ISLAMIC FINANCE IN NIGERIA: ISSUES AND CHALLENGES

SO much interest has been generated in Islamic Finance on a global scale because of its phenomenal growth within a relatively short span of time, and more especially, as an aftermath of the recent financial crisis.

On a regional and sub-regional plane several countries are struggling to become the hub of Islamic Finance in African continent or in the West African Sub-region or at least to become pioneers in the field.

On the national scale, market operators including banks, insurance companies and asset management entities are busy exploring this alternative financial model and its potentialities, and most recently regulators, are gearing up to the role that they have to play in regulating and supervising this innovative financial service industry, whose entry into the Nigerian economic arena is only a matter of time.

These and many other considerations make the topic of my presentation to such a forum of financial correspondents and editors quite relevant to this workshop, not only for the benefit of closing the information and knowledge gap, but also to complement financial regulators' efforts in creating a much-needed public awareness and promotion of a nascent  global  financial  industry  that is rapidly  asserting itself as a virile and vibrant alternative to conventional  finance.

The paper is structured into eight sections. The foregoing is the introduction.

Section 2 introduces the concept of Islamic Fiannce, followed by Section 3, which addresses the main differences between Islamic Finance and Conventional finance. Section 4 explores the contemporary global trends in Islamic Fiancé, and Section 5 presents the efforts at institutionalising Islamic finance in Nigeria. In Section 6 and 7 the potential impact of Islamic finance on the Nigerian economy and the challenges are discussed respectively, while Section 8 concludes the paper.

Concept of Islamic finance
Islamic finance is a financial system that is based on adherence to the Shariah or Islamic law. It offers services, products and instruments based on compliance to this Divine Law.

Central to the precepts of the Shariah regarding all commercial and financial transactions is the prohibition of the following actions.

• Prohibition of Riba, which is usury or interest. The Sahariah, just like the teachings of the Old Testament, and the early position of the Christian Church as contained in the First Ecumenical Council of Nicea in 325 AD and the Second and Third Lateran Council l (1139 and 1179 respectively), all prohibit the use of and association with interest. The rationale for the prohibition of interest and a critique of interest is beyond the scope of this paper.

Former President Obasanjo, speaking in 2000 about Nigeria's mounting debt to international creditors said, 'all that we have borrowed up to 1985 was around US$5 billion, and we have paid about US$16 billion. Yet we are still being told that we owe about US$28 billion. The US$28 billion came about because of the injustice in the foreign creditors' interest rates. If you ask me what the worst thing in the world is, I will say it is compound interest.' Well it is both simple and compound interest that is evil.

• Gharar is the next most important prohibition in Islamic transactions and contracts. Gharar means lack of certainty. Its prohibition stems from informational asymmetry and refers to any uncertainty created by the lack of information or control in a contract or its conditionalities. This includes want of knowledge over the subject of the contract, or the nature of the contract, or the price to be paid - its nature, amount, or period of payment. It also includes cases where the subject of the contract is something over which neither party has control.

Classic examples include transactions involving the sale of birds in flight or fish not yet caught or an unborn calf in the mother's womb, or a runaway animal. More modern  examples include  transactions  where the subject is not in the possession of one of the parties and there is uncertainty  even about its future possession, as is the case with speculative  contracts.

This prohibition of Gharar is considered to be the prohibition  of risk or the prohibition of derivative  instruments in today's financial  markets, which are designed to transfer risks from one party to the other. (zamir Iqbal, Abbas Mirakhor: 2007).

• Prohibition against gambling (maysir). Gambling represents an unproductive exchange of property, and in every transaction involving gambling one side wins and the other side loses. It is a clear case of squandering people's wealth unjustly, and its prohibition is unequivocal  in the Qur'an and Sunnah  (sayings, actions and approvals of the Prophet of Islam, peace be on him), which are the two main sources of the Shariah.

• Prohibition against the sale or purchase of unlawful goods and services. Examples include pork, alcohol, pornography, tobacco, narcotics and any item that is deemed harmful and unlawful  according to the Shariah. This, therefore, imposes the need to screen all transactions and activites through moral and legal filters based on the Shariah, which is largely equivalent to the western concept of socially responsible or ethical investing. These provisions combined together form the bedrock of Islamic finance.

