* U.S. commercial paper market shrinks* Below-forecast data seen paving way for ECB easing* Rate cuts or further non-conventional action expectedBy Ellen FreilichNEW YORK, Sept 20 The amount of seasonally adjusted U.S. commercial paper shrank for a third consecutive week in the week ended Sept. 19, Federal Reserve data showed on Thursday. U.S. seasonally adjusted commercial paper outstanding fell $7.2 billion to $1.008 trillion in the week. But U.S. non-seasonally adjusted commercial paper outstanding - which some analysts believe is the more telling figure after seasonally adjusted figures were distorted by the financial crisis - rose $12.2 billion to $984.9 billion. U.S. non-seasonally adjusted foreign bank commercial paper outstanding fell $3.9 billion to $187.0. U.S. short-term rates remained low with three-month bills yielding 0.11 percent and six-month bills yielding 0.14 percent. Rates are low because the U.S. Federal Reserve has pledged to keep its overnight federal funds rate near zero through mid-2015. Euro zone interbank lending rates ground to fresh lows on Thursday as downbeat economic data modestly raised expectations the European Central Bank would cut interest rates or otherwise ease policy again.
Unexpectedly gloomy surveys showed the ECB's aggressive new bond-buying plan has so far failed to inspire any major improvement in business across the region, with the downturn in the service sector accelerating to its fastest pace in more than three years."It was weak (data) and increases the probability for the ECB to cut rates in coming months," said Barclays Capital rate strategist Giuseppe Maraffino. Money market rates, the anchor for borrowing costs throughout the economy, are driven by expectations of central bank monetary policy. Benchmark three-month Euribor rates have hit new lows almost every day since early July and dropped to 0.233 percent on Thursday.
Euribor rate futures, which reflect expectations of where the three-month Euribor rate will be and incorporate expectations of where the ECB will set its main refinancing rate, rose across the curve after the data was released, pushing implied rates lower . The December contract ticked up to a new high of 99.82, giving an implied rate of 0.18 percent."That is consistent with some probability of a refinancing rate cut," Maraffino said. "But (it) is a reflection of expectations of monetary policy generally...of more easing by the ECB, both in terms of standard and non-standard measures. Slovakia's central bank governor Jozef Makuch said on Tuesday the ECB had room to cut rates again if warranted, echoing comments by his Belgian counterpart Luc Coene who said both rate cuts and further cheap loans to banks were options. Barclays expects the ECB to cut its refinancing rate by another 25 basis points to 0.50 percent in the fourth quarter.
BNP Paribas strategists also expect the rate to be cut by 25 basis points -- in December -- and to remain at record lows through 2014. They also look for a cut in the rate the central bank pays other banks to park funds overnight, which would see it fall into negative territory. By contrast, a Reuters poll shows money market traders do not expect the deposit rate to fall below zero this year , with market pricing based on forward overnight Eonia rates also only showing a slim chance of a cut. When the ECB cut the deposit rate to zero in July, banks, rather than increasing lending to each other or to the wider economy, merely left their excess funds at the central bank. Societe Generale's chief European economist James Nixon said the ECB had more effective options at its disposal than a further rate cut -- steps that would more directly tackle the problems faced by the banking sector in Spain and Italy."The innovations are going to be designed to address the fragmented nature of the money market and the elevated interest rates in (Spain and Italy)," he said."This is no longer a monetary policy problem when we've reached the zero-boundary in rates...if the high rate of deposit withdrawal in Spain continues the banking sector will implode."Spanish bank deposits fell by around 230 billion euros in the year to the end of July, ECB data shows. The ECB has so far offered banks unlimited liquidity, bought covered bonds from them and eased reserve and collateral requirements.
* Banking law requires charging of interest* But RBI governor suggests non-banks could develop services* Sharia-compliant investment options may grow* Regulatory changes could be made without touching banking law* Court case now underway may clarify legal environmentBy Bernardo Vizcaino and Manoj Kumar and Suvashree Dey ChoudhuryDUBAI/NEW DELHI, Dec 20 India's tiny Islamic finance industry is hoping to expand by developing products that would work around the country's ban on sharia-compliant banking. But political and legal obstacles mean progress is likely to be slow. 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. This policy has persisted since 2005, when the Reserve Bank of India (RBI) set up a committee to study Islamic finance."The Reserve Bank's position has been that the current Banking Regulation Act does not permit Islamic banking because interest rate is an important component of banking in India," RBI governor Duvvuri Subbarao told reporters in October. Last month, the governor added that some Islamic financial services could be delivered through vehicles other than banks - a comment which is encouraging some firms to look at developing sharia-compliant products outside the banking sector."It can be got around not through banking, but other vehicles," Indian media quoted Subbarao as saying. Shariq Nisar, director of research and operations at Mumbai-based Taqwaa Advisory and Shariah Investment Solutions (TASIS), an advisory firm, said of Subbarao's statement: "This is a good thing - it is the first time the RBI is saying that Islamic banking is possible through other mechanisms."The message is to try out other things."Because Islamic banks pay depositors based on the returns earned by pooled investment funds, equity- and investment-related products might to some extent mimic the operations of Islamic banks and fill the gap left by the ban on them, the products' proponents hope. Saif Ahmed, managing partner at Bangalore-based Infinity Consultants, said: "The RBI's comments will enable a more creative approach to developing Islamic finance in the country, by getting people to critically think through ways they can introduce Islamic finance under the present regulations."
