As public confidence in the Islamic finance and banking sector remains low, consumers are looking for greater transparency and risk avoidance from their bank. Can Islamic banking provide an alternative to Western banking models, and how is this model looking to expand into African states?
Since the economic crisis, eight years ago, the banking world has been widely criticised and come under much greater public scrutiny. With financial scandals becoming almost commonplace, it seems that the public has lost faith not only in the banks themselves, but also in the banking system and, perhaps, the ability of regulators to address the core issues.
As regulators and banks attempt to address the issues that have plagued the finance industry and clean up its reputation, consumers are also looking for alternatives, ones which are more visibly compliant with ethical or religious norms. The Co-operative Bank’s much-touted guarantee of ethical banking is one such, rooted in 19th Century non-conformism. One non-Christian alternative is Islamic banking, a system which follows the core principles of Sharia law.
Islamic banking and finance is based on profit and loss sharing, along with a religious prohibition in dealing in interest and transactions which are deemed too speculative in nature. These aspects of Islamic finance also invariably apply to the infrastructure of all Islamic financial institutions – for example, Sharia compliant operational procedures, relating to the purchase and sale of assets as well as, usually, audits by the bank’s Sharia advisors.
While the conventional banking system is based on paying interest at a pre-determined rate, this function is prohibited under Sharia law. The foundation of the Islamic finance model is based on a profit-sharing principle, whereby the risk is shared by the bank and the customer. Faizal Jusob partner at Couto, Graça e Associados in Maputo, Mozambique, tells ALB: “This system of financial intermediation contributes to a more equitable distribution of income and wealth, which is attractive to clients (Muslims and non-Muslims).”
Hogan Lovells partner Imran Mufti, based in the based in the firm’s associate office in Riyadh, Saudi Arabia,points out that “Islamic finance is very much seen as an ethical mode of finance given the asset screenings that the majority of Islamic banks adopt. For example, [there is a] prohibition against investing in enterprises involved in the arms, alcohol or gambling sectors”.
Faizal Jusob, a partner at Couto, Graça e Associados in Maputo, Mozambique, explains that currently there is no Islamic finance in Mozambique, although he notes the “growing popularity of Islamic banking/finance across Africa”.
He attributes this to the significant Muslim population that exists across Africa (although he points out that Islamic finance is also available to non-Muslims), as well as the risks being shared among all parties.
Zineb Bensaid, senior consultant at Islamic markets advisory ISFIN in Brussels, explains that transparency behind Islamic banking is about conducting business in “a fair and transparent manner.
“Guiding you through to ensure full understanding of risks and costs associated with the products and services is the utmost prerogative”, says Bensaid.
Her colleague, Ihssane Bouhyaoui, international sales manager at ISFIN, adds: “The strong ethical and moral dimensions of doing business and selecting business activities to be financed play an important role in promoting socially desirable investments and better individual or corporate behaviour. “
Although Mufti notes that transparency is likely to “become more of an issue when it comes to sukuk transactions as investors (both Islamic and conventional) will always want to be comfortable with the underlying credit of the issuer”.
Another key element of Islamic banking is actively discouraging speculation.Speculative transactions are sources of instability, under Islam, which means by nature, they lead to the misallocation of capital, says Bensaid, and Islamic banks are prohibited from carrying out such activities. Instead, she explains, they focus on “deployment of capital to the real economy, to promote socio-economic justice”.
Despite a number of benefits offered to customers including transparency and risk sharing, the system is also subject to a number of constraints – most notably transaction costs and difficulties involved in supervising and monitoring.
Nevertheless, Jusob states, “Islamic finance is supposed to have a strong ethical and moral objectives of doing business and in selecting business activities to be financed, which raises the need to promoting socially desirable investments and better individual or corporate behaviour”.
Jusob points out that the Islamic Financial Services Board (IFSB) has recently released a number of exposure drafts providing Core Principles for Islamic Finance Regulation specifically aimed at Islamic financial institutions.
He states: “The aim is not thereby to establish an entirely new governance framework for the Islamic finance industry, but rather to build on and complement existing international standards and encourage institutions to view compliance as part of a general strengthening of good corporate governance culture.”
Therefore, he adds, Islamic finance can contribute to dealing with current issues of transparency in finance with the increased use of “robust corporate governance systems of internationally recognised standards, incorporating transparent, fair and ethical working practices”.
However he explains, that particularly in Mozambique, the introduction of Islamic finance will have to deal with issues relating to capital gains taxation for sukuk (Islamic bond) issuances and other Islamic finance products.
ISLAMIC FINANCE IN AFRICA
According to IMF report, Islamic finance is growing in Sub-Saharan Africa, including Botswana, Kenya, Gambia, Guinea, Liberia, Niger, Nigeria, South Africa, Mauritius, Senegal and Tanzania have Islamic banking activities. There is also scope for development of Islamic finance in a number of African states says Jusob, particularly those with relatively large Muslim populations, such as Zambia – which is interested in using Islamic finance instruments to fund investment in the mining sector.
The Ugandan central bank has gone further, having already started the process of amending its banking regulations to allow for the establishment of Islamic banks – to date, three Islamic banks have applied for a license in the country. Jusob identifies four countries in particular, which have considerable potential for becoming a regional hub of Islamic finance activities, namely South Africa, Nigeria, Kenya and Mauritius.
Mufti notes that Islamic finance is growing in Africa, particularly across the Francophone jurisdictions: “We are also seeing an increasing interest in Islamic financing transactions from the international development banks, particularly for infrastructure projects in the transportation and telecoms sectors.”
The growing popularity of Islamic finance in Africa is no coincidence Mufti tells ALB: “Africa has a significant Muslim population, which means there is a natural synergy with that market.”
Bensaid agrees, anticipating that Africa’s middle-class population is expected to increase and this will “boost demand for Islamic finance products”.
Islamic finance FUTURE GROWTH
“Africa is attracting interest globally, not solely from Islamic banks,” says Mufti. “I see a growth in Islamic finance as issuers and sponsors in the continent look to diversify their investor base.”
“That coupled with African governments encouraging the development of Islamic finance with the introduction of legislation specifically to accommodate Islamic structures means that prospects are positive for future growth.”
Among the opportunities for Islamic banks in Africa, Bouhyaoui points out the potential role these could play in funding small-to-medium enterprises (SMEs) across the continent. She states that in light of “relatively low-income levels, a large informal sector and the prevalence of small businesses in Africa, Islamic microfinance is also a [key] growth area”.
However, Jusob stresses that despite its growing African presence, Islamic finance is still at an early stage of development in Sub-Saharan Africa – pointing out that currently, the share of Islamic banks is still small, and Islamic capital markets are virtually non-existent.
However he has an optimistic outlook for the sectors future in Africa, estimating a likely increase in Islamic finance products in the coming years, something that will comfort many Muslim-owned businesses.
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