Islamic finance in Sri Lanka
Riyazi FAROOK
Islamic finance is certainly the fastest growing industry in the
world, worth over US $ 1 trillion to date-a 28 percent increase from
last year, which clearly demonstrates the industry’s potential despite
the global financial crisis and the consequent economy downturn.
Interestingly, the industry is already catering to a non-Muslim customer
base as much as 15 percent throughout the world.
The Sri Lankan financial sector remained comparatively insulated from
the global financial crisis, despite the fact, like the island’s
conventional finance sectors, Islamic finance has also witnessed
insolvency before even the industry kicked off.
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Islamic financial institutions must
invite customers to play an active role in the governance
process |
Institutions offering Islamic financial services cannot undermine the
corporate governance practice, which should be on top of its strategic
agenda to credibly protect particularly depositors’ and shareholders’
resources in the investment pools.
Regulatory measures should also ensure Islamic financial service
ventures are not just merely attracted to quick profit from the emerging
industry but to aim at what the global Islamic finance industry is
achieving over the last three decades.
Industry overview
In March 2005, the Central Bank of Sri Lanka (CBSL) issued an
ordinance to include provisions for Islamic finance in which Sri Lanka
became one of the few countries to have specific legislation for
Shari’ah-compliant financial operations.
The amendment also provided flexibility for conventional financial
institutions to establish windows to offer Islamic banking and finance
products and services.
According to Islamic Finance News, Malaysia, the Islamic banking
sector in Sri Lanka is estimated around US $ 900 million. Sri Lanka has
a number of Islamic financial services providers including market leader
Amana Investments Limited.
The Muslim Commercial Bank (MCB), the People’s Leasing Company -
Islamic Financial Services Unit, the First Global Group, and ABC
Investments (Baraka Islamic Financial Services). Amana Takaful Limited (ATL),
the only takaful provider in the country, was introduced in 2002 and ATL
was listed on the Colombo Stock Exchange (CSE) in late 2006.
Amana Securities Limited (ASL), a subsidiary of Amana Investments
Limited, is a trading member of the CSE and is one of just 20
stock-broking companies licensed to operate on the CSE.
The country’s largest bank, Bank of Ceylon, was planning to launch an
Islamic banking unit in early 2008, but the bank decided to delay due to
the global financial crisis.
In a remarkable development, Amana Investments Limited was recently
issued a Letter of Provisional Approval by CBSL.
Presently AIL is in the process of fulfilling certain condition
listed in the Letter of Provisional Approval such as the raising of a
minimum capital of Rs. 2.5 billion to establish the island’s first ever
full-fledged Islamic licensed commercial bank named Amana Bank Limited
under Section 5 of the banking Act No. 30 of 1988 to carry out Islamic
banking business in Sri Lanka aiming to deliver retail, business and
private banking facilities including wealth management, infrastructure
financing, bonds, corporate treasury placement and many other financial
products and services in the country to attract Shari’ah compliant
investment funds from the Middle East and the Far East.
The ‘DJIM Amana Sri Lanka Index’ launched in collaboration with Dow
Jones Indexes, USA, the DJIM Amana Sri Lanka Index, the only Islamic
Index in Sri Lanka, provides access to investors who seek investment
opportunities in Sri Lanka stocks that comply with Shari’ah
requirements.
The country’s first ever planned Sukuk issuance attempt to raise Rs.
500 million (US $ 4.5 mn) by the Islamic Financial Services Unit, window
of the People Leasing Company Co. Ltd. - a fully owned subsidiary of
People’s Bank (100 percent State-owned bank) was postponed primarily due
to procedural delays and with regard to regulatory authorities, and
consequences of the global financial meltdown.
However, the company sources said that it is now rescheduling to
launch the Sukuk once the investors’ sentiment and market condition
become more favourable.
Corporate governance practice
The Corporate Governance, including risk management staged a rigorous
debate as corporate scandals and failures around the world shook the
financial industry, and indeed Islamic finance industry is not immune to
scrutiny.
Sri Lanka has also been experiencing increased scams and failures in
conventional finance including Islamic financial industry for last few
years, which resulted CBSL to issue a voluntary code of corporate
governance practice to financial institutions but, corporate governance
code is yet to be made mandatory for financial institutions to prevent
such scandals and failures in future.
Generally, corporate governance in Islamic finance institutions is
quite similar to a combination of both Combined Code and Sarbanes -
Oxley, because the corporate governance of an Islamic financial
institutions distinguish in many forms to that of its conventional
counterparts, most importantly Islamic finance institutions need to
ensure that they comply with the Shari’ah (Islamic law) meaning that
unlike secular governance practices Shari’ah would first examine at the
transactional structure to find whether the process involves any
activities or elements that contradict the profits generation.