As the alternative to interest-based lending, Islamic Finance adopts asset-backed financing. This type of financing uses a number of instruments of finance. Among them are the following:

• Musharakah, which involves partners providing funds for a venture, with profits shared according to their invested capital, and the loss is borne by them in the same way;

• Mudaraba h financing is when one partner gives money and the other party provides his entrepreneurship to invest and manage the project. When a financier contributes money on the basis of these two instruments, the money is converted into assets having intrinsic utility.

Profits are generated through the sale of these real assets, and all parties share in the risk and reward, as opposed to what is obtained in interest-based financing, where the financier does not bear any risk of the venture or project, but gets his reward come what may.

• 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.

• Murabaha, though originally, a particular type of sale and not a mode of financing, it is nevertheless used for financing subject to conditions. Murabaha is kind of sale where the seller expressly mentions the cost incurred by him of the commodity offered for sale, and sells it to another purchaser by adding some profit or mark-up thereon. The payment can be on the spot or deferred or instalmental. Murabaha , as a mode of finance is used to finance raw materials, inventory, equipment, asset financing, import and export financing, consumer goods financing, even working capital financing.

Furthermore all services that can be sold in the form of a package, like education, medical, tour etc can be financed through Murabaha.

• Ijarah is the hiring of the services of person, or the transfer of the usufruct of a property in exchange for a rent. The second type of Ijarah is the one that is used as a mode of finance, though originally not being a mode of finance. It has many features similar to a financial lease. It has also been used as a basis for securitisation helping to create a secondary market for financiers.

All these modes of finance involve the transfer of assets and are not based on making money from money alone as is the case with interested-based transactions. From the prohibition of dealing in unlawful goods and services and from the other prohibitions, we can see that Islamic finance is an ethical finance and investments and activities are socially responsible.

Furthermore, Islamic Finance is a socially inclusive financial system, which is another point that makes this topic on Islamic Finance very relevant to the theme of this workshop, which is about financial inclusion.

A primary determinant of the soundness of a financial system and its stability is the public trust and confidence in its institutions and markets. Within a large a segment of the Moslem community, compliance of financial services with Shariah rules and principles is a primary concern for the users of these services.

As such efforts to enhance the access of Moslem community and societies to these services will depend, among factors, on the extent of the compatibility of these services to their religious beliefs.

'In other words successful, financial sector development in countries with such communities requires the promotion of Islamic financial services within appropriate regulatory frameworks. Such strategies will enable a much larger proportion of the population all over the world to participate actively and effectively in the process of economic development.

'While catering to such specific needs of society, Shariah-compliant financial services could appeal to other segments of the population so long as the quality of these services could appeal to other segments of the population, so long as the quality of these services is at least comparable with other alternatives.'

This concept of financial inclusion is what informed the UK government decision to support the development of Islamic finance in the UK (Mohammed Amin, British Government Policy on Islamic Finance, 6th World Islamic Economic Forum, May 2010), and it also informed the decision of the FSS 20:2020 of Nigeria vision to include the development  of Islamic Finance as one of its initiatives as will be mentioned later.

Global trends in Islamic finance
The Islamic Financial Services Industry (IFSI) is passing through its 40th anniversary. During those years it has gone a long way in spreading geographically, and offering a wide range of financial services in various segments including banking and non-banking services, insurance and capital market. The composition of this industry is as follows:

• Islamic banks - that is, deposit-taking and financing institutions, including full-fledged Islamic banks, Islamic subsidiaries and 'windows' of conventional banks such as onshore and offshore commercial and investment banks.

• Islamic non-bank financial institutions, including Islamic leasing and factoring companies, finance companies, ijarah and mudarabah companies, Islamic housing  co-operatives, Islamic  microfinance  institutions, credit sale subsidiaries of trading companies and other similar institutions, and private equity/venture capital, as well as, institutions managing  haj funds, awqaf, zakah and sadaqah.

• Islamic insurance and re-insurance or takaful and re-takaful, operators.

