Sri Lanka islamic finance poised for growth

Islamic finance, based on financial transactions within the realm of shariah or Islamic law, focuses on real assets while shunning speculative transactions. The broader principle here is to share risk as well as profit.

Riyaz Mihular, partner at global accounting firm KPMG spoke to LBR about how this booming sector can help develop Sri Lanka’s infrastructure and capital markets. Excerpts from the interview:

LBR: What are your growth projections for Islamic finance in Sri Lanka and the Asian region as a whole? What are the main catalysts for growth?

A: I believe the prospects for growth of Islamic finance in Sri Lanka is going to be extremely attractive. Almost all the banks are opening windows. We have the first fully fledged commercial islamic bank u in Sri Lanka now. In addition to that you also have leasing companies which have gone into Islamic finance relating to leasing called ijarah, and that’s a fairly strong growth area. It lends itself well Islamic finance because there is an asset behind those ijarah transactions. So I think there will be a lot of growth.

LBR: What are the most popular Islamic finance products in Sri Lanka? In Malaysia we see that sukuk bonds are quite popular. Similarly in Sri Lanka which products are most in demand?

A: In Sri Lanka I think the most popular product is ijarah, the leasing product. It’s a fairly simple product. Another popular product is diminishing musharakah, which is used where people want to buy a house. We have a few issues on that because for tax purposes if you take a conventional housing loan interest is allowed. By practice the department assessors have allowed the profit element as comparable to interest but it’s not in the law. We’re dependent on the interpretation of an assessor. That’s one of the challenges we have in Sri Lanka.

If we are going to have sukuk we need certain changes in the regulatory framework. A sukuk involves issuing a bond and transferring an asset to that particular SPV, people subscribe to the bond and then from the rental of the asset people are paid off. If you take it strictly as a purchase and sale transaction there is a lot of indirect tax involved. If you factor all that in the whole thing becomes not viable. On the other hand if you consider it as a financing transaction then it may be viable. So if you are going to have sukuk in this country we will have to seriously look at our regulatory provisions to facilitate sukuk transactions. I believe it is very important for Sri Lanka to go into this area. Some of Sri Lanka’s best friends are the middle Eastern countries and they would like to help with Sri Lanka’s renaissance. They may rather invest in a sukuk that the government issue. If you provide the right instruments these countries can come and subscribe to them. It is important fo./r Sri Lanka to look at sukuk seriously. I don’t think it is advisable to purely depend on the conventional bond market.

LBR: Foreign investors are looking very keenly at Sri Lanka with the development phase going on right now. What prospects would they have in Sri Lanka for Islamic finance?

A: We read a couple of weeks ago that the Qatar prime minister, the finance minister and quite a big delegation came in a big way to invest in Sri Lanka because there are projects they are coming into as foreign direct investment. Not all of them would come into these specific investments. There may be other players in the middle east who may not be interested in doing a study and taking a specific project and investing. They may rather subscribe to a sukuk that the government offers which may be used in infrastructure projects. All they have to evaluate is the government’s rating and government’s ability to honour its commitments.

We have to give the instruments for people to come in. not all of them will come in and make direct investments

LBR: A recent KPMG report on Islamic finance highlighted the shortage of skilled workers in the industry. How can this issue be addressed?

A: This is an important challenge for the country. There is a huge burst of activity in windows and you need people. It’s a war for talent. We may be behind the curve on that. Therefore we need to quickly ramp up our capacity. There are some institutions which have taken quick steps to try and introduce qualifications. There is an IFQ qualification in Sri Lanka and quite a lot are taking to that. These are all steps in the right direction. What we need is a greater level of capacity building. We need more Islamic education providers. They need to be credible as well. If you don’t deliver on what you claim to have people will look away. I think there is a big market. If we do provide the right programs there will be quite a big uptake. The thirst for knowledge is there. People know that this is a growing industry.

LBR: We’ve seen in the past the Islamic finance industry has come off relatively unscathed amidst global financial crises. Currently we are seeing a financial crisis in the west. What kind of impact will this have Islamic finance and how will the industry survive going forward?

A: the Islamic finance industry came off reasonably unscathed on the issue because they didn’t have the concept of money on money. You have to a real transaction which underlies the Islamic finance instrument. That’s one of the reasons it survived.

The current crisis that is facing the world, how will Islamic finance fare? The challenges will be there no doubt but the key for Islamic finance going forward and surviving would be to make sure that there is adequate rigour behind the financial instruments that are issued. There is a tendency sometimes to do a lot of structuring. Trying to shadow the conventional bonds. We need to be careful that while we try to structure the bonds that the larger market is familiar with that we don’t move away from the basic principle that Islamic finance must always have a real transaction that has an underlying asset.



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