Maas Riyaz Malik

The Potentials and Challenges of Introducing Islamic Financial Services in the Non-Muslim
Countries (CIS, China, African Countries & Australia)

Maas Riyaz Malik

International Center for Education in Islamic Finance

INCEIF

July 10, 2010

June – August 2010.

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Abstract

Contemporary Islamic finance industry has developed extremely rapidly. In

the past few years, overall market growth has been outstanding. In this
backdrop Islamic financial institutions are urged to transcend beyond its
historical boundaries. The growth prospects in new territories would further
boost the global demand for Islamic finance. This paper explores the potential
and challenges non-Muslim markets present to Islamic finance. Paper further
discusses the abundant opportunities lie in new markets. The information was
collected using a library research where books, journals, articles and online
resources were used. Paper also presents an analysis of selected non-Muslim
countries which Islamic finance has already made in roads. Finally, the
common challenges faced by Islamic finance are briefly discussed.

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The Potentials and Challenges of Introducing Islamic Financial Services in the Non-Muslim
Countries (CIS, China, African Countries & Australia)

Maas Riyaz Malik

INCEIF

June, 2010

1. Introduction

The unprecedented rise of Islamic finance has been one of the major topics of new era.
Essentially based on Islamic Shariahh principles Islamic finance is viewed as a vibrant model
that could challenge the powerful conventional banking system. Islamic financial institutions
and their assets have been continuously growing globally at an impressive rate. Wharton
University published article (2004) outlines that Islamic banking has gone from almost
nothing to an industry with assets of hundreds of billions of dollars and half of the consumer
market. Currently these assets have reached the USD 1 trillion mark in global level. In the
aftermath of global recession the Islamic finance fraternity remains highly optimistic of the
future growth of Islamic banking and finance. Banking customers in the Arab world and a
large part of Asia, as well as Muslims in the West, are increasingly attracted by the Islamic
model that coincides with their beliefs (Islamic financial outlook, 2008).

It is a peculiar system that thoroughly rejects interest and transactions prohibited by Shariahh.
Unlike conventional banking, Islamic model emphasizes on profit-sharing principles that risk
taking an essential part of any transaction. It is not essentially based on borrowing and
lending practice where financial institutions act as intermediaries. In Islamic banking model
the deposits are accepted as a part of profit sharing investments and effectively channel those
funds for various financing activities. In financial markets Islamic finance offers a range of
securities from money market instruments to highly popular sukuk. The rapid growth of
Islamic finance has increased the demand for Islamic products and new products are on
horizon (Islamic financial outlook, 2008).

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Despite exponential growth in last decade, Islamic finance is largely concentrated in specific
parts of the Muslim world. The potential in non-muslim countries and remote parts of the
world is overlooked in many instances. Nevertheless, Increasing interest in Muslim and non-
Muslim countries alike are contributing to the development of Islamic finance beyond
historical boundaries. This paper intends to discuss the potential markets that present huge
opportunities for Islamic financial industry and how it can foster the future growth by
expanding beyond the historical boundaries. Moreover latter part of the paper offers an in-
depth analysis of challenges and recommendations faced by the ever growing industry. The
growing preference for Islamic financial instruments is all the more meaningful with the
spread of Islamic banking into new markets.

2. Rapid expansion: Thirty years of modern Islamic banking and finance

Islamic finance began as a participative system, compatible with maximizing banks’ profits
and value and mirroring the aims of conventional banks for over four centuries. Also integral
under Islamic law, however, are ethical and religious considerations regarding the sharing of
risk and returns. First experimental Islamic banks developed interest-free savings and loans
societies in Pakistan and the Indian subcontinent (Murdoch, 2009). Egypt and Malaysia
contributed with pioneering ventures in 1960s and Dubai instituted its first Islamic bank in
1970 that would grow in number. Over the years it has developed to a resilient banking
model with the potential of achieving greater heights. When it was first introduced, Islamic
finance had to face the fierce competition from mighty conventional players. However, the
steady growth helped Islamic financial institutions (IFI) to emulate conventional banking in
terms of efficiency and profitability while complying with Shariahh aspects. Since its
inception Islamic banks relied on the gradual building of demand through the development
and marketing of Shariah-compliant financial instruments. The S&P report on Islamic finance
outlook (2008) outlines that profits generated by some of the Islamic subsidiaries of ABG--
the financial arm of the Dallah Albaraka group--were far lower than for conventional banks
operating in the same countries.

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Signaling a departure from the slow growth of Islamic finance through a steady flow of
attractive offerings over two decades, demand for Shariah-compliant investments and loans
began to take off in the early 1990s (Islamic finance outlook, 2008). This fresh interest was
sparked by a new geopolitical backdrop in the Gulf and abundant liquidity flows from the
recycling of oil dollars in the region’s economies. Muslim investors became increasingly
aware of the Shariah compliant nature and profitable investments of Islamic finance. This has
led to create a tremendous demand for Shariahh products in gulf region and Asian countries
like Malaysia. Today, demand rather than supply is driving the development of Islamic
products and services, fulfilling the predictions of the pioneers of modern Islamic finance
(Islamic finance outlook, 2008).

