By Prashansa Srivastava
In a monumental move, the Reserve Bank of India (RBI) has decided not to pursue the proposal for the introduction of an Islamic banking system in the country. Islam prohibits the practice of charging interest and Islamic or Sharia banking is a finance system based on these principles.
According to the central bank, the issue of introduction of Islamic banking in India was examined by the RBI and the government of India thoroughly. “Taking into account, the wider and equal opportunities available to all citizens to access banking and financial services, it has been decided not to pursue the proposal further,” the central bank said in its reply to the RTI application filed by a PTI correspondent.
Prospects of Islamic banking in India
It all began in late 2008, when a committee, headed by former RBI governor Raghuram Rajan, opined on the need for a closer look at the issue of interest-free banking in India. “Certain faiths prohibit the use of financial instruments that pay interest. The non-availability of interest-free banking products results in some Indians, including those in the economically disadvantaged strata of society, not being able to access banking products and services due to reasons of faith,” the committee had said.
An inter-departmental group (IDG) was later set up in the RBI as per the instructions of the government. The group evaluated the legal, technical and regulatory issues for introducing interest-free banking in India. The RBI sent its final report to the finance ministry, recommending an “Islamic window” in conventional banks for the phased introduction of banking compliant with Sharia law.
The proposal gets a red flag
“In our considered opinion, given the complexities of Islamic finance and various regulatory and supervisory challenges involved in the matter and also due to the fact that Indian banks have no experience in this field, Islamic banking may be introduced in India in a gradual manner. Initially, a few simple products which are similar to conventional banking products may be considered for introduction through Islamic window of the conventional banks after necessary notification by the government,” it had said in a letter to the ministry.
Islamic banking was given a separate window in order to ensure fewer complications in the financial process. This was done keeping in mind the complexities of Islamic finance, multiple regulatory and supervisory challenges involved and the inexperience of Indian banks. However, the RBI did not set any deadline for the proposal. Now it has evidently decided not to go ahead with the proposal at all. This is also in compliance with the government’s Jan Dhan Yojana, which is a national mission to bring about the comprehensive financial inclusion of all the households in the country.
The Islamic Banking System
Islamic banking complies with the Islamic law or sharia and prohibits ‘riba’, or usury, which is defined as the interest paid on all loans of money. Investments in businesses that provide goods and services that go against Islamic principles such as alcohol or pork are also prohibited. Proponents of the system see it as a significant step of Islamic revivalism and promise that once the system is fully implemented the results will be “no inflation, no unemployment, no exploitation and no poverty“. The system is also seen to be more stable as investments move slowly as risky businesses are usually kept away.
However, the lack of interest on loans also leads to the discouragement of players in the banking process. The inexperience of regulatory and financial bodies makes the implementation of the system extremely difficult. The added costs and risks of implementing a new and even more complicated system act as a significant drawback as well. Since documentation is tailor-made, the transaction and issue costs increase exponentially. The system also prohibits hedging; thus, risk cannot be minimised. The incompatibility of Islamic banking with the international financial regulations will also hinder India’s growth.
The need for an equal and just financial system, keeping in mind the various drawbacks of the Islamic banking system make the prohibition of its implementation justified. The need of the hour is a system that is inclusive and gives equal opportunities to all with minimal complications, to ensure the smooth overall working of the Indian financial system.
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