Introduction to Islamic Banking in

Nigeria: Regulatory and Supervisory

Challenges

A Paper Presented by

Dr Bashir Aliyu Umar

Special Adviser to the Governor on Non-Interest

Banking

Central Bank of Nigeria

at the Annual Banking Supervision Conference

Held at the Nike Lake Hotel, Enugu

July 27-28, 2011

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Introduction:

I feel highly honoured to be invited to make this presentation at the BSD Annual Conference holding in Enugu, and I am highly delighted to be present here this afternoon. The title of my paper is: "Introduction to Islamic Banking in Nigeria: Regulatory and Supervisory Challenges". This is a topic that is quite relevant to the theme of this Conference, which is: Implementation ofBasel II and III and Transition to IFRS: the Challenges for Bank Regulators. As non-interest banks based on the Islamic model are poised to come on-stream with their operations in the not too distant future, the Central Bank after developing the regulatory framework for this banking model is facing the challenge of developing operational and other prudential guidelines peculiar to the model and bringing them to international standards. This forum therefore provides a good platform to present some of the challenges facing the regulation of these institutions globally and proffer possible solutions to them especially in the context of our national situation.

This is what I will humbly attempt to do in this presentation, and I have divided the paper into the following sections, after the introduction:

1. The Approach to the Introduction of Non-Interest Financial Services in Nigeria.

2. International Standards for the regulation of IslamicBanking

3. Regulating Islamic Banking Institutions Globally

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4. CBN Guidelines for the Regulation of Non-Interest (Islamic) Banks and Financial Institutions.

5. Challenges for the Regulation and Supervision of Non-Interest (Islamic) Banks and Financial Institutions in Nigeria

6. CBN's Efforts in Addressing the Regulatory Challenges7. Conclusion.

Section 1: The Approach to the Introduction of Non-Interest Financial Services in Nigeria

The approach to the introduction of non-interest financial services in Nigeria is anchored on the need to provide alternative and complementary financial services to the financial service sector of our economy, and this is informed by a number of considerations, which can be summed up as follows:

The deepening and broadening of our financial markets through the introduction of new market players, products, services and instruments and the whole array of supporting financial infrastructure that comes along with these new operators and instruments.

The diversification of the sources of funds and investment outlets for both the private and public sectors. It is now common practice in most financialcentres to have multiple tranches of conventional and alternative modes of finance structured for project finance, and many conventional bond investors invest heavily in alternative finance instruments in order to diversify their investment portfolios.

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Developing a more inclusive financial system in the country. A primary determinant of the soundness of afinancial system and its stability is the public trust and confidence in its institutions and markets, and this could best be achieved through financial inclusion of the major segment of the economically active sector of the society. Islamic finance as an alternative financial service and product will play a great role in terms of financialinclusion by bringing a large segment of the hitherto unbanked and under-banked segments of the society into the mainstream organised and formal financial system.

The vision to engineer Nigeria's evolution into Africa's major International Financial Centre (IFC) and enable Nigeria's transformation into one of the 20 largest economies in the world by 2020, which is the Financial System Strategy (FSS) 2020. No countrythat hopes to become an international financial centre can afford to be oblivious to a new financiallandscape that has already become mainstream and an intrinsic element of the global financial landscape.

The fact that Islamic finance has become mainstream is borne by a number of factors:

i. It is universally accessible to and enjoyed by people of diverse religious persuasions or ethicalbeliefs across the globe. 20% of the client base of the Gulf Africa Bank of Kenya is non-Muslim, while in Malaysia OCBC Al Amin Bank has reported that nearly 50% of its banking customers are non-Muslim (The Banker, November 2009).