According to the S&P report (2008) the general uptrend in market share of Islamic banks,
since 2003, in the six Gulf cooperation Council (GCC) countries and Malaysia denotes the
increase in Islamic banks’ assets, which is outpacing already spectacular asset growth at
conventional banks. Malaysia which runs a dual banking system has increased its Islamic
banking assets to18.97 in June 2009 from 10% in 2004 (ISRA, 2009). All the impressive
numbers indicated do not necessarily mean Islamic finance is all about growth and expansion.
It faces numerous challenges coupled with the risks emanating from recent global economic
crisis. For an instance, scholars have called for greater Shariahh harmonization in order to
strengthen the Shariah basis and acceptability in modern Islamic banking products.
Moreover, IFIs have shown resilience to recent financial instability however, they are not risk
immune to dire changes in financial markets. The way forward for Islamic finance is to
develop more Shariahh compliant products and explore untapped markets that present great
opportunities for further development.

3. Huge prospects: potentials of expanding beyond historical boundaries

Islamic finance offers financial products with a unique blend which conventional
counterparts have failed to address. Its religious considerations and monetary benefits
certainly have attracted Muslims to invest in Islamic banking products. Presence of Islamic
finance in some Asian countries and gulf region is increasing due to the favorable market
conditions and the backing of regulatory agencies. Support provided by the governments of
the Gulf countries and certain Muslim states such as Malaysia where track records in Islamic

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finance are long has fostered favorable views of Islamic finance by regulators and
supervisory agencies across the Muslim world (Islamic finance outlook, 2008). Moreover, the
participation of non-Muslims in various Islamic financial activities has increased, making
them a valuable part of client base in many Islamic banks. The sector is constantly attracting
non-Muslims in many countries where Islamic banking is present ( Reuters, 2008).

The attempt to transcend beyond historical boundaries would create endless opportunities for
already popular Islamic banking model and its products. Regions with predominantly Muslim
populations that were previously reluctant to open their borders to Islamic banks, particularly
North Africa, are now also showing interest in Islamic finance (Islamic finance outlook,
2008). This up-ward trend will create huge markets for Islamic banks which are well
positioned to serve both Muslims and non-Muslims. The S&P report on Islamic finance
(2008) stated that in February 2007, Tunisia joined growing Islamic finance industry with
passing legislations permitting the creation of the country’s first Islamic bank for the
development of trade between Arab countries.

Islamic finance being built upon religious considerations sees it is critical to have large
markets in order to steer the growth. The ever growing Islamic finance sector indicates that it
is well poised to serve large markets outside its historical boundaries. In addition, market
dynamism has been felt in both the traditional Islamic finance centers and a number of other
markets that is evident by the growth in IFIs. Islamic finance which was viewed as a one-
dimensional market in the past is now being rightly identified as multi-dimensional market
complete with opportunities in fund, asset and wealth management (Growth and
Diversification in Islamic Finance, 2007). The result has been that more international banks
are setting up Islamic finance banks either in form of Islamic windows or full-fledged banks.
Thus, expanding in to new markets seems inevitable with new banks venturing in to Islamic
finance.

This expansion is further encouraged by the 1.6 billion of Muslims around the world which
makes up to 24% of world population. In addition to Muslim states in gulf region, south-east
Asia and Africa, large Muslim minorities across the world would further boost the demand
for Islamic finance. It is also reported that a considerable number of Muslim minorities in
Europe are avoiding conventional banking due to interest taking, thus Islamic model would

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help them to involve in banking while upholding their Shariah views (Islamic finance
outlook, 2008). The non-Muslim states which consist of large Muslim minorities would boost
the market for Islamic finance to record levels. The emerging markets such as china and India
whose investment appetite is growing day by day would certainly offer large scale
opportunities for Islamic finance. These economies are well poised to take off to new levels
and would require huge amounts of investments in every sector to bolster the economic
growth. Indeed, Islamic finance comes of age in infrastructure and project finance that offers
variety of flexible financing options to investors. Despite the decline in sukuk issuance in
2008, future remains healthy and the market is attracting interest from an increasing number
of issuers in both Muslim and non-Muslim countries (Islamic finance outlook, 2009).
The new century has challenged human population in many ways, mainly with adverse
climate changes and financial crises crippling many economies. These sudden but long
expected changes have instilled the concept of ethical investments in the minds of masses.
The increasing popularity of the idea of ethical investment, and of the closely related
concepts of Socially Responsible Investment (SRI), Corporate Social Responsibility (CSR)
and Social Business is indicative of a change (Siddiqi). Public have experienced the
destructive effects of highly complex financial products and moral hazards of conventional
banking system. It is in this backdrop Islamic finance rises as a viable and alternative model
to conduct financial affairs. Islamic finance is a direct product of Islamic economics that
emphasizes morality and social justice beyond profit maximization. The tenants of Islamic
finance eagerly promote the ethical investment concept that avoids complex securities and
stands against evil interest. The current financial crises affecting the U.S. economy and the
growth of “social screening” highlight how moral issues pervade the current economy
(Sorenson, 2008).

When addressing the concerns of non-Muslims, IFIs could promote the idea of ethical
investments where Shariah appeal could be less effective and attractive. From a broader
perspective, environmental, social, and governance issues in ethical investments are parallel
with Shariah objectives in terms of welfare and well-being. Growth of ethically screened
products in western countries and Islamic financial products which prohibit involvement with
alcohol, tobacco, and gambling provide the perfect platform for Islamic finance (Sorenson,
2008). Author Sorenson (2008) also mentions that ethical investment will become coupled
with Islamic finance and become a major theme in global financial markets is one of the big
new developments in the growth of Islamic finance. This opens an array of avenues for
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Islamic finance to explore and grow in markets that previously thought to be impenetrable.
Moreover, the global Islamic financial sector has remained somewhat insulated to the
financial crisis would be an added advantage when entering new markets. The dramatic
changes in financial arena are fast helping the Islamic finance to gain popularity among
investors around the world. For instance, in its report S&P (2009) sated “Standard & Poor’s
Ratings Services believes that Islamic financial institutions (IFIs) have felt the repercussions
less because Shariah law prohibits interest-based financial products” (p.9). In other words
IFIs didn’t invest in some impaired asset classes that have hampered many conventional
banks financial profiles and performance. This will be a major force for IFIs to successfully
operate in new geographical areas where radical changes are taking place.

