Globally, in the last decade, there has been unprecedented growth in the non-interest banking and finance, which is generally known as Islamic Banking. The existence of Islamic finance has become imperative in many jurisdictions of the world and it is expected to continue to spread in view of the economic growth in countries with huge Muslim population.
Nigeria is home to the largest population of Muslims in sub-Saharan Africa. It accounts for over 80 Million Muslims. In recent times, Nigeria is opening itself to Islamic financing with hope of establishing a hub for non-interest banking.
Nature of Islamic Banking
Islamic finance is a financial system that is based on adherence to the Sharia or Islamic law. It offers services, products and instruments based on compliance to this Divine Law.
Sharia prohibits the payment or acceptance of interest charges (riba) for the lending and accepting of money, as well as carrying out trade and other activities that provide goods or services considered contrary to its principles. Money in Islam is not regarded as an asset from which it is ethically permissible to earn a direct return. Money tends to be viewed purely as a medium of exchange. Interest can lead to injustice and exploitation in society.
There is no real ‘lending’ in Islam since all ‘lenders’ obtain ownership interests in the assets that they finance, or earn a profit-share or purely fee-based remuneration. In order for an Islamic bank to earn a return on money lent, it is necessary to obtain an equity, or ownership, interest in a non-monetary asset. This requires the lender to also participate in the sharing of risk.
Modes of Islamic Finance
There are basically two folds of Islamic financing. They are:
- Profit-and-loss-sharing (PLS), also called participatory modes, i.e., musharakah and mudarabah; and
- Purchase and hire of goods or assets and services on a fixed-return basis, i.e., murabaha, istisna, salam and leasing (ijarah).
Some of these Islamic finance terms are discussed hereunder:
Musharakah is a profit-and-loss sharing partnership and the most authentic form of Islamic Financing. It is a contract of joint partnership where two or more partners provide capital to finance a project or own real estate or movable assets, either on a permanent or diminishing basis. Partners in musharakah have a right to take part in management; they seem to bear the greatest risk among all Islamic financing modes with the potential for earning the highest reward. However, whereas profits are distributed according to pre-agreed ratios, losses are shared in proportion to capital contribution.
Murabaḥah is a popular Sharia compliant sale transaction mostly used in trade and asset financing. The bank purchases the goods and delivers them to the customer, deferring payment to a date agreed by the two parties. The expected return on murabaḥah is usually aligned with interest payments on conventional loans, creating a similarity between murabaḥah sales and asset-backed loans
Mudarabah is a profit-sharing and loss-bearing contract where one party supplies funding (capital owner) and the other provides effort and management expertise (manager) with a view to generating a profit. The ratio in which the total profits of the enterprise are distributed between the capital-owner and the manager of the enterprise is determined and mutually agreed at the time of entering the contract, before the beginning of the project. In the event of loss, the capital owner bears all the loss and the principal is reduced by the amount of the loss. It is the risk of loss that entitles the capital-owner to a share in the profits. The manager bears no financial loss, because he has lost his time and his work has been wasted. This is, in essence, the principle of mudarabah
Ijarah is a contract of sale of the right to use an asset for a period of time. It is essentially a lease contract, whereby the lessor must own the leased asset for the entire lease period. Since ownership remains with the lessor, the asset can be repossessed in case of nonpayment by the lessee. However, the lessor is also responsible for asset maintenance, unless damage to the leased asset results from lessee negligence. This element of risk is required for making ijarah payments permissible.
Salam is another mode of financing in Islamic Finance. It is a sale where the seller undertakes to supply some specific goods to the buyer at a future date is specified in exchange of an advanced price fully paid at spot. This mode of financing is used to finance the agricultural sector.
Istisna is another mode of financing where the commodity involved is manufactured to the specifications of the purchaser. This is widely used in the housing finance sector, where the client seeks finance for the construction of a house. The financier may undertake to construct the house on a specified land either belonging to the client or purchased by the financier, on the basis of Istisna with payment fixed in whatever manner the parties may wish.
Sukuk is the Islamic equivalent of bonds and they are similar to asset-backed securities. Whereas a conventional bond is a promise to repay a loan, Sukuk constitutes partial ownership in receivables In practice, Islamic finance often involves structuring transactions in a manner that closely mimics conventional finance insofar as a periodic rate of return is provided. In certain types of Sukuk instruments, a predetermined rate of return is often paid to the investor; this rate is based on the expected return of the underlying assets that collateralize the Sukuk. In the case of debt-like financing by Islamic banks, interest is not charged; instead, debtors will provide predetermined and periodic payments to the bank, based on the expected profit that would accrue to the underlying asset (in the case of a capital investment), or on the rent that might be charged for the use of the underlying asset (in the case of a home or car loan)
Musharakah and mudarabah can be used for short, medium and long-term project-financing, import-financing, export financing, working capital financing and financing of single transactions. Diminishing musharakah can be used for large fixed assets such as houses, transport, machinery, etc. Murabaha can be used for purchases of goods needed by the bank’s clients. Salam is useful for financing farmers, trading commodities for the public and private sectors and other purchases of measurable and countable things. But it must be kept in mind that buyback and rollover modes may not be used, because they are seen as a back door to interest.
