Guest Post: Islamic Banking in India

(This is a guest post kindly provided by Amit Malviya. It is approximately an year old and has not been edited to reflect any changes that may have since occurred).

What is Islamic Banking?

Islamic banking refers to a system of banking or banking activity that is consistent with the principles of Islamic Laws (Sharia). As a genre of financial services, Islamic banking denounces the very idea of interest rates, and rests on profit-sharing principles. Based on the Sharia law, it abhors the business of making money out of money, upholding the belief that wealth is generated through actual trade and investment.

Say, a customer buying a home with bank funds, will not ‘borrow’ from the bank and service it through equal monthly installments. Instead, the bank will purchase the property and then rent or lease it out to the customer. Once the bank recovers the investment, it will transfer the property to the customer at a reasonable rate.

Revival of demand for Islamic Banking in India

In 2008, the Planning Commission appointed a committee, headed by International Monetary Fund former chief economist Raghuram Rajan, to recommend various ways to take the country’s financial sector reforms forward. The high profile committee on financial sector reforms submitted a report to Prime Minister Manmohan Singh, who is also chairman of the Planning Commission. The report had recommendations on improving infrastructure for financial inclusion and did suggest including interest-free banking as an option in accordance with “faith” of a section of the society. The committee opined that this was in consonance with the objectives of inclusion and growth through innovation. The committee contended that interest free banking is currently provided in a limited manner through NBFCs and co-operatives and its delivery should be broad based through the banking system.

This demand was again raised in January 2010 by the Deputy Speaker of Rajya Sabha and Senior Congress Leader K Rahman Khan, who urged the Government to create a Sharia-compliant institutional mechanism in the banking sector and termed it “Participatory Banking”. He demanded that Sharia-compliant banks should work as an alternate banking system, similar to what existed in the UK, Russia and the U.S. He is of the view that a Sharia-compliant system would instill social justice even in economic activity in which profit and loss will be shared.

He argued that the Muslim population constitutes 15pct of India’s total population of over a billion, and they were not investing in savings accounts because it generates interest which is non-Islamic. He is of the opinion that if Sharia-compliant banking is introduced, this segment of society would come into the saving net. Khan also said Sharia-compliant banking could increase the flow of investments from the Arab world. The demand is being looked into by the PMO.

Sharia compliant products are not only offered by banks in the Middle East, Pakistan and Malaysia, but also some of their high street peers in the UK and US. A year ago, the RBI was asked by the government to look into the matter. The members of the committee submitted their recommendations few months ago, but the regulator, perhaps held back by obvious sensitivities, have not yet put the findings in the public domain.

Issues with adopting Islamic Banking – From a regulatory perspective

The Reserve Bank of India (RBI) constituted a committee to evaluate if Islamic banking can be offered in India. The committee examined the option and concluded that Islamic banking cannot be offered by banks in India as well as the overseas branches of local banks under the present legal framework. Except a basic offering like current account, almost no other banking product in India can be modified to meet the conditions of Islamic banking.

While the final form of the report is not known, it is learnt from media reports that the members have pointed out how Indian banking laws come in the way of various Islamic banking principles.

These are as follows: Al Wadiah (for saving bank account): Section 21 of the Banking Regulation Act requires payment of interest on such deposits; thus, interest-free deposit and a simple charging of premium or Hiba is not permissible.

Mudarabah (for term deposit or investment): Here again, Section 21 of the BR Act disallows such products where the bank can invest the money in equity funds (in India, equity exposure is determined by a separate set of rules), and the client has complete freedom in the management.

Mudarabah, Musharakah (for project finance and SME credit): Sections 5, 6 of the BR Act indicate the forms of business a banking company can undertake, and does not allow any kind of profit-sharing and partnership contract – the basis of Islamic banking.

Ijarah (for home finance): As against Islamic banking where the banks owns the asset and hold the title, Section 9 of the BR Act prevents the bank from any sort of immovable property other than private use.

Istisna (leasing, buyback): Besides the usual curbs on acquiring immovable property, offering

Islamic banking products many not be bankable due to stamp duty, central sales tax and state tax laws that will apply depending on the nature of the transfer.

In markets like the UK, there is separate law that makes it possible to launch Islamic banking products. The BR Act even disallows an Indian bank from floating a subsidiary abroad to launch such products, or offering these through a special window. Thus, as per the findings such a banking experiment is not possible without a new law (or multiple amendments to the BR Act).

Issues with adopting Islamic Banking – Constitutional position

There are two aspects to be evaluated in the context of India’s constitutional position with respect to Sharia compliant Islamic financing:

a)      The role of state, if any, in a venture like this

b)      The role of such financial institutes and its possible impact on demography

Scenario (a)

The Sharia is a personal law of those professing Muslim faith. A financial services company set up with government participation which would follow the personal law of a particular religion is a clear instance of the state favouring the law of a particular religion and by extension, that religion itself. This violates Article 27 of the Constitution.

