The decision follows RBI’s reluctance to allow commercial banks to offer these products for viability reasons.
Islamic banking is based on the principle that money cannot be lent for receiving interest. Money can be used to generate wealth through legitimate trade and investment in assets.
There are some NBFCs that offer Islamic banking products but the business in not viable because of the rules. One reason is that because Islamic NBFCs work on lease-transaction and hire-purchase model, there is double taxation of benefits.
In 2006, an RBI committee had also said Islamic banking did not fit into the country’s banking laws. The finance ministry says issues such as asset classification, accounting standards, capital adequacy and provisioning for bad and doubtful assets will have to be looked into.
“We can’t deviate from the basic principles of banking, but if there is a room for relaxation, it can be explored,” the finance ministry official said.
However, there is no dispute over the need for Islamic banking products. The Raghuram Rajan committee on financial sector reforms had recommended the introduction of interest-free Islamic banking in India.
The India Centre for Islamic Finance (ICIF) recently made presentations to RBI and finance minister Pranab Mukherjee on issues restricting the growth of Islamic banking into the country.
“If finance is available without the burden caused by pre-determined interest rates, it will be a welcome development for all the marginalised sectors, and especially SMEs. Interest-free Islamic banking can fill this gap,” the Centre has argued.
The ICIF has also suggested that NBFCs should be allowed to float Islamic bonds to raise resources. “We’ll be working out the guidelines with RBI, to work out a set of exemptions that can be worked out specifically for Islamic NBFCs,” the official said.
The Kerala government is already in talks with Islamic Investment company named Al Barakah Financial Services Company for setting up an Islamic NBFC with the support of Kerala State Industrial Development Corporation (KSIDC). RBI allows only four categories of NBFCs — Asset Financing Companies, Investment Company, Loan Company and Infrastructure Finance Company.