Shari'ah compliant financial services present potential for African development

Nov 20, 2018

Banks, especially in Africa with its large Muslim population, can afford to be a lot more innovative in developing the structures and skills to unlock the full potential of Shari’ah-compliant financial services to drive Africa’s growth.   

In a recent IMF survey of 140 000 Africans, 5% responded that they did not access financial services for religious reasons. Five percent of Africa’s 650 million Muslim population is 37.5 million people. In addition, it is estimated that, globally, there is over US$30bn in funds potentially seeking Shari’ah–compliant investment opportunities. With Thompson Reuters’ research showing that a full third of the world’s top Islamic finance markets are in Africa, this means that a full third of the global capital seeking Shari’ah opportunities have the potential to be deployed in Africa.

“These figures give an indication of the size of the potential for Shari'ah finance to drive financial inclusion and economic growth on the continent,” says Ameen Hassen, Head of Shari’ah Banking, Standard Bank Group. 

While the potential of Shari’ah finance in Africa is vast, the challenges that have prevented the development and growth of a much bigger Shari’ah finance sector are equally as real. 

The concept of Shari’ah finance, in which money is not recognised as an asset, has existed since the dawn of Islam. Shari’ah-compliant financial services were, however, only institutionalised about 50 years ago. This means that for most of the last one and half millennia many Muslims consciously avoided banking institutions since, “the only formal finance structures available were not compliant with the Shari’ah and were therefore not able to be used by those who followed this body of law,” says Mr Hassen. 

Today, despite the existence of institutionalised Shari’ah-compliant financial services, its practical application and take up, especially in Africa, still faces many challenges.  

Under Shari’ah only objects specifically defined as having intrinsic value are recognised as assets. Money is not recognised as having any intrinsic value under Shari‘ah and cannot be used as an asset. As such, under Shari’ah when a client wishes to buy a house, for example, the bank does not lend money to the client as money is not recognised as an asset. Instead, under Shari’ah the bank buys the house for the client. The client then rents the house from the bank, buying back units of the house from the bank over a specified term. 

In short, by restructuring the contractual arrangement between the bank and the client - into a physical property rental contract - “banks can provide access to Shari’ah-compliant financial services to those almost 37 million people on the continent currently unable to use traditional loans for financing,” explains Mr Hassen. 

The drawback, however, is that this restructuring of the contract has the potential to make the Shari’ah transaction more costly than the conventional financial instrument, or bond. This is because the asset, or house in this case, needs to be bought twice – once by the bank and then again by the purchaser. This incurs a double transfer and triggers VAT events by virtue of rent being a vatable item. 

Instead, for Shari’ah to be effective in the market place legislation has to be changed to allow parity between Shari’ah and conventional contracts, so that neither party is prejudiced in terms of cost. This need to change legislation or develop new and separate legislation has traditionally been a hurdle to the adoption of Shari’ah banking across much of Africa. 

That said, South Africa successfully developed and adopted Shari’ah legislation in 2010. Today, similar legislation exists in ten other African countries. The fact that Shari’ah legislation has only recently been adopted in Africa – with a number of significant African markets yet to enable Shari’ah financing - accounts for its relatively slow uptake. 

And even where the ability to conduct Shari’ah transactions exist, uptake has not been as widespread as anticipated. This is because many clients who wish to use Shari’ah compliant products and services are, “currently waiting to run down their existing conventional financing contracts before they commit capital to Shari’ah-compliant structures,” says Mr Hassen. 

While these are some of the challenges facing the uptake and execution of Shari’ah financing at the individual and business level in Africa, “a huge second opportunity for the rapid growth of Shari’ah finance exists at the sovereign level,” says Mr Hassen. 

This potential was demonstrated by Standard Bank’s role as lead arranger in South Africa’s inaugural US$ 500 million Sukuk, or sovereign bond, in 2014. This transaction opened South Africa for the first time to Shari’ah-compliant investors – and capital - from the Middle East and the Gulf.  

Beyond sovereign or Sukuk bonds, however, the potential of Shari’ah finance to support development and growth in Africa is even broader. 

Sovereigns generally approach capital markets either for funding general expenditure, or to fund infrastructural development. Since Shari’ah recognises certain ‘intangibles’ as having intrinsic value, correctly structured Shari’ah debt instruments can be used to fund infrastructure development as well. 

Thomson Reuters research shows that 25% of investors would like to see these structures in the market. Also, “the existence of more Shari’ah–compliant investment options have the potential to channel significant Middle Eastern and global funds to Africa,” says Mr Hassen. Yet despite this huge appetite and potential, “the dearth of subject matter expertise able to develop these alternative Shari’ah structures is limiting the potential of Shari’ah finance to drive much higher levels of development in Africa,” says Mr Hassen.  

As Africa’s largest bank by assets and present in 20 markets across the continent, Standard Bank is building the infrastructure to provide Africa’s Muslim population with Shari’ah-compliant financial services. This is set to significantly expand financial inclusion on the continent by empowering a previously largely excluded segment of economically active African’s with access to finance. At the same time Standard Bank is conceiving and building a Shari’ah-compliant debt capital markets infrastructure in Africa capable of supporting African sovereigns access wider pools of global capital in their drive for higher levels of growth and development. 

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