ALTERNATIVE BANKING: Why Islamic Banking is said to be irrelevant for India?


Why Islamic Banking is said to be irrelevant for India?


Syed Zahid Ahmad
Srinagar, Publish Date: Feb 9 2017


In 2006 the RBI’s Working Group to examine the financial products used in Islamic banking stated that ‘as distinct from modern, conventional banking, Islamic banking due to its inextricable influence of religious doctrines has often evoked a sense of mysticism and curiosity’. RBI officials despite being financial professionals took ten years to apprehend and make recommendation about Islamic banking windows. Besides Deepak Mohanty Committee and Inter Departmental Group, the Central Board of RBI was also convinced that Islamic banking would be helpful for financial inclusion in India. But the way State Finance Minister declined RBI’s proposal; it seems that only mysticism has induced political boycott for Islamic banking in India. 




Often asked that if countries like UK, France and Switzerland can adopt Islamic banking, why India can’t go for it? Don’t forget that unlike these countries on eve of independence India experienced worst riots on the name of partition. Partition followed by wars made India and Pakistan as rival nations for each other. Since that partition was aimed to divide India’s Hindus and Muslims, it also evoked them to boycott each other’s religious ideology. Post partition the Indian society failed to resolve issues like Ram Janm Bhoomi Babri Masjid; and Government was found insensitive over killing of human beings on the name of protecting cows. The elected leadership instead of assuring adequate flow of required capital resources for inclusive growth prefers to protect their vote banks by continuing division of India on the basis of religion and caste. Somehow after observing the nonsense of religion based politics, India has now framed law to restrict politician use religion during elections.  But considering the socio - political sensitivity it was never easy for the Government to approve RBI’s proposal to introduce Islamic banking windows for financial inclusion of Muslims in India.



Thus when the whole nation was struggling to manage the impact of demonetization and the opposition was united to disallow the Government pass any Bill, the Government found an opportunity to silently decline RBI’s proposal on Islamic banking. Accordingly during zero hours on 7th December 2016 Lok Sabha MP from Shiv Sena Shri Chandrakant Kahire (who is also Member of Standing Committee on Finance) opposed the proposal to introduce Islamic Banking in India. Thereafter on 9th December 2016 relying to a written query by Smt. K. Maragatham (M.P. form AIADMK) about Islamic banking, the State Finance Minister Shri Santosh Gangwar stated that on consideration of inter-departmental group report, it is observed that even to introduce limited products, various legal changes would be required. Moreover, the objectives of financial inclusion for which Islamic Banking was explored by RBI has no relevance, as Government has already introduced other means of financial inclusion for all citizens like Jan Dhan Yojna, Suraksha Bima Yojna, Mudra Yojna etc.  Such statements may please the anti Muslim voters, but it is certainly a blow for Indian banks that need to draw more capital and reduce their NPAs to be fit under Basel – III standard. Perhaps Islamic banking windows would have allowed Indian banks to draw sought capital from Muslim countries. Now to improvise our banks we may need to redesign the financial products used under Islamic banking to make them fit for Indian banks without any religious conflict. 



Considerably the model of Islamic banking prevalent today was not there at time of Prophet Muhammad , or during his companions and followers thereupon. It was only 1950s when some bankers through realizing the need of interest-free finance, presented Islamic banking model with collection of Shariah compliant financial products. These products were actually retrieved through tailoring Shariah compliant transactional behavior. Notably despite holding 32% of global Islamic banking asset country like Saudi Arabia has no commercial bank on the pattern of  of Sharaih banking. But after observing upsurge trend in Islamic banking around the world, Indian Muslims with limited financial skill instead of asking for equity based financial products preferred raising demand for Islamic banking in India. To assist them global Islamic banking professional presented their viewpoints before the RBI to convince them that it has high potential in India; but they failed to apprehend socio-political sensitivity of Islamic banking in India. Finally RBI made a politically controversial proposal to introduce Islamic banking windows for financial inclusion of Muslims in India; which has been silently declined by the Government without any debate in the Parliament. 