Islamic capital markets and their players, such as brokerage houses, investment banks, etc., as well as, fund management institutions including Islamic asset management companies (such as mutual funds/unit trusts, hedge funds, etc.), and Islamic financial architecture and infrastructure, including payment-settlement systems and infrastructures, financial markets and products, including market microstructures (Shari'ah screening and product identification systems), trading and clearance systems, and e-business infrastructure;

support facility providers, legal institutions and framework, safety net, liquidity support providers.

Regulators and supervisors, including licensing authorities; governance infrastructure, including Shari'ah governance institutions, standard setters for financial supervision and infrastructure, including financial reporting, accounting and auditing, capital adequacy and solvency, risk management, transparency and disclosure, and corporate governance, rating and external credit assessment institutions, financial statistics and information providers;

(source: Islamic Financial Services Industry Ten-year Framework)

The Islamicbanking sector worldwide has grown at a strong rate of 15 per cent-20 per cent annually over the past decade, from about USD 150 billion in the mid-1990's to an estimated USD 780 billion in 2009. In 2010, the Islamic Banking sector assets are expected to grow by more than 20per cent to USD 950 billion.

The Islamic Financial Service Board (IFSB) expects the global Islamic Finance assets to reach USD 1.6 trillion by 2012, with Islamic Banking expected to remain the major contributor at more than 80per cent share.

Islamic Finance is rapidly growing across the globe, with presence in Europe, the Middle East, Asia, North America and Africa.

There is also a manifest upward momentum of its assets and revenue growth, which indicates as the Banker magazine says, 'that Islamic finance is not simply weathering the financial storm, it is moving forward to a new level of industry maturity that will test the long-term viability of the industry and the sustainability of the institutions engaged in Sharia-compliant finance.'

The enactment of the Bankers and Other Financial Institutions Decreed of 1991 (Amended). This Decree recognises banks based on profit and loss sharing and empowers the governor of the Central Bank to expect such banks together with Community banks from the provisions of the Decree (see 52). The Decree also recognises 'specialised' banks and includes in the definition such other banks as may be designated from time to time (Sec 61). It however, proscribes the incorporation or registration of any bank with a name, which includes the words, 'Islamic,' 'Christian,' 'Qur'anic,' 'Biblical' etc.

Habib Bank Plc opened a non-interest banking window offering a limited number of Shariah-compliant products. However, since there was no framework for non-interest banking in the country, the attempt did not register a significant success nor growth.

Nigerian under President Olusegun Obasanjo joined the Islamic Development Bank as a full-member.

An Approval-in-Principle (AIP) was granted to the proposed Jaiz Bank Plc to operate a full-fledged Islamic bank on meeting the mandatory capital requirement of N25 billion.

The Financial System Strategy (FSS) 20: 2020 was launched. This blueprint aims to engineer Nigeria's evolution into Africa's major International Financial Centre (IFC) and enable Nigeria's transformation into one of the 20 largest economies in the world by 2020. Among its initiates regarding the Money Market is

(a) to create institutions to attract the huge un-banked informal sector.

(b) create non-interest banking instruments to capture huge

unbanked segments of the society.
•  The Islamic Development Bank offered the Central Bank of Nigeria a Technical Aid grant for training Central Bank examiners for the development of a framework for the regulation and supervision of Islamic finance in Nigeria, and for the organisation of an International Conference on Islamic Finance in Nigeria.

•  The Islamic Finance Working Group was formed. Supported by EFInA (Enhancing Financial Innovation and Access), this group brought together the main stakeholders, which include the NDIC, NAICOM, PENCOM, DMO, market operators interested in offering Islamic finance products and the a representative of the central Bank as an observer. EFInA was conceived and funded by the UK Department for International Development (DFID), the Ford Foundation and the Bill and Melinda Gates Foundation to promote financial development in Nigeria.

In January 2009, the Central Bank of Nigeria under Prof. Charles Soludo, joined the International Financial Services Board (IFSB) as full member. The IFSB is an international standard-setting organisation for the Islamic Financial Service Industry and is based in Malaysia.  It comprises of central banks of several countries and the other

regulatory and supervisory bodies and multilateral organisations like the Islamic Development Bank, the IMF and World Bank (the last two are associate members).

