Islamic finance makes a big sale in new markets

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| Nairobi Business Monthly September

EMERGING NICHES

BY AAMERA JIWAJI

Centuries ago, the monsoon winds were

credited for bringing trade ships from

the Indian sub-continent and the Arab

peninsula to the East African coast, carrying

valuables like silk, pottery, metal goods, jewel-

lery and medicine.

The latest offering that these trade winds

have wafted down the eastern coast of Africa

is Islamic finance. And as happened with theitems, the first port of call was Kenya and from

here Islamic finance is sweeping across the

region.

According to theIslamic Banking Competitive-

ness Report, Islamic finance assets have grown

at double-digit rates over the past five years and

in 2012 exceed $1.1 trillion (Sh92.4 trillion).

International estimates predict that up to half

of the savings of the Islamic world will end up

being managed by Islamic financial institutions.

The growth rates of Islamic banks globally have

outstripped those of conventional institutions

(threefold, according to the IMF). And because of

their ethical and risk-sharing approach, Islamic

financial institutions shrugged offthe finan-

cial crisis, making them more attractive and

helping contribute to their growth beyond the

traditional areas of Asia and the Middle East.

What this means is that Islamic finance can

no longer be ignored. At 1.5 billion, the Muslim

population is the second largest in the world. In

Africa, 540 million people 50% of the popula-

tion are Muslim. With only 38 Islamic financial

institutions operating on the continent, it is

Islamic finance makes abig sale in new markets

considered to be a huge untapped market.

Estimates suggest that 9 million Kenyans are

Muslims (or 11% of the countrys population)

and the rapid uptake of Islamic products has

led several conventional banks to introduce

sharia-compliant products to tap the Muslim

population.

Kenya is considered to be among the African

countries leading in sharia-compliant services.

Islamic banking started in Kenya in 2005 when

Barclays, a conventional bank, offered currentaccount products through its Islamic window,

LaRiba. But it was only in early 2008 that two

fully fledged Islamic banks First Community

and Gulf African opened for business. This

created the first link in a chain of financial

inclusion that heralded the establishment of

Islamic finance in East Africa.

The launch of an Islamic insurance compa-

ny, Takaful Insurance Africa, in 2011 was the

second link. Six months ago, the third link in

the chain was created when First Community

Fund Manager was licensed, an institution that

will grow into an investment bank with time.

Before the end of the year, two more links will

be added: an Islamic pensions scheme and the

most important cog in the wheel around which

all other Islamic institutions will spin, a basket

of shares at the NSE which will be screened for

consistency with Islamic law. The availability

of sharia-compliant investment products at the

capital markets will work in a complementary

manner to fund management.

In February 2009, Kenyas pioneering Islamic

lender First Community Bank participated in a

Sh1 billion sukuk issue from the government,

which was split between itself and Gulf African

Bank and raised Sh18.5 billion. First Commer-

cial Bank this year announced its intention

to launch a sukuk through its newly-formed

investment bank.

Sukuks are sharia-compliant and trad-

able asset-backed, medium-term investment

certificates that have been issued internation-

ally by governments, quasi-sovereign agencies

and corporations. They represent ownership

claims in pools of investment assets or services.

Their launch in Kenya allow Sharia-compliant

banks to participate in government debt market,

which is a major source of interest income for

conventional financial institutions, says Mr

Kabaki Wamwea, executive director of Dyer &

Blair, an investment bank.

The challenge with sukuks in Kenya is lack ofan enabling legal framework complete with tax

neutrality measures. Islamic finance industry

players say Uganda and Tanzania have a better

chance of issuing a sukuk than Kenya However,

the amendment of section 45 of the Central Bank

of Kenya Act last year to recognize the payment

of a return rather than interest on govern-

ment securities was a major win, as it opened

up the spectrum of sharia-compliant invest-

ments in Kenya.

The regulatory changes that Islamic insti-

tutions are pushing for include allowing their

authorised capital to be waived or accepted as a

guarantee in an Islamic bank, since the interest

earned on the amount while it is with the CBK

is forbidden by sharia law and cannot be used

on operation costs. It must go to charities or

disadvantages communities.

Other changes include the separation of

operations and risk fund accounts. The first

goes into running the company while the other

into the pool of premiums from which claims

are paid. There are things we are supposed to

do within the sharia model, which cannot be

Growth of Islamic banks globally outstripsthose of conventional institutions three-foldand opens a new niche market as countries

change laws to accommodate sharia models


SPECIAL FOCUS:ISLAMIC FINANCE


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September Nairobi Business Monthly |

done within Kenyas regulatory environment,

said Mr Hassan Bashir, CEO of Takaful Insur-

ance Africa.

Another contradiction between sharia law

and Kenyan law is the treatment of zakat. Under

Islamic law, 2.5% of the companys liquidity has

to be declared at the end of the year as zakat, an

obligatory alms giving. Kenya Revenue Author-

ity considers this amount as a profit and taxes it

whereas in other countries zakat is tax exempt.

