Tag Archives: Regulations

Islamic financial institutions must boost transparency to meet AAOIFI governance standards and address critics

A key difference between Islamic and conventional financial institutions is the legal rights of depositors. While in practice, institutions treat their (profit-and-loss-sharing mudarabah) depositors as if they were conventional deposits, they are subject to losses as if they were equity instruments (the depositor as rabb al-mal shares profits with the bank but remains subject to losses).

Despite being on the hook for losses from the mudarabah assets in a similar way as the equity investors are to the overall institution’s losses, mudarabah depositors are not permitted to vote and can effectively only vote with their feet by withdrawing their deposits if they believe them to be at risk of loss or can find a higher return elsewhere. In this regard, mudarabah depositors (or as they are usually called — profit-sharing investment account holders or IAHs) do have priority over equityholders in the liquidity they are granted, which, in normal situations, entitles them to withdraw their deposits without any loss.

All of these factors contribute to the need to develop standards on the governance within Islamic financial institutions (IFIs), which AAOIFI instituted in 2005. The particular standard that focuses on corporate governance issues begins by outlining the underlying principle for the management that ensures they are “held to the highest fiduciary standards since they are accountable not to the equity-holders who appointed them but also for the safety of all key stakeholders as well as the community the IFI serves”.

The governance standard is that — just a standard — so it doesn’t prescribe certain methods for ensuring that an Islamic financial institution must do certain things as a result of its fiduciary standard; that is left up to the individual institution. However, it does outline some principles that are of interest to IAHs and how the financial institutions ensure what is referred to as “equitable treatment of fund providers and other significant stakeholders”.

Without really laying out what these principles are, it does provide specific context about the transparency responsibility of IFIs towards ‘fund providers’ (which includes the IAHs): “An IFI should ensure equitable and unbiased treatment of fund providers and other significant stakeholders and associated investments as well as in relation provision of adequate financial and non-financial information to allow them to take appropriate decisions regarding their dealing with the institution.”

Many IFIs provide at least the minimum transparency to IAHs that they do to their equity investors in the form of interim and annual reports available on their public websites. They also have specific presentations for investors that cover some of the information that depositors (or those who advocated on behalf of depositor protection) would need to identify the strength and stability of the bank and trends in the payout.

The investor presentations (for the institutions that produce them) and annual reports (to shareholders) provide details on the stability of the institution and its ability to generate profits to share with depositors. This is a good step towards transparency (and banks should be required to make their annual reports available if they take deposits from retail depositors), but this information does not address the underlying conflict that the governance standard asks banks to meet.

By not creating a report that addresses the conflicts of interests inherent in managing a financial institution where management and those whose funds they are managing (like IAHs) can diverge, it leaves the goal of the standard unfulfilled. More importantly, it leaves the process of generating profits as a ‘black box’ that makes it easy for critics to suggest that there is no difference between Islamic banks and conventional banks and that the statements of profit-sharing between the banks and their deposits is artificial. Greater transparency would help cut through these arguments and encourage better practices by Islamic banks.

Find out more information about the governance standards which are now accessible through the Legal & Shariah section of Zawya Islamic.

The Islamic Finance Industry in Nigeria: From History Mystery to Future Reality

Muslims advocacy for Islamic financial system in Nigeria dates back to 1980, however, it met the cold response. The first initiative is taken by the government is to provide profit and loss sharing banking. This is clearly stated in section 23(1) and 61 of the Banks and Other Financial Institutions Act 1991. Thus, the profit and loss sharing enactment in 1991 marks the evolution of modern Islamic banking in Nigeria. Following this enactment, several attempts had been made to get license for Islamic banking operation between 1993 and 1995 but they all end up in vain. The failure of which is attributed to not comply with Central Bank of Nigeria (CBN) requirements by the respective investors. Then, Habib Bank Nigeria Plc, currently known as Keystone Bank successfully opened non-interest banking account, which breaks a record of being the first Islamic banking window in 1996 in Nigeria. However, no success story or significant growth is recorded owning to the absence of formidable regulatory framework from the Apex Bank.

The demand for full-fledged non-interest banks comes on board from the interested investors in 2004, but the application was given an Approval-In-Principle (AIP) pending the satisfaction of paid-up capital.

The government set up the Financial System Strategy (FSS) in 2005 with the aim to make Nigeria as Africa’s major International Financial Center (IFC). This leads to economic transformation in Nigeria, in which the following are among of their initiatives:

i. To provide financial institutions that involve un-banked informal sector
ii. To establish interest-free banking mechanism to catch vast underserved sector.

In view of the objectives formulated, the Islamic Finance Working Group was formed in 2008 with the support from Enhancing Financial Innovation and Access (EFInA) Group. This working group involves main stakeholders in Nigeria include among others the Nigeria Deposit Insurance Corporation (NDIC), the National Insurance Commission (NAICOM), the National Pension Commission (PENCOM), the Debt Management Office (DMO), market operators and representatives of CBN.

In January 2009, the CBN joined the Islamic Financial Services Board as full-member while in March 2009; the CBN released the draft framework for non-interest banks with the aim to get comments and insights of the stakeholders.

Also, in August 2010, the CBN categorized non-interest banks under the specialized banks in Nigeria. Furthermore, in reference to the requirement of paid-up capital, non-interest banks are classified into two, namely National and Regional non-interest bank.

i. The national non-interest bank shall pay paid-up capital of ₦10 billion full permission to operate throughout Nigeria including the Federal Capital Territory.
ii. The regional non-interest bank shall have to pay paid-up capital of ₦5 billion, and the operation being limited to 6 to 12 adjacent states of the Federation, and not more than two geo-political zones and Federal Capital Territory.

In October 2010, the CBN joined other 11 Central Banks and 2 multilateral banks to set up the International Islamic Liquidity Management Corporation (IILM).

The Malaysian-based IILM aims to provide Sharīʿah compliant treasury instruments to address the liquidity management of Islamic banks and serve as instruments for open market operations for Islamic financial institutions.

In January 2011, the CBN released the Framework for non-interest banking. Currently, there is one full-fledged Islamic bank in Nigeria known as Jaiz bank Pls, and three Islamic windows namely, Keystone Bank, Stanbic IBTC, an international bank; and Sterling Bank. In insurance and capital market sectors, the Lotus Capital; a full-fledged Islamic fund management company and Takāful Windows in African Alliance Plc and Cornerstone Insurance Plc. The commencement of operation of these banks and other financial institutions marks the true evolution of Islamic finance in Nigeria.

Continue reading the blog post that is hosted on Zawya Islamic here to see the challenges and way forward of the Islamic Industry in Nigeria.