(MENAFN - Arab News) Zeti Akhtar Aziz, governor of Bank Negara Malaysia, has called on greater cooperation and shared responsibility among regulators to realize the full potential of and to meet the growing challenges of the Islamic finance industry going forward.
Speaking to delegates at the 8th Islamic Financial Services Board (IFSB) summit in Luxembourg last Thursday, the Malaysian central bank governor warned that "as the international integration of Islamic finance intensifies, cross border financial flows and its associated challenges will also increase. This will call for an even greater degree of international cooperation and coordination. While this new decade beckons the prospect of immense opportunities in Islamic finance, our ability to realize this potential will be determined by the ability to recognize the shared responsibility it demands and to collectively advance forward the agenda of financial stability and resilience to achieve our ultimate goal of a shared prosperity."
The globalization of Islamic finance is due to more Islamic financial institutions (IFIs) venturing cross-border in search of wider opportunities, better returns and expansion. This means the increased presence of IFIs in new jurisdictions, the increased international participation in Islamic financial markets and the increase in Shariah-compliant cross border flows. According to Bank Negara, there are more than 600 IFIs that operate in more than 75 countries. The sukuk market in particular, has evolved as a major contributing factor driving the internationalization of Islamic finance. It has become an important avenue for international fund raising and investment activities, generating significant cross-border flows.
"Following the return of investor confidence reflected by the strong performance of financial markets in 2010, activity in the sukuk market also gained momentum. Islamic finance has become the fastest growing segment in the international financial system. Moving forward, the international dimension of Islamic finance is set to become even more pronounced in this post crisis-era, "plained Zeti.
In fact, this pace of internationalization of Islamic finance is projected to gain further momentum. As such, the rationale behind Zeti's clarion call is that greater collaboration among supervisory authorities of such internationally active IFIs needs to become part of the overall supervisory framework to ensure financial stability of the Islamic financial system.
A word of caution though. Shared responsibilities and commitments through effective international cooperation also means the recognition of national autonomy given that financial regulation and intervention are very often subject to country-specific circumstances.
The recent global financial crisis exposed the lack of proper cross border supervisory cooperation underlined by inadequate mechanisms for such cooperation; lack of information flows; and the inability of supervisors understanding the extent of the systemic risk and its contagion across borders.
Given the evolving nature of Islamic finance, the task for supervisors in those areas where Islamic finance is well established is even greater, especially in keeping abreast with the pace of innovation, taking into account the uniqueness of Islamic financial contracts in addition to the universal scope of Islamic banking business. "This," warned Zeti, "warrants supervisors to recognize the different aspects of risk management in Islamic finance. Islamic financial institutions in most jurisdictions have evolved within the confines of the conventional system and have been accustomed to business practices in their respective jurisdictions. This could result in distinctly different business and risk taking activities. These efforts would require regular engagement between home and host supervisors to ensure alignment of the supervisory oversight."
This, the governor believes, will allow for a more holistic evaluation of risks and vulnerabilities for Islamic finance businesses that operate across borders.
While Gov. Zeti is right in saying that effective sharing of surveillance information and assessments of other supervisory issues on Islamic financial institutions is already taking place through bilateral cooperation and other informal arrangements, this remains on an ad hoc basis and not on a structured multilateral institutional basis. As such the efficiency of the process is not robust enough, which in turn undermines any effective assessment and early detection of any cross-border risk-transmissions from an IFIs group-wide activities.
Currently, the IFSB's various standards are issued on the basis of voluntary adoption, which in itself is very underdeveloped in the polity of Muslim countries. To what extent they are actually adopted by member countries through the process of parliamentary debate, ratification and legal enactment remains a moot point. Early indications show that the uptake is minimal. Nor surprisingly, at the Luxembourg Summit delegates such as Mohammed Iqbal Belath, Second Deputy Governor, Bank of Mauritius, stressed that it was high time that the IFSB standards should become legally enforceable in member countries. This would enhance greater standardization of the Islamic finance industry globally.
Such pragmatic suggestions would however take a seismic shift in the mindset of several IFSB Muslim member countries to realize. Many of them do not have stand alone Islamic banking laws let alone the parliamentary ratification structures in place. In contrast, the directives from the Bank of International Settlements (BIS), to which the IFSB aspires to be the Islamic finance industry equivalent, and the Basle Committee Directives are indeed adopted by the member countries as if they are second nature.
Any country that ignores this process does so at its peril and would soon become a pariah state. This is the institutional maturity to which the IFSB has to aspire to going forward. The task will be difficult because it involves sovereignty issues and even petty nationalisms which can be pervasive among some IFSB member countries.
Indeed, Zeti agrees that "the next stage is the implementation of these (IFSB) standards in the different jurisdictions, which is just as important as the development of the standards itself. This is an area in which global cooperation and collaborative action is critical so as to ensure the consistent implementation of the regulatory framework. The full adoption of IFSB standards will eliminate the opportunity for regulatory arbitrage, in particular, regulatory arbitrage due to cross-sectoral differences, cross-border differences and the differences between conventional and Islamic finance."
The consistent implementation of these standards will also ensure greater certainty in the regulatory treatment of Islamic financial transactions, thereby enabling comparability among institutions as well as surveillance by regulatory authorities. This harmonization, maintains Bank Negara, will not only contribute towards global financial stability, but will also promote greater transparency across borders.
Islamic finance is also oft equated with the real economic sector through the various modes of Islamic financing contracts such as Murabaha commodity trade finance, leasing (Ijaraha), istisna (construction finance), Bai slam (forward sale for commodity purchases), Musharaka (equity participation) etc. As such a comprehensive understanding of the entire risk spectrum is often difficult and challenging.
Zeti in fact calls for the establishment of "an integrated framework of macro surveillance for Islamic financial activities across jurisdictions". In this respect, the global database for prudential Islamic finance statistics due to be initiated by the IFSB, would need to go far beyond ensuring standardized data collection among jurisdictions, but also to enable the generation of various macro and financial indicators, and global sharing of best practices in macro surveillance.
Developing an integrated surveillance mechanism, identification and prevention of emerging risks in the Islamic financial system, as well as the establishment of an integrated crisis management and resolution framework, are crucial to the maintenance of financial stability in the global Islamic financial system.
This, argues Zeti, would allow for a comprehensive and prompt response to a financial stress, and thus increase the prospects for an early recovery. This was the basis behind the setting up of the Islamic Financial Stability Forum (IFSF) in 2010, as a platform to build closer cooperation among regulatory authorities. More specifically, the IFSF carries the mandate of promoting international dialogue, engagement and cooperation in the area of financial stability.