Islamic banking given a blank cheque

Monday June 13 2011

By DAVID WANYOIKE [email protected]

The banking community has been waiting for the government to enhance the playing field for Islamic banking.

Unfortunately, they got silence from Finance Minister Uhuru Kenyatta on Wednesday which appears to say, “keep waiting.”

Has the government failed to recognise the immense potential in this financial segment?

Due to stiff competition, banks have been forced to rethink their strategies to remain competitive. One of the recent avenues that has Islamic banking.

Islamic banking is consistent with Islamic Shari’ah (law) and guided by Islamic economics. Islamic law prohibits the payment and collection of riba (interest or usury).

The argument against interest is that money is not used as a commodity with which to make a profit but that it should be earned on goods and services .

Islamic banking is based on ethics. Islamic Shari’ah allows all economic activities in the framework of protecting public interest.

For an investment to be legitimate, one of the most important requirements is that its outcome must fulfil the reality of investment transactions and that it enables the Islamic financial institution to state what it expects to make in profit.

Main conditions governing Islamic investment include: Money does not generate or beget money in itself, but it becomes productive if it is involving an activity or work; investment is subject to the rule of profit and loss sharing; investment in business activities is lawful, but prohibitions should be avoided; contracts must be free of gharar (uncertainty, ignorance and the conditions which lead to disputes).

Islamic banking has recently gained ground in Kenya, attracting a number of players. Currently, two fully fledged banks have been licensed.

In addition, many other commercial banks are offering Sharia-compliant banking products alongside conventional banking products.

In view of this, there have been calls for new legislation by banking players to enable companies to invest in this segment.

Is Shari’ah law recognised in Kenya? And do the Islamic banking products conform to Kenyan banking laws? These questions needed to squarely provoke the minds of the policy makers.

The jurisdiction of Kadhi’s Court which deals with matters involving Muslims does not extend to contractual relations in the context of financial relationships.

In essence, Kenyan law has for a long time not recognised Islamic financing. In order for Islamic banking transactions to be enforceable the transactions must conform to applicable laws in Kenya.

The government recently took some steps in recognising the special needs of Islamic banking and finance.

Through the 2010 Finance Act, Central Bank of Kenya Act was amended to accommodate Islamic banking products offered under Shari’ah law by introducing the concept of “return” as opposed to “interest”. Interest is applicable under conventional banking to mean return on deposits or charge to loans.

The amendment was just the beginning. More comprehensive changes are needed in banking laws to implement interest-free economic systems. Lack of the legislation has constrained its potential.

Among the significant changes that were expected in the budget is the legislation governing issuance and administration of Shari’ah-compliant debt instruments such as Islamic bonds and bills.

Its absence has prevented Islamic banks from investing in long-term and short-term government instruments putting them at a great disadvantage compared to their counterparts in the conventional commercial banking.

There were also expectations that new legislations would be passed to eliminate tax barriers and vagueness that may inhibit development of the Shari’ah-compliant financial operations. Relevant provisions under the tax legislation needed to be amended to bring clarity and ensure fairness.

For instance, is withholding tax applicable on a return paid by an Islamic saving/deposit account? Kenya could be squandering an opportunity to become the Islamic finance hub.

The writer is a tax manager with Ernst & Young. Views expressed here are not necessarily those of Ernst & Young.