When the SA government issued the continent’s first sovereign Islamic bond (sukuk) in 2014, it was oversubscribed four times and could have become a watershed moment for the country’s Islamic banking industry. Although a growing number of banks are offering increasingly sophisticated products that are compliant with Islamic religious law (shariah), this industry still holds huge untapped potential.

Since the humble beginnings of formalised Islamic banking in SA in 1980, there has been ‘respectable growth across both asset and liability categories’, according to Amman Muhammad, CEO of Islamic banking at FNB. ‘Forty-two years later, the industry has grown its balance sheet to approximately R52 billion in deposits and just under R20 billion in advances. The industry has continued to progress, even through the worst of the pandemic. The profile of the South African Islamic banking industry perpetuates the profile of international Islamic banking industry where deposits outweigh advances.’

According to Global Finance magazine, the net profit for Islamic banks rose worldwide by more than 50% in 2021, with banks in the Gulf achieving particularly strong results. ‘The sector is expected to maintain growth in most market segments, including financing, investment, sukuk and insurance. Segments such as mortgage financing are experiencing rapid growth, while sustainability financing is blooming,’ it reported in May 2022.

Ratings agency Moody’s predicts further growth, seeing that sub-Saharan Africa is home to around 16% of the world’s Muslim population (expected to increase to 27% by 2060), but its shariah-compliant assets account for only 1% of global Islamic banking assets.

Also, the appeal is not only faith-based, as a growing number of non-Muslim investors are attracted to the ethics and social responsibility principles of Islamic finance. The total global value of these assets reached an estimated $2 trillion in 2019.

‘We find that people from all walks of life, irrespective of race, gender or creed, hold certain values as to what is beneficial or detrimental to society,’ says Ameen Hassen, head of shariah banking at Standard Bank. Islamic banking prohibits investments in what it deems socially detrimental sectors, such as gambling, arms and weapons, alcohol, tobacco, non-halaal meat and transactions purely for speculation. ‘What this offering makes available is for a cohort of client that holds a specific value system, and this is why it’s also appealing to non-Muslims,’ he says.

‘In fact, there is much work being done across the industry to relook at the naming convention to ensure that it’s more inclusive and does not give the unintended connotation that this is something only for Muslims.’

Another key difference between Islamic and conventional finance – in addition to not allowing investments in the sectors mentioned by Hassen – is the prohibition of any type of interest (called riba). The other two core principles are: absolute transparency in contracting; and the sharing of risk and reward.

‘The basis of Islamic finance is equity (through profit and loss sharing schemes) and rental income, whereas the pillar of conventional finance is debt (through interest),’ explains a special report in Accountancy SA. ‘The Islamic financier or investor deals in physical assets, whereas the conventional financier deals mainly in paper assets.’

An essential distinction also lies in the type of business relationships the Islamic bank has with its client, and the way this is regulated, according to Al Baraka Bank, which was the first fully fledged Islamic bank in SA. In contrast, some of the country’s major conventional banks, such as Absa, FNB and Standard Bank, have an ‘Islamic banking window’ – a separate ringfenced division to solely offer Islamic financial services that are overseen and approved by a sharia supervisory board.

In Islamic finance, the bank acts as ‘a trader, an investor, a lessor and a service provider to its client’, states Al Baraka. ‘In conventional banking, deposit and loan transactions typically involve monetary exchange, with interest being earned or charged whereas in Islamic banking (since money is not treated as a commodity), transactions are structured as trade or partnerships or service agreements designed to facilitate the customer’s requirements.’

In response to the rising demand for Islamic investment products, the JSE offers four FTSE/JSE shariah indices that are independently screened to reflect shariah-compliant companies. These are the Shariah All Share, the Shariah Top 40, the Capped Shariah Top 40 and the Shariah 40 Net Total Return Index.

In support of the small-businesses sector and entrepreneurship, Standard Bank (in partnership with Merchant Capital) launched the SA region’s first shariah-compliant unsecured funding solution for SMEs, which enables clients to receive funding in less than 48 hours. ‘The product is underpinned by a robust technology platform and innovative credit algorithms, prior to which there had been only limited ideation in the area of shariah-compliant fintech funding solutions in sub-Saharan Africa,’ says Hassen. ‘With this, and other new ideas that are now coming to the fore, we can bridge the gap of funding to the SME market, where these businesses may not have sought traditional funding solutions because of their requirements for shariah-compliant products and services.‘

As with all nascent sectors, government action is crucial in supporting the development of SA’s growing Islamic finance industry. ‘It is through the efforts of government and the amendments effected in 2010 that we have been able to grow this sector to the stage that it is right now,’ adds Hassen. ‘We are currently working with government to look at the required changes for us to enter the next phase of the business cycle.’

Specific developments in Islamic banking regulation and legislation would further enhance and improve the overall industry, says FNB’s Muhammad, who suggests that government-backed sukuks would also significantly drive this development.

While a sukuk is similar to a conventional bond, it is based on risk sharing instead of generating interest. For sukuk investors this translates into part ownership of the issuer’s assets until maturity, when they will receive their share of the revenue generated by the underlying assets.

‘Sukuk could play a crucial role in encouraging innovative product development and supporting liquidity management issues that Islamic banks face,’ says Muhammad.

‘The South African Islamic finance industry requires a local currency, rand-denominated sukuk issuance. Sukuk that qualify as high-quality liquid assets would benefit both Islamic and conventional investors.’

The country’s debut domestic sukuk is on the horizon. In 2020, National Treasury already stated that it would issue a R1 billion sukuk for state-owned utility Eskom. Government reconfirmed its commitment to the Islamic bond in its 2022 Budget Review, stating that ‘a floating rate note and domestic rand-denominated sukuk remain part of the funding strategy’.

For the state, the attraction of Islamic finance is not so much in the pricing but in finding alternative sources of finance, as a way of diversifying the debt portfolio and introducing a new set of savers.

In 2017, First Rand’s merchant and investment division, RMB, was the first bank to structure a sukuk for the African Finance Corporation. Muhammad explains that this type of investment plays an important role in supporting infrastructure development. ‘Emerging African economies, including South Africa, are looking to either improve or completely redesign their respective infrastructure,’ he says.

Islamic finance can help attract a different class of foreign and local direct investment, which will mutually benefit issuer and investor, on top of the broader socio-economic benefits that come with improving infrastructure in Africa.

By Silke Colquhoun
Image: Gallo/Getty Images