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Sri Lanka banks on Islamic finance for sustainable economy

Today, the entire world is bringing together brilliant brains onto one platform to come up with a solution as to how a sustainable economy can be developed. Modern economic system has faced many financial crises in the past, and countries globally are wondering as to when and how the next one will recur.

Generally, a financial crisis gets recognized when it knocks on the rich people’s door, but we tend to overlook that the poor person is actually living the crisis on a daily basis. It is noteworthy that the US dollar, which the only currency that carries the slogan of “In God We Trust”, has somehow failed to show us how to earn, spend and distribute the dollars – God is out of the picture, and human-developed systems are implanted and influenced over periods of time. This, is one of the main reasons, as to why we are struggling to come up with a lasting solution of developing a sustainable future to live peacefully without unwarranted financial stress. On this note, Islamic banking and finance’s growth has been a vital proposition for the governments and other stakeholders as the alternative system for ill-economies to move towards a more sustainable economic system. Global assets of the Islamic banking and finance industry have been estimated to reach US$1.6 trillion this year, and are expected to leap to US$5 trillion by 2015

Every day, there is a talk about this growing industry held in almost all countries, from the individual level to the government. This is an indication of the Islamic banking and finance industry’s steady and strong growth. In fact, non-Muslim developing and developed countries, such as India, China, Hong Kong, Thailand, Singapore, Malta, Australia, France, Malawi, Mauritius and Canada, are actively engaged to accommodate the growth of this young and niche market by making amendments to their rules and regulations, or legal frameworks.

Local market overview Sri Lanka, dubbed the miracle of Asia by some, is stamping a stronger footing on the roots of the economic growth by considering long-term development after the civil war ended. A fact in point, it has encountered several victories, including the long-awaited establishment of the first full-fledged Islamic bank, with many branches in strategic places in the country, leading the starved market to joy over. It is expected to be listed in Colombo Stock Exchange in the near term. It is also noteworthy that the major conventional commercial banks in Sri Lanka, including one of the state-run banks, has started the Islamic finance windows three years ago. Today, the country has more than 40 corporate players participating in the Islamic financial industry, including banks, finance firms, leasing companies, software enterprises, education institutes, fund managers and many other support-service businesses. Back then, there was a period when Islamic banking and finance industry in Sri Lanka seemed unlikely to respond to the appetite for changes needed to meet the aspirations of more innovative products to cater to the market of the globally accepted emerging industry.

Research shows that Sri Lanka’s Islamic banking and finance market is expected to grow to US$2.5 billion, but signs within the market show bigger possibilities. Moving towards the next big step
Even though the Islamic capital market in Sri Lanka has a long way to go, there are some initiatives giving birth to some new ventures to identify and assist the Islamic finance investors to fulfill their investment needs in the country. The absence of capital and money market regulations for Islamic financial institutions will hinder growth of this market segment. Continuous lobbying with the relevant authorities will facilitate in addressing some of the issues.

The recent initial public offerings in the country, for instance, are witnessing the expansion of the listed companies and the increase in foreign direct investments, particularly from the Gulf Cooperation Council (GCC) investors. A reform of the current system will see more effective investments. Nevertheless, there have been landmark achievements in the field of Islamic finance in Sri Lanka, including the approval of Islamic fund management and unit trusts. The stakeholders of the industry are continuously lobbying with the relevant authorities to make the next big necessary changes to venture into bigger realms, such as Sukuk, also referred to as the Islamic bond. This is one of the remarkable and expected strategic changes to facilitate the ongoing and new mega infrastructure projects, in order to enjoy the real sustainability of the economy and then the prosperity of the country. Sukuk has been identified as one of the main alternatives for the government’s “Build-OperateOwn” and “Build-Operate-Transfer” infrastructure projects. Islamic finance can play a significant role in facilitating the development of the infrastructure sector in Sri Lanka by attracting foreign capital from investors, rather than go for debt obligation instruments with soft conditions, such as longer repayment or lengthy lease periods. Islamic investment, however, is based on equity and profit and loss sharing basis, and not on debts with tricky interest clauses. This provides a fair deal to the investing parties
and facilitates real investments into the country. It should be noted that while the concept is not new in other jurisdictions, it is somehow not yet heard by many in Sri Lanka.

