Regulations are hindering growth of Islamic finance

The steady growth in Islamic banking in Kenya is a spectacle that was unexpected when Islamic finance started in Kenya in the last decade. As of the Islamic Financial Services Board (IFSB), 2016, global Islamic banking assets were recorded as $1.9 trillion.

As per the Islamic Financial Services Industry Stability Report 2017, published by the Islamic Financial Services Board (IFSB), the composition of these assets as: Islamic banking (79 pec cent), Sukuk or Islamic bonds (17 per cent), Islamic funds (three per cent), and takaful contributions or Islamic insurance) one per cent. Middle East and North Africa jointly account for 30 per cent of the global Islamic finance assets. The Sub-Saharan Africa accounts for 1.7 per cent of total Islamic finance assets.

Islamic banking continues to be a key contributor in improving access to finance and aiding in eliminating extreme poverty.

The Finance Act of 2017 made amendments to the Co-operative Societies Act and the SACCO Societies Act to facilitate shariah compliant products and enhance financial deepening. It also amended the Public Finance Management Act to recognise Sukuk as one of the national government securities.

Despite this growth, there is still much to be done in developing regulations that can ensure safety and stability of the sector, in terms of corporate and shariah governance framework, capital markets regulations, Takaful regulations and prudential guidelines specific to financing arrangements by Islamic banks and management of profit rate risk and displaced commercial risks that are unique to Islamic banking.

The IMF criticised last year the legal framework governing Islamic financial institutions and averred that the law as is exhibits some gaps, prudential frameworks have not been adapted to the specificities of Islamic banking and there are also remaining gaps in the Shariah governance framework, consumer protection framework, liquidity management, resolution and safety nets," says the IMF report.

In this article, we will examine shariah governance and how it can be strengthened. Subsequent articles in this area will address issues of prudential framework required for Islamic banks and Islamic finance deposit insurance.

Shariah governance remains pedestal to survival of Islamic banks. Overtime, shariah governance has evolved in Malaysia, a key model market for Islamic finance.

The Islamic Financial Services Board (IFSB) defines shariah governance as a set of institutional and organizational arrangements through which an Islamic bank ensures that there is effective independent oversight of Shariah compliance for each of the following structures and processes: Issuance of relevant Shariah pronouncements or rulings, dissemination of Shariah pronouncements or rulings to the operating personnel, Internal Shariah compliance review or audit and annual Shariah compliance review or audit performed to verify that the internal Shariah compliance review or audit has been appropriately carried out and its findings have been duly noted by the Shariah board.

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) does not provide definitions on Shariah governance. Its standards provide guidance on matters relating to Shariah supervisory boards, Shariah reviews, internal Shariah reviews, and audit and governance committees for Islamic financial institutions.

Shariah governance can be looked at as peculiar to banks that are fully shariah compliant or operate shariah windows since they are exposed to shariah non-compliance risks.

Kenyan Islamic banks have tried embed shariah governance within their governance frameworks. However, coordinated mechanism lacks to ensure parity in shariah interpretations, product development and advisory and regulations at an industry level in as far as shariah governance is concerned. Islamic capital markets remain hugely untapped in Kenya. Whereas the treasury is keen on issuing Sukuk to fund infrastructure development and embracing further incorporation of Islamic finance by financial institutions in their operations through the Finance Bill of 2017, much needs to be done to set up appropriate structures to address issues of Shariah governance at an industry level. This will provide impetus to ensure remarkable growth is achieved in the development and regulation of Islamic financial markets by providing guidelines that address specific needs of Islamic financial institutions, their business model and risk taking behaviour.