Islamic Banking comes to India

Written by Arijit Dutta || June 10 2016

The Islamic banking system, where neither the borrowers nor depositors are paid or pay any interest, is set to launch in India. It will completely function under the tenets of sharia law, where the bank doesn’t charge interest but the customers share a part of profit or loss of the bank. The idea is to encourage the economic and social development of the region the bank is based in.

Jeddah based Islamic Development Bank (IDB) will start its Indian operations in the state of Gujarat, tracing its origins to an agreement made when Indian Prime Minister Narendra Modi visited the UAE in April 2016. This move is set to facilitate funding of Indian exports to many African and central Asian Muslim nations.

The IDB will establish a non-banking finance company (NBFC) which will provide interest free loans to start-ups as well as medium and small enterprises (MSMEs). With this move, the IDB could prove to be a competitor to angel investors and venture capitalists targeting the substantial MSME market, as the IDB only takes a 15% cut of the profits as opposed to other equity and debt based investors. The other important objective of the bank will be to provide a $100 million line of credit to promote India’s exports to the IDB’s 56 member countries. To facilitate this, a Memorandum of Understanding (MoU) was signed between the IDB and India’s EXIM bank. the IDB is also starting a social service program that will provide $55 million for medical vans to serve rural areas of India.

It will be interesting to see whether Indian Muslims start using the IDB’s services in large numbers, especially given the fact that India has the 2nd highest number of Muslims in the world. This represents a huge opportunity for the IDB to expand its customer base starting from Ahmedabad which too has a significant Muslim population of 6 million. Another potential development that might come out of the program is increased investment from other Islamic countries into India. Earlier, such deals would have run into rough weather as companies based in Islamic countries preferred to invest only if provided with interest-free financing that they are long used to.

This interest-free approach to banking could also be useful to counteract the growing NPAs (non-performing assets), as a large portion of bad loans came from poor farmers, weaver and traders who couldn’t afford to service the rapidly rising interest on their debt during lean seasons. Meanwhile several Indian IT companies are already looking at this development as an opportunity to provide an India-centric Islamic Banking solutions and give a boost to their sagging revenues. The coming days could see some friction with regulations as the air is not completely clear on whether existing commercial banks too can offer such services.