The Bank of Uganda recently released the Financial Institutions (Islamic Banking) Regulations (the “Regulations”), which were gazetted on 2 February 2018. The Regulations seek to operationalise Islamic banking in the country, which was introduced by The Financial Institutions (Amendment) Act, 2016 as part of its wider efforts to boost financial inclusion. With this development, Uganda joins several African countries that have sought to develop the sector to expand financial access and inclusion among rural communities.
Islamic banking refers to institutions undertaking to make sustainable responsible investments (“SRIs”), with a focus on people over profit in which the institution becomes a partner in both the profits and losses suffered. They do this in accordance with the religious tenets of Islam. Notable is that these financial SRIs are interest free.
The purpose of the Regulations is to provide for the regulatory framework, licensing and operation of financial institutions conducting Islamic financial business and to ensure that it is conducted in accordance with the relevant Shari’ah principles.
Licensing of financial institutions seeking to undertake Islamic financial business
Persons seeking to undertake Islamic financial business may do so by applying for a licence to establish an Islamic bank, while conventional banks may apply for approval from the Bank of Uganda to operate Islamic banking windows. T he Regulations have maintained the same licensing criteria as conventional banks (provided for under the Financial Institutions (Licensing) Regulations, 2005) for institutions seeking to offer Islamic financial services.
Deposit structures under the Regulations
Under the Regulations, deposit accounts operated by financial institutions offering Islamic banking services may be held in profit-earning investment accounts, profit-sharing investment accounts and non-profit bearing deposit arrangements.
Credit provision structures under the Regulations
The Regulations classify the different credit provision structures for Islamic financial business into three structural arrangements as follows:
- equity partnership financing, which includes Musharakah, Musharakah Mutanaqish, and Mudarabah;
- lease-based financing, where assets are acquired by the financial institution and leased to the customer, who may or may not have the option of acquiring the leased asset; and
- sale-based financing, where assets are purchased by the financial institution and sold to the customer at a higher price than what they were purchased by the financial institution.
Mechanisms have been put in place to ensure that financial institutions undertaking Islamic financial business are Shari’ah compliant. These include the requirement for an internal Shari’ah audit function and a Shari’ah advisory board and a provision for a Central Shari’ah Advisory Council within the Bank of Uganda.
The Shari’ah advisory board must be independent of all other functions of the financial institution and is mandated to advise, approve and review the activities of the Islamic financial institution to ensure that they are Shari’ah compliant. It would also be in charge of overseeing the Shari’ah audit function.
The Central Shari’ah Advisory Council will be chaired by the Governor of the Bank of Uganda. Its duties include approving products offered by the financial institutions undertaking Islamic financial business and advising on their regulation.
The Bank of Uganda has taken a single regulatory approach for both conventional banks and financial institutions offering Islamic financial business. Financial Institutions offering Islamic financial business are required to adhere to the same rules and regulations as conventional banks as far as capital adequacy, corporate governance, credit classification and provisioning, credit concentration and large exposure, insider lending, liquidity and ownership and control are concerned.
The Regulations, however, include special provisions to cater for the unique risks to which financial institutions undertaking Islamic financial business may be exposed, particularly risks associated with Shari’ah compliance and deposit protection.
The Regulations also provide for Shari’ah compliant deposit and credit arrangements on an economically equivalent basis with conventional banks without specifically prescribing the products to be offered by financial institutions to allow for flexibility within the market.
We, however, note that there is a need to review Uganda’s tax legislation to accommodate the aspects of Islamic financial business with specific regard to the apportionment of allowable deductions, capital gains, withholding tax, thin capitalisation and double taxation agreements such that the Islamic finance products are not prejudiced or advantaged in comparison to conventional banking products in line with the regulatory approach of maintaining a level playing field.
A big barrier to formal credit is lack of traditional collateral and the high cost of credit. With Islamic banking, we expect a more concerted effort at providing less costly financial services to people who lack traditional collateral but can partner with the financial institution to obtain assets for their business. Further, for many business people who were averse to borrowing under interest terms might be pulled back into the formal financial sector.
The Regulations are a positive step in the right direction towards achieving financial inclusion and welcoming investment in the area of Islamic financial services.