In addition, sophisticated financial centers like Singapore, Switzerland, United States and
United Kingdom would add superior financial infrastructure for IFIs to accelerate the growth.
These highly acclaimed financial centers also offer skills and endless investment
opportunities. As more conventional banks start to explore Islamic finance opportunities
vibrant financial centers would provide the confidence and essential infrastructure. For
instance, the recent amendments to tax laws in UK would further accommodate Islamic
finance and encourage other countries to make necessary changes. The Singapore with its
strict regulatory policies and a highly transparent corporate governance infrastructure is one
of the perfect destinations to take Islamic finance into the next stage of growth (Sultan,
2008). IFIs should take the full use of opportunities available in these thriving financial
centers that would further enable them to enter remaining markets. Construction of the
Islamic finance system on a platform of good governance would be a reliable way to attract
investments from around the world.

On the other extreme under-developed countries also present huge opportunities for Islamic
finance model to penetrate in to markets that conventional financial institutions have had a
little success. Islamic finance being a participatory system in many ways provides ideal
conditions for communities in these countries to participate in banking in a meaningful way.
Micro-finance and other partnership contracts professed in Islamic finance will be the key to
enter these markets. It is noted that banks remain highly liquid in many countries in the
subcontinent and reluctant to expand credit other than the most creditworthy borrowers
(Sacerdoti, 2005). Although, Islamic finance is not about extending credit, these under-served
markets should be targeted that could be best served with Islamic banking products.
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4. Country analyses: Unique Prospects and Challenges

4.1 People’s Republic of China

The next phase of growth of Islamic finance will certainly require market development and
breaking into newer frontiers. One market, which Islamic finance has for long identified as a
strategic gap is china, where the current economic power would transform in to a super power
in near future. The spectacular economic growth of the Chinese economy over the past two
decades, ever since the economic reforms of 1970’s, has seen becoming the fastest growing
economy in the world (sultan, 2008).

The country has the world’s largest population of 1.31 billion and Muslims represents 1.5%
or 19.5 million of total population according to 2005 estimates (wolfram alpha, 2008). The
unofficial figures put total Muslims in China as much as up to 130 million, which is
staggering concentration of Muslims in Far East Asia. However, with its huge population
china has diverse ethnicities and further grouped in to internally diverse small ethnic groups.
Interestingly, Chinese population is under-going tremendous changes in every aspect of their
lives. As the GDP of world’s most populous country grew by 16% on a compounded annual
rate between 2000 and 2004, population has become more urbanized and will continue to do
so in the future (Sultan, 2008). The poverty rate in china has fallen from 53% of the
population in 1981 to 8% by 2001.

Figure1: Wolfram alpha, computational knowledge engine.

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The pace of urbanization is significant, reaching 41.8% in 2004, where between 2000 and
2004 an average of 21.1 million people moved to the cities. This rate is expected to reach
50% by 2020 and 70% by 2050. All this simply means greater need for housing, power,
transportation, modern infrastructure and essentially food. China’s hunger for capital and
investment flow is insatiable as the economy moves forward. Islamic finance without a doubt
has one of the rare opportunities in china where infrastructure and project financing are the
driving forces of Chinese economy. Islamic banks should seek to establish direct investments
in infrastructure projects through the development of business hubs for energy companies,
ports or roads in the country.

Its foreign reserves, which have increased steeply since 2000, reached US$2.5 trillion in
March and now account for nearly one-third of the world total (Wharton). China is
aggressively diversifying its reserves in commodities and other investments to cushion any
possible devaluation of the dollar as the US dollars represents 70% of reserves. It is also
considering the safe investments to park its reserves in order to decrease the over reliance on
U.S treasury bills. The emerging sukuk and Islamic capital market instruments could largely
benefit from the Chinese investment appetite. Attracting Chinese attention of these asset-
backed instruments (Sukuk, etc) will certainly drive the Islamic financial markets up.

Chinas recent liberalization policies and the speed of de-regulation in government sector have
fueled the interests of foreign investors. The staggering growth of foreign direct investment
(FDI) from a meager US$15 billion in the late 1980s to US$633 billion in 2005 shows the
growing relationship of investors with the Chinese economy (Sultan, 2008). Among many
reforms have had taking place, Banking reforms are at the core of China’s strategy to
improve the intermediation of its large private sector savings. Reforms in the banking sector
have been implemented over the last two decades in China, replacing the monobank system
with a multilayered system that separates commercial lending and central banking functions
(Podpiera, 2008). Amid banking reforms taking place state still controls the majority of
banking sector. At end-2004, the four SCBs the Industrial and Commercial Bank of China
(ICBC), the Bank of China (BOC), the China Construction Bank (CCB), and the Agricultural
Bank of China (ABC) accounted for almost 60 percent of banking system assets (Podpiera,
2008).

