The effect of Islamic banking product and financial inclusion in Nigeria

Introduction (Preamble, Statement/Justification, Aims and Objectives of the Project work)

Islamic banking or non-interest banking as it is alternatively called is

a banking system based on the principles of profit and loss sharing by
all the stake holders (TAJUDEEN, 2014). Islamic banking concept owes its origin to
the Islamic concept of money. In Islam, money does not in itself produce
interest or profit, and is viewed as a medium of exchange and not as a
commodity. Already Ribah (interest) is prohibited in Islam. The
status of Islamic bank in relations to its clients is that of partner –
investor and trader. Whereas, in conventional banks of the West the
relationship is that of creditor or debtor (TAJUDEEN, 2014)

Islamic banking will be based on the universally recognized

principles of Shirakah (partnership). That is, the whole system of
banking in which the holders, the depositors, the investors and the
borrowers will participate on a partnership basis i.e through the
application of the external principle of Mudarabah – labour and
capital combine as partner for work.
In their actual operation, Islamic banks use various techniques and
method of investment such as Mudarabah contracts, under which a
financier provides capital and the Mudarib (labour partner) provides

Islamic banking will be based on the universally recognized

principles of Shirakah (partnership). That is, the whole system of
banking in which the holders, the depositors, the investors and the
borrowers will participate on a partnership basis i.e through the
application of the external principle of Mudarabah – labour and
capital combine as partner for work.
In their actual operation, Islamic banks use various techniques and
method of investment such as Mudarabah contracts, under which a
financier provides capital and the Mudarib (labour partner) provides
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his technical know – how and skill, and the profit is shared between
the partners according to and agreed percentage. Islamic banks are
also involved in Mudarabah (cost plus) contracts, under which banks
purchase a certain commodity according to its client’s specifications
and give delivery on the basis of sharing on an agreed ratio profit.
Islamic banks are also involved in dealing with foreign exchange
markets and other banking services operations, such as letters of
credit and letters of guarantee. Islamic banks may also provide
various non – banking services such as, trust business, real estate and
consultancy services. The concept of Islamic banks and their
operational techniques will be discussed in detail in the preceding
chapters. The first reason why we need Islamic banking is because;
Allah has prohibited any form of interest on loans and allowed lawful
trade and profit from the business. In the other hand the conventional
banks which was introduced to us by Europeans, their mode of
operations is principally dependent on interest. They advance loan in
which the recipient must refund with and increment. But Allah has
prohibited such types of loan. He created us and brought us into this
world while we were unconscious of anything. He provides to us the
air we breathed, the water we drinks, the food we eat and the clothes
we clad our nudity. Whenever we are in hardship or fall sick or are
10
experiencing a disaster we turn unto him, we seek refuge from Him.
At the end we will surely return unto Him. Did He then create us to
turn deaf ears to what He has forbidden us? Allah has prohibited such
transaction in one of the places where he says:
“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 a war from Allah and his
messenger” Qur’an chapter 2:278-279.
Certainly, we are in problem if we are to continue transacting with
interest without replacing it with Islamic banking. That is an act of
disobedience to Allah. The prohibition is not only to those that
advance loans with interests, but including those that borrow and
refund with interests and all those that assist them. “The curse of
Allah is upon who collects interest (Ribah), the person given it, and
who write it and witness it. He says those are all the same” 850
(Bulugul – Maran).
Non – interest banking was introduced in the Nigerian financial sector
by ex Habib Nigeria bank plc, now known as Keystone bank ltd. The
system is alternatively called interest free banking or “Islamic
banking” is the wider context comprising of the people of the book
who belief in the followings:
I. Oneness of God
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II. The Holy book revealed to mankind and
III. All the prophets (peace be upon them) sent by Allah (SWT).
But if the term Islamic is confined to the religion of the followers of
prophet Muhammad (peace be upon him) only, then this name does
not appear to be proper as it is not only the holy book of Qur’an
which prohibits, but also the Christian holy books have also advised
followers to shun away from interest

The Shariah Advisory Council (SAC) of CBN for now is the only Council that
examine the validity of application and screening of Islamic financial
products, it also issue Shariah resolutions and decisions relating to both
Islamic Capital Market (ICM) and Islamic Banking in Nigeria. The Council will
not approve any instruments and activities that are contrary to Shariah
principles.

