At the just concluded World Bank/IMF Annual Meetings, Financial Vanguard had an interview with Mr. Abayomi Alawode a Nigeria, who is the Head Islamic Finance and Financial Systems Global Practice at the World Bank Group. He spoke on how Islamic Finance can help in the war against poverty and SME development. He joined the World Bank in 1997. Previously, he was a Lead Financial Sector Specialist in the East Asia and Pacific Region of the Bank and also served as Adviser, Financial Stability at the Central Bank of Bahrain. Abayomi holds an M.Sc in Economics from the Obafemi Awolowo University, Ile-Ife, Nigeria and an M.Phil in Development Studies from the University of Cambridge. He is the author of several academic papers on monetary and financial sector issues in Africa.
How will Islamic banking contribute to poverty alleviation, which is one of the targets of the World Bank and also financing SMEs. What should we be expecting from the Islamic Banking workshop and how is Islamic finance going to help reduce poverty in a country like Nigeria?
I agree with you that there is a need to raise awareness in Nigeria, in particular around the issue of Islamic finance, one thing I will like to make clear is that people think that Islamic finance is for Muslims only, that is not true, am a Christian and I have been doing this for the last five years and is something I believe in not because of any religious convictions but because I think the model itself is sound and relevant for growth and development and I’ll tell you why.
First Islamic finance emphasizes partnerships between financial institutions and businesses, that is to say that you don’t necessarily have to give a loan to a business man waiting for interest rates and your principal at the end of the day but you are encouraged to actually go into partnerships with businesses. The Islamic financial institution is like an investor going into a joint venture with a business man. So they have something at stake, the business man have something at stake, so the incentives are aligned for them to ensure that the business does well. At the end of the day you have a situation where financial institutions are not just stand by providers of finance but active participants in business.
Islamic finance does have this kind of instruments that encourage financial institutions to be partners with businesses and I think this is good because for SMEs in particular they struggle to get loans from banks and other financial institutions because they don’t have collateral and if you don’t have collateral you have very limited chance of raising funds externally if you are an SME. But for Islamic financial transactions, what you then get is a situation where financial institutions are willing to go into partnerships with businesses and we think that this offers SMEs a better chance of getting the external funding they need for working capital as well as for investments.
Interest rate is price for money, what is the drive if you are going to partner with somebody or you are going to give out facility and there is no charge or cost to it?
There is a return, is not an interest rate but there is a return. What Islamic finance emphasizes is that money is put to work and when money is put to work it generates a rate of return. When you get that return, the financial institution and the business share the profit, so the financial institution is not just seating down and waiting for interest rates to come in periodically but it actually shares in the return, there is a concept called profit and loss shared, this is where the partnership dimension comes in.
It is not that the financial institution will not make money out of this, they do, otherwise nobody will set up an Islamic financial institution, they do make money, but they make money in a different way, not through interest rate but through actual profit that you make. The underlying concept is that if a business is sound, it will generate profit and the financial institution that is putting money behind this business should get some returns from it, the returns come in but they share the return with the business man so there are so many instrument that are structured like this on the basis of profit and loss sharing.
If you look at the small scale enterprises, a number of them do not have good accounting system, therefore the possibility of them making profit for them to share in the short term, say one to three years may not be there, so how do we hedge against that?
There is an instrument, called mundaraba under Islamic finance, what this means is that the Islamic finance brings money to the table. For example, you are a journalist, you want to set up a newspaper and you go to a bank and say, I want to set up a newspaper business in Nigeria, the Islamic bank will say ok, we want to go into this business with you, we will give you X amount of dollars to set up the business. You will run the business because you are the journalist, we don’t have any experience in journalism but we will sign a contract that the two of us from day one will closely track the money that we make.
You may not have an existing business, you may want to start a new business, where from day one you can track how much money you are making, everybody knows how much money comes in, you may not keep the books properly but if you focus on keeping the books properly, both the financial institution and the business man can track the returns from their investment. Remember that you want to make money you don’t want to put all your effort and make losses, nobody wants to make losses.
The business man and the financial institution together, they will track the returns from that investment, you are putting your time and energy, you will get a salary based on the energy you are putting in and you will track the profit which you will also have a share with the business. So it sounds strange especially in environments where you’ve had conventional financing working for so many years.