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Although there are already more than 70 foreign banks operating within China, their market
impact is negligible (Salim, 2007). They simply have no volume since they are operating as
foreign banks. In his article Salim (2007) further states that assets of foreign-funded banks in
China totaled US$105.1 billion as at September 2006, accounting for 1.9% of the total for all
banking institutions in the country. It could be expected that banking reforms will further
accommodate foreign banks in business. This gradual transformation is part of an on-going
series of changes taking place in Chinese financial markets. As regulators have rightly
identified the opening of financial markets for foreign players and to the world economy as a
whole would immensely benefit the economic power house.

In much awaited regulatory changes, time has arrived for IFI to test the Chinese waters.
Islamic finance had seen some success in china, although not necessarily in banking sector.
The year 2006 started with Bahrain-based Shamil Bank launching its US$100 million Shamil
China Realty Mudarabah. This was the first-ever Islamic property fund for investment in the
Chinese real estate market. The four-year Mudarabah invests in the Xuan Huang China
Realty Investment Fund, a joint venture between Shamil Bank and state-owned Chinese
conglomerate CITIC Group (Salim, 2007). Similar Shariahh compliant funds have been
introduced in last few years by the global players like Gulf finance house, Al-rajhi bank and
Deutsche Bank.

Undoubtedly, China with its complex market structure presents enormous opportunities and
unrelenting challenges for Islamic. As Sultan (2008) rightly mentions the challenge is
obviously, to engage within the existing regulatory framework, without creating any unique
provisions for Islamic finance. At the same time allowing for an equal playing field to allow
for adherence to Shariah compliant structure. Moreover, rights to property ownership will
have to be objectively clarified because these are paramount areas of concern in Islamic
transactions. Highly bureaucratic government administration and decentralized environment
would require substantial investments in time and effort to establish the Islamic finance
friendly atmosphere. China is by far the fastest-growing energy consumer in the world and
energy is perhaps the single most crucial issue for the country. Because of this, the strategic
importance of a more intimate relationship with the Gulf region for China cannot be under-
emphasized. This may mean that the country is ripe for Islamic investors from this region to
move in.

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4.2 Australia

Australia is one of the many non-Muslim nations that have shown a keen interest in
establishing Islamic banking and finance in the country. It is a country closely watched by
Islamic finance scholars and practitioners as the favorable developments have encouraged
tapping the Australian financial market. It can be understood that country’s interest has been
further fueled by the United Kingdom’s successful implementation of Islamic finance and
growth potential of the sector. Australia with its vibrant and efficient financial markets
undoubtedly is an ideal platform for Islamic finance to grow.

Muslims are one of the many minorities in Australia, the history of the Muslim Community
in Australia dates from the sixteenth century. Some of "Australia's" earliest visitors were in
fact Muslim fishermen from the island of Makassar from the east Indonesian archipelago
(Brief history, 2002). Their population has seen ups and downs due to reasons of history,
economic development and politics. It is only in the recent decades that the Muslim minority
in Australia has become more noticeable (Mirza, 2003). Author Mirza (2003) also states that
in 2001 (the last official census date), there were 281,578 Muslims representing 1.5% of the
total population up from 1.1% in 1996. This number is continuously growing as the 80% of
current Muslim population arrived after 1980’s.

As other Muslims around the world, Australian Muslims share the same discomfort of
dealing with conventional banks. As a result, demand for Islamic finance has been growing in
the country. Today, the Muslim Community Credit Union Ltd (MCCU) and the Muslim
Community Co-Operative (Australia) Ltd. (MCCA) cater to the financial and banking needs
of Australia's Muslim minority community (Mirza, 2003). The MCCA operates as a co-
operative and specifically deals with investment accounts, where withdrawals are restricted.
The services offered by MCCA are personal and business finance, halal investments, qard
hassan and zakat collections and distributions. This institution has had a tremendous response
from the Muslim community. The MCCA and MCCU are now well established and on the
way to becoming a fully-fledged Islamic Bank (Mirza, 2003). These developments translate
in to one that Australia’s Muslim community drives the demand for Islamic finance.

In general, Australia is a multi cultural and multi faith society that enjoys high living
standards. Australia, like most developed countries, has an ageing population. As
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productivity commission report (2005) indicates the proportion of people aged 65 and over is
expected to more than double over the next few decades. This trend also indicates
population’s possible inclination towards ethical investment approach would further increase.
Moreover, this generation is more conscious of the environment and socially responsible
activities is more likely to be interested in ‘ethical investing’ The concept has already been
well received by many Australians who have a positive view of ethical financial deals. For
example, Australian Ethical Investment (AEI) Limited is on investing in highly ethical
companies through using positive screens for finding companies involved in the renewable
energy sector, the production of ‘natural food’, recycling and public/efficient transport
providers (Wikipedia). Company states that baby boomers are converting their socially
responsible consciousness of the 1960’s into a useful tool to help them determine how they
will invest as they  near-retirement.

For non-Muslims Islamic finance has the same appeal as ethical investing where Islamic
finance deviates from conventional finance. In this aspect, it would be wise for Islamic
financial institutions to promote the concept of ethical investment which is the very idea of
Islamic finance eagerly endorses. Australia provides the right market for IFIs to introduce
these products that would be widely received by interested parties. In addition, baby boomers
would create perfect conditions for takaful operators to establish their presence in Australian
market.

