The development of Islamic banking in Tanzania

In this article, we review the key principles of Islamic banking and its development in Tanzania.

It has recently been reported about the first Sukuk bonds that were issued in Tanzania by Imaan Finance Limited. Sukuk are financial certificates which represent an undivided share in the ownership of tangible assets which are not receivables. The company sought to collect Tanzanian Shillings 2 billion but received a total of Tanzanian Shillings 2.72 billion in bids – which is an oversubscription of 36%. As Sukuk bonds are novel in Tanzania, this evidences the investors’ appetite in Tanzania in relation to Islamic financing. There is an opportunity for issuing further Sukuk bonds as it gives investors an alternative investment scheme rather than government securities and corporate bonds, both of which attract interest.

Islamic banking is the provision of financial services based on the ethical principles of Shari’ah. Shari’ah refers to the Islamic principles and jurisprudence that govern social, political and economic relationships and actions of Muslims and Islamic institutions.[1] Islamic banking generally results in the Islamic financial service provider becoming a co-owner of the underlying assets thereby assuming some risks and sharing in losses and profits.

Investment in illicit, also known as Haram activities, such as alcohol or gambling is prohibited under Islamic banking. Other prohibitions include Riba which are transactions on a risk-free basis such as conventional loans and bonds, and Gharar which are excessively speculative transactions such as future sales or swaps. In essence, Islamic principles prohibit collection and utilisation of interest for business purposes. Permissible transactions include Islamic loans called qard hasan, otherwise known as benevolent loans. These are loans which are given for no consideration and where the lender receives no benefit for giving the loan.

Tanzania currently has one fully fledged Islamic bank which primarily offers Shari’ah compliant financial products. There are, however, other commercial banks which offer Islamic banking services. The main concern with respect to Islamic banking in Tanzania is that there is currently no specific legal framework to cater for Islamic banking as well as resolution of legal disputes arising from Islamic banking. This could be seen as hindering the progress of Islamic banking in Tanzania. When the legal framework for this is set up, we anticipate an increase in Islamic banking customers.

Other structures of Islamic financing

We have set out some other structures of Islamic financing below which we anticipate will be more commonplace in Tanzania in the future once a legal framework for Islamic banking is introduced.

Musharaka

Musharaka, also known as Partnership Financing, is a partnership between two entities or individuals whereby they contribute capital/assets/work towards a venture to share profit/loss. In such an agreement profits can be determined for more than one partner’s contribution, but a lump sum amount cannot be specified. Losses will only be incurred proportionately on the basis of each partner’s contribution. Management of the partnership is carried out according to mutual agreement between the parties.

Diminishing Musharaka

Similar to the above, but in this instance the partner/customer is entitled to replace the other partner/bank as the owner of the asset by setting aside part of the accrued income to pay the bank’s share of the partnership until full ownership is assigned. Under this structure, the bank gets a dividend on its equity and at the same time, a third-party purchases some of the bank’s equity hence the bank’s equity is gradually reduced until it ceases to be a partner.

Mudaraba

Mudaraba is a profit and loss sharing arrangement where one partner (the bank) provides capital to another partner (the customer) who is responsible for the management and investment of the capital. Profits are distributed in accordance with the agreed ratio and loss is borne solely by the bank unless such loss is occasioned by the customer’s negligence or breach of contract.

Murabaha

This is a contract between a customer and the bank wherein the bank purchases goods upon request of the client, who makes deferred payments that cover the costs and at an agreed profit margin for the bank. The buyer takes instant possession of the goods but pays on a deferred basis.

Ijara

This is an agreement in which a lessor/the bank leases a property to the lessee/the customer for rental and purchase payments, ultimately resulting in the transfer of property ownership to the lessee.

Takaful

Takaful is a Shari’ah complaint insurance scheme operated on shared responsibility and mutual obligation to safeguard participants against a defined risk.

Currently, Islamic insurance licenses are not provided for under Tanzanian insurance laws, therefore, one cannot offer Islamic Insurance as the existing legal framework only caters for conventional insurance.

In 2015, draft regulations known as the Takaful Regulations began circulating online. The Takaful Regulations were to be published and gazetted in the fourth quarter of 2015; however, we understand that these regulations have not yet been passed. Companies that wish to provide Islamic insurance must wait until laws relating to Islamic insurance are established and liaise with the Tanzania Insurance Regulatory Authority accordingly.

We hope this information has been useful. Should you require further information, please do not hesitate to contact us.

Clyde & Co LLP accepts no responsibility for loss occasioned to any person acting or refraining from acting as a result of material contained in this summary. Further advice should be taken before relying on the contents of this summary.