Remember that conventional financing is over five hundred years old and Islamic finance in its current form is about forty years old. So is still taking time for people to understand exactly how it works but if you look at countries where this work, when you have this kind of transactions between banks and businesses, there are challenges no doubt but there is more incentives for the two sides to work together to make sure that the business succeeds. We have seen this happen in so many countries; otherwise, you will not see this growth of interest in Islamic finance from even non Muslim countries. If you go to Britain, they do have Islamic finance growing rapidly. Last year, David Cameron, announced that he wanted London to become the centre for Islamic finance in the Western World. South Africa has issued a Sukok months ago, Hong Kong has issued a Sukok because they see not the religious side but they are seeing this as financial instrument with certain features that can help their economy develop.
The scenario you have painted brings us to the question of confidence in the relationship between the Islamic financier and the businessman, in an environment where that is absolutely lacking, how will a bank thrive?
The issue of confidence is not only in Islamic finance problem, you also see it in conventional finance. If a business man takes a loan from a bank, the bank will monitor how the funds is being used, they will come and check your books to make sure that you are spending the funds appropriately, it is exactly the same in Islamic finance. What is the added level of confidence or trust is the fact that in Islamic finance you need a strong legal framework for contracts to be honoured, so there is a contract, is not that we shake hands and we all go and do no harm, there is a contract and there are contracts that are signed that can be enforced. Yes you can have problems when enforcement is weak, but this is also a problem for conventional finance, is not only Islamic finance that has this, this is a problems, yes I admit.
Nigeria environment for instance, nobody respects contracts, contracts that are entered into are broken, am worried how Islamic finance can thrive in this kind of environment where sanctity of contract is a big issue.
If you go to a conventional bank, and you take a loan, you will still sign a contract, even though contracts are poorly enforced, everyday contract are being signed in Africa, in Nigeria in particular, you still have to enter into contracts, you still have to go to court to enforce those contracts. You rent a house from your landlord you have to enter into a contract to pay your rent. This is why the World Bank has a strong focus on helping countries to strengthen this environment where contracts, the rule of law, having cut that function properly, these are the basic building blocks of a well functioning financial system, whether is conventional or Islamic you still need those legal frameworks.
So we as World Bank do work with different countries including Nigeria on legal reforms putting in place stronger enforcement mechanisms, not only for Islamic finance but also for all kinds of transactions. If you look at any economy, there are not many things you can do without signing contracts, if you take a loan you sign a contract, if you rent a house you sign a contract, even if you get a job from a company you sign a contract that this is the salary am going to get and am going to work so many hours.
Our role as a development organisation is to help countries improve this. In the United States, you have lots of contracts and I can tell you, this is why lawyers make lots of money here, contracts here are also difficult to enforce because no matter what contracts you sign, somebody will find some loop holes in it one day. This is a process of constant improvement, Africa may be far behind but is a journey that is going towards a better environment where contracts are respected and where contracts are honoured and where the court system functions effectively.
So there may be challenges, yes am not saying there are no challenges, my point is that this kind of challenges cuts across all kind of financial and economic transactions and the role of financial institutions such as the world bank is to help countries such as Nigeria and other Africa countries to improve the legal environment and to improve investment climate. When we worked on investment climate issues, these are some of the issues that we looked at.
In Nigeria there were Islamic bank, the defunct Habib bank which metamorphosed into Bank PHB now Keystone Bank, what do you think are the constraint to embracing this issue in Nigeria?
In Nigeria the challenges are several and I think the central bank has done a lot of work to put in place a regulatory framework for Islamic banking. But you do have a big problem in terms of perception and awareness. Anytime I talk to fellow Nigerians about Islamic banking, they still see it from a religious point of view which is why the CBN could not call it Islamic banking, they call it non interest banking, so that sends you the signal that the word Islamic banking is loaded and the CBN took a step of shying away from that and they call it non interest banking. When people now see it from a religious point of view, in a country that historically has had tensions between Muslims and other religions, in a country where today you have an Islamic insurgency in the Northern Nigeria, the Boko Haram thing, it becomes really tricky for you to promote and aggressively develop Islamic banking. Until people become aware of it that it is really not for muslims only and is not muslims trying to take over Nigeria or take over the Nigeria financial system.
These are political economic issues that you and I cannot solve, these are fundamental issues that we cannot wave our hand and they will go away but until the general level of awareness increases and people understands it better and the overall environment improves is going to be challenging for these banks to develop, but it is not an issue unique to Nigeria. In Turkey as well they could not call them Islamic banks because the Turkish constitution says that Turkey is a circular country with no national religion, in Turkey they call them participation banks. You do have challenges in some of these countries where the political economy is not conducive to aggressively promoting “Islamic banking” because either the constitution forbids it or the current environment is not conducive to aggressively championing a particular form of finance that has got a religion attached to it.
Let me take you back to the issue of legal system, the Islamic jurisprudence is quite different from the normal legal system that people operate, if there is a default, do you go to the normal court or the Islamic court.