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ii. The industry is over 35 years old. From the first Islamic bank that was established in 1975, there are by 2009 over 435 full-fledged Islamic banking institutions and over 181 Islamic windows of conventional banks (The Banker, November 2009).

iii. The industry has grown from Islamic banking and spread to Islamic Insurance (Takaful), Islamic wealth and asset management, Islamic leasing and factoring companies, Islamic capital markets and their players, and an array of financial architecture and infrastructure including payment/settlement systems, support facility providers, rating and external credit assessment institutions.

iv. The global assets of Islamic financial institutions have hit the USD 1 trillion mark and is expected to reach USD 1.6 trillion by 2012 (Global Islamic Finance Forum quoting IFSB).

v. The Islamic banking sector is growing worldwide ata strong rate of 15.0%-20% over the past decade.

vi. It has achieved wide geographic presence outsidethe Middle East and North Africa. It is offered inEurope in the UK (which is the 8th country in the world in terms of Islamic finance assets), Switzerland, Luxembourg, Germany and France. In Africa, there are Islamic banks in Kenya, Tanzania, Uganda, Botswana, South Africa, Mauritius, Senegal, Gambia, Mauritania, Benin, Niger etc. In Asia, outside the Muslim majority countries it is offered in Singapore, Thailand, Hong Kong, Sri Lanka, Japan and South Korea. It isalso offered in the US and Australia.

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vii. Major western international financial institutions have windows or subsidiaries of Islamic financial institutions. These include HSBC, Citigroup, Standard Chartered, BNP Paribas, Deutsche Bank, Lloyds Banking Group, Tokyo Marine Insurance, Swiss Re etc.

viii. Islamic banking and finance has become a discipline of study in which degrees both undergraduate and postgraduate are now offered in universities and institutions of higher learning all over the world, including many Western institutions, such as Harvard Islamic Finance Forum, University of Reading, Durham University, Loughborough University, Luxembourg University; and courses in Islamic finance are being offered by professional bodies such as the UK Chartered Institute for Securities and Investment (CISI) to name just one.

ix. Islamic investment portfolios are tracked by major index providers including the Dow Jones, NASDAQ, Hang Seng and FTSE.

x. The Big Four professional services firms – PricewaterhouseCoopers, KPMG, Ernst & Young, Deloitte – have each established an Islamic Finance division providing specialist services in this area.

It is therefore, no wonder that Islamic finance is being explored by the various sectors of the Nigerian FinancialSystem.

As early as 2002 approval was given to African Alliance Insurance Plc to offer Takaful (Islamic Insurance), and

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two other insurance companies are currently offering thisproduct along with African Alliance. In the capital markets, the Securities and Exchange Commission (SEC) hasreleased draft rules on Islamic Fund Management in May 2010 and the final rules were released officially on January 27, 2011. Already two Islamic fund management entities have been registered by SEC and are already in operation.

The Central Bank of Nigeria, as early as 1994 has sent a team of banking supervisors to study the operation and supervision of Islamic banking in Malaysia, and had approved for a conventional bank, the then Habib Bank to offer non-interest (Islamic) banking products as a windowin 1996.

Section 2: International Standards for the Regulation of Islamic Banking

Islamic banking like every other established banking model needs to be regulated, and in the four decades of its history international standard setting organisations have been formed to issue internationally accepted standards for the regulation of the industry. These organisations are:

a. The Accounting and Auditing Organisation of Islamic Financial Institutions AAOIFI. Based in Bahrain, it was formed in 1998 and it issues accounting and auditing standards for Islamic banks, as well as Shariah, governance and ethics standards for the Islamic finance industry.

