Islamic banking rivals Western-style lending
Helps developing nations, Muslims
ABIDJAN, IVORY COAST | It works like this: No interest on investments, but the borrower and the lender share the risk and split the returns. This growing form of banking, known as Islamic finance, is now making significant headway into Africa, one of the fastest-growing regions in the world.
In fact, proponents of Islamic banking are touting this alternative to classic Western financial practices as a better way to help Africa improve roads, develop state-of-the-art health care systems and create a massive middle class to address some of the issues hindering growth.
“Islamic finance offers excellent prospects for the African continent, which we should seize,” Ivory Coast Prime Minister Daniel Kablan Duncan said last month before an audience of around 500 people at the region’s first Islamic Finance Forum.
Nigeria’s securities commission last month staged a roundtable discussion to educate local lenders and businesses about the benefits of an “Islamic capital market.” The Central Bank of Djibouti this week is putting together a two-day event billed as the International Banking Summit Africa, which is designed to boost trade and investment between the oil-rich Middle East and sub-Saharan Africa using Islamic financing practices.
This form of financing — Standard & Poor’s estimates that Islamic finance grew by as much as 15 percent in the past decade to reach $2 trillion globally — could also be a way for rich Muslims from the Middle East and beyond to enhance their portfolios while adhering to their religion, which prohibits “riba,” or the charging of interest on monetary loans.
Those same investors might not otherwise recognize the potential in markets such as western Africa, said Fabrice Toka, a South Africa-based senior director covering sub-Saharan Africa at Fitch Ratings.
“Islamic finance doesn’t take away from that which you can already do with traditional financing,” Mr. Toka said. “It adds another pool of investors.”
Rather than charging the borrower a set interest rate for a set period, Islamic lending is based on Shariah principles and works on the basis of risk- and profitsharing. The customer and the bank share the returns and risk of investments on negotiated terms.
“There is a level of return that is expected,” said Nida Raza, advisory director of the Saudi Arabia-based Islamic Corporation for the Development of the Private Sector, or ICD. “The difference is, it’s not interest; it’s profit.”
Home to roughly a quarter of the world’s Muslim population, Africa represents a growing market for faithful Muslims to put their money to work, according to an ICD report.
“Although the potential contribution of Islamic finance in favor of African economic development has long since been recognized by experts, the rhythm is now accelerating,” said the report, titled “Islamic Finance in Africa: A Promising Future.”
Ready for takeoff
Economic growth in Africa averages roughly 5 percent a year, rivaling Asia and other regions, according to the International Monetary Fund.
But since 2001, at least half of the 10 fastest-growing economies in the world have been in Africa. The continent also sports 15 percent of the world’s population, two-thirds of the Earth’s uncultivated arable land, rich energy resources and a rising youth population, according to the IMF.
Developed nations such as the United States, Japan and China have actively wooed African countries in recent years, typically with high-profile summits in which billions of dollars in deals and financing projects have been struck. Last week, India hosted its first such gathering for 54 African countries, including 41 heads of state, announcing a doubling of subsidized loans to the continent to $10 billion over the next five years, along with some $600 million in grants.
But around 340 million people in sub-Saharan Africa still lack reliable access to traditional banks, the ICD report noted.
Those trends have led the ICD to boost its funding in Africa by more than double to around $12 billion in the next five years.
“Africa has the highest growth in the world. It needs more finances to back up the growth,” said Islamic Corporation CEO Khaled Al-Aboodi. “Access to finances presently here are scarce and difficult to attain.”
Islamic financing can take different forms. An “ijara” investment involves a bank buying an asset — such as a tractor — that is leased to the debtor, who uses it for business. In “murabaha” lending, banks purchase goods and resell them to customers, who make installment payments on the goods at markups. In a “musharaka” deal, the bank and its customer launch a joint venture and share the resulting profits or losses.
Ms. Raza said Islamic banking protects debtors from interest charges that cut into debtors’ revenue whether or not they are operating in the black. Islamic financing also gives lenders more flexibility when debtors encounter hardships and threaten default, she said.
“The majority of Islamic finance transactions do carry a level of risksharing,” she said.
Ms. Raza noted, however, that debtors couldn’t necessarily exploit banks in Islamic financing. Banks can quickly repossess assets loaned under the terms of most transactions, for example. “There are deterrents put into place during the structuring process to avoid any sort of misuse of the flexibility that Islamic financing is supposed to ensure,” she said.
In West Africa, where at least 80 percent of the population is Muslim, Islamic financing has grown in popularity. Since 2014, Ivory Coast, Nigeria, Niger and Senegal have issued “sukuks,” or Islamic bonds, totaling almost $800 million, according to the countries’ financial filings.
A sukuk pays a dividend based on a return from a tangible asset. It is similar to a traditional Western-financed bond, without the interest. Proceeds from sukuks often finance large state development projects for purposes such as education, agriculture and infrastructure.
“With these tools, we could build a freight terminal at the Felix HouphouetBoigny Airport,” Ivory Coast’s Mr. Duncan said at the forum. “Cote d’Ivoire can use these finances for infrastructure development.”
Despite its promise, Mr. Toka said, it will take more than a new financing mechanism to bring prosperity to a region that has struggled with issues such as political instability and corruption, epidemics such as Ebola and terrorist threats from Islamic extremist forces such as Boko Haram.
“For Islamic finance to thrive, we need to provide the legal and regulatory framework that goes with it,” he said. “Countries need to have those frameworks put into place so it can actually help with the expansion of Islamic finance in Africa.”