"Under our banking law and our banking regulation act, it is not possible for banks to do business without collecting interest. Every evening if the bank is short of money, they have to borrow from RBI for which they have to pay interest.
"They cannot do this if they are under the Islamic banking system," he said during an interactive session with students of Business School of Kashmir University here.
Subbarao further said while the present laws are inconsistent with Islamic banking, it does not mean that there is no scope for it.
"The government must debate on this issue, they must decide that we will have Islamic banking and then legislate accordingly and the Reserve Bank will implement that law.
"Or if it is inconsistent with the mandate of Reserve Bank, there will be different regulatory authority as Islamic banking is regulated by Shariah law," he said.
Subbarao further said Islamic banking is an important business model and popular in many countries.
"It is popular in many Islamic countries, many non-Islamic countries. Some countries are actively promoting Islamic banking. We receive requests that RBI must allow Islamic banking in the country," he said.
The RBI Governor said there cannot be dual regulation.
The matter is a "political question" that has to be debated and decided by the government.
Islamic banking is a banking system that is based on the principles of Islamic law and prohibits collection and payment of interest. However, profit and loss can be shared.