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In an attempt to cover the current market opportunity prevailing in the Islamic banking and finance sphere in Sri Lanka, Redmoney Malaysia in association with Amana Bank facilitated a comprehensive forum titled ‘Islamic Finance News Roadshow 2013’. Attended by senior officials involved in conventional banking and Islamic banking systems, the event featured Central Bank of Sri Lanka (CBSL) Governor Ajith Nivard Cabraal as the keynote speaker.
Held in the country for the second consecutive year, the road show served as a platform for those involved in the industry to share their knowledge, and identify factors necessary for continued growth and sustenance for Islamic banking and finance in the nation.
Background of Islamic finance in Sri Lanka
Setting the stage for the conference to kick off, Amana Bank MD/CEO Faizal Salieh noted that Sri Lanka is an emerging market that has great potential since it is geographically well positioned to attract funding through Islamic banking. Pointing out that Islamic finance in the country is 15 years old, he shared how Amana Bank took the lead role at that time to establish this initiative.
Sri Lanka today has one fully-fledged Islamic bank, two domestic commercial banks with Islamic windows, a Takaful company, and several Islamic leasing companies. With the market potential estimated to reach US$ 1.5 billion, Salieh said: “Noteworthy is that an increasing number of individuals are opting for this finance type. We see a higher number of non-Muslims.”
Stating that the market is still fragmented and a number of challenges are yet to be addressed, he emphasised that the challenges lie in the areas of products, product development, liquidity management, levelling the playing field, integration to other sectors and taking the value proposition beyond Muslim customers. “A challenge faced by the country in the Islamic finance sphere is to communicate to the world what it wants to be. The industry has a lot to do to communicate to the local financial sector its value proposition first before getting across to the world,” he added.
Highlighting the progress made in Sri Lanka in Islamic finance since the first road show that was held last year, Salieh shared that a committee to standardise Islamic finance system was formed by the Banking Association of Sri Lanka where it has already made a proposal to the Central Bank of Sri Lanka to introduce a Sharia bank alternative tool to enhance market confidence.
Islamic finance as an avenue for economic growth
With Sri Lanka targeting an economic growth of 8%, CB Chief Cabraal said the country has to broad-base its instruments and requires partnership with new institutions to achieve this growth. According to him, with the current savings, the country will be able to achieve a sustainable growth of 4-5%.
Identifying Islamic finance as an avenue to reach the 8% target, he said: “The CB sees Islamic finance as an enormous opportunity for Sri Lanka and the world as well. We need to make the best use of this opportunity by opening up channels and allowing investors to enter the country with new instruments.”
Opining that Sri Lanka today is what Malaysia was 20 years ago, he stressed it is important for the nation to start early if it wants to witness progress in the Islamic finance sphere. “Unlike Malaysia, Sri Lanka did not plant trees 20 years ago. To ensure that our country moves forward in terms of Islamic finance, local companies should start planting trees today,” said Cabraal
Pointing out the post war progress of the country, he said while the country is on a massive infrastructure development drive, Sri Lanka has not left out the macro-fundamental elements. According to him, the platform is available, but it needs to be enhanced and protected.
He added that while Sri Lanka has been the fastest growing economy in the past four years, the Government has invested US$ 3 billion on infrastructure within that period. Cabraal noted that while the amount is equivalent to constructing 15 Colombo-Katunayake Expressways, the country chose to build and uplift provinces that were behind in terms of economic progress.
Stating that the country welcomes new businesses, he called for foreign financial institutions to support the tourism industry and the five hub concept which Sri Lanka is promoting aggressively.
“We brought into these sectors features that were not there before. Looking at Sri Lanka as a commercial hub, we see the country not only doing business within the country but outside the region as well. We highly encourage foreign institution to be a part of our progress,” said Cabraal.
Laying the foundation for long-term growth in Islamic finance
Taking into account Sri Lanka’s evolving landscape, KPMG Sri Lanka Managing Partner Reyaz Mihular asserted that to achieve sustained growth, short term routes don’t work. At a panel discussion at which Mihular was moderator, the role of Islamic finance and its impact in the economy was addressed.
