Both Professor Rifaat Abdel Karim, the secretary general of the Islamic Financial Services Board (IFSB), the prudential and supervisory standard setting body for the global Islamic finance industry, and Islamic bankers such as Richard Thomas, the CEO of Gatehouse Bank in the UK, agree that the complexities lie with trying to match short-term deposits placed with the IBWs with their longer term liabilities.

In fact, the QCB last week reportedly justified its directive and stressed that its new regulatory regime for Islamic banks is based on guidelines issued by the IFSB which are specific to Islamic banks and different to those applicable to conventional banks per se under both the old Basel II and the new Basel III.

Asked if the IFSB standard on capital adequacy for Islamic banks is vindicated by the action of QCB, Rifaat explained in an interview that the directive “is a decision of the Qatar Central Bank (QCB). They are following our guidelines. We expect every central bank to implement IFSB guidelines but the decision is ultimately theirs and independent of the IFSB. We support the implementation of the IFSB standards, but that decision is the sole prerogative of the QCB. The IFSB does not interfere in the internal decision-making process of member central banks and regulatory authorities. We are not mandated under our articles of memorandum to interfere in the internal decision-making processes of members.”

Rifaat, who is leaving the IFSB at the end of April 2011, advised that the QCB knows better than anybody else why it issued the directive because only they are privy to information, which others including the IFSB do not have. “Even if we had the information it is not within the mandate of the IFSB to comment,” added Rifaat.

The IFSB secretary general also dismissed suggestions that Qatar is necessarily going down the Malaysian route which required all Islamic banking units of conventional banks to convert into standalone full-fledged Islamic banking subsidiaries.

The Malaysian route, insists Rifaat, is different. Malaysia started with a full-fledged Islamic bank, Bank Islam Malaysia Berhad (BIMB) which was established in 1983. Malaysia is also multi-ethnic — Malays, Chinese, Indians and others. “They wanted to expand the Islamic banking sector. They knew at the time they could not expand it organically by having other Islamic banks. So they wanted others to offer the services. But the Malaysians ring-fenced these Islamic banking units (IBUs). When they came to a certain stage in their and the market’s development, Bank Negara Malaysia required these IBUs to convert into full-fledged standalone Islamic banking subsidiaries.”

These subsidiaries are also different in other crucial respects, explained Rifaat, because they allowed foreigners to come in with up to 49 percent of the equity. Following the announcement by Malaysian Prime Minister, Mohd Najib Tun Abdul Razak, in April 2009 of the government’s financial liberalization plan for Islamic finance, Malaysia expanded its foreign equity ownership rules stressing that each subsidiary can become a $1 billion banks in terms of paid-up capital and can have foreign equity ownership of up to 70 percent.

“I don’t think it is then fair to compare the Qatar Central Bank directive to the Malaysian model, which developed in stages in the context of their regulatory and operating environment. Qatar may have a different environment. We don’t know. The arbitrariness of the directive may have taken the market by surprise, but I am sure that the central bank must have done their homework thoroughly before deciding to introduce the directive,” says Rifaat.

The QCB has given the conventional banks till the end of the year to implement its directive. But Qatari bankers stress that this implementation has already started with the IBWs no longer accepting new deposits or investments nor opening new Shariah-compliant accounts. Indeed, some of the Qatari IBWs say that they are already closing existing accounts.

Richard Thomas, CEO of Gatehouse Bank, the last of the UK Islamic banks to be authorized by the Financial Services Authority (FSA), who recently returned from a visit to Qatar and other GCC states, advises caution to pre-empt a run on the deposits of the IBWs.

“Talking to the bankers in Qatar they have stopped accepting new money and have already closed some accounts. Investment funds are immediately returned as soon as it comes due depending on the maturity instead of being rolled over for another investment period,” he says.

Both he and Rifaat concur on the operational complexities involved in the implementation of the directive, especially matching short-term deposits with long-term liabilities. These IBWs are paying their short-term deposits but cannot do anything about the long-term loans. Ironically, the IBWs may end up having to go to the QCB if there is a run on IBW deposits in which case they would expect the QCB to bail them out effectively as a lender of last resort.

The directive was ostensibly introduced because the Qatari regulator felt that there was co-mingling of conventional and Islamic funds within the IBWs, which consequentially comprised the Shariah compliance of the windows. Others stress that the QCB must have had a very good reason to introduce the directive, irrespective of the IFSB Standard, and suggest that there must have been some serious cases of breakdowns in the Shariah compliance governance of these IBWs, which tolerated co-mingling of funds and other practices.

The arbitrariness of the directive and the way it was introduced without market consultation did surprise some of the local banks including Qatar National Bank (QNB), the largest bank in the emirate; Commercial Bank of Qatar; Doha Bank; HSBC Amanah; Ahli Bank; Al-Khaliji Bank and International Bank of Qatar (IBQ), which between them have 16 Islamic banking branches in Qatar.

It is unlikely, according to industry experts, that QCB Gov. Sheikh Abdullah bin Saud Al-Thani will review his decision, which ironically comes at a time when Islamic banking has been flourishing in the emirate as in neighboring states in the Gulf Cooperation Council (GCC) region. The Islamic banking sector has a 20 percent market share of the total banking industry in Qatar, which also has four dedicated standalone Islamic banks of which the largest and oldest one is Qatar Islamic Bank (QIB).

It was way back in 2005 that the QCB allowed conventional banks to launch Islamic banking units (IBUs), which have contributed to the growth of the sector and to the profitability of the banks, and which have attracted an estimated customer base of just under 100,000. In fact, embarrassingly for the QCB, Gov. Al-Thani recently opened a branch of HSBC Amanah, which according to his new directive will have to cease the activities of the branch by the end of the year.

Co-mingling of funds is a real and contentious issue especially in situations where conventional institutions get involved in Islamic finance. It has in a contemporary historical sense assumed different manifestations. For instance, in the early days in the 1970s and 1980s, Islamic financial institutions had serious problems parking their short-term funds in Shariah-compliant vehicles and institutions. This was because of the lack of such institutions and Islamic liquidity management instruments to absorb this liquidity, usually on an over-night or short-term basis.