Reaching Banking and other Financial Services for Minorities

Thanks to Skoch for organizing such a valued summit with a separate session to discuss about banking and other financial services for minorities. Its a privilege to interact with high level delegates involved in working for Minorities. Please note that though the title of the paper is Reaching banking and other financial services for Minorities the focus in this paper would be upon Muslims only because the following facts published in the Sachar Committee Report 2006 stresses the need to do so. 1. RBIs efforts to extend banking and credit facilities under the Prime Ministers 15 point programme has mainly benefited other minorities, marginalizing Muslims. 2. Share of Muslims in the amount outstanding is only 4.7% compared to as high a share of 6.5% for other minorities which is disproportionate to their respective population shares. 3. The outstanding amount per account for Muslims is about half that of other minorities and one to third of others. 4. The Census, 2001 data shows that the percentage of households availing banking facilities is much lower in villages where the share of Muslim population is high. 5. The financial exclusion of Muslims has far-reaching implications for their socio-economic and educational upliftment. Self-employment is the main source of income of Muslims, thus to empower Muslims economically, it is necessary to support self-employed persons by ensuring a smooth flow of credit to them. Sachar Committee has further stressed that Steps should be introduced to specifically direct credit to Muslims, create awareness of various credit schemes and bring transparency in reporting of information.

Financial Inclusion of Muslims for Inclusive Growth

If one sector of the economy grows faster and other lags behind; the sector lagging behind will pull the other sector down, thus diffuse the momentum of economic growth. Therefore we need inclusive growth to ensure that growth of one adds growth momentum for others. Financial inclusion is a tool to accumulate growth process of the economy in a manner that allows the

financially excluded sections of the society to attain better growth rate by optimizing available financial resources. Acute financial exclusions add poverty and illiteracy among Indian Muslims and thus make inclusive growth more difficult. If India has to have Inclusive growth, financial inclusion of Muslims in particular needs priority based attention by the planners, policy makers and regulators. Financial inclusion of Muslims will allow them avail better education and training; and also encourage taking required initiatives for economic growth by a community with more self-employed workers engaged into activities of micro small and medium enterprises levels. This will help India achieve inclusive growth and reduce socio-economic disparities among communities. The percentage share of Muslims in all individual amounts deposited at Scheduled Commercial Banks (7.4%) and outstanding loan amounts under Priority Sector Advances (4.6%) as published in the Sachar Committee Report suggests that Muslims have worst credit deposit ratio. The credit deposit ratio for Muslims was calculated as 40.1% against national average of 62.2% in 2005 (which caused credit loss of approx. Rs. 86,000 crores to Indian Muslims). By 2011, when the credit deposit ratio for all Indian is more than 75%, we dont know what this ratio has turned for Indian Muslims. The revised data on flow of credits to minorities does not segregate data on flow of credits to Muslims and other minorities. This lower credit deposit ratio pushes over 40% Muslims into the darkness of illiteracy and around 31% below poverty line. Almost 40% as self-employed workers among the 97% Muslim workers engaged in the unorganized sector with no socio- economic securities deserves RBIs attention (as monetary regulator) to ensure justified flow of credit to Muslims allowing them grow along with other communities. No Ministry or Commission can put Muslims on higher growth trajectory if RBI does not fulfill its responsibility to ensure justified flow of credits.

RBIs working groups report on feasibility of Islamic Banking products

On Prime Minister Dr. Manmohan Singhs instruction, the RBI in 2006-07 constituted a working group to study the feasibility of Islamic banking products in India. Since that working group had no expert on Islamic banking to diffuse any sort of confusion during analyzing the feasibility and prospect of Islamic banking product in India, there was chance of errors in the observation

report. Thats what happened when the working group under the chairmanship of Shri Anand Sinha submitted its observation report to the Government of India on 18th July 2007. They did few mistakes in analyzing the products and summarized that in current statutory and regulatory framework, it would not be feasible for banks in India to undertake Islamic Banking activities in India or for branches of Indian banks abroad to undertake Islamic banking activities there. Since that report was never put on for public feedback, no question raised about the study and analysis of that working group. Nevertheless it is unfair to compile and submit any report by any working group comprised of no expert on the relevant subject. Considering the limitations of RBIs working group constituted to analyze the feasibility of Islamic banking products in India, and the performance of Islamic banks compared to conventional banks amidst global financial crisis; and thereafter the changes noticed with regard to Islamic banking in the financial growth trends at international level, RBI should revisit Islamic banking by reconstituting any committee comprising of experts on the subject to study and analyze the feasibility and prospects of Islamic banking in India.