This is one of the areas where we are working right now, is not only in Nigeria even in Muslim countries, let me pick a country at random, UAE. If you go to UAE they have a system where for financial transactions you have to agree before hand, which court you are going to use to settle disputes.
Because even though they have Sharia, Sharia does not cover all transactions, is not a fully Sharia economy even in the UAE. Today if you go to Dubai, they have what we call Dubai international financial centre where you dso have Islamic banks, where you have Sukok, however, the laws they use is the common law of England and everybody agrees we are going to settle any disputes with the common law of England and the contract law applicable in England.
There is some contradiction here, the contradictions is this, Islamic financing, you don’t use the money to get involved in certain activities, now I get the money and some how I get involved in some of these activities, if you take me to the normal court, the court will say yes he is running a business and Islamic jurisprudence will say no this is not the normal issue how will the dispute be settled?
If I take you back one step, the first statement that you can use your money for anything is not applicable in Islamic finance.
Islamic financing will not allow investment in ; alcohol, armament, anything harmful to the society, If a man sees a business opening in this area would you say no, this is a contradiction?
The reason why that cannot be disputable is because there is another feature of Islamic finance called asset backing where any sum of money you get is assigned to a particular investment from day one and you identify the asset, there is no dispute about what you are financing, this is again why people think Islamic financing can be used for development because for every dollar or every naira you come up with you can identify what you are buying with that naira. Example; if you go to an Islamic bank and say I want to buy a car and I need a car loan, they are not going to give you the money and then you go and buy a horse instead.
What happens is that the Islamic bank will ask you what kind of car you want and Islamic bank will go and buy that for you and hand it over to you, you have no room to run away. This asset backing also happens in business as well, where if you need money to expand your factory in terms of machine they will identify what you want to buy and be involved in you actually buying those machine. There is this asset backing feature which ties Islamic financing to specific assets, if you recall when Osun State issued a Sukok last year, they had to say specifically what they are going to use the money for and they actually said they are going to build schools and hospitals with this. So that is how Islamic finance functions, it says you must tie the financing to specific assets that are identified.
This is the case because you are not looking for interest you are looking for returns generated by your investment, so from day one you must know what exactly the assets are that you are purchasing with that money. To come back to your hypothetical situation, that can not arise because the Islamic financier and the businessman from day one would identify which assets they are actually purchasing with the money. This happens also with the government, when government are issuing Sukok Islamic bond, they have to identify which assets they want to buy with it.
In Sudan there is a programme of using Sukok to buy hospital equipment like X-ray machines, MRI machines, every time you issue the sukok to raise money, you must specify what you are buying with it. So this asset backing we believe is a strong feature of Islamic finance that makes it more conducive for development because you can actually tie for instance, financing to infrastructure.
A government can say we want to borrow money to build roads, if you use Islamic financing instruments, there is no way they can use that money for something else because the money is tied inextricably to the road construction. These are some of the features of Islamic finance we think that if you use properly in an environment like Nigeria, you wouldn’t have this forgibility of money that we are referring to. When you come to the Sharia issue and settling disputes, they are seen strictly as a contractor issue in many countries, if you look at the UK they have Islamic banks but UK is not a sharia jurisdiction.
They look at it purely that you have sign a contract and if the contract is enforceable or not, they will take advice from sharia scholars based on whether the contract itself is admissible under the sharia rules. Before the contract is finalized, remember each bank has a sharia board that looks at the contract and certifies that it is sharia compliant. That is another layer of scrutiny that you do get but if you have somebody who says I cannot pay back and you want to go back on your contract that you have signed, then you can use a regular court, it is not ideal but in may jurisdiction they use a regular court. Where you use a sharia court will be in country’s like Saudi-Arabia where there is no doubt about what is the dominant legal system.
So which countries in West Africa will you say this initiative is succeeding?
In Africa Islamic financing is just starting, Nigeria of cause has the potential because of the population and the size of the economy, Senegal has issued a Sukok, Gambia as well has used a sukok, there is some interest from Mali, Bokinafaso, but limited extent at this time. Again is because lack of awareness is an issue, in addition many of these countries are wrestling with many other problems that this is not their priority at this time, but for West Africa right now Nigeria, Gambia and Senegal and to some extent Mauritania, if you can count Mauritania as west Africa although is beginning to switch over into northern Africa. Those are the countries where you can see a strong interest in Islamic finance.
Is World Bank just offering capacity in that respect or it involves money?
Our work in Islamic finance has four main branches, the first one we are beginning now to lend money on sharia compliant principles and we have two pilot projects, it goes in Egypt and in Turkey we have loans to SMEs Islamic finance laws but of cause the loan goes to countries first and then the countries disburse on sharia compliant basis.
