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Islamic Finance in Africa

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African Economies and Views on Islamic Financing

Islamic finance in Africa is rapidly spreading to counter already dominant Western and European financial systems. These forms of funding indicate that organizations need to change focus from traditionally used banking systems and incorporate or consider the Islamic ones. Notably, the Islamic funding system is based on ethical finance and investment guidelines. This paper will analyze the ways it has spread across the African continent affecting the modes of businesses, benefits, and challenges of its nations. Islamic finance advocates strategies that hinder profit making at the expense of others while ensuring that morality principles are upheld.

Africa consists of the developing nations with underdeveloped economies. Their level of per capita income is below $750. According to the research, African economies are characterized by high poverty levels, high dependence on the agricultural sector, and underutilization of natural resources. Furthermore, they have insufficient industrialization, dualistic economies, and lack of capital and infrastructure. (Ahmed, 2012: p 526-533). Governments of the African states are corrupt, which is the main reason why public infrastructure, such as roads, financial services institutions, hospitals, and school, is inefficient (Imam & Kpodar, 2013, p. 112-118). African countries have dualistic economies where manufacturing industries exist in the urban areas while agricultural activities are mostly concentrated in the countryside. Dualistic economies present challenges in developing economical solutions for the continent.

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Islamic banking is a set of the investment activities guided by Sharia Law and their application through the creation of Islamic economies. Sharia Law prohibits fixed payment or interest concerning intangible goods. African nations find Islamic system very convenient as it reduces the countries’ debt structure significantly since they are not required to make interest payments after incurring debts (Gundogdu, 2010, p. 20). Given the friendly terms of Islamic financing, African nations and businesses are turning to Islamic financial institutions as a means of raising revenue for regional and international trade deals. Sukuk and Sharia principles only charge interest for tangible assets that make Islamic finance appealing to the trading houses operating in sub-Saharan nations.

Islamic finance has a religious background that governs trade, banking, and investment practices. The Quran provides guidelines on commercial contracts, future, and immediate payments. Islamic finance accepts the market as a major determinant of prices for both sellers and buyers in trade. The Quran condemns ar-ribaa, also known as usury; therefore, Islamic financial institutions do not permit unfair interest rates, and they avoid lending money at interest for intangible assets. Hadith sayings prohibit trading facing some risks, thereby, controlling the investment practices of Islamic financial institutions. These establishments do not invest in businesses that provide services contrary to Islamic religion and in those that are considered sinful, such as alcohol and pork manufacturing companies. Islamic law upholds a person’s right to own private property except the cases where private ownership harms others (Freudenberg & Nathie, 2012, p. 58). This ensures that Islamic law protects state-owned natural resources. Islamic finance has developed methods and instruments that protect the developing world from evils arising from poverty, high inflation, and interest rates.

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In a competitive world where reducing costs, maintaining high-profit margins, and price competitiveness are vital for the survival of the businesses, trading houses and startup companies in Africa consider Islamic finance to be an ideal way of borrowing money. Islamic financial institutions are looking to establish a greater presence on the African continent especially in the commodities sector.

Types and Classification of Islamic Financing in Africa

There are three types of Islamic financial instruments including profit and loss based instruments, lease based contract instruments, and sale based contract instruments (see Table 1). From a Sharia perspective, these financial instruments are acceptable, although their effectiveness in the finance sector is similar to the interest based financial instruments that Islamic background and theories attempt to replace. Islamic banking offers a new solution to the African continent because conventional banking is not accessible by many poor people because of high interest rates and lack of collateral.

Table 1: Growth of different types of Islamic finance between 2005 and 2010 in Malaysia (Qouym, 2010).

2005 2010
Murabahah 63% 54%
Musharakah 12% 22%
Mudharabah 20% 14%
Qard 1% 5%
Ijarah 2% 4%
Istina 2% 1%

Profit and Loss Sharing Based Financial Instruments

Profit and loss tools (PLS) used by Islamic banks and institutions are based on the ideas that suggest fair sharing of the benefits and risks between the parties in a business transaction where Islamic institutions act as an intermediary (Durán & García-López, 2012: p 49). The Islamic system does not receive a fixed rate of interest but shares an agreed percentage of profits and losses of the investing partner. Therefore, these establishments share with savers and investors Mudarabah and Mushakarah, an equivalent to equity.