RBI Should ensure justified flow of Credits to all communities

We dont know if RBI as monetary regulator ever evaluated the impact of banking regulations upon different sections of the society. Due to conflict between interest policy and Islamic ethics, Muslims in India never felt comfortable with the banking services. This caused poor participation of Muslims into banking services because they had to choose between faith and banking services. No innovation in banking sector ever induced them to join banking with joy. According to Sachar Committee report Muslims employees in SCBs is just 2.2% whereas it is less than 0.8% in RBI. The distribution of credits form specialized financial institutions to Muslims are also dismal. They just get 4.4% refinance made through NABARD; and mere 0.48% credits extended by SIDBI. If Muslims with higher self employed ratio continue to loose credits, it will restrict India achieve inclusive growth. RBI should ensure justified flow of bank credits from SCBs and finances extended through specialized institutions. The institutionalization of NABARD and IDBI reflects RBIs sincerity to ensure flow of financial resources to the needy sectors. Again the financial inclusion mission initiated by RBI is appreciable, but we have yet to see any report on its impact upon Muslims. Though in January, 2008, the Report of the Committee on Financial Inclusion published some important data and

made significant recommendation, there was not a single word about Indian Muslims or Minorities. We have yet to see any official report showing the actual reasons, nature and extent of Muslims financial exclusion. The report on Minorities not reveals facts because we have seen that minorities other than Muslims have been mostly benefitted, marginalizing Muslims in the credit schemes floated under Prime Ministers 15 point programme.

Recommendations by CFSR for financial inclusion of Muslims

After publication of the report on financial inclusion, during interactive meetings between the Committee for Financial sector Reforms (CFSR) and Muslim socio-economic activists, the need of interestfree banking was discussed in length. Thanks to CFSR for making following recommendations in its final report submitted to the Prime Minister on September 12, 2008. Another area that falls broadly in the ambit of financial infrastructure for inclusion is the provision of interest-free banking. 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. While interest-free banking is provided in a limited manner through NBFCs and cooperatives, the Committee recommends that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system. This is in consonance with the objectives of inclusion and growth through innovation. The Committee believes that it would be possible, through appropriate measures, to create a framework for such products without any adverse systemic risk impact. Unfortunately by the time CFSR submitted its final report, the impacts of global financial crisis had made financial regulators over conscious to accept all recommendations made by CFSR. There has been silence over CFSRs recommendations on interest free banking which needed attention of our Parliamentarians who either indulge in or otherwise afraid of blame game politics. Never mind! If nobody dares to break the ice, time will let the ice melt. Kerela Governments initiatives to form state owned Islamic Finance Company followed by launching

of BSETASIS Shariah50 Index may guide RBI to test pilot project of Interest-free banking module in coming days.

IMFs working paper on Introduction of Islamic Banking

The working paper on Introducing Islamic Banks into Conventional Banking Systems as prepared by Juan Sole and published by Monetary and Capital Markets Department, IMF in July 2007 (Vide No. WP/07/175) suggests that Islamic banking has been making headway into an increasing number of Western countries. This is indeed a trend that is likely to carry on, as oil-exporting nations continue to accumulate wealth, GCC and South East Asian Islamic financial markets develop further, and companies in Western nations keep on competing to attract international investors. The paper suggests that at first, a commercial bank may only want to probe the potential of this market, and thus may be interested in launching a pilot project. The bank can take advantage of its existing branch network to open so-called Islamic windows, through which to reach the potential new clientele. As the activities of the Islamic window expand, the bank may consider fully segregating the window into a separate subsidiary. An additional channel through which Islamic finance is swiftly penetrating conventional systems is via investment banking activities. Indeed, in an increasing number of Western countries, conventional banks are offering products specifically designed to attract Shariah compliant investors. Once a conventional bank has operated an Islamic window for some time and has gathered a sizeable customer base for its Islamic activities, it may decide to establish an Islamic subsidiary, or even fully convert into a full-fledged Islamic bank. By following either of these two routes, the bank may benefit from economies of scope and concentration of knowledge and expertise. The bank will be able to offer, under one roof, a wider range of Shariahcompliant banking products than through the Islamic window alone. As Islamic finance keeps expanding, the supervisory authorities will have to ensure that these new institutions become fully integrated with the rest of the financial system. The integration process will not only entail allowing Islamic institutions to operate, but also providing a comprehensive regulatory framework, as well as developing a supportive financial infrastructure.

