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Over the past decade, Islamic
Finance has become a burning and topical issue around the world
(Europe, Middle East and Asia) and has most recently reached
Nigeria, over the introduction of the Islamic Banking model to the
financial industry by the Central Bank of Nigeria. This has
generated outcry from some quarters and a not so unexpected media
frenzy.
A lot of scepticism and public opinion has been garnered about the
motive behind the introduction of this alternative system of
banking in Nigeria. However before this alternative mode of
financing is dispelled by the general public or the government,
the concept needs to be explored and understood in order to
clarify its purpose and subsequent effect on the country.
What is Islamic finance?
Islamic Finance is a form of Finance that is in accordance with
Islamic Law (which is also known as the Shariah Law). Islamic Law
provides for the rulings and guidance on the Islamic way of life.
One of the objectives of Islamic Law is the preservation of good
for humanity. Hence it believes in the universal principles of
equity, justice, fairness and accountability on the one hand and
the preservation and distribution of wealth for the common good on
the other. How is this achieved? This is by the prohibition of
interest, otherwise known as Riba (Quran 2:275). Riba is regarded
as an unjustified increase in capital which is used to oppress the
poor in the capitalist-driven conventional system of finance. It
is worthy to note that the prohibition of interest as outlined in
Islam is also endorsed by other religions such as Christianity
(Deuteronomy 23:19) and Judaism. In summary, the Shariah provides
a framework that can help strengthen the conscience and integrity
in the market place.
Features of islamic finance
Prohibition of the earning/charging of interests: Islamic law
prohibits „usury’ which is defined as any unjustified increase
between the value of goods given and the counter value of goods
received – including charging interest on a loan. This is one of
the main features of Islamic Finance and its main difference from
Conventional Finance. Interest is considered as an unjustified
increase in capital without any effort made to earn it. For
instance a loan given to a borrower in the conventional banks will
attract a percentage of interest and regardless of the outcome of
the borrowers business transaction (profit or loss) he is obliged
to pay back the loan with the agreed interest.
Profit and Loss Sharing
Structure: Islamic Finance is based on a Profit and Loss sharing
structure rather than the earning of interest. In other words,
financial institutions are required to invest with a client in
order to finance their needs, rather than lending money to their
clients. This is because in Islamic Law, money is strictly seen as
a medium of exchange which in itself does not have any inherent
value and should not derive an increment in itself. Therefore
there must be some human effort, initiative, and risk involved in
a productive venture or asset before money can be invested. Thus,
by investing with or in a client’s business venture, the financial
institution partakes in the risks of the business and shares in
the profit and loss (if any) of the business.
Prohibition of Uncertainty and Gambling
Islamic Finance prohibits any form of uncertainty or ambiguity in
any business or contract. These include uncertainty as to the
terms of a contract, its price or a mere speculative risk
(gambling) which can result in unpredictable or unanticipated
circumstances. Islamic Finance upholds the principle of fair
dealing and transparency in any business and ensures that all
parties in a business transaction understand the terms of the
contract and any associated risk that comes with it.
Prohibition of investment in unethical business activities
Islamic Finance prohibits dealings in business activities
forbidden by Islamic Law. These include dealings in alcohol,
gambling, pork, adult entertainment, prostitution, tobacco,
ammunitions and any other economic activity that is deemed morally
or socially harmful to humanity. Islamic Finance is developmental
in nature and as such only promotes businesses which aid in the
development of the society by appealing to people’s moral
conscience..
It is however note worthy that despite these distinguishing
features of Islamic Finance it is still based on similar business
objectives with conventional finance which is to make profit,
although the manner in which it is made is what differentiates
them. In addition, apart from the Shariah laws which apply,
Islamic Finance Institutions are also governed by the same laws
and regulated by the same authorities as other financial
institutions in the various categories e.g.
Capital market Operators (Securities & Exchange Commission), Banks
(Central Bank of Nigeria), Insurance Companies (National Insurance
Commission).