The Laws Regulating Islamic Banking in Nigeria
The Banking system in Nigeria is generally regulated by Banks and Other Financial Institution Act (BOFIA), Cap B3 Laws of the Federation 2004; Central Bank of Nigeria Act (CBN Act) 2007; and Companies and Allied Matters Act (CAMA) Cap C20 Laws of the Federation 2004. Over the past years, Nigerian authorities have announced a number of regulatory initiatives that will prepare the landscape for the development of a strong Islamic finance hub. They are:
- Guidelines for the Regulation and Supervision of Institutions Offering Non-Interest Financial Services in Nigeria.
The Guideline is issued pursuant to the non-Interest banking regime under Section 33 (1) (b) of the CBN Act 2007; Sections 23(1) 52; 55(2); 59(1)(a); 61 of Banks and Other Financial Institutions Act (BOFIA) and Section 4(1) (c) of the Regulation on the Scope of Banking Activities and Ancillary Matters, No. 3, 2010. It shall be read together with the provisions of other relevant sections of BOFIA, the CBN Act, CAMA and circulars/guidelines issued by the CBN from time to time.
Under the Guidelines, the non-interest banking and finance models are broadly categorized into Non-interest banking and finance based on Islamic commercial jurisprudence, and Non-interest banking and finance based on any other established non-interest principle.
The non-interest banks are to be categorised into two, namely:
- National non-interest bank, which shall have a capital based of N10 billion and will operate in every state of the Federation including the Federal Capital Territory (FCT).
- Regional non-interest bank, which shall have a capital base of N5 billion, and will operate in a minimum of six states and a maximum of 12 contiguous states of the federation, lying within not more than two geo-political zones as well as the within the Federal Capital Territory.
A non-interest financial institution under this model will ensure that its Memorandum and Articles of Association (MEMART) state that its business operations will be conducted in accordance with the principles and practices of Islamic commercial jurisprudence. The institution offering Islamic financial services will transact business using only financing modes or instruments that are compliant with the principles under this model and approved by the CBN.
The Islamic bank may charge such commissions or fees as may be necessary in accordance with the principles under the Guideline and the Guide to Bank Charges. The funds received as commissions and fees shall constitute the bank’s income and shall not be shared with depositors.
In view of the provisions of Section 39 (1) of BOFIA, the registered or licensed name of an Islamic Bank shall not include the word “Islamic”, except with the consent of the Governor of the CBN. The financial institution shall, however, be recognized by a uniform symbol designed by the CBN. All the signages and promotional materials of Islamic financial institution shall bear this symbol to facilitate recognition by customers and the general public.
An Islamic financial institution shall ensure that relevant disclosures are made to Profit Sharing Investment Accounts (PSIA) holders in a timely and effective manner and also ensure the proper implementation of investment contracts. Also, they are expected to inform its prospective PSIA client(s) operating under profit-sharing, loss-bearing contracts, in writing that the risk of loss rests with the client(s) and that the institution will not share in the loss unless there is proven negligence or misconduct for which the institution is responsible.
Pursuant to this Guideline, there are only two institutions that currently provide Islamic finance services in Nigeria – Stanbic IBTC, a unit of South Africa’s Standard Bank, and Jaiz Bank, a full-fledged Islamic lender which has operated in Nigeria since 2012. Sterling Bank has been granted approval in principal to launch an Islamic finance arm.
- Guidelines on the Regulation and Supervision of Non-Interest (Islamic) Microfinance Banks in Nigeria.
In April 2017, the CBN issued the Guidelines on the Regulation and Supervision of Non-Interest (Islamic) Microfinance Banks in Nigeria. This Guideline is to provide a level playing field for the conventional microfinance bank and the non-interest (Islamic) microfinance bank. It provides the standard operating procedures and other operating requirement that operator of Islamic microfinance bank ought to comply with.
Despite the innate restrictions in Islamic banking, there is a room for the market to grow. Islamic financial institutions present various products and services that can cater for the needs of the banking public Nigerians as captured herein.
As expected, the introduction of the Non-Interest (Islamic) Microfinance Banks in Nigeria is expected to engender a wave of healthy competition in the microfinance industry which will bring about a possible reduction of interest rates. This will help drive the Nigerian economy and ensure its steady growth considering the fact that Nigeria not too long ago was in recession.
As an alternation to the established conventional banking system, the Non-Interest (Islamic) Banks in Nigeria will give opportunities to non-Muslims. Though Islamic finance is based on a religious law, the opportunities therein are not just for religious faithful. It is a business activity open to all segments of the society.
As captured earlier, charging and paying interest is banned under Sharia law, Islamic finance institutions instead invest in infrastructure or other types of projects and share risk and earning with the clients.
The opinions in the articles are for general information purposes only and do not form a legal relationship or be taken as legal advice. To explore legal advice, please consult your solicitor or feel free to get in touch with us directly.