 2006 said that Muslims hold 12.2% of accounts in public sector banks and 11.3% in private sector banks — lower than their share of 13.4% cent in the population as a whole.

A large chunk of Muslims are, however, a part of the conventional banking system, and both pay and receive interest. Some religious scholars have noted that the interest in the conventional banking systems is not the same as usury, and the levying and receiving of interest at a fixed rate is allowed. Large parts of the Islamic world, including Pakistan, adhere to conventional banking practices.

Introduction of Sharia or Islamic banking could bring more Muslims into the banking system, and help in the inflow of institutional wealth from entities operating in the Islamic world to the Indian economy. Sharia banking is not restricted to Muslims alone, and other communities who are interested in other forms of banking like ethical banking could be allowed to participate.

Okay, but how does a bank work without interest being charged or given?

While banking itself is premised on charging interest while lending and paying interest on deposits, certain banks do structure their accounts in Sharia compliant ways. For those who want to take credit from a Sharia compliant bank the instrument of Ijara is available — in which the bank purchases the asset on behalf of the client and allows its usage for a fixed rental. After a mutually agreed time, the ownership of the asset is transferred to the client.

Another instrument is the Murabaha for working capital, in which the asset is purchased by the bank at market price and sold to the customer at a mutually-decided marked-up cost. The client can repay in instalments.

Musharaka is a joint investment by the bank and the client, in which both contribute to funding an investment or purchase, and agree to share the profit or loss in agreed-upon proportions.

For savings accounts, there are two kinds of deposits. In one, customers can deposit their savings and allow the bank to use this money, with the assurance that they would get the full amount back. The bank is not liable to pay interest to the savers. However, some banks do give a certain sum back to the account holder as profit accrued from their operations.

In the other kind, the holder allows the bank to invest his money in specific projects and gets returns after a stipulated term based on how the business performs.

How common is Sharia banking globally?

A 2015 World Bank report estimated Sharia-compliant financial assets to be in the range of US $ 2 trillion, covering bank and non-bank financial institutions, capital markets, money markets and insurance. The Islamic Finance Industry has been expanding at a rate of 10%-12% annually. According to the World Bank, in many Muslim countries, Islamic banking assets have been growing faster than conventional banking assets. There has also been a surge of interest in Islamic finance in non-Muslim countries such as the UK, Luxembourg, South Africa, and Hong Kong.

“Over the past decade Islamic finance has emerged as an effective tool for financing development worldwide, including in non-Muslim countries. Major financial markets are discovering solid evidence that Islamic finance has already been mainstreamed within the global financial system — and that it has the potential to help address the challenges of ending extreme poverty and boosting shared prosperity,” the World Bank report said.

What are the hurdles to implementing Sharia banking in India?

There is some political opposition — parties such as the Shiv Sena have said they will oppose its introduction. Because of the strict adherence to not paying or taking interest, Sharia banking will call for a complete overhaul of the banking regulatory system. There is also concern that India lacks adequate manpower trained in Sharia banking.

What steps have been taken towards Sharia banking in India so far?

In a report submitted to the government in 2008, a committee headed by Raghuram Rajan (who subsequently went on to become RBI Governor) had, without naming Sharia banking, suggested the need to have interest-free banking in India. “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,” the report said.

The Kerala government had subsequently tried to co-promote an Islamic finance institution, but the move was challenged in the High Court.

The RBI has now said that given the complexities of Islamic finance and various regulatory and supervisory challenges involved, and also due to the fact that Indian banks have no experience in this field, Islamic banking may be introduced in a gradual manner.

“Initially, a few simple products which are similar to conventional banking products may be considered for introduction through Islamic window of the conventional banks… Introduction of full-fledged Islamic banking with profit-loss sharing complex products may be considered at a later stage on the basis of experience…,” the RBI has said.

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