Funding of SMEs and Islamic Banking Option

With the age-old funding challenges that Small, Medium scale Enterprises (SMEs) have to contend with and the steady ascendancy of non-interest banking, analysts x-ray the possibility of Islamicbanking bridging the funding gap in the SME sector, writes Olaseni Durojaiye

Against the backdrop of the importance of Small and Medium scale Enterprises (SMEs) to the growth of per capital income and the economy of any country as a whole, the funding challenges faced by the sector, especially with the seemingly prohibitive lending rate from conventional banks, the issue of alternative and friendly funding have again returned to the front burner of discourse amongst economists and analysts alike.

According to Director General, Lagos Chamber of Commerce and Industry (LCCI) Alhaji Muda Yusuf, “The SMEs sector contributes over 70 per cent of the jobs in the economy and yet enjoys less than 10 per cent of total credit in the financial system.  This is critical issue that needs to be addressed if the economy must be inclusive,” he told THISDAY.
THISDAY findings indicated that funding is a major problem for many small businesses.  Most small business owners finance their businesses through personal savings, support from family and friends and suppliers credit. This challenge, findings revealed, is one of the major impediments to job creation in country.

It will be recalled that the International Organisations of Securities Commissions (IOSCO) had among others stated that “Capital Markets therefore have a role in bridging this financing gap for SMEs by providing alternative funding sources,”
Reacting to enquiries on capital markets as a source of access to fund by SMEs, Chief Executive Officer of Global Analytics Derivatives, Tope Fasua, had contended that the Nigeria Capital Market was not accustomed to providing financing for SMEs at the present and argued that this may be due to issues bordering on sharp practices on the part of some of the listed corporation and companies in the bourse.

According to Fasua “At present, our Capital Market is not very much attuned to helping SMEs raise money, chiefly because we have issues with the big companies already listed and if we should concentrate on SMEs raising money at the stock exchange, things could get pretty messy. There are strict rules, and global best practices that must be adhered to for a company to raise money in the capital market. What we have seen is a situation where even the large companies cut corners, present fake accounts, and perpetrate a lot of schemes and scams that have reduced confidence in capital markets”.

This, among other factors, has caused industry watchers to look the way of Non-Interest bankingmore popular as Islamic banking as a possible route for accessing funds by SMEs. Proponents of this line of thought argued that besides that Islamic banking is open to Muslims and non-Muslims alike, it presents a win-win situation for the borrower as it helps to shoulder the risks involved in the eventuality of loss. They also added that some SMEs may not be able to access funding from Islamic banking by virtue of the kinds of business they do.

Background
Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Sharia, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba´ (interest). Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah).

However, Islamic banking in Nigeria received the nod from the central bank in 2011 after several years of attempts by different groups and organizations. A framework, released in the same year by the Central Bank of Nigeria (CBN), spelt out guidelines for the establishment, operations, Shari’ah governance and supervision of Islamic banks which can be standalone full-fledged institutions, subsidiaries or windows.

Both Jaiz Bank Plc and Stanbic IBTC were granted licenses to operate based as a full-fledged Islamic bank and window respectively in the same year and both began operations in 2012. Sterling Bank Plc joined the market in April 2013 as a window.

THISDAY findings revealed that Jaiz bank, which was licensed to operate as a regional bank, is already eyeing a national license to enable it to penetrate the southern part of the country. The bank’s balance sheet grew to about 36 billion naira as at the end of 2012 and its branch network increased from an initial three in 2011 to 14 as at May 2013 and 30 by June 2015. The other two operators that operate as Islamic windows offer Islamic banking products and services in all their branches nationwide. This has helped expand the reach to prospective clients even in the southern part of the country where the majority of the population are not Muslims.

Islamic banking operators collectively provide several Shari’ah-compliant products and services to cater for the diverse needs of their clients. These include products based on murabaha, mudaraba; musharaka, ijara WA iqtina and kafala, the products provided include current, term deposit and savings accounts on the liability sides using qard, wadiah and mudaraba contracts. Financing of automobiles, household equipment, housing, and import financing have been the major focus of the Islamic banks, using murabaha, ijara wa iqtina and istisna contracts.