In March 2009, the Banking Supervision Departmentof the CBN released the

exposure draft of the Framework for the Regulation and Supervision of Non-Interest Banks in Nigeria for comments, suggestions or inputs by stakeholders.

October 2009, University of Ilorin held an International Conference on Islamic

Finance jointly organised by the Department of Islamic Law of the

University, and the Islamic Research and Training Institute

(IRT) of the IsDB, Jedda, Saudi Arabia.
January 2010, the CBN under Governor Sanusi Lamido Sanusi, set up a non-interest banking unit in the Financial Policy and Regulation Department of the Apex Bank. Conventional banks are requesting for regulatory approval to introduce Islamic financial products into their market offerings. Some banks have even gone ahead to appoint Sharia Advisory Committees in accordance with international governance standards for Islamic Financial Institutions.

July 2010, CBN is represented in the Technical Committee of the IFSB.

August 2010, the CBN released the new banking model, which designated non-interest banks among the specialised banks. 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.

September 2010
• The Nigeria Deposit Insurance Scheme (NDIC) released its draft framework for a Non-interest (Islamic) Deposit Insurance Scheme for stakeholders comments and inputs.

•  The Security and Exchange Commission posted on its website regulations guiding funds and securities, which included Islamic fund management.

•  The Debt Management Office (DMO) set a tentative timetable for the development of the first Sukuk (Islami bonds).

October 2010
• The CBN under Governor Sanusi Lamido Sanusi joined 11 other Central Bank and 2 multilateral organisations to form the International Islamic Liqudity Management Corporation (IILM), to be based in Malaysia.

The central banks are Malaysia, Kuwait, Luxembourg, Saudi Arabia, Iran, Mauritius, Nigeria, Qatar, Sudan, Turkey, UAE, Indonesia; and the multilateral organisations are: the Islamic Development Bank (IsDB) and the Islamic Corporation for the Development of the Private sector.

The aim of the IILM is provide treasury instruments that are Shariah compliant to address the liquidity management issue of Islamic banks and serve as instruments for open market operations involving Islamic financial institutions.

With these landmarks all we are awaiting for is the release by the Central Bank of the final framework for the regulation and supervision of non-interest financial institutions in Nigeria and other guidelines for the sound and efficient operations of this nascent sector.

Section 6: The potential impact of Islamic finance on the Nigeria economy.

Given its transaction dynamics and unique features, there is no gainsaying the fact that non interest banking would have significance impact on the Nigerian banking system and the economy as a whole. The following areas of potential impact are clearly discernible.

Market deepening
The introduction of non interest banking in Nigeria would herald the entry of new market and institutional players such as the Islamic Money Market, Islamic asset management companies, Takaful (Islamic Insurance) companies etc, thus deepening the financial market.

Financial inclusion
The introduction of Islamic financial services in Nigeria will enable a larger proportion of the Nigerian population to participate actively and effectively in economic development. Nigeria has a very large Moslem population (estimated at over 80 million) majority of whom are either under-banked or totally unbanked, and have steered away from conventional banking service due to their aversion to interest-based products and services offered by these banks.

The financial inclusion of such a sizeable number into the economy, and winning their trust and confidence in the financial institutions based on their religious belief will go a long way in strengthening the resilience and stability of the financial system. Furthermore, such an inclusive financial sector development strategy can be expected to replace informal markets with formal and regulated ones.

Monetary policy implementation and effectiveness.
The non interest banks cannot hold conventional treasure bills or other interest bearing securities and thus cannot participate in conventional Open Market Operations. This has implication for monetary policy and in the development of appropriate liquidity management products.

Enhance product offering
Islamic banks offer an array of products and services that cater to the financing needs of the banking public, as highlighted in the section on the concept of Islamic finance.

The entry of non interest banks is expected to engender a wave of healthy competition in the banking industry with a possible concomitant reduction of interest rates, which would have a salutary impact on the economy.

Non-Moslems are expected to patronise the system, as they have done in other economies, either based on the ethical and social responsiveness of its investment strategy, or based on their desire to explore an alternative to conventional finance. Islamic finance though based on a religious law, is not just a religions activity that adherents are the only expected people, who engage in it. It is a business activity open to all segments of the society.

• Umar is the special adviser to the CBN Governor on Non-Interest Banking.