Contemporary Challenges facing Islamic Banking in Kenya and Possible Solutions

Introduction

Islamic Finance is defined as a way to manage money and conduct business that fits with/ within the moral principles of Islam and is more often described as Shariah Compliant.

The main aspect of Islamic Finance is that it does not believe in the payment of interest, which is prohibited in Islam because money is not regarded as a commodity from which to benefit. This is based on the principal that risk must be shared and hence Shariah compliant Banks share the risk with the borrowers for a share of the profit.

Islamic finance entails using traditional investing strategies and structures that adhere to Sharia principles to build arrangements that function similarly to, and duplicate, the economics of, modern conventional finance.

Key features of Islamic Banking and Finance

Says God: “That which you give as interest to increase the people’s wealth increases not with God; but that which you give in charity, seeking the pleasure of God, multiplies manifold”. (Quran, 30:39); Says God: “O you who believe: Eat not Riba (usury) doubled and multiplied, and fear God that you may be successful. (Quran, 3:130)

Islamic finance is founded on the concept that money should not have any intrinsic value and that money is simply a means of exchanging valuable goods and services. The belief that one should not make money from money is linked to this way of thinking about money. This means that if possible, avoid being entangled with interest by either paying or receiving it.

Another fundamental principle that supports Islamic banking is that it should not cause harm. As a result, Islamic financial services refrain from investing in business that deals with items such as alcohol, tobacco, and gambling which are considered haram in Islam.

Islamic financing also promotes collaboration. This implies that, if possible, reward and risk should be shared. In the circumstances therefore the capital provider/financier and the entrepreneur/borrower must share the business risk for a share of the profit.

Businesses involved in speculative behaviours such as gambling (Maysir) and extreme uncertainty (Gharar) are also prohibited and hence sufficient effort is required to create a return.

Key Financial Instruments under Islamic Finance

The Islamic banking model relies on several financial instruments. Most of these instruments have been developed over a long period of time and are now acceptable for application in Islamic finance. Some of these instruments are as follows;

Mudarabah (partnership) – This is a business contract in which one party avails the capital and the other party the effort/operation. The parties then agree on a profit sharing and allocation of the risks related to the venture/business. The loss if any is borne by the financier while the borrower gets nothing for his labour.

Musharakah (Joint venture/equity participation) – both parties involved share in the profits and the losses incurred by the business in a predetermined ratio.

Murabaha (deferred payment sale) – The bank buys a specific item from a client for a predetermined profit over the cost of the item, then sells the item back and the client pays for it in instalments.

Ijarah (leasing) – It denotes a contract where one party transfers the right to use an item it owns to another party for a specified period in exchange for an agreed consideration. It is mainly used in asset finance under Islamic Banking.

The Practice of Islamic Finance in Kenya

In Kenya, Barclays Bank (now ABSA Bank Kenya PLC) became the first bank on 21st December, 2005 to launch Islamic banking products on a window basis when it launched La Riba account an interest free bank account.

On 29th May, 2007, First Community Bank became the pioneer bank in Kenya authorized by the Central Bank of Kenya under the Banking Act Cap 488 to operate as a full-fledged Sharia Compliant banking institution and it commenced operations on 1st June 2008. In the same year Gulf African Bank opened its doors and became the second fully shariah compliant bank in Kenya.

Later on, Dubai Islamic Bank PJSC (AE) set up a subsidiary in Kenya DIB Bank Kenya Limited in 2014. This created awareness to the Islamic finance owing to the increased competition by the fully fledged Islamic banks.

Kenya has in the last 10 years experienced a steady growth in the Islamic finance industry and hence witnessed increased awareness of the Islamic finance products as a result of the competition by the main players. The country currently has three fully fledged Islamic banks and several other conventional banks with Islamic windows offering Islamic banking products and services that include National Bank (National Amanah), Standard Chartered (Saadiq) and KCB (Sahil).

Islamic banking is however yet to acquire considerable uptake as it constitutes a small percentage of the market share in Kenya. There is therefore, need to explore strategies which Islamic Banks can adopt to attract more customers and increase their market share in the highly competitive banking industry.