The Turkey project, we have the money going to the government and then the government on lends the money to Islamic banks and the Islamic bank then lends to SMEs, we are providing the liquidity and they then lend on sharia compliant basis to SMEs.
In Egypt is the same structure except that the Islamic banks there are using this to finance their leasing equipment to SMEs because many SMEs want leases. Now we are trying another one in Bangladesh where this will be another project that provides money for SMEs. We do have loans that we on lend on sharia basis. Secondly, our private seetor arm, the IFC they do invest, they take equity in Islamic banks because IFC is a profit making entity and they do have equity investment and so they invest in Islamic banks. Third, you do have knowledge and capacity building activities which I just described, we do a lot of workshops, this is one of them, we have Islamic finance centre based in Istanbul through which we are doing conferences and workshop to dialog, raise awareness.
Many of the issues you brought about legal awareness we brought it and we bring lawyers and sharia scholars who debate what the problems are and what possible solutions there might be. We do have in addition to the knowledge and capacity building, we offer direct assistance to central banks and regulators if they want to develop Islamic fiancé and they are trying to put together a framework for regulation and supervision, we have experts here. I myself have done this, where you go and seat down with them and you work through the building blocks to know what they need to put in place, what are the best practices. We just finished one in Tanzania, they want to introduce Islamic banking we help them to put in place the regulatory framework, we call that technical assistance and advisory services we have a range of ways in which we provide support to different countries. In Nigeria we may start doing something soon because we have gotten a request from the central bank to explore possible ways in which we can collaborate to develop Islamic finance and in the first phase of this programme, it might be conferences and workshops to raise awareness and discuss what the issues are and how to move forward including how Islamic finance is relevant to Nigeria’s economic development. We do a range of things and we can deploy this in different countries depending on the need. We are client focused if they say they want conferences and workshops we focus on that, we don’t necessarily push a certain kind of intervention.
How much has World Bank voted for this?
The two projects am talking about if you look at the Islamic finance components of the two projects is about $200 million, $50 million in Egypt and $150 million in Turkey but this is over the next five years, money available to be disbursed at the sharia compliant basis for SMEs. However, if we begin to get into infrastructure projects, you can expect this to get much bigger because infrastructure projects are big ticket items that take a lot of money, here we expect to leverage available public sector of financing. In Nigeria for instance, is mostly the public sector that finances infrastructure, if you bring Islamic finance, is a case of bringing private sector money to join with public sector money in PPP type of arrangement. It depends on projects, is going to be a project by project assessment to determine the size of the investment but we don’t have any limit or caps, it depend on the country limit because each country has a borrowing limit with the world bank, is not that countries can borrow as much as they want, there is a limit for every country, as long as you remain under that limit that is fine.
As a Nigerian, what will you be advising the authorities, on Takafu, micro insurance, one thing that is lacking in Nigeria today is insurance awareness, people are not interested in insurance, what will you advise CBN to do in respect to this and do you see micro insurance as far as Islamic financing is concerned working in this kind of environment where people are adverse to paying premium?
Well you’ve made a point because even conventional insurance is not well developed in Nigeria and is not a Nigeria problem, is a global problem, conventional insurance is not well developed in many countries, what you discover is that there is a linkage between level of development and level of development of insurance, insurance is more active in the advanced economies because of the income levels, people are more willing to pay premiums when their per capital income is at a particular level. Many developing countries struggle to develop conventional insurance and you are absolutely right that takafu will struggle in an environment where conventional insurance itself is struggling. The advice we have given many other countries, which is the same advice I will give CBN is that you need to go stage by stage, get the banking right first. If you look at global Islamic finance, banking is over 80 percent of global Islamic finance even in countries where they have well developed Islamic financial systems like Malaysia, banking is the biggest. My advice would be to get the banking sector right first, before you start looking aggressively at insurance, it does not mean you don’t look at all at insurance but you take things step by step because is relatively new. What we’ve also found relatively is that you can bundle Takafu with microfinance, if you have microfinance products which are very well known in Nigeria, you can bundle micro takafu with micro insurance and this has been done in many countries where there are premium but they are linked to the fact that you are engaged in a microfinance enterprise with a particular MFI. These are possibilities to slowly getting people used to Takafu, but this applies to conventional insurance as well, you need to find ways to bundle conventional insurance with other financial products. We have our focus on financial inclusion and the message is that we focus always on financial services and how you bundle products that will serve the clients, for Takafu, it will be a challenge but you need to find ways of bundling this with other financial services.