In SR Bommai v. Union of India (1994) 3 SCC 1, 233, the Apex Court read Arts. 14, 15 and 25 together and held:

While Article 25 of the Constitution guarantees to all its people freedom of religion, Articles 14, 15 and 16 enjoin upon the state to treat all its people equally irrespective of their religion. While the citizens of this country are free to profess, practice and propagate such religion, faith or belief as they choose, so far as the State is concerned, i.e. from the point of view of the State, the religion, faith or belief of a person is immaterial.  To it, all are equal and all are entitled to be treated equally.

How is this equal treatment possible, if the State were to prefer or promote a particular religion, race or caste, which necessarily means a less favourable treatment of all other religions, races and castes ? This position of equal treatment of people of different faiths was reiterated by the Honorable Court in subsequent decisions also.

In M.P Gopalakrishnan Nair v. State of Kerala, (2005) 11 SCC 45, the Honorable Supreme Court held:

The State is not only prohibited to establish any religion of its own but is also prohibited to identify itself with or favouring any particular religion.

Thus it would follow that the setting up of a company with the co-ownership of the state, which expressly favours the personal law of a particular religion is antithetical to the equal treatment of people of all religions.

We have had a recent case where Kerala State Industrial Development Corporation (KSIDC), a wholly owned government company of Kerala State, got into an agreement with other promoter groups to offer Sharia compliant financing to the Muslim community in the state. It was proposed that KSIDC would hold 11pct in the venture. At the time when the proposed company got its sanction, KSIDC was headed by Prime Minister’s Principal Secretary, Mr T K A Nambiar.

The Government Order in this case was challenged in the Kerala High Court and was stayed on grounds of violation of Art.14, 25, and 27. RBI and Union Ministry of Finance were asked to file counter affidavits.

It is now well-settled that Corporations which are acting as the instrumentality or agency of the Government will be subject to the same limitations in constitutional and administrative law even though such corporations are separate legal entities (Ramana D Shetty v. International Airport Authority of India, AIR 1979 SC 1628: (1979) 3 SCC 489). The KSIDC being a wholly owned company of the government of Kerala is well within the definition of “State” in Art.12 of the Constitution of India.

Scenario(b)

Any Sharia compliant Islamic financial services company will take up activities like PE & Venture Capital Fund, Leasing, Investment in Equity, Mutual Funds, etc. In accordance with the prohibitions contained in Sharia the financial companies will not be able to deal with riba or interest. This will also cover other prohibitions like dealing with companies and people involved in activities involving alcohol and pork, which are considered “haram” in the Muslim faith. The prohibitions contained in the Sharia may also extend to entertainment, including cinema and music. Not restricted to this, Sharia as interpreted by Islamic scholars also classifies financial derivatives, a tool for financial engineering, as un-Islamic.

Giving and taking of interest, running businesses involving alcohol, pork or entertainment are perfectly legal under Indian laws. In fact, Art.19 (1) (g) guarantees the freedom to practice any profession or to carry on any occupation, trade or business. This freedom is subject to Art. 19 (6), the restrictions envisaged therein should be in interest of the general public. Art.19 (6) goes on to specify two cases of restrictions – a) specification of qualifications for practicing any profession or carrying on of any trade, occupation or business and b) the setting up of monopolies by the state and its entities.

The prohibitions imposed by Sharia on various businesses and means therefore impinge on freedom to practice any profession, trade or business as enshrined in the Constitution.

But there is an unwritten and unstated danger from such Islamic financial institutions. When thousands of crores of rupees will start arriving from the Muslim world and Muslim youth will get loans, while Hindus will be denied on one technicality or another, there could be a conscious attempt to lure away Hindus to convert in anticipation of an easy loan / financial assistance. Given the high unemployment of educated youth in the country, it is quite likely that in no time, under economic pressure, India will turn into a Hindu minority state. Country will slip into the hands of Darul Islam, and like Kashmir, soon the Hindus will either migrate or be driven out of India, or convert to Islam. This is already happening in Europe a fast growing center for Islamic Banking (for details read section on Learning from non-Muslim world particularly Europe – Islamic Banking a vehicle to perpetuate religious doctrine).

We are not alien to the impact of Christian Missionaries, who on the strength of financial support from overseas lure the poor and under privileged into conversion. The effort required to reconvert is huge. Imagine the impact on demography of the country if a particular religion had a blanket approval to operate legitimate financial firms largely supported from overseas.