Understanding Islamic banking is also essential from a financial stability perspective, at least on two accounts. First, Islamic banks may become systemically relevant as they grow and increasingly interact with systemically important conventional banks. Second the current lack of Islamic hedging instruments results in the concentration of risks in a smaller number of institutions. Overseeing the concentration of risks and its potential impact on Islamic financial institutions should become a daily task for the regulatory authorities.

Legal Provisions for Interest-free banking in India

Study of the Reserve Bank of India Act 1934, the Banking Regulation Act 1949 and different master circulars issued by the RBI from time to time suggests that for Islamic Banking in India we need few changes in a couple of acts; but to allow interestfree banking we dont need any change in any act. The section 17(1) and 45W (1) of the RBI Act 1934 reflects the RBIs power to allow interest free banking business in India without any amendment in any act. If in coming days, the interest rate on saving deposits be de-regulated, experiment of interest free banking in India will be possible without any amendment in any act. Banks intending to experiment interest free banking may start charging service rate instead of interest rate to recover the actual cost of services from the beneficiaries. Such service rates are commonly known as service charges in Islamic Banks. Besides debt based lending on service rates, Interest free banking can also handle many para- banking products on commission basis. Few feasible products under interest free banking may be as belowA. Deposit Side Products & Services 1. Saving Deposits with cheque book facility (with zero interest if interest rate deregulated) 2. Current Account with cheque book facility 3. Term deposits with zero interest (but provision for rental income) 4. Equity Deposits ( conditions prescribed in contract for bank as trustee of any company) 5. Mutual Fund Deposits (With floating and fixed maturity). 6. Safe Deposit Locker Services 7. Online Trading Services 8. Resident Foreign Currency Account (For NRIs returning home) 9. Foreign Currency Non Resident Deposits (For NRIs)

10. Internet Banking services for receiving, disbursing and transferring funds. 11. Consultancy Services (On Commission basis) to customers seeking Shariah Complaint Investments in Mutual Funds. 12. Consultancy Services (On Commission basis) to customers seeking Shariah Complaint Investments in Equities / preferred Shares. B. Lending and Investment Side Products & Services 1. Equity Financing (as an Executor if bank acts as a trustee) 2. Lease Finance business 3. Hire purchase business 4. Discounting of bills and Vouchers (on Commission basis) 5. Factoring services 6. FOREX Services 7. E-Freight Services 8. E Tax services 9. Letter of Credits (without interest but on commission basis) 10. Issuance of Bank drafts 11. Issuing bank guarantee 12. Mutual Fund Business 13. Disbursement of corporate benefits services 14. Retail Sale of Gold Coins 15. Foreign Inward Remittance Services 16. Gift Cheques Services 17. Gift Card Services 18. Pay Roll Card Services 19. Foreign Travel Card Services 20. Initial Public offer Services 21. ATM Services 22. Broking services

Innovative Banking products in India as Emerging Market Economy

After global financial crisis and thereafter recession in developed countries has raised expectations of emerging market economies like India to lead global economic growth. But we

cannot lead international growth unless our agricultural and industrial labours are benefitted through appropriate financial products. How long we will be increasing fiscal deficits by waiving loans for farmers or weavers? We need to innovate suitable banking and financial products to empower our farmers, artisans, and marginalized entrepreneurs whose financial exclusion and exploitation by private money lenders makes our task of inclusive growth tougher. There could be following ultra modern financial products under Islamic banking to empower our work force associated with agriculture, industry and trade. These products may help Indian achieve better growth rate along with fiscal consolidation. 1. Bai Salam (Shariah Compliant derivatives) facilitating agriculture finances 2. Sukuks (Sharian Complaint Bonds) useful Public finances for infrastructure 3. Ijara (leasing arrangement) to finance manufacturing units 4. Istisna (Progressive finance) to finance housing and infrastructure projects 5. Murabaha (cost plus finance) for industrial equipments and machineries 6. Takaful (Mutual Insurance) to cover risks of masses without interest.