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b. The Islamic Financial Services Board IFSB. This organisation was formed in 2003 and is based in KualaLumpur, Malaysia. It issues global prudential standards and guiding principles for the Islamic finance industry, which it broadly defines to includebanking, the capital markets and insurance sectors. While working not-to-re-invent the will, it strives to complement the work of the Basel Committee for Banking Supervision, the International Organisation of Securities Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS). Its 191 members comprise 54 regulatory and supervisory authorities, seven international inter-governmental organisations, including the World Bank,the IMF, the Bank of International Settlements, the Islamic Development Bank, the Asian Development Bank,and 130 market players and professional firms and industry associations operating in 43 jurisdictions. It has issued 17 standards and guiding principles including risk management, capital adequacy, corporate governance transparency and market discipline and Shariah governance all for institutions offering Islamic financial services.

c. The International Islamic Financial Market IIFM. It is the global standardisation body for the Islamic capital and money market segment of the Islamic Financial Services Industry. Its focus lies in the standardisation of the industry's financial products,documentation and related processes.

These organisations have made the regulation of this industry more effective and have since their inception

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prevented the recurrence of the few bank failures witnessed in the short history of the industry.1

Section 3: Regulating Islamic Banking Institutions Globally

Regulating banks generally is anchored on a number of

objectives:

to maintain public confidence in banks as custodians

of depositors' funds;

to promote healthy competition in the financial

system that is geared towards providing efficient and

reliable services, without endangering any sector or

putting it at a competitive disadvantage;

to ensure the health of individual financial

institutions for the development of a sound and

stable financial system;

to protect the interests of depositors and customers;

to promote good market practices and high standard of

corporate governance; and

to prevent the risk of contagious collapse of the

financial system.

1 These include the financial distress of the Kuwait Finance House in 1984,and the loss of 30% in equity of the Islamic International Bank of Denmark between 1985 to 1986, the collapse of the South African Islamic Bank Ltd in1997, and the collapse of Ihsan Finance House of Turkey during the Turkish financial crisis of 2001 (see: Mahmoud Nathie, Islamic Bank Failure: A Case Study, International Journal of Islamic Finance Vol 2. Issue 1 2010).

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These objectives apply in principle to Islamic banks as

they do to Conventional banks, because both are

institutions that are privileged by law to accept

deposits from members of the public. Despite these shared

objectives, a single and uniform regulatory framework for

conventional and Islamic banks may not achieve the stated

objectives because of the specificities of Islamic banks,

which could be narrowed down to the following:

The asset and liability structure of Islamic banks is

unique

The risk exposure of each stakeholder in an Islamic

bank is also unique

The financial instruments offered by Islamic banks

have their own specificities. Islamic financial

instruments are asset-based (Murabahah, Salam,

Istisna' which are based on the sale or purchase of

an asset, and Ijarah on the selling of the benefits

of such an asset), or profit-sharing (Musharakah and

Mudarabah) or Sukuk (Shariah-structured securities)

and investment portfolios and funds which may be

based on the above asset structure.

Islamic banks in addition to complying with the rules

and regulations of their domicile, are also bound to

conform to the principles of the Shariah, Islamic

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commercial jurisprudence, which is their raison

d'être. Regulation and supervision should enforce

Shariah compliance in line with customer expectations

of the operations of Islamic banks.

These specificities call for a separate regulatory

framework for Islamic banks, which will take into account

the unique features of these institutions, and at the

same time make them conform to international prudential

standards.

In regulating Islamic banks there are key elements that

must be addressed, which I will mention below.

Legal Basis

The first among these is the provision of a legal basis

under the governing law for the establishment and

operation of Islamic banks. The confidence of the members

of the public either as shareholders or as depositors or

other stakeholders in Islamic banks cannot be secured if

there is doubt as to the legality of the institutions.

Capital Adequacy

Another very important element in the regulation of

Islamic banks is capital adequacy. All organizations that

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incur liability require some form of capital backing in

order to support those liabilities. In the case of banks

the adequacy of capital needs to be regulated as a

mitigation of the systemic risk of contagious collapse,

whereby one firm's failure triggers a series of others,

thus imposing social costs. For this reason, the Basel

Committee on Banking Supervision (BCBS), part of the Bank

for International Settlements, issued its first Capital

Accord ("Basel I") in 1988, which was followed with a

Revised Framework for capital adequacy, commonly referred

to as Basel II, the final version of which was issued in

June 2004. Pillar I of Basel II covers minimum capital

adequacy requirements and the idea behind it, among other

things, is that a bank needs to set aside capital, which

is the bank's own money, for each of a set of defined

category of risks. Basel II was developed with

conventional banks in mind and does not explicitly cater

for Islamic banking products. However the need for

Islamic banks to have a cushion against possible adverse

effects that could trigger a systemic failure of the

financial system makes it imperative to regulate their

capital adequacy in accordance with recognized

international standards.

