Uganda’s Parliament has just passed the Financial Institutions (Amendment) Bill, 2015, into an Act pending presidential assent, introducing Islamic banking as an alternative form in the banking sector.
Islamic banking is a system of banking that is consistent with the principles of Islamic law (Shari’ah). The system is based on two main financial principles; the prohibition of interests and the development of financial instruments on the basis of profit and loss sharing.
The crux of Islamic banking is freedom from Ribā, which is commonly equated with interest and the system is open to all persons regardless of their religion.
People who are not conversant with the principles of Shari‘ah and its economic philosophy sometimes believe abolishing interest from the banks and financial institutions would make them charitable, rather than commercial. This is a wrong assumption.
In this system, if financing is meant for a commercial purpose, it can be based on the concept of profit and loss sharing, for which mushārakah (joint venture) and mudārabah (profit sharing) have been designed since the very inception of the Islamic commercial law.
There are, however, some sectors where financing on such modes is not workable or feasible and for such sectors, contemporary scholars have suggested some other instruments which can be used for the purpose of financing, as explained below;
• Musharakah (joint venture) literally means sharing. This is a joint enterprise formed for business where all the partners (bank and customer) contribute capital and share the profits according to a specific agreed ratio while any possible loss is in turn shared according to the capital contribution by the parties.
Diminishing musharakah is where the share of the bank in joint enterprise is divided into a number of units and purchased periodically by the customer, thus increasing his own share until all the units of the bank are purchased making him the sole owner of property.
• Mudārabah (profit sharing) is a special kind of partnership where one partner (bank) gives money to another (client) for investing in a commercial enterprise. The bank contributes 100 per cent of the capital and the client contributes technical know-how. Profit is in turn shared on an agreed ratio. If there are any losses, the bank absorbs it fully. This is equivalent to 100 per cent financing by the bank.
• Murābahah (cost plus) refers to a kind of sale where the bank purchases the commodity as per the requisition of the client and sells on cost plus basis. This is not a loan given on interest rather it is a sale of commodity at profit. The goods must remain in the risk of the bank before full payment.
• Ijārah (leasing), means “to transfer the usufruct of a particular property to another person in exchange for a rent claimed”. The bank owns the property and leases it to a client for rent.
• Salam (forward sale) is where the seller (client) undertakes to supply some specific goods, to the buyer (bank) at a future date in exchange of an advanced price fully paid at spot. Here the price is cash, but the supply of the purchased goods is deferred.
• Istisnā (manufacturing contract) means to order a manufacturer to manufacture a commodity for the purchaser. A client agrees to produce or build a well-described good or building at a given price on a given date in the future. Price can be paid in installments as agreed between the client and the bank.
In summary, the various financing modes under Islamic banking system are suitable to Uganda since they encourage the development of trade, industry, construction and above all boosting agriculture. Let us all welcome Islamic banking in Uganda’s economy.
Mr Senkumba is an advocate.
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