Even with these gaps, Kenya is miles ahead

of the rest of the region, said Mr Bashir. Most

countries are still struggling with whether they

should license the first banks. Tanzania is done

with theirs, Uganda is trying to do theirs and

we are looking at a complete sector.

The irony, however, is that while Kenyas

regulatory framework is playing catch-up on

sharia, Islamic institutions are operating in an

over regulated environment since in addition

to following prudential guidelines that are

enforced by their boards, they are also evalu-

ated by a sharia board that follows standards of

equity and fairness and protects the interests

of policy holders.

We are over-regulated as a takaful model

but all these government institutions create

solidness. Ultimately, this is a profit motivated

risk mitigation model, explained Mr Bashir.

Corporate governance is simpler and stronger

in Islamic banks by design.

FCB Capitals First Ethical Opportunities Fund

(FEOF), which was licensed in March, delivers

a choice of investment opportunities, in addi-

tion to sukuks, allowing sharia investors to

construct balanced portfolios across a range

of asset classes.

The other major financial inclusion is the

creation of an Islamic cooperative of people who

cooperate for their mutual social, economic, and

cultural benefit, and who follow the principles

of Islamic law. 2012 has been identified as the

year of Cooperatives by the United Nations. As

businesses driven by values, and not just profit,

cooperatives fit naturally into the principles of

Islamic law and enhance the financial opportu-

nities offered to Islamic SMEs and micro finance

institutions.

Kenya has a very well developed cooperatives

sector, said Mr Bashir But the missing gap is

a sharia-complaint cooperative, both a credit

as well as a deposit taking co-op.

When this circle is complete, the implications

for Kenya and the region are enormous. The

development of enabling capital market regula-

tions and a nascent Islamic security markets

will open Kenya up to the large pools of sharia-

compliant funds from the Middle East, South

East Asia and other Islamic markets.

The other country in which Islamic finance

is growing rapidly is Mauritius. Although it has

only 200,000 Muslims in a national popula-

tion of 1.8 million, and its first Islamic bank

was recently licensed in October 2009, the

Bank of Mauritius has been busy creating the

infrastructure for a sharia-compliant retail and

investment banking. The small Indian Ocean

island has already attracted the Tata Indian

Sharia Equity Fund, suggesting that Mauritis

is positioning itself as the offshore financial

centre for the Islamic banking in the same way

that Caribbean nations like the British Virgin

Islands or Cayman Islands have serviced the

conventional funds industry.

With this full circle in place, funds fromother East African countries will be attracted

to Kenya, while local sharia funds that are being

invested outside will be retained. Research costs

and compliance concerns incurred by sharia-

compliant investors in Kenya will also reduce,

and projects in sharia-compliant industries

including oil, real estate and mega infrastruc-

ture projects will thrive. Innovation will open

up and Kenya will be positioned as the Islamic

finance gateway to East Africa. Even as the Capi-

tal Markets Authority (CMA) plans its own shar-

ia-compliant index, it signed a Memorandum

of Understanding with the sharia compliant

Somalia Stock Exchange Investment Corpora-

tion to establish links between the bourses.

The procedure is not uncommon and major

index providers across the globe, including

Dow Jones, MSCI, Russell, Canadian index S&P

(Standard & Poor) and Securities Commission

Malaysia and FTSE have launched sharia indices.

In June, S&P launched a sharia index measuring

the performance of 50 leading sharia-compliant

companies from 19 countries and territories

who are member states of the Organisation of


First Community Bank, the first full fledged

Islamic bank to open in Kenya


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Islamic Cooperation. In the same month, FTSE

launched its trading of 48 global and regional

indices and 48 country indices that are sharia-

compliant. Smaller markets that are home to

a large Muslim population have also begun to

offer sharia-compliant indices, including the

Bombay Stock Exchange.

Last year, leading financial news providers

Bloomberg and Thomson Reuters set up Islamic

finance platforms to provide analytical tools

to maximise investment performance in the

rapidly growing market for sharia-compliant

products and services.

Today, Islamic institutions can be found in

developing economies where the financial

sector is almost entirely Islamic (such as Iran

and Sudan) or where Islamic and conven-

tional financial systems co-exist (including

Indonesia, Malaysia, Pakistan and the United

Arab Emirates). They can also be found in

developed economies (such as Europe and the

United States) where a small number of Islamic

financial institutions have been established and

large conventional banks have opened Islamic

financing windows.

Kenya has adopted the co-existence model.

Metropolitan Life Insurance (Kenya), a subsidi-

ary of South Africas listed MMI Holdings, earlier

this year opened a Takaful window to sell sharia-

compliant life insurance product making it the

second in the country to do so after Cannon

Assurance.

A number of conventional banks including

Standard Chartered, Barclays, Chase and KCB

have set up Islamic banking divisions. Equity

Bank, the countrys largest bank, recently

received its licence to operate an Islamic

window. The reason they are called windows

is because it is only the outer facade, the window

dressing, which is different - the essentials of

the conventional financial model remain.

