Is the Law and Practice of Islamic Banking and Finance Really Feasible In Uganda?

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Last year, Prince Kassim Nakibinge attacked Archbishop Lwanga after the latter made some comments on Islamic banking.

Instead of attacking Archbishop Lwanga on Islamic banking, I think Nakibinge should focus his energies on the government.

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Let him put more pressure on the government and Bank of Uganda to set up the Shariah Advisory board in the central bank to regulate Islamic Banking. This is what has delayed operationalizing Islamic banking in Uganda.

Islamic finance is a fast growing segment of the global financial industry. In some countries, it has become systemically important and, in many others, it is too big to be ignored.

It is estimated that the size of the Islamic banking industry at the global level was close to $820 billion at end of 2008.

The largest Islamic banks are located in the countries of the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates).

Recently, the IMF made a study that concluded Islamic banking/finance wasn’t affected by the recent 2008 global financial crisis. Why? Because Islamic finance doesn’t believe in the idea of securitization of junk assets (subprime mortgages) that led to the 2008 financial crisis.

Numerous junk loans that were acquired by non-credit worthy U.S home owners were bundled together, creating something called collateralized debt obligation (CDOs) or mortgage backed securities (MBS) and subsequently sold to many western financial institutions.

The Financial Institutions Act 2004 (as amended in 2016) already permits Islamic banking. Prince Nakibinge is therefore involving himself in unproductive battles with Archbishop Lwanga.

Section 38 of the Financial Institutions Act makes it illegal to invest in real estate. However, due to introduction of Islamic Banking, an exception was made.

Under Section 115 (c), any Islamic bank or a bank operating an Islamic banking window can invest in real estate, since Islamic banking doesn’t charge interest.

Banks use equity participation systems where a bank loans money to a business and the business instead gives the bank a share in its profits. If the business defaults or does not earn a profit, then the bank also does not benefit.

In many Islamic banks asset portfolios, short term financing, notably Murabahah and other debt-based contracts account for the great bulk of their investments.

The Islamic banking contracts, services and products include; Mudarabah, Musharakah (joint venture), Diminishing Musharaka, Murâbaḥah, Musawamah, Istisna, Bai Salam and Ijarah.

However, Archbishop Lwanga only said, and I quote, “Parliament passed the Islamic Banking Act but it is still an issue of concern to all of us, including the Muslims themselves because we do not know how this is going to work”

I agree, because Islamic banking can’t work without a Shariah advisory board that government is delaying to put in place that will advise Bank of Uganda on Islamic banking transactions that are enormously complex.

That aside, not many Muslims understand the complexity of Islamic finance so they have to first be trained if it’s to be effective. You can’t introduce it to operate in a vacuum.

World over Islamic finance is facing a grave challenge of standardization on interpretation and legal documentation as indicated in the global S&P (Standard & Poor’s) Report in the last quarter of 2018.

This has deterred some of the issuers on the Sukuk market (the Arabic name for financial certificates, also commonly referred to as “sharia compliant” bonds.)

Properly understood, in compliance with Sharia principles, Sukuk holders are not entitled to receive interest.

Instead, they receive a portion of the revenues generated by the assets they own. If no revenues are generated, the Sukuk holders are not entitled to any returns.

I am sure the shariah board will be effective in this area once it’s put in place.

There are challenges and complexities relating to issuing a Sukuk in Islamic finance due to lack of standardization and Prince Kassim Nakibinge as a former banker should know this.

Therefore, you just can’t rush into Islamic finance.

This notwithstanding, last November, there was some progress on the standardization of Sukuk documentation.

The AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) and the World Bank signed a MoU to work together on the standardization of the sukuk legal documentation.

In the memorandum, AAOIFI will look into the Sharia aspects, International Financial Services Board (IFSB) will create a global frame work for the market disclosure of transactions and the Foreign Exchange Market (IFEM) will look into the legal documentation.

This MoU means we shall now have standard legal documentation in Shariah interpretation in a sense that if you are a Sukuk issuer, you will take a standard set of documents where you will attach an underlying asset and you hit the market


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Islamic banking institutions, once they begin operations, should also navigate the murky waters of real time gross settlement systems in Bank of Uganda.

Anyone who knows how reserve accounts (not foreign reserves) & real time gross settlement systems work, understands these systems rarely have glitches.

Islamic banking institutions should also be integrated onto this payment system.

The central bank reserves that banks keep in their accounts in Bank of Uganda don’t store cash but electronic central bank reserves. It’s important to appreciate that although central bank reserves are created by BoU, they are still numbers in a computer system.

These numbers are stored on a file similar to an excel spread-sheet which are much smaller than an mp3 song on a mobile phone.

The computer system that records all these central bank reserves is referred to as the real time gross settlement processor (RTGS). It’s a system where banks just settle payments to each other immediately.

This is in contrast to multi-lateral net settlement in which all payments are cued up, cancelled out against each other and only the final net difference is transferred.

When a payment is put through the RTGS processor, it is considered to be final and risk free. If one bank owes money to another, there is always a small chance it won’t pay the other bank.

But when the money arrives in the central bank reserve account, then the deal is considered done because holding central bank reserves is as good as holding cash.

Despite all I have written above, how many Muslims can confess that they are informed or trained to trade in these complex Islamic finance products without adequate education in Islamic finance?


 

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Louis Kizito is General Counsel at Pixan Technologies

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