Give Islamic Finance a Chance

By Sugata Ghosh

Some questions recur with unfailing regularity, are tossed around for months, points, counterpoints emerge and slowly peter out, only to resurface later, often before polls. Islamic finance is one such subject.

It has an academic hue, with faith and politics weaved around. Those who feel strongly about it argue why it should happen; men who matter point out why it can’t, but rarely lay the way open for changes that will make it happen. The turn of events is predictable: finer points of law and taxationare discussed , letters are exchanged, the finance ministryrefers the matter to the law ministry, asks RBI to take a relook at it and then, finally, the central bank throws the ball back to New Delhi.

Nothing changes. For the rule makers, it continues to be an exotic, if not an esoteric, idea while most members of the Muslim community, other than those who have given a serious thought to the issue, do not pursue the matter as forcefully as they feel about many other things. There are few motherhood statements from government functionaries and regulators, who, given the obvious sensitivities, never spell out their reservations, if any, towards Islamic finance. It’s quickly forgotten, leaving very few flustered.

But the discourse can be shaped differently. Forget for a moment that the concept has its foundations in Sharia’h, the sacred law of Islam; that it can be a potential tool in the hands of politicians; and that its very introduction does not mean unsettling the law of the land to placate a few. Think of it as a pure, simple bouquet of financial products that’s different: different as it offers another way one can own a home or buy a car; whether it makes sense to have such products; and if there’s merit, how to go about selling it.

As a genre of services, Islamic finance abhors the idea of making money out of money and upholds the belief that wealth is generated through actual trade and investment. It’s just a different kind of commercial banking: instead of charging interest on loan, the product is structured differently –” if a company wants to buy an aircraft for $300 million, the institution financing it buys the plane and transfers it to the company 10 years later after collecting installments with a profit margin. Unlike plain vanilla loans, Islamic finance products have multiple contracts, but as a structure, it is considered in its entirety. A lot depends on how these are structured. For instance, even though Sharia’h forbids trading of loans, there are structures that can be used to ‘securitise’ portfolios.

While India’s current legal framework on lending is interest-based, Islamic finance is founded on participatory finance that entails sharing of profit or loss. If the profit earned is less than expected cash flows, then a smaller profit pool is shared — a mechanism that can lower the cost of capital. The RBI governor recently said that laws have to be amended before one goes about allowing such products. Advocates of Islamic finance think it’s no big deal and one need not go through the rigmarole of standing committees and parliamentary proceedings — if the central bank can use its powers to let commercial banks open a new window. Other countries, even a few not particularly sensitive to Islamic sensibilities, have gone ahead with it. That’s because they sensed that any leading financial centre should be open to various investment possibilities.

So, why not India where savings have dipped? It’s a valid point, but there is a widely shared perception that regulators are not keen about it. The reasons are unknown: RBI may not have the regulatory comfort, or the market may not be large enough, or there could be resistance from some political parties. Around seven years ago, RBI had almost closed the chapter on the subject with a report (briefly put up on its website). More recently, the central bank pulled up a finance firm carrying out participative finance on the grounds that it violated the fair practices code where finance companies have to state upfront the return it was paying to depositors — something not tenable in Islamic finance. The dispute is pending before the Bombay High Court.

There will be resistance to changes that look dramatic. Prof Hussein Hamid Hassan, an authority on the subject, had once told this paper that when the first Islamic Bank was set up in 1975, “it was easier to say Islamic whisky than Islamic bank”. But if indeed there is a savings pool awaiting Sharia’h defined instruments, institutions should have the opportunity to tap it. If high stamp duty is a deterrent — as multiple contracts make Islamic finance tax-inefficient — let the transactions take place in states where the duty is lower.

The Wall Street meltdown has made regulators conservative. But it would be a pity if perceptions and political undercurrents stand in the way of financial innovation.

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