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COUNTRY REPORT
Islamic Banking in India: Challenges and Prospects
By Syed Burhanur Rahman
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 would be one way to ameliorate the disadvantaged
classes.
The potential benets of introducing Islamic banking include:
decreased economic disparity between the haves and the have-nots,
better integration and consequently, accelerated economic growth. The
Indian government can step closer towards the fulllment of “Garibi
Hatao” (“Abolish Poverty” in Hindi and the theme of Indira Gandhi’s
1971 election bid) by reforming its banking sector and allowing the
establishment of Islamic banks in the country.
To get a clear picture, let us analyze the position of Islamic banking
in India using a SWOT (Strengths, Weaknesses, Opportunities and
Threats) scale. This will help in examining the feasibility of Shariah
banking in India.
Strengths
In the past few years, offering banking products that comply with
Islamic law has become increasingly popular not only in the Gulf region
and countries with signicant Muslim population like Malaysia but
also in western markets such as the UK and continental Europe. Wellestablished and reputed conventional banks like Standard Chartered,
Citibank and HSBC now have Islamic banking units operating in
countries around the world. India offers a huge potential market for
interest free banking products.
The Raghuram Rajan Committee Draft Report, released on the 7th April
2008, endorsed interest-free banking as a part of its recommendations
for reforms in the Indian nancial sector. While interest-free banking
is provided in a limited manner through non-bank nancial services
companies (NBFCs) and cooperatives, the committee recommended
that measures be taken to introduce the delivery of interest-free
nance on a larger scale, including through the banking system. It
believes that a dual banking system of conventional and Islamic would
be possible, through appropriate measures to create a framework for
such products without any adverse systemic risk impact.
India’s Eleventh Five Year Plan envisages inclusive growth in the
country, which by denition implies an equitable allocation of
resources with benets accruing to every section of society and all
sectors of economy. Islamic banking and nance would be an effective
mechanism to subjugate the liquidity and ination problems, and at
the same time allow for inclusive growth within its society.
With the introduction of Islamic banking, the inadequate labor capital
ratio (for informal sector workers associated with agriculture and
manufacturing industries) could be resolved through equity nance,
and in turn may provide a boost to these sectors.
While Shariah compliant investment avenues are now becoming
available in most countries around the world, India has not seen largescale development in this area. As yet, only ve Indian companies
— Reliance Industries, Infosys Technologies, Wipro, Tata Motors and
Satyam Computer Services —gure in the Standard & Poor’s BRIC
Shariah Index.
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An estimation of the scope of Islamic investment opportunities in the
Indian stock market: “Out of 6,000 BSE (Bombay Stock Exchange)
listed companies, approximately 4,200 are Shariah compliant. The
market capitalization of these stocks accounts for approximately
61% of the total market capitalization. This gure is higher than for 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-Shariah compliant
stocks.
“The software, drugs and pharmaceuticals and automobile ancillaries
sector were the largest sectors among the Shariah compliant stocks.
They constitute about 36% of the total Shariah compliant stocks on
NSE (National Stock Exchange of India). Further, on examining the
BSE 500 the market capitalization of the 321 Shariah 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.
Most of these funds are invested in diversied sectors like IT,
automobile, telecommunications and cement. The Tata Mutual Fund
made a pioneering attempt when it launched the Tata Core Sector
Equity Fund in 1996. This scheme was specially tailored to prohibit
dealing with interest-bearing and haram investments. To the surprise
of many, the scheme was able to raise INR230 million (US$4.7 million)
worth of funds from the public.
Weaknesses
The Indian legal framework does not explicitly prohibit Islamic banking
but there are provisions in the banking laws that make Islamic banking
in the country an almost unviable option. The nancial institutions in
India comprise banks and non banking nancial institutions (NBFCs).
The banks come under the Banking Regulation Act 1949, Reserve
Bank of India Act 1934, Negotiable Instruments Act 1881 and Cooperative Societies Act 1961.
Certain provisions in these:
• Section 5 (b) and 5 (c) of the Banking Regulation Act 1949
prohibit the banks from investing on a prot loss sharing
basis.
• 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 banks from
using any sort of immovable property apart from private use.
• Section 21 of the Banking Regulations Act requires payment of
interest.
With regards to Islamic banks entering into a partnership with a
business, the bank has to ensure that the entrepreneur does not
avoid his responsibilities or obtain other non-pecuniary benets at the
expense of non-participating partners, as well as ensure the veracity
of the prot statements. Monitoring the internal function of their joint
ventures would burden the Islamic banks with exorbitant expenses.
The implication of this is that the banks and entrepreneurs have to
function very closely in their partnership.
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17th July 2009
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Opportunities
Of the 1.1 billion people in India, 15% or 150 million are Muslims, the
most in a non-Islamic country and the second highest in the world,
and they offer a fertile ground of opportunities for Shariah compliant
banking. Even though the majority of them are looking for interest-free
banking and nance, it is important to stress that Islamic banking is
not reserved for Muslims alone.
“Introducing Islamic banking
in India at this juncture could
create more problems rather
than help the current situation”
COUNTRY REPORT
India is already facing controversy with the Muslim Personal Law and
in trying to implement the Uniform Civil Code. Therefore, introducing
Islamic banking in India at this juncture could create more problems
rather than help the current situation.
Conclusion
Islamic banking in India is at an incipient stage. The existing legal
framework needs to be signicantly amended to allow for a parallel
Islamic banking system alongside a conventional one. Referring to
Islamic banking as “interest free banking” can enable it to be viewed
through a broad economic kaleidoscope rather than a narrow religious
prism.
I truly believe that both systems can co-exist in India. The young sapling
of Islamic banking must be nurtured by the government so that the
country may reap the benet of the fruits it will bear in the future.
The post 9/11 backlash and the economic crisis in the West has also
seen the growing Indian economy garnering much interest from Islamic
nations, as they eye India for the many opportunities it has to offer.
By introducing Islamic banking in the country, the Indian government
could certainly gain diplomatic advantages for nancial ties with the
Middle Eastern Muslim nations.
Threats
Islamic banking in India could potentially become a political issue. The
use of the word “Islamic” in the terminology could be viewed as antiIndian. Some could even argue that the concept of Shariah compliant
banking goes against the secular society of the country.
Syed Burhanur Rahman
Advocate
New Delhi, India
Website: www.yourstory.in
E-mail: [email protected]
Next Forum Question
Will Islamic standard-setting bodies, like AAOIFI and IFSB, continue to be relevant as Islamic nancial institutions
become more mainstream and are subjected to regulation by international standard-setting bodies? Is convergence
of accounting and other standards the key? If so, is this feasible?
If you would like to air your views on the next Islamic Finance Forum Question, please email your response of between 50 and 300
words to Christina Morgan, Forum Editor, at: [email protected] before Wednesday, 22nd July 2009.
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