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Interest-free Banking in India – Challenges

Indian banking laws do not explicitly prohibit Interest-free banking but there are provisions that make it an almost unviable option. Banks in India are governed under the Banking Regulations Act 1949, Reserve Bank of India Act 1934, Negotiable Instruments Act 1881, and the state and central Co-operative Acts. One of the most distinguishable features of these Acts is that they define Banking in such a way that Banks can accept deposits from the public only for further lending.

For instance, payment of interest on deposits is mandatory as per section 21 of the Banking Regulations Act; Sections 5(b) and 5(c); specifically prohibit investments based on profit and loss sharing; and section 8 of the Banking Regulation Act1949, which reads “No banking company shall directly or indirectly deal in buying or selling or bartering of goods.”

The interest earned on fixed deposits is subject to TDS as per the Income Tax Act1961, whereas the profit on Interest-free banking deposits is treated differently. Commercial banks borrow from other banks or RBI to meet their short term funding requirements, but Interest-free banks can’t do so because it involves interest. Some other factors that help in stealing the shine of Interest-free banking are the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) requirements. These together eat up about 30 per cent of the banks’ total deposits. Adding to this the priority sector lending, it leaves Interest-free banks with very little capital that could be invested in earning non-interest income.

Interest-free banks are required to closely monitor their investments in various businesses, and ensure that the invested firms are managed properly. This calls for expensive supervisory infrastructure. There is a serious dearth of Interest-free banking experts and trained personnel in India. Although there are a few training institutes, they are unable to compensate for the shortage of experienced alternate banking professionals.

There is a lack of awareness of Interest-free Banking. It has been found that the Ideology of Interest-free banking is the strongest independent determinant that has the maximum influence on the banking system. People from all sectors either regulators, policy makers, politicians, social activists, bureaucrats, bankers or customers have some misconceptions. Even people from the Muslim community who lack deep knowledge in Interest-free financial systems have expressed their concerns and reluctance towards Alternate banking.

There is common thinking that Interest-free Banking is only for Muslims, and it is meant to serve some religious purposes only. There are some social groups which are regularly propagating against Interest-free banking by associating it with terrorist funding, which is a baseless allegation.

Operational problems worth mentioning are the product development and modifications according to the Indian scenario. Additional efforts and further research are required in handling alternate financial products and its administration. The product development process requires substantially higher time and cost efforts (more problems are likely to occur with respect to Shariah compliance requirements). There is a dearth of Shariah scholars who can assist in product development and in customizing it as per the Indian scenario. Interest-free banks incur additional external costs arising out of the hiring of Shariah Supervisory Board and Shariah advisers. Stiff competition from well established conventional banks is also a big challenge before the Interest-free banks in India. It is quite difficult to manage a changeover of consumer attitude towards a new banking system.

It is observed that the inability to evaluate a projects’ profitability has tended to act against investment financing. Some borrowers frustrate the banks’ appraisal efforts as they are reluctant to provide full disclosures of their business. These exercises are not limited to relatively few large loans but need to be carried out on nearly all the advances made by the bank. Yet, widely acceptable and reliable techniques are yet to be devised

Popular misconceptions about Interest-free banking and financial products

  1. Interest-free banking is exclusively for Muslims
  2. There is no difference between Interest-free banks and conventional banks
  3. Interest-free banks are meant for spreading Islam among other religions
  4. Interest-free banks are trying to help terrorists
  5. Interest-free banks are charity institutions
  6. Interest-free banking is riskier than conventional banking
  7. Interest-free banking is against secularism and India is the biggest secular country in the world

All these misconceptions have to be cleared for the smooth implementation of alternative banks in India.

Article by,

Fathimathul Nishna TM
Research Scholar,
DCMS, University of Calicut

Previous parts on Interest-free Banking
1. Interest-free Banking, the precedent pathways.
2. The working of an interest-free Bank.

References:

www.twocircles.net

www.shariqnisar.com

https://www.researchgate.net/publication/312575190_Islamic_Banking_in_India_Scope_and_Challenges

http://shodhganga.inflibnet.ac.in/jspui/bitstream/10603/183948/4/03%20abstract.pdf

https://www.academia.edu/5132939/Islamic_Banking_in_India_What_More_Needed

https://yourstory.com/2009/01/islamic-banking-in-india-2

www.slideshare.net/ superior university, Lahore

www.en.wikipedia.org

www.scribd.com

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