Bringing Sharia Rule of Law to African Banking - OZY | A Modern Media Company


This little-known sector could be the next big thing for infrastructure in Sub-Saharan Africa and beyond.

By Tom Thriveni

Africa’s financing needs have exploded. But foreign investors from New York and London haven’t exactly been lining up to provide money for bridges, energy plants and other basic infrastructure projects. Which throws a window wide open for others to enter the market: wealthy Muslim investors in the Middle East and Southeast Asia.

Even for those familiar with international finance, Islamic banking — also known as Sharia-compliant banking — isn’t well-known, much less understood. If you’re picturing small-scale bartering at a Middle Eastern street bazaar, stop. This is a sophisticated capital market, much like any traditional banking sector, where companies, governments and individuals borrow from investors who, make no mistake, intend to earn a return.

For investments to be halal  (in keeping with the Quran’s teachings), they must:

• Be in a competitive market (no monopoly).

• Practice zakat (charitable giving).

• Steer clear of alcohol, tobacco, firearms, gambling, pork and pornography. 

But the fundamental difference is also a seemingly insurmountable paradox: Islamic law allows investors to make a profit but not to charge interest. How is that possible? By structuring a loan certain ways, the lender and borrower technically — in spirit, anyway — share the profit that a business or project makes rather than explicitly requiring the borrower to pay interest. To Western ears this sounds like a distinction without a difference, but to followers of Islam it makes all the difference.

Islamic law allows investors to make a profit but not to charge interest.

Think stocks versus bonds: Stockholders are owners of a company and get paid dividends, which are, technically, portions of profit a firm generates. Bonds, by contrast, are loans where the borrower pays interest for using the money and, eventually, repays the principal as well. Sharia transactions mimic the ownership-dividend model until the money paid by the firm or project equals the initial loan plus the return the lender expects — then, voila, the investor is no longer an owner.

men working on the road with dirt all around them

Kenyan men work at a road construction site near Isiolo town, 320 km (199 miles) north of Kenyan capital Nairobi,

A niche? Maybe. The sector represents less than 1 percent of global financing — but it’s growing. Assets of Islamic financial institutions grew by an average of 15 percent from 2006 to 2011 to reach over $1 trillion, and HSBC Bank estimates that number could reach $4 to $5 trillion by the end of next year.

Similarly, Africa’s capital markets are nascent but rapidly growing. For example, at the end of 2013 Sub-Saharan African governments had issued $4.4 billion in bonds , and that was by only four countries: Ghana, Nigeria, Rwanda and South Africa. And that’s nearly double the $2.4 billion issued the previous year. Thus far in 2014, Kenya has already issued $1.5 billion in bonds and Senegal another $500 million, with most of these proceeds being used for travel or energy infrastructure. Sub-Saharan Africa has a $93 billion annual infrastructure need , with a shortfall of approximately $50 billion per year because of an inability to get foreign investors to lend money. International funds accounted for 18 percent of total debt in Africa at the end of 2011, but nations there continue to look outside the continent and have realized that Islamic financial instruments can link them with wealthy Muslim investors in the Middle East and Southeast Asia.

Islamic investors have developed many financial tools to meet this need. If you thought choosing between cash back and air travel points was tough, try deciding between a  musharaka and a murabaha , terms that refer to various ways to structure a Sharia-compliant joint venture. 

Musharaka – A joint venture where two business partners agree to share in the profits or losses of a company according to a predetermined ratio.

Murabaha – An arrangement where, instead of loaning someone money to buy an asset (e.g., a factory or building) and charging interest, one party buys the asset and sells it to a second party at a higher price under a rent-to-own agreement. The “rental” payments that the second party makes to the first essentially replace paying back the loan with interest.

Perhaps the most popular arrangement is the sukuk , where a borrower agrees to pay lenders a fixed percentage return as the investment generates profits. Sound a lot like interest? Well, technically it isn’t because profits are paid out to the lenders as if they actually owned part of the company versus an explicit interest payment, but, other than some tax implications, from the perspective of investors it doesn’t make a difference. They lend money and demand a 10-percent return, and the borrowers pay it. It’s akin to buying a shirt at 10-percent off that originally was marked up 50 percent. Technically the retailer gave you a discount — while making a tidy 40-percent profit.

Sub-Saharan African governments have been adept at capitalizing on this growing opportunity to borrow from cash-flush Muslims and Muslim nations. While more traditional investors like Western pension funds and insurance companies may hesitate to invest in Africa, countries like Senegal — where approximately 95 percent of the population is Muslim — have found investors looking for Sharia-compliant investments more open to opportunities on the continent.

Students in uniform facing towards front of class which is towards the camear sitting in desks.

Students sit during lecture at Government Secondary School, Ikoyi in Lagos, Nigeria’s commercial capital.

Nigeria, a great example of the potential success of Sharia finance, is developing specific tax and regulatory guidelines to facilitate a smooth introduction of sukuk into its national economy and plans to issue a national sukuk in 2014. And one of the country’s states, Osun, has already issued a $71 million, seven-year sukuk to fund the construction of 27 schools. Local banks, fund managers, insurance companies and high-net-worth individuals agreed to contribute the $71 million in capital for an agreed-upon return of 14.75 percent.

The sukuk operates like its own company, using the money to buy land and fund construction of the schools. Instead of paying interest directly to the investors, the state makes rental payments to the sukuk , which owns the land and schools, and the sukuk then distributes the money to its investors until they receive their agreed-upon return. Then the state becomes the owner of the schools. Senegal plans to issue a $200-million international sukuk in the next year to fund infrastructure and energy projects, and South Africa expects to launch its first sukuk in 2014.

Despite the additional complexity introduced by using a sukuk as an intermediary between borrowers and lenders, investments like these that have been critical for infrastructure projects in the Middle East and Southeast Asia may soon play the same role in Africa, where leaders hope they’ll spark a domino effect that brings in more Western-style financing.

That vision could be a long way off, though, if more African countries don’t adopt rules and regulations — in essence, a modern legal structure — to assure Western investors their money is safe. 

In the meantime, the 99 percent of global financing that does not follow Sharia compliance needs to bone up on this new beast. It may seem byzantine and unfamiliar but it’s working — just ask a local bank getting a 15-percent return on its investment, or, better yet, the kids in Osun attending brand-new schools.


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