Unlocking the huge potential of Islamic banking and finance services in Kenya

A Gulf African Bank branch on Kenyatta Avenue in Nairobi. PHOTO | FILE

By: Farrukh Raza

Founder & Managing Director IFAAS

Islamic banking has been a key topic of discussion in Kenya. Several recent banking sector incidents have been allegedly linked to Islamic banking by some, and denied by others.

Islamic banking is not understood by the majority of Kenyans. It is important to help people understand it, how and why is it different and its place it in the market.

Islamic finance refers to all types of financial activities that operate in accordance with the rules and principles of the Islamic law (Shariah) and particularly the prohibition of dealing in usury or interest, called Riba in Arabic.

This translates to focus on the ‘‘real economy’’ as the generation of income solely from money-lending is not allowed. The emphasis is therefore on trading and investments on a profit/loss sharing basis.

It is argued that a financial system built on these principles is likely to promote the creation and distribution of wealth in a fair and equitable manner.

In respect of financial transactions, Islamic principles aim to promote ethical transactions encouraging trade, labour, entrepreneurship, transparency, honesty, integrity and fairness, which also inspire kindness, charitable donations and social welfare.

Shariah principles prohibit the use of interest and gambling in the transactions e.g. short selling, misrepresentation, exploitation and unfairness in contracts.

All Islamic financial activities are conducted by financial institutions authorised by the financial sector regulators to operate in accordance with laws of the country. In addition, financial institutions offering Islamic products and services need to ensure that all their products, services and activities are compliant with Shariah.

Besides their general corporate governance framework, the institutions have an additional requirement of Shariah governance which is fulfilled by an independent body of Islamic scholars.

This body, usually called the Shariah Supervisory Board (SSB), is independent and its responsibility is limited to providing guidance to financial institutions to ensure compliance with Shariah.The SSB does not interfere with the day-to-day management of the business.

Due to the ban on paying and charging interest, financial institutions offering Islamic products operate in a distinctively different way.

They are not in a money-lending business, instead they engage in real economic activities including trading and investments in projects. Instead of lending money to customers and charging interest, they buy and sell assets, earning profit or lease their assets against rent.

Different projects

They also provide services and charge fees. Similarly, they do not pay interest to their depositors but instead invest their customers’ monies in different projects and investment portfolios and share profit and loss with them.

Instead of receiving interest depositors earn a return from the various sources of income of the financial institution, including profit generated by its investments, rent received on assets and fees paid for services.

With an operating model and products that are structurally different from the conventional financial system, the risks involved in Islamic banking and finance are different from conventional risks hence a different approach — with more hands-on risk management — is required.

Similarly, the balance sheet of such institutions is different from conventional institutions and requires a different type of accounting.

The size of Islamic banking and finance industry worldwide is estimated at $2 trillion (Sh200 trillion) with an average annual growth rate of 15 per cent over the last decade, outperforming the conventional finance industry.

Islamic banking and finance has attracted attention from around the world in the aftermath of the global financial crises. Regulators, researchers and practitioners have started looking at Islamic banking and finance as an ethical alternative.

An increasing number of countries are embracing Islamic banking and finance, including the United Kingdom, France, Luxembourg, the US, South Africa, Japan and China. Some of these countries have raised funds through issuing sovereign Islamic bonds.

Islamic banking and finance in Kenya is still in its infancy with two fully-fledged banks, five Islamic windows of conventional banks, one fund, one Takaful (Islamic insurance) firm, and one Re-takaful company operating in the country.

In addition two Islamic Saccos have been registered. However, these financial institutions are regulated under the same legal and regulatory framework as their conventional counterparts as a specific framework for Islamic banking remains yet to be developed.

The government also intents to enter the Islamic bond market to raise funds to be invested in infrastructure and economic development programmes.

In order to develop the market and unlock its potential, the government has established a Project Management Office (PMO) to develop an institutional, policy and regulatory framework for the Islamic finance industry in Kenya.

The PMO is guided by an international consultancy, IFAAS (Islamic Finance Advisory and Assurance Services), specialised in association with Simmons & Simmons, an international law firm with Islamic finance expertise.

The PMO has identified preliminary challenges in the market such as lack of awareness among all stakeholders; lack of human capital to manage the unique business; absence of specific policies, regulatory and Shariah governance frameworks; and lack of technical expertise and infrastructure including suitable systems and risk management.

Rising out of the challenges, the PMO has embarked on the development of adequate policies, regulatory and Shariah governance frameworks and capacity building for the market.

This includes engaging with stakeholders in order to develop the required frameworks and policies that respond to industry needs and support Kenya’s ambitions in its individual context.

Since Islamic finance has a significant opportunity in Kenya and great potential to put the country on the international scene, in order to unlock this potential and avail the opportunities, the PMO is out to deliver.

Firstly, making Islamic finance inclusive for all Kenyans and allowing them to benefit from the new opportunities regardless of their background and enabling Islamic finance to play an active role in Kenya’s economic development.

Secondly, by developing Islamic finance regulatory framework in line with Kenyan laws, with the aim of keeping the changes to the minimal required and least disruptive for the system>

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