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Interest Free Banking Key to Growth in India, Says Rajan

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Points of Essence:

  • Raghuram Rajan, who was responsible for the financial sector reform report which recommended Islamic banking to the Indian Government, is now an economic adviser to the Indian PM, Manmophan Singh. In that famous report, he suggested that Islamic banking be introduced on a larger scale in India being identified as key to  an economic growth in India. It is also a means to reach out to the bankable society in India who have stayed away from the mainstream banking due to their faith restrictions on interest charges.

The International Monetary Fund’s former Chief Economist Raghuram Rajan has just been appointed as 
economic adviser to Indian prime minister Manmohan Singh.

Just before taking up this responsibility, Rajan was given the job to lead a high-profile committee on financial sector reforms, including the one on Islamic banking and finance.

Rajan has given India’s apex bank, Reserve Bank of India, a blueprint for the numerous changes required in the financial architecture of the economy. It even wants RBI to adopt a freewheeling approach to the management of exchange rates. In the report that Rajan submitted to the government, he has referred to equity financing in place of charging interest on lending a key principle of Islamic banking. Rajan tells exclusively to Khaleej Times on what he thinks of the subject. Excerpts.

Provisions of interest free banking in India:

“I have recommended measures be taken by the government to permit the delivery of interest-free finance on a larger scale, including through the banking system. The committee believed that it would be possible, through appropriate measures, to create a framework for such products without any adverse systemic risk impact. This area falls broadly in the ambit of financial infrastructure for inclusion of interest-free banking.”

Islamic banking is key to growth: “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. If we bring in a regulation, we would be able to check this.”

Economic priority vis-a-vis Islamic finance:

“I have highlighted the shortage of credit, financial services like savings, insurance and money transfer in the report.

The interest-free banking is provided in a limited manner through NBFCs and cooperatives. This is in consonance with the objectives of inclusion and growth through innovation.

The shortage of credit etc. is based on three principles: inclusion, growth and stability.

While inclusion means the participation of all the communities in the country’s economic growth, the committee is dead against the government offering any kind of subsidies.”

What is Islamic Finance?

  • The concept of Islamic Finance is based on the concept of Islamic economics as determined by the Shariah (Islamic Law).
  • Its two main principles are (a) no riba (interest) can be earned on loans and (b) investments should be socially responsible.
  • The no-interest principle governs the main difference between Western Finance and its Islamic counterpart.
  • Islamic banks take equity positions in homes rather than availing a traditional mortgage. Others cases include essentially profit sharing plans, leasing, and repurchase plans. Hence, Islamic banks are able to make money while adhering to the no-interest principle.

History of Islamic Finance

The Classical Period:

  • Dates back to nearly 1500 years when early types of commerce flourished under Islamic commercial law during the era of the Caliphate.
  • Gold and silver currencies were the standard metals that determined the value of all other substances traded. Since the value of these benchmark metals remained constant , therefore riba (interest) could not be changed.

The Modern period:

  • Dates back to roughly 30 years.
  • The initial modern foray with Islamic banking was undertaken in Egypt in 1963 and lasted till 1967, as a result of nine Islamic banks became operational.
  • In 1975, the Islamic Development Bank institutionalised with the purpose to give funding to projects to the member Islamic countries.
  • The first modern commercial Islamic bank which aggressively re-introduced Islamic banking on a commercial level is the Dubai Islamic Bank, which started its operations in 1975.
  • Current status of Islamic Finance
  • Presently, Islamic banks and 
financial institutions manage 
an impressive near total of US$200 billion of funds all over the 
  • Recently, the whole Islamic finance movement has been given a major boost by the rise of Bahrain as a key intermediation centre in this market and by Malaysia’s decision to adopt Shari’ah compliant financial instruments as an integral component of its growing market.
  • Due to these developments Islamic financial institutions have developed a vast range of products designed to serve the growing market. These cater for housing and consumer finance, business loans and project funding.
  • Lately, Malaysia and Bahrain have been instrumental in launching tradeable securities. These should create much needed liquidity and a secondary market for institutional investors in the Islamic finance market.
  • Several Islamic equity investment funds have also been launched, with both FTSE and Dow Jones providing indices to monitor this growing market.
  • The Islamic Financial Services Board (IFSB) is expected to be launched in Malaysia this month. This initiative of D-8 countries will lay a consistent foundation of the regulation of the Islamic Finance market.
  • Finally, in countries like the United Kingdom, much progress has been made towards launching mainstream housing and other consumer 
finance products compliant with the Sharia.
  • Within six months’ time, many 
such products will be marketed from high street financial institutions in the UK. Similar initiatives are expected amongst the twenty million Muslims in Europe and the United States.



Written by Suapi Shaffaii

November 10, 2008 at 10:42 am

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