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COUNTRY REPORT

Sri Lanka: Uncovering the Islamic Finance Framework
By Muath Mubarak
With the end of the civil war in the country that had plagued the economy for more than three decades, it is high time Sri Lankans began thinking about the development of the nation. Sri Lanka has to grow like other developed countries within a short time by exploiting untapped opportunities. The post-war period requires rapid development in all sectors of the economy, especially the banking and financial sector. Unfortunately, the sector has seen lackluster growth due to the global financial crisis. The crisis however has led experts and economists alike to consider an alternative financial system. As one of the fastest growing industries in the world today, Islamic finance is growing at 20%-25% a year, according to analysts and rating agencies. It is forecasted that the industry will hold assets totaling US$4 trillion by 2012. In addition, seven of the top 10 conventional banks with an international presence have commenced Islamic banking. The following are the main barriers for the growth of Islamic finance in Sri Lanka (and most other emerging countries): • Regulation • Taxation • Standardization • Awareness • Skill

Today’s Challenges to regulators:
• Regulatory/law: Existing banking regulations in most countries (including Sri Lanka) are based on the conventional banking model, meaning the need for separate consideration for Islamic banks and financial institutions. • Accounting, transparency and surveillance. • An Islamic financial system needs sound accounting procedures and standards. • Western accounting procedures are inadequate because of the differing nature and treatment of financial instruments. • Well-defined procedures and standards are crucial for information disclosure, building investors’ confidence, and surveillance. • Shariah compliance. • Emerging financial markets are trending towards Islamic banking.

The Islamic finance framework
Islamic finance and Takaful are not unfamiliar to the Sri Lankan business community. The concept was introduced a decade ago, and several initiatives via seminars and workshops have also been undertaken by companies and organizations to create public awareness and educate the masses and officials concerned. The Banking Law of Sri Lanka was amended in 2005 to allow both commercial banks and specialized banks to operate on a Shariah compliant basis. But there is no specific law for Shariah compliant financial transactions. For example, the definition of “deposit” in the law provides the same treatment for deposits in conventional banks and Islamic financial institutions, which disadvantages these institutions in terms of taxes and statutory requirements. On the other hand there is an initiative by the Securities and Exchange Commission of Sri Lanka to enact a law on securitization to facilitate the issuance of asset-backed securities through the creation of special purpose vehicles (SPVs) and for the regulation and supervision of securitized transactions. One of the key principles of Islamic finance is that almost all the financial transactions should be backed by real assets. The proposed law can lead to the promotion of Sukuk in Sri Lanka. According to officials, infrastructure development in the country can be financed via Sukuk, with Middle East and other foreign investors possibly interested in participating.

“There is an initiative by the Securities and Exchange Commission of Sri Lanka to enact a law on securitization to facilitate the issuance of assetbacked securities through the creation of special purpose vehicles and for the regulation and supervision of securitized transactions”
Conclusion
The increasing acceptance of Islamic banking and finance in Sri Lanka is apparent. There are now eight institutions in the market and five educational institutions offering Islamic finance courses as well as workshops to generate awareness among Sri Lankans. So, in order to nurture this industry in Sri Lanka, it is critical for us to first understand the principles and advantages of Islamic finance. Muath Mubarak works for First Global Group, a Sri Lanka-based conglomerate of companies involved in the Islamic financial industry. He can be contacted at muath.2009@gmail.com

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27th November 2009