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As it graduates from aid to investment, Islamic finance could prove crucial to Africa's development

Over the last year, whenever I have asked anyone where the next big market for Islamic finance is, the answer has always been the same. It's resource rich, its countries consist of some of the fastest growing economies in the world and it's home to a sizeable Muslim population. Over the last year, service providers I've interviewed have not been able to avoid mentioning Africa.

Education providers tell me of more students logging onto online courses from African countries, IT companies tell me of more African banks demanding Islamic solutions and law firms boast about African clients needing more advice on Islamic transactions. And it's hardly surprising. Africa's growing middle class is expected to have a collective disposable income of $1.4 trillion by 2020, 50 per cent of which will be in Muslim hands.

The developing continent also needs to fund long-term growth strategies and infrastructure spending, as well as spur private sector investment. Islamic finance promises all this and more.


With only 38 Islamic institutions and an enormous Muslim population, 50 per cent of which is unbanked according to KFH Research, the opportunities for Islamic finance in Africa are as diverse as the continent itself. From retail banking in Kenya to Islamic transactions in South Africa, the continent represents a vast, largely untapped market for Islamic finance.

KFH Research cites retail banking as a promising segment, especially in North Africa where the population is over 90 per cent Muslim. "Unlike major urban areas which have a penetration rate of approximately 60 per cent, banks in rural Africa have a very low penetration rate of less than 20 per cent, given the branch infrastructure which makes it inadequate to serve the population," it said. "Given the continent's growing middle class and large young population, this serves as an opportunity for banks to expand their network of banking services."

Islamic retail banking has a promising future in Africa due to its increasingly affluent, youthful market. "In terms of retail financing, the growing number of middle class Africans, which tripled over the last 30 years to contribute more than 34 per cent of the continent's population, will boost the demand for housing, auto vehicles and insurance products, and herein lies an opportunity for broad-based expansion of Islamic banking systems in Africa," Jaseem Ahmed, Secretary General of the Islamic Financial Services Board (IFSB), said.


Countries such as Kenya and South Africa have been offering Islamic retail banking for many years, however uptake has been slow. "The demand for Islamic banking has grown consistently in South Africa and there is great potential for this to continue for some years as only about 15 per cent of South African Muslims currently use Islamic banking, Avinash Singh, Acting Head of South Africa's Absa Islamic Banking, told Islamic Business & Finance. "This is because the option of banking according to Shari'ah is a relatively new one from mainstream banks in South Africa and the product range is still somewhat limited. We are continuously working to improve and broaden the product offering and to make Muslims aware of the availability of Islamic banking."

Singh explained that the expansion of Islamic finance in Africa's non Muslim countries relied on it appealing to all customers regardless of religion. "There are two main reasons why Absa customers choose Islamic banking products," he said. "Customers who are Muslim are attracted by the opportunity of banking according to their faith. They like the fact that Islamic banking products are as competitively priced as conventional products, which means they can bank according to Shari'ah without having to pay more. Many non-Muslims are attracted to Islamic banking as they like the peace of mind of knowing that their funds will never be invested in potentially harmful industries. Both Muslims and non Muslims find the excellent profit share rates currently offered on the Absa Islamic Banking savings products very attractive."

However, African countries have much work to do promoting the young industry, which remains unheard of or misunderstood in many parts of the region. "Many Muslims either don't know that Islamic banking is an option or don't understand how the products work. The product offering is continually growing but is not yet at the level of the conventional banking offerings available in South Africa."

SME financing and microfinance have also received a lot of attention, both as a means to relieve poverty in what remains the world's poorest continent and harness steady economic growth. "Other opportunities include the small- and medium-sized enterprise (SME) sector as well as Islamic microfinance which are crucial to create jobs and help to support economic growth and eradicate poverty through greater financial inclusion," said Ahmed. "This calls for Islamic banks to play a bigger role in the real sector development."

