India to consider allowing Islamic banking...maybe

Reports are out that India is considering allowing Islamic banking, which would be a groundbreaking change for Islamic finance, but before getting too excited it is worth remembering that India has made moves, like forming a committee at the Reserve Bank of India, that have so far led to nothing but more discussion (and no Islamic banking). 

The current report, in the span of two paragraphs, gives two very different reasons for Islamic banking to be attractive to India:

Experts believe that in order to tap the immense investment potential of the oil-rich Middle East, it was in India's interest to introduce Islamic banking.

An official of the National Committee on Islamic Banking told Gulf News: "It will provide the opportunity to bring a large section of the Muslim population into the mainstream. It is a sophisticated banking and finance structure based on moral and social values and is compatible with modern-day financing needs."

These are two very different areas for any potential Islamic bank to focus on.  I think that the latter is a more important reason for India to allow Islamic banking, although the latter is probably a more compelling reason to spur the decision-makers to action. 

The problem with the argument that Islamic banking is necessary to attract funds from the Middle East is that there are already flows from the Middle East, including using Islamic finance.  For example, (admittedly not the best example given its current financial state) Arcapita set up a joint-venture with CapitaLand, a Singaporean developer to build an office park in Navi Mumbai.  The companies' websites say the development is in planning stage, although it is likely at a standstill as Arcapita sits in Chapter 11 Bankruptcy.

Now, allowing Islamic banking in India would likely help along the cross-border flows, but the biggest beneficiary would be (or should be) Indian Muslims who want to use Islamic banks.  That does not contradict the idea that Islamic banking is for non-Muslims as well, but the biggest source of early demand would be from Muslims who otherwise would be outside of the financial system to avoid paying or receiving interest. 

There is a clear reason for both the benefits from encouraging in-flows of capital from the Middle East and the demand locally to be cited (the former may nudge other financial institutions into playing a supportive, or at least not acting in opposition to the change) but the main reason to open India to Islamic banking should be to increase financial inclusion among the large Muslim minority.