School of Post Graduate Studies

Nasarawa State University Keffi

Faculty of Administration
Department of Accounting

Course Code: ACC 724

Course Title: Seminar in Accounting and Finance
Topic: Islamic Finance System: Evolution, Development and
Prospective

Being a seminar presentation by

Salisu Saad
NSU/ADM/MSC/ACC/340/12/13
salisu.saad@yahoo.com
08033370478

Course Lecturer: Assoc. Prof. S.A.S Aruwa

May, 2014.

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Abstract

Islamic financial institutions continue to demonstrate resilience across the world in the face of the
global financial crisis relative to their conventional counterparts which has exhibited weakness in
recent times. The practice of Islamic finance now spreads from East to West all the way from
Indonesia and Malaysia towards Europe and the Americas. The successful operation of these
institutions and the experiences in Bahrain, Iran, Malaysia and Sudan are satisfactory to show that
Islamic banking and finance offers an alternative method of banking. The fact that many
conventional banks, including some major multinational banks such as Citibank and Standard &
Chartered, have also started rendering Islamic financial services is a further proof of the viability of
Islamic finance products. In early 2012, Central Bank of Nigeria (CBN) re-issued the latest
guidelines for Non-Interest Financial Services in Nigeria and this was followed by a grant of
implicit approval to Jaiz Bank Plc, the country’s first Islamic Bank. This paper attempts to explore
the evolution and development of Islamic Finance System and brings to fore some of its global
prospective and for the Nigerian Islamic financial system in particular. The first part is the
introductory stage, while the second part focuses on the evolution and development of the industry
in conjunction with the principles and products of Islamic financial system. The industry as a whole
is then tracked across a three-stage timeline consistent of 1970-1980, 1980- 2000, and 2000
onward. The third part highlights the global problems and the three-issues considered to be the
prospective of the system thereon. The fourth part of the paper discusses the findings, conclusion
and recommendations. This serves as a suitable guide for further research into Islamic finance and
for many of the absence of standardized products, shortage of supportive and Institutional links and
lack of Islamic Capital Market that are yet to be addressed.

Key words: Islamic Finance, Mudarabah, Musharakah, Qur’an, Riba.

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Introduction
On a global scale, the Islamic financial system has witnessed a rapid development over the last four
decades to become a dynamic and competitive from of financial intermediation within the global
financial system (Eboh, 2010). Early experiments with Islamic institutions took place in Malaysia in
the mid 1940s, in Pakistan in the late 1950s and Egypt’s Mit Ghamr Savings Bank and Nasser Social
Bank in 1963 and 1973 respectively and the practice now spreads from East to West all the way
from Indonesia and Malaysia towards European countries and the United States of America (USA).
The successful operation of these institutions and the experiences in Bahrain, Iran, Malaysia and
Sudan are satisfactory to show that Islamic finance system offers an alternative method of banking.
The fact that many conventional banks, including some major multinational banks such as Citibank
and Standard & Chartered have also started rendering Islamic financial services is a further proof of
the viability of Islamic finance products. Research has shown that the system has recorded a
dramatic growth, rising to about 435 institutions operating in 75 countries around the world (Eboh,
2010). Gambia, Egypt, Ethiopia, Mali, Nigeria and Senegal already have operational guidelines and
regulations governing non-interest finances. Several other countries in Africa are at various stages of
crafting and consequently executing their regulatory guidelines (Onuba, 2010).

The domination enjoyed by the conventional system of finance revolutionized the emergence of
Islamic finance system, which most essentially is based on the principles of the shari’ah, that is, the
Islamic laws. The system is coveted for its prohibition of interest, despising uncertainty and
denouncing speculation. With emphasis on resource mobilization for active partnership with
enterprenuers and real sector operators of the economy, the Islamic system proved to be capable of
stimulating real growth – non inflationary growth, by way of forging mutual cooperation in risk
taking and profit or loss sharing. In addition, islamic financial system is admired for fostering
economic development, social progress and distributive justice, which is why, unlike the
conventional system, it is more concerned with the viability of business proposal and, equally its
profitability, as against the size of the collateral, business cash flow and rate of return, that is,
interest. Islamic bank, therefore, is capable of attracting large pool of investors and enterprenuers,

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especially in the informal sector, which have been alienated by the conventional banking system
(Rano 2012).

