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Prospects in Islamic banking's investment products


April 21, 2010 By Tosin Fodeke


Many may not be conversant with the practice of a banking system that prohibits the charging of interest, focuses on investment made in the private sector through interest-free financing, is built on Sharia principles, and not the least, the details of how securitisation and conventional insurance issues are handled using the Islamic banking model.



Recently, major initiatives have gone out to aid Nigeria's participation in the financial world without violating Islamic principles and without bearing the economic penalty.With this, most recently, at a seminar series organised by the Chartered Institute of Bankers (CIBN) and Lotus Capital, to sensitise the public on the benefits of Islamic finance & investment products, Prof. Monzer Kahf, of the Qatar Faculty of Islamic Studies, in dealing with the issue of securitisation (Sukuk) and the practice of insurance by banks (Takaful), explained that, Sukuk, which is the Arabic name for a financial certificate and securities, are structured to comply with the Islamic law and its investment principles, which prohibits the charging, or paying of interest.

According to Kahf, Sukuk, or Islamic fixed-income securities have emerged over the past five years as an increasingly important asset class as Islamic capital markets are experiencing phenomenal growth. Financial assets that comply with the Islamic law can be classified in accordance with their tradability and non-tradability in the secondary markets. In his paper presentation, Kahf elucidated that, "Sukuk can be structured alongside different techniques. While a conventional bond is a promise to repay a loan, Sukuk constitutes partial ownership in a debt (Sukuk Murabaha), asset (Sukuk Al Ijara), project (Sukuk Al Istisna), business (Sukuk Al Musharaka), or investment (Sukuk Al Istithmar).

"Most commonly used Sukuk structures replicate the cash flows of conventional bonds. Such structures are listed on exchanges, commonly Luxembourg Stock Exchange and London Stock Exchange in Europe, and made tradable through conventional organisations like Euroclear or Clearstream. A key technique to achieve capital protection without amounting to a loan is a binding promise to repurchase certain assets, e.g. in the case of Sukuk Al Ijara, by the issuer. In the meantime, a rent is being paid which is often benchmarked to an interest rate like LIBOR (which is disliked by Sharia Scholars).

In Sukuk Al Ijara, according to him, debt certificates can be only bought before the finance occurs and then held to maturity from an Islamic perspective, which is critical on debt trading at market value regarding any difference to be like the prohibited Riba (interest on money). As Sharia considers money to be a measuring tool for value and not an asset in itself, it requires that one should not receive income from money (or anything that has the genus of money) alone. This generation of money from money (simplistically, interest) is "Riba", and is forbidden. The implication for Islamic financial institutions is that the trading and selling of debts, receivables (for anything other than par), conventional loan lending and credit cards are not permissible.

This principle is widely understood to mean uncertainty in the contractual terms and/or the uncertainty in the existence of an underlying asset in a contract, which causes issues for Islamic scholars when considering the application of derivatives. Sharia also incorporates the concept of Maslahah or "public benefit", denoting that if something is overwhelmingly in the public good, it may yet be transacted - and so hedging or mitigation of avoidable business risks, may fall into this category, but there is still much discussion yet to come on this issue.

Also Takaful, or Islamic insurance, Kahf explained, is based on mutual cooperation, responsibility, assurance, protection and assistance between groups of participants. It is a Sharia-compliant alternative to conventional insurance. Under Takaful, policyholders agree to jointly indemnify each other against loss or damage, thereby offering crucial protection against risk whilst at the same time being Sharia compliant. Takaful also acts as vital agent in the mobilisation of funds and is an important component of domestic and international financial systems.

According to a draft framework released by the Central Bank last year March, Islamic banks, referred to as non-interest banks shall be licensed in accordance with the requirements for a new banking licence issued by the Central Bank of Nigeria from time to time.Conventional banks operating in Nigeria may offer Sharia-compliant products and services through their non-interest banking branches or windows. However, such branches or windows cannot offer conventional banking or interest based products and services.

Banks offering non-interest banking products and services shall not include the words "Islamic" as part of their registered or licensed name. This, the draft described as being in line with the provisions of Section 39 (1) of Banks and other Financial Institutions Act (BOFIA) 1991 (as amended). They shall however, be recognised by a uniform logo to be designed and approved by the CBN. All non-interest banks are required to maintain a minimum Risk Weighted Asset Ratio of 10.0 per cent or as may be determined by the CBN from time to time for the purpose of calculating its Capital Adequacy Ratio (CAR).

All applications must be submitted with the required documents including a non-refundable application fee of N500, 000.00 and deposit of minimum capital of N25 billion with the Central Bank of Nigeria. Not later than six months after the grant of an Approval In Principle (A.I.P.), the promoters of a proposed bank must submit application for the grant of a final banking licence to the Director of Banking Supervision with a non-refundable licensing fee of N5 million in bank draft payable to the CBN and other required documents

Also, according to Alexander Lis, managing director at the consulting firm Oliver Wyman, there exist $300 billion in assets managed according to Islamic principles, ranging from commercial to investment banks and investment funds, all providing Islamic products.


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