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The Islamic Financial Services Board (IFSB) has developed

a capital adequacy standard (IFSB-2) for Islamic banking

products to cater for this need. The standard addresses

the specific character and contents of Islamic banking

products and services that are not addressed by the

international capital adequacy standards, and in effect

seeks to interpret and apply Basel II to Islamic banking

products. It sets the minimum capital requirements to

cover the seven classes of Islamic financing assets

(Murabahah, Salam, Istisna, Ijarah, Musharakah, Mudarabah

and Sukuk) taking into account both credit and market

risks as appropriate.

Capital requirements are not limited to classes of

financing assets alone. Islamic banks are also expected

to set aside a capital charge for operational risk, which

is the risk of losses resulting from inadequate or failed

internal processes, people and systems. There are

different approaches for measurement of the capital to

cater for operational risk which have been detailed in

the IFSB-2.

An Islamic bank is also liable for losses arising out of

its negligence, misconduct or breach of its investment

mandate with regards to profit sharing investment account

holders. The risk of losses arising from such events is

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characterized as a fiduciary risk, and the capital

requirement for it is dealt under the fore-going

operational risk.

Another type of operational risk is the Shariah-

compliance risk, which is a type of risk facing Islamic

banks that can lead to non-recognition of income, when it

becomes clear that the income was not Shariah-compliant

and thus lead to resultant losses. Capital provision for

that class of risk is also part of prudential

requirements necessary for effective regulation of

Islamic banks.

Islamic banks in their dealings with investment account

holders who deposit their funds with them on the basis of

profit-sharing and loss-bearing experience what is termed

as ''displaced commercial risk''. This arises because

Islamic banks in practice often forego part or all of

their investment manager's share of profit on such

funds , when they consider this necessary as a result of

commercial pressure in order to increase the return that

would otherwise be payable to the investment account

holders. Regulatory capital is therefore required to

cater for this risk. Supervisory authorities out of

concern that the triggering of withdrawals by profit-

sharing investment account holders could give rise to

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systemic risk, may make the practice of displacement of

commercial risk mandatory on Islamic banks.

Risk Management

Risk management is another important element in the

regulation of Islamic banks. It is an area of equal

concern to all financial institutions including Islamic

banks. In this respect also, the IFSB has issued a

standard (IFSB-1) on Risk Management for Islamic

Financial Institutions, which complements the risk

management principles issued by the BCBS. Effective risk

management in Islamic banks requires that high priority

be given to proper measurement and disclosure of

aggregate banking risks and specific types of risks. This

should include appropriate board and senior management

oversight to identify, measure, monitor, report and

control relevant categories of risks, and where

applicable to hold adequate capital against these risks.

The categories of risks to which Islamic banks are

exposed are six: credit risk, equity investment risk

(Mudarabah and Musharakah investments), market risk,

liquidity risk, rate of return risk, operational risk

(which includes Shariah-compliance risk and reputational

risk).

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Shariah-Compliance Mechanism

Islamic banks are established to operate based on

compliance with the Shariah, which in this context is the

Islamic law of commerce. This is the expectations of the

stakeholders of Islamic banks. Supervisory authorities

therefore should have a role in monitoring or enforcing

Shariah compliance among Islamic banks, in order to

maintain public confidence in these institutions as

custodians of depositors' funds which is a principal

objective of regulating banks. Another reason for

supervisory enforcement of Shariah-compliance among

Islamic banks is that Shariah non-compliance in an

Islamic bank could lead to massive withdrawals of

deposits, which could lead to an adverse systemic effect

on the financial system. A third reason is to prevent the

so-called 'Shariah arbitrage', where the non-interest

(Islamic) financial institutions would use the pretext of

Shariah-compliance to woo customers away from the

conventional institutions, while in reality they are not.

