Looking up to the crescent for redemption

Given the less stringent terms attached to them, Islamic financial instruments offer hope to millions of African farmers and traders in need of trade finance. Ayo Akinfe reports.

Given the more friendly terms associated with Islamic finance, it is no surprise that of late, more and more businesses, particularly in the developing world, are turning to it as a means of raising revenue for trade deals. Given that sharia principles and sukuk only charge interest on tangible assets, trading houses operating in Sub-Saharan Africa are increasingly turning towards Islamic finance as a means of raising funds to do business.

In today’s cut-throat competitive world where reducing production costs, maintaining high margins and being competitive on price are essential for survival, trading houses in developing countries are finding out that Islamic finance is actually a good way of borrowing money, especially for companies just starting out. Aware of how this could be a potentially lucrative market, Islamic banks are looking to step up their presence in the African commodities sector.

In March this year, Jaiz International, the investment holding company set up to establish Nigeria’s first fully-fledged Islamic bank, took the initial steps towards getting the project off the ground. Between March 11 and 16, the Islamic Development Bank (IsDB), sent a delegation to Nigeria to carry out due diligence and was impressed with the way things were taking shape.

Mustapha Bintube, Jaiz International’s managing director, says he was convinced about the financial and commercial viability of the proposed bank. He adds: “The IsDB wrote to the governor of the Central Bank of Nigeria (CBN) to support the establishment of the proposed bank and the CBN has started taking positive steps towards implementing some actions suggested by them.”

Bintube also announced the engagement of Millennium Finance Corporation, a subsidiary of Dubai Islamic Bank and KPMG, as Jaiz’s financial advisers for the purposes of attracting foreign investment in the proposed Nigerian Islamic bank.

He adds: “It is important to point out that we are not only setting up the first Islamic bank in Nigeria, but are also working very closely with the relevant regulatory authorities to create the necessary legal and regulatory framework for Islamic financial institutions.

“The current legal and supervisory framework is mainly focused on the conventional banking system. To this extent, we are also charting the course and laying the foundation for posterity and others to follow.

“In this regard, we are pleased to let you know that the IsDB, Jaiz’s management and our financial advisers have at various times met with the top echelon of CBN, Nigeria Deposit Insurance Corporation, Securities & Exchange Commission and the Nigeria Investment Promotion Council (NIPC). These regulators have all pledged to support the establishment of Jaiz Bank International and facilitate the necessary amendments in the legal and regulatory laws for the smooth operations of Islamic financial institutions.

“CBN has already taken the first step by inaugurating a committee to set up the supervisory framework for Islamic banking. NIPC has also invited our financial advisers to explore areas where they can assist.”

Investment efforts

Over the last eight years, Nigeria has stepped up efforts to attract investment into its oil and gas, agriculture, solid minerals and telecommunications industries and Islamic banking could be an avenue through which local investors in particular obtain finance to enter these sectors.

Like most other African economies, Nigeria’s exports are heavily centred on commodities and many small-scale operators in these sectors may struggle to cope with the lending rates of conventional banks.

Bintube adds: “In spite of these initial challenges, we believe there is a compelling need for a full-fledged Islamic bank in Nigeria. Besides the fact that it is profitable, our people are in dire need of an alternative financing mechanism that will do away with the heavy burden of interest, known as riba in our lives. This is because riba has destroyed many families and small enterprises.”

Already Islamic banks are making a lot of progress expanding out of their traditional enclave in the Middle East, developing inroads into key markets such as Kazakhstan, Singapore and Europe. With its increasing popularity, the Islamic banking industry is hopeful of increased expansion over the coming years.

Abdullah Haron, the assistant secretary general of the Islamic Financial Services Board (IFSB), says: “At the last seminar we held, it was estimated that the Islamic banking sector accounts for a total of about US$500bn. For now, the growth is in the Gulf area in countries like Dubai, Bahrain and Saudi Arabia, as well as Malaysia, Indonesia and Sudan but it is also spreading to other countries.

“According to our figures, the growth rate is 24% in the Gulf states and 26% in Southeast Asia. It is spread across consumer banking, private equity, structured products, Islamic bonds and mutual funds.”

He adds that the real estate sector is one area that is seeing increased demand for Islamic finance as the boom in property development goes on. There is also increasing demand from non-Muslims who are attracted to Islamic finance because of its ethical trading principles.

Haron comments further: “We can divide those who apply for Islamic finance into three. Those attracted for the sharia principles, who are prepared to sacrifice profit margins for it; those who prefer Islamic principles but do not want to sacrifice returns; and those who are indifferent but want the presence and the relationship with the Islamic banking industry.