Islamic banking is no longer associated with the the Muslim community but it is today more significantly open to customers of all faith. Islamic Banking therefore ought to be as competitive as conventional banking and leverage on the advantages to attract more customers. This demands clear understanding of the needs and preference of their customers on Islamic banking products and services.

Challenges facing Islamic Banking in Kenya and solutions

Despite the growth of Islamic finance sector, the industry continues to face a number of challenges that include but not limited to:

1.????Lack of awareness and Poor perception.

Islamic Banking is not widely embraced owing to the low level of awareness in the market. It is important to note that the level of awareness and the perception of customers are most important for the success and growth of Islamic banking in Kenya. Islamic Banking is still associated with the Muslim community and hence loosing a great opportunity to reach the majority of non-Muslim community. The banks should therefore aggressively market to non-Muslims as well and appeal to them on the basis of fair dealing by Islamic finance and value proposition.

It is necessary for the Islamic banks to spread awareness to the customers about Islamic products and services through adverts and conferences across the Kenyan economic landscape without bias. This can also be done through public sensitization programmes for the purpose of managing the poor perception stemming from ignorance about the industry.

2.????The absence of standardised legal and regulatory infrastructure in Kenya.

Banks in Kenya are mainly regulated by the Banking Act No. 9 of 1989 and the Central Bank of Kenya Act No. 15 of 1966. Islamic finance products, on the other hand, are to be governed by Shari’ah.

Shari’ah offers its own framework for execution of commercial and financial contracts and transactions. Nevertheless, commercial banking and company laws appropriate for implementation of Islamic banking and financial contracts do not exist in Kenya. The commercial, banking and company laws that exist in Kenya contain provisions that are narrowly defined and limit the scope of Islamic banking activities within conventional banking space.

It is therefore necessary that special laws for the introduction and practice of Islamic banking are put in place. This includes an amendment to the existing laws to broad their application in the context of Islamic finance and hence ensuring certainty in the application.

3.????Lack of skilled Islamic banking professionals

At the global level, we have the Accounting and Auditing Organisations of Islamic financial Institutions (AAOIFI), based in Bahrain that seeks to harmonise Shariah standards and practices across the globe. However, in Kenya, there is lack of harmonisation of the Shariah standards that indeed forms the very basis of Shariah compliance in respect to financial transactions. Kenya is also experiencing shortage of experts in Islamic banking which has not only caused a lag in the expansion of Islamic banking but also diminished innovation in the Islamic finance products available in the market.

The Shariah scholars have the divine duty to interpret the scriptures and offer guidance to the members of the public so as to ensure alignment between the conduct of the individuals and the expectations of Islam. They also serve to approve financial products applicable in Islamic finance, offer advisory services, train the stakeholders, resolve Shariah commercial disputes and exercise oversight on the implementation of their edicts.

In this day and age, Islamic banks need to have well informed and empowered scholars who have the trust and confidence of the customers and the stakeholders within the sector.

4.????Digitization for Islamic Banks

Islamic banks can realise more benefits from digitizing their services across all areas of banking. The reluctance on the part of Islamic banks to embrace technology in advancing the banking practises such as mobile banking in compliance with Sharia expose the Banks to low update of their products by the public for lack of flexibility. The customers would naturally be drawn to faster and more convenient digitalized services.

Furthermore, digitization will help Islamic banks become more efficient and save money in the long term. Islamic SaaS, automation, blockchain technology, and electronic contracts will make banking faster and easier. That means Islamic banks can focus on providing better services to their customers without worrying about losing out to the established competition.

Conclusion

The grown of Islamic banking in Kenya is inevitable due to the growing population and enlightened work force. With the growth in the economy, Islamic banking is expected to grow if it remains responsive to the need of the customers.

With innovative products, there will be lower transaction costs and more efficiencies as Sharia jurisprudence and Islamic finance papers and transactions become more standardized. As a result, more customers will embrace Islamic banking as an equal competitor to the conventional banking owing to its unique features.

There is however great need for the stakeholders engagement and especially Islamic banks to steer the revolution at the forefront through practical solutions to the issues that pose challenges to the sector. This will also require involvement of the regulator and other government authorities such a Kenya Revenue Authority and Parliament in order to review the relevant legislation to align to the Islamic finance practices.

?Authors: Isaiah Mungai Kamau and Vivian Namisi