Where are the main centres for sharia-compliant capital?

Islamic finance is no longer confined to Muslim-majority countries as it was before. Beyond its traditional geographies, the industry has found firm footing in new jurisdictions such as European countries, the Far East, and sub-Saharan Africa, serving both corporate and sovereign sectors as well as individuals.

What are the key barriers for small businesses looking to tap into Islamic finance?

Similar to conventional banking, Islamic banking faces challenges in the financial inclusion of small and medium-sized enterprises (SMEs) despite having huge potential.

Banks, including Islamic banks in developing countries, are risk-averse by nature. In Islamic banks, product offerings for SMEs are mostly limited to murabaha (sales contracts). The reality on the ground is that SMEs are in need of financing along supply chains. However, there is a clear shortage of diversified products to address the wide-ranging funding needs of these enterprises.

Additionally, transaction costs and taxes are relatively higher for Islamic finance products due to cumbersome verification processes and adverse taxation frameworks.

Last but not least, SMEs as well as the general public are not sufficiently informed on Islamic financing options as compared to conventional finance. Meanwhile, some have common misconceptions about Islamic financing that make them hesitate to invest and benefit. Overall, this challenge partly stems from the fact that banks face a significant lack of employees trained in Islamic financing practices for SMEs.

What are the legal and regulatory instruments available for sharia-compliant investments?

Sharia governance: The establishment of centralised (national level) or internal (bank level) sharia advisory boards.

International supervisory bodies: The Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB) have been established to implement standards and norms for sharia-compliant banking practices worldwide.

Tax treatment: Tax neutrality provisions ensure Islamic financial institutions are on a level playing field with conventional banks.

Liberalising foreign exchange administration rules: This is to allow corporations to issue local and foreign currency-denominated instruments in capital markets.

Tax incentives/exemptions/deductions: This is to encourage sharia-compliant investments.

Issuance of banking and takaful (insurance) licences: This is to develop the Islamic finance industry.

Different interpretations of sharia law make enforcing regulations across jurisdictions a tricky task

How are regulations changing to support the use of Islamic finance? 

More countries are adjusting their regulatory framework to support the expansion of Islamic finance. For example, sukuk (Islamic bond) regulations have recently been introduced in new markets such as Egypt and Uzbekistan or revised in countries such as the UAE and Oman in order to accommodate the rising demand for Islamic bonds.

For example, in 2021, Bangladesh started offering tax benefits to popularise the issuance of sukuk. The government has also approved the transformation of a number of conventional banks into Islamic banks in the past few years. This may have been fuelled partly by laxer prudential requirements for Islamic banks relative to their conventional counterparts. Meanwhile, Algeria’s government recently approved takaful (Islamic insurance) regulations.

Are governments and central banks doing enough to support the Islamic finance industry?

Several challenges need to be addressed for the Islamic finance industry to expand. This includes focusing on the capacity-building needs of supervisory authorities and market players, as well as the development of legal and regulatory frameworks for rising trends (such as fintech and digital currencies) in the sharia-compliant finance industry.

Different interpretations of sharia law also make enforcing regulations across jurisdictions a tricky task. Therefore, it would be very useful to ensure harmonisation in regulations and standards across different countries to promote the Islamic finance industry.

Published in partnership with ICD