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ABSTRACT
Indian Muslims have always been trying to manage their economic affairs within the
framework of Shariah. This paper aims to highlight the attempts made by Indian
Muslims in this regard and how some of the later developments since mid eighties
affected their functioning. The paper focuses on how the period of late 1980s and
early 1990s saw the proliferation of Non Banking Finance Companies (NBFCs) in
India and the subsequent failures of a large number of finance companies caused by
the depressed economic scenario in early 1990s and the highly changing regulatory
environment in the late 1990s. Some prominent Islamic NBFCs of India are taken for
detailed case studies.
1: Introduction
Financial arrangements constitute an integral part of the process of economic
development. A growing economy requires a progressively rising volume of savings
and adequate institutional arrangements for the mobilisation and allocation of savings.
These arrangements must not only extend and expand but also adapt to the growing
and varying financial needs of the economy. A well-developed and efficient capital
market is an indispensable prerequisite for the effective allocation of savings in an
economy. A financial system consisting of financial institutions, instruments and
markets provides an effective payment and credit supply network and thereby assists
in channeling of funds from savers to the investors in the economy. The task of the
financial institutions or intermediaries is to mobilise the savings and ensure efficient
allocation of these savings to high yielding investment project so that they are in a
position to offer attractive returns to the savers.
Islam’s teachings are not confined to the religious spheres but extend and
control every aspect of human endeavors including the economic activity. Islam
provides guidelines to regulate the economy and seeks to curb the unbridled race for
material pursuit. Concern for equity and justice, halal and haram and a sense of
responsibility towards the weaker sections of society and the need to share the
economic resources with them, are some of the principles which guide and control the
economic activity in Islam.
Keeping in view the Islamic aspirations, Indian Muslims have always been
trying to manage their economic affairs within the framework of the Shariah. The
present paper seeks to highlight the attempts made by Indian Muslims in this regard
and how some of the later developments in the form of changing regulatory
environment has affected their functioning.
Besides being the world’s second most populous country India also is Asia’s
third largest and one of the fastest growing economy. It has a huge Muslim population
between 150-200 million.1 There are several places where Muslims constitute
majority of the total population (Bagsiraj, 2002). There are a number of industries in
which Muslims traditionally have major stakes2.
Since the last two decades, India has continuously managed an average saving
rate at above 20 percent of the GDP (Bhandari, & Aiyar, 1999, p.29). Considering
their relative economic backwardness even 15 percent saving rates for Muslims would
fetch an enormous amount of annual savings to the community. Besides, there are
billions worth properties lying in the form of Awqaf. Zakat potential of the Indian
Muslims still largely remains untapped and under utilized.
1
Even a conservative estimate by Syed Shahabuddin in “Muslim India” puts Muslim population as
133.54 million in the year 2001. For details please see,
www.milligazette.com/Archives/15092001/29.htm
2
Like leather, cotton, bronze, lock, sari, carpet, etc.
(BR Act, 1949, 1999, pp. 6-7). Further, section 8 of the Banking Regulations Act (BR
Act, 1949, 1999, p. 12) reads, “No banking company shall directly or indirectly deal
in buying or selling or bartering of goods …”.
Besides India is among the countries that explicitly provides guarantee to its
depositors. Deposits of each account up to the value of Rs. 0.1 million are guaranteed
through the Deposit Insurance and Credit Guarantee Corporation (DICGC), a
subsidiary of the Reserve Bank of India established in 1962. Moreover, government
also interferes at the assets side by asking banks to provide concessional credit to
certain priority sector.3
Above all the Government of India explicitly clarified its position with respect
to the permissibility of Islamic banking in the country. Minister of State for Finance
Mr. Zulfiqarullah, informed the Indian parliament that the Government is not in
favour of its own or permitting the private sector to open an Islamic bank (Dalvi,
1999).
Some other factors that help stealing the shine of Islamic banking is
governments’ policy of large-scale pre-emption of banks’ resources through Cash
Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) requirements. These
together eat up over 35 percent of the banks’ total deposits. Counting another 40
percent of banks’ resources directed towards the priority sector leaves banks with very
little capital at their own disposal. Also, to increase the banking habit among people
and for the purpose of extending banking facilities to the larger sections of the
population, banks are asked to open branches in the rural and semi rural areas that
mostly are economically nonviable4 (Kanta, 1996, p.24).
3
The Concept of priority sector lending was proposed by Prof. Gadgil Study Group (1967). Later on
the Ghosh Committee (1981) recommended a target of 40 percent of the total credit to priority sector
including 18 percent to Agriculture and 10 percent to weaker section.
