An Islamic Banking ACT in Kenya? Detonating the Conundrum

“And for whatever Riba you give so that it may increase in the wealth of people it does not increase with Allah” Al-Quran, Surah Ar-Rum Verse 39

INTRODUCTION TO ISLAMIC FINANCE

The principles of Islamic finance are entrenched in Shari’ah law. Shari’ah law itself is derived from the Quran (Islamic Holy Book) and the Sunnah (the sayings and practice of Prophet Muhammad-pbuh). The principles are also rooted in the Consensus (ijma) and Analogy (qiyas) which are teachings from highly learned Islamic Scholars. Despite being strongly rooted in the Islamic faith, one does not have to be a Muslim to access Islamic financing products. The intent of Islamic finance is to increase maslah, which is the good of society as a whole, and therefore any member of the society is welcome to enjoy the benefits of ethical Islamic finance.

Shari’ah law prohibits charging or receiving of riba-interests on loans. For purely Islamic states charging of riba has been prohibited at all levels, even extending to express inclusion in the constitution in some cases. For instance, Article 38(f) of the constitution of the Islamic Republic of Pakistan provides that the state shall eliminate riba as early as possible. To the Islamic community charging of interest on loans is regarded as unjust since Islam treats money as a mere intermediary between goods and/or services, which cannot appreciate on its own merit unless it is increased through trading activities.

Islamic finance also excludes projects related to gambling and game of chances (maysir), dealing in forbidden commodities or engaging in excessive risk or uncertainty (gharah). For this reason and to introduce certainty, most Islamic finance transactions are asset backed or asset based, with the sharing of business profits and losses through shared investments.

From the onset, it is evident that any advancement in terms of product offering by Islamic banks and Conventional Commercial Banks (CCBs) with regard to Islamic financing products must be structured along the principles of Shari’ah law.

Islamic Finance in Kenya

One of the major pillars on which Vision 2030 is premised is to place Kenya as a regional financial hub both in East and Central Africa. Achieving this demands that stakeholders in the Kenyan banking industry consider the ever-bourgeoning Islamic banking and finance sector. The best way would be to enact a sector specific legislation tailored to Islamic finance sector to monitor and regulate Islamic finance transactions in the country as a whole.

It is appreciated that Kenya, through Central Bank of Kenya (CBK), has made considerable steps in ensuring and recognizing the influence and positive market reception of Islamic finance since its inception. The licensing of Gulf African Bank in the year 2007, First Community Bank in the year 2008 and The Dubai Islamic Bank in 2017 to operate as fully-fledged Islamic banks alongside other CCBs which had previously been offering a cocktail of both conventional and Islamic banking products is indeed a milestone.

However, riba continues to be a murky area in the operations of fully fledged Islamic banks in a largely conventional economy. The prohibition of interest is in outright contrast to routine operations of CCBs which are in business to make return on the interest charged for financial accommodations extended to their customers. CCBs take high risks and will finance any projects with potentially high returns as long it is not prohibited under the relevant laws, and usually recoup on the risk by charging interest. Islamic banks also lend but have to eliminate any aspect of riba in their products while still expecting to recoup on their outlay. Managing these two diverse modes of banking under one legislation with almost similar regulations and guidelines when the goal of each mode is different can only be equated to unjust and unfair system of administration thus the need for a positive discriminatory form of legislation for Islamic financing in Kenya.

This article therefore briefly fronts the avenues that can be taken by the CBK and the stakeholders in the banking and finance industry (in addition to what has already been done) to develop the Islamic financing sector in Kenya. The overall impact of this is increased accessibility to the variety of banking products offered through Islamic financing and alleviation of poverty with an aim of achieving the Millennium Development Goals (MDG’s) and the Vision 2030.

HISTORICAL DEVELOPMENTS IN THE LEGISLATION OF KENYA’S ISLAMIC FINANCE SECTOR

Riba

Amendment to section 45 of the CBK Act to recognize the payment of a ‘return’ rather than ‘interest’ on government securities was in itself a positive step. The Finance Act 2017 also made amendments to the Co-operative Societies Act and the Sacco Societies Act to legally facilitate and entrench the concept of Islamic financing to Sacco’s.

Profit and Loss

Most Islamic financing models therefore adopt Musharakah (full partnership between the bank and the customer) allowing partners to share specific percentages of capital. Any profit or loss earned from the business or the project is divided according to the proportion of capital contributed. However, the CBK has put in place a requirement that while profits made from deposits (Mudaraba) may be shared, the depositors cannot share in the losses made by the bank. This is similar to the protection extended to customers in the CCBs.

Open Market Operations (OMO)

With an aim of controlling inflation, raising revenue and controlling liquidity ratio through Open Market Operations (OMO), the CBK buys and sells government securities to the financial markets in form of bonds which are later repaid with interest. These facilities could not be accessed by fully fledged Islamic banks. This necessitated the amendment of the Finance Act 2017 and the Public Finance Act to add Sukuk which is a Shari’ah compliant bond, to the list of the national government securities. Unlike debt instruments offered by CBK, Sukuk represents ownership of Shari’ah compliant assets which in essence form the basis of ‘return’.

STATUTORY GAPS FOR ISLAMIC FINANCIAL INSTITUTIONS (IFIS)

Lender of Last Resort

The CBK is regarded as the lender of last resort to CCBs whenever they have a ’cash crunch’. The fact that CBK charges interest on these loan advances to CCBs automatically disqualifies IFIs from accessing these facilities. An Islamic Finance Act might want to legislate ways in which the CBK can still extend funding to these Islamic financing institutions with special riba-free arrangements.

Self-Regulation

Regulation and management of Islamic financing both for the fully fledged Islamic banks and CCBs with Islamic windows has largely been left to internal mechanisms. The personnel appointed to regulate, manage and issue these Islamic financing products vary from one Islamic institution to another, thereby creating a lack homogeneity in the operations of IFIs, which also portends auditing crises. In essence there is no overall regulator at the level of the CBK appointed to specifically oversee the management of Islamic financing and its products.

As a matter of public interest, it is crucial to set up an industry specific regulatory mechanism under the CBK since IFIs do take deposits from the public. This can be managed by having an act which lays out the irreducible minimum qualifications of person(s) tasked with overseeing the operations of IFIs in Kenya. This can also be achieved by embedding within the structure of the CBK, a Shari’ah council constituted of very learned and/or accomplished local and international Islamic scholars to sit in an advisory capacity with the aim of producing a congruent regulatory framework for Islamic financing.

CONCLUSION

There is no doubt that there has been growth in regulating Islamic financing in Kenya. However this is deemed insufficient in light of the unique requirements of Islamic financing. It is apparent that Islamic financing cannot be properly regulated, administered and managed under the same Act as CCBs without siring ambiguous outcomes. The absence of specific legislation on Islamic finance is in itself a hindrance to the realisation of the financial benefits of the untapped potential of this unique form of finance.

An Islamic Financing Act is urgently needed to take Islamic financing in Kenya to the next level. The enactment of an Islamic Financing Act will also foster growth of Takaful (Islamic insurance) and microtakaful (equivalent of microfinance) in Kenya and the region thus realizing the Vision 2030 dream of becoming the region’s financial hub.