The Islamic Financial Services Board (IFSB), the prudential and supervisory standard-setting organization for the global Islamic financial industry, embarked on a new phase of its development which may lead to a review of its mandate to facilitate a wider reach including those countries and organizations that are not currently members of the board. (full story)
At its 8th Annual Summit in Luxembourg last week and held for the first time in Europe, new Secretary-General Jaseem Ahmed; summit host, Yves Mersch, Gov. Banque centrale du Luxembourg; and Faris Sharaf, the chairman of the IFSB governing council and governor of the Central Bank of Jordan were indeed upbeat about the remarkable performance of the global Islamic financial services industry amidst the more challenging environment presented by the recent international financial crisis.
This is reflected in the phenomenal growth of assets, albeit from a small base initially, reaching about fifteen percent per annum during the last decade and currently estimates at $1.2 trillion with the potential to grow to $4 trillion over the next few years. The growth, according to Ahmed, has been across all asset classes, including banking, Takaful, asset management and Sukuk; and across new geographical areas. The strengthening of Islamic finance in the Middle East, its gathering momentum in emerging economies, and its emergence in Europe are all part of this transformation.
The global financial crisis has led to a recognition of the importance of moving toward a macroprudential framework that would help to maintain financial stability in order to minimize the impact on the real economy of disruptions to the financial sector. For Islamic finance in particular, the pressing issue concerns the need to ensure that the regulatory and supervisory framework for Islamic finance is consistent with ongoing global regulatory and supervisory reforms. This is particularly important since Islamic finance is rapidly being mainstreamed and increasingly integrated into global financial markets.
Gov. Mersch stressed that Islamic finance stands for an ethical attitude and a viable and profitable proposition. "We in Luxembourg share this view. Luxembourg stands as an interface between Islamic finance and global finance," he added.
He warned that the world can do without the devastating global financial crisis it has witnessed over the last two years. Islamic finance developed to some extent as a result of this global development. "We will not be able to prevent the next crisis. But what we can do is to dampen the negative effects of the next crisis," he added.
Sharaf observed that despite its phenomenal growth, Islamic finance in many ways remains a fringe industry relative to the global financial industry. "Are we responsible for obfuscating the development of the global Islamic financial industry?," he asked. With many Muslim countries not even adopting enabling standalone laws for Islamic finance, Gov. Sharaf has a point. Even in his own patch, Jordanian conventional banks are barred from setting up dedicated Islamic finance windows. It also shows the challenge for the IFSB going forward. How does one reconcile the development of prudential and supervisory standards for Islamic finance with the complete absence of enabling laws to facilitate Islamic finance in most of the Muslim countries?
In the aftermath of the global financial crisis and the financial stability forum of the IMF and the Basel III regime, Sharaf warned that "we (the Islamic financial industry) cannot wait for the international standard setting boards to recognize or develop standards for the Islamic finance industry. The global financial crisis has brought to the forefront wide issues, including re-evaluation and internationalization of standards and the need for vital reforms." He urged the international bodies to look at the Islamic finance system with its link to the real economy, and emphasis on transparency and disclosure. Shariah standards, he added, could take a lead in developing international standards for the new financial regulatory architecture.
The presence of Sri Muliani Indrawati, managing director of the World Bank Group, underlined the importance the global multilateral development bank views the Islamic finance industry. The Basel II regime for capital adequacy, she conceded, failed to prevent the financial crisis. Hopefully the proposed Basel III provisions are aimed to strengthen the risk management and micro-prudential regulation of the financial system and to boost its resilience and soundness. In the Islamic finance space, she advised, it is important to ensure that the regulatory and supervisory framework is consistent with global financial reforms, especially in the context of Islamic finance increasingly becoming mainstream and integrated into the global financial system. In this connection, the IFSB itself has announced that it was preparing exposure drafts of two new standards on liquidity risk management. These standards will complement Basel III liquidity standards by providing guidance on Basel III's application to Islamic financial institutions.
Islamic banks, she noted, are some of the best capitalized in the world and show capital levels that far exceed the regulatory requirement. However, she warned that the Islamic finance industry is still faced with several weaknesses and challenges that may undermine its progress. These include the lack of customized prudential standards for Islamic financial institutions (IFIs) in many jurisdictions where Islamic finance is practiced; accounting and auditing standards for IFIs similarly are not fully developed; the legal underpinning of Islamic transactions are not yet robust especially in the case of dispute there remains uncertainty whether the court ruling is based on Shariah or civil law; there is also uncertainty of how insolvency and default should be handled; the different interpretations of Shariah rulings across the jurisdictions; the lack of standard documentation which in turn contributes to the high cost of transactions and financing and the pressing issue of liquidity management in Islamic finance.
The rapid growth of the Islamic finance industry has also exposed the global shortage of skilled and experienced professionals in the sector. There is also a scarcity of Shariah scholars with adequate knowledge of banking and finance. In addition, there has been relatively little research on the functioning of Islamic financial systems around the world.
However, more encouragingly, Indrawati confirmed that the World Bank Group has "formally recognized Islamic finance and have designated it a priority area in our financial sector program". The World Bank's strategy for Islamic finance is based on four pillars - capacity building and knowledge management; influencing policy and market development; diagnostic work and analysis in the industry; and providing technical assistance especially in developing a regulatory framework. "The World Bank has always closely cooperated with the Islamic financial services sector. This demonstrates our commitment to help strengthen the institutional development of the industry. In Sudan in the Islamic microfinance space, we have a full program which we hope to see develop to cover other countries and sectors. The World Bank will play a positive role in industrial development and economic growth, as such.
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