Truths of Islamic Banking

Islamic or Sharia banks differ from regular banks in two major ways.

a)      As commanded in the Koran, the charging of interest is prohibited in all monetary transactions.

b)      The other defining feature of Islamic banks is that they are supervised by a board of Islamic scholars and clerics whose job it is to ensure that the banks’ activities comply with Sharia law.

The truth, however, is that, like all banks, Sharia banks do charge interest – they just give it another name – and that the clerics supervising the banks have ties to extremist, even terrorist, groups which work towards the Islamization and world dominance.

Point (a): Islamic Banking – Only the nomenclatures change

Any bank, be it Islamic or conventional, risks running losses if it does not charge some form of interest; Islamic banks circumvent this danger by extending a type of Islamic “credit” that shifts risk to the borrower in a manner similar to interest.

An Islamic bank granting “murabaha” credit to a customer for an automobile, for example, would purchase the automobile for the customer for Rs10,000 and the customer would owe the bank Rs12,000 in a year’s time. Similarly, under the “diminishing musharaka” credit, the Islamic version of a mortgage, the bank and the customer purchase the property together. The customer must make monthly payments to the bank and pay a monthly rental fee, both based on the portion of the purchase price the bank still owns. Ironically, the interest this amounts to ranges between one and two percent higher than the interest on a conventional mortgage.

Although the resale price of the vehicle and the rent paid on the house are akin to simple interest charges, the banks’ Sharia boards legitimize the charges by renaming them “commissions” or “profits.” Islamic banks could not remain profitable – or ideologically influential – if they complied with the Quranic injunction again interest. The truth is that while Islamic banks do not pay interest, they try to mirror interest rates in one way or the other.

Also people come to banks for safety of capital and steady returns. They do not go there to take risks, and invest in unpredictable propositions. Should they want to do that they have the option to invest in venture capital funds, shares, mutual funds, or even directly in small-time businesses. Also only the rich can afford to take risks so the poor – even if they are good Muslims are left behind. Should an Islamic Bank try and ensure a fixed return, under whatever name, then it is no different from any other conventional bank.

Point (b) – Way to perpetuate religious doctrine

Given that Islamic Banking implies quite different stakeholder relationships, with depositors expected to have a direct financial stake in the bank’s investment and equity participations, the governance structure is different from conventional banks. Islamic Banks therefore have an individual Sharia Advisor and/or Board that assesses the suitability of its investment and financing and ensures strict conformity with Islamic law and the expectations of the Muslim community.

However in reality these boards are turning out to be agents for proselytizing and are using Islamic Banking to perpetuate religious doctrine. This is inspired by religious extremism and with a world view to achieve radical Islamization.

Islamic Banking caters largely to the religious minded. Consequently it is propounded that an Islamic organization must serve God. It must develop a distinctive corporate culture, the main purpose of which is to create a collective morality and spirituality which, when combined with the production of goods and services, sustains the growth and advancement of the Islamic way of life. To quote Janachi (1995) (p.42): (Janachi, A.L., 1995. Islamic Banking, Concept, Practice and Future, 2^nd edition, Manama: Baharain Islamic Bank.)

Islamic banks have a major responsibility to shoulder ….all the staff of such banks and customers dealing with them must be reformed Islamically and act within the framework of an Islamic formula, so that any person approaching an Islamic bank should be given the impression that he is entering a sacred place to perform a religious ritual, that is the use and employment of capital for what is acceptable and satisfactory to God.

The Islamic Banks lay equivalent obligations upon employees (p.28):

The staff in an Islamic bank should, throughout their lives, be conducting in the Islamic way, whether at work or at leisure.

Further, obligations also extend to the Islamic community (p.29):

Muslims who truly believe in their religion have a duty to prove, through their efforts in backing and supporting Islamic banks and financial institutions, that the Islamic economic system is an integral part of Islam and is indeed for all times … through making legitimate and Halal profits.

Islamic Banks are also targeting non-Muslims with the message that their services are ethically superior to those of the conventional capitalist models, pushing the idea that interest – and capitalism – is unethical and should be replaced by the Islamic financial model. It is in the hope that the world will see conversion to Islam.

Sharia compliant Islamic Banking still continues to be welcome because they attract huge sums from Muslims, “ethically”-driven non-Muslims, and investors from Muslim countries. Initially it was restricted to Muslim dominated countries but is now gaining acceptability as a “socially responsible” way of banking. But one would wonder how “socially responsible” and “ethical” is it to try and grab a share of the billions of dollars amassed by rich Arabs, while turning a blind eye to the fact that a substantial part of the money is used to promote terrorism and the establishment of an Islamic government over the entire globe ?

Specific experiences/learning from non-Muslim world, particularly Europe

London is the leading Islamic banking center in the West. In 2005 the first stand-alone British Islamic bank, Islamic Bank of Britain, opened its doors. Middle Eastern Islamic banks have also set up shop in the UK.

