Islamic Finance and Global Financial Stability by Dr. Ahmad

Top 20 FREQUENT WORDS

islamic 438 financial 412 finance 191 global 140 stability 96 ifsb 69 shari 67 banks 65 institutions 65 services 65 risk 60 principles 57 standards 57 international 54 management 51 assets 48 crisis 48 conventional 47 banking 42 takaful 42

DOCUMENT KEY POINTS

the establishment of a platform for constructive dialogue islamic financial stability forum conclusion appendix i standards and guidelines issued by the ifsb appendix ii comparative table on standards and guidelines issued by the islamic financial service board and basel committee on banking supervision appendix iii comparative table on standards issued by islamic financial service board and international association of insurance supervisors appendix iv al qur an surah yusuf joseph verses references
key principles box basic principles of islamic finance box participatory mode in fund mobilisation box distinct features of islamic financial transactions perspective on musharakah mutanaqisah diminishing partnership box non profit unilateral contracts in islamic finance box islamic microfinance ar rahnu b

the first meeting of the task force on january led to the formation of three working groups to examine the conceptual aspects of islamic finance and its role in enhancing financial stability conduct stocktaking of the state of the islamic financial services industry following the global financial crisis and examine the financial architecture of the islamic financial industry amidst the more challenging post crisis environment
the report of the three working groups were presented and discussed at the second meeting of the task force held at the idb headquarters on march in jeddah

doctor zeti akhtar aziz for her pioneering endeavours in supporting islamic financial industry in general and for guiding the work of the task force in particular

the global financial crisis of unprecedented in modern history has brought to the forefront wide ranging issues concerning the stability and soundness of financial syste miss this has prompted an extensive global re examination by the international community on the need for regulatory reform and the adequacy of the existing international financial architecture and the search for a more enduring solution

while the endeavour to strengthen the islamic financial system and the international islamic financial architecture is important in this highly integrated international financial system equally important is to have in place a platform for greater international engagement on the developments and issues concerning maintaining financial stability in the islamic financial system
for the islamic financial services industry to thrive in this new environment and to transition to the next level of development and trend towards greater international integration its level of resilience needs to be strengthened further

introduction the task force on islamic finance and global financial stability task force was initiated by the islamic development bank idb on october in response to the recommendations of the forum of the global financial crisis and its impact on the islamic financial industry organised by the idb group
to examine important strategies and key building blocks towards further strengthening the resilience of islamic finance and advancing global engagements towards promoting financial stability in the islamic financial system as part of the current reform process of the international financial system

doctor zeti akhtar aziz governor of bank negara malaysia and includes an international group of eminent scholars practitioners and experts in islamic finance
shaikh yousef talal delorenzo chief shari ah officer and board member shari ah capital inc

the global financial crisis of has brought to the forefront issues concerning the stability and resilience of financial syste miss at the heart of the crisis is the near breakdown of the functioning of the financial intermediation process amid a generalised loss of confidence in the financial system
while the banking institutions had employed increasingly sophisticated financial engineering techniques to repackage mortgages into complex structured securities such financial innovation was not supported by commensurate enhancements to their governance processes and risk management infrastructure and practices

the inherent features of islamic finance have the potential to serve as a basis to address several of the issues and challenges that have surfaced in the conventional financial system during the current crisis
the key strength of the shari ah injunctions is its emphasis on a strong linkage to productive economic activity its inbuilt checks and balances and its high level of transparency and disclosure

islamic financial transactions must be accompanied by an underlying productive economic activity that will generate legitimate income and wealth thereby establishing a close link between the financial transactions and productive flows

this has led to its proliferation through multiple layers of leveraging and disproportionate distribution which in turn could result in higher systemic risks thus increasing the potential for instability in the financial system

a c a typical islamic banking balance sheet is as follows a c liability side the liability structure of islamic banks ie funding structure is characterised by two distinct categories of funds o non return paying demand current accounts for which the principal is guaranteed and o psia which refer to deposit products structured based on mudarabah profit sharing loss bearing contract where customers and islamic banks agree to share profits generated from the assets funded by psia based on a mutually agreed profit sharing ratio while the loss shall be borne by the customers

