Factors contributing to the growth of Islamic finance in Kenya

If they do not charge interest, how do they make profit? This is the question that lingers in the minds of most people who are accustomed to the traditional banking system when they hear about the Islamic banking model. The fact that such question is common attests to the novelty of the system in Kenya.

However, since the introduction of the system in the country, the growth of Sharia compliant products has been phenomenal. Islamic banking was widely practiced in the Middle East, Asia and parts of Europe such as the United Kingdom for the past 50 years. In Kenya, the first fully fledged Islamic banks were launched in 2008 even though a number of conventional banks were offering Islamic banking windows since 2005. The first to offer financial products compliant with the Islamic law was Barclays bank of Kenya, perhaps taking the cue from its parent in the United Kingdom where Islamic banking practice was already gaining acceptance. Barclays launched the La Riba account and was closely followed by KCB with Amana account. Today about 5 banks still offer Sharia compliant products along their mainstream banking systems.

Islamic banking defined:

Islamic banking is simply a system of banking that is consistent with the tenets of Islamic law (Sharia). The fundamental principle in Islamic finance is the prohibition of Interest (Arabic: Riba) which is viewed as usury. Islam prohibits the charging or paying of interest in all business dealings but highly encourages trade and profit sharing. Most Islamic Financing transactions are therefore based on trading and deferred exchange contracts. Mudarabah (profit sharing) and Murabahah (Cost Plus or mark-up) are two common financing structures offered by Islamic banks. Murabahah is where an intermediary (The bank in this case) buys a property with free and clear title to it. The intermediary and prospective buyer (bank customer) then agree upon a sale price (including an agreed upon profit for the intermediary) that can be paid through a series of instalments.

In the Mudarabah model, the bank and the client enter into a joint venture. The entrepreneur (client) provides management expertise while the investor (bank) provides the capital. The share of expected future profits between the bank and the client is agreed at the outset in any ratio mutually agreed to by the parties involved. In case of a loss, the bank bears all the losses since the entrepreneur who manages the business is deprived of a reward for his labour, time and effort. This arrangement is more equitable since both the bank and the client benefit or lose depending on the outcome of the business.

Depositors in Islamic banks can be compared to investors or shareholders, who earn dividends when the bank makes profit or lose part of their savings if the bank posts a loss. The bank pays hibah (gift) to its customers when it reports profit. This is unlike the contractual interest which must be paid regardless of the outcome.

Growth of Islamic financial services in Kenya.

Islamic finance is developing at a commendable rate in Kenya since its inception. Within one year after their launch the two fully fledged banks commanded 1% of the gross assets in the banking industry. Gulf African bank managed to break even two years after it was launched while First community bank took three years to report profit. Their conventional peers that were established at the same time are still struggling to register any meaningful profit.

Riding on the success of their banking products the two Islamic banks have diversified their financial services to include insurance and investment banking services. Both banks have fully owned subsidiaries of Takaful (Islamic insurance) businesses that were launched in early 2011. In March, 2012, First Community bank launched FCB capital, the first Islamic investment bank which is geared towards offering its customers investment opportunities that are in tandem with their faith.

This exponential growth has been facilitated by a number of factors which we shall discuss below.

Niche Market

Islamic banks curved for themselves a market niche that was previously untapped. Muslims shunned interest based banking since they could not reconcile their economic decisions and their faith under the interest based banking and were left with no option but to remain unbanked. Islamic banks filled this gap and the community was naturally drawn towards them. The Muslim population currently stands at about 5 million consisting of communities that are known for their strong entrepreneurial tendencies. The Islamic banks therefore thrived since they entered the market without much competition from the more established conventional banks. It must be noted that the banks have appealed not just to Kenyan Muslims but also to Non-Muslims looking for an alternative to the traditional banking model.

High level of trust:

Islamic banks have Sharia Supervisory boards that ensure the products offered by the banks are sharia compliant. The boards also audit the products to ensure that Islamic principles are implemented. The boards are made up of Islamic scholars who are well versed with fiqhula muamalat (Islamic jurisprudence) and Islamic law in general. They are well known to the Muslim community and they command a strong following. Even before the advent of Islamic banking they were widely consulted by the community for guidance on what constitutes lawful business investment or transaction. By having respected scholars in their management, Islamic banks have gained the trust of their customers. Trust is essential for any bank to prosper.

Government support

Kenya has positioned itself as the hub of Islamic finance in eastern and central Africa. Kenya was the first country in eastern and central Africa to amend the banking laws to accommodate Islamic finance. In the 2010-2011 budget former finance minister proposed further amendments to the banking Act and the Central bank laws to facilitate the flourishing of Islamic transactions in the country. Although, the Islamic finance sector still faces teething legislative challenges, the attitude of the government in embracing the idea has been positive. Central bank governor Professor Njuguna Ndung’u has taken a central role in the Islamic finance narrative. He has not missed an opportunity in praising the role of Islamic banks in bringing the unbanked to the banking halls and in painting a bright outlook for the future of Islamic finance in the country. The promotion of Islamic products is in line with the government push to increase cash flows from the Gulf countries. The government has already indicated its willingness to issue treasury sukuks (Islamic bonds) in the near future. Such facilities are meant to tap investments not only from the local market but also from investors in Muslim countries in the Middle East and Asia.

Personalised products

In addition to offering general products to their customers, Islamic banks also offer highly customised products that are hinged on their target customers’ faith and which facilitate Muslims to perform their religious obligations.

 One such product is the Hajj or Labeyka account which enables Muslims to save for the performance of annual pilgrimage to Mecca. Hajj or Pilgrimage is one of the pillars of Islam and must be performed at least once by those with the means. It is usually a life dream for Muslims and therefore the uptake of such products has been high. The banks have also come up with products that are geared towards empowering the vulnerable in the society like women and children. The Annisaa account enables women to save for their future. These products offer higher returns than the other accounts.

Low risk products

A study commissioned by the International monetary fund found that Islamic banks fared better than the conventional ones in the aftermath of the recent financial crisis. In the study “The effects of the global crisis on Islamic and conventional banks: A comparative study” the authors concluded that Islamic banks contributed to financial and economic stability during the crisis.

Gharar (uncertainty in the subject matter) and Meysir (Speculation) are forbidden. Thus transactions that are considered to have excessive risk due to uncertainty are not allowed. Falling in this category are derivatives such as forwards, options and futures. For this reasons, Islamic banks are more resilient to crisis. This model appeals to the majority of people who want stability and are generally risk averse.

Signs point to a continuing growth of Islamic finance not only in Kenya but the world over. Analysts believe that Africa is the next frontier for Islamic finance considering the large Muslim population after middles East and Asia. There is a growing business interaction between Africa’s middle class and the Middle East and Islamic finance can potentially play a part in facilitating more trade between Africa and the Middle East with the involvement of more Islamic banks from both regions.