It has been widely written in the European media that Islamist clerics with terrorist connections and a mission to Islamize Europe are infiltrating the United Kingdom through its banking system. The Sharia advisory boards, which is entrusted with ensuring compliance of Islamic Banks with tenets of Islam, are represented by Islamic scholars and clerics who are well entrenched within the Islamic circles.

Sheik Yousef Al-Qaradawi, a leading Sunni cleric, spiritual leader of the Muslim Brotherhood, and instigator and financier of terrorism in Europe and the Middle East, heads the fundamentalist European Council for Fatwa and Research, several of whose most prominent members sit on every major British Islamic bank’s Shari’a board. Both Al-Qaradawi and the Council have expressed their hope that “Islam will return to Europe as a conqueror” by way of “preaching and ideology” or “by the sword.”

They are aggressively targeting non-Muslims under the pretext that Islamic Banking is an ethical alternate to the conventional business model. The justification for replacing capitalism with the Islamic model is based on an intentional corruption of Sharia law, but the banks’ clerics don’t seem to mind undermining their theological philosophy, since the ethical image their misrepresentation has created for Islamic banking has managed to spread Islamic ideology to non-Muslims in Britain. According to Al-Qaradawi, Islam’s ideological infiltration into the West will be the vehicle through which it will establish an Islamic government over the entire globe:

Perhaps the next conquest [of Europe], Allah willing, will be by means of preaching and ideology. The conquest need not necessarily be by the sword […] Europe will see that it suffers from materialistic culture, and will seek an alternative […] It will find no lifesaver but the message of Islam […] Allah willing, Islam will return to Europe and the Europeans will convert to Islam. Then they themselves will be able to be the ones to disseminate Islam in the world.

Replacing western institutions with a global Islamic order is, in fact, the goal of Al-Qaradawi’s Muslim Brotherhood. According to its founder, Hassan Al-Bana, the Brotherhood seeks to “[reclaim] Islam’s manifest destiny; an empire, founded in the seventh century, that stretched from Spain to Indonesia,” and its 1982 “secret plan” exhorted its members “to channel thought, education and action in order to establish an Islamic power on the earth.” The Muslim Brotherhood is a central link between Islamic banking and Islamic fundamentalism; the first Islamic bankers were members of the Muslim Brotherhood who wanted to use “the structural power of bank ownership” to advance the fundamentalist movement in the Gulf States in the 1970s. Today, its most powerful progeny, the Kuwait Finance House, covertly finances fundamentalist groups in Kuwait and abroad.

Dr. Ahmad Al-Rabi, a former Kuwaiti official, stated in a 2005 newspaper column that the “beginnings of all of the religious terrorism that we are witnessing today were in the Muslim Brotherhood’s ideology.” This is not a casual exaggeration; the Brotherhood’s members founded Al-Qaeda, bombed the World Trade Center in 1993, and applauded the 2001 World Trade Center massacre as America’s just desserts.

With the Muslim Brotherhood directly involved in Islamic banking in Europe, Al-Qaradawi’s hope that Islam conquers Europe either by “ideology” or “by the sword” is becoming a palpable possibility.

It would be naïve to believe that Islamic Banking, if adopted, in India will remain insulated from uncharitable influence of radical Islamists who are driven by religious motive of ensuring dominance of Islam on the world.

Conclusion

Everyone realizes that Muslims need jobs, education and other support systems to develop just like any other citizen of the country. But it is ironic that in a secular country like India we need Islamic Banking to promote Muslims lest they rot in poverty. It is strange but no poor Muslim in Bangladesh has accused Grameen Bank founder Mohammed Yunus of being a kafir for lending with interest.

Moreover, there are provisions for interest-free banking even now. Banks can invest in zero-coupon bonds, short-term treasury bills and corporate bills — all of which are based on implied interest rates, but don’t actually pay interest. Any bank can offer you a portfolio account where your money is invested in non-interest-bearing securities. Individuals can open non-interest bearing current accounts. All of them in a sense comply with doctrine of Islamic Banking.

Islamic Banking is not what is needed to help Muslims. When below-poverty-line (BPL) families can be helped without communal identification and state benefits can be given on socio-economic grounds, why are Muslims being treated any differently ?

It’s obvious that giving benefits on the basis of caste or religion is useful for political mobilization and hence is being pushed for politico- religious payoffs. Quotas, Islamic banking, and Sachar-induced victimhood are all one of a piece: they promote communal identity at the cost of true development.

Those who support the plea for an alternate financing channel to support the Muslim community need to realize that India’s banking is “inclusive” and the reluctance of some Muslims to use banks is a case of self-exclusion, not discrimination.