The signs suggest it may not be long before Islamic trade finance in Africa goes from niche to mainstream, writes Sarah Rundell.
The growth in Islamic trade finance is part and parcel of a broader growth in Islamic banking, now one of the fastest growing sectors in global finance. Africa, with its vast Muslim populations in countries like Nigeria, Kenya and Sudan, together with the continent’s strong trade links with the Middle East and Asia, is an obvious market for shariah-compliant trade finance, where deals are structured so as not to charge interest, and financing businesses like tobacco, gambling or arms is forbidden. Today the demand and supply of broad-based Islamic finance in Sub-Saharan Africa is only just starting to appear, and what specialist Islamic trade finance exists, tends to be under the radar and transacted on an ad-hoc, tailored basis. But it seems likely that Islamic trade finance on the continent will soon become increasingly popular.
It is something Waleed Al-Wohaib, CEO of the Jeddah-based International Islamic Trade Finance Corporation (ITFC), part of the Islamic Development Bank Group, believes is already starting to happen. “Last year we lent over US$3bn globally to finance trade and nearly a quarter of that went to Africa.”
Just some of the ITFCs recent deals include financing oil imports in Senegal and Benin – which it sees as a gateway for petroleum products into Niger and Burkina Faso – and pre-export financing of the cotton crops in Burkina Faso, Côte d’Ivoire and Cameroon.
In March 2011 the ITFC lent US$14mn to Gambia to fund the export of its groundnut crop in the first structured commodity financing for the country. In March this year, it pledged to provide a US$400mn three-year loan to finance petroleum imports.
In a deliberate strategy to further boost African trade, the corporation says it wants to push its African lending up to US$1bn in the next three years.
The ITFC says it is ‘inundated’ with requests from African corporates seeking out alternative sources of liquidity in the local market. The conventional trade finance market has been hit by Basel regulations and the shortage of dollar liquidity amongst European banks, once the biggest lenders. It has created an opportunity for new players to build a foothold, says Al-Wohaib. “The major players in Africa have had serious liquidity issues; there is a gap in the market that we are trying to fill.”
Islamic trade finance is not only another source of funding in today’s constrained markets; it also offers corporates an alternative strategy when it comes to raising finance, because of the rules around which it is governed.
One common product offered by an Islamic bank is a supply chain financing solution, known as a murabaha facility, whereby the bank will buy the underlying asset on behalf of the client. It then sells the asset back to the client at a fixed profit on deferred payment terms, helping corporates that have little or no credit headroom by stepping into the trade cycle.
“Islamic finance can be of immense use to a business that needs alternatives to fund its business or has reached its credit limits,” says Mohammed Paracha, head of Norton Rose’s Islamic finance practice in the Middle East and Africa. It is this kind of broader appeal that could make Islamic trade finance attractive beyond just the Islamic business community. Proponents argue that the popularity of zero coupon bonds is a real example of Islamic finance attracting a much broader pool of investors.
In Kenya, where a quarter of the population is Muslim, shariah-compliant banking groups First Community Bank and Gulf African Bank both have growing retail bases and say they already do ‘some’ Islamic trade finance. Shariah-compliant takaful, or insurance companies, have set up shop in the country and now reinsurance can also be shariah-compliant since the Kenya Reinsurance Corporation became the latest East African insurer to expand with an Islamic offering.
The Nairobi-based African Trade Insurance Agency (ATI), a trade insurance provider for global companies looking to invest in member states and local companies exporting or trading within the region, is conducting a regional strategic market survey to measure demand for Islamic trade insurance.
“So far we haven’t found huge demand from the Islamic business community. But once the product is available we believe the Muslim business community will refuse to work with anything else,” predicts Jef Vincent, chief underwriting officer at the ATI.
