Project Finance & Investment: How Non- Interest or Islamic Banking will Impact Nigeria’s Real Estate Sector and the Economy
In this article:
Ø Back ground to the study : Non-interest banking/ non-profit banking
Ø Models simulation: Drawing the dotted lines that exists between BOOT (build, own, operate, and transfer) and non-interest banking
Ø Impact and advantages of non- interest banking in Nigeria’s real estate sector and the economy
Ø Profitability of investment in real estate: Structural and operational efficiency
Back ground to the study
As it is their custom, conventional banking makes it seem as though the only way to profit in the business of commercial banking is by giving out loans and then charging the borrower a pre-defined rate of interest. Nationally and beyond, this general idea and practice of conventional banking is increasingly losing ground to the advent and rate of growth of, non-interest banking- otherwise known as Islamic Banking. As a matter of fact, there is no doubt that convention banking practice is increasingly becoming unsustainable, following the opportunities impregnated in the challenges or demands of today’s banking - and the prospect of greater challenges and opportunity in the rapidly unfolding future of the world’s economy, particularly that of developing nations like Nigeria. As such, non-interest banking is strongly shaping the banking practices, even as it is important to note that; Non-interest banking/ non-profit or non-return banking.
Globally, it is said that non-interest banking is growing at an average of 15 to 20 per cent per annum as it is increasingly being adopted in major financial centres around the world. It is, more or less, the strongest and fastest growing sub-sector of the financial system globally. Nationally, it is growing even as high as about 20 % annually - as Mr. Hassan Usman, the Managing Director/ Chief Executive of Jaiz Bank Plc said that his bank has been growing at 30% annually for the past five years.
While conventional banking just gives money to someone with the aim of gaining profit from it, non-interest banking has to partake in commercial and entrepreneurial risk to earn income. That is, they make returns by having to deal with real commodities or assets either by buying/leasing the commodity/asset and selling/sub-leasing it on credit.
The significant difference between non-interest banking and conventional banking is that the concept of the former tilts toward trading and partnership, while the latter tilts toward loans. Deducible from the difference; whilst conventional banking just gives out the loan -without partaking in the commercial or finance or entrepreneurial risk - and then charge the borrower a pre-defined rate of interest, non interest banking seeks to jointly finance and share profit or loss from their trade with their partners. That is, non-interest banking brings on board and prioritizes business risk over just financial risk.
Models simulation: Drawing the dotted lines that exists between BOOT (Build, Own, Operate, and Transfer) and non-interest banking
Non-interest banking model works how BOOT (build, own, operate, and transfer) model does. As such, in the quest of simulating the model of BOOT with that of non-interest banking, it is important to draw the dotted lines, however parallel, that exists between both models. However, we cannot possibly clearly draw the dotted lines without first building a knowledge bank you may already know about BOOT (build, own, operate, transfer).
BOOT is a form of public-private partnership (PPP) project model in which a private organization, who often having secured finance from a funding organization or by itself, builds a large development project (like real estate and its related services and assets, transportation, health services, tourism, energy, power, communication/internet and so on ) under contract ( extends from like 5 to 40 or more years) to a public-sector partner (e.g. government agency) such that the private-sector partner transfers (could be retained or renewed depending on contract) ownership to the government, either freely or for an amount stipulated in the original contract. However, in the event where public partner would like to redeem a concession from a private partner before the end of the concession, it would be at an amount stipulated in the buy-out clause in the original contract. The private partner usually charges the customers who use the infrastructure or project that's been built to realize a profit, sponsored concession. However, the returns to the private party come from government transfers - administrative concessions.
The government may not have interest operating the project herself, following the concession phase, therefore the operation is usually left to the operating company afterwards, but at an operation-renewal amount that's agrees. BOOT is sometimes known as BOT (build, own, transfer). Variations of the BOOT model include BOO (build, own, operate), BLT (build, lease, transfer) and BLOT (build, lease, operate, transfer).
To various degrees of involvement or partaking, the borrowing partner - typically an individual, large corporation or consortium of businesses with specific expertise - long-term contracts with a bank (lender) with the aim to jointly design and implement a large project. The borrowing partner may provide limited funding (known as equity) but they (lender to the bank) jointly assume the risks associated with financing, designing, constructing, owning, operating and maintain the project for a specified time, or life time of the project. During that time, the borrower and bank jointly charges customers who use the infrastructure or project that's been built to realize a profit. At the end of the specified period, the private-sector partner retains or transfers ownership to the bank, either freely or for an amount stipulated in the original contract.
The joint or shared responsibility by both parties, fully or partly, through the specified run-time or life-time of the project slightly differentiates non-interest banking model from the traditional BOOT model which leaves only one party (private sector) to assume the risk and charge the users or public party to make profit. In this regard, non interest banking model can be better described in the light of JBOOT (Joint build, own, operate, transfer) arrangement where a private or public party partners with a bank with the aim of funding a project under a ‘term and reversionary’ agreement that affects the valuation (capitalization) of the income-flows of the project. However, the JB factor which represents joint build as described in JBOOT can be adapted into the variations of the BOOT model which may give birth to a partnership arrangement like; JBOO (joint build, own, operate), JBLT (joint build, lease, transfer) and JBLOT (joint build, lease, operate, transfer) , and so on.
Impact and advantages of non- interest banking on Nigeria’s real estate sector and the economy
Let’s assume a real estate investment project is the reason why a borrower, maybe an expert in real estate business, has gone to the bank to assess a loan. The conventional banks only assume the financial risk by just giving the borrower a loan and then charge him a pre-defined rate of interest over a specified period of time. But in the case of non interest banking, business risk is assumed, and eventually the financial risk. In other words, the lending bank and the borrower jointly design and implement a large real estate project. That is, they jointly finance, design, construct, own, operate and maintain the project for a specified time or life-time of the real estate assets.