Structures of Islamic finance
Islamic Finance has various structured finance products tailored
to meet the peculiar needs of its clients. The main forms of
Islamic Finance practice is categorised into sale, leasing and
partnership contracts.
Equity-based Products
Musharakah: This can be referred to as a joint venture/partnership
arrangement, through an equity participation contract. Ownership
is distributed according to each partners share in the financing,
and profit is shared at an agreed profit sharing ratio while loss
is shared according to each partners capital contribution towards
the business. Such contracts are often used in connection with
large project finance and private equity funds.
Mudarabah: This is an investment whereby one party („rab al maal/investor)
provides the entire capital while the other party („Mudarib/entrepreneur)
provides the management. The entrepreneur with the management
expertise is usually a bank or a financial institution. Profit
sharing is pre-agreed by both parties while the loss is borne by
the provider of the funds alone. However, a Mudarabah can be
reversed whereby the bank is the investor providing the capital
for the investment.
Products for financing working capital and liquidity management.
Murabaha: This is literarily a form of sale at a mutually
agreed profit. Unlike lending money as in conventional loan, this
mode of financing involves an actual purchase of a commodity by a
bank (thereby taking in part of the risk) upon the request of a
customer and sells it to the customer at the agreed mark-up price.
The customer thereafter pays the bank at an agreed tenure in order
to manage its liquidity.
Istisnaa: This is used for the acquisition of goods by
specification or order, where the price is paid in advance for
future delivery or paid in future for future delivery. It is
usually aimed at long-term construction projects and is frequently
used to finance the construction of real estate developments,
roads, bridges and large assets such as ships and power plants.
Products for asset acquisition
Ijara: Ijara is essentially an Islamic lease whereby there
is a transfer of the usufruct (use) of an asset in exchange for a
consideration which is the rent. In an Ijara the investor (lessor),
upon the request of a prospective borrower (lessee), purchases an
asset and immediately leases it to the lessee for an agreed term
and fee. Ownership of the asset remains of the lessor while the
lessee is only entitled to the right to use the asset during the
agreed duration. Ijara is frequently used to finance the
acquisition of equipment, vehicles and real estate.
Diminishing Musharakah: Diminishing Musharakah is another
form of partnership where a financier and its client participate
in the joint ownership of a property, equipment or any fixed
asset. However, the share of the financier is thereafter divided
into a number of units and it is mutually agreed that the client
will purchase the units of the share of the financier on agreed
instalments, thus increasing the clients share in the investment
and reducing that of the financier until all the units of the
financier are purchased by him so as to make him the sole owner of
the property or the business venture. Diminishing Musharakah in
recent times has become a mode of financing Islamic mortgages.
Fixed income investment Product
Sukuk: This is an investment certificate (bond) that
represents a proportionate interest in a well-defined pool of
assets that yield income and capital returns. This differs from
the typical corporate bond, which pays a fixed rate of interest to
investors. It is usually set up with a special purpose vehicle
acquiring the assets and whereby the returns from the assets are
passed to Sukuk holders (investors). The most common asset classes
used to float a Sukuk have included real estate. Sukuk has become
a popular way for many governments to raise funds for
infrastructure, and accounts for the largest portion of Islamic
finance.
Common misconceptions about islamic
finance
Islamic Finance is only for Muslims
Islamic Finance is an alternative means of making money through
wealth creation and distribution and it is available to both
Muslims and non-Muslims. There is nothing prohibiting a non-Muslim
from using Islamic Financial services or owning an Islamic Finance
institution. Although Islamic Finance is based on the principles
of Islamic law, its features grant social justice to mankind,
which actually appeals to both Muslims and non-Muslims. It is
worthy to note that among the largest institutions offering
Islamic financial services are conventional banking groups such as
Citigroup, HSBC, Standard Chartered, and BNP Paribas. This is to
prove that the values of Islamic Finance are not exclusive to
Muslims. This is also evidenced by the staggering percentage of
non-Muslim investors benefiting from Islamic Finance services
through these banks mainly because of its competitive returns. In
Malaysia, for instance about 40% of the customers in its Islamic
Banks are non-Muslims.
