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Sunday, 9 November 2008

Why not Islamic banking for India too?

G Sampath / DNA MONEY | Sunday, 09 November , 2008

"The only reason I have an account in a conventional bank is to encash my salary and file income tax returns. Whatever interest accrues on my deposit, I give away to charity," says Faizy, 54, a mathematics professor at Mumbai's AP College of Commerce.

"I get many calls from banks offering loans, but I refuse them because Islam prohibits the charging or paying of interest," says Ayaz Barudgar, 38, a businessman from Santa Cruz. Barudgar takes 'loans' by mortgaging gold ornaments with an Islamic co-operative society which extends credit without charging interest.

Faizy and Barudgar are among innumerable Muslims who stay away from the conventional banking system. It is precisely for this reason that the Raghuram Rajan Committee on Banking Sector Reforms in its report had recommended introducing Islamic banking in India, creating a flutter of excitement in the Muslim investment community. Rajan, who earlier this week was appointed economic advisor to the Prime Minister, prefers the term 'interest-free banking' instead of 'Islamic banking'. "Interest-free banking offers a set of new contractual possibilities that may bring hitherto excluded citizens into the formal financial system," he told DNA. "Interest-free banking does not mean charity, of course. It only means that the investor/lendor does not get interest, but gets compensated through a form of profit-sharing."

This involves equity-based financing, and risk-sharing. When a conventional bank extends a loan, it takes zero risk, as the loan has to be repaid with interest irrespective of whether the business succeeds or fails. But under Islamic banking, if the borrower makes a loss, the 'loan' liability is mitigated as the bank will share the loss. On the other hand, if he makes a profit, he'll have to share it with the lender at a pre-determined ratio. This could make a big difference for poor and small entrepreneurs because chances of the borrower falling into a debt trap are less.

Despite the Rajan Committee's endorsement of interest-free banking, India hasn't been proactive in tapping this rich vein of capital, unlike other 'secular' nations. Britain, with a population of less than 2 million Muslims, already has 6 Islamic banks, of which three were set up in 2008. According to estimates, globally, assets worth $300 billion are under the management of Islamic banks at present, and this is set to cross $1 trillion by 2013. "People are starting to see that Islamic banks are not a threat but an opportunity for economic growth," says Ali Ravalia, associate, UK Financial Services Authority (the UK's equivalent of SEBI).

In India, with the world's second largest Muslim population of 154 million, the lack of Islamic banking is a barrier to the flow of substantial funds into the market. "There is at least Rs5,000 crore of unclaimed interest in Kerala alone. People prefer to put their money in gold or jewellery, which is the worst kind of investment from an economic point of view," says Shariq Nisar, CEO, Bearys Amanah Investment. "I know of at least 300 Islamic societies which accept deposits and lend money, but can't make a business of it because of the Shariah's prohibition of interest. And they are not able to convert themselves into banks because the government will not permit any form of banking without interest. Some of them have collected more than Rs200 crore in interest-free deposits, but they do not have any avenue to invest that money," he says.

Another opportunity is funds from the Gulf. "We are losing millions of petro-dollars which is now eluding a mature market like India and going to smaller places like Malaysia," says Ashraf Mohamedy, MD, Idafa Investments. "But the good thing is that SEBI has now started giving licences for Shariah-compliant portfolio products."

Despite the potential, India has been strangely tentative about introducing Islamic banking. "So far nobody has approached us saying they want to set up an Islamic bank. If such a proposal comes in, we'll definitely look at it," says RBI spokesperson Alpana Kilawala. But why not take the initiative instead of waiting for a proposal? Only last week the RBI took some desperate measures — cutting repo rates, CRR and SLR — to inject liquidity into the economy. And yet here is a huge well of liquidity lying untapped.

"The main problem is politics. Any step to introduce Islamic banking can immediately be interpreted as 'appeasing' Muslims," says Mohamedy.

Politics apart, there may also be regulatory barriers to contend with. Islamic finance consultant MH Khatkhatay identifies two fundamental problems: Firstly, a bank in India cannot raise deposits without promising a specified rate of return to depositors, but under Shariah, returns can only be determined post-facto depending on profit; secondly, banks have to maintain a statutory liquidity ratio (SLR), which involves locking up a substantial portion of funds either as cash, gold or in government securities. "Cash will not get you any return; keeping it in gold is risky as it could depreciate; and government securities are interest-bearing, which is unacceptable under Shariah. These two issues make Islamic banks unviable at present," says Khatkhatay. The other hurdles involve restrictions on equity investment (the primary investment avenue in the Islamic system), and in trading (Islamic mortgages, the main source of revenue for Islamic banks, would be construed as trading under Indian law).

"These are not insurmountable problems," says Khatkhatay. "They can be addressed with some flexibility in regulations." Ultimately it boils down to political will, believes Zafar Sareshwala, CEO, Parsoli Corporation, a brokerage that offers Islamic stock broking services. "If you see this through the prism of Islam, you'll see a problem. But if you see Islamic banking through the prism of economic benefits, you'll see a huge opportunity."

Rajan concurs, "I do think there is a growing market for Shariah-compliant products. The operative issue is that India should be ready for it."

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