Islamic Banking legalised; what does it mean and will it benefit Uganda?

By Abubaker B. Mayanja

Since Parliament has finally approved Islamic Banking, expect an increase in investment from numerous Islamic Banks that provide commercial services free from interest (Riba in Arabic) compliant with the religious tenets of Islam.

Islamic Banking is a non interest system for financing projects that relies on the viability of the project and less about collateral, facilitating direct trade finance and equity joint venture partnership. The bank is a partner to the corporation or entrepreneur and they share profits and losses.

Islamic funds undertake sustainable responsible investments (SRIs) in people over profit and have $60b of assets under management (AUM). They do not invest in sin industry; narcotics, gambling, alcoholic beverages, pork, cigarettes and arms.

I anticipate an increase in Capital inflow of $600m over the medium term; driven first by international banks that already include Islamic Banking products in their offering elsewhere. They enjoy the advantage of experienced expert knowledge. They will introduce them with special capital, as conventional deposits cannot be used given their interest bearing nature. 

The second wave will come from regional players that are already in the East African market. The third wave will come from the traditional Middle East players that possess substantial capital and knowledge but are experiencing business shrinkage due to the turmoil in their traditional markets in the Middle East. The fourth wave will be an expansion of Islamic finance system; insurance (Takaful), capital markets- sukuk bonds and funds, pension management, leasing (Ijara), mortgages and investment banking.
 
Uganda is late within East Africa, but possesses the key advantage of Islamic Development Bank (IDB) membership. That will easily turn it into the hub for Islamic banking in East Africa by attracting institutional technical support and long term capital from IDB giving it an edge over non member countries that legalised Islamic banking in East Africa. 
 
How do they operate? The best way to understand how Islamic banks operate is to break down some products. In an Islamic bank; the rate of return on a deposit is directly linked to the quality of the bank's investment decisions. The most common lending product is trade financing cost plus method (murabaha), the bank takes possession of goods and passes them to the entrepreneur at a markup that allows them to share profit.
 
The key principles that drive Islamic banks are; the prohibition of pre-determined loan repayments as interest (riba); profit-and-loss sharing; making money out of money is unacceptable; financial transactions must be asset backed; prohibition of speculative behaviour; only sharia'a-approved contracts are acceptable; the sanctity of contracts
 
Why do we need it? To increase inclusive savings and business financing emanating from more people accessing the formal financial system which some have avoided due to its incompatibility with non negotiable religious dicta. Islamic banking will allow acceptable savings products that reward risk better through a share of project profits and thus make more finance available for projects with better risk price characteristics.

A small open economy must attract new investment and expand exports to grow. Uganda needs capital for public and private projects. Islamic banking will trigger new investments that will attract job creating foreign direct investment. Foreign capital will ease large and growing current account deficit induced inflationary volatile shilling depreciation pressure through the capital account and directly expand financing and growth of our exports by investing long term and facilitating export trade.

 
How does it benefit the common man? Not collateral; but a productive profitable venture will be required to get finance that was not available before the law was passed. Islamic banks rarely issue consumer loans (Qard Al Hasan) that are not productive. If they do; they come with no interest at all as there is no profit to share!  

How does it benefit corporations? Competition breeds efficiency and a reduction of prices thus increasing investments and directly impacting on the bottom lines of corporations.  The loanable funds model predicts a reduction in price when supply increases which will certainly happen when the Bank of Uganda (BOU) implementation regulations allow Islamic banking operations.

Implementation will increase fiscal revenues and Sukuk bonds issuance will enable Government and municipalities to undertake infrastructure projects that benefit the economy by increasing public capital stock.

What are the facts? Islamic banks have existed for long and pose no risk to the financial system. What BOU needs to do to regulate and implement the law for our benefit is documented and practiced elsewhere. Mobilisation of savings to channel them to profitable investments (Financial Intermediation) is a key critical enabler of business capital formation and growth. New theories of growth emphasise increase in breadth and broadness of the financial system to unlock the potential of primary productive ventures for job creating GDP growth

The writer is a financial economist with ABL Dunamis
abm@abl.co.ug