Opinion and Analysis
Banks must comply with Islamic banking principles
Posted Friday, October 15 2010 at 00:00
A number of Kenyan banks recently introduced sharia friendly financial products, which target the Muslim population in the country.
Few know that in Kenya - unlike other markets - sharia banking focuses on profit sharing with a customer, so if a loss should arise the customer bears all costs.
This is Haraam, or forbidden, according to the sharia principles guiding financial transactions, because a bank must share portion of a loss for it to comply with the sharia guideline.
In addition, in the Kenyan market, where commercial banks are highly regulated by the Central Bank of Kenya, additional financial services that sharia banks can offer are not approved by the regulator.
Islamic banking refers to a system of banking or financial services that is consistent with the principles of the sharia which prohibits payment or acceptance of interest (riba) on loans, bills, bonds and bank deposits or on any other transaction between a borrower and a lender.
Investing in businesses that provide interest earnings is considered to be Haraam, or forbidden in the sharia context.
However businesses that provide return on investment such as provision of services, manufacturing, livestock trading, farming, professional services, foreign exchange, information technology are considered to be clean businesses by the sharia as long as the seed capital was obtained from Halal sources, which are not associated with bank borrowings and the business activities are free from haraam activities.
Sharia banking has the same purpose as conventional banking except that it operates in accordance with the rules of the sharia known as Fiqh-almuamalat (the Islamic rules on transactions).
The basic principle of sharia banking is the sharing of profit/ loss and prohibition of riba.
In a sharia compliant mortgage transaction, instead of loaning the buyer to purchase the property, the bank purchases the property from the seller and resell it to the buyer at a profit while allowing the buyer to pay the bank in installments.
In addition, the banks profit cannot be made explicit and therefore there are no additional penalties for a late payment.
Unlike sharia banking in Kenya, in more advanced markets like the Middle East, the customer and the bank share profit and loss based on predetermined ratio agreed at the time of the agreement.
Banks conduct a thorough credit analysis of the customer and the viability of the intended use of an asset to minimise volatility of earnings the investor might get.
Interest on loans is strictly prohibited by the sharia. Should a loss arise on the normal trading, bank must share the losses and prevent hidden charges on the customer accounts something sharia banking in Kenya has not yet realised.
One hopes that commercial banks in Kenya that offer sharia banking will soon comply with the principles of islamic banking.