Non Interest (Islamic) Finance, despite its name, is not a religious

product/service restricted to Muslims alone but a series of financial products
developed to meet the requirements of specific group of investors.

Non Interest (Islamic) Finance is built on principles that uphold a positive

ethical message derived from the holy Quran and the Sunnah, moral
considerations, fair and just trading practices. This includes the avoidance
of ribah (interest and gharar), contractual and legal uncertainty, as well as
leniency to debtors where the borrower can prove mitigating circumstances.
Also avoided are investments in forbidden commodities such as alcohol, tobacco
and companies whose debt exceeds one — third of its assets.

(SEC, 2021)

The principles of Islamic finance are laid down in the sharia, Islamic law. Islamic
finance, comprising financial transactions in banks and non-bank financial institutions
formal
and non-formal financial institutions, is based on the concept of a social order of
brotherhood
and solidarity. The participants in banking transactions are considered business
partners
who jointly bear the risks and profits. Islamic financial instruments and products are
equityoriented and based on various forms of profit and loss sharing. As Islamic banks
and their
clients are partners, both sides of financial intermediation are based on sharing risks
and
gains: the transfer of funds from clients to the bank ( depositing) is based on revenue-
sharing
and usually calculated ex post on a monthly basis 1; the transfer of funds from the bank
to the
clients is based on profit-sharing (lending, financing), either at a mutually agreed-upon
ratio
as in the case of mudarabah or at a mutually agreed-upon fixed rate. Such ratios and
rates
vary between institutions and may also vary between contracts within the same
institution,
contingent upon perceived business prospects and risks. Islamic banking finances only
real
transactions with underlying assets; speculative investments such as margin trading
and
derivatives transactions are excluded. Lending, or financing, is backed by collateral;
collateral-free lending would normally be considered as containing a speculative
element, or
moral hazard. Similarly, to avoid speculation and moral hazard, normally only investors
with
several years of successfully business experience are financed. The paying or taking of
riba,
interest, is prohibited.
The same principle of partnership is applied to Islamic insurance. It is based on a
collective
sharing of risk by a group of individuals whose payments are akin to premiums invested
by
the Islamic banking institution in a mudarabah arrangement for the benefit of the group.
The fundamental principle of solidarity at the societal level finds its expression in a
special
category of financial products without remuneration, qard. Investors without adequate
business experience who are considered high-risk may receive a moderate amount of
financing on qard hasan terms, free of any profit-sharing margin, but usually repaid by
instalments and backed by collateral. Similarly (but rarely in Indonesia), depositors may
save
in an Islamic financial institution without receiving a remuneration, usually with the
expectation that the funds are used for social or religious purposes. In inflationary
economies, qard deposits and financings pose unresolved problems.

(Omar et al, 2006)

Islamic banking is a system of banking based on the ethos and value system
of Islam, which targets the achievement of goals and objectives of an Islamic
economy, free from interest-based transactions, speculative activities or excessive
risk-taking, gambling or games of chance, and engaging in unethical investment.