a c this form of intermediation is not merely the collection of a a spread between the cost of funds mobilised and the return on funds advanced in the context of the conventional debtor creditor relationships but a more active economic role involving either the provision of assets or services or entering into partnerships
indicates that the ifsi has a sufficient range of products that can be used in meeting the needs of its customers and o an islamic bank may enter into joint venture as a means of financing where the islamic bank acts as joint partner in a specific economic activity based on a pre specified profit and loss sharing arrangement

under the mudarabah principles there is a need for disclosure by islamic financial institutions to investors on how the funds are being managed so as to provide the assurance that the underlying business operations the risk profile and the risk control mechanisms are in place

financial innovation in islamic finance must be within these shari ah parameters and tested against the a maqasid al shari ah objectives of the shari ah where the primary objective is the realisation of benefits to the people
this demands the internalisation and preservation of shari ah principles in islamic financial transactions both in form and substance in order to ensure that the religious and ethical principles are not compromised

as a result banking institutions are exposed to both market risk associated with the joint ownership of the underlying asset as well as credit risk associated with the obligation on the part of the customer to acquire and on the banking institution to sell its share of ownership in the asset
chart shows the key risk exposures and risk management practices at the different stages of a transaction in musharakah mutanaqisah as well as additional risk mitigants that can be introduced

return risk enforceability of potential loss in contract and future income recognition of arising from early beneficial ownership settlement under the law credit risk market risk t n customer default t a t m lease rental non payment of arising from the transfer of bank s rental by the fluctuation of market ownership customer price in the case of transactions without risk management wa d
in the process the economic empowerment of the less fortunate would elevate their status from the non bankable to the bankable segment thereby benefiting the borrowers the financial system and the community at large as well as increasing financial inclusion see box and

a c the economic empowerment of the less fortunate if carried out in a systematic and structured manner may elevate them from the non bankable to the bankable segment thereby benefiting the individuals themselves the financial system and the community at large as well as increasing financial inclusion
a c zakat may be compared to a type of a wealth tax being an obligation related to defined types of assets from which a part is to be paid by the owner of the assets when the assets reach a certain amount nisab

the proceeds will be used to settle the outstanding balance while any excess will be returned to the borrower unlike conventional pawn broking where the excess will not be returned to the borrower
firstly it represents a credit channel to those who want to use the ar rahnu scheme to obtain financial resources to meet their daily financial requirements and secondly it can be a credit channel to those who require temporary working capital particularly for small businesses

in summary the features and value proposition inherent in the islamic financial model can have the potential to contribute to global financial and economic stability through the following channels a
don t sell what you don t have is one of the fundamental principles of shari ah which restricts the possibility of excessive speculation

as the financial crisis become prolonged the global recession the collapse in commodity and oil prices and the sharp erosion of asset values that followed affected the performance of the islamic financial institutions
islamic financial institutions which are subject to shari ah regulations are forbidden from investing in such derivative instruments and therefore did not have exposure to such derivatives

table significant developments in islamic finance prior to s s s s contemporary primarily retail commercial property finance equity funds advanced banking banking and syndication treasury services leasing islamic insurance balance sheet takaful islamic management securitisation innovative asset management the rapid expansion of islamic finance as a viable form of financial intermediation reflects its ability to meet the changing pattern of demand by consumers and businesses its competitiveness and its ability to withstand the more challenging environment

as at the end of the combined revenue of international islamic financial services is estimated to amount to usd billion while islamic profits totalled usd billion and is expected to more than double to usd billion over the next years
in terms of geographical distribution the middle east is now the largest islamic finance market accounting for about of global islamic finance assets

table shows the comparison in terms of aggregate size and performance of islamic banks and conventional banks in the gulf region saudi arabia kuwait qatar united arab emirates and bahrain

from being concentrated in muslim populated regions islamic finance has drawn significant participation by non musli miss exceptional growth in islamic finance has been registered not only in the muslim world where its growth is premised on religious considerations but now spans across the western world and the asia pacific region where the growth is driven by commercial and business considerations
chart includes non muslim countries such as australia china france germany hong kong italy japan korea luxembourg singapore and united kingdom in which there are some initiatives in introducing islamic finance in their financial syste miss china has issued its first licence for islamic banking while five islamic banks have been established in the united kingdom as at end

