Authored by Oluwatosin Lawal*
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 Shari'ah 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 Shari'ah 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 Shari'ah 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.
- Musharakah: This can be referred to as a joint venture/partnership arrangement, through an equity participation contract. Ownership is distributed according to each partner's share in the financing, and profit is shared at an agreed profit sharing ratio while loss is shared according to each partner's 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.
- Istisna‟a: 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 client's 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 Shari'ah from knowingly assisting, let alone actively participating, in terror-related activities. This is because the Shari'ah 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 "Shari'ah". 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 Shari'ah. 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 Islam‟s 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 world's 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 alternative 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 Shari'ah 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 Shari'ah-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 Istisna'a 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 don't 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 party's 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 country's economy and the society at large.
* Oluwatosin Lawal is an Intern in the commercial law firm of Perchstone & Graeys Lagos.
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