The Islamic banking sector worldwide has been growing at a very fast rate of over 15 percent
annually over the past decade. From a total asset value of USD 150 billion in the mid-1990's to an
estimated USD 780 billion in 2009. The Islamic Financial Service Board (IFSB), for instance,
forecasts the global Islamic Finance assets to reach USD 1.6 trillion by the year 2012, with Islamic
Banking expected to remain the major contributor at more than 80 percent share. Despite these
sterling features, wide benefaction and tremendous successes recorded by the Islamic finance and
finance globally, the adoption of the Islamic banking system by the apex financial institution – the
Central Bank of Nigeria (CBN), as an alternative system of financial intermediation was greeted
with steep resistance in certain quarters in the country (Rano 2012).

Against this background, this paper seeks to explore the evolution and development of Islamic
Finance System and brings to fore some of its global prospective and for the Nigeria Islamic
financial system in particular. The rest of the paper is structured as follows; following the
introduction, the second part is concerned with the evolution and development of the industry in
conjunction with the principles and products of Islamic financial system. The industry as a whole is
then tracked across a three-stage timeline consistent of 1970-1980, 1980- 2000, and 2000 onward.
The third part being highlights of the global problems and the three-issues considered to be the
prospective of the system, while the fourth part discusses the findings, conclusion and
recommendations thereon.

Evolution of Islamic Finance System

A large number of Islamic finance definitions are found in the literature, ranging from the relatively
simple definitions for specific aspects (say, Islamic banking) to more complex definitions covering
all financial operations. Warde (2000), for example, defines Islamic finance as “Islamic financial
institutions that are based, in their objectives and operations, on Quran’s principles (principles of the
Muslims’ Holy book)”. This particular definition suggests that Islamic financial firms are not just

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banks, but also other types of financial intermediaries that employ Shari’ah principles. The other
point of departure is that the Shari’ah ostensibly requires the adjustment of all aspects of Muslims’
lives and the formation of a complete moral system. According to Iqbal (1997), while the prevailing
Western financial system focuses on the capitalistic features of economic and financial processes,
Islamic finance aims to make an actual moral and equitable distribution in resources and social
fairness in all (Muslim) societies.

Therefore, Islamic Finance System is said to be any financial services primarily employed to comply
with the tenets of Shari’ah (or Islamic law). In turn, the main sources of Shari’ah are the Holy
Quran, Hadith, Sunna, Ijma, Qiyas and Ijtihad. The Holy Quran is the book of revelation given to the
Prophet Muhammad; Hadith is the narrative relating the deeds and utterances of Muhammad; Sunna
refers to the habitual practice and behaviour of Muhammad during his lifetime; Ijma is the consensus
among religion scholars about specific issues not envisaged in either the Holy Quran or the Sunna;
Qiyas is the use of deduction by analogy to provide an opinion on a case not referred to in the Quran
or the Sunna in comparison with another case referred to in the Quran and the Sunna; and Ijtihad
represents a jurists’ independent reasoning relating to the applicability of certain Shari’ah rules on
cases not mentioned in either the Quran or the Sunna.

The evolution of Islamic finance commenced at the beginning of the 7th Century when Prophet
Muhammad (PBUH) received revelations directly from Allah. At the time, the doctrine of financial
operations during Muhammad’s era was derived directly from the Holy Quran and the Sunna
(traditions) of the Prophet. Since then, while Islamic Shari’ah (Quran and Sunna) has ostensibly
coordinated all financial transactions between Islamic persons, there has been a continuing process
of mutual adjustment between Shari’ah and the actual financial practices of Muslim societies. Kahf
and Khan (1993) have pointed out that Prophet Muhammad (PBUH) was the first to use the
Mudarabah (silent partnership) in trade with rich women named Nana Khadijah (who later became
his wife). At the time, Muslims used to practice Musharakah (joint venture or full partnership) when
operating large commercial enterprises under a profit/loss sharing principle. In addition, Muhammad

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made it permissible for people to use sale on credit (bai salam) which was to finance consumption or
production without usury and he encouraged Muslims to provide benevolent loans (Quard Hassan).

According to Moore (1997), the Islamic finance system during the four centuries following Prophet
Muhammad’s death has rapidly spread to both Muslims and non-Muslims, Morocco and Spain to the
West, India and China to the east, Central Asia to the North and Africa to the South. The extension
of Islamic tools of finance is also indicated by historical records of contracts registered between
businessmen at the time, including Mudarabah and Musharakah. Islamic finance practices continued
largely unchanged until the beginning of the 19th Century (Warde 2000). From the nineteenth
century, nearly all Muslim countries fell under the control of the Western colonial powers (France in
North Africa, Britain and France in the Middle East, Britain in the Indian sub-continent and Britain
and The Netherlands in South-East Asia), effectively dividing the Islamic world into many small
states. Anwar (1995) argues that by the mid nineteenth century almost all Muslim-controlled areas
fell to the Western colonial powers and thus the existing financial scheme which complied with
Shari’ah was effectively replaced by the capitalist system. From then until the second half of the
twentieth century, most Muslim economies were dominated by the economic traditions and systems
of Western Europe (Moore 1997). However, while commercial banks, insurance companies and
other types of intermediary firms employed conventional methods of finance (mostly as branches or
agents of institutions in the colonizing country), Islamic methods of finance were still often practiced
between individual Muslims.