In one of the latest developments in Islamic finance, Australia has expressed its interest in
accommodating Islamic finance in country’s financial framework. Australia has arguably the
most efficient and competitive financial sector in the Asia-Pacific region, but there are further
opportunities to expand country’s exports and imports of financial services. . This is
complimented by the high recognition of Australia’s financial sector with Australia’s
financial system and capital market ranking second among 55 leading nations in 2009
(Freudenberg). Australia, its location within Asia-Pacific with its large Muslim population
combined with its political stability and prudential banking record provides a competitive
advantage in facilitating greater penetration of Islamic finance (Freudenberg). Australia sits
on the doorstep of the some of the largest Islamic regions in the world and as analysts predict
it could become a major Islamic financial hub in 10 to 20 years time (Lannin, 2007). Standard
and Poor's in Australia, says it expects an Islamic stock market index to be based in Australia
within the next few years.
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It is noteworthy to mention the views expressed by Australian Assistant Treasurer Senator

Nick Sherry in Doha, Qatar that how keen Australia is to embrace Shariah finance. In a
renewed attempt to make Australia’s financial infrastructure more attractive government
made a range of recommendations including steps to ensure Islamic finance is enabled in
Australia (Muehlenberg, 2010). According to Muhelenberg (2010) Australian government
believes that this will present opportunities for Australian-based banks and financial
institutions to develop Shariahh-compliant finance products for domestic and international
markets. Australian government report on this regard has made several recommendations
including removal of regulatory barriers to the development of Islamic finance products. The
report further recommended an inquiry by the Board of Taxation into whether Australian tax
law needs to be amended to ensure that Islamic financial products have parity of treatment
with conventional products ((Muehlenberg, 2010). The future potential for Islamic finance is
bright and government concern in promoting Islamic finance would further encourage IFIs to
move in to country.

Among the major issues IFIs would face in a non-muslim country like Australia the current
financial regulations remain a hurdle. While these countries have an interest in
accommodating Islamic finance, a separate regulation dedicated for Islamic finance would be
hard to enforce. The IFIs would be required to operate in existing conventional framework
that will have certain provisions to support Islamic finance. There needs to be tax reforms
(amongst others) to ensure taxation is responsive and enabling for Islamic finance although
not preferential. However, this raises the fundamental question as to whether it is
constitutionally possible for Australia to implement such tax reforms to encourage and
facilitate faith-based transactions (Freudenberg). The possibility of providing a responsive tax
structure must be studied in the light of Australian constitution.

4.3 Africa

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It is the second biggest continent on earth, and home to a more than 986 million people.
Africa is often stereotyped with political instability, social distress, corruption and poverty.
However, Africa's economic story is beginning to develop new chapters as its resource rich
but under-developed nations have made considerable efforts to bring normalcy to political,
economic and social life. Africa has 8% of world oil reserves while gold and diamond supply
to the world markets amount to 50% of world output (factsmonk). The resources alone could
drive African nations in to the next high phase of development. Islamic finance being a
participatory model that emphasizes on principle of profit sharing would clearly fit into this
region where entrepreneurs and business opportunities on rise. The infrastructure projects
will be a vital component of African success story in coming years. These factors coupled
with large Muslim population, financial market growth, credit expansion and favorable
regulatory reforms will help Islamic finance grow in Africa.
Africa is probably the second most Islamized continent in the world with most of its northern
countries fully Islam (Mwanza). Clearly, Islamic banking in Africa has a big untapped niche.
With over 50% of the population in Africa being Muslim, Islamic banking services are bound
to grow at a very fast rate. This will ensure satisfied clients both financially and spiritually.
Africa holds a promising growth opportunity for Islamic finance institutions in this aspect.
Egypt as a pioneer of Islamic finance has tremendous potential to cater surging financial
needs in the country, in a Shariahh compliant manner.

In Kenya, Uganda and Tanzania, the Muslim population commands a sizable number that
cannot be ignored (Mwanza). In most sectors of the socio-economic setting, Muslims are a
force to reckon with both politically and socially. Muslim minorities in Sub-Saharan Africa
would still create a considerable demand for Islamic banking services. Again the demand is
not the issue but supply that needs to be catered immediately. The uniqueness of the Islamic
banking principles makes it a perfect alternative for traditional banking system that leaves a
larger part of Africans unsatisfied (Mwanza).

In Africa, the financial landscape has changed with the growth of stock and bond markets as
well as the private equity market. The number of stock markets in Africa has risen from 5 in
1990 to 18 currently. In the banking system, credit to the private sector and bank assets, both
indicators of banking sector development have increased significantly since 1990
(Andrianaivo, 2009). As the normalcy returns to African financial markets foreign
investments could be expected to grow in large numbers. The new economic trends in Africa
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provides an investor friendly environment that could be exploited to turn these economies
more efficient. For example, Mauritius is a good example of investor-friendly policies that its
government invited investment in the areas with the best infrastructure instead of least
facilities. As a result, manufactured goods replaced sugar as the leading export and country is
enjoying the fruits of investor-friendly policies (Wharton).

These developments should attract IFIs in other countries where Africa offers a unique set of
opportunities from rural micro-finance to massive infrastructure development projects. These
projects require financing from private sector as the African governments are unable to
provide necessary funds. Continued success of project and infrastructure sukuk will play the
major role in financing aspect. IFIs presence is required in the remote parts of Africa where
people have a limited access to banking services. For example, in Ghana and Tanzania, only
about 5-6 percent of the population has access to the banking sector. This lack of access to
financial services from the formal financial system is quite striking, when one considers that
in many African countries the poor represent the largest share of the population and that the
informal sector is an important part of the economy (Basu, 2004). In this case, IFIs could the
fill the gap by participating in financing of this important sector of the economy in form of
micro-finance or a mudarabah/musharakah model. Micro-finance is widely practiced in many
parts of Africa because poverty is pervasive particularly in sub-Saharan Africa.

