Islamic banking sector on a roll

19 June 2007
MANAMA: The Islamic banking industry is fast becoming a force to be reckoned with, but there are still major obstacles to the development of fully-fledged Sharia-compliant capital markets, bankers were told yesterday.

The industry also faces the challenge of harmonising different regulatory regimes around the world, Central Bank of Bahrain (CBB) Governor Rasheed Al Maraj told delegates in an opening address to the Second International Islamic Financial Markets (IIFM) Conference in Bahrain.

The two-day event, which brings together some of the chief regulators and players in the global Islamic finance market, is being held at the Diplomat Radisson SAS Hotel, Residence and Spa.

Key issues up for debate include how to encourage greater liquidity in the Islamic banking sector and how to bring the various Islamic banking industries around the world into greater harmony.

The regulators present, including the CBB governor, stressed the importance of developing common standards for the industry.

"The Islamic finance sector continues to demonstrate strong growth with higher levels of market penetration. It is also fast internationalising," said Mr Al Maraj.

"But it has also reached a stage where it faces some interesting challenges, if it is to really take off as a major component of global financial market activities.

"These challenges revolve around the continuing need to achieve greater alignment and convergence, without which the vision of deep and liquid global Islamic financial markets risks being compromised."

The accounting standards and prudential regulations applied to Islamic finance need to be aligned, he said.

It was also important to work at standardising financial instruments and market practices.

This global alignment was essential if the recent growth of the Islamic banking sector was to continue, said Mr Al Maraj.

"Greater harmonisation in these areas is critical, in my view, in order to help sustain the rapid growth and internationalisation of Islamic finance.

"To state the obvious, such differences create additional costs for internationally-active firms and competitive distortions, as well as reduce transparency for investors and counter-parties.

"Of course, this is a challenge facing conventional finance as well. But the relative newness of modern-day Islamic finance means that the disparities in approaches in these areas are somewhat greater in this industry."

Despite the fierce competition in this fast-growing sector of the banking world, many speakers stressed the need for Islamic banks to pull together.

The new Bahraini chairman of IIFM, Khalid Hamad, who is also an executive director of the CBB, said that industry players and regulators needed to work closely to protect the longer-term interests of the industry.

He pointed to the example of Islamic hedging instruments - a comparatively new Sharia-compliant product. IIFM is working on a framework agreement that will introduce common guidelines for Islamic finance houses around the world.

"Islamic hedging is a challenging issue and the framework document is important for the industry, and with the contributions from the market participants the objectives can be realised. I hope that key institutions that have developed certain hedging products will come forward to the benefit of the industry and not take these efforts as competition," said Mr Hamad.

Banks could work through the IIFM to share knowledge on other areas of new product development, such as short-term commodity Murabaha contracts, he said.

Development of these and other financial instruments was essential to the development of genuine Islamic primary and secondary markets, delegates heard.

One of the biggest obstacles to growth at present is the long-term nature of many Islamic products. Investment is typically tied in for periods of months or even years, which means that financiers are less able to trade paper and that there is comparatively little liquid flow of capital through the sector.

This is preventing the Islamic banking industry from competing properly with the conventional finance market.

A prime example is Murabaha, a form of cost-plus contract that is the most common form of financing used by Islamic banks at the moment.

"Murabaha is not a very efficient way of managing short-term liquidity," said Calyon Corporate and Investment Bank senior adviser Colin Willis.

"It has a total lack of tradability, as once you've tied up you money, that's it for months. Elsewhere we've seen the rapid evolution of sukuks (Islamic bonds) or Islamic project finance but what has yet to take off is what I consider the holy grail of Islamic finance, and that is short-term management products."

Another example is the development of an Islamic equivalent of "repos", sales and repurchase agreements that are a highly tradable staple of conventional finance markets.

"There are many questions such as how to structure interest payments and what sort of underlying assets would Islamic repos have," said law firm Linklaters' representative Luma Saqqaf.

"I think it is all structurally possible, but the details are going to take some time to work out."

Reference:: Islamic banking sector on a roll

Islamic Capital &
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Unification
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