A Shariah-compliance mechanism involves the creation of

Shariah supervisory bodies in individual Islamic banks

that will, among other things, advise the bank on Shariah

matters and give sanction to products and services

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offered by the banks to consumers, as well as undertake

routine internal Shariah-compliance audit.

Another component of the Shariah-compliance mechanism for

effective regulation of Islamic banks is the

establishment of an internal Shariah compliance unit in

individual banks, which will ensure compliance of the

bank's operations with the rulings and guidance notes of

its Shariah supervisory body. Finally, there is a central

Shariah council which serves as the highest authority on

Shariah-compliance matters and is given the

responsibility to scrutinize and endorse the rulings of

individual Islamic bank's Shariah supervisory bodies.

This will promote harmonization and uniformity of Shariah

rulings, while allowing innovation by permitting

individual banks to develop their own products based on

the advice of their individual Shariah supervisory

bodies.

Firewalls for Islamic Window Operations

Islamic windows are a form of Islamic banking business

model in which conventional banks offer Islamic banking

products and services from their existing network, thus

bypassing the cost and overheads associated with the set

up of stand-alone Islamic banking operations. There are

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various arguments and counter-arguments that are

presented for or against Islamic window operations. But

where they are allowed to operate it is important to

address a number of regulatory issues regarding their

mode of operations. The most important of these issues

are:

establishment of a dedicated Islamic banking division

to oversee the overall window operations of the

institution and its compliance to the Islamic banking

principles;

segregation of Islamic funds from conventional funds,

with separate clearing accounts and separate cheque

clearing system;

separate disclosure of Islamic banking portfolio in

financial statements;

separate submission of statistical and prudential

reports;

separate compliance to statutory reserve

requirements, liquidity and other prudential

requirements frameworks.

The segregation and lack of commingling of funds in the

window operations is an additional disclosure requirement

to provide transparency for the stakeholders of the bank.

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Investment Account Holders

Investment account holders are a class of Islamic bank

depositors that need special attention from a regulatory

perspective. They are account holders that deposit their

funds on a profit-and-loss sharing basis (Musharakah), or

on a profit-sharing and loss-bearing (Mudarabah) basis.

They are categorized into two:

Restricted Investment Account Holders (RIAH), where

the placement of funds by the bank is subject to

investment criteria specified in the contract between

the RIAHs and the bank.

Unrestricted Investment Account Holders (URIAH),

where the bank has full discretionary power in making

investments decisions.

Both are susceptible to the possibility of capital loss,

because by the nature of the contract between them and

the bank, their capital contribution is not guaranteed

according to the Shariah, except in the case of

negligence or gross misconduct or breach of investment

mandate on the side of the bank. They are also vulnerable

to variability of returns on their investments. These are

potential regulatory issues that must be addressed in the

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regulation of Islamic banks, because they border on

consumer protection.

Ultimately, the best protection IAHs can get is

transparency and full disclosure, which should extend

from transparency of the underlying legal contract

between the bank and the customer, to transparency and

regular disclosure of the relevant profit and performance

measures. The last will include disclosure on the Islamic

bank's Rate of Return (ROR) framework, and the practice

of maintaining a profit equalization reserve (PER) and

Investment Risk Reserve (IRR) for income smoothing. There

are other qualitative and quantitative disclosures for

each category of IAHs, details of which are covered by

regulatory guidelines. In this context again, the IFSB

has issued a standard (IFSB-4) on Disclosures to Promote

Transparency and Market Discipline for Institutions

offering Islamic Financial Services.