The financial systems of most African countries have undergone substantial changes over the
last few decades. Andrianaivo, (2009) asserts that most countries traditionally depended on
the banking system, but in recent times capital markets have gained a prominent role. This
duly indicates that African economies are gradually resorting to sound financial policies.
Islamic financial institutions could play a vital role in both banking sector and capital
markets. These positive changes must be assessed according to each IFIs vision to increase
activity in this region. Despite its small size compared to other economies, banking systems
in Africa are reasonably sound (Gulde et al., 2006). Better macroeconomic conditions and
less government intervention seem to have diminished the ratio of nonperforming loans. It
should be noted, there is a large vacuum in financial services sector in Africa that
conventional banks have not been able to fill for years. Current growth of Islamic finance
around the world gives a competitive edge for IFIs to explore these un-tapped markets.

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It is noteworthy to analyze the ongoing efforts to accommodate Islamic finance model in

many parts of Africa, particularly in North Africa. North Africa is increasingly seeking
investment to finance its economic development, and the evolution of North Africa’s
financial landscape is paving the way for the gradual emergence of Islamic finance in the
region. Tunisia for its part has made a significant advance in terms of Islamic finance by
adopting, in February 2007, a law pertaining to the creation of an international Islamic
institution. This is in partnership with the Islamic Development Bank, whose authorized
capital would amount to $3 billion (Islamic Finance outlook, 2008). The new institution is
expected to increase business and investment with Arab countries in many folds. In a similar
effort, Moroccan banks were authorized to offer banking services that conform to Shariah. At
present, this authorization is limited to three products: ijara, murabaha and musharaka
(Islamic Finance outlook, 2008). These gradual changes would further encourage regulators
to introduce full-fledge Islamic banks in the country. In East Africa, Islamic banking is
already practiced in Kenya and Tanzania. Ghana recently announced amendments to the
Financial Institutions Act 2004 to Parliament which will allow commercial banks to offer
financial products under Islamic banking.

South Africa was the first sub-Saharan African country, excluding Sudan to start Islamic
banking in earnest in the 1990 with the establishment of Albaraka bank. Since then local
banks such as First National, ABSA and Nedbank are all offering Islamic products (Arab
news, 2010). Nigeria joined the Islamic finance list in March 2009, with central bank of
Nigeria authorizing IFIs on par with the same provisions relating to conventional banks (Arab
news, 2010). The country is expecting a rapid growth in next year as it is home to some 97
million Muslims. The oil rich nation has been accumulating a huge amount of wealth owing
to recent oil price windfall. Islamic financial practitioners remain optimistic of the Africa’s
aspiration to become one of the major centers for Islamic finance.

No amount of international goodwill will matter until African countries adopt policies of
transparency, reduce corruption, and accept the rule of law and other reforms. Moreover,
despite the rapid growth of African banking systems, indicators of financial depth in Africa
are the lowest in the world. These weaknesses must be duly addressed by African nation to
pave the way for financial sector to remain solid and stable. Another key characteristic of
Sub-Saharan Africa is that currently the stock of bank credit to the private sector remains
very low, when compared with the situation in other developing countries (Sacerdoti, 2005).
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Compared with their counterparts in emerging markets, African banks have a limited role in
the economy. In addition, banking services penetration is as low as 5 percent, and access in
most countries is limited to the urban centers (Andrianaivo, 2009). In this backdrop, IFIs as
late entrants should asses the extra-demand they would create for Islamic financing and the
ways to increase private finance which currently remains extremely low.

In markets where Islamic finance is not yet widespread, like North Africa for example, banks
may face difficulties to satisfy demand for Shariah-compliant financial products. As late
entrants, Islamic banks face the risk of gaining clients with weak credit standings and that
have not been part of conventional banking networks (Islamic finance outlook, 2008). In this
case, it would accumulate bad debts, and would encounter a lot of difficulty in realizing its
guarantees in view of its “ethical” character, which went hand in hand with its Islamic status.
An Islamic bank would have greater difficulty in recovering its loans to households in default
of payment. It is quite common for Islamic banks to propose financing instruments at higher
rates than those offered by their conventional peers. This is perfectly acceptable in the Gulf
States where the average credit quality of clients is higher than it is in North Africa (Islamic
finance outlook, 2008). The banking clientele in North Africa seeks more to minimize the
costs attached to banking services. Therefore the financing strategies employed in gulf region
would not exactly fit in to Islamic banking sector in Africa.

4.4 Commonwealth of Independent States (CIS)

Commonwealth of independent states represents the countries that were part of former
Russian federation. CIS mainly consist of central Asian countries and Russia in the
commanding position. After the collapse of the USSR in 1991 ex-Soviet republics started to
implement the market-oriented reform policies (Aliyev, 2007). Previously held in the grips of
communist regimes, CIS are now gradually moving towards capitalism with liberalization
oriented policies. A transition to the new economic and political order has not been smooth
and calm, but accompanied by the economic decline, political cataclysms and military
conflicts (Aliyev, 2007). Despite the critical situations CIS have faced, the potential for these
countries to grow economically remains highly probable and close proximity to Europe is an
added advantage. For, Islamic finance CIS presents the need of a multi-prolonged strategy to
penetrate both central Asia and Europe.