INNOVATION The 2006 Sachar Committee report, commissioned by the state to examine the social, economic and educational conditions of India's Muslim communities, recommended steps be taken to improve Muslims' access to credit, which it called inadequate. Muslims across all income categories in India are shunning conventional banks because of Islam's ban on interest, said Ahmed. "Access to sharia-compliant credit is the biggest issue, followed by access to sharia-compliant investment options."The issue of investment options looks easiest to resolve. Some capital market products, regulated by the Securities and Exchange Board of India (SEBI), are already based on Islamic equity indexes, such as one launched in 2010 by TASIS and the Bombay Stock Exchange; Islamic indexes exclude firms involved in areas forbidden by the religion, such as alcohol and gambling. In May, SEBI introduced guidelines for alternative investment funds (AIF) which allow the pooling of capital from local and foreign investors."We expect sharia-compliant funds to be registered under the AIF regulations," and to invest in permissible assets such as real estate, said H. Jayesh, founding partner of Mumbai-based law firm Juris Corp. Both Infinity and the Bangalore-based Amana Group have developed savings schemes known as chit funds which they say comply with Islamic finance principles. In chit funds, subscribers pool their money; members can then obtain temporary use of the funds through a bidding process.
"Our schemes have been approved by major sharia institutions...along with prominent scholars. This can promote Islamic banking in the country more wisely," said Asifulla Khan, founder and partner at Amana. CREDIT But providing any form of credit in India under Islamic principles appears much more difficult, and would probably require regulatory changes. A handful of politicians, particularly Muslim leaders such as Vice President Mohammad Hamid Ansari, has been lobbying for years to start Islamic banking in India. Politicians from the southwestern state of Kerala, where there is a large Muslim population, have raised the issue many times in parliament. 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. Also, the government is struggling to shut down channels for illicit flows of funds from the country, which are used by businessmen, politicians and bureaucrats to evade taxes. For these reasons, India seems unlikely in the foreseeable future to permit any form of Islamic banking.
Nisar at TASIS said that one possibility, which would not require amendments to the banking act, would be for the RBI to issue an order allowing non-bank financial companies (NBFCs) to operate under a participatory model. Under this model, NBFCs would not charge interest but instead pay depositors with the proceeds of investment funds. However, RBI officials told Reuters they did not think this would be feasible. Rules for NBFCs are the same as for banks with regard to interest rates, they said. Abdur Raqeeb, general secretary of the Indian Centre for Islamic Finance in New Delhi, said laws other than the banking act could be amended to facilitate Islamic finance. This has been done in Singapore, Japan and Britain, he said."Changes have been introduced through the finance act as in the UK and other jurisdictions in the tax laws, to create a level playing field," Raqeeb told Reuters via email. Tax rules are important for Islamic finance because many popular asset-based transactions are vulnerable to double taxation under conventional accounting methods."It primarily will be a political decision that has to be made by the government through legislation in the parliament," similar to steps taken by Sri Lanka in 2005, Ahmed at Infinity Consultants said. This will test how serious the government is about creating an inclusive financial system, he added. Even if top government officials decide in principle to change rules, though, progress is likely to be very slow because of a complicated consultation process, the large number of stakeholders involved, and opposition in some political parties. Contacted by Reuters, the RBI declined to elaborate on Subbarao's comments. A person with direct knowledge of India's regulatory environment, declining to be named because of the issue's sensitivity, said the RBI had written to the government requesting clarification of its stance on Islamic finance. COURT CASE A court case now underway is testing the legal climate; in May, the RBI revoked the licence of Kochi-based Alternative Investments and Credits Ltd (AICL), which had operated under a participatory model since 2002."The RBI took a stance that compliance to the code requires declaring a fixed rate of interest rather than profit-sharing ratio," AICL chairman Mohammed Ali A. said in September. AICL has challenged the RBI's decision, with the matter still being heard in Indian courts."In our opinion sharia-compliant NBFCs can operate within the existing legal framework," said Jayesh at Juris Corp. He noted that in a separate case, the High Court in Kerala had upheld the constitutionality of the state government's investment in a company set up to carry out sharia-compliant financing activities.