the huge potential in the sukuk market is evident from the active participation of global players including international investment banks islamic banks and securities firms that have participated in the issuance of sukuk

in terms of islamic funds shari ah compliant investible assets in in the gcc and asia reached usd billion compared to usd billion in
saudi arabia remains the largest takaful market in the gcc with contributions of usd

complementing these initiatives are the efforts by the central banks in issuing islamic monetary instruments which is integral to the functioning of the islamic money market and the islamic financial system
ifsb an international prudential standard setting body was established in to develop and disseminate prudential standards for regulation and supervision of the islamic financial services industry

five of the top conventional banks received government financial assistance to the extent of usd billion in aggregate or of the affected banks combined equity
the resilience of the islamic financial institutions during the recent crisis epitomises the intrinsic strengths in islamic finance which purpose and objectives are guided by the shari ah principles

chart net profit loss of top conventional and islamic banks a pre post crisis chart total assets of top conventional and islamic banks a pre post crisis chart leverage ratios assets equity of top conventional and islamic banks a pre post crisis sources a c company annual reports and websites financial database websites thomson reuters etc
a c as of april the kuwait stock exchange suspended trading in investment dar s shares until further notice as a result of the postponement of the release of its full year financial results for the year ended december

to the extent that this is diluting the distinctiveness of islamic finance it could also expose the islamic banks to the destabilising forces inherent in the conventional financial system
these criteria represent part of the screening process to identify companies which business activities do not comply with a minimum shari ah compliant standard thereby rendering their stocks ineligible for purchase by shari ah based investors

this could be due to the exclusion of conventional banking and insurance stocks from islamic indices including stocks that failed to pass the screens owing to the nature of their business e

going forward it is envisaged that the strong growth in islamic finance will be sustained given the potential for widening the current range of islamic financial products and services on offer as well as increasing demand particularly from the high number of untapped markets
a similar outcome is apparent in chart which compares the performance of the standard poor s global shari ah index vis a vis its global conventional index

to support the orderly development of islamic finance for sustained global financial stability it is vital to accelerate the development of critical building blocks of the islamic financial system to respond to the changing economic and financial landscape
this is even more important as islamic finance operates within the global financial system that is characterised by increasingly large and volatile cross border capital flows amid an environment of deeper international financial integration

these standards take into account international prudential standards across the banking investment and securities and insurance markets issued by the basel committee on banking supervision bcbs the international organization for securities commission iosco and international association of insurance supervisors iais respectively and simultaneously cater effectively for the specificities of islamic financial firms their risks and shari ah compliance

in this regard the ifsb has emphasised the need for the adoption of a coordinated cross sectoral approach to the regulation and supervision of iifs that encompasses the banking the investment and securities market and the takaful sectors
significant efforts to issue comprehensive prudential standards for the islamic banking sector have contributed towards establishing an internationally consistent framework for islamic banking that is equally robust as those applicable to the conventional banking sector

the tools for liquidity risk management presently available for use by iifs remain rudimentary and markets are insufficiently liquid leading to inefficiencies in normal times due to low returns on liquid assets as well as the potential for systemic risks in times of crisis owing to the relative limited liquidity of the instruments involved
towards addressing this the ifsb has established a high level taskforce on liquidity management hltf mandated to develop a liquidity framework to facilitate and offer liquidity solutions to market players so as to promote better liquidity management by the islamic financial institutions

while shari ah requirements in this respect would be met by the upsia themselves being the participants in the scheme providing insurance coverage for upsia might raise several concerns relating to matters such as the appropriate fair value of upsia that should be insured the evaluation of the riskiness of the underlying assets the quality of the asset management for the purpose of setting the levels of the takaful contributions and the unlevel playing field between upsia as investors in iifs vis a vis investors in a cis
practice of managing liquidity through interbank murabahah or wakalah arrangements structured finance and enhanced deposit schemes may function well under normal market conditions more efficient and tradable shari ah compliant financial instruments are required for lolr facilities and emergency financing operations when inter bank liquidity comes under pressure in a crisis situation