Another regulatory issue involving IAHs is the capital

adequacy requirement for assets financed by their

accounts. This is normally covered under Capital Adequacy

Guidelines for Islamic Banking Operations.

Market Conduct and Consumer Protection

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For effective regulation of Islamic banks there should be

a dispute resolution mechanism that will offer speedy

resolution of dispute. This could include a dedicated

complaint unit within the regulatory authority, and a

dedicated unit to adjudicate Islamic banking and finance

matters in the courts of law.

Relevant disclosure requirements should also be in place

to ensure that market participants in Islamic banks have

accurate, timely and relevant information, and a minimum

standard on product transparency and disclosure is

observed. The regulator should also foster greater

awareness of risks and rights of Islamic finance

products.

Section 4: The CBN Framework for the Regulation of Non-Interest (Islamic) Banks

The objective of the framework is to provide minimum

standards for the operation of institutions offering non-

interest banking and financial services in Nigeria.

As mentioned above, the unique features of Islamic

financial transactions and the institutions offering them

requires that a set of regulatory requirements different

from that of their conventional counterparts is

essential. However, despite these unique features and

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differences, relevant provisions of the extant banking

laws and regulations shall apply.

The framework defines a non-interest financial

institution (NIFI) as “a bank or other financial

institution (OFI) under the purview of the Central Bank

of Nigeria (CBN), which transacts banking business,

engages in trading, investment and commercial activities

as well as the provision of financial products and

services in accordance with any established non-interest

banking and finance principles”.

The framework recognizes two models under this generic

definition:

a. Non-Interest banking and finance services based on

Islamic commercial jurisprudence.

b. Non-Interest banking and finance services based on

other established non-interest banking and finance

principles.

In the context of the first model, these institutions

identified by the convention of international standard

setting organizations as Institutions Offering Islamic

Financial Services (IIFS) refer to a wide-ranging type of

financial institutions categorised as follows:

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a full-fledged non-interest (Islamic) bank or non-

interest (Islamic) subsidiary of a conventional bank;

a full-fledged non-interest (Islamic) merchant bank

or non-interest (Islamic) subsidiary of a

conventional merchant bank;

a full-fledged non-interest (Islamic) microfinance

bank;

a non-interest (Islamic) branch of a conventional

bank or financial institution under the purview of

the CBN;

a non-interest (Islamic) window of a conventional

bank or financial institution under the purview of

the CBN;

a development bank registered with the CBN to offer

non-interest (Islamic) financial services either

full-fledged or as a subsidiary;

a primary mortgage institution registered with the

CBN to offer non-interest (Islamic) financial

services either full-fledged or as a subsidiary; and

a finance company registered with the CBN to provide

non-interest (Islamic) financial services, either

full-fledged or as a subsidiary.

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The framework sets out the legal basis for authorizing

IIFS in Nigeria which are the relevant sections of the

CBN Act 2007 and BOFIA 1991 (as amended).

It also contains provisions and offers guidance on the

establishment of windows. Windows shall form a part of

the Non-Interest financial landscape in Nigeria, to

foster healthy competition and to widen the product base

for Islamic banking products and services. Specific

guidelines on the operations of windows and branches have

also been released and these guidelines serve to erect

the relevant firewalls needed to ensure Shariah

compliance and proper segregation of funds.

The framework also set out a Shariah-compliance mechanism

for IIFSs, and it has followed it with a detailed

guideline on Shariah Governance of IIFSs. Shariah

Governance is a corporate governance requirement specific

to IIFSs. The Shariah-compliance mechanism provides for

Advisory Committees of Experts (ACEs) at the level of all

IIFSs, whether stand-alone or windows, as well as a

dedicated internal Shariah compliance unit. It also

provides for a Central Council of Experts to review and

endorse individual bank's ACEs' validation of products

and to advise the Central Bank on Shariah-compliance

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matters pertaining to financial transactions for the

effective regulation and supervision of IIFSs.

