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Tuesday, 1 June 2010

Islamic Finance under Indian Legal System

It is possible to operate a financial institution following the extant laws and regulations and at the same time ensure that the transactions carried out by the institution comply with the principles of Islamic Shari’ah. The existing statutory regime provides enough leeway to follow the law and Shari’ah at the same time. Thus, it is possible to carry on financing activity based on Shari’ah by constituting;
(a) a co-operative credit society or a non deposit accepting Non-banking financial institution or
(b) a trust or a company registered with SEBI operating as Domestic Venture Capital Fund or
(c) a Foreign Venture capital Fund, registered with SEBI or
(d) run Takaful business (Islamic Insurance as a co-operative Society where the cover is available to members only) or
(e) open an Islamic window in a conventional bank without awaiting any change in the existing laws and regulations and without contravening any of the existing Laws or Regulations. 
The easiest way to introduce Islamic Financial system in the Indian Financial market is to start doing whatever is permissible within the extant laws and get noticed. The Government and the Regulator then, will have to step in, to regulate the working of Islamic Finance. It is un-realistic to expect that the Government will facilitate introduction of Islamic financial system by taking suitable Legislative measures or by issuing necessary administrative fiat and ensure that each of the Shari’ah compliant transactions is defined in the statute in a manner that suits the requirement of Shari’ah scholars. Hence, the absence of suitable statute and the problem related thereto will have to be tackled by the practitioners of Shari’ah till such time as the regulators find it desirable to come out with solutions. In any case, it is not necessary to wait for the Government to put on platter all the Legislative reforms for financial transactions to be carried on, based on Shari’ah.
The question that we need to ask ourselves is, are we serious? Do we want to carry on financial transactions as much as possible on Shari’ah principles? If the answer is yes then we must start working for it. Have reliable (i) Co-operative Credit Societies (ii) Co-operative Takaful Societies, (iii) Domestic Venture Funds (iv) Shari’ah compliant Mutual Fund and (v) Shari’ah Compliant Window in a conventional Bank to carry on the activities strictly on Islamic Shari’ah Principles. It is possible to carry on all these activities without seeking any change in Laws and regulations. And, this needs to be told to the masses. Not everybody is aware of it and there is need to make people aware and convince them of the factual position.
In UK the FSA while trying to provide level playing field for Islamic financial transaction involved the Imams of Mosques to generate public awareness. Something similar needs to be done to increase awareness among the masses and create a demand for Islamic Financial Transactions. For the success of the Islamic Financial Institutions, there has to be a demand and the demand would be made only when people are aware of what is possible. Again, for the Government and the Regulator to feel the need for regulatory changes, there has to be enough Islamic Finance activity to justify introduction of Legislative changes.
If there are viable Islamic Financial Institutions in place, ready to lend a helping hand in a non-discriminatory manner, the advantages of the system would be there for all to see, the Government, the Regulator and the foreign investors. To expect the Government to take the first step is trying to put the cart before the horse. Such a move is also likely to face serious hurdles in a democratic country like ours, where public opinion is not always based on logic and sound reasoning. The writ petition in the Kerala High Court against the efforts of establishing a Shari’ah compliant NBFC where the Government of Kerala was inclined to be a minor participant, shows that those interested in the introduction of Islamic Finance in India, will have to work for making their demand acceptable by bringing awareness and showing that the benefit of the structure proposed by them is for all to avail and the benefit is far more than that available under the conventional arrangement. Acceptability will come only if the alternative system is shown to be beneficial for reasons beyond religious belief. An average Indian would like to know whether introduction of Shari’ah Financing would;
a.       Create value for the Financial System;
b.       Contribute to the Economic Development of the Country;
c.        Expand consumer choice; and
d.       Allow fair competition in providing credit access and in making various financial services available at competitively price.
On all these counts Islamic Finance stands a better chance to score high marks.
i.         A significant Muslim population is likely to provide the critical mass for the success of the Shari’ah compliant banking activity.
ii.       A report on financial inclusion revealed that the ratio of deposit accounts (data available as on March 31, 2004) to the total adult population was only 59%. Despite serious efforts in the past the banking facility has not reached to a large section of Indian masses. As per a survey conducted by Reliance Money, 35 % of the Muslims live in urban areas and 80% of them because of their illiteracy, ignorance or, belief, the last playing an equally important role, do not avail banking facility. This is also borne by the Sachar Committee Report. Hence there is need for innovative approach to popularise banking services among the masses. An Islamic window in a conventional bank, having a local feel, would encourage such people to become constituent of a bank and thus help the financial inclusion effort made by the Government and the Reserve Bank of India.
iii.     Unlike the industrialised countries, India’s GDP is growing continuously at a high rate. It makes sense for the investor to catch the investment opportunity in India.
iv.     A number of Indian banks and financial institutions have a presence in Middle Eastern and South Asian markets for decades, allowing them to develop knowledge and expertise of local markets and systems. So there is no dearth of technical knowledge.
v.       The branches of Indian banks in the Middle East want to introduce Islamic financial services through ‘Shari’ah compliant windows’, of Indian Commercial banks. This would need approval by the respective Boards of the Bank. If they are allowed to do Shari’ah financing, they would be able to increase their client base and contribute to the development of Islamic finance through their knowledge of product development. They would also be able to create similar products for domestic market.
vi.   India has a large pool of legal, accounting and financial engineering skills. In fact, a number of Islamic banks in the Middle East and other centres are being managed by experts from India.
It is interesting to note that huge investments in India, in Dollar terms, are taking place in Shari’ah compliant transactions. The big investors whether from India or a foreign country, have enough opportunities to make Shari’ah compliant investments. These investments are being routed through NBFCs and Mutual funds. One of the reasons why such investments do not get noticed is that they involve bulk investments and do not touch the life of ordinary masses. They are not very material from the angle of financial inclusion. It is only when the financing in a Shari’ah compliant manner is carried out keeping ordinary people in mind and its advantages are seen to have positive impact on their lives that the need for suitable legislative changes will get addressed. ‘Economic reason’ is likely to succeed much better where ‘politics and religion’ have failed. 
i.      We need to focus the man on the street. The NGOs, the Social workers and in fact everybody who wants introduction of Shari’ah financing should start contributing in whatever manner possible in their respective locality for its success under the extant regime. If there is sincerity in the effort, it is bound to get noticed. The Working Group constituted by Reserve Bank to examine the financial instruments used in Islamic Banking came to the conclusion that “appropriate amendments are required in Banking Regulation Act, 1949 and separate Rule and Regulation will have to be framed to permit the business of Islamic Banking.” In relation to Islamic banking window in the branch of a banking company, the working group observed that “such branches may be able to undertake only those activities, which are permissible to a banking company in India as per the provisions of Banking Regulation Act 1949.”
ii.    For a full fledged Islamic bank to operate in India, Legislative changes are imperative. These changes may take a long time to get introduced. But, that need not hold the introduction of Shari’ah financing under the existing legislative regime. There is sufficient scope for a conventional bank to open a specialised counter to carry out Shari’ah financing activity and introduce products and services that comply with the extant laws and the rules, regulations, directions issued under and the Shari’ah. The need is to avail the existing opportunity and make the effort relevant for the masses, changes in law will come in due course. 


[The writer is Former joint legal adviser, Reserve Bank of India. He was involved in revising the Banking and Finance laws of Bangladesh to facilitate Islamic Finance. Presently he is partner in India Law Services.]

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