Eight years after the introduction of Islamic banks to Lebanon, and despite efforts by the Central Bank to regulate the industry, Shariah-compliant lenders have yet to make significant inroads into the country’s thriving and competitive banking sector. Statistics provided by the Central Bank showed that Islamic banks in Lebanon had $674 million in total assets in December 2012 and that by November 2013 the amount had only grown to $712 million, with the four Shariah-compliant banks operating in the country failing to increase their market share beyond even 1 percent.
Bankers and financial analysts interviewed by The Daily Star gave varied opinions as to why Islamic finance had failed to make a mark in the Lebanese banking sector, but a lack of awareness ranked among the top responses.
“People in Lebanon are not very well cultured about the various Islamic banking options, and more awareness must be created of this system by organizing workshops and conferences,” said Adnan Youssef, president and CEO of Al-Baraka Banking Group.
But Youssef admitted that it would take time for any society to accept such new products in the market. “Even in the Gulf region where Islamic finance is booming, it took a lot of time for people to invest in the industry,” he explained. “Islamic banks were not available in Saudi Arabia, Qatar and Oman 15 years ago, for instance, and they went into full gear only a short time ago.”
Gulf Cooperation Countries represent about 90 percent of the total assets of Islamic banks in Arab countries, according to a report issued by consultancy firm AT Kearney in 2010. That document adds that nearly half of these Shariah-compliant banks are in Saudi Arabia, followed by the UAE with 20 percent, Kuwait with 17.4 percent and Bahrain with 11 percent.
Ghassan Chammas, adviser to the board of directors of BLOM Development Bank, concurs. “This is a black box for many people,” he said. “Investors need to know how the system works from the inside in order for them to accept it.”
But Chammas believes Islamic banks themselves are partly responsible for this lack of awareness. “The cost of marketing in Lebanon is extremely high,” he explained adding that launching a marketing campaign to change attitudes toward the industry would be costly.
Chammas also pointed out that the government’s fiscal laws were not very encouraging of Islamic banking operations in Lebanon. “The fiscal laws should consider Islamic financing operations as financing tools and not as operational tools and hence they should exempt them from stamp duty, double taxation and, at the same time, from value-added tax,” he said.
Islamic banks are subject to double taxation of their financing operations because they act as merchants – they must acquire a given asset prior to selling it to their customers. Moreover, the structuring of Shariah-compliant products into separate contracts, such as the promise to sell and the sale contract in Murabaha operations, entails a financial stamp duty of 3 percent for each contract. These double registration fees, value added taxes and stamp duties present a financial burden and substantially increase the cost of financing, supporters of Islamic banks argue.
Murabaha is a sale-of-goods contract between the bank and the client. In such a transaction, the client selects the goods to be financed, and the bank subsequently purchases the goods, adds an agreed-upon profit margin and delivers the merchandise to the client. The client then pays reimbursement for the original cost of the goods plus the bank’s profit over prearranged installments.
However, Rima Turk Ariss, a finance professor at the Lebanese American University, explained that Islamic banking in Lebanon focuses on debt-based contracts, and mainly on Murabaha, but not on equity-based contracts, which lie at the heart of Islamic banking.
According to Ariss, although Murabaha is considered the most popular tool used in Islamic banking, it is the equity-based contracts that lead to productive activities and jobs in the economy. “We do have Central Bank regulations in Lebanon but we need regulations on how Islamic banks should conduct their equity-based type of activities,” she said.
The two major profit-and-loss-sharing equity-based modes of financing in Islamic finance are Mudharaba and Musharaka.
Musharaka is the establishment of a partnership or joint venture between the bank and the client for a specific business or project. It is a profit-and-loss-sharing financing agreement in which the bank and the client both contribute their capital and expertise to the deal.
Mudharaba, as in Musharaka financing, takes the form of a partnership or joint venture between the bank or investor (Rab al-Mal), and the client or entrepreneur (Mudarib) for a specific business or project. However, the main difference is that the bank provides the capital while the client provides the management, expertise and know-how.
