When one thinks of Islamic banking and finance, certain markets spring instantly to mind.
Saudi Arabia and Malaysia for sure. Kuwait, Qatar and the UAE too; also Turkey, Indonesia and Singapore. Even London could be a long-term leader in the sector, Bandar Hajjar, president of the Islamic Development Bank, said in March.
But Sri Lanka? Whatever comes to mind when conjuring up images of this tropical island in the Indian Ocean – outsourcing, cracked highways, drinks on the beach – it surely isn’t the complexities of sukuk and Shariah-compliant profit sharing.
Why would that be needed or wanted in an overwhelmingly Buddhist country where Muslims account for just under 10% of the population?
Nonetheless, this is an industry that is growing fast. Since banking laws were tweaked in 2005, a host of new and existing financial players have pushed into this business in search of untapped profit and new customers. The first institution to secure a licence, Pakistan’s Muslim Commercial Bank, remains a peripheral player on the scene.
But the industry really took off when Amãna Bank entered the fray. Founded in 2009, the Colombo-based bank serves retail and corporate customers, has a wealth-management division targeted at mass affluents, and reported a pre-tax profit of SLRs739 million ($4.7 million) in 2017, more than seven times the previous year’s figure, on net financing income of SLRs2.75 billion.
Total assets rose 17% over the same period, to SLRs63.5 billion, while the financing margin increased to 4.2%, from 3.6%. Amãna remains the domestic industry’s only pure player; it only offers accredited Islamic services.
Hatton National Bank
The first big established player to throw its hat into the ring, in 2012, was Hatton National Bank. Hisham Ally came over from Amãna Bank to head up the new unit, Al Najah Islamic Banking.
“It’s a bank-within-a-bank, inside HNB but adhering strictly to Islamic principles,” Ally says. “We take the business seriously and aggressively. We’re now up to 30 branches nationwide and second only in market presence to Amãna Bank.”
Tracking down reliable industry data isn’t easy. Islamic banking is a growing pursuit, but with few of the big players willing to release much in the way of internal figures, the picture has to be pieced together.
In its 2017 financial report, Hatton said outstanding lending at Al Najah had risen 33.2% on an annualized basis, to SLRs13.2 billion, with total deposits up 65.6%, to SLRs8.3 billion.
When pressed though, Ally said Islamic banking contributed “a little over 4% to group income”, which jumped 24.8% year on year to SLRs119.7 billion in 2017.
In other words Al Najah, its Islamic banking unit, generated just over $30 million in clear income in 2017: not bad for a division in only its fifth full year of operation.
Ally says there is still enormous capacity for growth, even for leading industry players.
“Islamic finance isn’t close to capturing 10% of the market, so the potential is still very big,” he says. “There’s lots of untapped business still out there – we can continue growing every day for years.”
It’s clear to see why the likes of Hatton and Amãna, which together, Ally reckons, control about 40% of the market, are so keen on Islamic banking. Sri Lanka has far too many standard-issue commercial lenders, many of which compete for the attention of the same sprinkling of standout corporates and high-end retail customers.
By contrast, Islamic banking offers a dearth of competition but a wealth of opportunity. Ally says “the total market in asset terms is worth SLRs1 trillion, and we are currently at between SLRs20 billion and SLRs50 billion.”
Another Islamic finance specialist notes that while “the population of Sri Lanka is around 10% Muslim, the contribution by the community to overall GDP is far more significant. My view is that 10% of the population generates 25% to 30% of all economic output.”
Some put industry penetration as low as 2%, and others as high as 20%.
Yet locating unbanked customers and convincing them to put their assets at an accredited institution won’t be easy. Sri Lanka’s Muslim population is mostly based in rural areas in the east and northwest, but also widely dispersed across the island; many of them are farmers, fishermen, traders, civil servants and other professionals, and some are of Malay and Indian descent.
Most business owners “aren’t part of the financial system at all, which is one of the reasons why it is taking time to grow our customer base,” says Ally.
Another banker adds: “A lot of the growth you see each year involves cash that has spent most of its life under mattresses and in the family safe. When it comes to new clients, their money is often as new to us as our banking is to them.”
That of course puts the onus on lenders, not just to convince these customers that putting their money to work at a licensed Islamic financial institution is in their best interests, but also to act as both financial provider and educator.
Shiraz Refai, deputy general manager at Al-Falaah Islamic Financial Services, runs regular awareness programmes at its growing network of 57 branches.
“Part of our strategy is to hold monthly group meetings across the country,” he says. “Each one typically involves around 200 to 250 participants. Many of them are brand new to us and to the industry, so we dispense with the theory of banks and focus on explaining how our products can actually work for them. We are more of a school per se, teaching new customers what Islamic finance is and bringing them into the mainstream.”
Most of the customers of Al-Falaah – which translates as ‘success’ and is the Shariah-compliant arm of the island’s largest leasing firm, LOLC Finance – are merchants, ranging from medium-sized corporates down to micro-enterprises.
“They are at the bottom of the pyramid, mostly traders and smallholders,” Refai adds. “Their biggest need, and our biggest challenge, is to provide them with services that replicate or reflect the products they are accustomed to using outside the traditional banking space. What they want are products that reduce the chaos in their lives, actively help them in the workplace and are acceptable under Islamic law.”
