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27 September 2011

Islamic financing: RBI asks Kerala's AICL to explain the basis of its financing deals

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Mumbai: In the quaint world of Islamic finance, something is brewing between the regulator and one of the active players. RBI has show-caused Alternative Investments and Credits (AICL), a Kerala-based firm, asking it to explain the basis of its 'participative financing' deals.

The development is being closely tracked by the proponents of Islamic finance as the outcome could determine how such activities may be pursued in India. According to the regulator, AICL, a registered NBFC, is not complying with the fair practices code under which the financier has to lay down the terms and conditions of funding.

As a genre of financial services, Islamic finance forbids the use of interest rates and rests on principles of sharing the surplus or profit. It abhors the idea of making money out of money and upholds the belief that wealth is generated through actual trade and investment.

"There has been some exchange of communication between AICL and RBI, which is asking AICL to review its financing model. Last week, directors of the company met the central bank which earlier carried out an inspection of the company," said a source.

While one of the AICL directors told ET that the company hopes to sort out the issue with RBI, some in the industry are interpreting the development as the regulator's discomfort with an activity that is not fully understood. They said RBI's reactions could be driven by the turn of events following a petition moved by Janata Party president Subramanian Swamy last year, challenging the Kerala government's decision to support another state-based group carrying out Islamic finance.

"In the course of the hearing, it was mentioned that RBI had permitted registration of a few NBFCs carrying out Islamic finance. So, it's possible that RBI, keen to distance itself from any controversy, wants to ensure that NBFCs such as AICL function within prescribed regulations," said another source. "Otherwise, why should RBI raise the issue a decade after the company was formed?" said the person.

The challenge before AICL - and also other NBFCs in similar space - is to make their funding structure compliant with Sharia'h, the sacred law of Islam, as well as RBI regulations. "We have asked them to explain certain issues," said an RBI official. "We are trying to narrow down the differences. RBI is asking that in the absence of a fixed return what happens if there are losses in investments. We told them that we hardly suffered any loss, and have been declaring dividends regularly," said the AICL director.

With a paid-up capital of Rs 7.5 crore, AICL's liability is comprised of shareholder funds while the assets are various non-loan funding in the form of participative finance. As per this, the 'borrower' shares the profits of the business with AICL in proportion to the equity capital of the borrower's and the amount provided by AICL; and the profits are shared only if the borrower has earned them. In case of losses in any year, no outstanding is fixed for future recovery.

RBI has always maintained a certain silence on Islamic finance. According to an RBI report prepared some years ago, but not put on the official website, neither banks in India nor overseas offices of local banks can offer Islamic banking under the current legal framework.

But according to studies undertaken by the Delhi-based Indian Center for Islamic Finance, conventional banking products such as savings bank account, term deposits, credit cards and consumer and farm loans can be structured in a way that fulfil the requirements of local banking laws as well as the Sharia'h. Indeed some of the legal experts think that under the Bombay Stamp Act '58, it's possible to carry out transactions to avoid 'double stamp duty', often perceived as a deterrent to Islamic banking, where the deals can have two legs of buy and sell.

(Courtesy: The Economic Times)

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