Islamic Finance is a camouflage for terrorism financing
An Islamic financial institution is strictly prohibited by the
Shariah from knowingly assisting, let alone actively
participating, in terror-related activities. This is because the
Shariah does not condone violence against innocent victims and
hence categorically condemns terrorism. Quite unfortunately, the
effect of the 9/11 attack on the United States and other similar
activities in other parts of the world (and recently in Nigeria)
has skewed the general perception of Islam, thereby raising undue
fear and scepticism to anything branded “Islamic” or “Shariah”.
Hence, the misconception that Islamic Finance is a front for
terrorism financing. However, the reality is, Islamic Finance does
not operate in a vacuum and is no different from other financial
institutions which are subject to and bound by the strict laws and
regulations within its jurisdiction of operation. For instance,
there are provisions of the law on anti-terrorism and anti-money
laundering and there is no financial institution that is immune to
these laws. Therefore, regardless of whether an institution is
providing Islamic Finance or not, if it is proven to be involved
in or is supporting terrorist activities, it would be held
accountable and face the consequences.
Islamic Finance is only charitable
Islamic Finance is about wealth creation and just like any other
business, is profit oriented. Islamic Financial Institutions are
accountable to their shareholders and investors who have invested
their funds in the business with the aim of making reasonable
returns on their investment which the institution is to ensure
that it delivers in line with the principles of the Shariah.
However, as is already evident above, Islamic Finance is not a
capitalist driven system of finance. There are inherent mechanisms
to encourage Islamic Financial Institutions to undertake corporate
social responsibility in Islam such as the mandatory Zakat (alms
giving) and voluntary Sadaqah (donations) which can be used to
contribute to societal development.
Islamic Finance is aimed at paving the way towards Islams World
Domination –“Islamization”
Islamic Finance accounts for less than 1% of the global financial
system. Furthermore there are more than 1.5billion Muslims spread
around the world and therefore are too heterogonous to have such a
common agenda. Muslims around the world belong to different races
and are of diverse cultures. It is almost improbable that such
diversity can create a single government with a common goal to
dominate the world. As historical evidence has illustrated,
Islamic Finance should be viewed in the same vein as halal foods
which has been around for centuries and is available everywhere
around the world including non-Muslim countries and consumed by
both Muslims and non-Muslims. In view of the fact that the
presence of halal food has not resulted in the demise of non-halal
foods or instigated world domination, Islamic Finance should not
be viewed differently.
Islamic finance - global perspective and the growth of the
industry
Islamic Finance is the worlds fastest growing financial sector
recording a growth rate of about 15-20% per annum with assets
exceeding $300bn. In the past decade it has grown from its niche
market to a global financial industry, with over 280 Islamic
Financial Institutions in about 75 countries around the world,
including mainstream conventional banks operating windows where
Islamic products and services are offered to their discerning
customers. A few of these western banks, such as HSBC, BNP
Paribas, Standard Chartered and Citigroup, have been offering
Islamic banking windows for almost a decade while a few others
such as Morgan Stanley, Barclays Capital and Deutsche Bank have
also bought into its unique value proposition in recent times.
Although, its development started in the Middle East, it has since
spread to other non-Muslim countries that have begun to embrace
Islamic Finance and its investment philosophy.
The United Kingdom, a non-Muslim country with a minority
population of Muslims, has introduced laws and amended its
regulations to cater for Islamic Finance. This was not done
specifically for religious purposes, but as an alternaative form
of financial solution creating a choice for customers,
irrespective of their faith and at the same time, meeting the
needs of those who indeed prefer access to financial products in
line with their faith.
