RBI ‘clears deck’ for Islamic banking in India

The Reserve Bank of India (RBI) has almost paved the way for Sharia-compliant, interest-free or Islamic banking in the country. The measure, if implemented, is expected to give a boost to the economy and increase “financial inclusion”. The total Islamic financial assets were estimated at around $2 trillion in 2015, practically a 10-fold increase from a decade ago and outperforming the growth of “conventional finances” in many countries.
An RBI committee on “Medium-Term Path for Financial Inclusion”, headed by Deepak Mohanty, has recommended “interest free windows” in existing conventional banks. It has sought comments on the report from people till 29 January.
“Commercial banks may be enabled to open specialised interest-free windows with simple products like demand deposits, agency and participation certificates on the liability side and cost-plus financing and deferred payment, deferred delivery contracts on the asset side,” the committee has recommended. The committee has also recommended that “in the event that interest-free banking is allowed in India, the extant regulatory guidelines in respect of capital and liquidity as applicable in the case of commercial banks would have to be made applicable to those as well”.
The government, on the other hand, also appears to be keen on implementing the Islamic banking. The government had advised the RBI that before taking a decision, the legal/technical/regulatory issues need to be clarified by the RBI. Following this, an inter-departmental group on Alternative/Islamic Banking was set up within the RBI to examine the issues for introducing Islamic banking. The group has already submitted its report. The central concept in interest-free banking and finance is justice, which is achieved mainly through the sharing of risk. Stakeholders are supposed to share profits and losses and charging of interest is prohibited. This type of banking has four important features — Riba, Haram/Halal, Ghararar/Maysir and Zakat. Riba is the most important aspect of interest-free banking, and means prohibition of interest. Haram/Halal is a strict code of “ethical investments” for interest-free financial activities. Such investment gives priority to the production of essential goods which satisfy the needs of the population such as food, clothing, shelter, health and education. Under Ghrarar/Maysir, gambling in all forms is prohibited. Zakat is an instrument for the redistribution of wealth in the form of a compulsory levy. Another feature condemned under interest-free banking is economic transactions involving elements of speculation.
The Mohanty report says: “One area that has not been adequately addressed is the role of interest-free banking in financial inclusion. Globally, interest-free banking, also known as Islamic banking, has witnessed a significant increase, especially in the wake of the financial crisis.” The report cites a survey saying “the evidence suggests that Muslims are less inclined to access formal finance, in general, although they might be accessing long-term formal finance”.
Interest-free banking has witnessed a lukewarm response in India and now it is time for change. The Committee on Financial Sector Reforms (CFSR) is headed by the chief economist of the International Monetary Fund (IMF). Raghuram Rajan, who is now the RBI governor, had in 2008 talked about the need for a closer look at the issue.
The Indian Centre for Islamic Finance (ICIF) has welcomed the RBI committee’s recommendations on interest-free windows in existing banks. Its general secretary Abdur Raqeeb said it will give a boost to Prime Minister Narendra Modi’s Pradhan Mantri Jan Dhan Yojana. “For the first time, the RBI has come out with a concrete document on Islamic banking. I hope the government will implement the Mohanty committee’s recommendations at the earliest,” Raqeeb said.