Also Islamic financial institutions must invite customers to play an
active role in the governance process.
For instance, the Accounting and Auditing Organisation for Islamic
Financial Institutions (AAOIFI) Financial Accounting standards 11
provides clear principles and guidelines for Islamic financial
institutions to disclose the share of the actual profits and of the
funds from the returns they receive and emphasise the their disclosure
in the financial statements and annual reports.
The CBSL, as regulator should regulate corporate governance practice
by improving the levels of disclosure, compelling transparency,
reporting standards, risk management and accountability to protect
investors and maintain the integrity of this emerging financial industry
competitive.
In the absence of sufficient legal and regulatory framework the
emerging market is unable to remain and perform competitive in the
financial industry.
A good example, in the UK or USA is Islamic finance services industry
subject to higher standards of corporate governance requirements and
making them attractive for investment. To improve the viability of the
island’s Islamic finance and get greater benefit from this fastest
growing industry, Corporate Governance should be enforced at the core of
the Islamic financial institutions in Sri Lanka.
Regulatory and legislative issues
The country’s Islamic finance institutions and experts will continue
advising the CBSL on the development of new laws and regulations to
facilitate the Islamic finance industry.
Amana Investments Limited has not only established itself as the
pioneer of Sir Lanka’s Islamic financial services industry, but is in
the forefront lobbying the CBSL for relevant changes in the Islamic
finance legal framework.
The Islamic finance directive issued by the CBSL supervision
department defines Islamic banking and two of its fundamental elements
clearly in the legislation.
Receiving money for the investment in a commercial venture agreed
based on the profit and loss sharing principles including Mudaraba and
Musharaka contract.
Second, a contract based on buy and sale transaction agreement based
on deferred payment option such as Murabaha.
Islamic Finance Focus Group (IFFG) was recently set up by Islamic
finance industry experts and interest groups, including KPMG Sri Lanka.
The main objective of IFFG is to advise and lobby the Sri Lankan
government, relevant regulatory bodies and parties to allow Islamic
finance to compete on a level playing field with conventional financial
institutions.
IFFG continues to play a pivotal role in the development of new tax
legislation and regulations in Sri Lanka to facilitate Islamic finance.
In order to achieve this development there are few areas of anomalies
in the Sri Lanka’s tax system that is required to be addressed carefully
for urgent reform and restructure to accommodate all forms of Islamic
finance transaction in Sri Lanka.
Some Shari’ah compliant transactions are more affected by the Value
Added Tax (VAT) than conventional finance, but this area of legislation
is difficult to modify, as it is quite similar to the EU tax system.
However, it is significant to note that the Sri Lankan tax regime is
not as complicated and extensive as the EU, UK or US tax system.
IFFG also working closely with CBSL and regulatory bodies to enable
new legislation to be drafted to allow Islamic financial institutions to
offer comprehensive range of Shari’ah compliant products without
incurring the adverse direct tax consequences.
The Sri Lanka government should aim these measures to promote the
island as a leading centre for Islamic finance in the South Asian
region.
Growth potential
The stable foundations for future development of Islamic finance in
Sri Lanka have yet to be laid firmly. Although future growth cannot be
precisely forecast due to lack of research on the island’s Islamic
financial market, there is clear scope for expansion.
With mega post-war development projects in the pipeline such as
infrastructure and economy development, the majority in the road sector
would that have a positive impact on the construction industry,
sovereign sukuk (Bond) issuance will potentially attract widespread
international and local investors’ interest.
Islamic finance institutions and experts realise the importance of
encouraging the Sri Lankan government to issue sovereign sukuk as an
alternative to government bonds in the future.
On the aspect of development and challenges of Sri Lanka’s Islamic
finance industry, Managing Director of the island’s market leader Amana
Investments Limited, Faizal Salieh added, “Having completed twelve years
of strong presence in the country’s financial industry, we are
continuously lobbying for regulatory and fiscal legislation to ensure
innovation and growth; we are happy that CBSL has introduced promising
changes in regulatory framework to support Islamic banking and Insurance
Board of Sri Lanka has also licensed Takaful operators.
Islamic finance has been supported by the tax authority applying
substantial reform so far, but now we need progressive tax neutrality
for Islamic financial products. At this stage the Islamic finance
industry is imposing tremendous challenges for market players to ensure
good corporate governance, risk management, transparency and Shari’ah
compliance practices.”
The Sri Lankan government has allowed enough avenues in the fiscal
and regulatory policy framework to facilitate Islamic finance since
2005.
Furthermore, positive support and a favourable financial regulatory
environment are encouraging for Islamic financial institutions to set up
operations and for local and international investors to participate in
taking the country’s Islamic finance industry to new growth.
(The writer can be contacted for further enquiries at [email protected])
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