A myth called Islamic banking

Is Islamic banking a workable proposition in India? A committee set up by the Reserve Bank of India (RBI) has, according to a report in The Economic Times, concluded that major changes in the law may be required to facilitate Islamic banking.

I don’t know why the RBI needed a committee to tell it the obvious. The purpose of this column is to question whether there is something called Islamic banking, and, if there is one, whether we need it at all. In fact, there are enough options even within existing financing formats that can be compliant with the basic Islamic injunction against earning or levying interest and profiteering. These are the options that must be explored first before we chase a separate kind of banking ideal that can only feed sectarian thinking.

If the basic idea is that no interest can be charged, it follows that all transactions must be equity-based. Such a bank would, by definition, be rock solid since it would have 100 per cent capital adequacy. It takes in only equity from depositors, and returns only dividends or capital. What can ever be wrong with that?

Nothing. It wouldn’t be banking, though. If the purpose of creating such an institution is the abolition of “interest,” we already have several vehicles for doing just that. At the top end of risk, we have venture capital, where the fund manager gives no guarantee that money will be made. He loses his shirt or makes money hand over fist depending on whether the ventures he finances make money or losses. Does that sound like Islamic banking? I have no quarrel if you want to call it that.

Next, we have pure equity-based mutual funds. There is no “interest” being earned or paid here. (Though equity funds do invest short-term surpluses in debt instruments, this can always be avoided). Any open-ended fund can easily meet the Islamic ban on “interest”. Some can even issue you a cheque-book in association with banks. You can call funds run to Koranic principles as Islamic banks.

Even when it comes to financing purchases of fridges or homes, you can do hire-purchase. Many Indian non-bank financial companies (NBFCs) do just that. In the south, VG Panneerdas was a pioneer in financing the hire-purchase of everyday goods. If you want to do the same with houses, all that NBFCs have to do today is raise the capital, buy the house you want, and lease it out to you. Traditional Islamic banks buy the house, and sell it to you at a higher price, claiming the difference as profit-share. Once again, you can call this Islamic banking, but it is a kind of accounting fiction. True sharing of profit means if the value of the house doubles while you are paying off the cost, the bank should get to keep a part of that as well. Otherwise, it is interest-based financing by another name. What I am getting at is this: If you don’t want to be paying or earning interest in keeping with Koranic injunctions, you can do that even now. There is no need to create an entire body of banking law to facilitate so-called Islamic banking.

The irony is that the government is trying to pander to some sectarian idea of banking at a time when the world is feting Mohammed Yunus of Grameen Bank, who won the Nobel Peace Prize for taking microcredit to the masses of largely Muslim Bangladesh. Yunus’s bank lends at rates as high as 20 per cent. And yet, his achievements are being extolled because he realised that “costly” credit for the poor is better than no credit at all.

To ask a more common sense question: Was the Prophet of Islam really against the idea of paying interest or against exploitation of the poor? If we take the latter view, it only means that you shouldn’t be charging usurious interest rates from people who can’t afford it. This works out to be, at worst, an injunction against interest-based lending to the poor. One can always offer interest-free loans to the poor even within the existing framework of banking law as long as it comes out of profits.

But that still leaves the question of “paying” interest to the poor. Is this unIslamic, too? If banks borrow from the poor and give them risk-free returns, I can’t see anything criminal about it. Asking the poor to be venture capitalists just to avoid giving them “interest” sounds even more like exploitation to me.

Email: r_jagannathan@dnaindia.net