Islamic Banking meets norms for secured banking in future

The profound impact of the global financial crisis prompted G20 leaders to seek agreement on a set of internationally effective rules to improve both the quantity and quality of bank capital as well as to discourage excessive leverage - Basel III. Islamic banks already have stricter capital requirements than what are proposed in Basel III. With the Islamic banks being amongst the best capitalized on a global scale, they are on the safe side compared to their European or US counterparts, Tier 1 and total capital requirements currently stand at 8 per cent and 12 per cent, respectively, which are already higher than the target 2019 ratios set by Basel III. The prejudice that Islamic banking would help Islamic fundamentalists organizations and encourage money laundering has no logical reasoning; rather introduction of Islamic Banking and Finance in countries like United Kingdom, France, Singapore, Japan and China reflects that it has emerged as new financial business. Further to note that after global financial crisis and recession in modern countries, the capital surplus holders of GCC countries are looking for avenues in emerging market economies. Allowing Islamic banking in India will help us pull capital from GCC countries because historically India holds better trade relations with GCC

countries. Since these inflow of capitals would not be in form of debts, but mostly in terms of Investments on profit / loss basis, it would least inflate the domestic economy; rather boost economic growth that too with fiscal consolidation. The Shariah Complaint bonds (Shukuks) have gained momentum in countries like Malaysia and Kuwait to arrange funds for public finance. Hopefully soon we may see launching of such products by Government of India to meet infrastructural requirements with object to attain faster economic growth with fiscal consolidation and keep inflation under control.

Government Initiatives for Islamic banking in India

Perhaps the kerela Government who was first to secure 100% literacy in the state had visualized the potential of Islamic Finance for industrial development, thus initiated formation of ever first state owned Islamic Finance company in India. Though it was challenged in the court, the clearance to Kerala Government has shown ways to Central Government as well as other State Governments to mobilize required long term funds through interest free finance. RBI should take note of Kerela Governments initiatives to establish state owned Islamic finance company for arranging long term low cost fund for industrial development in the state. SEBIs initiative to allow launching of BSE-TASIS Shariah50 index to attract investors seeking investments in Shariah Complaint stocks in India also shows that in India the market for Islamic finance is picking up. This may induce RBI to think about testing the market of Interest free banking through a pilot project. If RBI intends to do so, there would be many private players to cooperate RBI. Since 2005, the State Bank of India has been finding ways to open Islamic banking windows in GCC countries. Few other foreign banks like Standard Chartered and HSBC are looking to grab the opportunity if allowed to open branches of Islamic banks in India. Similarly insurance giant in India the Life Insurance Corporation of India is working upon Islamic Insurance called Takaful and may launch it in India if legally allowed to do so. If India has to achieve the goal of financial inclusion and inclusive growth; and lead international growth, we need to attract international investors and expand our market share in international finance. This needs RBIs intuition to test alternative mode of banking and finance which could boost financial inclusion of deprived Indian Muslims and; also allow India financially and economically grow at level par to lead international growth.

Summary
The Sachar committee report suggest that so far the RBIs efforts to extend banking services to Minorities have largely benefitted other minorities and marginalized Muslims. The community with predominantly self employed workers in the unorganized sector, the lower credit deposit ratio is adding poverty and illiteracy among them. RBI should publish a report on impact of banking regulation upon Indian Muslims. The recommendations made by CFSR for financial inclusion of Muslims are very significant and deserves RBI attentions. Kerela Governments initiatives to form public owned Islamic Finance Company, and SEBI permission to launch BSE-TASIS Shariah- 50 index has added hopes for positive thinkers. Further if in coming days, the saving deposit interest rate is deregulated, RBI may allow experimenting model of interest free banking in India which does not need any amendment in any act. After successful experiment of interest free banking model, RBI may allow introduction of Islamic Banking windows. Thereafter we may expect subsidiaries and then full fledge Islamic Bank in India. But in during this period RBI need to interact with experts of Islamic banking so as to develop better understanding about Islamic banking and to design required infrastructure and regulatory framework. By now Islamic banking is not a matter for Muslims only, but has emerged as alternative banking to attract excess of capital from GCC countries that after global financial crisis are searching for better investment avenues in emerging markets. If India does allow Islamic banking, it would help attain financial inclusion of Muslims, inclusive growth for India along with fiscal consolidation and stability in market prices.

Syed Zahid Ahmad Founder - Economic Initiatives 201, Mobin Nagar A Wing, Near Millennium Hospital, Kausa, Mumbra, Thane 400612, India Tel. 022 2549 4800 / 0 9869814113 E mail economicinitiatives@gmail.com Website www.economicinitiatives.com