March 14, 2008: Islamic banking is set to take off in Kenya following the commencement of operations by the country's first fully fledged Islamic bank targeting Kenya's estimated nine million Muslims.

The entry of Gulf African Bank brings to an end months of waiting and speculation surrounding the licensing of an Islamic bank in the Kenyan banking system. Debate had raged on the viability of an Islamic bank in the banking system where interest is charged by all players, a prohibited practice in Islam.

But with two branches and expansion plans underway that will see Gulf African Bank step up its operations in Kenya as well as the region, Salim Abdalla, the bank's chief executive officer, is confident that the bank's model is a sure success.

"There is a huge market niche in Islamic banking that needs to be filled and we are looking forward to meeting this market's needs," said Mr Abdalla.

Gulf African Bank is offering corporate banking, housing finance, car finance, retail banking products as well as other services that conform with tenets of Islam, which are available to any individual or outfit seeking an "alternative" banking solution.

The Islamic bank boasts of a capital base of Sh1.7 billion with private equity firm Istithmar World, BankMuscat International, PTA Bank,United Arab Emirates investment firm GulfCap as well as leading local and international investors forming the firm's main shareholders.

Banking analysts had raised queries on the viability of a fully fledged Islamic bank in Kenya.

One major issue is that since all conventional banks participate in the interbank market where interest is charged on borrowing, an Islamic bank would find it somewhat difficult to operate since it goes against the tenets of Islam to charge interest.

But while agreeing that a fully fledged Islamic Bank would find it difficult to operate in the Kenyan banking scene, Hassan Zubeidi chairman of Dubai Bank last year insisted that such a bank would be able to transact with other such banks in other countries especially in the Middle East.

In most jurisdictions where Islamic Banks operate, they co-exist alongside conventional banks. Iran and Sudan are considered to be the only countries that have only Islamic Banks in existence.

Another Islamic bank, First Community Bank which has links with Kuwaiti investors is yet to commence operations as a fully fledged Islamic Bank despite obtaining a license last year.

The Central Bank says one of the critical considerations in assessing the licence applications for First Community Bank was ability to operate viably in the existing banking sector environment.

Interest in Islamic banking follows the amendment last year of section 53 of the Banking Act, removing prohibitions on trading in and holding of fixed assets.

The amendment was intended to promote the introduction of innovative products in the banking sector, including Islamic Banking products that may require an institution to hold a fixed asset, such as in the case of mortgage financing, or goods or commodities in the case of consumer lending.

An indicator of the potential of Islamic banking, in 2006, Barclays Bank of Kenya is understood to have attracted nearly Sh560 million from traders in the community through the introduction of La'riba account.

The Central Bank, however, cautioned that Islamic Banks will operate within the existing legal and regulatory framework, a challenge that Mr. Abdalla says Gulf African is up to.

"Before giving us a licence the CBK asked hard questions and went on fact finding missions in other countries such as Nigeria and Malaysia to see how other banks operate alongside conventional banks," says Mr. Abdalla.

Globally, HSBC and UBS have created separate brands for their Islamic offerings while others such as the Maybank in Malaysia and Samba Financial in Saudi Arabia have opened special branches that sell only Islamic banking products.

Research carried out by Mckinsey & Company in partnership with the World Islamic Banking conference however points out the operational complexity of Islamic banking products in comparison with those offered by conventional banks.

Documentation, management of credit risk and breadth of transactions involved in Islamic bank products were some of the challenges highlighted.

To mitigate these complexities, Mckinsey recommends that Islamic banks need to pay greater attention to three identified pillars of successful operations: cost attainment, fast processing times, and low error rates.