With the independence of the Arabic countries from the colonial powers by the second half of the
twentieth century, many Islamic economies also became more independent. As a result, Muslim
economists started reconsidering the application of Islamic finance into a formal banking industry.
Therefore, between 1970 and 1980, the concept of Islamic finance was being translated into reality
by a group of pioneering Islamic financial institutions, such as Kuwait Finance House, the Islamic
Development Bank and Dallah Albaraka- a Saudi conglomerate. Iqbal and Molyneux (2005) suggest
the first attempt to establish an Islamic financial institution was in 1971 when the Egyptian
government established the Nasser Social Bank. This bank provided a number of Islamic financial

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products, including interest-free loans to the poor, student scholarships and small business credit on
a profit/loss sharing basis. This was followed by the Dubai Islamic Bank in 1975 and subsequent
rapid expansion.

The period of 1980 to 2000 is where we see Islamic finance evolving, gaining momentum as a
growth industry, and establishing itself as a niche product. A number of new products are also
coming out, there is tremendous improvement in documentation capabilities, and we see more
Istisna’a’, Bai’ Salam, and Ijarah transactions. In this period, equity has opened up as an asset class
to us, giving tremendous opportunities for Islamic financial investors. This period is also seeing the
gradual liberalization of the economies of the Organization of Islamic Countries (OIC). The
evolution of Islamic finance – banking, in Nigeria dates as far back as 1991 when Banks and Other
Financial Institutions Decree (BOFIA) was enacted with sections 23 and 61 of the decree recognizes
banks that are based on profit or loss sharing (BOFIA, 1991). Between 1993 and 1995, several
investor investors began applying to the CBN for licenses to operate Islamic banks. In 1996, Habib
Bank, now Keystone bank, opened an interest free banking window and began offering Shari’ah
compliant products and services. In 2004, investors continued to demand for full-fledged Islamic
banks in the country and a piecemeal approval was then granted to Ja’iz international to establish
Ja’iz bank subject to meeting mandatory capital requirement (Sanusi, 2011). While in the period of
2000 and beyond, focuses on infrastructure and venture capital, giving Islamic finance increasing
mainstream relevance in the OIC world and a niche-product status in the rest of the world. From
stage to stage, this is an industry that is in transition and is evolving along with the markets in which
it operates.

General Principles of Islamic Finance System

As stated earlier, Islamic finance is controlled by Shari’ah and the structure provides general
principles for evolution of its system in order to ensure equitable distribution of income and wealth
among Muslims. These principles have been comprehensively talked about by Muslim and non-
Muslin scholars’ a like (Kahf and Khan 1993, Moore 1997, Warde 2000) and they are as follows:

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 The belief that Allah is the real and actual owner of everything: The Qur'an says,
"Whatever is in the heavens and the earth belongs to Allah" (2:284). Allah is the owner of the
whole universe. It is in this capacity that He has allowed us to own the blessings of this world
by saying, "He has created for you whatever that is in the earth" (2:29). Thus, ownership by
human being is recognised as a divine permission from Allah to use whatever is in the
heavens and in the earth.
 Prohibition of Riba (usury or interest): It is generally argued that the prohibition of Riba
(usury or interest, whether small or large) is the most important principle of Islamic finance.
Any interest or predetermined payment over and above the actual amount of principle is
strongly prohibited by the Holy Quran and the Sunna with the following evidences as follows:
“O Ye who believe! Fear Allah and give up what remains of your demand for usury, if Ye are
indeed believers. If Ye do it not, take notice of war from Allah and His Apostle. But if Ye
turn back, Ye shall have your capital sums: Deal not unjustly and Ye shall not be dealt with
unjustly” (2:278-279). Muslim narrated on the authority of Abou Said Al-Khudriy: Bilal
visited the Messenger of Allah with some high quality dates, and the prophet inquired about
their source. Bilal explained that he traded two volumes of lower quality dates for one volume
of higher quality. The Messenger of Allah said: “this is precisely Riba! Do not do this.
Instead, sell the first type of dates, and use the proceeds to buy the other.
 Prohibition of Gharar (risk and uncertainty): The second significant prohibition in Islamic
finance is Gharar, generally translated as risk, hazard or uncertainty. Iqbal and Molyneux
(2005) suggest that “Gharar refers to acts and conditions in exchange contracts, the full
implications of which are not clearly known to the parties and agreed on some basic features
of Gharar to includes any contract for sale or purchase that consist of uncertainty in genus,
species, quantity of the object, price, time of payment in deferred sales, existence of object,
and identity of object. Ibn Majah narrated on the authority of Abu-Said Al-khudriy of a
Hadith banning Gharar sales, that: Prophet Muhammad (PBUH) has forbidden the purchase
of the unborn animal in its mother’s womb, the sale of the milk in the udder without
measurement, the purchase of spoils of war prior to their distribution, the purchase of
charities prior to their receipt, and the purchase of the catch of a diver.

