According to a new report, titled Islamic Finance: The New
Agenda, published recently by KPMG, the international auditing and advisory
firm, a new agenda is emerging for the industry in which Asia will continue to
be the engine of growth, and that Islamic finance will have a prominent role in
the "Asia growth story" going forward.
“The Islamic finance industry has spent over a decade
debating various issues of principle that the global credit crunch proved to be
increasingly irrelevant. Replacing them is a new context that has at its center
the continued improvement of governance, better asset and liability management,
and greater product suitability and transparency. It is important for Islamic
finance to progress in the right direction as it and conventional finance
recover from the global crisis,” stressed the authors, who comprised members of
KPMG International.
The good news, however, is that the Islamic finance industry
is now not only addressing the credit and liquidity restraints that linger
following the crisis, but is also focusing on its key business activities;
principally how best to provide customers with suitable products which meet
their specific requirements and which offer the return, transparency and
ethical structure demanded. It is also re-examining the wider approach to asset
and liability management given the lessons learned during the crisis. Similarly,
while the issue of standardization of documentation and practices are still
pertinent to the growth of the industry, differences in Shariah interpretations
in different regions are becoming less significant, although some of these
variances still pose issues relating to liquidity management in terms of
acceptable instruments.
KPMG confirms that although Islamic finance was by no means
unscathed by the global financial crisis, it had a less severe impact than
elsewhere. However, the economic impact did create a serious shock, and any
liquidity crisis will in principle affect Islamic banks as badly as
conventional banks, and a number of Islamic financial institutions came close
to collapse, with the result many Islamic banks, like conventional banks, have
had to respond by selling and restructuring assets and liabilities.
The positive side saw the crisis helping to focus the minds
of market players on their core business strategies and operating models,
highlighting corporate governance and asset and liability management
specifically.
As the industry continues to convalesce, Islamic finance now
has the potential to resume its growth, offering an increasingly broad array of
products to both established and emerging Islamic markets. Its distinctive
ethical stance also chimes with the desire of many politicians, regulators and
customers in the mainstream banking sector for a focus on responsible,
sensible, principled banking. This may complement the speed of growth in
emerging eastern markets with greater uptake in developed western economies
such as Europe. Consequently, the financial crisis should allow the Islamic
finance industry to emerge in a stronger position and advance the agenda to
address current critical market issues.
The new agenda for Islamic finance is underpinned by several
assumptions and conclusions. They include:
1. The process of standardization has been helped by the
emergence of a general consensus within the industry about the nature and
principles of the products being offered.
2. Shariah advisory is dominated by a limited cadre of
leading scholars, with only an elite small number possessing the detailed
theological knowledge as well as an understanding of modern financial
instruments.
3. The existence of this small elite is leading to a broad
commonality of Shariah interpretation across different markets and thus wider
standardization in practice despite many in the industry expressing unease with
this situation in the past.
4. There are no major regulatory barriers to the
implementation of Islamic banking in existing markets.
Feedback from KPMG member firms around the world shows that
meeting the needs of the customers will be crucial going forward. “Islamic
finance needs to better match liability providers, such as depositors with asset
seekers, to include investment and financing within the holistic customer
choice range,” observed the report.
One market segment that may feature more importantly in this
respect is small-and-medium-sized enterprises (SMEs), where there is a growing
opportunity to begin innovating and testing new service lines. In Malaysia, for
example, where the SME market is under-served by conventional banking, Islamic
banking could exploit a distinctive niche and lay the foundation for similar
approaches in other geographies.
KPMG spoke to several senior Islamic bankers at the CEO
level who stressed that the main requirement for customers is that a product
meets their requirements in terms of price, return and transparency of risk,
and Shariah-compliance.
Many of the above bankers felt the true test of the
resilience of the Islamic financial system would be in relation to the
liquidity deficiency resulting from the financial crisis. The problem is that
the sector relied too heavily on replicated debt-based conventional structures,
which probably hindered the practice of managing liquidity risk by matching
asset and liability portfolios. For example, those banks who had large
exposures to private equity, particularly in some emerging markets, were hard
hit.
“To enable Islamic financial institutions to manage their
liquidity, global connectivity should be increased, with building scale through
larger fund flows between countries facilitating this progression. As it
stands, Islamic regulations are currently framed from a conventional base and
as long as the conventional yardstick is applied certain structures such as
Mudaraba and Musharaka products will likely continue to be treated as higher
risk … Additionally, the development of robust integrated risk management
processes, such as matching assets and liabilities according to their maturity
pattern, liquidity and ability to hedge, should facilitate the development of a
more robust approach to asset and liability management,” said the report.
In terms of geographic market development, the existing
developed markets in Islamic finance will continue to dominate especially those
in the Gulf Cooperation Council (GCC) and Asia, particularly Saudi Arabia and
Malaysia respectively. The projection is for an explosion of growth in Islamic
finance in Saudi Arabia; Indonesia will eventually follow Malaysia’s lead;
Africa is a new frontier market; Central Asia also offers good opportunities;
Turkey and parts of China also offer major potential for growth.
Outside of the Muslim world, many countries in Europe, the
UK being at the forefront, continue to look into Islamic finance and this is a
space that needs to be watched.
The report stresses that new entrants to the market will
continue to emerge, although the trend will be toward the consolidation of
existing institutions in their home markets. The Islamic retail banking sector
will offer greater competition and challenges to conventional banks in the near
future as the Islamic finance industry matures, perhaps more so in Malaysia as
opposed to Saudi Arabia, where the majority of the market is Muslim.
With more customers increasingly attracted to Islamic
finance, the sector is “more strongly positioned for growth in a world where
the reputation of conventional banking has been damaged as a result of the
financial crisis. Politicians, regulators and many in the global financial
industry itself are calling for more responsible, prudent banking which avoids
reckless speculation and focuses on supporting businesses and consumers.
Islamic finance may face its biggest opportunity in asserting itself to take
advantage of this broader movement.”
However, the authors warn that those Islamic banks that will
most likely to successfully capitalize on these prospects will be those with
the most robust governance structures, are able to best manage their asset and
liability portfolios and have the resources and industry knowledge to bring
products to the market that meet the needs and expectations of their customers.
Although Islamic finance is likely to remain one of the most
rapidly growing, dynamic and fascinating sectors of global finance, the growth
strategy of individual institutions will need to be carefully managed to
address these issues and realize a competitive advantage.
