The cold tussle between advocates of Islamic finance, which forbids the use of interest rate, and the Indian banking regulator, which is adamant that local laws prohibit such funding, is headed for a climax.
Alternative Investments and Credits (AICL), the Kerala-based firm that has been stripped of its licence to carry out non-banking finance activities by the Reserve Bank of India, is planning to move court against the central bank. AICL, which is among the very few Islamic finance entities in the country, will also take up its case with the finance ministry.
A director of the company told ET that the board is weighing legal options to obtain a stay on the regulator’s decision to cancel the certificate of registration.
Till now there was a widely shared perception that while commercial banks planning to offer Islamic banking products will run into legal hurdles, non-banking finance companies will face no restrictions. That has now changed, with RBI directing AICL to stop financing business almost a decade after it was founded.
Earlier, the central bank had pointed out that the NBFC was not complying with the fair practices code under which the financier has to lay down the terms and conditions of funding, including the interest charged.
“Basically, the Indian banking and finance system runs on the interest concept and Islamic finance is based on profit-sharing,” said an RBI spokesperson on Thursday, a day after the regulator revoked AICL’s registration.
As a genre of financial services, Islamic finance abhors the idea of making money out of money and upholds the belief that wealth is generated through actual trade and investment. Across markets, funding structures of Islamic finance institutions have to be compliant with Sharia’h, the sacred law of Islam.
While RBI’s directions will have to be complied with by all NBFCs – irrespective of whether or not it’s operating as per Sharia’h – the question is what constitutes “interest” for the purpose of especially in the present context of RBI’s NBFC Fair Practice guidelines.
“In our view, there are no stipulations under the regulations issued by the RBI which prevents a non-deposit accepting NBFC from carrying out interest-free or participative financing,” said Suprio Bose of the law firm JurisCorp, which has advised AICL in the past.
In the conventional sense, “interest” means a fixed rate of return on the principal loan amount or a floating rate linked to a pre-specified benchmark. But commercially, various financing structures operate on the model of expected or internal rate of return, which would qualify as “interest” for the purpose of the RBI guidelines. Bose and his colleagues at JurisCorp think it should be possible for NBFCs looking at Sharia’h-based financing to take a middle path. NBFCs, they feel, can consider utilising the concept of net return and disclose the same to ensure compliance with the RBI directions on Fair Practice Code and the Sharia’h principles. But it now appears that the regulator is unwilling to accept this.