Islamic Banking – Participatory, Equality & Indian law

February 13, 2013 by  
Filed under newsletter-india

Islamic banking is nothing but participatory bankingFebruary 10, 2013: The secular system adopted by the Reserve Bank of India (RBI) for banking and financial services in India is conflicting with the fundamental right to freedom of religion. RBI being a secular institution may not adopt any religious model of banking, but it is equally important that RBI should not make any law conflicting with any religion including Islam. So far the Government of India (GoI) and RBI have been reluctant to allow financial inclusion of Indian Muslims by resolving this specific conflict of secular banking system with Islamic laws. Being a secular democratic country, we should not develop any secular policy or practice which is against any religious laws.

Had RBI as financial engineer studied financial products used under Islamic banking system, might have developed new secular financial products with equally attractive and acceptable to Indian Muslims as well. But the internal working group of RBI constituted for this purpose sensed mysticism in Islamic banking with inextricable influence of religious doctrines, and delineated the principles and entire gamut of financial products used in Islamic banking for better understanding. So the report presented by that working groups mostly dealt about legal hurdles disallowing Islamic theology in present banking system; and did not focus on evaluating the scope of alternative financial products potential for financial inclusion. That group did not interact with any professional group practically working for Islamic banking to find its pros and cons, rather based on study of two theological websites ( and put statements like “every Islamic bank has to establish a Zakat fund for collecting the tax and distributing it exclusively to the poor directly or through other religious institutions” in its report.

Considering the better growth rate in Islamic banks around the world amidst global financial crisis, RBI has been approached through different parties (including Minister of Minority affairs). But probably based on the study done by the working group, the RBI Governor concluded saying that “Islamic banking is not possible,”…. “We have studied the issue. We appreciate the objectives behind the request. But there are some legal problems. It can be got around not through banking, but other vehicles.”The sensed mysticism in Islamic banking by RBI working group might be a big reason behind such stand by the RBI.

It is better to call Islamic banking as ‘Participatory Banking’ because the products used under Islamic Banking are driven by spirit of participation. It allows through participation of the depositor and financier in trading, leasing, forward sale, equity subscription, risk sharing and partnership activities. So the term ‘Participatory Banking’ can well replicate the term ‘Islamic Banking’ in India. Any additional banking system based on principles of participation along with interest based banking would help achieve effective financial inclusion among all communities (including Muslims) without any sense of mysticism.

Deregulation of interest rate has opened gateway for Shari’ah Compliant banking and financial services within existing regulatory framework. Under present banking regulations, following products and services are potentially Shari’ah Compliant and can be carried out by any subsidiary doing participatory banking.

A. Deposit Side Products & Services
1. Saving deposits with zero interest
2. Current Account
3. Safe Deposit Locker Services
4. Online Trading Services
5. Internet Banking services for receiving, disbursing and transferring funds on fee basis.
6. Consultancy Services (On Commission basis) to customers seeking Shari’ah Compliant Investments in Mutual Funds
7. Consultancy Services (On Commission basis) to customers seeking Shari’ah Compliant Investments in Equities / preferred Shares

B. Finance and Investment Side Products & Services

1. Investment in Equity of any listed company (selected after Shari’ah Screening)
2. Investment in Mutual Fund (selected after Shari’ah Screening)
3. Lease Finance business
4. Hire purchase business
5. Discounting of bills and Vouchers (on Commission basis)
6. Factoring services
7. FOREX Services
8. E-Freight Services
9. E Tax services
10. Issuance of Bank drafts by charging Fee for the service
11. Issuing bank guarantee / Letter of credit by charging Fee for the service
12. Retail Sale of Gold Coins or other metals
13. Gift Cheques Services
14. Gift Card Services
15. Pay Roll Card Services
16. Foreign Travel Card Services
17. Initial Public offer Services
18. ATM Services
19. Broking services

If these products and services are clubbed together as a package and offered through subsidiary model in the name of Participatory banking; or through NBFCs, it would resolve problems related to financial inclusion of Muslims along with helping the disadvantaged groups and sectors to get suitable financial products and services at better prices.

Currently NBFCs are regulated through Chapter IIIB in the RBI Act 1934, which allows NBFCs to operate under scheme framed by the NBFCs itself. So NBFCs can be permitted to accept deposits and extend finances on participatory basis. This view is based on a report published by the Department of Financial Services, Ministry of Finance, Government of India on 31st January 2012. Section 4.3 of that particular report significantly put following two specific directions with regard to NBFCs undertaking Participatory Financing –

“As regards NBFCs that are undertaking participative financing and / or any other non-interest based financing, the following directions should be complied with:

(i) The Fair Practice Code should set out the model on which facilities will be granted to borrowers. The NBFCs should also set out the commercial considerations for its facilities, (after factoring in aspects such as cost of funds, expected return and other parameters to determine credit viability). The Fair Practice Code should be displayed on the website of the NBFCs and updated periodically;

(ii) The borrowers should be made aware of these commercial considerations in the agreement and the loan sanction letter. Expected returns, servicing charges should be communicated separately. If the expected rates of return and service charges are different for different category of borrowers, then the same should be communicated to the borrowers.”

Based on the above directions, RBI should frame regulatory provisions to allow NBFCs accept deposits and extend finance on Participatory basis. The depositors may be clearly told that their deposited funds will be invested on basis of sharing the financial risks and rewards.

There is a need to constitute a working group for studying the scope and challenges to allow Participatory Finance through opening up of subsidiaries at SCBs for Participatory Finance or introduction of a new category of NBFC in India. We expect that considering the Union Budget for 2013-14 as opportunity to set the pathway for next Parliamentary election, this time the union Finance Minister may propose any working group for studying the hurdles for financial inclusion of Muslims with an object to enable India achieve inclusive growth with better financial inclusion of 150 million Indian Muslims.

Anything proposed by the GoI in the name of Participatory Finance instead of Islamic banking may reflect as pure alternative financial model instead of religious agenda. Hopefully such initiatives by the GoI would help us resolve the age old conflict of secularism in the financial sector with that of Islamic economic principles without raising any mysticism and religious politics. We need to ensure removing hurdles in financial inclusion and inclusive growth without any conflicts in secular system and religious ethos. Hopefully Participatory banking may allow equality for all before the law in India.

– tcn

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