New agenda emerging in Asia 

(MENAFN - Arab News) The doctrinal phase of the Islamic finance industry over the last decade - which was underpinned by the debate over Shariah-compliant versus Shariah-based products is effectively pass.

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 Malaysias 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.

By Mushtak Parker