A friend of IEB who wishes to remain anonymous, The Graduate has sent us a great post on Islamic banking in India.
The Graduate is a recently minted MBA who is currently employed with a foreign bank’s business banking operations. He does not consider himself an expert on banking, he hopes to bring lay readers an inside perspective and further insight on finance in India.
This Great Indian Mutiny post on Islamic banking in India has prompted me to write about some aspects of both Islamic banking and banking for Muslims in India.
A few caveats: I have only a little more than a year’s experience in banking, and I’m no expert, but I would hopefully have a greater degree of insight than the lay reader. Also, this post does not have any central theme, but is more a collection of responses to the points raised in the Mutiny.in blogpost, as well as some additional points on the subject I thought would be worth raising.
Let’s address the points raised in the blogpost first:
I’ve known many Muslims who invest in mutual funds, shares and traditional non-Shariah compliant banking products. Most Muslims in India who would go on to bank tend to think with a secular starting point.
The reality is a little more complex. I’m currently working in small business banking, and several of my customers are Muslim-owned partnerships who are borrowing crores. So Sandil’s point that there are Indian Muslims who have no compunctions about dealing with debt and interest is valid. However, I was working in personal banking for a while. Over there, me and my colleagues had to deal with a number of other Muslim customers who had a more orthodox approach. They would deal with the prohibition on interest and insurance in a variety of ways, including:
1. Not investing in mutual funds with a debt component
2. Donating the interest on their salary savings account to charity
3. Using a zero-interest current account instead of a savings account
Obviously, I would never have come into contact with Muslims who were so orthodox that they did not utilise banking services at all. The size of that market is anybody’s guess.
It would be best if existing retail banks offer Islamic products within their current schemes and carry out their ledger-separation, overlooked by a Shariah authority, who can certify that the profit is indeed separated. Besides, it offers a more legitimate front – the Sena would have to think twice before attacking at a larger and more ‘legitimate’ organization like ICICI, Stancy, HDFC or HSBC.
Existing retail banks, including my employer are in fact anxious to do exactly this. Malaysia and the UAE are the laboratory where domestic and foreign banks are concurrently running Shariah and non-Shariah compliant products. HSBC’s Islamic mortgage in Malaysia has apparently been quite a success, and Standard Chartered has recently launched a Shariah-compliant credit card in the UAE.
The Islamic REIT
However, with or without banks jumping in, Indian Muslims have already been making their own Shariah-compliant financial products.
When I was working in personal banking, I had to investigate a transaction that showed up on the money-laundering alerts. A current account which had been lying dormant for almost three years suddenly had a huge sum credited to it. I went to meet the customer.
When I got there, it turned out that the customer was a trust representing a number of local Muslims. They had pooled in money four years ago, used it to invest in real estate, develop it, and had now sold the property. The sales proceeds had been deposited into the account, and would be distributed again to the contributors. They had done this because they felt that this was more moral then investing in debt (interest prohibited), or in equity (too much akin to gambling).
This is quite fascinating. Long before REITs had been permitted by the Indian state, a group of Bombay Muslims had gone ahead and created a synthetic-REIT on their own. The diversification and risk management was much lower than a real-REIT, but there is a lesson here: marketing to Muslims who worry about the ethics of their financial product does not necessarily need an Islamic banking label.
Is Shariah Compliance the Biggest Hurdle?
Is Islamic banking the magic bullet which will pull India’s Muslims into the financial system and enable them to access credit and secure their savings?
A much bigger problem faced by India’s Muslims is that the majority of them are too poor to be targeted by the banking system as serious customers. Financial exclusion of the poor is a much bigger worry for them than the absence of Islamic banking. And of course there’s the whole issue of ‘negative areas’, which I’ll address shortly.
When my employer was conducting market research on Islamic banking in Pakistan and the Gulf, it discovered that Shariah-compliance was ‘sufficient but not necessary’. Customers would readily use traditional banking services, but if they were offered an alternative which was Shariah-compliant, they would feel happier with that and switch to it. If the same insights hold good in India, it’s clear that bringing Muslims into the financial system requires financial inclusion rather than Islamic banking.
The ‘Negative Area’ Trap
It’s an open secret that when it comes to retail lending, Muslims find it difficult to get credit cards or personal loans.
This difficulty arises not because of actual negative scoring for Muslims, but because the neighbourhoods which are classified as negative, no-lending areas, are usually ones which have high Muslim or Dalit populations.
Honestly, I’m not sure why this is. My employer is committed to diversity, opposed to discrimination, and also operates in several Muslim countries. At least at a global level, it doesn’t have anything against Muslims. So why does the credit policy fail Muslims in India? There are three possible reasons:
1. A complete mismatch between the global office and the country office. Everyone in the country top management is conspiring against Muslims. Unlikely, but possible. What makes it more unlikely is that this would be a conspiracy perpetrated by the top management of all banks in the country, who all have the same negative areas.
2. Plain laziness. The list of negative areas was drawn up a long time ago by the first bank to do retail lending, and then copied by all other banks, none of whom bothered to test it against actual experience. This is possible.
3. Negative areas are drawn up by banks in consultation with collections agencies. Collections agencies are not willing to work in ghettoised areas, because the people here who are creditworthy enough to borrow, are also probably politically well-connected. If they default, and a collection effort is made, it can be responded to with violence with impunity. I think this is the most likely reason.
So, at the end of this, where are we?
1. Islamic banking makes Muslim customers feel good. So banks could adopt it as a differentiating strategy. This makes more sense in countries like the UAE and Malaysia where there are many high net worth Muslim individuals than in India. But there might still be enough of a market in India.
2. India’s poor Muslims face a real problem in accessing organised financial services, and this is the same problem that the rest of India’s poor face. Greater financial inclusion, such as no-frills-banking accounts, and higher banking outreach will fix this. The fastest way to do this is enhancing competition.
3. India’s poor Muslims face an additional problem over other poor people in that they live in ghettos, and so have trouble accessing credit. The solution to this probably can’t come from the banking system, but from NBFIs, subprime borrowers, or community finance institutions. If these institutions could be plugged into a credit grading system, it would help.
4. Tweaking financial products to make them Shariah-compliant is not very hard. However, as the Percy Mistry report has pointed out, the way the RBI conducts regulation makes developing any new product hard. This is a separate challenge, and worth many blogposts.
Sidebar from Prashant: As we’ve said earlier, IEB’s always looking for new contributors.