After opening doors to differentiated banks, RBI now reviews Islamic banking norms

The Reserve Bank of India (RBI) has begun the process of reviewing regulations on Islamic banking in India. The central bank has set up an internal committee to examine the matter, according to two persons familiar with the development, who spoke on condition of anonymity.

Islamic banking, practiced in some countries, especially in the Middle East, follows Shariah law. The model differs from conventional banking on two main accounts: It does not allow payment or receipt of interest and it does not permit investment in matters that are considered sinful - like manufacture of alcohol, gambling and pornography.

The model doesn’t accept deposits, only investments, which, more or less, make banking a venture capital activity.

According to the people quoted earlier, the RBI has set up a three-member panel comprising senior RBI officials, Rajesh Verma, a deputy general manager, department of banking operations, Archana Mangalagiri, general manager, non-banking supervision and Bindu Vasu, joint legal adviser.

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Firstbiz couldn’t ascertain whether the committee has submitted its final recommendations to the central bank. An email sent to the RBI seeking its response on Monday did not elicit any response.

Long-drawn battle

The question on whether India should allow Islamic banking or not have been debated in the country for long, but the attempts made by several Islamic institutions and private groups to seek recognition for the model haven’t succeeded due to regulatory constraints and opposition from local politicians, who argued that permitting Islamic banking will open for inflow of terror funding to the economy.

In 2007, an RBI appointed working group under the then executive director, Anand Sinha, had ruled out Islamic banking in the country, saying current regulations do not permit the model.

“There is a massive potential for Islamic banking since it can help mobilise substantial amount of funds from Muslim investors in both India and abroad,” said Abizer Diwanji, partner and national leader (financial services) at EY India.

“This can be implemented with a separate set of regulations to govern Islamic banks,” said Diwanji.

In 2012, the arguments for Islamic banking received a boost when the national minorities commission, under the then chairman Wajahat Habibullah, made a case for it with the finance ministry.

But since the model projects itself as interest free, the RBI, during the governorship of D Subbarao, yet again maintained that under the existing banking laws, interest-free banking is not possible.

That was the scenario until August 2013, when the RBI, in a surprise move, allowed a non-bank finance company in Kerala - Cheraman Financial Services - to operate in Shariah-compliant mode, which was seen as a shift in stance by the RBI towards the idea.

Globally, Islamic banking is prevalent in many countries with global lenders such as Standard Chartered and Hongkong and Shanghai Banking Corporation running Islamic banking divisions, along with conventional banking operations.

According to the UK Islamic Finance Secretariat, a part of The CityUK, the global market for Shariah-compliant assets reached $1.3 trillion in 2011 from $509 billion in 2006.

Another report from Ernst and Young (E&Y) said the assets of Islamic banks expanded at an average rate of 17 percent per year between 2008 and 2012 - thrice as fast as the rate at which conventional banks grew over the same period.

Knocking at RBI’s doors

The demand for re-look at Islamic banking regulations have revived again with the Indian central bank opening up doors for differentiated banks in India - payments banks and smaller banks - to begin with. Supporters of Islamic banking are making a case for Islamic banking in the face of the reforms in the banking sector.

“One shouldn’t link Islamic finance to religion but approach it as an alternative model of banking, which is prevalent worldwide,” said General Secretary of Indian Centre for Islamic Finance.