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 Prohibition of Maysir (gambling and other games of chance): Most Islamic scholars
regarded Maysir as gambling or any games of chance including lotteries, lotto, casino-type
games and betting on the outcomes of animal races). Iqbal and Molyneux (2005) provided
evidence of Maysir from the Holy Quran as follows: “O, you who believe! Intoxicants (all
kinds of alcoholic drinks), and gambling, and Al-Ansab (animals that are sacrificed in the
name of idols on their altars) and Al-Azlam (arrows thrown for seeking luck or decision) are
an abomination of Satan’s handiwork. So avoid that (abomination) in order that you may be
successful” (Q 5:90). They further stated some reasons underlying the prohibition of games of
chance and gambling and argued that because of the high risk available in these types of
transactions, some people win a large amount of money, but others suffer from a loss of their
money, and sometimes face bankruptcy. Hence, this could lead to greater financial and
societal problems.
 Prohibition of using or dealing in forbidden commodities: According to Islamic principles,
some commodities, such as alcohol, drugs, and pork, are strictly forbidden. Thus, people
should not use or exchange items banned by the Holy Quran. Therefore, the aim of Shari’ah
in this regard is to promote ‘ethical’ investments that again do not affect people and society
adversely through the violation of religious prohibitions.
 Paying and collecting of Zakkat (payments to the poor): Zakkat is the foundation stone of
the financial structure in an Islamic economy. It is one of the fundamental tenets of Islam.
Literally, Zakkat means purification. Technically it means a contribution of a proportion of
wealth for the use of the poor and needy as sanctification for the remainder of the property.
Hence, in modern terminology, Zakkat is a tax collected from the relatively richer Muslims
and distributed (mainly) among the poorer Muslims. The Holy Quran includes references to
Zakkat “…alms are for the poor, and the needy, and those employed to administer the funds,
and those whose hearts have been reconciled to truth, and those in debt and those in the cause
of Allah, and the Wayfarer” (Q 9:60). Prophet Muhammad (PBUH) indicated a number of
ratios for different assets for Zakkat. For example, for all ‘idle assets’ (like gold, silver and
money) 2.5 percent should be imposed and is payable annually.

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Islamic Financial Products
As discussed in the previous section, Islamic finance is designed according to the general principles
that comply with Shari’ah. This section centers on the most common modes of Islamic finance
products as practiced by individuals during the evolution period and also at present time where
Islamic financial system is witnessing greater developments. These includes; (i) Mudarabah (capital
trust) (ii) Musharakah (full partnership) (iii) Murabaha (mark-up on sale) (iv) Bai muajjall (deferred
payments) (v) Bai Salam (advance sale contracts) (vi) Istisna (manufacturing contracts) (vii) Ijarah
(lease financing) and (viii) Quard Hassan (benevolent loans).

Mudarabah (capital trusts)

Abdul-Gafoor (2006) explains the concept of Mudarabah or capital trust to be a form of profit or loss
sharing used by tradesmen in Mecca during the pre-Islam period and the best evidence for its
existence is when Prophet Muhammad (PBUH) was employed by a rich woman named Nana
Khadijah about fifteen years prior to his being sent by Allah as a Prophet. Therefore, Mudarabah is a
contract between an individual or institutional investor-called Rabb-al-mal, who provides an
entrepreneur-called Mudarib, with funds to finance a particular business. Profits are then shared
between the two parties (rabb-al-mal and mudarib) according to some pre-agreed ratio, but if there
are losses the investor bears all financial losses and the entrepreneur the operating losses.

Musharakah (full partnership)

Musharakah (or full partnership) is “…an arrangement where two or more parties establish a joint
commercial enterprise and all contribute capital as well as labour and management as a general rule”
(Iqbal and Molyneux 2005). The profits and losses that flow from the Musharakah are again shared
among the parties on a pre-agreed ratio. Generally, Musharakah is most suited for financing private
or public companies and project financing. In the context of Islamic banking, Musharakah is
described as a joint venture between an Islamic bank and a customer or business firm for certain
operations. The Islamic bank can potentially act as the fund provider to finance industry, trade and
almost all legal enterprises through either equity investment or direct participation.