“Among the non-Muslim population, the sukuk principle is one of the main things they are interested in. Islamic finance is actually an ethical investment as in order for the banks to lend money to a client, there are certain prohibitions they put in place.”

More growth to come


Adding that he sees Africa as a growth area, Haron says he sees no reason why the continent should not see similar growth rates as other parts of the world. Already, Sudan is a very important market, where 100% of the retail banking in the country is carried out by Islamic banks.

Haron adds: “As far as I know, Kenya and other countries are opening up and there is increasing investment in Egypt, Tanzania and Morocco. Across the board, volume is growing and the main area of activity is in the retail banking sector.”

Kenya is the world’s second largest tea exporter behind Sri Lanka and Islamic finance is generally going to producers and traders who operate on the Mombassa Tea Auction. Low interest rates enable growers to borrow money ahead of the planting season, which they use to buy pesticides, fertilisers and pay for picking labour and then repay these loans at harvest.

In the Muslim world, this facility is known as morabaha and is traditionally an agreement entered into between farmers and agricultural banks. Witnessing an increase in popularity of late, morabaha financing is the Islamic financing of trade transactions with known products and fixed maturity dates.

Profit as agreed can be paid during the transaction or at maturity. Profit rates are always agreed before the transaction begins and therefore cannot fluctuate. Conventionally this would be fixed interest rate financing.

A financing institution will normally pay the proceeds of a morabaha facility to the supplier of the goods being purchased and the buyer would pay profits and principle to the financing institution at maturity. On occasions, the buyer’s obligations may need to be guaranteed by a guarantor acceptable to the financing institution.

Morabaha financing is suitable for transactions of between one month and three years. In the case of agricultural trade finance, they are traditionally fixed for a year, with agreements being entered into just before planting and payment due at harvest time.

However, because it is a tool of Islamic finance, morabaha agreements have to meet Islamic criteria and must be sharia-compliant. This facility is subsequently not available to livestock farmers producing pigs for instance or those producing dried fruits fermented to produce alcohol.

Mahmood Faruqui, the vice-chairman of the Institute of Islamic Banking and Insurance (IIBI), says he believes there is a lot of potential for the growth of Islamic finance in commodities. He adds, however, that morabaha is so well entrenched in the sector, that new financial instruments such as the sukuk, are having difficulties establishing themselves.

Pulling teeth

Despite teething problems associated with the growth of Islamic finance, African countries are taking a keen interest in it, simply because it is one of the few sources of capital. Local African banks have continued to step up their interest in the sector with a view to establishing Islamic trading arms.

Last year, a group of South African banks went to Malaysia to learn more about Islamic finance with a view to replicating it in their country, despite the fact that South Africa’s Muslim community is barely over 1mn out of a total population of 50mn.

Sureiya Adam, the economic counsellor at the South African embassy in Kuala Lumpur, says the interest in Islamic banking has been evident of late. She adds: “There is quite a number of Islamic banking areas that have attracted our banks.” Adam points out that Malaysia’s AmBank Group has already started negotiations to set up an Islamic bank branch or provide Islamic banking services in South Africa.

One of South Africa’s largest financial lenders, the Absa Group, has also stepped up plans to provide full Islamic banking services to the country’s Muslim community. In 2004, Malaysian palm oil giant Golden Hope Plantations acquired South Africa’s Hudson & Knight, the wheat and bakery products company, opening up the possibility of increased activities between the two countries in the agricultural sector.

Strength in numbers

African countries also constitute the largest single block among the membership of the IsDB. It has 56 members of which 27 of them are African and stand to gain from the recent new emphasis on Islamic finance.

African countries that are members of the IsDB include Algeria, Benin, Burkina Faso, Cameroon, Chad, Comoros, Cote d’Ivoire, Djibouti, Egypt, Gabon, Gambia, Guinea, Guinea-Bissau, Libya, Mali, Mauritania, Morocco, Mozambique, Niger, Nigeria, Senegal, Sierra Leone, Somalia, Sudan, Togo, Tunisia and Uganda. Senegal hosted the latest IsDB board of governors meeting in Dakar at the end of May.

Designed to enhance socio-economic development, the purpose of the IsDB is to foster the economic development and social progress of member countries and Muslim communities individually as well as jointly in accordance with the principles of sharia law. It is an international financial institution established in pursuance of the declaration of intent issued by the Conference of Finance Ministers of Muslim Countries held in Jeddah in December 1973.

Following the agreement, the inaugural meeting of the board of governors took place in Tehran in July 1975, and the bank was formally opened on October that year. Its functions are to participate in equity capital and grant loans for productive projects and enterprises besides providing financial assistance to member countries in other forms for economic and social development.