Mudarabah is a Muslim principle that allows firms to conduct joint ventures where the financier provides capital, and the agent provides labor. Profits between the two are shared based on a mutual consent, but if the investor suffers losses, the agent, the Islamic bank, does no recoup for its labor. On the other hand, Musharakah is a business contract where Islamic banks offer capital to business partners requiring that profits and losses are shared among the participating parties depending on the amount of money each partner provides to the business venture. However, Musharakah does not respond to the needs of most modern businesses (Demirguc-Kunt, Klapper, & Randall, 2014, p. 117-130). Therefore, these partnerships end with one of the partners taking full control of the venture by buying out all other partners through an equity redeeming mechanism agreed upon by all parties. Islamic financial institutions use the concept of diminishing Musharakah to finance fixed assets, such as factory building, plant, and machinery projects

Islamic banks depend more on the short-term debt instruments as opposed to the Islamic partnerships guided by Musharakah and Mudarabah principles (see Table 2). In Malaysia, for example, reports of two Islamic banks showed that Bank Islam Malaysia Berhad used 0.66% of Mudarabah and 3.53% of Musharakah of total financing (Mustafa & Razak, 2012: p 94). Bahrain Islamic Bank used 9.33% Mudarabah and 2.16% Musharakah for total funding.

Table 2: The ratio of Musharakah and Mudarabah financing in total assets in Islamic banks, 2010 (Mustafa & Razak, 2012).

Name Musharakah Mudarabah
ABC Islamic Bank 0.001 0.001
Al Baraka Bahrain 0.041 0.019
Bahrain IB 0.086 0.040
Dubai IB 0.108 0.041

Islamic financing instruments (IFIs) use only 10% of PLS contracts in African countries because they have very high risks, prove to be vulnerable to agency problems, need well-defined property rights, and are not feasible for short-term financing. Agency problems and high risk of loan default are very common in developing nations. The PLS concept is based on sharing profits and losses between contract partners depending on their funds utilization (Hearn, Piesse, & Strange, 2012, p. 338-353). However, this idea emphasizes more on the profitability of physical investment of the creditor or financier and diminishes the importance of the possibility of loan default that is very high in Africa.

Leasing Based Instruments

There are two types of leasing based Islamic financial instruments, which are ijarah and ijarah walqtina. Leasing in Islamic finance provides for interest dealing and risk-taking by transforming financial assets into tangible assets and by taking economic risks in the form of reduced demand for an asset or as an economic recession. Returns from leasing an asset are not considered as a riba (interest) transaction. The leasing instrument allows the financier to fix a rate of performance against capital funds.

An ijarah is a contract associated with scrutiny for a given period and particular considerations that do not arise from it. Sharia law permits lease of assets and enjoyment of the benefits by the lessee against payment of a pre-agreed upon rent. Islamic financial institutions commonly use ijarah contracts for financial products, such as vehicle, project, and property financing (Faye, Triki, & Kangoye, 2013: p136-151.). Ijarah walqtina bi al Tamlik is a variant of the conventional ijarah contract. It is a leasing contract that allows the lessee to become the property owner for a certain practice at the end of the lease period. Ijara walqtina is accepted in Islam finance since it brings an element of profitability.

Table 3: Ratio of ijara issued between Senegal (2014) and South Africa (2015) (Oseni, 2015, p. 454).

Issuer Issue type Issue size Time Oversubscription
Senegal Sukuk ijara 208 million 4 years 3*
South Africa Sukuk ijara 500 million 5.75 years 4*

The ijara helps to cover external financial requirements and contribute to support reserve building in African countries (Durac, 2009, p. 255-266). Senegal issued a sukuk ijara valued $208 million to fund certain energy projects in 2014. In 2015, South Africa followed by issuing a $500 million sukuk ijara with a 5.75-year term in international markets.

IFIs have used the sukuk ijara to offer customers and investors an alternative option of diversifying their investment portfolio. The sukuk is the center of development in Africa since it offers more returns compared to the traditional fixed income on assets approach. The sukuk allows the investors to make gains from both debt and equity, thereby, allowing equitable distribution of wealth in the developing nations. The sukuk ijara is more stable and secure concerning the rising rates of interest and market volatility (Adeyemi & Zare, 2015, p. 425). It uses leaseback agreements that use revenue from underlying assets to offer investors a good return.

The sukuk ijara and other sukuk financial instruments have a wide access to funding. They have been instrumental in addressing infrastructure and developmental needs of African nations with the current account and fiscal deficits. The governments of African nations are developing a legal framework that supports sukuk ijaras in an effort to finance new growth (Haynes, 2005, p. 1321-1339). Sukuk structures raise funds from private sectors of the economy to fund public projects as well as offer diverse exposure to credit that would propel development and growth of the continent.

Sale Based Instruments

Islamic debt financing is structured through exchange sales and purchase contracts. Use of the sales based instrument is an alternative mode of finance in cases where debt cannot be obtained through the PLS financial instruments (Rammal, 2010: p 185). They are divided into the following three types: price deferred price, object deferred sale, and price sale contracts.

