By Dr. Tumubweinee Twinemanzi
Islamic Banking has recently attracted media attention and generated animated commentary from the public. This debate about a new financial product or service is healthy and warranted. However there are some misrepresentations and falsehoods in this debate that need to be corrected. .
In line with its constitutional mandate, Bank of Uganda (BoU) worked with Parliament to ensure that legislation enabling the introduction of Islamic banking products in Uganda was enacted. Consequently the Financial Institutions Act 2004 was amended in 2016. The amendments included specific provisions allowing for the establishment of fully fledged Islamic Financial Institutions and for existing Financial Institutions to offer Islamic Banking alongside their conventional banking services.
But what then is Islamic banking? In essence, it is a banking system based on the principles of Islamic or Sharia law. It is underpinned in application by concepts derived from the Quran and the writings of Islamic scholars. These concepts revolve around the value of a sound currency and fairness in transactional dealings, the latter being structured within the bounds of Sharia law. Parties to any transaction in this banking system are obliged to conduct their business affairs, with a focus on what is permissible and lawful under Sharia law.
As indicated earlier, Islamic banking transactions are guided by morals and value system as derived from Sharia Law, and these demand: transparency and full disclosure between parties to a transaction; good faith in conduct by the parties to a transaction; and participation in transactions that do no harm to the wider society. Consequently, transactions in Islamic Banking are often viewed as a culturally distinct but religiously motivated form of ethical investing.
And last but not least, the central premise in Islamic Banking is that money, in of itself has no intrinsic value, but rather it must be used to generate income through trade and / or investment in tangible assets; whence it derives its value. Any gains arising from the trading are shared between the party providing the capital and the one borrowing the money and providing the expertise. In supplement to this fundamental premise, there are four key principles that provide additional anchor for this type of banking, namely:
a) Prohibition of payment and receipt of interest
Interest represents any fixed or guaranteed payment on cash advances or on deposits, therefore representing a sure gain to the lender regardless of the performance of the borrower’s business or commercial undertaking. This is precisely what Islamic Banking prohibits. However, Islamic Banks are permitted to engage in trade and commerce, and the value they create is through the profits earned in trading or participating in other forms of commercial enterprise. But this option is not available to conventional banks, since the value they create is through the earning of interest.
b) Mutuality of risk sharing-profit and loss
In Islamic Banking, the Banks and their customers are partners, and share in a predetermined and agreed ratio, the profits or losses arising from this “joint venture”. This of course demands full disclosure or rather minimal information asymmetry from both the lender and borrower with respect to the said transaction.
c) Prohibition of investment in harmful sectors / Businesses
Islamic Banking integrates Islamic moral and ethical value systems, and as such, prohibits the financing of harmful products and or activities. The definition of what constitutes harmful is derived from Sharia Law, and thus Islamic banks cannot therefore finance businesses such as casinos, nightclubs or any such activity.
d) Prohibition of uncertainty and speculation
There are strict rules in Islamic finance or banking against transactions that are highly uncertain or speculative or that may cause any injustice or deceit against any of the parties. For example: the sale of goods or assets of uncertain quality or delivery or payment; or contracts not drawn out in clear and unambiguous terms; are some of the many transactions prohibited under Islamic banking. This prohibition extends to transactions or contracts where uncertainty is combined with one party taking advantage of the property of the other, or where one party can only benefit when the other party loses. And by extension, speculative transactions are also prohibited since no asset is created.
How Islamic banking will operate in Uganda
In operation, Islamic Banks mobilize customer deposits and provide financing arrangements to customers by structuring various types of financial contracts. These contracts or transactions must uphold the four (4) key principles of Islamic Banking that were described earlier.
Mobilization of Deposits:
Under mobilization on deposits or funds, the existing legal and regulatory framework in Uganda allows for customer deposit mobilization through the following arrangements:
Profit Sharing Investment Accounts
These are akin to fixed deposit accounts in that the account holder allows the bank to invest the funds on their behalf either in projects specified by the account holder or in unspecified projects. The bank and the account holder share profits / losses arising from the investments.
Profit Earning Investment Accounts
These in operation are akin to savings accounts in conventional banking. With these accounts, the customer earns a profit on their deposits held with the financial institution.
Non-profit-bearing deposit accounts
These are akin to current accounts in conventional financial institutions. The depositor does not earn any profit on their deposits.
Disbursement of Credit: Regarding funds mobilized in a Sharia compliant manner, Islamic banks provide and extend Sharia compliant credit facilities in the following forms:
Sale Based Financing (Cost-Plus Mark-up); in this contract, the financial institution purchases an asset directly from a supplier and sells it to customer at a pre-determined price. The selling price includes the original cost plus a negotiated profit margin.
Lease Based Financing: where the financial institution purchases an asset directly from a supplier and leases it to the customer for a certain period at a fixed rental charge. The repayments made by the customer comprise the cost price plus the financial institution’s profit.
Equity Partnership: Financing; these contracts are based on Profit or Loss Sharing arrangements and they mainly take two broad forms: Trust Financing and Partnership as indicated below: i) Trust financing: The financial institution provides the entire capital needed to finance a project, and the customer provides the expertise, management and labor. The profits from the project are shared by both parties on a pre-agreed (fixed ratio) basis. However, in case of losses, the entire loss is borne by the bank.
ii) Partnership: These are similar to joint venture agreements, in which a bank and an entrepreneur jointly contribute capital and manage the business project. Any profit or loss from the project is shared in accordance with a pre-determined ratio. The financial institution would ordinarily terminate the joint venture gradually after a certain period or upon the fulfillment of a certain condition.
Regulatory framework: As indicated earlier, The Financial Institutions Act 2004 was amended in 2016 to enable Islamic Banking. The amendments therein included exemptions offered to licensed Islamic Financial Institutions with respect to restrictions on engaging in trade and commerce, activities not allowed for in conventional banks. Subsequently, Bank of Uganda issued the Financial Institutions (Islamic Banking) Regulations in February 2018 to cater for the technical aspects unique to Islamic financing, and to operationalize the amendments related to Islamic Banking in the Financial Institutions Act 2004.
This regulation covers the “how” and “what” for the licensing and regulation of Islamic banking in Uganda, and a proviso that outside of the specific exemptions granted in the amended Financial Institutions Act 2004, Islamic financial institutions are still bound to comply with all existing regulatory requirements.
One key requirement of the abovementioned Regulation is the establishment of a Shariáh Advisory Council (SAC) at the Bank of Uganda. This SAC is responsible for ensuring that all Islamic financial products presented and marketed as such, meet Shariáh based criteria for the said products and services. The establishment of this SAC should be concluded once consensus has been gotten with the relevant stakeholders.
Islamic Banking in Uganda, where we are today:
Various entities have expressed interest in establishing Islamic Banking entities in Uganda. Bank of Uganda is currently processing three applications: one for an Islamic products window by a locally domiciled conventional Bank, and two applications by foreign entities interested in establishing fully fledged Islamic Banks.
It should be noted that Islamic Banking is practiced in various jurisdictions around the World. In Africa, this includes countries like South Africa, Nigeria, Mauritius, Botswana, Kenya, Tanzania, Rwanda, Senegal, Algeria, Egypt, Sudan and Tunisia. The diversity of the dominant religious belief systems of the nations on the list above, underscore the fact that Islamic banking is not a preserve of Islamic states or nations.
The author is Executive Director Supervision, Bank of Uganda