Impacts Of COVID-19 on the Islamic finance industry In Nigeria

This article is a chapter out of the e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" that is available as a pdf download from HERE. Read the article in the e-book for the complete set of tables, charts and references. 

Unlike the 2008 financial meltdown which affected mainly the financial sector, the COVID-19 crisis has hampered real economic activities such as farming, trading, manufacturing and other businesses. It also affects households.

In Nigeria, the government has taken several measures to mitigate the negative consequences of the crisis. The government projected its budget on $57 per barrel and 2.18 million barrels per day. Upon the outbreak of the disease, it reviewed its budget and quickly offered stimulus to Lagos State, the epicentre of the disease, 10 billion nairas ($25.6 million) and additional 5 billion nairas ($12.8 million) to the Nigeria Centre for Disease Control (NCDC). Various stimulus packages of about 3.5 trillion nairas ($9 billion) were later announced by the Central Bank of Nigeria (CBN). These were targeted at households, businesses, manufacturers and healthcare providers to support efforts to fight COVID-19 and to build a more resilient and more self-reliant Nigerian economy.

The disease affected 2,170 people in Nigeria, with 68 deaths, as of May 1. However, 351 persons were discharged after full recovery, also as of May 1.

Overview of Islamic finance in Nigeria

Nigeria is Africa’s largest economy and most populous country with more than 55% of its total population of over 200 million being Muslims. The majority of Nigerians live below the poverty line of $1.90 a day, mainly due to the problem of financial inclusion2. Though the effort to establish Islamic banking in Nigeria has a long history of struggle, the industry started with the first full-fledged Islamic bank opening in 2011 with the approval of a regional license by the Central Bank of Nigeria.

In Nigeria, Islamic banking is relatively new in the country’s financial system. The release of the Bank and Other Financial Institutions Act 1991 as (amended 1997, 1998, 1999 and 2000) provided a legal  impetus for the evolution of Islamic banking in the country’s financial system. Nigeria`s Islamic finance industry largely depends on constitutional provision and guidelines from relevant regulators. The Central Bank of Nigeria, National Insurance Commission (NAICOM) Securities and Exchange Commission (SEC), Nigeria Deposit Insurance Corporation (NDIC) and Pension Commission (Pen- Com) have been issuing related guidelines on the modalities and operations of Non-Interest Financial Institutions in the country.

In April 2003, Jaiz International Plc was registered as a Special Purpose Vehicle (SPV) to offer Islamic financial services in Nigeria. Jaiz Bank was established as a full-fledged non-interest bank, after increasing its capital base from 2 billion nairas to 25 billion nairas in December 31, 2005. By November 2011, the bank received its final approval and license granted by the CBN, in order to operate as a regional full-fledged bank. The bank started full operations on January 6, 2012 and has been growing ever since. In 2019, the second full-fledged Islamic bank, Taj Bank, was also issued a regional license. With regards to Islamic windows, the CBN required that all conventional banks with Islamic windows establish a separate and self-accounting Islamic banking department, with designated management as contained in the CBN Guidelines for the Regulation and Supervision of Institutions Offering Non-Interest Financial Services in Nigeria. Subsequently, Islamic windows of conventional banks were opened by Stanbic IBTC (albeit reversed its decision few years later), Sterling Bank Islamic Window and more recently, Zenith Bank Non-Interest window.

Takaful companies started to spring up such as Niger Insurance, Halal Takaful, Cornerstone Takaful, Noor Takaful, the first full-fledged Takaful Company, Jaiz Takaful and recently Salam Takaful Insurance.

Impact on Islamic banks

Islamic finance has significant market potential in Nigeria but in spite of the increasing patronage of Islamic financial products, the bulk of small businesses are not being effectively served.

The recent initiative by Jaiz Bank to establish a dedicated department targeting micro, small and medium enterprises (MSMEs) will go a long way to contain the difficult situations faced by the sector. Jaiz Bank through its MSME department has disbursed over 4 billion nairas from May 2019 to December 2019 with average of 500 million nairas monthly. This promotes equitable distribution of wealth and income in the society. The existing level of non-performing loans (NPLs) stands at barely 1%, far below the CBN threshold of 5%.

Jaiz Bank’s success in this sector prompted the Bank of Industry (BoI) and Development Bank of Nigeria (DBN) to approach it with more funds on a non-interest based arrangement. In fact, during and post COVID-19, this MSME product would remain unique and give a cutting-edge advantage to the bank in promoting small-scale businesses.