The importance or resultant of these private -partnership, I.e. partnership between the real estate investors (borrowers) and the non interest banking (lenders) on Nigeria’s real estate sector as a whole is quite interesting to note, given that real estate is a fixed asset and it is one of the most important store of value today and also one of the most important components or fundamentals of a national and global economy. Real estate and its related services/assets sector are the top-most demanded projects by people, given their basic-need to humans. As such, a nation that lacks a growing and sustainable real estate sector will inevitably be poor and consequently have an under-developed economy that cannot easily be improved or recovered.
In corollary, the effects of the partnership estate investors (borrowers) and the non interest bank (lenders) on our real estate sector is even more dynamic, considering that the inter-industrial relationship between the real estate sector and finance-investment in economies all over the world is dominant and increasingly progressive. Reasons being that the huge funds required for real estate transaction purposes are secured from banks, even as real estate is the most globally accepted collateral by banks in giving out loans. And so, when the banks of a nation are financial tightened and consequently has quite limited funds to release for real estate investment, the economy will inevitably experiences a down turn and may go into recession.
However before we go on to discuss the aforementioned importance, it is necessary to discuss why or how aptly the use of the simulation of (J)BOOT with non-interest banking model suits the development of real estate and its related services in Nigeria which is the fact that BOOT is a private-funding model, majorly for heavily demanded projects or services, like real estate and its related services that require highly-skilled workers, a significant cash outlay and a suitable accountability to get started and completed. The heavy demands of these projects are consequence of their need by the majority of people- the public- who often pay for using the provided project or service.
Other than the common benefits derived from allocating shared risk and integrating resources, there is no gain saying that non-interest banking can address some of the key structural and operational reasons why projects embarked on and delivered solely by the borrower (without technical input from the banks) often fail. The implication of a failed project is that it cannot repay its loan, thereby making bad the loan that was given to the borrowers by the bank.
In one word, all-round efficiency is the principal gain of the strategic partnership between the real estate investor (borrower) and the non-interest bank (lender). On the heels of the managerial practices, experience and expertise of the banks, efficiency -which is very important in the management of developmental projects - is achieved. Inefficiency of a project (such as the development real estate or its related services/ assets) occurs structurally and operationally and it often causes the project’s life-cycle budget and schedule to overrun. Thus, the partnership between the non- interest banking and the borrower on a project encourages innovative problem solving during the bidding, design, construction, and long-term operational phases of the project, i.e. from start to finish.
Structural efficiency ensures the project is conceived (viably and feasibly) and constructed according to intended purpose and within its earmarked cost, time and scope without compromising quality. Operational efficiency, which is often determined by the successes of its precedent, structural phase, ensures the project delivers its projected Return on Investment(ROI) or profit as at when due. Efficiency of project or investment is the ratio of income to out-laid capital or cost. In other words, when a project is structurally and operationally efficient, its income will increasingly out-shoot its cost. There are published studies by professionals and academics that report the partnership of non-interest banking practices with investors (borrowers) on a project in the dimension explained herein increases the efficiency of such project by more than 50% when compared with traditional approach. And so, when the real estate projects created by the partnership between the banks and real estate investors makes blossomy profits that outweighs its cost, the real estate sector and economy at large in -turn inevitably experiences a sustainable boom.
The non- interest banking process helps to reduce the borrower's debt and to free up disposal capital to spend on other services, needs or projects like real estate, which in turn results in conducive investment environment for the internationals and an increased standard of living for dwellers. The connection between real estate and the general state of macro-economics of a nation is long standing and robust as explained overtime in the school of real estate economics: as more people build equity in their property, they feel freer or more comfortable to spend disposable income and increase economic activity which will further culminate into accelerated recovering and growing of the nation’s economy.
The non-interest banking also tries to avoid the creation of paper assets which is known for creating a bubbly-burst economy. Rather it creates assets (real estate) that are supported by reality. It brings the banks closer to the start-to-finish reality of investment projects, thus impacting them to create adequately informed banking and investment policies that would innovatively solve problems of our challenged investment climate, growth of the nation’s economy and improve the lives of the citizens.
Final words
Historically and very popularly, the collapse of real estate industry in any nation- no matter how developed or otherwise- leads to a 'Great Recession', as the usual trend is for real estate bubble to precede economic crash. However, Nigeria’s case is quite unique and complex because the economic crash, which the nation is presently slowly coming out of, preceded the real estate bubble.
Based on the non-interest system of banking, the bank’s intimate (i.e. deeply rooted and practical) involvement with the real estate provision in the country will victoriously recover and emerge our economy, particularly during this period when major economic recovery symptoms show that investment in fixed assets like real estate tends to be better than forecast. In other words, in spite of the acknowledged downward pressure that has heralded the slow but positive changes in our nation’s economy, improved real estate sector which is typically precedential to economic recoveries can still do the magic.
Through non interest banking, Nigerian banks can work to become a more agile partner in addressing the nation’s most pressing problem, which is extreme poverty whilst also boosting shared prosperity in a sustainable manner. That is, through non- interest banking, our banks can leverage and apply their unique capabilities to provide the innovative financing and creative solutions that will support our country in dealing with the challenge of poverty and under-development at the local, nation, regional, and global levels. No matter how interconnected, overlapped and unique the causes behind extreme poverty and under-development in the nation are, the sustainable solutions lies in the tapping of the potentials entrapped in the maximization of the triangular relationship between non- interest banking models, real estate sector and the economy.