However, KFH Research warns that this is a less stable area for Islamic institutions. "The risks are perceived to be higher, given agribusiness SMEs in Africa tend to be undercapitalised, lack collateral, and have poor expertise in management, commercial and financial skills," it said. "In this regard, Islamic banks can actually adapt from successful microfinance institutions such as Grameen Bank in Bangladesh and Bank Rakyat Indonesia who adopted dynamic incentives, regular repayment schedules and collateral substitutes to help maintain high repayment rates.One of the key success factors would be to develop products that not only meet the requirement of the target groups, but are also affordable for the masses."

Ahmed believes another way in which Islamic finance can contribute towards the growth and development of Africa is the provision of financial solutions for cross-border trade and investment. "Over the last 10 years, trade levels between Africa and the GCC increased by 170 per cent," he said. "This presents an opportunity for greater collaboration in Africa between Islamic banks from the two regions. At the multi-lateral level, the Islamic Development Bank has pledged its commitment to growing trade finance and funding agricultural projects in Africa, in particular countries in the north and west of the continent."


However, Islamic finance's most prominent  role in Africa will, for the near-term, be the financing of infrastructure the continent so badly needs. "African countries have been growing strongly over the past few years, and generally have huge infrastructure investment needs," said Standard & Poor's (S&P) in a recent report. "So far, only very few African countries have issued domestic sovereign Sukuk: according to our information, just Gambia and Sudan regularly issue short-term Sukuk. We understand, however, that a number of African countries are considering issuing Sukuk in the future, either in the domestic or in global markets."

One such country is South Africa, which announced its intention to issue Sukuk in 2012, which would make it the first non-Muslim African country to bring a sovereign Sukuk to the market. Nigeria, Senegal, Tunisia and Mauritania have also declared plans to issue sovereign Sukuk in the last two years, however none have come to fruition.

Despite the shelved plans, Ahmed believes African countries shouldn't abandon the idea of Sukuk or Islamic funds, both of which could prove a valuable source of project finance. "A country's infrastructure requirements and project finance can also be met by the issuance of Islamic capital market instruments such as Sukuk and Islamic funds, tapping funds from Asia and Middle Eastern investors - taking advantage of the existing channels for the allocation of funds across borders and the diversification of risks.

"Egypt and Sudan and Gambia are already on the Sukuk map, and other countries such as South Africa and Morocco are expected to develop their capabilities in the near future. While the range of investment products is currently limited, South Africa, Egypt, Mauritania, Nigeria and Tunisia have already witnessed a number of Islamic funds launched over the years. Factors that would buoy the Islamic funds industry in Africa include the continent's various commodities, namely agricultural products and vast natural resources such as metals and mining, and oil and gas," he said.


S&P believes North Africa in particular could be the next hotspot for Sukuk. "In our view, the North African region could also turn to sovereign Sukuk issuance in the future, either in the domestic or in the global markets. Some northern African countries are facing increasing fiscal and current account deficits, which may suggest their governments could look to increase and diversify their funding base, despite North Africa's existing access to conventional official and private sector financing.

"What's more, following the Arab spring, Islamist parties have dominated parliamentary elections in countries such as Egypt, Morocco, and Tunisia, and this has put the development of Islamic finance on their governments' agendas," it said.

Nigeria in particular has been locked in a regulatory struggle to develop Islamic finance products for the last two years. It has recently laid the groundwork for Sukuk, Takaful and interbank lending products; however its precarious political situation and a relatively small number of players have hampered further progress in the country, which is home to 80 million Muslims.

KFH Research noted that an Islamic finance industry in Nigeria would: attract foreign investment to develop infrastructure in Nigeria and to guarantee financial inclusion for more Nigerians; be used as positive catalysts in the banking sector; meet the demand for non-interest, profit-sharing form of banking and finance, irrespective of religious affiliation.

"The potential is there but the market is negligible in Nigeria because we have only one Islamic bank and one window - but it has potential to grow," Bashir Aliyu Umar, Special Adviser on non-interest banking to the Central Bank Governor, is quoted as saying by Reuters. The security situation reportedly held up product roll out last year, however slow progress continues to be made.