The operation of Islamic banks is adversely affected by the crisis. In the first place, the financial system and money markets are allowed to operate amid lockdowns in major cities, albeit on a skeletal setup. According to the President of the Federal Republic of Nigeria, the sectors that are exempted are food processing, distribution and retail companies; petroleum distribution and retail entities; power generation, transmission and distribution companies; and private security companies.

The banks were required to identify pharmaceutical firms for onward distribution of loans worth 1 billion nairas for the supply of medical equipment. The central bank has given a one-year moratorium for repayment effective from March 1, 2020. The Commercial Agricultural Credit Scheme (CACS) and Paddy Agricultural Scheme (PAS) with the loan of 100, 000 nairas to 500 million nairas are among the affected schemes. According to the regulator, the moratorium is only for loans made in the health sector or through the central bank or BoI interventions as in the case of CACS and PAS. Yet Islamic banks, particularly Jaiz Bank, has given the facility based on murabahah at 13% profit. The contract is now concluded. The lending has Shariah implications on the transactions. First, the bank is not allowed by Shariah to change the concluded transactions. Secondly, if there is a need to give subsidies to customers and to avoid falling into Shariah risk, it has to be unilaterally done by the bank perhaps through rebate.

Customer services have become difficult in all banks, as crowds are not allowed in the banking hall, yet, outside the banking hall there are still crowds where restrictions for movement policies are not made. Profitability and business development have been negatively affected as all the marketers were asked to work from home especially at the Head Office where there is total lockdown. This gives room also for business risk as what is projected by the bank in terms of profits and cash flow could not be attained. Moreover, there is default issue as those with facilities without salary or markets for their businesses could automatically default the repayment.

Through its corporate social responsibility and under the Coalition against COVID-19, a private sector initiative, Jaiz Bank supports government efforts with 100 million nairas during the pandemic while Taj Bank, though new, donated the sum of 50 million nairas. Jaiz Bank also took out radio jingles advising the public on safety measures against COVID-19. Other non-interest windows were required to donate in order to mitigate the crisis. This is necessary because according to the Central Bank Governor, “to procure all needed equipment, material, and all infrastructure needed to fight this pandemic, over 120 billion nairas need to be raised.”5 A total of 37 donors comprised of individuals and institutions have contributed 15 billion nairas as at April 2, 2020 as reported by the CBN.

Impact on microfinance banks

With a total of 898 microfinance banks, out of which 20 were granted national licences, 40 were given state licences, and the rest operating as units, the country stands a good chance to achieve financial inclusion. However, these banks are quite unevenly distributed across the country with the northern part where Muslims are in majority, having a lower number compared to the south. This is particularly due to the dealing in riba by the microfinance institutions and nonchalant attitude of the central bank to consider the need of the majority of the people in providing timely alternatives to interest-based microfinance banks.

With the emergence of the COVID-19 crisis, like the banking sector, the microfinance banks are allowed to operate on a skeletal level to offer essential services. The sector has not received proportionate support despite its being close to the people. For instance, the government injected 950 billion nairas to deposit banking to mitigate the crisis. At the same time the central bank, through its Nirsal Microfinance Bank, provides 50 billion nairas in stimulus packages to micro and small entrepreneurs at 5% interest rate. The same was not provided to other commercial microfinance banks in the country. This unequal opportunity has a long-term effect on the sector in particular and the economy in general.

In fact, the Nigerian Association of Microfinance Banks has requested 50 billion nairas. This is in addition to the need for relaxing the conditions of restructuring microfinance banks. Previously the government raised the capital of national microfinance banks from 2 billion nairas to 5 billion nairas, state microfinance from 100 million nairas to 1 billion nairas and unit microfinance banks from 20 million nairas to 200 million nairas. The deadline for meeting these requirements was put at April, 2021.

However, the Association has now requested the central bank to extend the deadline to April 2023 when businesses are expected to be fully recovered from the COVID-19 crisis. The Development Finance Unit of the central bank was said to review all the guidelines for the central bank interventions to include Islamic options. Unfortunately, this is taking a much longer time than expected.

