The Islamic finance landscape in Sri Lanka is currently in its formative stage but is experiencing rapid expansion. While its current presence constitutes a modest fraction of the banking sector (0.5–1% of total banking assets) and the insurance sector (slightly over 1% of the insurance sector as per the Islamic Financial Services Industry Stability Report 2022),
its potential for growth is substantial. Recent developments highlight this potential, with the Securities and Exchange Commission of Sri Lanka considering the introduction of Shariah compliant instruments, including Sukuk, into the Sri Lankan capital market. NAZEEM GHAFFOOR explores
Project financing emerges as a compelling prospect within Sri Lanka. Islamic finance has been present in Sri Lanka for the past 25 years.
The banking sector is prominently represented by entities such as Amana Bank, HNB, Commercial Bank, BOC, NDB, Seylan Bank, MCB and HBL. While Amana Bank stands as a fully-fledged Islamic bank, others provide Islamic services through dedicated windows. This spectrum of institutions offers a diverse array of Islamic financing products, encompassing Murabahah, Ijarah, Musharakah and Salam.Parallelly, finance corporations including LOLC, Arpico Finance, LB Finance, CDB, Orient Finance, Commercial Credit and Peoples Leasing Company extend Islamic financing products to both individual and corporate clienteles. Islamic investment banks, exemplified by I Capital Partners, facilitate equity investments, working capital financing and project financing for commercial enterprises.
Project financing, including Islamic, is a type of financing in which lenders and investors look solely to the cash flow generated by a single project, both as the source of repayment and collateral for the loan. This type of financing is often used for large infrastructure projects, such as the construction of a new power plant or a new bridge.Project financing differs from traditional methods, drawing its feasibility from the project’s generated cash flow, rather than the creditworthiness of its sponsors. This distinct approach minimizes risk and expands access to new capital channels, setting it apart from conventional financing techniques. In an Islamic finance context, this framework guides financiers and investors to solely rely on a project’s cash flow, thus strengthening its robustness and mitigating related vulnerabilities.
Project financing highlights the strategic benefit of shifting risks from project sponsors to financiers and investors, thereby decreasing the exposure to risk for sponsors. Furthermore, this structure facilitates easy access to funding, drawing from various sources such as banks, private equity firms and other investment entities. This multifaceted sourcing model not only reduces the cost of capital but also augments the project’s holistic financial architecture.
To ensure successful project initiation, it is crucial to have a deep understanding of risk assessment, cash flow patterns, repayment schedules, tax implications and legal structures. Given its complex and specialized nature, understanding Islamic project financing requires a detailed and intricate grasp.
The comprehensive integration of financing sources — encompassing various capital forms — further mandates meticulous identification of prospective funding sources.
Takaful policies occupy a pivotal role in the realm of project financing.
The ‘Contractor’s All Risk Insurance’ emerges as a vital Takaful policy, safeguarding against physical loss or damage to project works, materials and equipment. Concurrently, the ‘Professional Indemnity Insurance’ extends coverage to consultants and advisors against potential errors or omissions in their professional services.
‘Public Liability Takaful’ indemnifies project owners against third-party bodily injury liabilities. These insurance policies are indispensable in the context of Islamic financing projects. Nevertheless, significant challenges continue to exist. In the current economic crisis, project financing can be a difficult option for many companies. Lenders and investors may be more hesitant to finance these projects. One of the major challenges in Sri Lanka is the country’s political stability which is challenging to build confidence for global market investors.
Source : IFN Islamic finance News