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Murabaha (mark-up on sale)
Murabaha is an Islamic instrument for buying and reselling goods and other commodities by
individuals and institutions including banks. Under the Murabaha contract, the customer provides the
bank with the specifications and prices of the goods to be purchased or imported. The Islamic bank
studies the application and collects information about the specifications and prices of the goods,
focusing especially on the price and conditions for payment. When the bank and its client agree on
the terms of the deal, the bank purchases the goods or commodities and resells them to the customer.
The profit that accrues to the bank is mutually agreed upon as a profit margin (mark-up) on the cost
of purchase (Metwally 2006).

Bai Muajjall (deferred payments) and Bai salam (advance sale contract)
Bai Muajjall simply means a trade or sale on a deferred payment basis that allows individuals,
enterprises or companies to take delivery of products now and pay for their value in the future
(Obaidullah 2005). While Bai salam is a form of advance payment or forward buying defined by
Iqbal and Molyneux (2005) as follows: “Salam is a sale contract in which the price is paid in
advance at the time of contracting against delivery of the purchased goods/services at a specified
future date”. Furthermore, El-Gamal (2000) cited the following points as the main legal
requirements for Bai salam contracts to be permissible: (i) the commodities sold should not be
available at the time of contracting; (ii) the quality and quantity of goods must be known; (iii) the
date and place of delivery for these commodities should be defined; and (iv) the purchase cost price
should be paid completely at the time of the contract.

Istisna (manufacturing contracts)

Istisna is a relatively new method in Islamic finance, defined as a manufacturing contract which
allows one party to obtain industrial goods with either an upfront cash payment and deferred
delivery or deferred payment and delivery. It has been translated by El-Gamal (2000) as a “…
commission to manufacture” usually used to cover work progress in the manufacturing and building
industries. In the context of Islamic banking, individuals or firms request their bank to facilitate a
contract of production for a good, and the bank concludes an Istisna contract with a third party (the

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manufacturer) to produce and deliver the specific item under particular requirements (Lewis and
Algaoud 2001).

Ijarah (lease financing)

Ijarah literally means “…to give something on rent” (Lewis and Algaoud 2001). Ijarah is the reward
or recompense that proceeds from a rental contract between two parties, where the lessor (the owner
of the asset) leases capital asset to the lessee (the user of the asset). The use of Ijarah was known
before Islam and is evidenced by the Holy Quran and the Sunna. In Islamic finance, there are two
forms of leasing: (1) direct leasing finance (Ijarah), whereby the lessor allows the lessee to use
capital assets owned by the lessor for a specified period of time ranging from a few days to years
depending on the type of asset. In return, the lessee pays the rental fee monthly or annually.
However, the ownership of the capital assets cannot transfer to the lessee in this type of leasing (as
in finance leases) and insurance on the capital assets remains the responsibility of the lessor (Zaher
and Hassan 2001).

Quard Hassan (benevolent loans)

In the doctrine of Shari’ah, lending money is not forbidden in Sharia, only Riba is prohibited in the
process of lending and Quard Hassan is a benevolent loan without interest to assist the needy in an
attempt to alleviate hardship. Metwally (2006) and Lewis and Algaoud (2001) add that the
borrower’s payment of any amount over and above the principal to the lender is permissible so long
as it is at the borrower’s discretion. It is also permissible for the lender to request assets as collateral
and charge administrative expenses on the loan (Obaidullah 2005).

Phases in the Development of Islamic Finance System

This section appraises three phases in the development of Islamic finance; (1) an early phase where
selected Islamic financial products are offered by individuals from the pre-Islamic and post Islamic
periods; (2) a second phase where full-fledged Islamic and conventional institutions (Islamic
window only) are allowed to operate; (3) and the third phase is where various institutions develop
and expand the availability of ranges of Islamic financial products. Although country experiences

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tend to differ, there are some elements that are common in most, if not all, cases and thus can be
used as guide by other countries such as Nigeria, which is lagging behind in this process (Solé
2007). El-Qorchi (2005) attributes the rapid growth in the early phase to several key issues. First, the
wish to tap the growing pool of investors – Muslim and Non-Muslim, attracted to Shari’ah-
compliant financial services and transactions; second, the growing oil wealth found in the Middle
East; and third, the increasing competitiveness of Islamic finance products vis-à-vis their
conventional counterparts. The various Islamic products offered in this phase included Mudarabah,
Musharakah and Quard Hassan.

