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In a controversial move, the Reserve Bank of India has dropped the proposal for introduction of Islamic banking in the country. The idea, once pushed by former RBI governor Raghuram Rajan, has died a natural death, as it were, given the amount of resistance it managed to create. However, it seems that the reason for nixing the proposal is more political than financial.


In a reply to an RTI query by a PTI correspondent, RBI said, “Taking into account the wider and equal opportunities available to all citizens to access banking and financial services, it has been decided not to pursue the proposal further.”

Interestingly, it was the same “wider opportunities” peg for which Islamic banking was initially proposed, to include many Muslims who do not prefer the regular banking system because of religious beliefs.

Islamic banking and economy

Not all banking activities are accepted by the Islamic law. Sharia, the Islamic law, doesn’t allow a Muslim to engage in interest-based banking system, the basic principle of non-Islamic models of banking. So, a Sharia-compliant bank invests the money in only Sharia-accepted projects and then shares the profit or the loss with the account holders, without any interest rate. The account holders have to pay a minimum fee.

According to a report of the International Monetary Fund, Islamic finance assets grew at a double digit growth rate in the past decade from about $200 US billion in 2003 to $1.8 trillion at the end of 2013.

And, the growth is not only confined within the Muslim countries. China, Germany, the UK and the US are some of the non-Muslim countries with Islamic banking system in place.

Proposal of Islamic banking in India

In 2008, the financial sector reforms committee of the RBI, led by Raghuram Rajan, had recommended setting up of interest-free banking facilities in India. However, it did not mention Islamic banking or Sharia banking.

In its annual report 2015-1016, it again raked up the issue as in absence of non-interest banking, a section of the population was not being able to take part in the banking system.

The committee on medium-term path on financial inclusion recommended an “open, specialised, interest-free window with simple products like demand deposits, agency and participation securities, offering products, based on cost-plus financing, deferred payment and deferred contracts”.

The report also said: “It is observed that some sections of the Indian society have remained financially excluded for religious reasons that preclude them from using banking products with an element of interest. Towards mainstreaming these excluded sections, it is proposed to explore the modalities of introducing interest-free banking products in India in consultation with the Government.”

Meanwhile, the CPM in Kerala toyed with the idea, and after getting a go-ahead from the RBI, launched in July this year Cheraman Financial Services Limited, a co-operative on the lines of the practice of the Islamic banking system, with a corpus of Rs 250 crore. It was established with equity participation of Kerala State Industrial Development Corporation (KSIDC) and private investors, mostly Gulf-based NRIs.

In Maharashtra, too, Lokmangal Cooperative bank Limited launched a Sharia-compliant transaction window in 2016. Interestingly, state BJP minister Subhash Deshmukh was behind the idea.

So, the concept of interest-free banking, which could have bolstered the economy by inviting huge investment from the West Asian countries, is not new to India.

Why the change of stance?

Is there a political reason behind the change of stance on allowing Islamic banking?

Last year, in a written reply to the Lok Sabha, minister of state for finance, Santosh Kumar Gangwar, had said, "The objectives of the financial inclusion for which Islamic banking was explored by RBI has no relevance, as government has already introduced other means of financial inclusion like Jan Dhan Yojana and Suraksha Bima Yojna for all citizens." Apart from this, no financial reason was given so far.

We can ask if India has tried staying away from any "terrorism" controversy, given that in media, conflation of Islamic banking and terror-funding goes on without an iota of nuance and/or context. Though there is no proven connection between Islamic banking and terror-funding, some US financial institutions in the past, had expressed concerns about a possibility of Islamic banking transactions channeling funds to terrorist organisations, though that's a miniscule portion of the overall funding architecture that the extremists world over avail.

Therefore, the about-turn of RBI, without offering a substantial and financially sound logic to dropping the proposal that would have brought in billions of dollars worth investment and remittance into the mainstream, significantly boosting India's ailing economy, is a plain and simple political decision. Giving a green signal to allowing Islamic banking at an official and national scale, letting major public and private banks to open interest-free, Sharia-compliant banking windows in addition to existing services, would fly in the face of the Modi government's perceived anti-minority stance.

Posted Date : 15 November 2017

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