Islamic banking can play an important role in financing infrastructure growth

Shariah-compliant financial structures and products are growing and rapidly becoming an integral part of the mainstream global economy and changing the financial landscape.

Considering the growing share of the global gross domestic product of the predominantly Muslim countries and their huge youth population, there is certain to be more demand for Shariah-compliant products and solutions in the coming years.

One key area that has witnessed accelerated development is the global Sukuk market, which is valued at Sh24.5 trillion ($270 billion) and is outstanding as a unique platform for enhancing greater integration of the global economic and financial systems.

WIDE RANGE OF BENEFITS

Sukuk is the equivalent of a bond and is appreciated as a document or certificate, which represents the value of an asset.

It offers a wide range of benefits to the economy in terms of liquidity management, fundraising, balance sheet management, and securitisation.

It can serve as a tool for fundraising to fulfil corporate objectives. It offers solutions to a company that needs an optimum balance between debt and equity and can also be used to unlock funds tied up in assets through monetisation for the purpose of reinvestment.

In the conventional financial markets, firms or borrowers engage banks to access loans or tap into the capital markets.

Bonds serve as evidence of a loan from an investor to the issuer and the repayments reflect both the loan capital as the principal and the interest.

Bond issuance conflicts with Shariah principles, which dictate that loan contracts be devoid of interest.

The other instrument often used in the conventional debt market is asset-backed securities (ABS), in which the owners of an income-generating pool of assets — or originators — sell their assets through a securitisation or monetisation transaction.

The repayments to the investors are realised from the cash flows generated by the asset under the ABS structure.

While Shariah-compliant structures do not allow the sale of conventional debt, the ABS market has a significant proportion of assets with underlying receivables that may include mortgage, credit cards, and other loans.

The structuring of Sukuk is based on the relationship in the primary market. If the investors’ interest is to enjoy returns, then the primary relationship cannot be a loan transaction. In addition, the underlying asset should not include receivables that are traded at a discount or premium.

There is a need to appreciate the underlying asset and the fact that Shariah standards do not allow the secondary trading of Sukuk that is represented by debts.

There is also asset-based and asset-backed Sukuk, whose difference is reflected in the role of the asset in the structure and recourse available to the holders in the event of default. In asset-backed Sukuk, the underlying assets are the sole recourse for the investors.

LIMITS OVER-EXPOSURE

In the asset-based Sukuk, the holders may not necessarily obtain the asset in case of default unless the assets are charged as security.

Sukuk offers investors an opportunity for diversification into multiple asset classes.

Since Sukuk operates on the basis of underlying assets, it limits the opportunities for over-exposure in accessing financing beyond the value of the underlying assets, thus reducing the prospects of over-indebtedness and its harsh consequences on the stability of the financial market.

It also allows investors to participate directly in the projects and enjoy the beneficial ownership in underlying assets, with the right to receive a share of rental income or profits while at the same time bearing the associated risk of ownership.

Given the huge financing requirements for infrastructure development and the competing needs of government budgets, Sukuk markets have the potential to be a good source of funding for long-term projects.

The government should put in place the appropriate legal, governance, and regulatory framework to facilitate the issuance of Sukuk.

The proactive management of the tax regime can foster the growth of the Sukuk market to complement other initiatives that seek to channel the world’s growing pool of Shariah-compliant capital.

The writer is the Head of Islamic Banking at Kenya Commercial Bank Group. ([email protected])