The inner workings of Islamic finance

Money matters are as close to the heart as one’s faith. That is why rather than stick with conventional banking, Muslims established Islamic Banking.

Mr Sulaiman Lujja, a consultant on Islamic finance and Sharia says while Islamic banking, just like conventional banking is about savings and loans, the former follows Sharia principles.

“Islamic banking is based on sharia (Islamic) principles of buying and selling. We do not lend money as interest is prohibited. Rather, we buy what the client needs and sell it to them at a mark-up,” he says.

This was the case of Mr George William Ntuyo, a businessperson dealing in posho, rice, and beans in the Kireka Market. With a need for capital yet unable to qualify for a bank loan, he joined Thiqa Digital Finance, an Islamic fintech in April 2022.

“I was a first-time client and they explained that I was eligible for financing worth Shs250,000, according to my business sales and numbers. From there on, they would assess my trustworthiness and business growth prowess,” he says.

He says that, unlike other credit institutions, Thiqa does not give cash.

“They first analyse your business operations and what you may need to boost your business. Thereafter, you send them an invoice of the things you require for your business, introduce your supplier to them and they purchase those items for you. Then you start re-paying in small installments, according to the agreed-upon repayment period,” he says.

Mr Ntuyo says in the event of failing to make an installment payment due to some hardships, they can adjust the repayment date. Today, his finance portfolio is Shs2m.

Mr Luja explains that partnerships are a big part of Islamic banking and trust is key.

“If a client is trustworthy with proper books of accounts, they will partner with the financial institution in doing business. That way, they share in profits and losses,” he says.

While Thiqa Digital Finance is not a bank, it carries the tenants of Islamic banking and

Ms Danielle Lavan, the chief executive officer says the platform is essentially a financial technology business, drawing on the principles of Sharia and Islamic finance.

Though a Christian, the banking expert with over a decade of experience in global asset management and banking says she is a proponent of fair ethical finance hence finding Islamic banking one that embodies these as it rooted in religious principles.

“Here, money is a medium of exchange not a means for profit, which interest, in conventional banking, embodies,” she says.

Working with small businesses, the financial platform empowers entrepreneurs, youth, and the financially excluded to understand their pain points regarding access to credit, credit costing and pricing, and the challenges therein.

“We realised that finance access problems are not a Uganda-specific challenge. The remedy pointed to the need to move away from charging the entrepreneurs high interest rates, even when they can afford to pay. At Thiqa, we are working to accelerate trader development and access to fair, ethical and interest-free financial products,” Ms Lavan says.

Mr Ntuyo attests to the empowerment saying ever since he started working with Thiqa Digital Finance, they have helped him boost his business and he can see his dream of becoming a wholesaler unfold. His only request is that Thiqa increase the financing volumes for older clients.

Licensed by both the Uganda Microfinance Regulatory Authority (UMRA) and the Uganda Investment Authority, the financial platform has been in Uganda for three years.

Big on partnership, Ms Lavan says they are building products whose pricing ensures their client grows first before the company. The others are risk sharing, equity, affordability and asset ownership, which are rooted in Islamic finance principles.

“We cannot sell what we do not own. For example, if a tomato seller in Nakasero Market wants two boxes of tomatoes, we will buy those boxes and sell them to the trader at a markup. When the trader gains profit, then they share it with us,” Ms Lavan says.

One would think that this is a risky credit system but she says they look at the client as their guide on what is needed to gain profit in their business. Therefore, if one says they need two boxes and can sell them in 30 days, Thiqa follows that route.

“In the event of failure to honour that agreement, the first thing we look at is if it is a matter of negligence or the eco-system. If it is the latter, we work out new payment schedules within the current economic trends. However, if it is negligence, such as wilfully not coming to work for two weeks, we follow the Sharia perspective where we look for compensation. That starts with an investigation, then a roundtable conversation for a way forward. Technology plays a big role in this, helping us to gain oversight of the client. That is why we ask for personalised information for every transaction credit is interest-free,” she says.

Ms Lavan says everything they have put in their system is premised on the research and trader interactions by the team. The driving factor was how they could improve the financial wellness of the end client to walk in partnerships based on trust.

“In this partnership model, we understand the behavioural triggers and have features within the platform where the clients can upload their daily sales, expenses and unforeseen costs. That gives us more sight of their workings,” she says.

With this, they can pick up the red flags and better equip their clients about the product and their obligations for a profitable partnership through training.

Benefits: Joint venture                                                           

In Islamic banking, unlike conventional banking, Mr Lujja says the financial institution is ready to share with you in losses and profits.

“These partnerships make business easier because the institution will advise you on your intended venture since they are also affected should it fail,” he says.

No diversion

In conventional banking, the borrower can easily divert the money to other needs. They fail to meet the initial need but that also affects repayment.

“That is not possible in Islamic banking because the institution gets into an economic activity with you to get what you need rather than giving you money,” he says.

Penalties

While payment delays are not acceptable in Islamic banking, the penalties charged do not profit the financial institution as it is sent to a charitable organisation.

“In Islamic banking, failure to pay does not necessarily lead to a penalty because the client and the financial institution are partners. However, in case of negligent failure to pay, the penalty it attracts goes to a charity rather than benefitting the institution. This is seen to by the sharia advisory board within the institution,” he says.

Adding, “This penalty is not exorbitant and does not compound.”

Downfalls

However, there are several misconceptions about this banking type. One of these is that the loan is akin to an interest-free loan. Mr Lujja says that while they do not charge interest, it is not repaid as was borrowed.

“There is a mark-up to these loans, sometimes at the same level as the interest charged in conventional banks or more. That is also because Islamic banking has more costs than conventional banking such as two-tier governance (sharia advisory board and conventional regulation). These costs are catered to by the client,” he says.

Competition also weighs down Islamic banking because conventional banking has a bigger hold on the economy with 25 commercial banks having Shs150 billion capital.

“They have more influence thus dictating, say interest rate,” he says.