India’s central bank is ready to work with the government and introduce interest-free banking to tackle financial exclusion for religious reasons, potentially opening Islamic finance to the world’s largest Muslim minority population.
The Reserve Bank of India (RBI) made the proposal in its recent annual report, as its departing central bank governor Raghuram Rajan hands over to successor Urjit Patel.
The RBI has changed its stance, having previously maintained that Islamic finance could be offered through non-bank channels such as investment funds or cooperatives. An estimated 180m Muslims in India, the country’s second-largest religious group, have been unable to access Islamic banking due laws that require banking to be based on interest, which is forbidden in Islam.
The RBI said it would explore introducing interest-free banking products in consultation with the government, a key detail as this opens the prospects of 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,” Saif Ahmed, managing partner at Bangaluru-based Infinity Consultants, which specialises in Islamic finance, told Reuters.
“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,” he added
Last year, a central bank committee recommended opening a specialised interest-free facility to offer cost-plus financing, deferred payment and deferred delivery contracts, a reference to common sharia-compliant contracts such as murabaha and istisna.
The development of Islamic finance has been hampered by strong opposition from India’s bureaucrats and politicians from the ruling Hindu-nationalist Bharatiya Janata Party. However, in April the government’s external lending agency, Exim Bank, agreed to extend a US$100m credit line to the private sector arm of the Islamic Development Bank.
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.
Meanwhile, in a New York Times interview, the RBI’s departing governor warned that interest rates globally could distort markets and would be difficult to abandon.
Rajan said that the US and Europe have kept interest rates low in order to encourage growth, but countries could become “trapped” by fears that this would falter when they eventually raised rates.
Low interest rates should not be a substitute for “other instruments of policy” and “various kinds of reforms” that are needed to encourage growth, he added. “Often when monetary policy is really easy, it becomes the residual policy of choice,” he said, when deeper reforms are required.
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