Islamic ‘Finance’: Between Faith and the Law

By Sugata Ghosh & Shailesh Menon / Economic Times / Times of India

ON SEPTEMBER 9, a senior bureaucrat told an Indian court that the law of the land does not allow Islamic banking. He was stating the government’s position before the court which was hearing a petition that challenged the functioning of such institutions in India. What he was possibly unaware of was a meeting held at the Reserve Bank of India headquarters in Mumbai a fortnight before his court appearance.

At that meeting, a team of Islamic scholars and senior lawyers met a top central bank official to talk about the possibility of a pilot project where banks in India may open special windows to offer interest-free products that are based on Sharia’h, the sacred law of Islam. The RBI official, like most RBI officials, was non-committal. But the delegation that visited the regulator challenged the fundamental argument that the finance ministry as well as RBI have so far held on to.

According to an RBI report prepared some years ago, neither banks in India nor overseas offices of local banks can offer Islamic banking under the current legal framework. Interestingly, unlike other RBI reports, this was never put up on the bank’s official website.

Since then, this too has been the government line on the subject. Today, this is being questioned. The term “banking”, as defined in the Banking Regulation Act, has three essential features: (1) acceptance of deposits from the public; (2) the use of money so accepted for lending or investment, and (3) liberty to the depositor to withdraw the money.

“The definition does not require a banking company either to pay interest on deposits or charge interest on lending…the Monetary Authority of Singapore has allowed interest-free banking activity,” says H Abdur Raqeeb, who led the team to RBI. The studies undertaken by his centre claim that conventional banking products like saving bank account, term deposits, credit cards and consumer and farm loans can be structured in a way that fulfil the requirements of the Indian banking laws as well as Sharia’h.

For men like Raqeeb, general secretary of the Delhi-based Indian Center for Islamic Finance, persuading regulators to allow Islamic banking, even in a small way, may be a mission. For someone like H Jayesh, a senior lawyer, it’s a different challenge.

“We are often asked by people on investment products and ways to go about doing transactions that are Sharia’h compliant,” says Jayesh, founder partner at the Mumbai-based law firm Juris Corp. As a genre of financial services, Islamic banking shuns the very idea of interest rates and rests on profit sharing. It abhors the business of making money out of money and upholds the belief that wealth is generated through actual trade and investment. For instance, someone buying a home with bank funds will not borrow from the bank and pay EMIs. Instead, the bank will purchase the property and sell it back or lease or rent out to the customer.

It’s possible to structure the contract in a manner where the leased assets are held by borrower as an agent of the bank. Jayesh’s colleague Maymoona Mandviwala thinks that there are ways under the Bombay Stamp Act ‘58 to carry out transactions to avoid ‘double stamp duty’ — often perceived as a deterrent to Islamic banking, where the deals can have two legs of buy and sell.

As a lawyer, I take an agnostic approach, says Jayesh, who feels that Islamic banking is becoming too big to be ignored. Financial centres such as Singapore, Hong Kong, Geneva, Zurich and London have either changed laws or tweaked existing regulations to accommodate Islamic finance industry that is worth $800 billion globally and is growing at 10-15% a year. In some of these financial centres, said a Boston Consulting Group paper, the focus is “on leveraging deep and long-term relationships with wealthy Muslim clients from the Middle East who are seeking Islamic private banking services”. In Asia, Hong Kong’s position as a gateway to China is attracting Middle Eastern institutions which want to park petro dollars in China through Sharia’h-compliant vehicles. Money markets in the West were quick to spot the opportunity. At the peak of derivatives boom, the industry body International Swaps & Derivatives Association (ISDA) had even structured something called an Islamic swap.

Indian financial circles do sense the future possibilities of Islamic finance. For instance, real estate financiers are talking about the scope of mezzanine products — instruments that are somewhere between debt and equity — as an investment product to mop up funds. A senior banker with an MNC bank said that India’s proposed infrastructure fund may well receive a part of the seed capital from Gulf sovereign funds which follow Sharia’h principles. But there are issues that come in the way. One of the public interest litigations alleges that a Kerala government agency’s decision to promote a Sharia’h-based institution amounts to the state favouring a particular religion. “The government invited trouble by deciding to sponsor the entity…it could have let some NRIs set it up and then step in at a later point to pick up stake,” said Jayesh.

But there are activities that don’t face regulatory barriers. This is where many are beginning to make a difference between Islamic banking and Islamic finance. It could take years to convince RBI to give a banking licence, but setting up an non-banking finance company based on Islamic finance could be simpler. “Such an NBFC will not be a deposit taking one, but an entity where investors are either shareholders holding equity or subscribing to sukuks,” said Sameer Gupta of Ernst & Young which had advised the Kerala government agency on the project. Shariq Nisar, director, Taqwaa Advisory and Shariah Investment Solutions, and Suprio Bose, a lawyer at Juris Corp, too feel that the best option will be promote Sharia’h-based NBFCs.

These institutions can raise funds and invest in Sharia’h-compliant private equity funds, venture funds, real estate projects and asset-backed leasing companies. “Apart from investing in companies, Sharia’h-based NBFCs can issue Sukuks, where the asset is securitised and earnings are derived only from cashflows of the underlying asset. Sharia’h-based mutual funds, portfolio management schemes et al other options that can be considered under Islamic finance,” says Nisar. The Kerala government, in all likelihood, has made a mental note on the distinction between ‘banking’ and ‘non-banking finance’. Its plans have come under the media glare; and, the way it tackles the law and regulators to take them forward could shape the future of Islamic finance in India.

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