For example, the Islamic Bank of Britain offers Shariah compliant
products and services to both its Muslim and non-Muslim customers.
The UK has been positioned at the centre stage of developments in
Islamic Finance, seizing opportunities for growth through the
industry. The London Stock Exchange has listed 33 Sukuks (Islamic
Bonds) on the exchange since its launch in 2009 including two of
the largest Sukuks issued this year thus far. Islamic Finance has
also been present in South Africa as far back as 1989 with the
existence of the Al Baraka Islamic Bank (AIB) with a few other
private financial institutions providing Islamic products and
services to its customers. Other countries such as France,
Luxembourg, Hong Kong, Singapore, Sri Lanka, Kenya and a host of
others across Europe, Africa and Asia (which are predominantly
secular States) have established or are considering establishing
Islamic Finance as an alternative system of financial management
as its merits are evidenced by the minimal impact the global
financial crisis had on the industry in comparison to the
market-based conventional system.
Islamic finance - an alternative system of financial management in
nigeria
The purpose of the introduction of Islamic Finance in many
countries has been to serve as an alternative financial solution
to meet the needs of the people. Nigeria is a country with a
population of over 150 million with about 50% as Muslims. There
has always been a demand among Muslims for financial products and
services that conform with their beliefs and the development of
viable alternatives to conventional finance would create a level
playing field in which Muslims can also access a vast range of
financial services without compromising their religious beliefs.
Furthermore, Islamic Finance can create cross border trade and
investments as foreign investors seeking to invest in Islamic
products and services will find investment outlets to meet their
needs thereby creating access to foreign exchange and positioning
Nigeria on the map as an international financial centre. Customers
(Institutional Investors and foreign investors) with an investment
appetite can also benefit from Shariah-compliant funds as well as
Sukuks, which are increasingly becoming common in global markets
as a result of their impressive growth rates. Islamic Finance will
undoubtedly create job opportunities as a lot of specialised
skills will be needed to develop the industry and expand its
growth thereby contributing significantly to the reduction of
unemployment rate in the country.
The innovation brought about by the structuring of Islamic
products will also contribute to the creation of a new asset class
which will be available to customers of all faiths. The
introduction of Islamic Finance models such as the Mudarabah,
Murabaha, Sukuk, and Istisnaa which have been tried and tested in
other countries will further strengthen the financial system and
create risk diversification against future financial crisis.
Furthermore, the introduction of a new asset class will create
competition within the financial system and competition will drive
the market and the economy.
Finally, Islamic Finance will contribute significantly to
financial stability. This is because the principle of Islamic
Finance negates all the factors which led to the global financial
meltdown. Some of its inherent features identified by the IDB-IFSB
(Islamic Development Bank – Islamic Finance Services Board) Task
Force on Islamic Finance and Global Financial Stability provide
key potentials in contributing to the global financial and
economic stability:
The fact that investments or financing can only be extended to
real assets such as projects, trade, economic and commercial
transactions ensures that there is growth in real economic
activities which reduces the possibility of excessive leveraging.
The principle of ownership being very pertinent makes it
impossible to sell what you dont have, which also restricts the
possibility of unhealthy and excessive speculation as found in
derivatives instruments used in conventional finance.
Participation of risks provides a strong incentive for Islamic
financial institutions to ensure the success of the projects and
activities that they finance.
Its emphasis on certainty and transparency ensures that there is
full disclosure and documentation of contracts which avoids
unpredictable and unanticipated circumstances resulting in one
partys undue advantage over the other.
Stability and sustainable development have become the watchword in
global business and governance and Nigeria as a developing country
stands to gain immensely from this alternative means of financial
management, not only for its foundation in religious principles
but for its potential to contribute to the development of the
countrys economy and the society at large.
The author, Oluwatosin Lawal, is in the commercial law firm of
Perchstone & Graeys Lagos. The above article first appeared in
http://www.businessdayonline.com
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