There is so much to do already without talking about transforming us into an Islamic hub. More needs to be done to facilitate the investor. But we will get there- Shiraz Refai, Al-Falaah Islamic Financial Services
Al-Falaah’s popular products include musawamah (import finance), mudarabah (profit sharing and loss bearing) and of course, for a firm that specializes in leasing, ijarah.
Not all new clients are micro traders or pocket-sized SMEs. Some are corporates of substance and scale that have grown into full maturity while somehow remaining a stranger to every licensed lender.
Ally, HNB head of Islamic banking, gives the example of Soorya Rice, the country’s third-largest rice miller and processor, which is based in the central town of Kaduruwela.
“When I met Soorya founder Rizlan Riyal, I was still working at Amãna Bank,” Ally says. “He’d never had a bank account, never been in the financial system. He explained his business model, we told him what we did, and he came on board.”
When Ally moved to Hatton, the rice magnate followed him.
“He’s now one of our biggest borrowers, with loans that run into the billions [of Sri Lankan rupees], he uses Islamic banking services across all his businesses, and everything he does is automated and digitized.”
Ally offers the contact details of his client. But when Riyal is reached by phone on March 7, he sounds deeply distressed. The previous day, for the first time in nine years, a state of emergency was imposed, after unrest between the Sinhalese and minority Muslims led to riots and arson attacks.
“Our area has been attacked by mobs,” Riyal says, clearly in tears as he describes the situation. “Some of my establishments have been set on fire, even some of my vehicles. It’s been going on for days. They are burning my buildings, burning my life.”
It’s a stark reminder that even though the country has moved on from a bloody 26-year civil war between the Sinhalese and Tamils, which ended in 2009, religious tensions can flare up unexpectedly.
One of the quirks of Islamic banking here is the approach that lenders have chosen to take, in the sense that no two strategies are the same. Most financial institutions, whether in the public or the private domain, provide some kind of Islamic offering. But that’s where the similarities end.
Take HNB and Commercial Bank of Ceylon, the country’s leading private lenders. Both rolled out Islamic banking operations at roughly the same time, CommBank beating its rival to the punch by a few months.
But there the paths diverge. Hatton has bought into Islamic banking lock, stock and barrel. In December, it relocated its Al Najah unit to a new, dedicated office, a clear “recognition of its potential,” Hatton said in its 2017 financial report.
Asked why HNB had taken Islamic banking so completely to heart, Ally replies: “Because if you don’t, you lose business. More Muslim customers want these products, so if you don’t provide them, they’ll take their business elsewhere. And of course, we wanted to grab other banks’ business, which sometimes we do.”
For its part CommBank, which offers a strong suite of services tailored to the Muslim community, has been far slower off the mark. To managing director Jegan Durairatnam, the tortoise approach is more common sense than overt caution.
“We have been slow to grow Islamic finance, it’s true,” he says. “We like to learn a product, learn the procedures and build up our expertise before we really go for it. It has taken time for us to perfect the interaction between the commercial side and the Islamic side, but now we have got it right.”
For its part, LOLC’s Islamic division Al-Falaah arrived on the scene almost by accident. A veteran of the leasing industry, the group found itself losing momentum and clients after banking laws were changed in 2005.
“There was a considerable shift in our leasing business,” says deputy general manager Refai. “Eventually we found that non-bank competitors were offering Islamic leasing products, so we started testing prototype products. Most of these services, probably around 95% of them, were then entirely new to us.”
With its launch of Al-Falaah in 2007 LOLC, which pioneered leasing from the 1980s, again made a conscious effort to position itself at the industry’s cutting edge.
“We are seen in the market as an aggressive innovator,” says Refai. “We have done a number of firsts in Sri Lanka – the first regulated junior savings product, the first dedicated business savings product for women with a discount card, the first ijarah sukuk.”
Leading banks are keen to continue rolling out new services. In its 2017 report, Hatton points to the “significant potential for growth” in Shariah-compliant debit cards.
“A big product taking off in the near future will be short-term overdrafts, something that many of our customers require on a day-to-day basis,” says LOLC’s Refai. “There is a demand for credit cards that we are looking at. And while we cannot give cash-in-hand to customers, which is a constraint, we are on the verge of securing Shariah clearance on a hybrid of the mudarabah and wakalah models that will address the issue.”
Finally there is the long view. Can this little island become a champion of Islamic banking? Can local financial providers become regional players?
Many of its leading practitioners clearly believe so.
Hatton National Bank is “looking to expand into Bangladesh, and we are eyeing the potential of offering Islamic banking and finance services there,” says Ally.
LOLC’s Refai says the non-bank financial provider is “expanding regionally into two markets, Indonesia and Pakistan, where Islamic finance has huge potential for us.”
There is even talk of Sri Lanka becoming a regional hub for Islamic finance. That is probably premature for a host of reasons, from the volatility of the rupee to the parlous state of government finances, to the need to revamp the regulatory system to make it easier for funds to enter and exit the country.
On the positive side of the ledger, Sri Lanka has a relatively small but commercially driven Muslim community and genuine ambitions – focused on the Colombo International Financial City, a vast complex taking shape on the shores of the capital – to become a regional financial hub.
The government broached the idea of printing a sovereign sukuk in mid 2016, only to postpone quietly – but not cancel – the idea.
The recent religious disturbances aside, this is a largely peaceful and stable place to do business, overseen by a business-friendly government.
“There is so much to do already without talking about transforming us into an Islamic hub,” says Refai. “More needs to be done to facilitate the investor. But we will get there. In the long term – why not?”