Despite the lack of understanding and awareness about Sukuk locally, the state-owned airline and leading telecommunication provider have already initiated Sukuk issuance in recent years. This indicated the real value-addition of Sukuk to the extent that even private entities could benefit from this viable system. There are plenty of other examples in which Sri Lankan entities can
look into, ranging from German’s government-issued Sukuk to Saudi based Al Marai’s hybrid Sukuk.

Real challenges and initiatives
Considering the various growth potential and market developments, there is a vital need to review and assess all underlying legal and tax systems, particularly for Islamic banking and finance industry to nurture and protect all stakeholders. Otherwise, the centuries-old systems will not fuel the growth of this emerging industry to get the utmost benefit and to facilitate the economic
development of the country. Such understanding has awaken the most complicated tax-regime countries, such as the UK and the US, to reform and restructure their tax laws and other relevant regulatory requirements to attract Islamic finance investors. One noteworthy announcement made by the British Prime Minister David Cameron was the UK is set to become one of the great capitals of Islamic finance. There are many wise leaders making extraordinary and uncommon decisions to shape their countries economy by exploring a whole new level of Islamic finance system.
These are not one-off projects, but rather long-term with constant reviews beyond the disputes with workable solutions to be made by the responsible parties to work towards a sustainable economy.
One good example, an Islamic Finance Focus Group has been formed in Sri Lanka, comprising high-calibre professionals and industry experts in the field of Islamic banking and finance, and in other respective areas, to initiate relevant moves with the regulators and other authorities. The moves include legal and tax suggestions proposed in the country’s annual budget, some of which are to eliminate tax bars and facilitate Islamic financial institutions to compete and strategically position themselves in the finance sector, considering the enormous global market opportunities to explore on the same platform. The proposed tax reformation must take into account some of the existing taxes, including stamp duty, tax returns and withholding tax, before the industry can experience the true Islamic banking benefits under the purview of Shariah. Of course, there are still ample rooms to make concrete and visible changes in order to allow Islamic finance system in the country to prevail. At the other end of the yardstick, corporate governance, compliance and risk management of the Islamic banks are very important factors to facilitate a healthy growth of the industry. The relevant authorities must make the required changes in order to mitigate future major concerns, such as scams, corporate failures and worst, total collapse of Islamic banks.

Once the system is in place, it will not be a difficult task to monitor the banking operations and issue guidelines to direct the financial institutions to have in place the required regulation ratios, such as capital adequacy. Additionally, liquidity management, risk management and other financial measurements should be in place to have a clear demarcation since Islamic banks and financial institutions require special attention to their banking operations. The growth of this industry has yet to be laid down firmly, with strong initiatives by making necessary and timely actions. Due to the lack of researches in the field of Islamic banking, it becomes a difficult task to predict a more precise growth rate or asset size for the industry. There are few initiatives taken to
address this issue and one of them is a remarkable first-ever Islamic finance country report collated and compiled by the global audit, advisory and tax services firm KPMG in 2011. Other foreign research firms are also taking cue through continuous publication of Sri Lankan data in various magazines and websites.

Another key concern in the Sri Lankan Islamic finance industry is the human resources scarcity. According to KPMG’s Country Report 2011, only 14% of the workforce in Sri Lanka’s Islamic banking and finance industry have a certificate or diploma level qualification. In order to address this issue, there are more than five educational and training institutes conducting various programmes to promote public awareness by bringing in world renowned speakers, scholars and experts to speak on the subject matter. However, there is still a huge gap in knowledgeable and experienced industry professionals in the market – which is also a global issue to take the industry to the next level.

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