India: India's Islamic Finance: The First Steps Forward

Last Updated: 29 September 2016
Article by Jayesh H-

Article by Jayesh H, Monil Chheda & Sanjana Rao

In September 2015, the IMF estimated that the aggregate financial assets, held in Islamic accounts, were above US$2 trillion globally and that they would outperform the growth of conventional finance in many countries.

Renowned Indian economist MS Swaminathan, who is also the pioneer of green revolution in India, stated that Islamic finance could be an effective solution for resolving farmer suicides in India. Though Islamic finance has been sluggish in its traction in the Indian economy, there have been developments from an Indian context which provide hope for the future.

A concrete step toward ushering in Islamic finance into India was the execution of an MoU between the IDB and the Export-Import Bank of India (EXIM). The MoU's terms permit IDB to open its first branch in India to offer Shariah compliant financial and banking services. A commercial line of credit amounting to US$100 million is to be extended by the Islamic Corporation for the Development of the Private Sector to EXIM pursuant to the MoU. A state-of-the-art rural mobile network in Gujarat worth US$55 million has also been promised by the IDB. The SME sector seems to be the primary focus of IDB funding and investments in India.

The Committee on Medium-term Path on Financial Inclusion (the Committee), set up on the 15th July 2015 by the Reserve Bank of India (RBI) and headed by Deepak Mohanty, released a report (the Report) that strongly advocated the introduction of interest-free banking in India and also set out the advantages of adopting an Islamic finance-based model in India. The Report was submitted on the 28th December 2015, with various recommendations pertaining to the existing policy on payment and small banks, socially inclusive financial products and services and credit facilities which may be extended in the agricultural sector.

The Report elaborated upon the disadvantages the lower strata of Indian society faces due to the lack of access to Shariah compliant funding from conventional banks. The Committee delved into empirical research at a household level and collated the same in detail to reflect the present need for such a model of financing in India. The Committee acknowledged that commercial banks may approach this model and offer Shariah compatible instruments in a limited manner or as pilot projects initially.

One of the main reasons behind the slow growth of Islamic finance in India has been the lack of an adequate legislative framework for setting up Shariah compliant finance institutions. Due to the lack of laws to promote this financing model and the reluctance on the part of the legislature to amend the existing framework regulating the banking and finance sector, individuals and entities following Shariah rules find it difficult to invest or undertake any ancillary financing activities in India. This also leads to a sparsity of institutions, banking and investment products in this sector.

Private equity and venture capital investments based on the Islamic finance model have seen tremendous growth globally, although the same remain nascent in the Indian markets. Off shore investors based in countries which are a part of the OIC consider India an untapped market; the opening of this avenue will present innumerable options in the funding sector not just from an off shore perspective but also for investors domestically.

A development in this sphere took place in 2014 when the Indian capital markets regulator, the Securities and Exchange Board of India, was all set to introduce a new type of bond in the Indian market known as 'Sukuk bonds'. However, on the eve of this progressive step, the plan was abandoned and the scheme never took off.

To read the full article, click on the 'Download Report' button given below.

Note: This article was first published in IFN (Islamic Finance news), 17th August 2016 (Volume 13 Issue 33). Click here to access the website.

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