08 Nov The Alchemy of Investing: Islamic Finance, where innovation and profit meets social good
As a Technology investor we are always looking for the ‘alchemy of investing’, where innovation and profit meets social good. Like alchemy, it is often elusive and hard to achieve. One element usually outweighs the balance of the other. Very few practices undertake this with such delicacy as when you combine Technology, Social Innovation and Islamic Finance. It is for this reason that the subject matter gives me a huge degree of pride and excitement.
Whilst we believe that all business should perform a social function, they also need to stand on their own two feet and become financially sound. Building businesses, isn’t just about finding the next unicorn, it is about building society, creating jobs, helping people forge lives for themselves. So, these businesses need to be robust and be able to withstand economic shocks.
The concept of corporate ethics within banking has gathered momentum over the last decade, spurred on by the Financial crisis and the role that financial institutions played in the last global recession as well as the poor practices that many segments of the market, such as pay day loans deployed in the aftermath. But corporate ethics is not a new concept and in many parts of the world can be seen in the core principles of Sharia or Islamic Finance. I would like to explore the basics of these and explain why they are not only relevant in the Mena region, but also other parts of Africa.
This piece of work is not an attempt to provide a detailed understanding of Islamic finance, but rather it aims to outline some of the core practices and underline the value of the market on the African continent.
Like many practices, Islamic finance was born out of trade. Middle Eastern tradesmen would exchange goods on the basis of profits at a fair level and were prohibited from Riba or what was then know was excess returns. Today this is more narrowly defined as interest on money. Traditionally, Riba was considered one of the seven evil sins or Al-Saba-al-Mubiqut which included such actions as murder. In essence Islamic Finance created one of the first codes of ethics specifically covering finance and corporate behaviour.
Three core pillars formed the backbone in relation to financial affairs.
- Prohibition of Riba.
- Risk and profits should be shared between parties.
- Only real assets that are concrete and productive should be used in transactions, so value could not be ‘derived’.
Modern day Islamic finance gathered pace after the birth of the Mit Ghamr savings project in Egypt in 1963, which was based on co-operative practices. This being, that any depositors were also able to apply for loans. Shortly after, the Islamic Development Bank (IDB) was created to help transition funds in investment projects. In 1975, the first commercial bank, Dubai Islamic Bank (DIB) was founded in the United Arab Emirates. One interesting fact is that history points to the concept of ‘banking the unbanked’ being birthed in Malaysia, with the aim of assisting the underserved population saving towards Hajj.
The sector has now matured and is overseen by numerous international federations including the Islamic Financial Services Board (IFSB), the Accounting and Auditing Organization for Islamic Financial Institutions (ASAOFIFI and the SSB to promote stability and best practice.
Many of the same structural apparatus as mainstream finance are used in the modern Islamic Financial structure such as Regulators, Treasury, Capital Markets, Retail Banking and Insurance. And many of the same concepts of HiTech are also applicable such as DLT and Blockchain which can automate and reduced costs in say the loan approval chain.
Principles and Products in Islamic Finance
Principles are founded on commercial ethics and can be seen as a solid way to provide guidance. These are namely:
- Righteousness and Perfection at Work
- Stewardship of Humanity on Earth.
These are profoundly similar to the concepts underpinning Socially Responsible Investing, Environmental Social and Governmental as well as Impact Investing in modern day investment management. The Pillars of Zakat, Sadaqah and Waqf further provide guidance around charitable giving.
What is refreshing around the guidance given, is that it removes much of the burden of choice from the individual and sets out ‘good practice’. This cements what is considered to be the foundation of great ethical practice, in my view as it provides clear guidelines. Whilst these can also be found as far back as Ancient Greece, the acceptance of these practices in modern day finance has been tested by time.
Guidance is also set out on what not to do and Shariah identifies three major prohibitions. Riba or excess profit and interest, Gharar which recommends you don’t undertake ‘speculative’ trades or transact in ways that cant being easily verified or understood and Maysir, which is gambling.
The markets in Africa and the Opportunity
With existing markets being concentrated in the Middle East and Malaysia and with these markets accounting for over three quarters of the industry, there is a huge potential in Africa. A recent study by White and Case (2018) details many interesting numbers.
- There are around 600m+ Muslims in Africa, which represents 40%+ of the population.
- The Muslim population in Sub-Sahara Africa is set to grow by 60%+ to 385m by 2030.
- Islamic finance assets are expected to grow by roughly 15x in the twenty years after 2003. (This figure is looking to be accurate).
Muslim Population as a % in Africa: whilst many are condensed in the North of Africa, parts of Central and Ears Africa also have minorities.
There are challenges across the sector that apply to not only Islamic finance but also areas such as HiTech. The lack of consistent Regulatory frameworks, little knowledge around the subject matter, lack of access to banking products for those unbanked.
However, these are not new challenges, and many are already being tackled. If Islamic finance is taken hand in hand with regulatory approaches and access to new customer base’s, Islamic finance not only has the ability to grow rapidly in Africa, but also to be one of the leading sources of Social Innovation across the continent.
It is for this reason, why my team and I at Emerald Group, are excited about the sector. Not only does Islamic banking provide a great investment opportunity but it also fulfils one of the main criteria we look for as investors… Sovation, or Social Innovation. We look forward to working on projects in the future and hopefully being part of the pioneers of Islamic finance on the continent.