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A deferred price contract, murabahah, is an alternative instrument of debt financing that constitutes approximately 80% of financing provided by IFIs. The mubarahah is a sale contract between two parties at a price where payments are made either on the spot, on a deferred lump sum basis or in installments. It has a number of advantages; for example, its risk-bearing period is shorter than that of PLS and leasing contracts, and the financier makes profits immediately. However, Sharia law prohibits the financiers to sell debt or sales contract on the secondary market. Payment of services is made in advance and is used to purchase raw material and pay wages. To ensure that a producer delivers goods in accordance with the agreement and on a particular date, the financier asks the producer to take ownership of property that can be sold in case the manufacturer defaults payment. A salam is mostly used for a small-sized organization to acquire funds and working capital. Itisna, a future contract, is a purchase for future delivery of underlying assets (Rammal, 2010: p 189-190). It differs from a salam since the purchase price does not require payment when parties enter into the contract, and there is no exact date of asset delivery.

Prohibited and Permissible Things in Islamic Finance

Islamic finance is based on some prohibitions based on the Quran and Sharia laws. Money, silver, or gold should not be viewed as goods but rather as the means of exchange. This perception means that riba cannot be received or paid on loans. Secondly, Islamic finance framework requires a business to engage in ethically profitable dealings. Moreover, IFIs do not invest in pork-related production companies, gambling, or other detrimental firms. Additionally, Islamic institutions do not allow speculative businesses on the money markets (Elkhatib, 2013, p. 275).

IFIs are guided by Islamic tenets that specify the need for fair treatment and ethical behavior. They work with businesses that maintain high business ethical standards while conducting deals. Companies should engage in a trade with integrity maintaining morality and truthfulness at all times. Furthermore, they should not take advantage of information asymmetry on commodity prices since, in Islamic law, profit creation should stem from the activities that have real impact on the society.

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Failures, Challenges, and Success of Islamic Financial Institutions in Africa


Companies and IFIs engaged in issuing funds based on Islamic tenets belong to a stakeholder partnership as they are beneficiaries of fair and ethical business activity. These connections result in cooperation, mutual interest, and trust that benefit the partnerships, business activity, profit optimization, and the society (Khan & Bhatti, 2008: p 708-725). Islamic virtues prevent any form of speculative activities or short-term opportunism behavior encouraging parties in the firm to have a long-term view of the partnership’s success contributing to a more stable financial environment.

Drawbacks and Challenges

Prohibition of interest or riba and speculative business activities cause a much slower reaction from IFIs in the terms of market changes in demand. This is due to the inflexibility in product offering compared to CFIs. Since IFIs lack sufficient flexibility in adjusting to market changes, they are unable to take care of short-term business opportunities. Principal-agent constraints and moral hazards are very frequent between debtors and IFIs because Islamic finance principles require close partnership agreements between the parties involved (Ali, 2013). There is always information asymmetry between the parties, which creates negotiation costs.

Increased costs are also attributed to the development of the new financial services by the IFIs as they do not only have to comply with Sharia laws but also the country’s usual economic legislation and regulations. Secondly, Islamic financial products have a longer process of compliance before they are approved making it harder for IFIs to compete with regular financial institutions because of the restriction to smaller market locations. International financial bodies do not recommend some products by IFI. A diminishing musharak is not acceptable as a mortgage instrument although it serves the purpose (Akan, 2015, p. 109-139). Lack of compliance with international regulation increases insurance and legal costs.

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Some Islamic financial products are criticized and do not follow certain Islamic principles. Repayments on the murabarah contracts are based on the prevailing riba rather than profit conditions within which the underlying asset will be used. However, Islamic scholars support the idea that Islamic financial instruments should be developed in a way to remain competitive in all markets (Vahed & Vawda, 2008, p. 453-472). Benchmarking these financial products is necessary.

Lessons Learnt from Islamic Finance in Africa

Growth of Islamic finance in Africa is dominated by sukuk bonds, sukuk ijarah, and Islamic banking. Takaful and Islamic asset management accounts for very small share of the Islamic financing industry but offers significant growth in the future. Islamic finance is still at the infancy stage in most African countries, and most governments are making regulatory and legislative changes to encourage the growth of the Islamic finance. Sudan, Gambia, Senegal, Tunisia, and Nigeria are some of the countries that have issued sukuk for infrastructure financing and development (Monga & Lin, 2015, p. 431). Africa’s infrastructure needs will make sukuk more feasible especially in nations willing to attract capital from the Middle East and Asia Pacific investors who support the Sharia compliant instruments.


Increased use of Islamic finance is an indicator that organizations need to consider more sources of funding. Islam finance is founded on ethical finance and investment guidelines. With the impacts of financial crisis receding, IFIs will keep creating new innovative financial products, such as sukuk bonds and ijaras, and diminishing musharaka. However, these IFIs face various challenges, such as difficulties of countries and IFIs in complying with Sharia law, increase in costs of establishing IFIs, inflexibility of the IFIs, and managerial agency related constraints. With the help of governments, Islamic financial banks and regulatory bodies need to institutionalize strategies that correct these problems in order to ensure that Islamic financial compete favorably with the conventional riba-based financial products.

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