As part of efforts to extend its tentacles to the South-West of the country, the South-West Zonal Committee for the operations of Jaiz Bank recently held a stakeholders forum in Ibadan, Oyo State where it drummed up awareness for the concept of Islamic banking.
Speaking at the forum, an economist with specialization in banking operations, Professor Abdul-Hakeem Mobolaji, condemned what he described as exploitative interest rates charged by Nigerian banks and urged the apex bank to relax its regulations for Islamic banking to grow adding that “Islamic bank grows at an annual rate of 17.6 percent . The bank is not only for Muslims. In Britain, 73 percent of those who patronize the bank are non-Muslims,“ he stated.

Analysts’ reactions
Reacting to THISDAY enquiries, Head, Intelligence and Research, BGL Securities, Femi Ademola, explained tha,t “If we use the performance of the Jaiz Bank over the years, it shows that the specialised bank has grown quite impressively in the last three years, increasing total assets from N14.11 billion in 2012 to N44.5 billion in 2014. Muharaba receivables which represents loans and advances in traditional banks also grew from N1.1 billion to N10.28 billion over the period; leading to increase in profitability from a loss of N728m in 2012 to a profit of N691m. This can be taken as a sign of good performance of non-interest banking over the period.

“With the increase in the amount of financing by the Jaiz Bank, it can be inferred that SMEs would benefit from funding from Islamic Banking. The fact that most of the financing granted by Jaiz Bank is to corporate customers also shows that the bank is ready to finance any organised SME,” he stated.

However, in a telephone interview with THISDAY, an economist and Chief Executive of EZ Comms Resources, Ezeh Wordu, contended that before SMEs approach Islamic bank for funding it is important that the bank and the firm understand how the operations of the SMEs runs. He added that being an interest free banking makes it all the more suitable for SMEs to approach for funding compared to conventional banking considering the current exchange rate.

“Even though I am not a Muslim I wouldn’t hesitate to approach Islamic Banking for funding to execute a project; the fact that it is interest free makes it more convenient for any SMEs; however, it is important that the bank understands the kind of business that the SME is into to forestall issues cropping up in future,” Wordu stated.

Meanwhile, an economist and banker with a third generation bank with head office in Victoria Island Lagos who spoke to THISDAY under the condition that he is not named stated that Islamic Banking or non-interest banking was a good source of funding for SMEs, however noted that not all SMEs can access funding from the bank due to its strict compliance with Islamic law adding that the business line of the SMEs must however be Islamic compliant

” Islamic banking is restricted to islamically acceptable deals, which exclude those involving alcohol, pork, gambling. Unfortunately, this is a limitation on the kinds of SMEs that can approach the bank for funding. That said, it still remain a veritable source of funding for serious and well organized SMEs,” he stated.

But speaking further, Yusuf stressed that, “Interestingly, the most difficult funding challenge of small business is the problem of credit access rather than cost of credit.  Many SMEs cannot meet the credit risk assessment criteria of the banks, especially with regard to collateral.  This is why they fall back on finance companies and the informal financial markets where they pay atrocious interest rates, sometimes as high as 80 percent per annum.

“The Islamic banking model has not gained much currency in the Nigerian economy because of its peculiar framework and possibly because of perception.  The concept of Islamic banking forbids interest charges and payments.  This implies that debt financing is ruled out.  What is allowed is profit sharing. Not many SMEs are comfortable with this model of financing. Most small business owners and indeed many indigenous businesses would rather own 100 percent of nothing, than say 50 percent of something.   This is a major issue. The failure of the Small and Medium Enterprises Equity Investment Scheme [SMEIS] for SMEs was largely as result of this disposition of small business owners.

“The second key principle in Islamic finance is that there should be no reward without taking risk.  Capital can only be rewarded if it is exposed to risk.  This comes to the primacy of partnership.  This again could be a limitation to the growth of Islamic finance.  In partnership, trust is very critical; and in this environment, trust deficit is very high.  Therefore, a financing concept that would be driven principally by character and integrity of players may be difficult to sustain.  The risk management challenges in Islamic finance are enormous. This is why debt financing seems to be holding sway in the Nigerian economy.”

(This Day Live / 16 August 2015)

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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com