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The advent of Islamic finance in CIS countries has brought a positive outlook to the industry
as these countries consist of huge Muslim populations. CIS countries and Russia, has a
combined Muslim population of about 120 million. In 1990’s the population demographics of
the Muslim CIS have been explosive, with the birth-rate being the highest in the world
(Choudhury, 1994). Choudhary (1994) commenting on growing interest in Islam in the region
states that “the passionate search for the Islamic heritage in which the nationalistic divisions
among various Muslim territories are seen to blend away into a unified tapestry” (p.4). The
need for Shariahh compliant finance has been long felt in the region; in fact CIS should be a
natural market for Islamic finance like in other parts of the Muslim world.

Moreover, CIS have shown great economic potential with stability of the region is increasing
after a long and difficult transition period. Additionally, government finances sound with the
world’s fourth largest Foreign exchange reserves, account surpluses and improving ratings in
most of the region (GAIA Capital Advisors). These countries have a strong basis for
economic ties such as common education system, language, unified transport, freedom of
labor, legal basis and industrial structure. The transition period has also encouraged
liberalization and progress in improving market regulations. Among CIS countries Russia,
Kazakhstan and Azerbaijan have shown a good interest in Islamic finance.

The introduction of Islamic finance in Russia is vital for further development of Islamic
finance in CIS region. Despite economic problems, the growing interest of foreign investors
in Russia, which is among the world’s tenth largest economies, appears to be reasonable. As
Russia, being the third trade partner of the European Union and its main energy provider. In
general the Russian economy continues to diversify its sector’s structure, relying less and less
on raw materials sector. One of the most dynamic is the financial sector, which takes
advantages of the real sector’s growing demand on financial services. The Russia’s capability
to serve Islamic Finance has been augmented since its admission to Organization of Islamic
Conference OIC as an observer in 2005 (Parker, 2010). The bond between Gulf and Russia
can be expected to further strengthen as energy has become the main interest of both parties.
This growing relationship creates the ideal environment for Islamic finance to operate in
Russian market.

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The Muslim population in CIS, particularly in Russia is a driving factor to fast-develop

Islamic finance in the country. Muslims, as the main users of Islamic financial services, make
up 15% of the Russian population amounting to 22 million citizens. This large population has
shy away from conventional banking to a great extent. The lack of Shariahh based banking
services and the number of halal producers is small to meet the needs of all the Muslims. The
growing Russian halal market needs Shariah-compliant financial and investment institutions.
Return of the Muslim population to their traditions and the growing desire to live and work in
compliance with Islam would create a huge demand for Islamic financial products.

It has been estimated that the Russian Federation needs more than $1 trillion in infrastructure
investments over the next 10 years (Parker, 2010). Islamic finance perfectly fits in this
backdrop with issuance of sukuk, project finance, insurance, developing the halal food
business activities, and small and medium enterprises. Parker (2010) states there are already
encouraging signs that sukuk issuances may prove to be an attractive alternative for Russian
banks and corporates raising financing from the international markets for projects in the
federation and the region. The recently concluded, Moscow Forum on Islamic Finance and
Investments emphasized on the tremendous opportunities in the area of Islamic finance
(Richardson, 2010). The current global financial crisis and liquidity problem Russian banks
facing seems to make Russian authorities more tolerant towards Islamic banking. The takaful
and waqaf institutions could also play a major role in-line with Islamic banks.

The ambitious program to make Kazakhstan a major center for Islamic finance has been
widely discussed in international Islamic circles. The country is an emerging economy in
central Asia, providing adequate infrastructure for businesses and investments. Oil rich state
is a regional economic powerhouse in central Asia, with revenue from oil exports topping
$24 billion per annum. Its Muslim population is currently stands at over 7 million, with a per
capita income of $11,400. The rising income level in the country would require various new
financial and investment products to be introduced to the market. Kazhkastan first introduced
Islamic finance in 2009 and government expects to launch its maiden sukuk in 2010. The
outlook for Islamic finance in Kazakhstan remains highly positive.

It should be noted, that the Kazakhstan’s inclination towards Islamic finance was mainly
triggered by the global financial crisis. The rising business and investment community in
Kazakhstan have been looking for less-risky instruments that could reduce the exposure to
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global financial turmoil. Kazhakstan’s economy had gone through rough times when
financial crisis hit the markets. Kazakhstan’s financial regulator, the AFN, has been working
to improve the stability of the country’s financial sector and prevent a second bubble from
emerging as the economy starts to grow again (Richardson, 2010). Turnover on the Kazakh
stock exchange KASE fell sharply last year in line with global economic developments
(Richardson, 2010). In attempt to make the country’s financial district a major financial hub,
regulators have focused on reducing volatility and vulnerability in the financial markets. The
decision to introduce Islamic finance to the country perfectly fits with on-going efforts to
bring stability to Kazakhstan financial markets.

