Islamic Finance in Nigeria: Benefits, Characteristics, Principles and Practices - Presentation

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Slide1

Islamic Finance in Nigeria: Benefits, Characteristics, Principles and Practices

A Presentation by Dr Bashir Aliyu Umar, Special Adviser to CBN Governor on Non-Interest Banking at the Two-Day NDIC FICAN Workshop 2011, held at

Dutse

,

Jigawa

State, 28,29 Nov 2011Slide2

Introduction to Islamic Finance

Definition:

A financial system that offers products, services and financial instruments based on the Islamic law (Shariah)

Components:

Islamic Banking e.g.

Ja’iz

Bank,

Stanbic

IBTC Non-Interest (Islamic) Banking Window

Islamic Insurance (Takaful) e.g. Takaful windows in Africa Alliance Insurance Plc and Niger Insurance Plc,

Halal

Takaful, a division of Cornerstone Insurance Plc

Islamic Capital Markets, e.g. Lotus Capital Plc and

Halal

Fund of ARMSlide3

Intermediation in Conventional Banks

Assets Liabilities

Depositor

Conventional Bank

Borrower

Interest

Interest

Saving/Investment

LoanSlide4

Intermediation by Islamic Banks

Assets Liabilities

Depositor/Investor

Islamic Bank

Client

Profit on sales, lease/Profit sharing/Commissions (agency, services)

Gift/Profit Sharing

Deposit/Investment

Financing/Investment

Wadi’ah

,

Qard

,

Mudarabah

, CMD

Mudarabah

,

Musharakah

,

Murabahah

, Salam,

Istisna

,

IjaraSlide5

Core Contracts in Islamic Finance

Murabahah

(Cost-Plus Sale Contract)

A

Murabahah

transaction is a sale at a stated profit. In a

Murabahah transaction, the bank purchases something from a third party and sells it to the client at a stated profit on a deferred payment basis. In this way, the client can buy something without taking an interest-based loan.

Ijarah (Lease)An ijarah is an Islamic lease. The bank purchases an asset and leases it to a client for fixed monthly payments. An

ijarah may include an option for the lessee to buy the asset at the end of the lease, though such a provision is not required.Mudarabah (Silent Partnership)A Mudarabah

transaction is an investment partnership. In a mudarab arrangement, the contract is between an investor (or financier) and an entrepreneur or investment manager known as the mudarib. Risk and rewards are shared. In the case of a profit, both parties receive their agreed-upon share of the profit. In the case of a loss, the investor bears any loss of capital while the

mudarib loses his time and effort.Slide6

Core Contracts in Islamic Finance

Salam (Forward trade Contract)

It is a sale where the seller undertakes to supply some specific goods to the buyer at a future date that is specified in exchange of an advanced price fully paid at spot. This mode of financing is used to finance the agricultural sector.

Istisna

’ (Partnership in Manufacturing)

It is a

mode of financing where the commodity involved is manufactured to the specifications of the purchaser. This is widely used in the housing finance sector, where the client seeks finance for the construction of a house. The financier may undertake to construct the house on a specified land either belonging to the client or purchased by the financier, on the basis of

Istisna

', with payment fixed in whatever manner the parties may wish.Musharakah (Equity Partnership)This involves partners providing funds for a venture, with profits shared according to their invested capital, and the loss is borne by them in the same way

.Slide7

Main Differences between Islamic and Conventional Finance

Conventional

Finance

Islamic Finance

Characteristics

Interest-based financing with a fixed or floating rate of interest charged for the use of money.

Financing is not interest-based but is asset-backed and based on

generating a

profit from

sale

of an asset or its usufruct.

Interest-based financing

Deposits are interest-based and the investor and bank commit a predetermined rate of interest with a guarantee of principal payment.

Interest paid to depositors by banks is less than the interest they charge on loans, the difference being the margin that the bank makes.

Deposits are not interest-based but based on profit and loss sharing or as interest-free loans

Banks get a share of the profit from the business venture to which it is a party, and in case of loss

devoid

of

any

negligence on the part of the bank, the investor forgoes the reward for the activity during that period

Interest-based deposits

Interest-bearing

securities like government bonds

Asset-backed investment products like

Sukuk

(Islamic bonds) and other

shariah

-compliant investment certificates.

Investment productsSlide8

Conventional Finance

Islamic Finance

Characteristics

Not generally offered but available through venture capital companies and investment banks.

Normally they participate in management as well.

Offers equity financing for a business or venture.

Losses are shared based on the equity participation, while profit is shared based on a pre-agreed profit sharing ratio.

Equity Financing with Risk Sharing

Permissible

charge for late payment or default.

No extra money is charged as penalty for payment default

Penalty on Default

There are no such restrictions

Dealing in unlawful

goods and services like alcohol, pork, pornography prohibited

Restrictions

Trading in any kind of derivative/futures involving speculation is allowed.

Conventional insurance is allowed.

Transactions with elements of gambling and

speculation such as derivative trading are

strictly forbidden.

Conventional

insurance is

prohibited due

to the element of uncertainty embedded in that contract

Prohibition

of

Speculation

(

Gharar

)

and

Gambling (

Maysir

)

Main Differences between Islamic and Conventional FinanceSlide9

Conventional Finance

Islamic Finance

Characteristics

There is no such requirement.

Only financial audit

Islamic financial institutions are required to have a

Shariah

Supervisory

organ

appointed by the Board as part of its corporate

structure

to ensure that all business activities are

Shariah compliant.

There is Shariah audit in addition to financial audit

Shariah Supervisory Board

Main Differences between Islamic and Conventional FinanceSlide10

Benefits of Islamic Financial Services on the Nigerian Economy

Financial market deepening: new market and institutional players will be introduced e.g. Islamic Money Market, Islamic asset management companies, Takaful, etc.

Financial Inclusion: a large number of Muslims in the country that had hitherto steered away from the organised conventional financial services due to their aversion to interest and interest-based products will be integrated in the formal economic sector, which will in turn lead to replacement of informal markets with formal and regulated ones.

Enhanced product offering from an array of asset-backed instruments of finance as alternatives and complements to the conventional ones.

New competition in the banking industry which is expected to engender a concomitant reduction of interest rates.

Enhanced oversight and regulation through an added component of corporate governance, which is the Shariah supervisory board/committee.

Enhanced investment in the critical sectors of the economy through the use of

Sukuk

, a new financing instrument.Development of the real sector of the economy through its asset-backed financing which will avail funds only to production and real investment activities.Slide11

Practice of Islamic Finance in Nigeria

Challenges

Asset Liability Mismatch and absence of Shariah-compliant liquid investment instruments

Activities in other jurisdictions, CM, Short-term

Sukuk

Treatment of Profit Sharing Investment Accounts (PSIA)

Deposit InsuranceTax treatment of Islamic finance products

Shariah ExpertiseSlide12

Conclusion

Bracing up

to

the challenge

Thank you