The second phase is where full-fledged Islamic institutions are allowed to operate, as highlighted in
the introductory stage, where early experiences took place in various countries such as Malaysia in
the mid 1940s, Pakistan in the late 1950s and Egypt’s Mit Ghamr Savings Bank and Nasser Social
Bank in 1963 and 1971 respectively. Also, in 1963, Malaysia government granted operational
license to an Islamic savings fund which managed small funds for individuals preparing for their
pilgrimage to Mecca. A few years later, after the enactment of the 1983 Islamic Banking Act, the
first Islamic bank (Bank Islam Malaysia Berhard) was granted a full-fledged banking license and
started operations (Solé 2007).

Back to Nigerian experience, the Central Bank of Nigeria (CBN) issued guidelines for the regulation
and supervision of institutions offering non-interest financial services in Nigeria including Islamic
Banking, June 2011. This was followed by a grant of implicit approval to the country’s first Islamic
Bank - Jaiz Bank Plc. The guidelines, which became operational January, 2011, and signed by the
Acting Director, Financial Policy and Regulation Department of the apex bank, Chris.O. Chukwu,
interpreted Non-Interest Financial Institution (NIFI) as “a bank or Other Financial Institution (OFI)
under the purview of the Central Bank of Nigeria (CBN), which transacts banking business, engages
in trading, investment and commercial activities as well as the provision of financial products and
services in accordance with Shari’ah principles and rules of Islamic commercial jurisprudence”
(Nwokoji, 2011). Under this phase also, conventional institutions were allowed to open Islamic
windows using its branch network through which to reach the potential new clientele. In Nigeria,

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Habib Bank operated Non-Interest Islamic window between October 1998 and 2004 while Finbank,
Stanbic IBTC, Sterling Banks and other micro-finance banks such as Integrated Microfinance Bank,
Kada Microfinance Bank etc were presently operating in such window (Sanusi 2011).

The third phase is where various Islamic and non-Islamic financial institutions are developing and
expanding the availability of ranges of Islamic financial products. These include Kafalah (letters of
credit and guarantee), Takaful (Islamic insurance) and Sukuk (Islamic Bond). Kafalah is a form of
Islamic letters of credit and guarantee in which financial institutions applied their fund in trade
finance. Kafalah is a contract whereby a person accepts to guarantee or take responsibility for a
liability or duty of another person. While Takaful is Arabic word stemming from the verb “kafal”
which means to take care of one’s needs or “guaranteeing each other. Takaful means mutual
guarantee” or “guaranteeing each other. Under Takaful, resources are pooled to pay for events/losses
that individually none of the members of the pool could afford. On the other hand, Sukuk is the
Arabic term for Bonds or securities structured according to Shariah principles and referred to as
Sukuk, Islamic bonds, Islamic debt security or Islamic trust certificates. Moreover, Sukuk is an
asset-backed, stable income, tradable and Shariah compatible trust certificates. The primary
condition of issuance of Sukuk is the existence of assets on the balance sheet of the government, the
monetary authority, the corporate body, the banking and financial institution or any entity which
wants to mobilize the financial resources (AL-Maghlouth 2009).

Problems facing the Islamic Finance System

The global financial industry and indeed that of the Nigerian economy are emerging out of the deep
financial crisis which started in the country in the late 2008. Consequently, a number of countries in
the world have adopted the Islamic financial intermediation both as a means of diversifying the
financial industry and as a means of mitigating the risks associated with over reliance on only one
form of financial intermediation. The growing of the Islamic finance industry through large scale
adoption and unprecedented growth as highlighted above, no doubt pose a number of problems. The
problems are usually very common in the evolutionary process of any new activity. The Islamic

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finance institutions in Nigeria are, therefore, no exception to that. Rano (2012) provides the
following problems facing the system;

 Lack of understanding of the Islamic Finance System: Despite the growth of Islamic
finance and it institutional banks over the last 30 years, the general public in the Muslim and
non-Muslim world do not understand what Islamic finance actually is. The basic principle is
clear, that it is contrary to Islamic law to make money out of money and that wealth should
accumulate from trade and ownership of real assets.
 Absence of standardized Islamic finance products: Generally, there does not appear to be a
single definition of what is or not an Islamic finance/banking product and thus, has so far
prevented standardization. A number of Islamic finance products, for instance, are conceived
and packaged differently, and while some are available in some countries/regions, others are
not approved-off by the Shari’ah experts across the globe.
 Shortage of qualified/skilled professionals: Another problem is shortage of qualified/skilled
professionals in the field of Islamic banking and finance practice. This is critical to the
survival of any serious business. Because businesses that invest so much in human resources
training and re-training are more likely to ascend and attain their long term objectives faster
than those that spend less.
 Problem of forward contract/booking of foreign currency: Due to the restrictions of
Shari’ah, Islamic institutions cannot cover the risk of exchange fluctuations by forward
contract as Forward Booking is not permitted by Shari’ah. As per Shari’ah, currency
transaction is to be made under spot possession of both the currencies by both the parties
which are not available in Forward Booking.
 Poor Portfolio Management: The Islamic Financial institutions are still growing in
experience in many countries. Regarding constraints, Islamic banks in different countries do
not freely choose arrangements, which best suite their need. As a result, their activities do not
react flexibly to structural shifts in the economic setting as well as to changes in preferences.
It is known to the bank management that a certain portion of the short-term fund is normally
not withdrawn at maturity; these funds are used for medium or long-term financing.