After being under the central planning economies for decades, CIS countries collectively
have been undergoing rapid changes. However, following a decade of transition, results
differ. Although the Baltic States were able to build quite successful financial systems, in the
CIS countries financial systems remain a major obstacle to sustainable economic growth
(Golodniuk, 2005). Glodniuk (2005), further states the hyperinflations of the early 1990s, the
financial scandals that followed the collapse of monobank systems, and subsequent
incomplete progress in constructing non-bank financial institutions and effective regulatory
structures have had adverse consequences. The signs of improvement are readily visible, and
further effective regulations would be helpful in this regard. Islamic finance is new to Russia
and marrying the principles of Islamic finance with the legislative framework in Russia will
be a rigorous process. The regulatory setting may starkly differ from the historical Islamic
financial markets; this requires adaptation to such environments. The challenge for Islamic
Finance is to utilize the evolving economic conditions to establish presence in the region and
exploit the growth potential. However, unique challenge is to operate in post-communist or
transition environment, which Islamic finance has not so far tested or operated.

5. Common Challenges

5.1 Product Development and innovation

Successful financial markets offer the market players, among other factors, a wide array of
products t invest in. this provides adequate flexibility for investors to make investment
decisions. Similarly, for an Islamic financial market to be successful, it must provide the
market players with the range of products that would enable the investors to match their
investment appetite and profile.
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This is a challenge in Islamic finance, because the product development process in Islamic
finance has to go through a very tight process of Shariah compliance review and endorsement
by the Shariah scholars (Sultan, 2008). In addition the Shariah compliant products would
require several additional flows of contracts when compared to a similar corresponding
conventional instrument (Sultan, 2008). It may also entail new thinking in respect of
regulatory and tax treatment and a need to consider new accounting issues. This would
inevitably incur higher costs particularly legal documentation costs. Improving the process
and cost of rolling out a product to market would significantly improve the credibility an
efficiency of the industry.

5.2 Building credibility and confidence

The challenge of credibility and confidence in Islamic finance stems from a set of factual
issue combined with a slew of misrepresented beliefs about Islam. Perceptions of Islamic
finance being tainted with terrorist funding and home of anti-money laundering are far from
the truth. The case brought in Michigan court against AIG Islamic unit, that it indirectly
supports Islamic extremism are one of the many allegations directed towards this faith based
banking practice. It is paramount that Islamic finance corrects the false ideas about Islam and
Islamic banking.

The setting up of infrastructure institutions in Islmaic finance such as AAOFI and IFSB is a
move in the right direction to demonstrate that the Islamic banking industry is not without
credible corporate governance standards. To that effect, steps must be taken to see to the
integration of Islamic finance into the global financial industry instead of marginalizing it
from the mainstream financial markets.

5.3 Skills and expertise

One of the most vexing managerial issues in Islamic finance issues is the lack of skilled
personnel with knowledge and subject matter expertise in banking and Shariah compliance.
The issue has hampered the pursuit of product development efforts and has also at times
resulted in operational losses (Sultan, 2008).

The need to continuously provide quality professionals with vast experience in banking and
finance is crucial for the industry. It is accurate to say the human resource is the life line of
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future Islamic banking. Human resources can be seen from one aspect as an operational risk
issue and fro another angle as core competence of the IFI (Sultan, 2008). The lack of human
capital in the sector affects all regions, including nascent markets such as the U.K (KPMG).
Training of Islamic bankers has not kept pace with the rapid growth of the sector and, as a
result, there are shortages throughout the industry.

5.4 Designing an effective money market system

Islamic banks are operationally similar to conventional banks hence they rely on liquid, short
term maturity liabilities to fund asset growth (Sultan, 2008). This compels Islamic banks to
hold substantial liquid assets and excess reserves. This in turn inhibits financial
intermediation. Difficulties in defining rates in these instruments have also constrained the
development of money and interbank markets.

The absence of well-organized, liquid interbank markets that can accept banks overnight
deposits and offer them financing to cover short-term financial needs has exacerbated banks
need tendencies to concentrate on short-term assets (Sultan, 2008). Sultan (2008) also states
that one effort to close the gap is to attract sovereigns, multilateral and public sector
development institutions as well as top-tier corporations into issuing in the market on an
Islamic basis in order to establish benchmark levels of risk-reward maturity profiles. This will
create more liquidity in the market and attract more investors.

6.0 Conclusion

Mounting demand around the world for Shariah-compliant financial products and services is
fueling the Islamic banking industry’s rapid expansion. More and more banking clients are
choosing to invest in an ever broader range of Islamic financial instruments available through
long-established Islamic banks in the Gulf Cooperation Council (GCC) states and Muslim
Asia. The time has arrived for Islamic finance to venture in to new markets and new
territories. The paper discussed the ways to go about it; however IFI’s should asses the all
available factors to balance both business and spiritual aspects of Islamic finance. The
geographical diversification should not jeopardize the Shariah rulings which construct the
basis of Islamic finance.
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Islamic financial institutions have remained somewhat insulated from the global financial
downturn because Shariah law strictly prohibits them from handling interest based
instruments. This means that Islamic banks didn’t invest in structured products and so haven’t
suffered from the fall in these instruments’ values (Islamic Financial Outlook, 2009). This
indicates financial crisis has paved the way for Islamic finance to receive the global attention
that it did not have before. Thus, this is an extremely important point of time in Islamic
finance history, build its credibility in the global scale. The countries previously reluctant to
open the borders for Islamic finance have been gradually changing their stance and countries
like Australia and UK have gone to the extent to make country a Islamic financial centre.

It must be understood different countries and different regions poses diverse opportunities
and challenges when promoting Islamic finance. The IFIs should identify and asses these
unique factors when creating their strategic plans for the selected countries. Sultan (2008)
rightly mentions that as more IFIs are set up in various jurisdictions, the mobilization of
Islamic funds into dormant or untapped sectors of the economy will further spur this growth.

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