Islamic finance: Challenges and opportunities

By Devin Jayasundera

With the country’s Islamic banking still at a low penetration level, experts point out that with the strategic position that Sri Lanka occupies in the region, it should make forays into Islamic capital market to reap full benefits of this industry.

Central Bank Governor Ajith Nivard Cabraal addressing the gathering

KPMG’s Global Head of Islamic Finance Neil Miller making a presentation

Islamic finance was introduced in 1997 with the establishment of Amana investments. From there onwards the Central Bank of Sri Lanka has made crucial steps in improving the industry especially with the amendment of the Banking Act No. 30 in 2005 where it allowed licensing of Islamic banks and Institutions.

Islamic banking in Sri Lanka has been able to stir interest in all communal groups of the country. The current non-Muslim consumer market in Sri Lanka constitutes more than 20% of the total Islamic banking market share.

The Islamic Finance Road Show was held yesterday amidst a large gathering of finance professionals. At the event issues, challenges and the future of the Islamic banking industry was discussed. In one of the highlights of the event was the address by Neil Miller, who is the KPMG’s Global Head of Islamic Finance. In his presentation Miller gave an in depth overview of the status of the Sri Lanka’s Islamic Finance market and the prospects of the industry.

Islamic finance in a global context

Currently the Islamic finance industry is valued at US$ 1.3 trillion according to KPMG estimates. Miller noted that looking at the forecasts of the industry indicate it could reach up to US$ 31 trillion in value by 2016.

“Islamic finance is not only banking, it also encapsulates Takaful, Islamic asset management, private equity and other investment products. A Deutsche Bank study suggests that in several developing economies, Islamic finance would grow to 13% of its total financial mediation,” professed Miller.

Currently the major country that practices Islamic finance is Iran, which is 100% based on Sharia planned economy and other countries are Jordan, Bangladesh, Turkey, Indonesia and Malaysia. These countries are predominantly Muslim majority countries.

With regard to secular countries, the UK has the highest in providing Islamic finance with 22 institutions. “In a period of four years around five companies started catering Islamic finance products,” said Miller, who stressed that the interest shown in Islamic finance around the world is wide and very diverse.

Is an Islamic capital market necessary?

Miller inquired whether adopting Islamic finance in the economic spectrum is worth the time and effort. “Regulators, local investors and governments to commit to an industry which they don’t have an understanding of the value statements or its value proposition. If you look at the questions the politicians are interested in, they tend to assess the inclusiveness of it, if it will create employment, if it will create a more attractive investment climate for countries. Then the private sector would have the questions of the profitability of the industry and whether it really enhances the reputation of the company, and the regulators would be concerned on what scale it should intervene and the upholding of ethics and morality of such intervention.”

He stressed that these questions are not only faced by Sri Lanka but all over the world and Miller asserted that Sri Lanka has the ability to face these industry constraints and challenges due to its strategic position.

“The Muslim population consists of the 25% of the world population and surrounding countries to Sri Lanka such as Bangladesh, Pakistan and Maldives are Muslim majority countries, therefore Sri Lanka is at the doorstep and could act as a regional hub for Islamic finance. This would enable the country to increase its FDI.”

Market readiness for Islamic finance

KPMG’s Global Head of Islamic Finance projected a market readiness matrix that assists to identify and analyse the challenges of implementing Islamic finance.

He listed recommendations for regulators and highlighted that regulators need to assert certainty in the market and thereby it will generate confidence and as a result investments will come in. He also made note that the Government should initiate and germinate by setting up pension funds and provide incentive products, would incentivise the private sector to enter and create real growth.

With regard to the private sector, he emphasised that it was essential to work alongside the Government. Miller stressed that the private sector has to evaluate feasibility and to understand whether it has the capacity to cater its product to go beyond the minority to the communal majority.

“In Malaysia the majority of people who are involved in Islamic finance belong to other faiths. In the UAE where there is a 14% non-Muslim population, they are financing their cars and homes through Islamic finance. This shows that Islamic finance is not linked purely to faith.”

He also insisted that the private sector should develop products and service their needs. “To do this you need to educate people and this is a huge human resource challenge many countries face today. This enables to manufacture and innovate products and improve the quality of service. Sri Lanka should look into bond products as sovereign Sukuk, which is highly attractive for investments.”

Miller termed Islamic finance as “commonly different”. Explaining this, he said: “Islamic finance is different from conventional finance and it has to maintain its difference and it has to do this in way that is common. This is one of the challenges and one reason is that within the spectre of Islamic finance still there is disparity. Therefore it’s highly essential that banks collaborate and come to a consensus on its operations.”

In his concluding remarks, Miller professed that many countries and banks especially in Pakistan, which has been very active in Islamic finance, have shown interest in investing in Sri Lanka and hope to collaborate with financial institutions here.

Optimistic macroeconomic environment

Central Bank Governor Nivard Cabraal who delivered the opening keynote speech briefed the audience on the optimistic macroeconomic environment of the country. He stated that the stable macroeconomic fundamentals of the country would enable the private sector to be more flexible in investing.

He noted that Islamic finance is gathering momentum in all parts of the world, where it has been an important window in financing and banking. “Several windows have been provided with our existing banks and new banks based on Sharia principles. These are laudable principles that need to be encouraged and other banks will hopefully adopt and follow these healthy policies.”

He also assured that the Central Bank would always strive to design the regulatory framework according to the timely needs and requirements of the industry.

Cabraal was awarded a memento for his efforts in developing Islamic finance in Sri Lanka at the event.

Pix by Upul Abeysekara