The windows have not been successful in

Malaysia; it is the dedicated institutions that

capitalise Islamic finance which have been

successful. I dont know how successful they

will be in Kenya, said Mr Bashir. Malaysia only

allows Islamic institutions that have been capi-

talised separately, as they have greater Muslim

support.

Reinsurance companies are following suit

and last month, Kenya Reinsurance Corpora-

tion appointed a sharia board in preparation to

offer Re-Takaful products, which will bring it in

line with Africa Re and Zep Re, which already


Shareholder fund

Internal auditor

-Operating costs

-Claims

+Profit for

shareholders

+Profit for insured/

policy holders

Board of directors

Sharia board

Risk fund

Islamic banksoperating in other

East African countries arealso eyeing the Kenyanmarket and Sudans IslamicBank of Khartoum plans tomove into Kenya in what

will be the first crossborder

expansion in East Africa.

THE BUSINESS MODEL

SPECIAL FOCUS:ISLAMIC FINANCE


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have sharia-compliant subsidiaries: Africa

Re-Takaful and ZEP-RE Re-Takaful. The CMA

is also working to set up a National Sharia Advi-

sory Board that will ensure uniformity across

the sector.

Islamic banks operating in other East African

countries are also eyeing the Kenyan market and

Sudans Islamic Bank of Khartoum plans to move

into Kenya in what will be the first crossborder

expansion in East Africa.

The release of Takaful Insurance Africas

first year results in April showed heavy losses

from operating expenses and high set-up costs

prompting many to criticise the financial model.

This was, however, in keeping with the first year

results of Kenyas first two fully fledged Islamic

banks: Gulf African and First Community Bank

which respectively recorded a loss of Sh281

million and Sh307 million.

Both banks broke even in a relatively short

time given the global financial scenario prevail-

ing in 2008 and 2009. Gulf African Bank built

14 branches in four years and broke even in less

than two years, while First Community Bank has

17 branches and took three years to break even.

Gulf African Banks first quarter results for

2012 showed a remarkable 2,560% growth in

income before tax compared to the same period

last year, earning it the Best Recovery award fromThink Business. And if the case study of Islamic

banks in the Middle East and North Africa coun-

tries, which are projected to increase from $416

billion assets in 2010 to $990 billion in 2015,

is any indication, Islamic finance is poised to

become profitable.

Another reason for TIAs poor performance in

its first year was because it incurred a large claim

relating to goods in transit, which pushed total

claims to over Sh61 million. We paid because

the claim was due, and that is why we exist,

said Mr Bashir.

TIA Chief Operating Officer Habib Shatry

explained that although first year results reflect-

ed as a loss, if they had followed the Islamic

financial reporting standards, the loss would

not have seemed as large because the risk fund

(policy holders) would be declared separately

from the company fund (shareholders). Our

operations account is in the red because of high

set up costs but the policy holders account is

in the black, he said.

Kenya is on the pedal of Islamic finance; we

are really pressing the pedal, said Mr Bashir.

When the entire Kenyan insurance commu-

nity converged at the Hotel Continental

on the evening of July 18 to fete excellence

and creativity at the third Annual Insurance

Awards, there was a newcomer among the

participants.The big boys, Jubilee, UAP, CIC and Co. took

with the big prizes. There was, however, one

special prize that went to a special innovation

in insurance.

Takaful Insurance of Africa (TIA) scooped

the Special Award for product innovation. It

was the first award of its kind at the gala and

the judges confessed they could not ignore the

creativity. We are excited and honoured to

have won this award, said TIA Chief Executive

Hassan Bashir. This speaks volumes about

the appreciation of our insurance model by the

industry and its potential as an alternative to

conventional insurance.

The Takaful concept of insurance is based

on the principles of togetherness, cooperation

and mutual solidarity. It espouses tenets of

Shariah, which prohibit interest, gambling and

uncertain investments.

It is the first licensed Takaful operator in the

East and Central Africa and has pioneered a

unique alternative concept of insurance in the

region. The concept derives from the Islamic

financial principles whose rationale is provi-

sion of risk management and financial security

based on ethics and values.

The operational framework is a system

where each member contributes a given

premium to a general Takaful fund managed

by the operator. Through the concept of dona-tion, the members allow TIA to pay any losses

suffered by the participants contributing to

the pool. Any surplus left from the contri-

bution after payment of claims and other

expenses is either used to grow the reserves

or distributed among the members. This is

referred to as surplus profit.

Although Takaful operates and manages

its activities in accordance with Shariah law,

they play by Insurance Regulatory Authority

regulations.

In addition, operational matters, invest-

ment dealings, management and marketing of

Takaful products are overseen by the Shariah

Advisory Council to ensure that good govern-

ance and obligation to customers, also called

participants, are met.

Unlike the conventional insurance model

that is designed on the premise of risk transfer

model, ultimately maximising shareholder

value, TIA promotes a risk-and-profit sharing,

welfare-based model that balances the inter-

ests of both participants and shareholders.

DAVID WANJALA

Islamic insurance findsspace at the high table

RECOGNItION


Hassan Bashir,

CEO of Takaful

Insurance Africa

Islamic finance makes a big sale in new markets

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