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Raghuram Rajan Committee recommends Interest-free banking

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Points of Essence:

  • The author submitted that the term of ‘interest-free banking’ instead of ‘Islamic banking’ was aptly used in the Raghuram Report put to avoid any communal uproar before coming election.
  • The Raguran report argued that it was within the ambit of financial infrastructure for inclusion to provide for interest-free banking as certain faiths prohibit the use of  financial instruments that pay interest. Hence, no access banking products and services. Also, the delivery of interest-free finance on a larger scale, including through the banking system need to be allowed to be in consonance with the objectives of inclusion and growth through innovation.
  • Being mentioned the first time in any government report, it is a challenge to convince India that interest free banking is genuinely to boost faster and inclusive growth for Indian economy and this goes beyond politics and religious aspects of Islamic banking.

By Syed Zahid Ahmad

Though Raghuram Rajan Committee was silent about Islamic Banking in its draft report released on 7th April 2008, it has suggested Interest-free banking as a part of recommendations made for financial sector reforms. The term of ‘interest-free banking’ instead of ‘Islamic banking’ is needed to avoid any communal uproar before coming election. The next two paragraphs on interest-free banking have been inserted in final report as submitted to the Prime Minister on 12th September 2008.

“Another area that falls broadly in the ambit of financial infrastructure for inclusion is the provision of interest-free banking. Certain faiths prohibit the use of financial instruments that pay interest. The non-availability of interest-free banking products (where the return to the investor is tied to the bearing of risk, in accordance with the principles of that faith) 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. This non-availability also denies India access to substantial sources of savings from other countries in the region.

Raghuram Rajan shot to fame when he became the first Asian to be appointed as the chief economist of the International Monetary Fund (IMF).

While interest-free banking is provided in a limited manner through NBFCs and cooperatives, the Committee recommends that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system. This is in consonance with the objectives of inclusion and growth through innovation. The Committee believes that it would be possible, through appropriate measures, to create a framework for such products without any adverse systemic risk impact.”

The committee could have hardly said anything else to recognize the financial exclusions of minority community due to non availability of interest-free banking complying with their faiths. Indian Muslims owe thanks to the committee for this insertion; as first time in history of Indian economy, any Government report has considered banking problems of minority community related to their faiths. The committee has inserted the term under headline of infrastructure for financial inclusion because we need to develop infrastructure for interest-free banking. Had the proponents of Islamic banking approached the committee (well in time) with highlighting the significance of Interest-free banking for financial sector reforms, the committee may have added some more texts elaborating scope of Interest-free banking for financial sector reforms in Indian economy and could also have taken Interest-free banking under their priority list.

In fact our top economists are well learned, experienced, and influenced by interest-based banking running at national and international levels for centuries; and it is not easy for them to understand the arguments for interest-free banking in absence of any proven track record in India. Viewing the current financial crisis in international market and danger to affect our economy, It would be better in interest of the nation to evaluate the significance of interest-free banking in achieving targets like financial inclusion, inclusive growth, infrastructure finance, Credit-output and labour-capital ratios in unorganized sector industries, Insurance for unorganized sector workers, improvising credit market, exports and future trading and facilitating the agriculture and ignored segments of the economy.

We need to evaluate the economies of scale for Interest-free banking in comparison to interest based banking. Beside financial targets, we need to meet social and economic targets which require innovative financial products with ability to fulfil economic needs, social responsibilities with allowing financial advantages as well. This could be achieved through interest free banking but not through interest-based banking.  We talk to provide subsidized credits to priority sector agents; why to avoid cheapest credit with maximum possible returns for investors as well? These all need some homework by our regulators.

With second largest Muslim population in the world and more scope for economic growth, India has better prospects to catch higher market share in Islamic finance compared to any other country, condition we apply our thoughts in positive manner. I sincerely feel that we need to keep economics of Islamic banking up over politics and religious aspects of Islamic banking in India. We need to educate the general public explaining the reasons ‘Why Islamic banking is must for Indian Economy. After all the political parties need economic rationality to convince majority of voters that Interest-free Banking is not to please Muslim voters but to genuinely boost faster and inclusive growth for Indian economy.

Source: http://www.mynews.in

Note: Watch out for similar report here.

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Written by Suapi Shaffaii

September 22, 2008 at 3:18 am

One Response

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  1. It is high pleasure to read that a govermant commitee inserted, in their report to Prime minister, comments favoring interest-free bank (Islamic Bank). Indian Goverment should not wait more to amend the banking laws to facilitate Interest free banking system.

    Regards,
    Nabeel

    Nabeel Kattakath

    September 22, 2008 at 6:33 pm


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