the legal challenges relate to the issue of whether the conventional legal systems common law jurisdictions and codified systems adequately address among other things bank liquidation and insolvency issues arising from shari ah compliant financial transactions for example in terms of the priority of claims of depositors and shareholders during liquidation of an iifs

one of the challenges in the implementation of this macro prudential framework relates to the development of indicators that would not only provide a basis for the assessment of financial soundness and risk to vulnerabilities of the financial system as a whole and its components but also facilitates an analysis and assessment of how these indicators might interact with broader macroeconomic developments
as timely and accurate information and statistics is key enabler to this process it is therefore necessary to ensure that similar advancement in information technology is made to cater for the unique characteristics and features of islamic finance

to excel and produce results in a more challenging globalised environment practitioners and stakeholders in the islamic financial services industry need to be highly qualified and equipped with the for instance during the onset of the crisis rating agencies competed with each other to rate mbs and cdo securities issue by investment banks as the remuneration and incentives are three times more than grading less complex traditional corporate bonds

collaboration in this area would also enhance capacity building among countries and islamic financial services industry players to develop the best practices and standards harmonise of shari ah practices review standards to facilitate policy development and implement of standards and policy framework

this is critical in the harmonisation of prudential standards in promoting and enhancing the soundness and stability of islamic financial services industry as well as in contributing towards the consistent development of islamic finance across different jurisdictions
this should be supported by a transparent and credible assessment process which would serve to assist jurisdictions in evaluating their level of compliance with international standards and make recommendations for improvements such as peer reviews or the financial sector assessment program fsap process

while innovation is to be encouraged it must be consistent with the essential features of islamic finance that are in compliance with the principles of shari ah and aligned to the objectives of shari ah

in this regard the task force recommends the establishment of an islamic financial stability forum or ifsf based at the ifsb which shall inter alia be a broad based and constructive strategic platform for ifsb members to achieve the primary objective of building cross border dialogue in efforts to promote financial stability within the islamic financial system
the ifsf will be a dedicated forum to promote cooperation and collaboration among its members in areas such as surveillance sharing of experiences in crisis prevention management and resolution implementation of international standards as well as international cooperation in capacity building and in the development of emergency infrastructure and facilities

key to this is to maintain an interface between the financial stability board and ifsf so as to ensure there would be constructive exchange from the perspectives of conventional and islamic finance to maintain global financial stability
as islamic finance will continue to be an integral part of the global financial system it is important to have an integrated initiative both for conventional and islamic finance to preserve financial stability at the global level

as the synchronisation of policies and actions across jurisdictions and markets is a major task a broadbased and constructive strategic platform to build cross border consensus to promote financial stability within the islamic financial system as well as having linkages with the conventional financial markets is vital

disclosures to promote transparency and market discipline for institutions offering ifsb islamic financial services excluding dec islamic insurance takaful institutions and islamic mutual funds ifsb and basically form the equivalent of basel ii framework for iifs islamic finance and global financial stability
appendix i standards and guidelines issued by the ifsb preparation of standards and guiding principles list of all the ifsb standards guiding principles and technical notes that have been adopted by the council and those that are currently being prepared

compilation guide on prudential structural islamic finance indicators guidance on the compilation tn dissemination of prudential structural mar islamic finance indicators for banking near banking institutions offering islamic financial services

guidance note on rating for islamic gn insurance takaful operations other ifsb documents list of other documents that have been adopted by the council including those that are published in collaboration with other organisations
islamic financial islamic research and may services industry training institute a development tenislamic development year framework and bank strategies islamic finance and global financial stability

appendix ii comparative table on standards and guidelines issued by the islamic financial services board and the basel committee on banking supervision prudential and ifsb bcbs regulatory comments remarks standards standards areas risk a a a c while bcbs standards management have set out sound practices and principles pertaining to credit market liquidity and operational risks of financial institutions ifsb has provided additional guidance to cater for specificities of iifs requirement to comply with shari ah rules and principles as the essential feature of iifs activities
greater fiduciary duty requiring iifs to apply shari ah compliant risk mitigation techniques wherever appropriate