Luckily, many microfinance banks are using technology to offer their products and services. With the total lockdown, and skeletal operations, internet windows, point of sales terminals (POS), and other electronic services can still serve customers. This is widely applied between Islamic and conventional microfinance banks except some state microfinance banks that are operating manually and to some extent inefficiently.

However, what is becoming a challenge for Islamic microfinance banks is physical recovery. For instance, according to the MD of Tijarah Microfinance Bank, the first Islamic microfinance in Nigeria, every Friday they used to go out to the field to recover financing before the pandemic. However, when the pandemic hit the country, this became difficult. According to him, without close monitoring, many customers are likely to default. The money would even be diverted to another sector. Thus, at the moment, no funds mobilization and no investment can be made. Unlike conventional microfinance banks that can buy treasury bills, Islamic microfinance banks cannot do so.

Impact on Islamic capital markets

Before the emergence of COVID-19, Nigeria`s capital market was performing moderately well in terms of volume of transactions and returns on equity and shares’ dividends.

However, the market is largely interest-based with the Securities and Exchange Commission (SEC) targeting to increase the total market share of Islamic capital market to 25% by the year 2025. The ten-year master plan is intended to boost the development of the Non-interest Capital Market master plan by providing clarity of vision and set objectives that can positively impact on market capitalization. It is also aimed at ensuring that the market is well-positioned to support Nigeria’s economic development by providing alternative sources of long-term financing.

Currently, new issues approved by SEC have been suspended. There is panic in the market which caused investors to develop negative sentiments and trigger sell-off since February, 2020. Some investors have shifted to Forex as the central bank further devalues the naira, while many others migrate to BitCoin, despite a lack of concrete legal and regulatory framework for cryptocurrencies. The market closed the first-quarter of 2020 with a loss of 2 trillion nairas in market capitalization.

Specifically, in the Islamic capital market, the much expected Federal Government Sovereign Sukuk for the third tranche has been suspended indefinitely. Issuance now strictly depends on the new structured Year 2020 budget. However, there was timely payment of the rentals in March, 2020, amidst the COVID-19 crisis for the first tranche of sukuk issued in 2017. This is commendable from the part of the government and this, of course, has been part of the characteristics of Islamic finance i.e. fulfilment of promise.

In addition, the pandemic also necessitates the indefinite suspension of discussion on a Sub-national Sukuk issuance by one of the states of the federation. Previously, in 2013, Osun State issued the first sukuk worth 11.4 billion nairas for construction of 27 ultra-modern schools. The issue was oversubscribed. The Osun sukuk will soon mature and the last tranche of payment is due in October, 2020. Since the Osun sukuk, there has not been much attempt by other states with regards sukuk issuance. The two sovereign sukuk serve as benchmarks for sub-national sukuk.

Also affected by the COVID-19 pandemic is the suspension of the regular engagements among stakeholders in the sector through the Nigerian Association of Islamic Financial Institutions (NAIFI). Some of these players include non-interest based mutual funds such as Lotus Capital, Buraq Capital, Metropolitan Skills, and LCM Consult Nigeria Limited. The central bank allows Non-Interest Financial Institutions to open their pension funds based on guidelines available from the regulator.

The aforementioned developments negate the effort to the Islamic capital market sector in Nigeria in terms of products and services and the quest to increase financial inclusion.

Impact on non-bank financial institutions

The crisis has affected institutions such as pension funds, takaful, zakat, waqf and other non-bank financial institutions.

Takaful

There are currently five full-fledged takaful companies, and the sector has an exceptionally low penetration rate. This crisis perhaps provides opportunities for organizations to mitigate their different risks. Post COVID-19, there would be an increase in subscriptions, particularly in the health sector and businesses. On April 12, 2020, Salam Takaful, as part of its CSR, donated 10 million nairas to Kano State Government and instituted 40million nairas takaful coverage to health workers on the front line in the fight against the virus.

Pension fund assets are basically domiciled in either retirement savings accounts (for contributions under the Contributory Pension Scheme) or legacy funds (for employers who maintain Contributory Defined Benefit Scheme). The global outbreak of COVID-19 since December 2019 and more recently in Nigeria around February 2020 has eroded the values of the funds in both RSAs and Legacy Funds accounts due to negative returns and inability of some employers to continue regular remittance. The erosion in the balance is simply attributed to the effect of the pandemic on the global financial markets and hence Nigeria’s financial market is not immune from the shock and its subsequent adverse effect on the market. Pension assets are all invested in different portfolios in the market and the yields have drastically dropped on bonds, rates are being cut, stock prices have crashed, and the value of pension assets is facing the heat.

