LONDON, 26 January 2004 — The global Islamic banking sector enters 2004 with great expectations on several fronts — the adopting of global prudential and supervisory standards for capital adequacy and risk management; the launching of several corporate papers such as Sukuks (Islamic bonds); the development of Islamic insurance (Takaful) and reinsurance (Retakaful); and the increase in value-added product innovation.
However, the progress of Islamic banking over the last two decades has been piecemeal, with hardly any coordinated approach in regulating the sector especially by the regulatory authorities in the 55 or so Muslim countries. Muslim countries still tend to pay lip service when it comes to Islamic banking; some pretending to do something about it, and others showing an utter indifference to it. Some officials in some countries even have a contempt for the sector, arguing that Islamic banking is no different to conventional banking, and that Islamic bankers merely use casuistry to push their products by substituting ‘interest’ with ‘mark-up’ or ‘profit’.
The work of the Kuala Lumpur-based Islamic Financial Services Board (IFSB), in this context, assumes much greater importance for the future development and credibility of the sector. The good news is that the International Monetary Fund (IMF), the World Bank, the Bank of International Settlements (BIS) in Basle, the Singapore Monetary Agency, the Asian Development Bank have all recently been admitted to the IFSB either as associate or observer members.
The IFSB, established in November 2002, currently has a membership of 14 regulatory authorities (from the Muslim countries); the above international agencies; and 17 financial institutions and rating agencies. If IDB member countries are really keen about Islamic banking, then why are not all 55 member states showing any urgency in signing up for its membership?
Perhaps it is unrealistic to expect this. But if the IFSB is going to assume the role of an ‘Islamic Basle Committee’ then it is perhaps on the right track by pushing ahead regardless with its core work on issuing global prudential and supervisory standards for the sector. It would be nice to think that the IFSB could nurture the concept of a ‘G-7’ equivalent for the Islamic countries. The central bank governors of the Group of Seven (G-7) industrialized countries serve on the permanent committee of the BIS and together they set the rules for global banking. Their rules are adopted beyond the basic principle of ‘Voluntary Adoption’. In the UK, no sooner does the BIS adopts a directive, and the UK Parliament debates and ratifies the directive, and enshrines it into law, then it is left only for the Financial Services Authority (FSA) to adopt and enforce it. The UK of course by virtue of its permanent seat on the Committee plays a major role in drafting the directive.
But in the Islamic banking context, it may be hard-pressed to find seven countries that are fully committed to an Islamic financial system, perhaps running side by side with a conventional banking system. The notable exceptions are Malaysia, Bahrain, Sudan, and perhaps Kuwait. The others are either somewhere there or are still thinking about it.
The Islamic banking sector needs a four-pronged approach — at the international level as underlined by the work of the IFSB and its sister organization the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI); at the national level; at the industry level; and at the consumer level.
At the international level, the IFSB, under the stewardship of Professor Rifaat Abdel Karim, hopes to publish its first two prudential standards — on capital adequacy and risk management during 2004. It also will commence work on corporate governance standards sometime this year. Needless to say, all these issues are core principles for any banking regulatory, supervisory, and prudential framework.
At a recent Islamic banking conference in London, Sheikh Saleh Kamel, president of the Jeddah-based Dallah Al-Baraka Group, which has a global network of over ten Islamic financial institutions (IFIs), echoed the sentiments of many Islamic bankers by arguing for a fairer definition of capital adequacy for Islamic banks that would entail their so-called special characteristics.
The Basle Committee standard on capital adequacy sees “the basic capital representing the paid capital and retained profits and allowance for addition of supporting capital within the capital base”. According to Sheikh Saleh, if you apply this standard to Islamic banks, then most of them would be considered as high risk. This assumption, stresses Sheikh Saleh, “gives no consideration to the special nature of Islamic banking, due to the fact that most, if not all, Islamic banks deposits are considered as capital, because these deposits usually originate from investors and not depositors.”
Not surprisingly, he has called on the IFSB to consider this important point when developing their standards on capital adequacy and risk management. Others, including some international rating agencies, argue that despite this ‘difference’ in the nature of deposits in Islamic banking, the capital adequacy requirements should be the same. After all, they stress that in Islamic banking there are added risks namely fiduciary risks, which too have to be considered. Rating agencies such as Standard & Poor’s and Moody’s are also adamant that no special rating criteria are needed when rating IFIs and Islamic issues such as Sukuks (bonds).
At the national level, the challenge for Islamic banking is even more daunting. How can the Islamic banking system be taken seriously when many IDB member countries do not even have an Islamic banking legal framework on the statute book? Never mind the fact, that many of these countries do not also have insurance, capital market, mutual fund, trust, and consumer protection legislation in place. Then also, how many Muslim countries use Islamic financial instruments as a regular tool to complement their monetary policy requirements? Let us hope that the work of the IFSB would also encourage the above developments at the national level of its core member countries. Only this way, would we see the emergence of a level playing field for Islamic banking, and perhaps of an ‘Islamic Basle Committee’. Only this way would we see a meaningful globalization of Islamic banking and finance.
At the industry level, the sector is perhaps the most developed. Islamic banks are now holding their own and in countries such as Malaysia are competing not only with each other but with the wider conventional banks that are also offering Islamic financial products through specialized units. In 2003, for instance, we saw the emergence of pioneering products such as the global Sukuk; the Islamic BOT (build-operate-and transfer); the Sukuk Al Intifaa (timeshare); the equity builder certificate aimed at the retail end of the market; new developments in Murabaha such as the use of a metal and currency as a benchmark as opposed to LIBOR (London Interbank Offered Rate), and so on.
The industry players will continue to drive the sector, although they still tend to be risk-averse and short-term in their financing outlook. The mismatch between short-term funds and the demand for medium-to-long-term financing and therefore risk, is a major structural problem facing the sector.
Perhaps, the Achilles heel of Islamic banking remains the lack of awareness among consumers including in the Muslim countries about Islamic banking in general and the products on offer. The lack of consumer education; consumer awareness programs; consumer protection measures, will have a serious impact on the degree the sector is taken up by ordinary Muslims.
Take for instance the UK, where following the change in stamp duty law, a spate of Islamic mortgage products have been launched by various banks. One major high street bank, was ruing the fact that uptake and market penetrations has been slow, because of the “the lack of awareness of Muslims about Islamic banking products.”