When it comes to offering shariah-compliant trade insurance, the process is also relatively straightforward. Since trade credit insurance doesn’t involve charging interest it is ‘naturally’ shariah-compliant. Criteria include that the insurance provider should explain in the policy documents how the profits will benefit the community, and that the policy has to be issued by a shariah-compliant insurance provider, a takaful. The ATI is currently exploring ways to best work with takaful insurance providers to offer its products.
Nigeria, with its 50%-strong Muslim population, offers the most obvious allure for Islamic banks. The regulatory framework for Islamic banking is already in place and last February Jaiz Bank International became the first group to offer shariah-compliant banking.
Most of Nigeria’s biggest banks are also mulling so-called “Islamic windows”, or departments that offer shariah-compliant services, within their broader banking services.
Nigeria’s ethnic tension is stalling progress however, warns Professor Rodney Wilson, a Qatar-based expert on Islamic finance. “Islamic banking is a sensitive issue in Nigeria; it is operating in a constrained environment and so far there has been a lot of talk but not much has happened.”
Even in South Africa, with a Muslim population of just 2%, big banks like Absa and FNB are pushing a shariah-compliant offering to draw the continent’s Muslim population as the banks expand up from South Africa.
Smaller operators are also planning for growth. “At the moment trade finance only accounts for 15% of our total loan book but we see this growing to 20% in the short term,” says Shabir Chohan, CEO of Albaraka Bank, South Africa’s only fully-fledged Islamic bank.
Africa’s shariah-compliant banks are also working on ways to strengthen their co-operation with other banks. One of the main problems blocking growth of Islamic trade finance is that although not all the lending institutions within a transaction need to be Islamic, they do need to agree to follow Islamic principles.
It is something the ITFC is trying to tackle through building co-operation with other banks and pushing its products through them. “Our only condition is that both steps of the transaction – between the ITFC and the conventional bank and then the conventional bank and the client – are Islamic.”
In an effort to build links with local African banks the ITFC has made US$150-US$200mn in loans available to local African banks. It is also working to change negative perceptions around Islamic trade finance with marketing campaigns aimed at reassuring clients that Islamic finance protects their bottom line. The ITFC is also rolling out an increasingly varied product offering that includes structured commodity finance.
As Islamic finance becomes more widespread and competition increases, both from more Islamic banks on the ground and conventional banks getting in on the act, it will build awareness and knowledge of the rules governing Islamic trade finance.
Introducing a client to Islamic trade finance is still a time-consuming process holding additional risk factors to lenders. “It can get complicated and misunderstandings can occur,” says Chohan.
One common misunderstanding is the fact a bank can only sell the goods to the client if the bank is actually in possession of the goods – otherwise the income isn’t shariah-compliant. Nor can goods be used by the client before they have been sold to them by the bank.
Mohammed Paracha at Norton Rose highlights other sticking points: “Local laws are not always robust around perfection of security, and the concept of bonded warehouses and trust receipts are still not fully understood,” he says.
Additional challenges hinge around governments’ uncertainty as to what tax to levy on conventional interest earnings versus the shariah-compliant profit. And it’s not just potential clients or regulators in the dark.
In many cases the banks themselves don’t yet have a grasp of Islamic trade finance. “There are a lot of business organisations that want shariah-compliant products but they just aren’t available; if more banks offered these services there would be more take-up,” says Chohan.
Other factors are putting a brake on growth too. Although the licensing requirements for Islamic banks are identical to those for conventional banks in terms of capital requirements, Africa’s Islamic banks find it a tough operating environment.
Because Islamic banks can’t hold treasury bills paying interest, or accept interest payments on their deposits with central banks, these institutions can’t earn returns on treasury holdings unlike their conventional competitors.
A solution would be for African governments to issue short-term sovereign sukuk, or Islamic securities which Islamic banks could legitimately hold and earn a modest return from. There is talk of introducing them in Egypt and Tunisia.
When it comes to the US$1.1tn global Islamic finance industry, Africa is still playing catch-up.
The continent has both demand for more trade finance and a large Muslim population; now the banks just need to beef up their offering.