Islamic banking in Nigeria Explained

Islamic banking has emerged as a compelling alternative in Nigeria. It weaves its ethical threads into the nation’s financial fabric. Islamic principles prioritize fairness, transparency, and risk-sharing in banking. This approach fosters a more equitable and transparent financial ecosystem. Profit-sharing models replace interest, aligning financial transactions with real-world economic activities.

This blog post discusses Islamic banking in Nigeria, covering all necessary information.

What Is Islamic Banking System in Nigeria?

Islamic banking in Nigeria has seen significant growth. This growth is especially due to the establishment of institutions like Jaiz Bank. It is the first Islamic bank in the country. Jaiz Bank began operations in 2012. Islamic banking operates under Sharia law, which prohibits interest-based transactions. Islamic banks do not earn interest. Instead, they engage in profit and loss-sharing arrangements with their clients.

In Nigeria, Islamic banks accumulate funds through depositors’ accounts. They use these funds to finance businesses. The bank, the entrepreneurs, and the depositors share the profits from these business ventures. This aligns with the principles of equity participation. This means that the banks also share in the business risks.

Forms of Islamic Banking in Nigeria

Islamic financing is of two types. They are:

  1. Profit and loss sharing (PLS) or participatory modes
    1. Musharakah.
    2. Mudarabah.
  1. Purchase and hire of assets and services on a fixed return basis
    1. Murabaha.
    2. Istisna.
    3. Salam.
    4. Leasing (ijarah).

How Do Islamic Banks Operate?

Islamic banks operate based on principles of Islamic law (Sharia). These principles significantly differ from traditional banking systems. Here are the key aspects of how Islamic banks function:

1. Prohibition of Interest (Riba)

Islamic banking strictly prohibits the payment or receipt of interest. This is a fundamental difference from conventional banking. Interest plays a central role in most financial products and services there.

2. Profit and loss sharing

Islamic banks engage in profit and loss sharing arrangements. They do not earn interest on loans. When a bank provides funds for a business venture, it becomes a partner in the venture. The bank and the entrepreneur share profits according to a pre-agreed ratio. Losses are shared based on the amount of capital each party has contributed.

3. Asset-backed financing

Transactions in Islamic banking are typically asset-backed. This means that money is advanced not as a loan, but for the purchase of goods or assets. These are then leased or sold to the client.

  1. Types of Islamic Financing Instruments:
    • Musharakah: A joint venture where all partners share the profits and losses. The bank and the customer contribute capital to a venture and agree on a profit-sharing ratio.
    • Mudarabah is a partnership. One party provides capital. The other provides expertise and management. Profits are shared, but losses are borne only by the capital provider.
    • Murabaha is a cost-plus-profit arrangement. In this arrangement, the bank buys an item and sells it to the customer at a higher price. This allows the customer to pay back in installments.
    • Ijarah: Similar to leasing, where the bank buys an item and leases it to a customer for a fixed rental payment.
    • Sukuk are Islamic bonds. Investors receive a share of the asset, along with the commensurate cash flows and risks.

4. Ethical standards

Islamic banks are also committed to ethical standards and social responsibility. They avoid financing businesses that are considered harmful to society. This includes those involved in alcohol, gambling, or arms.

5. Risk-sharing

Islamic banks don’t charge interest. They share the risks of their investment and financing activities with their customers. This can lead to a more cautious approach to lending.

6. Deposit and profit-sharing accounts

Islamic banks offer deposit accounts. Depositors share in the profit/loss of the bank’s investments.

How Many Islamic Banks Currently operate in Nigeria?

Nigeria has many Islamic banks operating currently. However, here are the most popular ones:

  1. Jaiz Bank (Islamic bank)
  2. Stanbic IBTC
  3. Taj Bank Ltd. It offers personal and corporate banking products, investment services, and treasury services.
  4. Sterling Bank Plc. It offers Shariah-compliant financial services.

Conclusion

Islamic banking in Nigeria is experiencing rapid growth. The number of Muslim citizens in Nigeria is over N80,000,000 million. As a result, the growth of Islamic banking is expected to continue. This would result in economic growth for the country. It would also lower interest rates on loans. A major highlight of Islamic banking is its strict use for ethical purposes only. 
Categories: Finance
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