Starting off, he pointed out that the Government is talking about huge infrastructure development to ensure that the country is ready for higher growth rates. While noting that the nation has not tapped into the large fund base in the Middle East as yet, he questioned what is required by Islamic finance to participate in this growth.
Amana Bank CEO Salieh said what Islamic finance requires is instruments. “The Sharia compliant investor is highly concerned about instruments and the challenge is to create these instruments in the right manner,” he stressed.
He stated that the economic landscape of Sri Lanka has many positives. The first is the political stability which is important for investor confidence. The second is the geographic position. He explained this by saying that unlike India, which according to him got its equation wrong with regard to Islamic finance, Sri Lanka was open to this new model and allowed it to take off.
“Now that we have started this (Islamic finance), we need to perfect it. It should be understood that unlike conventional finance where products fly, in Islamic finance it is not the case. It is important we get the equation right to have it accepted across all sectors,” asserted Salieh.
Highlighting the acceptance of instruments in the country, Muslim Commercial bank (MCB) Country General Manager Afzar Alam Nomani shared that the Pakistan finance institution has had a good experience from the liability products where there was no need for marketing of products. However, on the asset side, he said due to the stringent structure and limited reach, the products didn’t grow.
“The consumers have to be confident that the product is Sharia compliant therefore the integrity and acceptability should be there,” Nomani expressed. He noted in the initial stages acceptability was not the in the asset side. To overcome this situation Nomani opined that companies should first offer asset based products and later the liability based ones as only then depositors will be able to achieve higher profits.
To shed light on issues prevailing in the existing Islamic finance framework when enhancing business, Lanka Orix Finance CEO Krishan Thilakaratne explained that the model looks at the fundamental. “In Sri Lanka the Islamic finance industry has excess liquidity which is a sad sate to be in. With the post war situation there is so much infrastructure development happening. The country has a 10% Muslin population that contributes to the GDP more than 10%. We (Lanka Orix) took the initiative to build the asset base and it was a real success story. Having said that, financial stability is required and we need assets to invite investors,” he noted.
Thilakaratne added that what stops investors from coming to Sri Lanka is the small scale of operations. “Investors will not come unless we have a billion dollar industry. The potential is there and it is up to the investors to develop the industry,” he said.
With Sri Lanka’s corporate environment changing, the role and impacts of Islamic finance in the economy was explored. To this CBSL Senior Deputy Governor Ananda Silva pointed out the market share of Islamic banking is rather small comparing to conventional banking.
“There is enough scope to grow this sector and it should be done through conventional banking. If the country is looking to promote the growth to 8%, foreign funding is required. The challenges prevail in liquidity management and talent of human resource in this arena. It is important to have this developed,” Silva advised.
Advancing Sri Lanka’s solid growth in Islamic financing
During a panel discussion, KPMG Tax & Regulatory Principal Suresh R.I. Perera, moderator of the panel discussion started off by questioning where does Islamic finance stand in the industry. From a regional perspective, Ideal Ratings Regional Director for Asia Ariff Sultan said Sri Lanka is an example for the South Asia region.
“It (Sri Lanka) is the only country that has the opportunity of dual banking which is conventional and Islamic,” he noted. Sultan observed that 
from a global perspective Sri Lanka is very small and the international markets do not here much from the country. “This is a setback for the country since it wants to raise fund. In terms of who carries Islamic finance news in Sri Lanka, it is only local media. There is a huge opportunity for media to capture this in the international market,” he said.
From a product point of view he said the country is faring well and has done more than nations such as Singapore. “In Malaysia it was a 10 man show in the 1980s and now it has become the lead in Islamic finance globally. Sri Lanka also has the same growth momentum. So it’s a matter of being patient, creating more awareness and products. In the next five years, the nation will certainly be a major Islamic finance player in the international map,” said Sultan.
Maldives Islamic Bank CEO Harith Harun contributed to this by highlighting that Sri Lanka and Maldives has many similarities. The bank having opened up to Islamic finance in 2011, he said developments are already witnessed. “The emphasis is that it takes time. It is important to look at the local market first. Issue a rupee Sukuk before trying to issue it in dollars. Coming from a small market, I can say Sri Lanka has immense potential,” added Harun.
