Shylock: “We trifle time: I pray thee, pursue sentence”
Portia: “Take then, thy bond, and take thou thy pound of flesh.”
The Merchant of Venice, Act 1, Scene 4, William Shakespeare.
The above tense exchange between the merciless merchant, Shylock, and the Judge, Portia, in William Shakespeare’s 16th Century drama, The Merchant of Venice, depicts the moneylender’s desperation for interest, figuratively described as the “pound of flesh.” Life has certainly moved on from the Shakespearean era, however, contracts are still the order of the day. For emphasis, sentient parties, and nations, freely enter into legal contracts and are bound by the terms therein in the normal course of commercial relationships. However, what is meant by “normal course”?
It invokes the proposition that all contracting parties have the legitimate capacity to contract, legality, a scrupulous understanding of all the terms, determinate consideration, the absence of undue influence, unfair terms and oppressive conduct; and that each side would fulfil his/her/their part of the bargain. That is the ideal. Yet, in the real world, contractual relationships are complex and oftentimes negate “the ideal.” Change is a constant in the natural order, so contracts, and contracting parties, are impacted by that dynamic.
To illustrate, country A, negotiates an agreement, containing an arbitration clause with an international engineering consortium, XYZ. This was for the construction of an overhead metro-line to ease crippling transportation problems over a five-year period worth $250 million, in its largest metropolis, B, home to 15 million persons! XYZ incurred significant capex upon commencement. Barely, two years into the contract, the democratic government of country A is toppled by a vicious military dictatorship, and the contract with XYZ is revoked!
XYZ commences arbitral proceedings against A, in New York, pursuant to the dispute resolution clause therein; seeking, inter alia, lost earnings, compounded interest and related quantum meruit claims.
XYZ’s claims were anchored upon the fatal breach of contract caused by A because: 1.) the violent change of administration was entirely unforeseen; 2.) government is a continuum, and; 3.) it fully honoured its contractual obligations and delivered every agreed milestone until the material breach. XYZ won the case.
A faces crippling costs and interests totalling over $450 million which will, ultimately, be borne by the ordinary taxpayers. Crucially, the inhabitants of metropolis B, continue to wallow in transportation misery because there is no metro-line!! This is a rather simplistic example however, it illustrates the challenges surrounding interest rates in major commercial contracting, which here, is already at 80 per cent. The conundrum traverses other kinds of contracts.
These complexities further highlight the inherent tension in financing models. Thus, pacta sunt servanda is a fundamental kernel of classical contract law, which intreats the binding nature of agreements. That is to say, contracting parties sink or swim by the terms of their binding and legally-valid contracts, including harsh penalty clauses and onerous interest charges for defaults. A phenomenon which accords with the free market orthodoxy of capitalism.
Because, of course, lending institutions, and indeed all commercial entities, exist primarily to make profits and return on investments for shareholders. The logic therefore, is impeccable: how on earth can they be profitable if they cannot lend money to people, entities and nations, applying commercially viable interest rates?! Afterall, they are not charitable organisations and do not pretend to be.
However, a strict application of this principle, evidenced in the aforementioned example, exposes an unfairness in that ordinary people, and by extension, developing nations, and poorer countries, with, invariably, weaker institutions and systems, ultimately bear the brunt of corruption, poorly drafted contracts and force majeure, which vitiate the purposive aims of contractual agreements and execution therein.
The emanating question then is: should financing models within contractual agreements ignore the unintended consequences of crippling debts on people, entities and nations; the environmental, social and governance impacts, without more, where those persons have scrupulously acted in good faith? No! Society is dynamic, so are forward-looking, innovative contracts, financial models, and nature abhors a vacuum.
Accordingly, whether wittingly, or unwittingly, Islamic financing ushers, in both global, and domestic finance, an interesting model. It demands all the established due diligence protocols, robust identity checks and verification; sound credit reference agency assessments; security evaluations, the capacity to borrow relative to existing gearing obligations, repayment risk assessments, prudential lending, commercial and international best practice; and regulatory compliance.
However, and importantly, there is no interest “riba” element irrespective of whether it is paid or received! So, as the name suggests, Islamic finance is underpinned by the jurisprudence of the Islamic religion and a strict moral code. Essentially, it is characterised by the key principle that money, in of itself, has no intrinsic value, and should be utilised strictly for legitimate and productive purposes.