The framework outlines standards for conduct of business,

which includes branding and procedures for the approval

of contracts, products and services.

It also takes into consideration the special position of

Investment Account Holders, whose accounts are referred

to in the framework as Profit Sharing Investment

Accounts. The relevant disclosures needed to offer them

regulatory customer protection are clearly outlined.

On auditing, accounting and disclosure requirements, the

framework requires IIFSs to comply with extant CBN

requirements, and in addition comply where appropriate

with relevant standards of international standard setting

organizations for Islamic finance, which include the

Accounting and Auditing Organization for Islamic

Financial Institutions (AAOIFI) (for accounting and

auditing standards) and the Islamic Financial Services

Board (IFSB) (for governance and other prudential

standards).

In the area of capital adequacy the framework refers

IIFSs to CBN prescriptions from time to time, which is in

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line with best practice in most jurisdictions. The same

is done with liquidity management and other prudential

requirements.

In the area of Risk Management, the framework refers

NIFIs to CBN Prudential guidelines, as well as the BCBS

Risk Management Guidelines, and IFSB Guiding Principles

of Risk Management for Islamic Financial Institutions.

Towards the end, the framework includes provisions for

IIFSs to have effective anti-money laundering and

combating of the financing of terrorism policies and

procedures that comply with relevant statutes and

guidelines issued by the CBN and other relevant agencies

in this respect.

Finally, the framework concludes with a non-

discrimination clause which prohibits all IIFSs from

discriminating against any individual or group on account

of faith, ethnicity or any other grounds in engaging or

accessing their services either as promoters,

shareholders, depositors, customers or employees.

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Section 5: Regulatory Challenges for Islamic Banking in Nigeria

Despite the release of a framework that has drawn from

international best practice and relevant international

standards, and the substantial progress that has been

made towards institutionalizing Islamic banking in

Nigeria, there are challenges that are envisaged in the

regulation of Islamic Banking in Nigeria. These include:

Dearth of knowledge, skills and technical capacity to

regulate, and supervise Islamic banks.

Lack of Shariah-compliant liquidity management

instruments. The CBN framework does not allow Islamic

banks to invest their excess liquidity in interest-

based instruments, which are the liquidity management

instruments in the market, which places them at a

competitive disadvantage with respect to their

conventional counterparts. Also the current inter-

bank market and the instruments used by the Central

Bank for monetary policy operations are all interest-

based with no equivalent government securities or

other money market instruments that are Shariah-

compliant, all of which are essential to avoid a

liquidity bottleneck for Islamic banks when they come

into operation.

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Absence of Islamic insurance to protect investments

of Islamic banks against unforeseen hazards and

facilitate the growth of the industry respectively.

Closely connected with this challenge is the lack of

a deposit insurance scheme for the protection of

deposits of Islamic banks' customers.

Lack of knowledge of accounting and auditing

standards pertinent to Islamic financial

institutions.

Lack of a robust and comprehensive legal framework,

especially at the level of adjudication of conflicts

involving Islamic finance contracts, products or

entities.

In the discharge of its traditional role of lender of

last resort, the CBN provides loans to banks at times

of liquidity crunch. Islamic banks cannot

legitimately benefit from such a facility because

such funds are usually provided on the basis of

interest. There is therefore, the need to devise and

implement an interest-free framework for such

assistance.

Dearth of Shariah scholars knowledgeable in

conventional economics, law, accounting, banking and

finance, which places severe constraints on the

regulatory Shariah-compliance mechanism.