According to level of economic development, the model of banking and finance for particular economy may differ from others. Historically the models of banking and finance have changed drastically. Being a Godly defined art of living meant for all humans forever; instead of prescribing any particular banking model, Islam is ethically guiding the humanity to always transact fairly with each other. According to Islamic teachings accumulation of wealth through interest or by any unethical practice is prohibited; wealth should not be hoarded with misery; nor should circulate among the richer only. Islam also guides the humanity to attain economic growth by inducing need based expenditure. Islam guides the humanity to provide support (from excess of income over expenditure) to the poor and needy among the relatives, neighbours, prisoners and wayfarers etc. Islamic teachings are so secular that even in financial prayer like Zakat (saving tax upon rich) fractional amount is provisioned for non Muslims. So, Islam is not meant for religion based banking and finance rather guiding the humanity to deal fairly while transacting each others. 



Considering the socio political fabric of India where Hindus are in majority, it is better to understand that interest is not forbidden for Muslims only, but also for other communities like Christians and Jews etc.. Interest is also not admired in Hindu and Budhist scriptures. Scholar L. C. Jain in his book ‘Indigenous Banking in India’ (published by Macmillan and Company, London in 1929) has written that “from the early Buddhist literature usury was held in contempt, as appears from the special law made against it by Vasishtha - the well-known law-giver of that period. The highest castes were not to be usurers, but the Vaishyas, who were traders, were excluded from the operation of the law. In the Jatakas also, the condemnation of usury can be seen; 'hypocritical ascetics are accused of practising it”. So ideally Hindus Upper Castes and Buddhists should also refrain from dealing with interest. Prohibition of interest should not linked with Islam only, rather be counted as ethical issue mentioned in almost all religions and not only in Islam. Banking being a commercial activity and needed to be rated only on commercial grounds. If any suitable product is found under Islamic banking, India may adopt that after giving a secular look.  



It should also be noted that Indian capital market is largely Shariah compliant without any mystical practices in the stock market.  Notably more non Muslims compared to Muslims are using the Shariah index. Similarly if we can design and adopt micro equity products for banking networks, it may enable India extend capital support to 50 million micro and tiny establishments who are otherwise deprived of capital support from stock market and banks. Besides allowing India for better capital formation, micro equity products may also help inducing financial inclusion of religious Muslims who are otherwise excluded from formal finance. Indian banking needs to explore still untapped potential for equity financing (direct as well as through venture capital). There could be simple or diminishing equity finance allowing the poor people to access sought capital.   Considering the fact that just 12.3% bank’s NPAs (including write offs and restructured loans) are through small industries against 55.2% NPAs by medium and large industries; banks really need to focus more upon micro and tiny establishments. With cap limitation of 30% paid up capitals to invest through equity and no experience in micro equity, banks should better invest in MFIs or cooperatives allowing the banks to get connected with poor and needy customers seeking micro equity.  



To attain required CRAR as par Basel –III standard Indian banks are in need to raise more capital. To draw fresh capital banks are required to reduce their NPAs and increase their profitability. Returns over investments without exploiting borrowers can be explored if banks opt to focus more upon micro equity compared to debts for micro enterprises.  If equity financing is linked through digital payment system, it may also help building transparency in the unorganized sector. The transparency in commercial transactions will seize scope of corruptions. It may enable us to find that ‘X’ amount of equity is generating ‘Y’ amount of value addition; after ‘C’ level of consumption ‘I’ amount of capital accumulation is being done. Banks may also ask MFIs and Cooperatives to access transactional accounts of micro enterprises linked through micro equity finance. So by promoting micro equity finance, we can promote a transparent and corruption free transactional system in our unorganized sector. 



Islam has not prescribed any particular banking model; but provides principles to do fair transactions suitable for all human beings. The so called Islamic banking is promoted by bankers only with support of Muftis. There is need to restructure financial products used under Islamic banking in a manner to make compatible through Indian banks. Indian banks also need draw capital by adopting innovative mechanisms. There is huge untapped market for micro equity product in India as around 50 millions micro and tiny enterprises are deprived of equity finance from banks and stock markets. Micro equity finance may not just empower millions of unorganized sector enterprises, but also enable us to create a more transparent, corruption free and advanced system so that we can better estimate about value additions, consumptions and capital formation in our economy. If Micro Equity product be linked through digital transactions, it would be found compatible for transactional tax in future. Micro equity may also help inducing financial inclusion of Muslims without disturbing the secular fabric of Indian banks. 

Syed Zahid Ahmad Founder - Economic Initiatives, Thane, Maharashtra, Indi


Posted Date: 09 February 2017

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