Islamic scholars have developed standards that serve as the main building blocks
which govern the Islamic theory of economics and finance, emphasising the
banning of interest as the most important attribute of the theory, defined as any
predetermined rate of return on loans or debts (Ayub, 2007). Islamic banking is a
financial system whose key aim is to fulfil the teachings of the Holy Quran (Elghattis,
2011). Islamic law reflects the commands of God and regulates all the aspects
of a Muslim’s life; therefore, Islamic finance is directly involved with spiritual
values and social justice. The basic intention behind establishing Islamic banks
was the desire of Muslims to reorganise their financial activities to complement
the principles of sharia and enable them to conduct their financial transactions
without riba (Zaher & Hassan, 2001). Islamic banking is expected to offer financial
products and services that are compatible with Islamic law, and hence encourage
Muslim individuals and firms with religious concerns to have access to finance
and move from the informal to the formal financial system (Abedifar, Hasan &
Tarazi, 2014). Ultimately, Muslims prefer subscribing to financial services that
adhere to the Islamic religious injunctions stated in the Quran, among which is the
primary prohibition of interest payments.
Islamic banks transform the nature of this relationship emphasising
partnerships through co-operation and participation. In the case of loss, this is
absorbed by the depositors according to their respective investment funds. In case
of profit, the returns for both fund owners and the bank itself is a function of
realised net profit at the end of the financial period. This sharing mechanism differs
considerably from conventional practices; the approach to financial intermediation
facilitates the use of a profit and risk sharing strategy in financing real economic
sector activities (Kahf, 1999).
In banning riba, Islam seeks to establish a society based upon fairness and
justice (HolyQur’an 2:239). A loan provides the lender with a fixed return,
82 Impact of Islamic Banking Inclusion on Sme Employment Growth In Nigeria
irrespective of the outcome of the borrower’s venture. It is considered to be
much fairer to have a share of the profits or losses. Fairness in this context has
two dimensions: the supplier of capital possesses a right to reward, but this
reward should be commensurate with the risk and effort involved and thus be
governed by the return on the individual project for which funds are supplied
(Presley, 1988). Therefore, what is forbidden in Islam are predetermined returns.
The sharing of profit is legitimate and acceptance of this practice has provided the
foundation for the development and implementation of Islamic banking. In Islam,
the owner of capital can legitimately share the profits made by the entrepreneur.
What makes profit sharing permissible in Islam, while interest is not, is that in the
case of the former, it is only the profit-sharing ratio, not the rate of return itself,
that is predetermined (Algaoud & Lewis, 2007, p. 46).
It is argued that interest-based lending allocates capital to creditworthy
borrowers rather than to the most productive investment, whereas Islamic-based
PLS financing allocates financial resources to good productive investment projects,
given the fact that sharing in ex-ante generated profit is more promising . In this
regard, Muslim economists contend that the profit and loss sharing system, given
its equitable or participatory nature, promotes harmony among social classes, as
financing is made available to anyone with a productive business idea (Zaher &
Hassan, 2001).
Abdouli (1991) posits that Islamic financial intermediaries, being founded on
Islamic principles of social justice, give priority to societal interests, emphasising
social imperatives rather profit maximisation. The Islamic banking system offers
a new lending approach which is dissimilar to the conventional common practice
of western financial intermediaries which allocate credit facilities mainly to those
with tangible collateral. Islamic banking based on equity financing gives equal
opportunities to prospective entrepreneurs, including small firms, by replacing
asset-based collateralised financing with intangible assets such education,
experience and skills. This enables small entrepreneurs to have collateral-free
access to finance, leading to overall societal welfare by ameliorating income
distribution.
Iqbal and Mirakhor (2013) argue that the core principles of Islam put substantial
emphasis on social justice, inclusion, and the sharing of resources between the
haves and the have-nots. Islamic finance addresses the issue of financial inclusion
from two directions: first by promoting risk-sharing contracts that provide a
viable alternative to conventional debt-based financing; and second by specific
instruments of wealth redistribution in society. The Islamic system advocates risk
sharing in financial transactions; such a system offers various advantages over the
conventional one based on risk shifting. Use of risk-sharing instruments could
encourage investors to invest in sectors such as MSMEs, which are perceived as
high-risk.

Tasiu Tijjani Sabiu1 and Muhamad Abduh2 2021

Musharaka

'Musharaka' in Arabic literally means sharing. Since Islam has prohibited interest it cannot be used
for providing funds of any kind. Musharaka is an ideal alternative for interest-based financing playing
a vital role in an economy based upon Islamic principles.

Ijarah (Lease)

"Ijarah" is a term of Islamic Fiqh. Literally, it means 'to give something on rent'. In Islamic
jurisprudence, the term 'Ijarah' is used for two different situations. "T o employ the services of a
person on wages given to him as a consideration for his hired services." The second type of Ijarah is
generally used as a form of investment, and also as a mode of financing. The difference between
Ijarah and a sale is that in the latter case the majority of the property is transferred to the purchaser.