Although the IsDB started off in the Middle East and its headquarters remain in Jeddah, Saudi Arabia, it also has field representatives in 11 member countries, among whom are Libya, Senegal, Sudan, Gambia, Guinea Bissau, Mauritania and Algeria. Morocco also hosts one of its two regional offices alongside Malaysia.

Fund help

As part of its mission to develop African countries, in 1989, the IsDB set up the Unit Investment Fund (UIF) to promote foreign direct investment in member countries. This fund has carved for itself a market niche of investments and sharia-compliant products both in short and long-term tenors.

Keen to help in trade finance, in its efforts to mobilise resources, the fund aims to assist IsDB to source additional revenue through the securitisation of its lease and instalment sale assets. In addition, the fund complements IsDB by financing projects and morabaha operations either directly or jointly with the bank or its affiliates.

On the other hand, the UIF aims to provide unit holders with an opportunity to invest in accordance with the sharia principles. It also provides attractive returns on investment with minimum level of risk.

Ijlal Alvi, the chief executive of the International Islamic Financial Market (IIFM), says he sees nothing but growth in the sector. He stresses that that the volume of sukuk products will grow by US$30bn over the next few months as increased demand from developing markets continues to drive growth.

He adds: “At the moment, the value of the global sukuk market totals US$65bn but looking at what we have in the pipeline, we expect this to grow by about US$30bn in the near future. To prepare ourselves for future growth, we are examining ways of discussing the issues affecting the sector and at the moment; we are working on a master agreement for hedging Islamic trading and settlement systems.”

Zamir Iqbal, a principal financial officer at the World Bank, says: “We believe that the growth of emerging economies will lead to increased growth. Large infrastructure investment needs will further growth in developing countries.

“Developing capital markets will attract institutional investors like commercial banks, pension funds and international companies. We realise that the financial sector has a strong input in economic development as you can get up to 0.7% additional economic growth due to a developed financial sector.”

Iqbal adds that the sector still faces several challenges, however, such as the development of secondary markets, sovereign borrowings, equity participation practices, the monitoring of infrastructure, transparency, standardisation and reputation risk. He says that governments in these emerging markets also needed to source Islamic finance to fuel growth in the sector.

No set rules

Probably the biggest problem Islamic finance faces is coming up with a uniform set of rules that will govern the way it works. Whereas conventional banking has a standard code of practice and the same language is used throughout the industry, different Islamic scholars interpret things differently in the Muslim world.

Robert Gray, vice-president of the International Capital Market Association (ICMA), says: “Both us and the IIFM board share a vision of having a level playing field for all players within the market. We want standardised market practices and this is important if the sukuk market is to develop its potential.

“There are about as many as 14 different sukuk products recognised by the marketing bodies of the Islamic financial industry and the transparency of approach will move us together as we and the IIFM work together on sukuk products. One issue we are working on for instance is how liquidity is shared between the lead manager and other underwriters.”

Chris O’Malley, also of ICMA, adds that for now, the main objective is to harmonise the establishment of accepted broad products in the primary markets. He claims he is optimistic that working together, ICMA and the IIFM can overcome challenges facing the industry.

Roger Wedderburn-Day, a partner at law firm Allen & Overy, adds: “We have the problem of a lack of precedence as we try to structure the industry. The industry faces this challenge as it tries to develop standardisation and acceptability.”

Faruqui at the IIBI says, however, that he believes that of late, most operators are being less rigid about the way they operate, which raises the hope for uniformity. He adds that although the sector is still a long way off having uniform procedures like the conventional banking industry, there has been some progress in recent years.

Farqui adds: “I believe that about 80% of the ijara clauses may be the same within a few years time. We are a long way off having one standardised clause in Europe but over the last 10 years, Islamic scholars have moved a great deal towards some sort of uniformity.

“What I have noticed is that over the last few years, there has been less possessiveness with regards to a particular way of doing things. When you see this type of convergence, it helps with the move towards speedier agreements in terms of conditions.”

Dominic Selwood, a director at Deutsche Bank, adds that he believes the market is still very fragmented but he is hopeful that some sort of standardisation can be achieved soon. Faruqui stresses that what we may end up having for now is harmonisation rather than standardisation across the sector.

On the whole, the combination of attractive lending rates, some sort of product harmonisation and the increased accessibility to Islamic finance, is certain to lead to its growth across Sub-Saharan Africa. Hopefully, this will spur the trading of commodities as the easy access to trade finance loans enables many small players currently restricted in what they can do to become fully-fledged and integrated members of the global trading fraternity.