For the purpose of this article we need to clarify a few interpretations so that one understands the gist of what is risk management in Islamic finance in context to conventional banking with emphasis on Kenya.
What is Risk Management? Risks are uncertain future events that could influence the achievement of the Bank’s objectives, including strategic, operational, and financial and compliance objectives.
What is Islamic Banking About? Islamic banking or Islamic finance or sharia-compliant finance is banking or financing activity that complies with sharia (Islamic law) and its practical application through the development of Islamic economics. Some of the modes of Islamic banking/finance include Mudarabah (profit-sharing and loss-bearing), Wadiah (safekeeping), Musharaka (joint venture), Murabahah (cost-plus), and Ijara (leasing). (Source: Wikipedia)
How do Islamic Banks Manage Risks? The main challenge we have is first to understand the issue of Riba which is technically prohibited in Islam in dichotomy to modern day conventional banking which actually revolves around interest. The profits reported by conventional banks is profits that are made from different products that lend money to those who have saved and have some in the bank to those who need money in terms of loans , mortgages etc and are individual entrepreneurs who require money for investments.
In Islamic finance banks there is a slightly different version. The underlying principles that govern Islamic banking are mutual risk and profit sharing between parties, the assurance of fairness for all and that transactions are based on an underlying business activity or asset. For example investments that includes long-term financing for developmental projects which translate into real economic development. We can say this is a more acceptable form of ethical, sustainable, environmentally and socially-responsible approach that further promotes risk sharing, which is the core principal where the larger good of the society is taken into consideration rather than individuals. It emphasizes on inclusivity and social welfare in the economy by investing in long-term tangible assets like roads, water systems, electrification in rural areas, provision of sanitation facilities.
From the above we can see clearly that Islamic banking contrary to what is believed is less risky than conventional banking is and the projects undertaken are not only suitable as a development of any country but the banking is open to all people irrelevant of your religion or any other background. The focus is on wholesome development of a society rather than individual focus. The risk and return are shared between the firm and its fund providers. In a conventional firm (which guarantees returns to its depositors and investors), only the institution bears the risk; no risk is transferred to the fund providers.
A summary of risks with conventional versus Islamic finance:
Challenges to Islamic Banking in Kenya: There are a number of challenges and even though I will not be able to go through the entire spectrum, however I can mention a few.
- Misconceptions: First and foremost it would be the general lack of knowledge and misconception that entails Islamic banking. The banks have to spend a lot of time in making the general populace including Muslims to understand the concept as compared to conventional banking which is well established. Many of the conventional banks have also come in offering Islamic banking but in my view it’s not in a true sense what it’s supposed to be as the funds are pooled together and it mainly differs only in the wordings as the banking rules are set by the Central Bank of Kenya which is conventional banking..
- Lack of Islamic Scholars: There is a dire need to synchronize all Islamic banks to read from the same page in respect of Islamic law and modern finance, documentary complexity, heightened competition, and the aggressive launch of innovation, lack of risk-hedging instruments, and the sophisticated products of other financial For example we have Muslims who simple cannot purchase a house as they will not pay riba on mortgages whilst the Islamic banks are not able currently to provide an alternative.
- Lack of Specific Legislation: Islamic Banks and conventional banks all fall under the Central Bank of Kenya and are given the same treatment as conventional banks with only a few exceptions. The central banks subject Islamic banks to the same controls, conditions, laws and regulations that also apply to interest-based banks.
- Bank Accounts versus Mobile Banking: The country being a third world country with very high unemployment rates there is a vast population that do not have bank accounts with the traditional banks. As per statistics by the Central Bank Governor as of February 2019. 99.3 percent of bank accounts in Kenya have deposits of less than KShs 1 million. Only 0.7 percent of accounts have deposits of more than KShs1 million. Whereas in comparison as per the World Bank report in 2017, 82 percent of Kenyans use mobile banking as alternative to traditional bank accounts. The growth in account ownership in Kenya has been largely driven by extensive use of mobile money solutions, which makes it easier and cheaper to send and receive money as well as to take out loans. The International Monetary Fund found that African countries accounted for only 1% of global Islamic finance assets. And according to The Economist’s Intelligence Unit report, Islamic banking represented only 2% of Kenya’s total banking assets.
Conclusion: Whereas there are sundry challenges in regards to Islamic banks getting a foothold in the market, it’s not all gloom and doom. The industry is gradually gearing up to face the challenges and it’s through international bodies like the International Islamic Centre for Reconciliation and Arbitration (IICRA) that education and awareness can be created and training of experts to guide on the required legislation and best practice in banking, financial and commercial with compliance of Shari’a principals to develop infrastructure in countries like Kenya.
Article by: Shafiq Taibjee
First Published in the IICRA Bulletin issue No 017- 1st January 2020
Honorary Fellow –International Islamic Centre for Reconciliation and Arbitration
|Conventional Financing:||Islamic Financing:|
|1) Credit (money lent to a borrower)||1) Equity Investment Risks|
|Market(Local competition) ||2) Displaced Commercial Risk|
|3) Liquidity(meeting financial obligations) ||3) Rate of Return Risk|
(negative impact on earnings, liquidity/ capital position)
|5) Profit and Loss Sharing||5) Operation (practices and procedures)|
|6) Constraint in terms of prohibited|