RBI open to interest-free Islamic banking

The Reserve Bank of India (RBI) has proposed to work with the government to introduce interest-free banking to help realise the government's goal of financial inclusion by catering to the needs of the country's largest religious minority, Muslims, potentially opening the way for the introduction of Islamic banking.

The proposal, made in the central bank's annual report last week, marks a departure from its earlier stance that Islamic finance could be offered only through non-bank channels such as investment funds or cooperatives and banks have to go by an interest-backed revenue policy. That, however, is forbidden in Islam.

Muslims, with a population of 180 million, form the second largest religious grouping in India and introduction of Islamic banking would support their cause.

The RBI said it would explore introducing interest-free banking products in consultation with the government, as it would require supportive legislation.

"This is definitely a significant development as it is the first time that the RBI has concretely mentioned that it will now work with the government to introduce Islamic banking," said Saif Ahmed, managing partner at Bangaluru-based Infinity Consultants, which specialises in Islamic finance.

The central bank made the proposal in its annual report last week, as departing RBI governor Raghuram Rajan hands over the reins to Urjit Patel.

"For Islamic banks to function in India, separate parallel legislation or an amendment needs to be passed by Parliament and that can only happen with the active support of the incumbent government."

In 2015, a central bank committee recommended opening a specialised interest-free window to offer cost-plus financing, deferred payment and deferred delivery contracts, a reference to common sharia-compliant contracts such as murabaha and istisna.

Development of Islamic finance has faced opposition, mainly from banks as no-interest loan would in any case be only a losing proposition and the business community has been slow to accept it.

Although there are signs that RBI is warming up to the idea of Islamic finance, government legislation is needed to back it.

The government's external lending agency, Exim Bank, said in April it would extend a $100 million credit line to the private sector arm of the Islamic Development Bank.

The Exim Bank's credit line would support foreign buyers of Indian goods and services, with the Saudi-based Islamic Corporation for the Development of the Private Sector acting as the intermediary.