Post By:Beata Paxford PhD is a senior lawyer in Warsaw law firm. She is responsible for banking and corporate matters. She specialises also in Islamic finance, being the author of many articles devoted to the issue, and being the speaker at banking conferences.
2010 has proved to be a year of changes in the banking and finance industry. The propositions of the so-called Basel III were announced as well as the need for common European supervision. Furthermore, the Larosiere Report confirmed the necessity to create a more-unified financial market that will – its authors hope – lead to greater industry stability.
Looking at it on global level, though, it’s worth asking if there is a need for common global Islamic supervision and changes in the regulatory area.
The proposed amendments to the hitherto banking regulatory policies have come as a result of the credit crunch and the crisis on the market of financial instruments. It was said that the breakdown on the housing market connected with complicated derivate structures led to a decrease in public trust in financial companies and thus regulatory institutions. Hence, the need for a European and global common regulatory policy appeared. A policy that would not only strengthen the national regulator but would also create a demand for a common regulatory institution. However, one should ruminate over the real need for such a legalised solution and should ask whether another bunch of provisions will solve the problem.
Many articles devoted to the issue of Islamic finance have addressed the problem of ethics, citing the concept as long forgotten in conventional banking. Some authors arguing that not adhering to moral principles along with the ever-present greed would lead to a crisis. Nevertheless, such opinions could be seen as oversimplified and lacking in deeper analysis. What should be looked into, though, is the issue of a common regulatory institution for the global banking and finance industry and the place of Islamic finance in the global regulatory policy, and the possibility to connect the regulatory provisions and the ethical values of Islamic finance for the institutions that deal in this industry.
Islamic finance boasts three regulatory bodies. There is the Islamic Financial Services Board, the Accounting and Auditing Islamic Finance Institution and the International Islamic Rating Agency. These institutions aim to create a set of unified standards in Islamic finance. Each one has a Sharia board to verify compliance issues. However, none of them has legal capacity to bind the institutions into complying with its standards. These bodies exist on an international level. They are composed of financial institutions, such as private banks, and also organisations such as the World bank. Thanks to such a wide array of members, the regulatory bodies for IF can tackle chosen issues both from a global and a domestic perspective. They can also analyse and compare the functioning of certain types of financial instruments in global banking and in Islamic one.
What should be taken into account is the need to set such regulatory standards that would be both Sharia-compliant and modern in light of the ever-changing banking sector.
First of all, the standards should be unified. That means that the Islamic Finance regulatory bodies should set the same standards for the same type of financial instruments (e.g. tawarruq, istisna etc.). Likewise, the fatwas issued by Sharia scholars employed by the Islamic Finance institutions or engaged in Islamic Finance transactions should not be contradictory to the standards set by the respective bodies. Otherwise, the Islamic finance & banking sector will be seen as not credible and, therefore, not competitive.
However, one should not forget that there are different schools of Sharia, each one with a different approach towards the Holy tenets of the religion. This might influence opinions issued by scholars employed on Sharia boards of Islamic Finance institutions. The same refers to members of Sharia boards working in non-Islamic states, such as the UK or France. The interpretation of a given transaction in respect of its Sharia compliance should not contradict the general standards issued by regulatory bodies. Furthermore, it should not differ to far from the standards and fatwas applied by Islamic Finance institutions that operate in Islamic countries.
Islamic finance & banking is a growing sector, on its way to becoming a constant fixture in global banking. It cannot afford to lose its credibility, particularly in terms of Sharia compliance. The situation, where, in a non-Islamic country, a certain transaction is deemed as a Sharia complaint one, while the same transaction is viewed as haram in an Islamic country, should not happen. The industry must speak with one voice, with the same set of rules and prohibitions. This will give Islamic finance & banking the strength and appeal it needs.
For instance, AAOIFI issued the Sharia Standards concerning Sukuk. It explicitly states that Sharia Supervisory Boards should, prior to issuing a fatwa in respect of a transaction, carefully review all relevant contracts and documents related to the transaction. A halal transaction should comply with Sharia on all levels, including the purpose of the transaction, its participants and the transfer of assets. Sukuk has to be owned by Sukuk holders with all the rights and obligations of ownership in real assets. Hence, short sales in terms of Sukuk would be not permissible. The question of ownership and its transfer is a crucial one. Sukuk transactions must be both Sharia compliant and reliable, not allowing for derivative-backed transactions or naked short sales.
Likewise, the Islamic International Rational Agency intends to provide credible ranking for Islamic Finance institutions. It offers a Sharia Quality Rating, which aims to give an unbiased assessment of the Sharia-compliance operation of an institution or a transaction. Contrary to standard rating agencies, which verify solvency and debt-management issues, the IIRA wishes to provide measurement tools that check the observance of Sharia according to Fiqh. This includes a check-up on the capital, mixing of capitals (in the case of Islamic Windows), procedures and transactions conducted by the institution.
Following the AAOIFI standard, an Islamic Finance institution can provide its clients with the best service – satisfying their religious and economic needs. One must remember that pious Muslims want to use Islamic Finance institutions and want to conduct their business. They want to make sure, though, that the Islamic Finance institution complies with the rules. They also want to have the same standards for the same transactions regardless of the country in which it is taking place.
Discussing regulatory issues, one should look at European changes in banking- and finance-compliance policy. The latest global crisis badly hit certain European Union member states. Losses stemming from uncontrolled banking operations undermined the trustworthiness of European financial institutions. New policies were needed. The EU issued the MIFID directive in respect of financial instruments, addressing the issue of derivatives. There has been a PSD directive, issued to increase the safety of payment. Moreover, new proposals on risk management were prepared by the Basel Banking Supervisory Committee, known as Basel III. IF institutions that operate on the EU market have to comply with EU law. Nevertheless, are these European regulations of any help to the global Islamic finance industry?
In the author’s opinion, the Islamic finance & banking sector needs to be aware of the legal and economic tendencies taking place in Europe. This, however, does not mean that the Islamic Finance industry should implement all the rules. The banking and finance sector operates on different levels in Islamic states – from poorer countries such as Pakistan to affluent Saudi Arabia. This includes the level of cash payments, non-cash transactions, project finance and PPP projects. There are also economic differences to be taken into consideration when comparing Islamic countries with Europe. Furthermore, the Islamic Finance industry has not been struck so deeply by the financial crises, hence it does not need to undertake such measures, in particular in respect of risk management and liquidity.
However, the author believes there should be co-operation between the Islamic regulatory bodies and those in the EU. It could benefit the whole community, and the clients of financial institutions.
The need for one voice for Islamic finance compliance is not to be undermined. It should be the first aim for the Islamic Finance regulatory bodies in the upcoming years. Islamic Finance should become an immanent part of global banking, and setting equal measures for its participants should be of utmost importance.
- What if the world had been following Islamic financial practices? | Imaduddin Ahmed (guardian.co.uk)