India mulls Islamic banking stimulus

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India is preparing legislation to promote Islamic banking as a way to make its financial markets more inclusive and provide new capital-raising opportunities to companies.

India’s Ministry of Finance has formed an internal committee to study the prospects for Islamic banking. Sources said the ministry is talking to the Reserve Bank of India and the Securities and Exchange Board of India about introducing rules to streamline sukuk issuance by Indian entities, among other regulatory amendments

Islamic banking is not new to India. The country already has a few non-banking financial companies (NBFC) operating under Sharia law. The Bombay Stock Exchange has also partnered with Taqwaa Advisory and Shariah Investment Solutions to create a Sharia-compliant equity index in the country.

Despite those efforts, however, Islamic banking services have not prospered. Existing regulation is prohibitive and there is a general lack of awareness about the benefits of Sharia-compliant finance.

Islamic banking would include India’s Muslim population of about 138m, one of the largest in the world, in the financial markets, while endorsing Islamic bonds, or sukuk, could help close the US$300bn funding gap for the infrastructure sector.

Islamic debt offers a way for issuers to raise funds without paying investors interest, which Sharia law prohibits. Sukuk investors receive a fixed rate of return on an underlying asset, rather than interest payments.

Adhering to these interest-free tenets could help debt-ridden farmers and small entrepreneurs in India prosper, and allow Indian issuers to target Middle Eastern investors.

“Islamic banking offers tremendous opportunities for infrastructure financing,” said Jayesh H, senior partner with law firm Juris Corp

“Most people are not aware of how large is this industry globally. At over US$2trn or so, Islamic banking is too large to be ignored by India.”

Despite these evident advantages and big potential, implementing new regulations and encouraging new Islamic business will not be easy.

“We will require a huge change in regulatory framework to promote Islamic banking,” said Atul Joshi, CEO of India Ratings and Research, the local arm of Fitch.

“Islamic banking works on different principles than the conventional banking. The profit-sharing principles of Sharia law have very different connotations for the Indian tax system.”

 

Certain banking provisions contradict Islamic banking tenets. For instance, India’s Banking Regulation Act makes it mandatory to pay interest on deposits, something not allowed in Islamic banking.

On the other hand, the act prohibits bank investments based on profit sharing and bars any banking company from buying or selling of bartering of goods. This contradicts the common Islamic banking concept of murabaha, a popular format for Sharia-compliant financings.

 

Legal action

A few NBFCs have been operating on Shariah-principles, but not without facing problems.

For instance, in April 2012 the RBI cancelled the banking license of Alternative Investments and Credits Limited on the grounds that AICL’s business contravened the Fair Practices Code for NBFCs by failing to declare the rate of interest it takes from its clients. However, AICL could not comply with this rule because, under Sharia law, profits are based on the performance of its client’s businesses.

AICL’s is contesting the RBI’s action before the Bombay High Court.

Meanwhile, Subramanian Swamy, an Indian politician and economist, unsuccessfully challenged Cheraman Financial Services in a public-interest lawsuit. Swamy contested Cheraman’s Sharia-compliant business activities on the grounds that they are based on religious principles and hence against the secular nature of the Indian constitution.

Industry officials believe the central bank, under Governor Raghuram Rajan, is more willing to make changes to regulations that would welcome more Islamic banking institutions and financings.

Rajan has shown interest in Islamic financing in the past. When he chaired a high-level committee on financial sector reforms for the Planning Commission of India in 2008, he recommended the introduction of interest-free financing.

Regulatory changes related to Islamic banking would be good news for a few Indian corporations that are eyeing offshore and onshore sukuk issues.

“Some tweaking of regulations by the government will help the product take off quickly,” said Juris’s Jayesh.

 

(Courtesy: IFR Asia)

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