The concept of Islamic banking — a financial, banking and lending system in which interest is not chargeable, remains a mystery to many. A lot of people are often left wondering how Islamic banks are able to make a return.
Although still fairly new, Islamic banking appears to have caught root in Kenya
Banks offering Islamic banking in Tanzania will have to face many legal hurdles, as their counterparts in Kenya faces particularly because the doctrines of Islamic finance and banking laws in Tanzania and Kenya
The operations of Islamic financial institutions are primarily based on a profit and loss sharing principle and trading arrangements as opposed to the interest charged by conventional banks. An Islamic bank does not charge interest, but rather participates in the yield resulting from the use of these funds.
The depositors also receives their share in the profits of the bank according to a predetermined ratio. Sharia law — the bedrock of Islamic banking — emphasizes on equitable contracts.
The restrictions under Sharia finance law are: the prohibition of payment or receipt of riba (interest), the prohibition of gharar (preventable uncertainty); the prohibition of maisir (gambling); and the prohibition of haram (forbidden) activities.
They have had to find innovative ways to make profits, under the watchful eye of Sharia. The biggest issue is the prohibition on charging or receiving interest. This affects the running of customer deposit accounts, mortgages, and all loans.
Islamic banks have come up with solutions such as replacing interest with a cost plus markup equation under Murabaha contract. Under customary banking, for instance, a customer wishing to purchase a Sh100million house financed by a bank would simply identify the house and enter into a sale agreement with the seller.
The customer would then negotiate with his bank for, for instance, a one year loan for a principal amount of Sh100 million at say an interest rate of 20 per cent and use the loan to pay for the house. The total amount repayable to the bank would be Sh120 million and this would include an interest element of Sh20 Million.
However, under Islamic banking, the bank cannot charge interest. The transaction would therefore work as follows. The customer would identify the house and agree the purchase price of Sh100 million. The Islamic bank would then purchase the house for Sh100 million and resell it to the customer for Sh120 million.
The Islamic bank would then grant right to occupy the house to the client and record a debt Sh120 million to the customer repayable on monthly installments to enable him to acquire title deeds of the house from the bank at the end of the year.
There are many other Islamic finance products. These include Diminishing Musharakah — a partnership agreement between a bank and a customer in which the parties invest jointly as partners and the customer then buys out the bank's share over a period of time using profits from the joint venture.
Important question.
The all important question is whether Sharia commercial law is recognized in
Although the Tanzania Constitution provides freedom of religion and in Zanzibar there are Kadhi courts "the jurisdiction of a Kadhi's court shall extend to the determination of questions of Muslim law relating to personal status, marriage, divorce or inheritance in proceedings in which all the parties profess the Muslim religion", it is noteworthy that jurisdiction does not extend to contractual relations in the context of a banking relationship.
The Banking and Financial Institution Act 2006 regulate the country's banking industry. Section 24 (4), 25(1), 28(1-3), 29 (1), of the Act limit banks from engaging in wholesale or retail trade or purchasing or holding any fixed asset and bank's investment in other institutions or single person. This limitation greatly cripples operations of an Islamic bank.
In order to conduct such Islamic banking in Tanzania therefore, a bank would need to obtain from the Central Bank exemptions from the provisions of the Act limiting and prohibiting banks from engaging in trade or acquiring or holding land.
There are many other complexities attendant to Islamic banking.
For instance, Islamic products such as Murabaha in which the bank acquires the asset and then resells it to the customer exposes the transaction to VAT. In addition to the bank profit margin, it may make the product very expensive considering the fact that some Islamic banks benchmark its product price with the prevailing interest rate. It is therefore important to consider the tax and accounting treatment payments under such product.
If a bank is a foreign bank or company, it makes matters pertaining to ownership of land for the business purpose more complicated. Land Act (CAP113 RE 2002) Section 19(1) and Village Land Act Section 22(1) restrict ownership of land to only citizens of Tanzania in their individual or corporate capacities. Even though, Land Act Section 20(1) creates exceptional circumstances, non citizens can only acquire derivative rights for investment purposes only under Tanzania Investment Act, 1997.
Aware of implications.
Therefore a bank which is foreign company (majority shareholders or owners are non citizen) intends to buy/construct a house in town busy area for the purpose of its business either by selling it at a higher price (Murabaha) to the customer or lease (Ijara) to the customers will need to have a special exemption to do so from BOT, TIC and Ministry of Land.
Therefore a bank which is foreign company (majority shareholders or owners are non citizen) intends to buy/construct a house in town busy area for the purpose of its business either by selling it at a higher price (Murabaha) to the customer or lease (Ijara) to the customers will need to have a special exemption to do so from BOT, TIC and Ministry of Land.
A bank undertaking Murabaha transactions may also be deemed to be a seller of goods thereby bringing it within the ambit of the Sale of Goods Act or Financial lease Act. The two Acts places a number of obligations on a seller of goods and lessor respectively.
Some of these obligations include an implied warranty that the relevant goods are of merchantable quality and fit for their purpose. As such, the bank should also consider the application of the Act and understand how to limit its exposure under the Act.
The hurdles that Sharia compliant banks have to contend with are many and onerous. In light of the significant impact that Islamic banking is set to have on the financial sector in Tanzania, it is time the Government consider some changes that need to be made to banking laws, Land Laws, Income Tax laws in order to accommodate Islamic banking to its full potential.