prudential and ifsb bcbs comments remarks regulatory standards standards areas measurement a a a c areas unique to islamic banks of capital covered by ifsb standards adequacy specific structure of requirement shari ah compliant pillar products and services offered by iifs that are not specifically addressed by bcbs e
a c while the ifsb s capital adequacy requirement is predominantly based on standardized approach of pillar supervisory discretion is allowed to adopt more advanced risk management approaches if they can address the infrastructure issues adequately

note that bcbs has recently issued consultative paper to review the recognition criteria for eligible regulatory capital of banking institutions supervisory a a a c ifsb acknowledges that review the internationally agreed process principles underpinning pillar supervisory review in the basel ii are equally applicable for iifs
treatment of investment account holders iah investor protection issues raised by the iifs role as managers of funds placed with them by the iah specific issues on islamic windows operation and real estate investment

governance a a a c ifsb seeks to complement the existing internationally recognised standards of good corporate governance by particularly addressing the specificities of iifs including a the rights of investment account holders iah a compliance with shari ah rules and principles and a transparency of financial reporting in respect of investment accounts
prudential and ifsb bcbs comments remarks regulatory standards standards areas transparency a a a c both the ifsb and bcbs and market standards are aimed discipline at enhancing market pillar participants access to relevant reliable and timely information on the financial institutions

guidance paper on the a ed exposure draft on structure of regulatory solvency requirements capital requirement for takaful operations a has been issued islamic finance and global financial stability
appendix iii comparative table on standards issued by the islamic financial services board and international association of insurance supervisors iais ifsb remarks regulatory requirement a financial p

supervisory standard on fit a ifsb guiding and proper requirements principles on governance a and assessment for of takaful operation has insurers been issued islamic finance and global financial stability
guidance paper on the structure of capital resources for solvency purposes x regulatory requirement a governance s

guidance paper a ifsb guiding on investment risk principles on governance management a of takaful operations has been issued gp
guidance paper on risk transfer disclosure and analysis of finite reinsurance x islamic finance and global financial stability

a ifsb performance and other guiding principles on risks of non life insurers governance of takaful and reinsurers a operations states that reference should be made to this iais standard on disclosures practices and regime islamic finance and global financial stability
principles for conduct of a ifsb guiding insurance business principles on conduct of a business for institutions offering islamic financial services has been issued s

a ifsb risks and performance for guiding principles on insurers and reinsurers governance of takaful a operations states that reference should be made to this iais standard on disclosures practices and regime s
guidance paper on anti iais standard is money laundering and applicable require no combating the financing of adaptation to apply to terrorism a takaful gp

supervisory standard iais standard is on the exchange of applicable require no a information adaptation to apply to takaful islamic finance and global financial stability
principles applicable to the supervision of international insurers and insurance x groups and their crossborder business operations p

iais standard is on the use of supervisory applicable require no a colleges in group wide adaptation to apply to supervision takaful islamic finance and global financial stability

o joseph he said o man of truth expound to us the dream of seven fat kine whom seven lean ones devour and of seven green ears of corn and seven others withered that i may return to the people and that they may understand

allen franklin and douglas gale financial fragility paper presented at third joint central bank research conference on risk measurement and systemic risk bis basel march
askari hossein zamir iqbal abbas mirakhor and noureddine krichenne the stability of islamic finance creating a resilient financial environment for a secure future johon wiley sons asia pte

rosenberg christoph ioannis halikias brett house christian keller jens nystedt alexander pitt and brad setser debt related vulnerabilities and financial crises an application of the balance sheet approach to emerging market countries imf occasional paper
tayyebi aziz eclipse by the crescent moon islamic finance provides some light in the global financial crisis financial services review acca global june

trichet jean claude a paradigm change for the global financial system speech delivered at the international colloquium nouveau monde nouveau capitalisme roundtable paris january
world bank imf financial sector assessment a handbook world bank institute

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DOCUMENT WORD ANALYSIS

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AlHuda Material\islamic banking

KeyWords

islamic banks banking financial finance investment conventional institutions funds risk financing deposits assets services management international countries equity profit products

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Number of Pages

77

Published Date

2010-04-01 18:11:44

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Islamic Finance and Global Financial Stability by Dr. Ahmad

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