Reserve Bank of India governor D. Subbarao said last week that the apex bank was holding talks with the government on how existing laws can be restructured or amended ‘so that they are in conformity with Islamic banking’. Photo: Hemant Mishra/Mint

Demands by Muslim groups over the past few decades to allow the method have thus far been stalled because of concerns over incompatibility and fears that it could be used as a conduit for terror funding.

Reserve Bank of India (RBI) governor D. Subbarao said last week that the apex bank was holding discussions with the government on how existing laws can be restructured or amended “so that they are in conformity with Islamic banking”. RBI has thus far maintained that Islamic banking is not feasible in India as existing regulations do not permit interest-free banking.

The finance ministry recently wrote to RBI asking it to examine the possibility of making the interest-free model part of India’s Rs.75 trillion banking system.

Interest isn’t allowed under Shariah law as it’s equated with usury; instead, lenders get a share of any profit made by the borrower, while having to absorb any losses.

The finance ministry’s communication to RBI followed a meeting with the National Commission for Minorities (NCM) in June, a constitutional body headed by former chief information commissioner Wajahat Habibullah.

NCM asked the apex bank to take a fresh look at Islamic banking. Following this, the National Committee on Islamic Banking (NCIB), a non-profit body, submitted an action report to RBI in this regard. Mint has reviewed these documents.

The NCIB report argues that it’s not necessary to change banking laws to implement interest-free products, though tax laws would need to be amended.

“The only area where a change is necessary is the tax laws, as they do not match with the sale and investment-based contracts offered by participator banks such as wakala (agency contract), murabaha (trust-based sale), musharaka (joint venture),” said H. Abdur Raqeeb, convenor, NCIB.

Supporters of Islamic banking say its implementation will lead to money coming in from organizations that can only make Shariah-compliant investments. Critics say it will destabilize the secular nature of the country’s banking system by imposing the laws of one religion, besides facilitating terror funding.

D.K. Mittal, financial services secretary, declined to say whether the government was considering any change in laws to facilitate Islamic banking, saying it’s a “larger issue”.