Housing Development Financing Corporation Maldives Managing Director Dr. A.D. Priyanka Baddevithana said bringing in capital markets is essential to develop this sphere and a level playing field is to be created. “Product takes meaning when we talk Islamic Finance. It is not only Muslims who can appreciate the fundamentals of this system. We are moving from an interest rate to profit share basis so there will be a diverse portfolio in the future,” said Baddevithana.
Developing an enabling tax framework to drive growth in Islamic finance
Presenting the current tax framework in Sri Lanka, KPMG Tax & Regulatory Principal Suresh R.I. Perera said the country being multi ethnic, the tax system here is similar to that of the English system. Sri Lanka currently has at least 17 types of taxes in the system and the concept of interest plays a major role.
Commenting on how Islamic finance can be developed into this framework, he said for this the push has to come from the Government. “If the Government is keen on developing Islamic Finance, they should be pushing it and this has not happened yet,” noted Perera.
Explaining the need for tax reforms to develop Islamic finance, Perera said that the alternative financing attempts to mirror the impact of conventional instruments. However, while this is achieved, tax consequences are attracted. “We don’t have a level playing field and due to this the cost of Islamic finance increases making it more expensive than conventional instruments,” he pointed out.
“Islamic finance instruments are essential for financial arrangements. So the tax consequences that are applicable for conventional arrangements should be extended to Islamic finance instruments as well. This is what is called creating a level playing field,” asserted Perera.
Nevertheless, after many discussions with the relevant Government authorities, the industry managed to get endorsement in the Presidential Taxing Commission to promote Islamic finance, he said. “The endorsement was reflected in the 2011 Budget proposal and this was followed by four tax statutes being amended,” noted Perera.
While the provisions introduced were to the Income Tax, VAT, NBT and ESC Act, the Inland Revenue Department is to come up with guidelines to ensure that there is a level playing field comparing to the conventional instruments. However to date, the guidelines have not been put forward by the Commissioner General. “What is good is that since the intention has been expressed by the Government in the budget speech, the 
Commissioner General is compelled to extend the same treatment to the Islamic finance instruments,” he expressed.
Comparing Sri Lanka to other countries in this regard, Perera said the nation has come a long way. “In UK, every time a product is introduced the law has to be amended. In Sri Lanka, the Commissioner General has been empowered to come up with detailed guidelines for the product. This is a progressive achievement comparing to other countries,” he stated.
Initiatives and developments in Takaful (Islamic insurance)
Islamic insurance is not very far off from the conventional industry and has grown hand in hand with the banking industry, according to Amana Takaful Life CEO Reyaz Jeffrey.
“If you take Takaful as a large perspective, it is not very far off from conventional insurance. The main aim is to protect the insurer or the insurable assets in interest. When you take that in context, insurance is a need, the issue is the way in which conventional instruments are structured,” said Jeffrey.
He explained that one of the aspects is the involvement of interest that makes Takaful prohibitive to Muslims. The second is the concept of risk transfer. “When Takaful is structured in such a way, it eliminates both these. It enables those compelled to insure their assets via the conventional insurance to move into something which is more permissible,” opined Jeffrey.
Shedding light on the global Takaful industry which is approximately US$ 8.3 billion, it is noted to be growing at 29%, although 50% comes from the Kingdom of Saudi Arabia (KSA). In Sri Lanka, Jeffrey said that the Takaful industry is predominantly Amana for the past 16 years and enjoys a market share of 2%.
“The Islamic finance industry, which is an integral stakeholder in the Takaful industry, has come out only in the last two or three years. In Sri Lanka the Takaful industry is valued at US$ 1.5 billion and is growing at 12% every year,” he shared.
Is it meant for Muslims by Muslims, Jeffery said this seems to be the perception the market has created. “Takaful is not something that should be sold with a religious label. It is about values, principles and benefits. There is no need to discriminate,” he emphasised, stating that in Sri Lanka, non-Muslims make up only 5% of the Takaful market share.
