Will Islamic banking meet the expectations of Ugandans?

By Nathans Sunday

Islamic Banking (IB) continues to become an integral part of many financial systems worldwide.

In Uganda, IB is gradually being adopted with some banks having expressed interest in providing Islamic banking services. The expectations from Islamic banking services are high and continue to grow among the business community, private sector and the country at large.

Given that IB transactions do not involve interest charging, it's anticipated that businesses that are constrained from accessing low cost and affordable credit due to high interest rates will be able to access credit. IB is also expected to lead to a fall in the lending rates of the conventional banks due to competition. At macro level, cheap and affordable credit is expected to attract foreign investors which will result into creation of jobs and more growth.

Notwithstanding the above expectations, the question of whether IB will succeed and really meet these expectations remains something to ponder about. The feasibility and sustainability of IB in Uganda is likely to be jeopardized by a number of issues. First, absence of Islamic financial markets in Uganda which will make it difficult for the banks offering IB services to invest excess liquidity and therefore, compromise their profitability and effectiveness in performing risk and maturity transformation.

Secondly, Inefficiencies in the legal system in handling the disputes arising from sharing of profits and losses may also be a great impediment to IB in Uganda. Thirdly, given operational differences between conventional and Islamic banking services, it's going to be difficult for banks offering IB services to fit into the current regulatory framework for the banks since some of the regulatory instruments do not comply with IB.

For instance, by the nature of operation of IB, there is nothing like interest on income which other conventional banks are required to report. Fourth, although the Financial Institutions (Islamic Banking) Regulations 2018 provides for an Islamic window for conventional banks, such banks are likely to use conventional deposits for Islamic banking at least in the short term.

This might affect their solvency since the banks have to pay interest on the conventional deposits. In addition, the regulation is silent about Sharia-compliant deposit insurance which is important for depositors.

Therefore, for IB to be successfully adopted in Uganda's financial system, government needs to ensure a supportive legal and policy environment. For example, civil courts need to be sufficiently acquainted with the rationale and operations of IB in order to ease handling of any disputes that may arise between the customers and the banks.

Conventional financial institutions that intend to adopt IB should be compelled to demonstrate adequate level of liquidity other than the conventional deposits to avoid running a risk of using conventional deposits for IB. Initiation of Islamic money and capital markets would also be of great importance to the operation of Islamic banks in Uganda.

Sharia Supervisory Boards both at the central bank and financial institution level need to be comprised of individuals who are conversant with the rules which govern economic and civil dealings in Islam. Additionally, being that Uganda is not an Islamic State, can it be assumed that such credit will be availed to non-Muslims, as long as they operate businesses that abide by Islamic values?

There is need to clarify the criteria for accessing this type of banking, since it is based on Islamic values that a large section of the Ugandan society does not subscribe to.

The writer is a research associate with Economic Policy Research Center