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  The Regulatory challenges: The regulatory authorities exercise control over Islamic
institutions under laws and regulations engineered to control and supervise both traditional
banks. These Islamic institutions came into existence in an environment where the laws and
attitude are set to serve an economy based on the principles of interest. Also, if there are
disputes to be handled, civil courts are not sufficiently acquainted with the rationale of the
operations of Islamic Banking.
 Absence of Islamic Money Market: In the absence of Islamic money market in many
countries, including Nigeria, the Islamic institutions cannot invest temporary their excess
liquidity to earn any income. This is because all the Government securities such as Treasury
Bills are interest bearing. As a result, they deposit their whole reserve in cash with various
Central Banks. Furthermore, many Islamic institutions lack liquidity instruments such as
treasury bills and other marketable securities, which could be utilized either to cover liquidity
shortages or to manage excess liquidity.
 Shortage of Supportive and Link Institutions: Any system cannot thrive exclusively on its
built-in elements but must depend on a number of institutional links and so is the case with
Islamic banking and finance. For identifying suitable projects, Islamic institutions can
profitably draw the services of economists, lawyers, insurance companies, management
consultants, auditors and so on. They also need research and training forums in order to
prompting entrepreneurship amongst their clients. Such support services properly oriented
towards Islamic banking are yet to be developed in most countries including Nigeria.

Prospective of the Islamic Finance System

Like countries in Asia, Middle East, Western Europe and some parts of Africa, not only does the
emergence of Islamic financial institutions in Nigeria poses a number of challenges as identified in
the preceding section of the paper but it equally presents an array of opportunities as well. Most
importantly, it offers a reliable alternative to the conventional mode of financial intermediation
globally. Therefore, in order to secure a promising prospective for the Islamic financial services
industry, three (3) main areas were highlighted by Aziz (2004) in which greater attention are needed
as follows;

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  Accelerating the pace of financial innovation: Greater attention needs to be given to
increasing the range of products and services to meet the greater sophistication of consumers.
Also several factors are important to provide an enabling environment that would encourage
and promote innovation, these includes; a highly qualified and skilled workforce, significant
investment in the infrastructure that supports research and development, and extensive
education of the consumer and business community to increase the outreach resulting in
increasing demands for new and innovative products and approaches. In addition,
collaborative efforts amongst Islamic financial institutions would strengthen the ability to
leverage on the industry’s expertise.
 Strengthening risk management capabilities: In Islamic financial institutions, the
requirement to manage risks becomes more important due to the special nature of the
financial intermediation process that is guided by the Shari’ah which has a multi-faceted role.
The risk management infrastructure in Islamic financial institutions must therefore be in place
to identify, unbundle, measure, monitor and control all the specific risks in Islamic financial
transactions and instruments to provide for their effective quantification and management.
 Leveraging on information technology (IT): Successful Islamic financial institutions will
be those that are able to exploit the full potential and opportunities that arise from the IT
revolution in near future. Greater application of IT in the industry can also enhance efficiency
by driving down costs for consumers and businesses. Other areas include leveraging on IT in
making strategic decisions in the alignment of business, in elevating institutional capacity and
operational efficiency and strengthening risk management capabilities.

To add to the above prospects of Islamic finance, “Umaru (2011) in his piece, identified the
following factors that could be responsible for the prospects and success of Islamic finance in
Nigeria if properly harnessed”; (1) Continuous awareness campaigns by the Regulatory bodies such
as CBN and NDIC. (2) Provision of deposit insurance cover by the NDIC. (3) Possible patronage by
the teaming Muslim population that had hither-to abstain from banking due to interest elements in
the conventional banking. (4) Acceptance as potential alternative to the conventional banks. (5)
Possible patronage by ethical Christians. (6) Global acceptance of the system.

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Methodology
This paper reviewed the work of some scholars in the area of Islamic financial system with the view
to making conclusions and recommendations. The data collected are secondary and qualitative in
nature and therefore is mainly for exploratory purposes.

