IMF Survey: Islamic Banking Makes Headway
IMF News, September 19, 2007
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- Authors: Juan Solé IMF Monetary, Capital Markets Department September
- Published: September 19, 2007
Overview
- Islamic banking is steadily moving into an increasing number of conventional financial systems, expanding in majority-Muslim nations and in countries where Muslims are a minority (examples in the text: the United Kingdom and Japan).
- Countries such as India, the Kyrgyz Republic, and Syria have recently granted, or are considering granting, licenses for Islamic banking activities.
- The article emphasizes the importance of familiarizing finance practitioners and supervisory authorities with the principles governing Islamic banking.
Key statistics and trends
- More than 300 Islamic financial institutions spread over 51 countries.
- Well over 250 mutual funds that comply with Islamic principles.
- Growth rates of 10-15 percent per year over the past decade — a trend that is expected to continue.
- Rapid expansion began in the 1970s; AAOIFI was created in 1990.
Four main principles governing Islamic banking
- Besides prohibitions against riba (interest), gharar and maisir (contractual uncertainty and gambling), and haram industries (prohibited industries such as those related to pork products, pornography, or alcoholic beverages), practitioners and supervisors must observe additional operational and regulatory principles.
- Shariah compliance
- Islamic finance is based on principles established by the Shariah and fatwa issued by qualified Muslim scholars.
- Islamic banks commonly appoint a board of Shariah scholars; where expertise is scarce, different Islamic banks often share the same scholars, promoting consistency.
- The first measure for an institution wishing to offer Islamic products is to appoint a Shariah board or, at minimum, a Shariah counselor to minimize Shariah risk (the risk that contract terms do not effectively comply with Islamic jurisprudence).
- Financial regulators should appoint their own Shariah experts to advise on instruments and services and ensure regulatory compatibility with Islamic principles.
- Regulators should aim for rulings and decisions consistent with Shariah boards of foreign supervisory agencies.
- Multilateral institutions that promote international consistency include the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB).
- Segregation of funds
- Funds intended for Shariah-compatible investments should not be mixed with non-Islamic investments to maintain moral purity and avoid involvement with riba, gharar, or haram activities.
- Conventional banks offering Islamic products must guarantee and publicize that funds for conventional activities will not be commingled with those for Islamic activities.
- Operational requirements include establishing different capital funds, accounts, and reporting systems for each type of activity.
- Accounting and auditing standards
- The rapid expansion was not initially accompanied by internationally recognized accounting rules; institutions developed their own solutions, complicating comparisons and sometimes creating perceptions of lack of transparency.
- AAOIFI was created in 1990 to design and disseminate accounting and auditing standards applicable internationally by Islamic institutions.
- AAOIFI also pursues harmonization of Shariah-based rulings across jurisdictions.
- Regulators and financial institutions in nascent jurisdictions should familiarize themselves with AAOIFI standards and apply them to the maximum extent possible to ease supervision and foster integration into the international financial community.
- Awareness campaigns
- The success of Islamic banking in conventional systems depends on whether potential depositors and investors are well informed about opportunities and risks and whether Islamic banking is perceived as transparent and well-regulated.
- From a prudential standpoint, regulators should communicate which types of Islamic institutions and products will be supervised.
- Regulators should require institutions offering Islamic products to pursue awareness campaigns; commercial banks should inform investment (mudarabah) depositors of the profit-and-loss nature of their deposits.
- Practical implementation can include providing an explanatory prospectus to interested customers.
Source of support and international coordination
- Multilateral institutions that provide assistance to governments and supervisory agencies include the IMF, IFSB, AAOIFI, and the Islamic Development Bank.
- Authorities should engage in dialogue with local interlocutors in the industry to promote open and fluid exchange of information and ideas.
IMF Survey: Islamic Banking Makes Headway — Juan Solé, IMF Monetary and Capital Markets Department; September 19, 2007.