Thus, wealth is generated through investments in lawful assets, endeavours and investments. Applying this model, investments in alcohol, gambling and tobacco are strictly forbidden, because they contravene Islamic jurisprudence on ethics and morality. And one does not have to subscribe to the Islamic faith to utilise Islamic financing. It is hardly surprising therefore to find its adoption in constitutionally secular countries like Nigeria, ditto countries with non-Islamic foundations like the United Kingdom, Luxembourg, South Africa and Hong Kong.
The Islamic finance industry has grown at approximately 11 per cent annually with financial assets estimated at $2 trillion traversing bank and non-bank financial institutions, capital markets, money markets and insurance takaful. The World Bank asserts that Islamic finance is “equity-based, asset-backed, ethical, sustainable, environmentally and socially responsible fine. It promotes risk sharing, connects the financial sector with the real economy, and emphasises financial inclusion and social welfare.”
The bank also emphasises that: “as the 2008 global financial crisis ravaged financial systems around the world, Islamic financial institutions were relatively untouched, protected by their fundamental operating principles of risk-sharing and the avoidance of leverage and speculative financial products”
In Nigeria, Islamic financing appears to be gaining a significant foothold upon the evidence of a three-year trend analysis. Total external debt in Q3, 2021, comprising multilateral, bilateral, syndicated and commercial loans was $37.95 billion, of which the Islamic finance element was $32.07 million or 0.08 per cent. In the same period in 2022, the external loan stock was $39.66 billion, of which the Islamic finance component was $124 million or 0.31per cent.
Whilst for the concurrent period in 2021, the external gearing quantum was $41.59 billion, comprising $236 million in Islamic finance or 0.56 per cent. And, Nigeria has the largest Islamic finance compliant bonds Sukuk in Africa worth $1.6 billion.
In South Africa, in March 2019 including, and through, March 2021, Islamic banking deposits grew by 41.51 per cent contrasted by a 15.16 per cent growth in conventional banking deposits. Plus, over the 12 months to Q4, 2021, deposits taken by Islamic banks increased by approximately 7.3 per cent whilst financing increased by approximately 13 per cent globally according to Statista.
That notwithstanding, Islamic finance is only as effective as its weakest link and has its drawbacks. For example, the absence of interest, the Shakespearean “pound of flesh” or, “riba”, in the financing model is not to be equated with the absence of profit. So, expectations have to be carefully managed in that department.
Islamic finance and profits are not mutually exclusive. Likewise, the low awareness of Islamic finance amongst the general populace is a constraint to its wider development in emerging markets.
In Nigeria, some analysts have questioned whether there is in fact a level-playing field between Islamic banking and traditional banking on the premise that more favourable prudential requirements underpin Islamic finance development. According to Fitch Ratings, the Central Bank of Nigeria (CBN), has set: “the regulatory liquidity ratio for Islamic banks (10 per cent) much lower than for conventional banks (30 per cent). CBN also grants Islamic banks a 50 per cent “alpha factor” which is a discount in the calculation of risk-weighted assets, but none for conventional banks. This provides a sizable uplift to Islamic banks’ capital ratios, and allows Islamic banks to capture market share with less capital constraint on growth”
Summing up, the attraction of Islamic finance in developing countries, and global financing, affords an alternative to the traditional interest-laden financial models upon which orthodox free market economies thrive. Increasingly, many nations, and people, irrespective of whether or not they possess an Islamic patrimony are enthused by, and therefore support, the ethical and jurisprudential foundations of Islamic finance insofar as it forbids unfairness, and investments in alcohol, gambling, tobacco and speculative products.
In the developing countries in particular, the absence of interest in Islamic finance is a major pull-factor. Because they will necessarily save billions of dollars, which could immediately be redirected to critical education, healthcare, security, transportation and welfare priorities.
Given the greatest wave in global interest rates in 40 years, developing countries, with invariably weaker institutions, and sub-optimal socio-economic metrics, spent $443.5 billion in servicing their external public and publicly guaranteed debt in 2022 alone, according to the International Debt Report. That is plainly unsustainable and raises important policy questions in those countries over the medium to longer-term.
Be that as it may, as with traditional financing, Islamic financing does not obviate the necessity for ethics, financial prudence and regulatory compliance. On the contrary, it simply reinforces it. Still, one thing is certain; it will not be business-as-usual.
Ojumu is the Principal Partner at Balliol Myers LP, a firm of Lagos-based legal practitioners and author of The Dynamic Intersections of Economics, Foreign Relations, Jurisprudence and National Development.
