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Opportunities and challenges:
Developing alternative finance in Sri Lanka
RAM Ratings Lanka’s Sukuk - Alternative Finance conference was held
recently with the participation of the Central Bank of Sri Lanka
Governor Nivard Cabraal, and the Securities and Exchange Commission of
Sri Lanka Chairman Udayasri Kariyawasam. Alternative Finance (AF) is
grounded on Islamic principles and, given the mushrooming of Islamic
financial institutions, this conference had been organized to address
the concerns of all stakeholders.
| According to Islamic
principles or Shariah law, all business activities must be
premised on moral and ethical values. Although trading in
tangible assets or services is permitted, merely making
money from money is forbidden, as money today only serves as
a medium of exchange and a unit of measurement. |
AF is not just about the avoidance of interest in financial
transactions. According to Islamic principles or Shariah law, all
business activities must be premised on moral and ethical values.
Although trading in tangible assets or services is permitted, merely
making money from money is forbidden, as money today only serves as a
medium of exchange and a unit of measurement. Therefore, any type of
Shariah-compliant financial product or service cannot involve the
element of interest, either explicitly or implicitly.
Contrary to popular belief, AF is not only for Muslims. In fact, even
non-Muslim nations such as the United Kingdom and the United States seek
to explore Islamic financial products due to their immense potential,
not to mention the healthy demand from the public and other
institutions.
Similarly, there is growing interest in AF in Sri Lanka. The vast
majority of domestic conventional businesses should be able to tap this
alternative source of funding - including those involved in garments,
tea, coconut, rubber, porcelain - and can easily comply with the Shariah
requirements. As a whole, Sri Lanka has the opportunity of becoming the
AF hub of the South Asian region.
Despite the vast potential, however, there are also fundamental
issues that need to be addressed. The first - and perhaps the most
significant - obstacle in the development of AF in Sri Lanka is the
current tax regime.
The basic tenet of AF is the sharing of risks - although the
substance of the transaction is financing. Meanwhile, interpreting these
contracts in the legal context renders the transactions fiscally
expensive and commercially unviable; therefore, tax neutrality should be
accorded considering the substance of the transaction. However, this is
not to say that special privileges or exemptions should be accorded to
AF; rather, there should be a level playing field for these instruments
to compete against and also complement conventional financial
instruments.
Secondly, public and regulatory confidence in AF instruments is
crucial. An integral aspect of this mode of financing is compliance with
Shariah requirements; there is a dearth of the requisite expertise in
Sri Lanka. In Malaysia, for example, Shariah advisory boards consist of
qualified Shariah specialists, who must possess a university degree in
Islamic finance. A strong Shariah advisory board will not only ensure
Shariah compliance, but also strengthen aspects of corporate governance
and risk management.
Thirdly, the risk-sharing concept of AF is open to abuse. Since AF
contracts are similar to conventional venture capital financing, there
may be a larger scope for fraud. Although these loopholes can be
minimized via structural and contractual mechanisms, the absence of a
regulatory ‘safety net’ and a tested legal framework may impede the
development of AF.
It is crucial that market players work in unison towards a common
goal, a clear strategy and a firm resolve to take AF to the next level.
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