4
By the end of 1992-93, 171 Regional Rural Banks out of 196 were loss making.
5
The Tata Mutual Fund made a pioneering attempt when, at the instance of the Barkat and some other
Islamic financial group, it launched Tata Core Sector Equity Fund in 1996 (IEB, 1996a). This scheme
was specially tailored keeping in view the Muslims inhibition of dealing with interest bearing and
haram investments. This scheme surprised many by being able to raise Rs. 230 million from the public.
After initial hiccups the scheme did well for three years. After that the nomenclature was changed to
the ‘Tata IT sector Fund’ (IEB, 2000a).
attempt could be made possible in the form of Muslim Fund Deoband in the year
1961.
These Funds are arguably the most popular format adopted by Muslims in
India specially in the highly concentrated Muslim belt of North. According to a list
prepared by the Federation of Interest Free Organization (FIFO), there are more than
130 Muslim Funds in the country. Of them, thirty Muslim Funds as well as some
others are the founding members of the Federation of Interest Free Organizations
established in 1986. FIFO acts as an apex body of the member organisations for
policy making, liquidity arrangements, staff training and representing to the
Government.
Jamaat-i-Islami Hind also attempted, particularly in the southern states of
India, to establish welfare societies. The main purpose was to financially help the
poor and needy on Islamic principles. Bagsiraj (2002) reports about 200 such
institutions.
Muslim Funds, cooperative credit societies and welfare societies are all non-
profit institutions and have started either out of the need to rescue people from the
ruthless moneylenders or out of a concern for the economically backward and
downtrodden.
By 1980s, Muslims started venturing into profit oriented business as well. This
was made possible for three reasons; firstly, by that time, Indian Muslims had gained
some financial expertise through successful running of non-profit financial
businesses; secondly, the Islamic financial movement started in late seventies had
gained momentum throughout the Islamic world giving an impetus to the Indian
Muslims as well; lastly, the new economic policy initiated in early 1990s focussing on
privatisation, liberalisation and globalisation from the old controlled regime provided
new opportunities for the overall growth of the business.
The first NBFC claiming to do business on Islamic principles called Al-Mizan
was started in 1980 at Madras (Bagsiraj, 2002). This was a loose constituent of many
small partnership firms engaged in leather trading. This effort miserably failed in
1984-85. Some other notable NBFCs established in India since then are as follows.
6
NOF: Net Owned Fund is the aggregate of the paid-up capital and free reserves, reduced by the
amount of accumulated balance of loss, deferred revenue expenditure and other intangible assets, if
Reducing the period of deposit between 12-60 months, from 24-120 months,
Ceiling on the rate of return not exceeding 16 percent.
Ceiling on brokerage fee and commission not exceeding 2 percent of the
deposit.
Changes in the content of application form as well as the advertisement
patterns for soliciting deposits only helped in tightening the situation.
The companies accepting public deposits were now asked to comply with all
the prudential norms of income recognition, assets classifications, accounting
standards, provisioning for bad and doubtful assets, capital adequacy, credit, and
investment concentration norms etc. The classification of assets and provisioning of
accounts have been laid down as follows: (Shah 1996, p.763)
Substandard: 10 percent of the total outstanding.
Bad and doubtful: Up to 1 year-20 percent of the outstanding.
1-3 years-30 percent of the outstanding.
Bad and doubtful uncovered-100 percent of the
outstanding
Total loss- 100 percent of the outstanding
The minimum capital adequacy ratio had been fixed at 12 percent while the
credit and investment concentration was fixed at 15 and 25 percent of the owned
funds to single borrower and group respectively. The total loans and investments were
subject to a ceiling of 25 and 40 percent of the NOF respectively for exposure to
single party or an industry group. Those soliciting public deposits were now asked to
specify their rating in the advertisements. Mobilizing public deposits was fixed not
more than 1.5 times of its NOF or Rs. 100 million whichever was lower.
Prohibiting NBFCs to invest more than 10 percent of NOF in real estate and
asking them not to invest in unquoted shares badly hampered the investment
opportunities of Islamic NBFCs. Moreover the companies were now required to
maintain liquid assets of not less than 15 percent of their public deposits into
commercial banks.
any, and further reduced by investments in shares and loans, and advances to subsidiaries, companies in
the same group and other NBFCs in excess of 10 percent of owned fund.
Barkat Leasing and Financial Services Ltd. (BLFSL) returns on capital shows
that the strategy had worked except for the year 1997-98 when its net return on
working capital was down by 7.23 percent (Table 6) and its net return to investment
by 6.99 percent. That was the year of heavy regulatory changes brought in the NBFCs
sector in India.