Ariss argued that, while the Central Bank had done very advanced work in terms of laying the groundwork for Shariah-compliant banks to operate in Lebanon, “it is still not as advanced as what we have in other countries.”
“We need a better infrastructure for Islamic banks to conduct their equity-based contracts,” she said.
Yet another obstacle, according to Khodr Temsah, an Islamic banking expert, is that the initial capitals required from Islamic banks upon their establishment are not sufficient to overcome the challenges facing the spread of Shariah-compliant financing in Lebanon. Such challenges “include educating the public, writing articles in the press and investing in the education of staff to project the proper image of Islamic banking,” he explained
Temsah said Law 575, issued by the Central Bank in 2004 to regulate the industry, required each Islamic bank to start with a capital of $100 million. However, it also allows the option of investing up to $20 million, on condition that the parent bank provide its unconditional guarantee to the Central Bank that it will assist the lender should it require aid. But “experience has shown it is better to pay the whole amount, because the bank needs the money to advertise and invest in its staff,” he said.
He also pointed out that the operations of Islamic banks in Lebanon are constrained by the fact that they were not allowed to accept deposits for any period of time less than six months. “The Islamic banking act in Lebanon has forbidden Islamic banks from taking deposits for one or three months, although these types of deposits account for 80 percent of the deposit portfolio in Lebanon,” Temsah said. “This has proved to be a large handicap in attracting customer deposits.”
Meanwhile, Raed Charafeddine, the Central Bank’s first vice governor, believes another reason for Shariah-compliant banking’s relative unpopularity in Lebanon is because clients are not drawn to non-guaranteed deposits. “Customers in Lebanon have for a long time been used to the conventional way of thinking, whereby they have a guarantee,” he said.
However, despite the slow growth and myriad challenges facing the industry, bankers and experts still believe that, with the right approach, Islamic banking can flourish in the country
Chammas, for example, proposed the drafting of a single communication campaign or strategy by Shariah-compliant banks to increase awareness about the industry. “We have to start by creating awareness even within the Muslim community because some don’t even know about the existence of these banks in their areas,” he said.
Youssef, meanwhile, stressed the importance of introducing the concept of Islamic banking into Lebanese university programs.
The experts also emphasized the need to issue sovereign sukuks, or Islamic bonds issued by the Central Bank on behalf of the government.
“If we start tapping into Islamic sovereign sukuks in Lebanon, we will attract a huge number of investors [who are otherwise] not interested in investing in the country for the time being because they want Shariah-compliant products,” Chammas said.
His view was echoed by Charafeddine, who said the performance of Islamic banks would improve with the availability of products that are Shariah-compliant and yield high returns, such as sovereign sukuks. “If you take the example of Bahrain and Malaysia, they have issued their own sukuks and this enabled Islamic banks to invest their excess liquidity in those papers so they were able to find avenues where they can place their money,” he explained.
But Charafeddine ruled out the possibility of issuing sovereign sukuks in the near future, saying: “We are not aware of any developments on that front.”
Regarding the law that restricts Islamic banks from accepting deposits for less than six months, he said this was in line with Islamic finance’s principle of profits-and-loss sharing that mainly concerns Musharaka and Mudharaba, which are long-term contracts. “Islamic banks are specialized banks that go for medium- and long-term investments and therefore cannot offer a proper return on a very-short-term basis,” he explained.
Charafeddine also pointed out that the conditional option given to new investors in Shariah-compliant banking to put in $20 million instead of $100 aimed to encourage the growth of the industry. “We should look at the pros and cons of each option,” he said, adding that banks always have the option to raise their capital whenever they wish.
Furthermore, Charafeddine said regulations aimed at fostering equity-based contracts were in fact available, but it was the conservative nature of Islamic banks in Lebanon that saw them shying away from entrepreneurs who want to enter into Musharaka and Mudharaba partnerships. “If you look at the regulatory framework, it is there but [Islamic banks] feel safer in the debt-based instruments,” he explained.
He also noted that the Central Bank was not involved with the taxation framework in Lebanon and was waiting for the Finance Ministry to issue an exemption of the double taxations on Islamic banks’ financing operations.
“This would definitely increase their attractiveness to clients.”