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Double taxation that would be levied on Islamic banks

as a result of stamp duties and capital gains tax

that are deductable upon asset transfer. Islamic

banks face a tremendous challenge in this respect

because their financial intermediation is asset-

based. In home financing for example, the Islamic

banks take possession of the asset either through

sale or construction contract, and they pay stamp

duty for that. When they sale the asset to a customer

through a mark-up sale or a lease ending with

ownership contract, another stamp duty is charged for

the asset transfer. Other jurisdictions, including

the UK and Luxembourg have modified their tax laws to

exempt Islamic banks from double taxation on assets

they acquire for the sake of financing.

Another challenge in the area of taxation is that

profit generated from the financial instruments

offered by Islamic banks are not given the tax relief

enjoyed by debt instruments in conventional finance.

Debt instruments issued in Nigeria are currently

exempted from taxes including income tax and VAT.

Similarly interest payments on loans advanced are

given the same relief. The same status should be

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granted to receivables in a Murabahah or Ijarah-based

financing.

The ethno-religious diversity of Nigeria, which makes

it imperative to create mass awareness and

acceptance. This is in view of the fact that religion

has become a volatile issue over the years.

Misinterpretation of the concept might jeopardise its

success.

Section 6: CBN Efforts in Facing the Regulatory Challenges

The CBN is facing these challenges through a number of

measures that will hopefully level out the challenges.

Among these measures are:

Continuous mass awareness programmes to educate all

stakeholders and the general public with a view to

correcting misperceptions and facilitating

acceptance. A communication strategy is being

implemented in that direction.

Capacity development for bank examiners, other

regulators and market practitioners in partnership

with relevant international agencies. The CBN in

conjunction with the IFSB has organized a workshop on

three IFSB standards in the last quarter of 2010 for

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regulators, with a view to organizing additional

workshops to build capacity on the remaining IFSB

standards.

Inter-agency collaboration: the CBN is driving

collaboration with relevant agencies in the financial

sector to address the challenges of introducing and

regulating Islamic finance in Nigeria. It is through

this collaboration that a number of pressing issues

are hopefully going to be addressed. These include:

o the finalization of a deposit insurance scheme

for Islamic banks which the NDIC has already

released a draft framework.

o Introduction into the market of Islamic

securities (Sukuk) in collaboration with the

Debt Management Office, the Infrastructure

Concession Regulatory Commission, the Securities

and Exchange Commission to address the liquidity

management and Islamic money market products

challenge.

o Address the issue of tax disadvantages that have

been highlighted as playing a prohibitive role

for offering Islamic banking and finance

products and services.

o Facilitating the issuance of a framework for

Islamic Insurance (Takaful).

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Enhancement of the legal framework. The CBN envisages

building capacity of the members of the legal

profession in the field of Islamic banking and

finance to address the legal infrastructure

challenges for Islamic banking in Nigeria.

Cross-border linkages and bridges and membership of

relevant international organizations. The CBN has

signed an MOU with the Bank Negara Malaysia (the

Central Bank of Malaysia) and is partnering with

other jurisdictions such as the Central Bank of

Bahrain and the Central Bank of Sudan in on capacity

building and mutual co-operation. The CBN is also a

full council member of the IFSB, and a founding

member of the International Islamic Liquidity

Management Corporation (IILM).

The CBN’s membership and participation in the IILM

initiative provides a veritable platform for

addressing the anticipated liquidity management

challenge for Islamic banks in Nigeria. The over-

arching objective of the CBN is to enable newly

licensed Islamic banks and windows start up their

operations devoid of any operational impediments,

thus enhancing their safety and soundness as well as

facilitating the orderly growth and development of

the nascent Islamic banking sector in Nigeria.

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Section 7: Conclusion

I have attempted to give an introduction to non-interest (Islamic) banking in Nigeria and the approach to its introduction by various regulatory authorities and marketoperators; the global approach to the regulation of this industry and what the Central Bank has put in place so far for its regulation. I then identified what I regard to be the major challenges and the possible way forward, which concludes the paper. I hope the points raised will serve as anchor points for further discussions with regards to the topic presented in the paper.

Thank you very much for your attention.

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