Discussion of Findings
Islamic Finance including banking is the only system that is performed entirely free of interest. The
establishment and application of Islamic tenets in finance particularly in Nigeria, is the best way to
curb the socio-economic maladies of interest (Riba) in our system. The main objectives of the
system are removal of injustice, bringing in the optimal level of social welfare and ensuring justice
in the lives of individuals and the society at large, through the concept of unity, brotherhood and
social justice. It discourages and prohibits all forms of exploitation, extravagance, hoarding etc. In
the Islamic financial system, the financial institutions (such as banks) become a partner in business.
The utilization of the funds from the institution by a business house or an enterprise is on a profit
and loss sharing basis. Gains from the business as well as losses earned due to the business are
shared proportionately by the institutions and the enterprise.

There are several factors inhibiting the full implementation of Islamic financial system including the
Nigerian experience. The lack of understanding of the system is there, absence of standardized
Islamic financial products, shortage of qualified/skilled professionals, regulatory challenges and
even the absence of Islamic Money Market. When we look at the regulatory factor, we can see that
the banking decree in Nigeria does not allow the establishment of any bank with a religious name
but a compromise has been reached to open an interest free banking based on the guidelines issues
by the CBN in 2011.

In my understanding the prospect of Islamic Banking and Finance is very bright since Muslim
populace everywhere in the world want system based on the teachings of Islamic.  This means that
Islamic institutions in any country should be well managed and successful so that people have faith
in the system. Established Islamic organizations and regulatory agencies across the globe should,
therefore, co-operate by lending competent officials in setting up new Islamic financial institutions,
Page 18 of 22
accelerates the pace of financial innovation, strengthens the risk management capabilities, leverage
on the information technology (IT), enhances the awareness campaign through media publications,
provision of deposit insurance cover by the NDIC and the increase patronage by both Muslims and
ethical Christians.

Therefore, strong risk management capabilities become more pertinent in view of the different
contractual arrangements entered into by the Islamic financial institutions with the different classes
of depositors. Demand deposits, under the guaranteed custody contract and investment deposits,
under the Mudarabah contract, each has its own unique risk and return attributes. Islamic financial
institutions must ensure that demand depositors are protected from the risks of Islamic banking
business. The ability to maximize risk-adjusted returns on investments and sustain stable and
competitive returns to depositors will contribute to promoting confidence in the Islamic financial
industry.

Conclusion and Recommendations

Based on the literature reviewed and discussion of findings, the research has drawn the following
conclusion:
 The study has established the evolution of Islamic finance which commenced at the beginning
of the 7th Century when Prophet Muhammad (PBUH) received revelations directly from
Allah.
 Based on the literature review, it was discovered that, the concept of Islamic finance was
being translated into reality by a group of pioneering Islamic financial institutions, such as
Kuwait Finance House, the Islamic Development Bank and Dallah Albaraka- a Saudi
conglomerate.
 This research has also established that the Islamic finance system is controlled by Shari’ah
and the structure provides general principles and modes of finances such as Mudarabah,
Musharakah, Murabaha e.t.c, in order to ensure equitable distribution of income and wealth
among Muslims.

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  The study found out several factors inhibiting the full implementation of Islamic financial
system including the Nigerian experience. The lack of understanding of the system is there,
absence of standardized Islamic financial products, shortage of qualified/skilled professionals,
regulatory challenges and even the absence of Islamic Money Market but to mentioned a few.
 The research concludes that the future prospects of the Islamic financial services industry will
be the result of the combined efforts of all the relevant entities in the financial sector - the
industry, the regulators, the market participants and the international community. These
collective efforts need to be galvanized as a coordinated and concerted effort to maximize the
potential for the industry.

Based on the conclusions of the study, the following recommendations are put forward for
implementation and for further study:
 The introduction of innovative Islamic financial products in a specific jurisdiction can be
expanded to other jurisdictions, which in turn, will contribute to broaden and deepen Islamic
financial markets and thus strengthen the overall development of the Islamic financial
industry.
 The potential for the Islamic financial industry to provide new products and services will be
enhanced only if institutions embrace new leading edge information technology. These also
represent the potential to increase access to financial products through a wider range of new
delivery channels.
 The Islamic financial and academic institutions as well as the regulatory authorities such as
CBN, being the apex regulatory authority in the financial sector, should endevour to invest
heavily in training and retraining of their staff in the area of Islamic finance.
 Under the Shari’ah, it is also prohibited to deal in the forward money market even if the
purpose is hedging to avoid loss of profit on a particular transaction effected in a currency
whose value is expected to be declined.  This problem requires a solution by Shari’ah experts
so as to maximize the potential of Islamic institutions in international trade.

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