LONDON, 14 October — When Malaysian Prime Minister Dr. Mahathir Mohamad officially inaugurates the multinational Islamic Financial Services Board (IFSB) on Nov. 3 in Kuala Lumpur, the global Islamic banking sector should technically come of age. The establishment of the board in a post-9/11 global political and financial environment could also prove vital in other respects.
After all, the IFSB is already being likened to the “Islamic Bank of International Settlements (BIS)” with an “Islamic Basle Concordat”, the body whose task is effectively to set prudential and supervision standards for the global Islamic banking industry. The Swiss-based BIS and Basle Committee is the ultimate standard setting body for global banking and is controlled by the central bank governors of the G-10 (Group of 10). In fact, the BIS is imminently preparing to launch Basle II, the updated set of standards for global banking which includes revised capital adequacy ratios, definitions of additional or subordinated capital, risk management, and compliance measures.
However, wholesale comparisons between the IFSB and BIS would be unfair. The BIS has been in existence for several decades, and is a powerful and influential club of central bank governors of the ten most powerful economies in the world, although in the last few years they have invited some members from the emerging countries as observers, including Malaysia. The rulings and directives of the BIS are set in stone and ratified and adopted by the G-10 countries. All other countries ignore these bank rulings, such as core capital adequacy or risk-weighted capital adequacy, at their peril. For, the cost of money for these banks and their countries would increase substantially if they were to ignore inter alia the so-called Basle ratios.
The IFSB has now been two years in the making, with the Washington-based International Monetary Fund (IMF) acting as facilitator, given the rapid rise of the global Islamic banking sector and that key members of the IMF are major markets for the sector. The founding committee of the IFSB comprised banking regulators from Saudi Arabia, Malaysia, Bahrain, Kuwait, the UAE, Indonesia, Pakistan, Iran, Lebanon, and Sudan; and the Jeddah-based Islamic Development Bank (IDB) and the Bahrain-based Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI).
The IFSB’s mandate is to set and disseminate standards and core principles, as well as adapt existing international standards for the regulation and supervision of the Islamic financial services industry, consistent of course with Shariah compliance. The IFSB is also required to liaise and cooperate with other standard setting bodies in the area of monetary and financial stability; and to promote good practices in risk management in the industry through research, training and technical assistance.
These standards and core principles, however, would be for “voluntary adoption by member countries”. In other words there would be no legal obligation for member countries to adopt them and no sanctions against errant countries, especially those outside the founding committee but members of the 54-member IDB. Given the dire state of intra-Islamic trade, information flows, correspondent banking, the task of the IFSB will assume an uphill struggle even at its imminent birth. A number of IFSB founder members including Pakistan, Lebanon, Kuwait, Indonesia, and Saudi Arabia, do not even have a comprehensive Islamic banking law on their statute books, although Kuwait has recently published a draft law which is currently being debated by the National Assembly.
Dr. Zeti Akhtar Aziz, governor of Bank Negara, the Malaysian central bank who is also the chairman of the IFSB Steering Committee, is keen to stress that like the BIS, the board will set prudential standards and bring harmonization of these standards to ensure the soundness, stability, integrity of and confidence in the Islamic financial institutions. “The BIS is not an agency that undertakes assessments of compliance. Similarly, the IFSB will not be making such assessments. That will be up to the individual countries,” she added.
The IDB and AAOIFI also should not be invited as founder members. For the simple reason that they are not financial regulators nor standard-setters in the monetary and financial sectors. Their inclusion is in danger of watering down the membership quality and credibility of the IFSB. If the main regulators of the Muslim countries have to rely on a regional development bank and a niche accounting standards body to help establish a financial standard-setting body in their name, then this would indeed be a strong and sad indictment on their own organizational capacities and capabilities. Both the IDB and AAOIFI are barely able to effectively carry out their existing mandates either because of their own organizational structures or because of a lack of resources. At best, their involvement should be on an “observer” basis.
It would be more effective, perhaps later, to invite the UK’s Financial Services Board (FSA) and the US Federal Reserves Board to become members, given that huge volumes of Islamic finance (billions of dollars) is structured through London and New York each year, and that huge Islamic financial flows are invested in US and European asset classes — equities, real estate, leasing, short-term cash management and liquidity schemes, and currencies. Increasing number of Muslim expatriate populations also live and work in North America and Europe.
The fact that the IFSB is to be based in Kuala Lumpur does augur well for the organization. The Malaysian banking regulatory and financial sector is arguably the most advanced of all the Muslim countries. The government is perhaps the most proactive in promoting Islamic banking and follows a unique dual banking policy — a conventional sector operating side-by-side an Islamic one, cooperating but not inter-acting. There are none of the obstacles of political sensitivities and instability; of lack of regulatory, legislative, and accounting infrastructure; of a lack of product innovation; and of marketing.
At least the IFSB will have a progressive and proactive leadership in Dr. Zeti, who is well respected equally by her peers in the West and in the developing countries, and will be working in a relatively open environment where innovation stands less chance of being stifled because of bureaucracy and political inertia.
A word of warning though. Expectations of what the IFSB will achieve over the next few years will have to be tempered with cold reality rather than the emotions of establishing a faith-based system of financial management and regulation. As such the secretary general and senior executives of the IFSB would prove crucial. This will apparently be decided at the first meeting of the board’s council and general assembly to be held in Kuala Lumpur on Nov. 4.
There are huge challenges for the IFSB. The pressing ones apart from the capital ratios, reserves, and risk management standards, is the vexed question of Shariah compliance convergence, especially to bridge the gap between Gulf and Malaysian practice. A failure to do this could undermine the very establishment of the IFSB, and further confirm the Islamic finance sector as a mere niche banking market as its is perceived by many, as opposed to a viable and equitable alternative system of financial management to that of the highly speculative and individualistic capitalist system.
