The Reserve Bank of India (RBI) has allowed a firm in Kerala to operate as a non-banking financial company (NBFC) that follows Islamic principles - a small step towards developing sharia-compliant finance in the country.
An estimated 177 million Muslims in India, the largest Muslim minority population in the world, are unable to use Islamic banks because laws covering the sector require banking to be based on interest, which is forbidden in Islam.
But some companies, especially in Kerala which has a large Muslim population and an overseas diaspora of workers who remit money back from the Gulf, are nevertheless trying to develop Islamic financial products outside the banking sector.
Cheraman Financial Services, based in Kochi, plans to offer leasing and equity-finance products under Islamic principles. It said it had obtained approval to operate from the RBI and would follow the Islamic ban on interest; it will not take deposits from customers.
"We propose to roll out the products by the end of August," a spokesman for Cheraman, formerly known as Al Barakah Financial Services, told Reuters.
He did not elaborate on the design of the products. Instead of interest, Islamic finance uses structures such as asset buy-backs and agency agreements to provide returns to investors.
The RBI did not respond to a request for comment on Cheraman's case. But its decision appears to open the door to the possibility of more NBFCs offering Islamic non-interest products in future, even though full-fledged Islamic banks are expected to remain banned.
RBI governor Duvvuri Subbarao, who will step down in September, has said Islamic banking is not possible in the country but sharia-compliant products could be delivered through alternative means.
Last year, the RBI directed Kochi-based Alternative Investments and Credits Ltd (AICL) to stop its non-interest NBFC business almost a decade after the firm was launched. This prompted an ongoing legal challenge by AICL.
"The grant of an NBFC licence should have an impact on the AICL proceedings and there are good chances that the matter may get settled soon," said Suprio Bose, Mumbai-based lawyer at Juris Corp, a law firm which previously represented AICL.
"The event reflects a significant and welcome change in RBI's attitude towards sharia-based NBFCs and sets a precedent for others to follow suit."
However, many analysts think that unless and until full-fledged Islamic banks are permitted in India, an Islamic finance sector will find it hard to develop.
"I don't think there is going to be a rush for NBFC applications. RBI's attitude towards the sharia-compliance concept is yet to be tested," said Shariq Nisar, director of research and operations at Mumbai-based Taqwaa Advisory and Shariah Investment Solutions.
Running a sharia-compliant financial institution under Indian regulations is still difficult and other firms are likely to stay on the sidelines pending the success of existing schemes before deciding to join in, he added.
Islamic equity and venture capital products have attracted little demand in India and NBFCs could face the same fate, said Nisar. "NBFC business overall has been declining over the years."
The RBI issued guidelines for NBFCs in June, cracking down on debt issuance by an industry that relies heavily on capital markets to fund its business but has faced less regulatory oversight than banks.
According to central bank data, credit extended to NBFCs increased by 1.9 per cent from a year earlier in June, compared with an increase of 43.9 per cent in June last year. There are over 12,000 registered NBFCs in India.
A handful of politicians have been lobbying for years to start Islamic banking in India, but they have met strong opposition from bureaucrats in the finance ministry and banking circles. Some politicians, especially from the main opposition Bharatiya Janata Party, say they fear Islamic banking could be used by militants and might strengthen the hold of clergy over India's Muslim community.