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www.islamicfi nancenews.com Vol. 4, Issue 1 5th January 2007 

The Way Forward to Islamic Banking in India

By Riyazi Farook

Islamic banking is the fastest growing concept the world

over but has not caught on in India. There are currently a

handful of foreign banks operating in the country which

are offering Islamic banking products. These include

Lloyds TSB, Citibank, Grindlays, Standard Chartered,

HSBC and ABN AMRO, which are already operating

interest free banking in several west Asian countries,Europe and the US. There are a few home-grown banks

like ICICI and Kotak Mahindra which offer Islamic banking

products as Indian banks become increasingly aware of

the Islamic banking concept and confi dent of the huge

potential market in India.

The resilience of the Islamic banking industry already

seen in many parts of the world could progress further with the

distinctive advantages which India can offer. A population of over 1.3

billion is certainly a massive market to tap. India has the capability to

offer huge manpower and natural resources. Opportunities which India

can offer are in the areas of technical and managerial talent, with theadded benefi t of international experience, given the underlying 

strength of its economy in which the country has emerged as one of 

 the fastest growing economies in the world.

At this juncture, Islamic banking in India is limited to the co-operative

sector scattered in various states all over the country. Islamic banks in

operation number less than 15, with deposits of about US$150 million.

In reality, they are just non-banking fi nance companies (NBFCs) which

function on the basis of profi t and loss. These so-called Islamic banks

cater to the needs of their locality except for a few that operate across

districts or states. As their sources of funds are limited and their

existence is small scaled, they miss out on any economies of scale.

Islamic banks in India provide housing loans on the basis of co-

ownership, venture fi nance on Mudarabah or profi t-sharing 

and Musharakah or equity participation and consumers ’ loans.

Some banks fi nance transport also on the Murabahah or mark up

basis through hire purchase.

As for investments, the Islamic banks put their funds in government

securities, small savings schemes or mutual funds and to a smaller

extent, investment in shares of companies or the stock market.

Conventional banks are showing preference to undertake this form of 

interest-free banking. However, the absence of a legal Islamic banking 

framework is making it diffi cult for scheduled commercial banks to

manage this form of banking or even adopt the Islamic banking system ina small way. Islamic banks in India are not under the control of its

banking regulations but are licensed under the Non Banking Finance

Companies Reserve Bank Directives 1997 RBI (Amendment) Act 1997,

operating on profi t and loss (Mudarabah) under Islamic principles. RBI

has also introduced a compulsory registration system.

Even if banks are allowed to set up windows that offer Islamic banking 

services, they need to maintain cash reserves and a Statutory Liquidity

Ratio (SLR) which involves interest. Settlement and clearing facilities

are not available from these banks, therefore their inability to issue

cheques.

There is an urgent underlying need to regulate the fi nancial institutions

in India given such an immense market among Muslims. A regulated

Islamic banking industry would offer the masses an avenue to channel

 their money into the formal banking system, be it conventional orIslamic.

Muslims in India have undoubtedly regarded religion as the biggest

hurdle for them to deposit their money in the bank or to obtain funding 

for developing their businesses or ventures. A huge proportion of 

 this population even avoids serving in fi nancial institutions. The non-

participation of Muslims in India’s formal banking institutions has not

only weighed down their economic prospects but also prevented a huge

sum of money belonging to the Muslim community to participate in the

national development. Islamic banking can certainly revolutionize the

micro-fi nance sector in the country and become an advantage for the

debt-ridden farmers in areas like Maharashtra.

The Indian fi nance ministry has advised the Reserve Bank of India(RBI) to draw a roadmap for Islamic banking in the country. This is a

step in the right direction to tap both the local market as well as major fi

nancial players from the middle-east.

Subsequent to this advice, RBI has taken the initiative to explore the

feasibility of Islamic banking. A committee comprising senior bankers

from the State Bank of India and other government and foreign banks

and headed by Anand Sinha, chief general manager in charge of 

banking operations and development have tabled a feasibility study

along with their recommendations. The fi ndings have yet to be made

public.

Other initiatives towards Islamic banking in the country have beensporadic in the form of press briefi ngs, literature circulation and

seminars. A recent move to get the government ’s involvement in

Islamic banking was the presentation to the fi nance ministry and RBI

by Jamaat-e-Islami Hind (JIH), on the need to amend the RBI Act and

launch Islamic banking in India. (JIH is one of the leading Muslim

organizations based in Delhi).

A Bahrain-based private equity fund, with an amount of US$1 billion

has expressed an interest to start an India-specifi c fund. Also fi rms

like Abu Dhabi Investment, Qatar Investment Authority and Islamic

Bank Finance House are looking at investing in India. This will all lead

 to the speeding up of the development process for the country as a

whole.

Regulatory issues need to be put in place before Islamic banking can

be introduced in India and its benefi ts can be enjoyed to the fullest.

Riyazi Farook has received a Professional Diploma from CIM-UK and

Postgraduate Diploma in Islamic Banking & Insurance from The Institute of 

Islamic Banking and Insurance in the UK. He can be contacted by email at

ri azif@ ahoo 

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