Islamic finance is a fast growing activity in world markets. This paper provides a survey on Islamic Finance in SSA. Ongoing activities include Islamic banking, Sukuk issuances (to finance infrastructure projects), Takaful (insurance), and microfinance. While not yet significant in most Sub-Saharan countries, several features make Islamic finance instruments relevant to the region, in particular the ability to foster SMEs and micro-credit activities. As a first step, policymakers could introduce Islamic financing windows within the conventional system and facilitate sukuk issuance to tap foreign investors. The entrance of full-fledged Islamic banks requires addressing systemic issues and adapting the crisis management and resolution frameworks. The IMF can play a role by sharing international experiences and providing advice on supervisory and regulatory frameworks as needed.

Islamic banking is a form of financial intermediation based on profit and loss sharing (PLS) and the avoidance of interest rate-based commitments and contracts that entail excessive risks and finance activities prohibited under Islamic principles (e.g. gambling and alcoholic beverages). Consequently, Sariah-compliant investments follow the structure of an exchange of ownership in tangible assets or services where money’s role is to facilitate the payment mechanism to implement the transfer. Moreover, risks are supposed to be shared among all parties: investors and entrepreneurs bear the business risk for a share in the profits.2 This contrasts with conventional banking where transactions involving interest payments are common (Chong and Liu, 2009, Kahf, Ahmad, and Homud, 1998). Under the PLS paradigm, an ex-ante lending rate in financial contracting is replaced by a rate of return determined ex-post on a profit-sharing basis. Only the profit sharing ratio between the capital provider and the entrepreneur is determined ex-ante. It is also possible for more than two parties to pool resources for investment (Chong and Liu, 2009). Such transactions do entail a number of risks but by their nature they limit asymmetric risk and moral hazard, while equity-based financing and prohibition of speculation limit risks on the asset side of a bank’s balance sheet. While a downturn in the real economy affects profitability of Islamic banks, their ability to share this risk with depositors provides a cushion against excess leverage in the financial system.3 In addition, Islamic banks are required to know the project and use of funds, leading to close relationships with entrepreneurs and the likelihood that funds are allocated for the stated investment.