Report says law does not fully protect depositors from exposure to Shariah lending.
The International Monetary Fund (IMF) has warned that the rapid growth of Islamic finance in Kenya is happening without adequate protection of depositors as is the case with conventional banking.
The IMF says in a newly released report that Kenya is yet to refine its prudential regulations to cater for Islamic banking despite the fact that the Shariah banks are offering loan products that are collateralised differently from conventional bank loans.
“The legal framework 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.
Kenya is also yet to come up with a Shariah-compliant deposit insurance scheme and is continuing to manage deposit insurance premiums in a single pool for all banks — a situation that could complicate compensation of depositors in the event a bank offering conventional and Islamic products collapses, the IMF warns.
Banks with Islamic windows are also not segregating Islamic deposits from other funds, says the IMF.
“The legal framework could benefit from further amendments to clarify permissible contracts and segregation laws to minimise risks of comingling funds that can weaken Shariah compliance and public confidence,” the report says.
Kenya, the IMF says, should seek to bring clarity to the grey areas in Islamic finance as it drafts amendments to the banking law as promised in the 2017/18 budget.
Yesterday, President Uhuru Kenyatta signed into law some of the proposed amendments, including a refinement of the Stamp Duty Act to provide for tax neutrality of Islamic financial products to enable them compete with similar conventional products in Kenyan market.
The Sacco Societies Act has also been amended to legally entrench Islamic saccos.
But the IMF report appears to be proposing wider and deeper banking sector reforms — citing banks as the dominant players in Kenya’s emerging Islamic finance market ahead of insurance and investment firms.
Kenya has three pure Islamic banks — Gulf African Bank, First Community Bank and Dubai Islamic Bank — besides 11 other lenders offering a mix of conventional and Islamic banking products.
Islamic banks have chalked up a significant amount of assets led by Gulf African Bank with assets worth Sh26.2 billion as at March 2017 and First Community with Sh15.5 billion.
There is still no data for Dubai Islamic Bank, which was licensed to operate in Kenya in April.
By end of March, Gulf and First Community had loan books worth Sh15.7 billion and Sh10.5 billion respectively.
Islamic law prohibits charging or earning of interest (riba) by both bank and customer, instead allowing them to share profit and loss.
Islamic banks therefore enter into specialised contracts with customers, the most common being a trade finance agreement where the bank purchases goods from a supplier on behalf of the borrower, sells them on to the borrower at an agreed mark-up, with the profit margin being shared between them as payments are made in instalments.
There is no law, however, preventing a conventional bank that offers Islamic products from using deposits from non-Islamic customers to service Shariah borrowers.
Currently, the IMF says, the Kenyan banking laws do not allow banks to trade in goods, meaning that Islamic banks have had to get exemptions in order to execute such contracts. The exemptions are renewable every five years.
“The law or regulations, however, do not provide adequate guidance on the Islamic contracts acceptable in Kenya,” says the IMF.
The IMF also warns of numerous shortcomings in the corporate governance of Islamic banks, pointing to the lack of a national supervisory board to oversee bank-based Shariah supervisory boards (SSBs).
Besides, there is no requirement in law compelling banks offering Islamic products to appoint independent board of directors to look after the interests of Islamic account holders.
The SSBs, whose role is mainly to check the Shariah compliance of a bank’s products, are subordinate to an Islamic bank’s board of directors through whom they report to shareholders.
The government has also been eyeing Islamic financing for infrastructure products, through a Sukuk bond.