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India's central bank is reviewing regulations on Islamic banking. Reuters file photo

India's central bank is reviewing regulations on Islamic banking in Asia's third-largest economy.

The Reserve Bank of India has set up an internal committee to examine the matter, unnamed sources told

The RBI has reportedly set up a three-member panel comprising senior RBI officials Rajesh Verma, a deputy general manager with the Department of Banking Operations, Archana Mangalagiri, general manager, Non-banking Supervision and Bindu Vasu, joint legal adviser.

Islamic banking is practiced in several countries, including in the UK, which in June issued an Islamic bond that attracted orders in excess of £2bn ($3.4bn, €2.5bn) from global investors.

What is Islamic Banking?

Islamic banking follows the Shariah law. The model differs from conventional banking in that it does not accept deposits, only investments, which essentially make banking a venture capital activity. The model also encourages interest free loans in a bid to boost financial inclusion.

Islamic banking is also based on profit and loss-sharing; the model forbids the payment and receipt of interest and prohibits investment in businesses that are considered sinful – such as adult entertainment or the production of alcohol.

Speaking to IBTimes UK, H Abdur Raqeeb, General Secretary of the New Delhi-based Indian Centre for Islamic Finance (ICIF) told us how India stands to benefit from the roll out of Islamic banking.

Q: Do you think that India is a key place for growing the Islamic banking market and why?

AR: The misconception among many Indians is that Islamic banking caters to only the Muslim population. The model promotes financial inclusion. India's small farmers and petty traders for instance are still not part of the banking system despite over 40 years of nationalisation of the country's major banks. They cannot go to the capital markets to raise money. Islamic banking can cater to [the millions] outside the commercial banking system.

In addition, Muslims' savings are not being ploughed back into the Indian economy as a large section of the Muslim population here does not bank with commercial lenders.

Q: What needs to be done in terms of rolling out Islamic finance in India?

AR: Political will is necessary. The government has to take a decision on Islamic banking and the RBI has to regulate it. The central bank has to look into it.

We have been pleading with the government and have met Finance Ministry officials in the previous [Congress Party-led] regime.

Moreover, we don't have to use the term 'Islamic banking' in India. We can refer to it as alternate banking, which is what the UK calls it. Or, we could call it participatory banking, which is what they call it in Turkey.

Q: But, if India adopts Islamic finance on a broader scale, will this mean that a lot of the legal framework will have to change?

AR: Not much actually. We in India can borrow and benefit from examples of Islamic banking in the UK or in Singapore.

India Reforms

The question about whether India should allow Islamic banking has been debated for long and RBI Governor Raghuram Rajan is no stranger to the debate.

In 2008, India's Planning Commission roped in Rajan, then a Professor at the University of Chicago, to head its High Level Committee on Financial Sector Reforms (CFSR).

The CFSR, tasked to identify 'real sector reforms', recommended that New Delhi 'permit the delivery of interest free finance on a larger scale, including through the banking system.'