With regard to Islamic financial instruments, despite the long existence of guidelines for investment of pension fund assets in non-interest financial instruments in Nigeria, the limited number of investment vehicles has restricted the ability of pension fund administrators to channel some portion of the funds. In 2019, the National Pension Commission added an asset class to the multi-fund structure named  “Fund 6”. This class is to enable contributors with ethical concerns to have their pension contribution invested in a non-interest financial instruments. However, the asset class is yet to start functioning as PFAs await further guidelines from the commission.

As at December 31, 2019, the total pension fund asset stood at 10.2 trillion nairas, with investment in sukuk representing 0.82%. Investment in domestic ordinary shares amounts to 5.41% of the funds. There is no clear filter as to which stock in the portfolio can be regarded as fully ethical or Shariah- compliant, there exist stocks of companies whose activities and line of operations do not violate provisions of the Shariah.

Zakat and waqf

With regard to zakat and waqf institutions,states and NGOs are making efforts to contain the crisis with limited mobilized funds at their disposal.

For instance, Zakat and Sadaqat Foundation, in addition to other measures, produced hand sanitizers for distribution, Kazaure Zakat Committee distributed zakat worth 34 million nairas, Sokoto State Zakat and Endowment Fund continue to support the poor virtually every day with full support of the government. The recently approved Association of Zakat and Waqf Operators in Nigeria (AZAWON) headed by the Sadaukin Sakkwato, Muhammad Lawal Maidoki, the Executive Chairman, Sokoto State Zakat and Endowment Commission has been working hard to provide direction and reposition zakat and waqf before, during and post-pandemic period through awareness creation, advocacy and leading by example.

Some foundations have generously donated to federal and state response funds. For instance, Dangote Foundations, owned by the richest man in Africa, Aliko Dangote, donated 1 billion nairas at the national level and set up 600 beds in isolation centres in Kano State, the largest Muslim population state in West Africa. Many other individuals and companies have also contributed to the fund as stated earlier.

Recommendations

1. The Federal Government should collaborate with reputable financial institutions and grassroots organizations to distribute palliatives to people especially at lower level in a transparent manner.
2. The Central Bank of Nigeria (CBN) should appreciate the sizable number of Muslims and provide adequate facilities to serve their needs and deepen the financial sector in the country.
3. The CBN should evaluate its interventions to ensure fairness and effectiveness among all citizens. Currently, the CBN’s circular on 1-year moratorium on principal repayment of loans, interest rates reduction on all its intervention facilities (from 9% to 5%), 50 billion nairas credit to affected households and SMEs and the 1 trillion nairas stimulus advanced to boost manufacturing, are mainly advantageous to conventional financial institutions, thus leaving the non-interest financial institutions behind. There is therefore the need for the CBN to further consider the Islamic financial institution in its intervention programmes, giving their peculiar nature and modes of operations.
4. In the capital market, there is currently a move to restructure especially mid-term bonds from 7 to 10 years, given the current economic realities. This is to avoid default. Similar attention should also be given to the sovereign sukuk issued, given the current realities on the ground.
5. Regulators in the capital market sector should further resume engagement with the federal government on the proposed third tranche of the sovereign sukuk. This will further strengthen investors’ confidence in the market.
6. The legislatures – both Federal and States - should enact a comprehensive law for robust Islamic finance in Nigeria.
7. Educational institutions should collaborate and offer training and capacity building on non-interest finance to various categories of people in society to promote wider application of Islamic finance thereby increasing wealth circulation in the society.
8. The Federal Government, through the Ministry of Finance should work with the multilateral Saudi- based Islamic Development Bank to address infrastructure needs such as housing, electricity, and jobs creations post COVID-19.
9. Zakat and waqf agencies should come up with programs and projects to support low income households and their businesses for sustainable development.

The full e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" is available as a pdf download from HERE. The e-book is published by Indonesia's Islamic Finance and Economy Committee (KNEKS) in partnership with DinarStandard and Salaam Gateway. It was launched on May 27, 2020. The 12 countries covered are: Bahrain, Bangladesh, Brunei, Indonesia, Iran, Malaysia, Nigeria, Oman, Pakistan, Saudi Arabia, Turkey, and UAE.