Murabaha

In modern Islamic banking, the term refers to a buying and selling transaction between the bank (or
financial institution) and the customer, whereby the former buys a property (or an asset, e.g. a
house) at the prevailing market price and sells it to the customer at a mark-up price where payments
are made by installments over a period of time agreed upon by both parties.

Al-Wakalah

Al Wakalah means agency, or delegating duty onto another party for specific purposes and under
certain conditions. Under the concept of Al Wakalah, the bank becomes your agent. You are then
required to deposit the full amount of the price of goods to be purchased or imported.
Mudaraba

Refers to an investment on your behalf by a more skilled person. It takes the form of a contract
between two parties, one who provides the funds and the other who provides the expertise and who
agrees to the division of any profits made in advance.

Mudarib

In a Mudaraba contract, the expert who manages the investment is known as Mudarib.

Concepts of Products

Product Classification All Islamic banking products and services are based on Islamic legal and
commercial concepts like Mudaraba, Ijarah and Salam etc. The interviewees had a sound understanding
of IB product structures and based on their responses; following four product categories were gleaned:
(i) Equity-based participatory products designed on the basis of the concepts of Mudaraba, Muqarada,
and Musharaka, mainly utilized for depository, equity-sharing and investment oriented offerings;

(ii) Lease-based products formulated on the basis of Ijarah and Ijahara Muntahiya Bitamleek, used as a
financing tool to fund vehicles, consumer durables and home appliances;

(iii) Trade-based products structured on the basis of various modes of Shariah-compliant sales including
Murabaha, Salam, Istisna, and Bai Bithaman Ajil, employed chiefly for financing of materials, fixed
assets, business equipment and commodities etc.
(iv) Service-based products crafted on the Islamic legal concepts of Wakalah, Kafalah, Tawarruq, used for
services like letters of credit (LCs), letters of guarantee, working-capital and liquidity financing, debit and
credit cards etc. The respondents had various versions of products and service classifications but all of
them were similar in the sense that only the nomenclature and wording differed, but the contents of
products they discussed were approximately the same as described above. The Shariah experts had a
superior understanding of products as compared to the regulators as evidenced from the detailed
responses of both respondent groups. Some of the responses of interviewees pertinent to product
classes are elucidated below:

Products/instruments in the money, capital markets

There are various Islamic finance products and instruments available to investors in the money and
capital markets, including Murabaha, Musharaka, Mudaraba, Ijarah, Istisna’a, among others. The
Murabaha, also referred to as cost-plus financing, is an Islamic financing structure in which the seller
provides the cost and profit margin of an asset. This is not an interest-bearing loan (otherwise called
“qardh ribawi”) but is an acceptable form of credit sale under Islamic law. Musharaka, meaning
partnership, is another instrument that alows two or more financiers provide finance to a project. Here,
all partners are entitled to a share in the profits resulting from the project in a mutually agreed upon
ratio. Mudaraba is a trust financing method which allows a partner to provide the investment (rab-ul-
maal) while the other partner invests it in a commercial enterprise (mudarib). Ijarah, on its part, is an
exchange transaction in which a known benefit arising from a specified asset is made available in return
for a payment. Also, Istisna`a is a contract of exchange with deferred delivery, applied to specified
made-to-order items. Although the Sukuk (originally known as “certificate” in Arabic, according to Lotus
Capital is perhaps the most popular instrument in Islamic finance in Nigeria, it is just one of the
instruments, products and asset available for investors and other stakeholders swayed by the growing
interest in Islamic finance. 8/13/2019 What Islamic finance products can do to Nigeria's capital market,
infrastructural growth https://www.premiumtimesng.com/news/headlines/343381-what-islamic-
finance-products-can-do-to-nigerias-capital-market-infrastructural-growth.html 7/13 Due to the sucess
of the debut FGN Sukuk bond, the Sukuk has become perhaps the most popular asset known to Nigerian
investors, especially on the stock market. How would Sukuk and other products impact the growth of
capital market, social infrastructure?