Explained: Banking on the Sharia

Charging and receiving interest is considered usury, and is prohibited under Sharia. The Sharia bars “unethical or immoral monetary loans” that are intended to unfairly enrich the lender. It also prohibits investment in companies or projects associated with alcohol, gambling and pornography. However, Sharia-compliant funds, structured in accordance to Sharia rules, are allowed in the stock markets of many countries, including India. Sharia funds can be managed as mutual funds, exchange-traded or hedge funds.

How are they different from other funds? 

Sharia-compliant funds are normal funds, but they invest only in companies or instruments that follow Sharia rules. Which means companies linked to alcohol, casinos, non-halal food products and conventional financial institutions based on interest are out. These funds also avoid investing in companies with high debt-to-equity ratios, and prefer companies with low leverage or debt burdens. However, such companies don’t necessarily follow the rules of the Sharia. Sharia funds have both growth and non-growth options. If an investor doesn’t want dividend or interest, he can opt for the growth option, wherein he benefits from appreciation in the net asset value.

Does India allow Sharia investment?

Sebi has allowed mutual funds to launch Sharia-compliant schemes. Three funds — Benchmark, Tata and Taurus — have launched Sharia-compliant schemes. SBI Mutual Fund is set to come out with its fund early next month. India’s stock exchanges have close to 600-700 companies which follow the principles of Sharia. BSE’s Sharia Index has outperformed the Sensex by more than 10 per cent in the last one month, signalling that such companies have performed well.

What about Islamic banking?

The Reserve Bank has not allowed Islamic banking so far. A panel headed by former Deputy Governor Anand Sinha had said that a system that does not allow charging or receiving interest is inconsistent with existing laws. RBI feels charging of interest is necessary for banking operations in India because banks have to borrow, on which they have to pay interest. Besides, banks have to deposit cash, under cash reserve ratio rules, with the RBI, on which they get interest. RBI is understood to have told the government that if Islamic banking is to be permitted, it must bring in legislation that is consistent with Islamic banking. An internal RBI panel is now reviewing this.