Islamic Finance: an opportunity for development?

148555584Facing development challenges and constraints related to the scarcity of financial resources through donations, African countries are trying to find cheaper alternatives to traditional funding mechanisms. To this end, they are more and more open to Asian financial resources: mainly Chinese and Arabic. If works on the Chinese strategy in Africa are in progress, the windfall represented by Arabic financial resources is not well known, whereas they seem to generate great interest among policymakers in the continent.  It is in this context that, on the 29 of March 2014, the Bureau of “Afrique des idées” Dakar organized a conference moderated by two specialists:  Dr Abdou Karim Diaw[1] and M. Rodolph Missihoun[2]. This article synthetizes the key lessons of this conference on Islamic finance and the role it could play in the development process of Africa.

Poorly known, Islamic finance has long remained the preserve of Muslim countries but there is a growing interest for this tool worldwide. Along with its own bank involved in development (Islamic Development Bank), Islamic Finance has others instruments such as sukuks (similar to conventional bonds) which interest many countries. London, world class financial centre, wants to position itself as a pioneer in the integration of this new way of doing finance in the West by issuing sukuks up to 233 MEUR. The regulation in this regard has been arranged and many specialized degree courses in Islamic finance are available in London. In Africa, Senegal is about to test the Islamic financial market by issuing up to CFAF 100 billion in sukuks. It has already received the approval of the Central Bank of West African States for refinancing. With hundreds of millions USD (nearly USD 1000 billion in late 2012 against USD 300 billion in 1990), the Islamic financial market is growing fast (its assets could reach USD 4000 billion in 2020) and therefore arouses everyone’s interest, particularly in Africa, whose financial needs are huge.

How does it work?

First, it’s important to remember that Islamic and conventional finance have the same characteristics. Hence, it does not defines itself as philanthropic. Islamic finance is based on the principles of Sharia, which considers illegal the perception of financial resources on financial investments through the mechanism of interest rates. Sharia principles assume that each gain should be motivated by the pursuit of an activity, which is not always the case in conventional finance. Thus, loans under Islamic finance rather take the form of an equity.

Leading stakeholders of Islamic finance play a role of multitasking entrepreneur comparable to an investment fund. Two cases are possible: financing a profitable activity (loans for business or a project completion) or a social project (loan to individuals or public entities). In the first case, if the stakeholders consider the project to be viable, they will participate as investors and not as bankers. In this context, the funds invested in the project will be remunerated depending on the benefits generated and the quota in the capital. The advantage in such a system is that the “Islamic” lender will be the one suffering the risks of the project. In the second case, the lender protects himself from the risks linked to investment.

The goal is to answer to an actual financial need while supporting risks and accompanying the borrower in its projects. To do so, the Islamic financial system relies on a banking group whose attributes are similar to those of the World Bank: the Islamic Bank of Development; and a set of Islamic commercial banks.

In the Islamic financial market, funds can be raised from commercial banks or the Islamic Bank of Development (whose activities are related to socio-economical development), or through the issuance of sukuks.  The sukuks are investment certificates working according to the same criteria above mentioned. For the holder, they consist in participating in the purchasing of a good to be resold to the client at a higher price, which then reimburses the investment according to the schedule on which both parties agreed. This way, he will receive the margin, depending on his level of participation, as a remuneration of the sukuk. 

Islamic Finance in Africa

The exercise of public finance is mainly due to the presence of the IDB. Twenty two out of the fifty six members of this bank are African, including 17 in sub-Saharan Africa (12 from West Africa).  In the third quarter of 2013, the commitments of the IDB in the world would have reach a hundred billion dollars. In Africa, these interventions are more concentrated in the Maghreb. To reinforce its presence in Sub-Saharan Africa, in 2008, the IDB established a program specifically dedicated to Africa: the Special Program for the Development of Africa, with a portfolio of USD 12 billion (including 4 billion from IDB and 8 from its partners) for the 2008-2012 period on areas such as agriculture, food security, water and sanitation, energy, transport, infrastructures, education, capacity building, health and communicable disease control. The results of this program reveal that a total of USD 13 billion have been committed through it, of which 5 billion from the Bank funds while 59%  of the total amount went to Sub-Saharan Africa.

The IDB itself is a solid institution, capable of mobilizing other donors who may finance development activities in Africa. The major rating agencies of the world attribute it a risk level of zero. Through the SPDA, the IDB could enable African countries to have an additional USD 8 billion, raised from its partners.

On the one hand, the IDB does not condition its intervention to socio-political criteria, very common in the African context and which can be a source of risk. On the other hand, its strength lies in the choices of the projects in which it operates but also in its principles of operation strongly rooted in Sharia’s principles.

The IDB has tools similar to the International Financial Corporation (IFC) of the World Bank: the Islamic Society of private sector development (ISPSD) and its Multilateral Investment Guaranty Agency (the Islamic Investment Insurance and Credits Export Company) destined to the private sector and very little known on the continent.

Some Islamic commercial banks are on the continent but are mostly concentrated in the Maghreb countries. Their emergence in the Sub-Saharan area is constrained by a lack of knowledge about the Islamic financial market, a regulation that does not encourage their establishment, but also by the particular debt conditions of African countries to which the IMF demands to have recourse only to financial resources comprising at least 35% of donations.

It’s obvious that Africa could benefit from the expansion of Islamic finance. The major stakeholder of this market alternative to conventional finance have already a strategy that should guarantee them a lasting presence on the continent, currently presented as one of the engine of the global growth. Some regional offices of the IDB have already been installed: in the Maghreb, West Africa and East Africa.

The IDB already works on a relaxation of the regulatory framework in order to encourage the implantation of Islamic commercial banks.  It increasingly directs states to sukuks. Africa, for its part, should try to appropriate this tool which has many advantages, in getting involved a bit more in its process of installation on the continent through regulation and by paying particular attention to the approaches used in the margin determination, but also by developing its capabilities in terms of negotiation, which so far, are a bottleneck in the process of development in Africa.

Translated by Olivia Gandzion

[1] Ph.D. in Islamic finance


[2] Chief Economist at the regional bureau of Islamic Bank of Development (IDB) in Senegal