Potential for Sharia compliant products
Adl Capital Associate Director Muhammad Azad Zaheed shared during a panel discussion for which he was moderator that the industry having evolved from humble beginnings; the borrowings vary from 4-6% which is high comparing to other regions.
In an attempt to explore the options to narrow this divide, Bank of Ceylon (BOC) Islamic Banking Chief Manager M.K.S. Mohamed Bishry said that with the current administration costs, bank cannot lend with high marginal costs. “The prime lending rate is 11.3% and within this framework we have no choice,” he said while sharing how the 4-6% rate has come about.
With Islamic finance taking the echo of conventional banking, Zaheed questioned what can be done on this regard. To this NDB Bank Head of Islamic Finance Imran Zahir explained that from the customer’s perspective, the spread is far too wide compared to other countries. “There are no efficiencies in the way we do our business. We need to bring our running cost to less 1% and for this we need to grow our books,” he noted.
Amana Bank Consumer Banking & Strategic Marketing Vice President Siddeeque Akbar said that the spread is too immature to talk about. “I am sure as the industry progresses and has products in place there is a possibility of being above the market. Before we get to the spread we need to focus on market demand and then go to the next stage of marketing to make product offerings better,” added Akbar.
Focusing on the product developments that have taken place in the industry over the past few years, Akbar said there has been a lot of traction as of late. In terms of leasing he said that there is immense potential but a lot has to be done to move in. “As an industry we need to look at smaller products.”
From a micro finance perspective, Muslim Aid Head of Microfinance Imran Nafeer said leasing could be looked into for vehicles such as three wheelers and motorbikes. “This is an emerging market and establishment the industry can target,” he opined.
With the intention of using Islamic finance to develop the national agenda, Zahir stated that Ijara (leasing) can be used in this regard. “It is not only about leasing and it is the ideal structure for infrastructure development. It is one thing to increase the product range and it is another to make the maximum with the products we have,” he clarified.
Moving on to challenges, Zaheed expressed that they always will be there and cannot entirely be overcome. “There was a need to educate a market out there that it was not about Islam. It was about educating the people who were confused with this. Now, Islamic finance has shifted gear and we have moved from a market where we once saw a single service provider. The CBSL is extending support in no small measure and today we have a complex environment,” expressed Zaheed.
Zahir added to this by saying that the number one challenge is to serve a customer. Elaborating further he said: “Is there stiff competition? Yes. Is it a problem? Certainly, since we are all after the same cake. The reach should be extended. There is a lack of innovative product structure. We need to develop products such as Salam (advance purchase) and start looking at the capital market,” he said.
Driving growth in Sri Lanka’s Islamic fund sector
Having provided a snap shot of the Unit Trust (UT) industry in Sri Lanka, Comtrust Asset Management CEO Pathmanathan Asokan spoke on the Islamic fund sector.
The first-ever Islamic fund was introduced in January 2008 where it was a close ended fund with a maturity of five years. It being an equity fund, Asokan said that the return to the investor was noted to be 10.03% per annum.
It was only three years later that an open ended equity fund was launched in Sri Lanka. After the open ended fund was introduced in October 2011, two more of the same nature was launched during the first quarter of 2013. It was also only in 2013 that the first ever open ended Mudarabah (trust financing, profit sharing) was launched.
“While there are three equity funds, one fund has a negative fund where it grew by 6%. The Mudarabah fund looks attractive for ordinary investors as it provides the necessary liquidity that individual and corporates go after,” explained Asokan.
Pointing out the recent initiatives provided by the Government for Islamic funds, he said that a VAT which increased the transactional cost was removed and was made effect since the beginning of 2013. On the income tax, asset management companies are liable only 10% tax. “Previously, if a foreign investor wants to come to Sri Lanka, he has to do so through a security investor account and it was a tedious process. The Government permitted foreign investors to can come in directly through a mutual fund,” added Asokan.
Although he called it a major benefit, the mutual fund in Sri Lanka failed to take off since the awareness on it was low. “In Sri Lanka, people are used to having savings and fixed deposits, and are highly reluctant to venture into the capital market,” noted Asokan.
Pix by Upul Abayasekara
