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Algeria turns to Islamic finance to prop up economy

Algeria's economy has caused political instability [Getty]

Date of publication: 16 August, 2020

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Algeria has launched Islamic finance product s to attract more money, but bankers warn it isn't enough to fix the country's economy.

Algeria has launched Islamic finance products in a bid to attract money from the informal market, but bankers warn it will take more to fix the country's struggling economy.

Falling oil prices and the coronavirus pandemic have battered the North African country, triggering alarm bells among officials and experts.

The International Monetary Fund (IMF) forecast that Algeria's economy will shrink 5.2 percent this year.

Prime Minister Abdelaziz Djerad has warned of an "unprecedented economic situation", and experts have estimated unemployment at nearing 15 percent.

In Algeria, Africa's largest nation and home to 43 million people, most transactions are done in cash circulating outside the formal banking sector, said professor Mohamed Boudjelal, an expert on Islamic finance.

Many Algerians "turn their nose up" at conventional banking, Boudjelal said.

Some Muslims believe that the traditional banking system is incompatible with their faith.

Islamic finance -- the provision of financial services in accordance with religious laws -- is a fast growing sector that has been adopted in many Muslim countries.

The industry is based on shared profit and loss, while earning interest is banned as "usury".

Funds are also blocked from investing in companies associated with tobacco, alcohol, pork or gambling.

Algeria is hoping the new products could woo new investors into the market, following the success of Islamic finance products over the past decade in other countries, notably in the Gulf and Malaysia.

No miracle solution

The country's neighbours have already rolled out similar schemes.

In Tunisia, Islamic finance has operated in the private sector since the 1980s, although the sector remains modest, while in Morocco it began in 2017, though it has recorded net losses it says are due to inital start-up costs.

But Algeria hopes to tap into the significant revenues of the informal market, estimated to be as much as $30-35 billion, according to Abderahmane Benkhalfa, a former minister of finance and ex-head of the banking association.

"It is not only necessary to draw these resources, but to inject them into banks in order to bolster the economy," Benkhalfa said.

Earlier this month, state-run National Bank of Algeria offered nine Islamic financial services, receiving a certificate from Muslim clerics ensuring they were compatible with Islamic law.

Only two other private banks, subsidiaries of the Bahrain-based Baraka Bank and Al Salam Bank, offer Islamic finance services in Algeria.

However, Algeria's other banks -- all state-run -- are now expected to follow suit by the end of the year.

Most foreign banks are also planning to sell Islamic finance products too.

But Benkhalfa, who is also a member of a panel of African experts tasked by the African Union to mobilise international funds to help the continent combat coronavirus, warned that Islamic finance is not a "miracle solution".

Only a small slice of cash in the informal economy circulates because of people's religious beliefs.

Create trust in banks

The solution, Benkhalfa argues, are to make steps to modernise the traditional banking system -- to make it more responsive -- and develop in parallel with Islamic finance.

Economist Abderrahmane Mebtoul was even more cautious in his assessment.

It is only viable if inflation can be brought under control and if households have faith in the government's management of the economy, Mebtoul said.

According to several studies, Islamic finance products are often more expensive that those provided by the traditional banking sector.

By the end of the year Algeria's state banks are expected to propose several Islamic finance products, including "murabaha", "ijara" and "musharakah".

Murabaha, or cost-plus financing, is among the most popular products, and is used to finance a variety of consumer purchases from cars to houses.

It involves the bank buying on behalf of a client a property or another product, which it sells back to the client at a certain profit that replaces an interest rate.

Ijara is a way of buying a house through a lease and subsequent ownership, rather than through a mortgage.

Musharakah is seen as a way of enabling a buyer to avoid taking an interest-bearing loan, though some Islamic scholars say it is too similar to the charging of interest.

Algerian authorities are also considering issuing Islamic bonds.

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