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Islamic banking: Who is in control?

The Islamic Development Bank’s (IsDB) successful sukuk issue clearly demonstrates the market remains open to welcoming this kind of financial activity. Also, the Islamic finance industry should face its challenges head-on.
Backed by a good track record and triple A ratings, IsDB issued a $1.5 billion sukuk as part of its ambitious program to raise $10 billion.
The issuance was met with success despite the general market uncertainty.
Nearly half of the amount, or 43 percent to be exact, was allocated to central banks. Banks gained 34 percent and lesser amounts went to fund managers and other investors.
These IsDB sukuk instruments could be regarded as high quality certificates like sovereign ones issued by governments. Although some of these will be listed in London Stock Exchange or Nazdaq Dubai or Bursa Malaysia, the prospects of trading them in secondary markets are very limited.
The value of sukuk offered is still small despite the fact the Islamic finance industry is believed to have grown to $2 trillion. Governments and institutions in the west and Islamic states are driving this lucrative business.
Both London and Hong Kong were doing their best to portray themselves as world hubs for the Islamic finance industry as they target opportunities worth billions of dollars.
Keeping away from conventional banking tradition of dealing with interest, Islamic finance opted for profit-sharing instruments as a way of doing business and managing liquidity. But experience has shown that such exercises are accompanied with a degree of volatility. Industry experts need to address the matter.
This is likely to become a more pressing issue as the industry prepares for new banking regulations, or what is called Basel-3 regulatory standards, which are expected to come on stream in the next few years. Ironically enough the volume of available liquidity at Islamic banks is strong and because of that they are subject to more volatility. This situation requires them to look for more high-quality assets as a relatively secure way to manage that liquidity.
However, such a trend faces three problems: There is not enough high quality assets to absorb all that liquidity, there is no central body with authority to issue guidelines that can govern the activities of Islamic banks and that even whatever regulations that emerge are limited, new, need to be tested as well so as to establish a track record to be followed by others.
The only known attempt so far to manage liquidity came from Malaysia’s central bank, when it classified profit-sharing investments into two types: Retail deposit, which is general and the more restricted one similar to managed investment accounts.
But this is only in Malaysia. Others may decide the same or something different. After all every country makes its own sovereign decision despite the existence of the Islamic Financial Services Board (IFSB), the Kuala Lumpur-based body, which issues guidelines only that are not mandatory despite its international character. Again it is the issue of sovereignty and whether countries are willing to concede some of that sovereignty to such bodies like IFSB. And this is one of the structural problems that need to be tackled at the political level basically.
Four years ago and following the global financial crisis that has engulfed the world back in 2008, the International Monetary Fund issued a working paper discussing the impact of that crisis on both the conventional and Islamic banking. It concluded that Islamic banking industry was becoming systematically important and too big to ignore.
The fact that they are asset-based and operate on risk-sharing reduced their exposure, places them in a better position to stand that storm. But that did not disguise the structural problems and challenges faced by the industry in terms of liquidity management through accepted instruments and well-established legal framework.
Existing regulations suffer from being incomprehensive and untested in most cases and that again could be traced to the lack of a central body with authority to enforce such regulation.
Accordingly, it is left to each individual country to come up with whatever it sees fit to adopt and apply.
At one point it was thought that IsDB could play that role because it was set up by Islamic governments. But that has not happened over the past 40 years because governments are not keen on conceding part of their power.
But the question is still valid today as it was decades ago.

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