Egypt and Tunisia have also amended laws to accommodate Sukuk, in the hope an issuance could smooth over cracks in the countries' finances. "Egypt's administration has recently presented a law allowing sovereign Sukuk issuance, which would help to finance the country's high fiscal deficits and also provide funding for the current account deficit," said S&P. "Similarly, Tunisia's 2013 budget law expects to finance the fiscal deficit partly by Sukuk issuance. If Morocco were to tap the Islamic finance market, we think this could originate more from political reasons rather than fiscal funding needs."


According to S&P, Sukuk issuances from Africa could attract a large GCC audience. "We believe that Sukuk issued by African sovereigns could address an investor base in GCC countries or at the Islamic Development Bank (ISDB), which may be looking for Shari'ah-compliant investment opportunities," it said. "Countries in the GCC generally benefit from strong current account surpluses, which we believe could make them potential investors in Sukuk issued in other regions. For countries with both fiscal and current account deficits, attracting foreign investors to sovereign Sukuk could provide fiscal funding, as well as help to cover external financing needs and support reserve-building."

S&P noted that the goals behind issuing sovereign Sukuk can be manifold; first and foremost Islamic bonds can give governments access to a new investor class and so diversify sources of fiscal funding. "Among potential sovereign Sukuk sponsors in Africa, the highest rated is South Africa (foreign currency BBB/Negative/A-2, local currency A-/Negative/A-2), followed by Morocco (foreign currency BBB-/Negative/A-3, local currency BBB/Negative/A-2), Nigeria (BB-/Stable/B), Tunisia (BB-/Negative/B), and Senegal (B+/Negative/B)," it said.

In some cases, S&P believes that governments plan to issue sovereign Sukuk not with a view to fiscal or external funding needs, but to establish a benchmark for the development of an Islamic finance market. They may be responding to the desires of a significantly Muslim population or aiming to become a hub for the global Islamic finance market," it said.

Another advantage is that Sukuk issued by African sovereigns could be eligible for investment by the Islamic Development Bank (IDB). Of IDB's 56 member countries, 22 are from Africa. "We understand that IDB, as a multilateral lending institution, considers the development of Sukuk markets to be one of its goals," said S&P. "Indeed, governments issuing Sukuk could wish to attract IDB funding. Furthermore, the ISDB is the only 'AAA' rated Sukuk issuer."

In spite of its many benefits, S&P believes that current Sukuk structures used by African governments and a shortage of viable assets may hold back issuance. "Sovereign Islamic bonds are mostly Sukuk al-Ijara, that is, those based on leases or rents," it said. "In contrast, those of government-owned entities, such as development banks, tend to use profit-sharing Sukuk structures. Governments typically do not have activities that lend themselves to profit-sharing. We have observed that the assets underlying sovereign Sukuk tend to be public real estate, such as schools, hospitals, or administrative buildings. The limited availability of such assets may appear to be a constraint for greater sovereign issuance.

"For instance, this is currently the subject of heated debate in Egypt: challengers of the proposed Sukuk law argue the Government may misappropriate public assets via Sukuk assets. However, we think sovereigns might use other types of government assets, such as infrastructure, especially if the proceeds of Islamic bonds are used to help finance infrastructure construction. Nonetheless, as the examples of South Africa, Nigeria, and Senegal demonstrate, some time may elapse between announcement and issuance of Sukuk, as governments weigh up potential political and legal hurdles and the costs of issuance against the benefits and potential demand."

As it graduates from aid to investment, Islamic finance could be crucial for Africa's development. However, a lack of qualified practitioners, poor awareness and an underdeveloped regulatory environment continue to stall the industry.

"To take advantage of the looming opportunities offered by Islamic finance, it is crucial for the African countries to put in place the relevant policies and financial infrastructure," said Ahmed. "This means that enabling environments must be improved and regulatory and supervisory frameworks strengthened. It will also be important to start the work on capacity and human resources development as soon as possible, as these typically have long gestation periods. These efforts will benefit from the participation and cooperation of the private sector, so that its energy and innovation is directed towards generating sustainable growth and a prosperity that is broadly shared across society."

© Islamic Business and Finance 2013


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