How ready is our economy for the Islamic banking?

As the impact of World Bank's suspension of public funding to Uganda start to bite, the Ugandan government has made deliberate and calculated moves to obtain the much-needed funding from friendlier sources in order to cover the ditches left by the World Bank’s actions.

One of the many calculated moves was the recent enactment of laws to accommodate Islamic banking in Uganda as part of the laws that were assented to by President Museveni on August 17, 2023.

Following this move, the central bank of Uganda, on Friday, September 8, 2023, issued the first Islamic banking license to Salaam Bank Uganda Limited, a subsidiary of the Djibouti-based Salaam African bank. This was according to the statement issued by Kenneth Egesa, the director, Communications at the Bank of Uganda.

Islamic banking, also known as Islamic finance or sharia-compliant finance is basically a financial system that operates under the principles and guidance of Islamic law or sharia as it is commonly known.

According to the central bank, the introduction of Islamic banking is a pivotal moment in Uganda’s financing landscape that unlocks fresh funding avenues for businesses and individuals, thereby fostering financial inclusion. With World Bank’s suspension of funding, government seems to have found a better and suitable match for its borrowing.

During the reading of the 2023/2024 financial year budget, the government intimated that it had earmarked Shs 8.3 trillion shillings from external financing for projects as part of its resource envelope. The suspension of this funding by World Bank could see Uganda borrowing this money domestically from banks offering Islamic banking products.

The beauty with Islamic banking is that it doesn't allow the charging of interest and this could eventually lead to a significant growth in not only the banking sector but also the economy at large. Islamic banking allows for market-based risk-sharing modes of financing that promote assets and enterprises but also forbid interest. This could be vital to Uganda.

As opposed to the conventional modes of banking that guarantee a predetermined rate of interest, banks operating the Islamic banking system have a provision that allows for profits sharing between the bank and depositors in accordance with an agreed profit-sharing ration.

Further, the fact that Islamic financial institutions are backed by real assets and economic activities creates a direct link between the financial market and economic development which gives an opportunity for a country to experience tangible growth in its economy. This explains why Islamic finance has had a significant growth in financial instruments globally that is projected to be about $3 trillion as of 2022.

Appealing as it is, there’s need to understand whether Uganda is ready for Islamic banking without giving much thought to the fact that it could have been adopted merely to get funding that would replace the World Bank’s aide that has been cut. In fact, Uganda seems to have rushed into issuing its first Islamic banking license.

It is intriguing that Salaam Bank Uganda Limited, which has only been in Uganda for less than 12 months following its acquisition of Top Finance Bank Uganda Limited last year, was the first to obtain a license from the central bank ahead of other financial institutions that have the capability to operate the Islamic banking window.

The intricacies of regulating a financial institution dictate that the central bank ought to satisfy itself as to the name, address, directors, shareholders, qualification of the staff, capital structure of the financial institution, its business plans, the history of the bank, the competence and integrity of its proposed management, among others.

It is difficult to comprehend how the central bank carried all this out in a span of one month as the law accommodating for Islamic banking was only assented to in August. Never mind that the central bank is legally mandated to prepare a detailed report on every licensing application within six months of the application detailing whether the applying bank qualifies for licensing.

There is, therefore, need to establish whether Salaam bank was regularly licensed in accordance with the Finance Institutions Act which sets out the licensing criteria. Licensing aside, the central bank has not come out to provide streamlined procedures to guide Islamic banks on how to steer clear of Uganda’s crude capitalism.

The fact that Islamic banks do not charge interest means that they will face an uphill task in ensuring that they obtain profits especially in the infant stages. If this is not done, these banks could be outcompeted by the conventional banks that operate on a cutthroat basis with an aim of maximizing profits.

There also seems to be a knowledge gap amongst Ugandan banking experts. As of today, the Uganda Bankers Association has not come out to provide any guidance on operations of Islamic banking. This indicates that Uganda is not yet ready for Islamic banking.

If Uganda is to benefit from the Islamic banking system, there will be need to develop a national Islamic Finance Agenda and policy guidelines on its operations.

The writer is an advocate of High court.