New regulatory changes enforced in April 1997 completely banned all firms
involved in investment activities from accepting any fresh deposits. This led to a one-
way flow of funds (outflow) from the firms in the group causing tremendous pressure
on the already trembling operations. Barkat’s commitment to Shariah forced it not to
access the usual avenues available to others for addressing its liquidity needs. Had this
not been the case, temporary liquidity from conventional banks might have sufficed
its liquidity needs. Since there were no Shariah complaint options available or lender
of the last resort, Barkat kept waiting for some sort of external assistance either from
within or outside the country, which never reached and finally one of the very
promising Islamic NBFC in India was closed in May 2000. (IEB, 2000b, 2002).
Starting with a meager fund of Rs. 12000 the society became one of the most
successful Islamic societies in India with 20 branches in the city of Mumbai.
Membership of the society increased to more than 150,000. Total deposits of the
society also reached Rs. 120 million. It is pity that the BUN was not closed for any
bad investments (as it was not allowed at all) but because it had, once upon a time,
floated Barkat Investment Group (Nisar: 2003). It was a classic case of rumor and
contagion effect taking its toll on an otherwise smoothly functioning institution. BUN,
in fact, has purely been engaged in banking activities, accepting deposits from the
public (members) and lending it to the same. All its lending were secured by property,
gold and silver. The society had developed a scientific system of calculation of
service charges and all its 20 branches were computerized to keep pace with the
changing technological developments and keep overheads low.
The only solace for the society is that despite it being closed for so long, its
depositors, by taking a lesson from Barkat, have not taken the case to the court. Till
date, the society is in a dormant state.
counter some of the regulatory changes that might have affected its business
prospects. Moreover the AMMB also follows a policy of putting a large chunk of its
deposits in commercial banks, which provides the company a solid source of revenue
besides giving it a good cushion during the time of crisis. Table 8 shows the financial
position of AMMB, which is getting stronger by the day.
has managed to distribute dividend at the rate of 12 percent since 1996. Despite share
capital being constant since 1997 reserve surpluses of the company has increased
constantly. Fixed assets too witnessed greater jump since the new regulation.
8: Conclusion
The decade of 1980s and 1990s saw proliferation of Islamic NBFCs. India’s decision
to introduce large-scale regulatory changes in the non-banking financial sector at a
time when most of the South Asian countries were passing through severe economic
recession did not augur well for the non-banking finance sector. More so Islamic
NBFCs appears to have suffered more because of the distinct nature of their business
and other religious constraints like not being able to avail the conventional avenues
available to other financial institutions. In a fast changing regulatory environment like
this, a conventional NBFC would prefer keeping its money in commercial banks than
to go with risk associated ventures that are part and parcel of Islamic financial
institutions. On the other hand small size of Islamic NBFCs and a lack of the lender of
last resort besides naive and complacent attitude towards the regulation also had a fair
share in their failures. Perhaps the recessionary economic phase could have easily
been tackled had the management been more alert and investors more informed.
there is need for some sort of advocacy groups that work quietly in creating soothing
conditions for Islamic oriented businesses.
Islamic financial institutions constantly need to diversify their investment
basket through innovations and improvement in technology. In a secular country like
India it could be difficult due to non-recognition of Islamic principles but nevertheless
they are important and need to be conveyed to the regulators through all the legal
means.
Self imposed moratorium on certain qualified modes of finance by certain
Islamic finance house instead of increasing the reputation led to isolation and lopsided
investments. Therefore, more flexibility is needed to cope with the changing business
environment. Lack of the lender of last resort has been a major cause of concern for
Islamic financial institutions the worldwide. Therefore, the establishment of any such
institutions that could act as the lender of last resort should be the topmost priority by
Islamic economists and policy makers.
Another issue that needs immediate attention of the policy makers is to put a
check on tainted profit seekers who just fore the sake of their small profit vitiate the
whole environment for genuine concerns. Many institutions that operate on the basis
of interest disguising them as an Islamic financial alternative, either overtly or
covertly, only help in creating a crisis of confidence. People also need to be informed
about the Islamic finance principles so that at the time of crises they do not create
unnecessary panic and rumors leading to contagion.
****
*Shariq Nisar, Ph.D. Economics, is Joint Editor Islamic Economics Bulletin, India.
Before joining academia he worked in the banking sector in various capacities.
*Mohsin Aziz is Ph.D. in Management from the Faculty of Management Studies and
Research, Aligarh Muslim University, Aligarh India.
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