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Saturday, 23 February 2008

Governor of SAMA Gives Insight Into Islamic Finance in Tokyo

TOKYO (Nikkei)--Government officials and private-sector leaders from home and abroad shared their views on the current state of Islamic finance at the Nikkei Islamic Finance Symposium in Tokyo Saturday.

Bank of Japan Governor Toshihiko Fukui made the opening remarks at the forum, which was hosted by Nikkei Inc.

Zeti Akhtar Aziz, governor of Bank Negara Malaysia, gave a keynote speech on "The Evolution and Opportunities of Islamic Finance."

Hamad Saud Al-Sayari, governor of the Saudi Arabian Monetary Agency, prepared the other keynote address, titled "The Evolution of Islamic Financial Services and its Future Prospects," which was delivered by Saudi Ambassador to Japan Faisal Hassan Trad on the governor's behalf.

Following is Al-Sayari's address.

I am very pleased to be here in Tokyo at this important symposium on Islamic Finance organized by Nikkei Inc, and to share my views on "The evolution of Islamic Financial Services and its future prospects." The location of this symposium also reflects an interest within the Japanese financial community in the development of the dynamic Islamic Financial sector and hopefully a desire to participate and contribute to it. This is also evidenced by the recent announcement of the imminent launch of a Japanese Sovereign Shariah Compliant Bond or Sukuk.

It is worth noting that, Islamic Financial Institutions like their conventional counterpart are first and foremost financial intermediaries. They offer services to depositors and investors on one side and provide loans and funds to companies, entrepreneurs and public sector on the other side. Islamic financial transactions also recognize the time value of money and are normally structured as a sale of underlying goods or provision of services such as rentals and leases. Essentially, IFI's are very similar to conventional financial institutions, but they are required to comply with Shariah principles. Therefore, they are referred to as Islamic or Shariah compliant financial institutions.

In the early days, Shariah compliant products initially appeared to satisfy an emotional religious feeling. Unfortunately, in the beginning, not enough work was done on the financial engineering aspects of these products. Nowadays, more attention is being paid to the financial engineering aspects; thus, satisfying both desires: emotional and financial. It is hoped that one is never sacrificed for the other. IFSB and other organizations are helping a lot in this area.
Islamic financial services industry is becoming an increasingly important part of the global financial system. Since its inception almost three decades ago, the number of Islamic financial institutions worldwide has increased to more than 300 located in over 75 countries. Though primarily concentrated in the Middle East, African and South East Asian countries with significant Muslim populations, a number of Islamic banks and asset managers are also establishing and expanding in Europe and North America. Islamic finance now transcends the boundaries of many countries across the World. Most of the major international banks have established Shariah compliant subsidiaries and opened their own Shariah compliant banking windows. According to a recent report by a leading rating agency, the global Islamic financial industry's Shariah compliant assets are now estimated to be worth over US$ 500 billion. These have grown at an annual rate of between 15-20% over the past decade and are expected to maintain this upward trend in the next decade and could reach $1 trillion.
Among the Shariah compliant products, bonds, known as Sukuk, are expanding rapidly. Currently valued at around $50 billion, they are expected to double in value by the end of the decade. Many banks in the GCC and MENA countries are viewing these instruments as an important tool in managing their assets and liabilities. Raising low cost funds by issuing Sukuk has become a viable alternative for a number of borrowers in the GCC countries due to ample liquidity conditions in the region. There has also been well publicized issuance of Sukuk by non-Muslim issuers including the State of Saxony-Anhalt in Germany and the East Cameron Gas Company of Texas among others. These examples amply illustrate the growing internationalization of Islamic finance and its move into the mainstream.
The demand for Shariah compliant financial products in the global market is far exceeding their current availability. The need of the moment is for Islamic financial institutions to focus on product development through innovation. There exists a wide scope in this regard in fields other than Sukuk, such as mortgage financing, retail banking and structured financial derivatives. Another area of growth and product diversification is Takaful (insurance) which is Shariah compliant insurance based on cooperative principles. Insurance has generally remained unpopular among the Muslim community for religious considerations. Takaful, the cooperative insurance, has therefore, great potential for development as a Shariah compliant product.
This is a broad overview of the current status of global Islamic finance. I will now address the evolution and growth of Shariah compliant finance in Saudi Arabia. The Shariah compliant banking industry has evolved as a viable and competitive component of the overall Saudi banking system with no special dispensations on compliance. We have taken the pragmatic approach of permitting the development of Shariah compliant financial industry along with conventional financial institutions and practices. This approach has permitted steady growth of specialist Shariah compliant financial institutions and also prompted conventional institutions to offer Shariah compliant products and services. As the demand for such products and services is driven by market forces, all financial institutions compete vigorously to increase or retain their market share.
During the past decade, Shariah compliant assets of Saudi banks have grown by around 20% p.a. At the end of September 2007, about 34% of assets of the Saudi banks and 79% of the Mutual Funds were Shariah compliant. Retail banking in Saudi Arabia has expanded its coverage of Shariah compliant banking products and services. Under the Cooperative Insurance Law, SAMA has already licensed 20 newly formed insurance companies, which will operate on the basis of Takaful. These companies, which are being partially floated to the public, will add to the diversity of the Shariah compliant financial industry in the Kingdom.
In terms of regulatory oversight and sound banking practices, all banks, whether conventional or Shariah compliant, are subject to rigorous risk management, sound corporate governance, transparency and full disclosure. As a founding member of the IFSB, we fully subscribe to the IFSB standards and are actively implementing these. In this context, we understand that IFSB regulations are designed to build upon the existing global standards by incorporating the unique Shariah features that are relevant to IFIs. This ensures their harmonized implementation across different jurisdictions. In Saudi Arabia, banks providing Shariah compliant products and services have strengthened their risk management systems, adapted model-based methodologies for rating, credit, market and operational risks as required under Basle regulations. The Basel Core Principles for Banking Supervision and Core Principles issued by International Association of Insurance Supervisors and IOSCO, though primarily designed to provide a framework of international standards for a conventional financial system, are equally relevant for the Shariah compliant financial services industry as they identify a number of key preconditions for a robust financial sector. These include, inter alia, the following:

1. A robust legal infrastructure underpinned by laws covering contracts, property rights, insolvency, and creditor rights, and financial safety nets
2. A corporate governance infrastructure, accounting and auditing framework, transparency and disclosure regime
3. A systemic liquidity infrastructure, efficient payment and settlement system, robust money, exchange and securities markets

It is important that Shariah compliant financial sector supervisors create an infrastructure that meets international standards. Consequently, international standards related to external auditing, financial statement publication and disclosure of information on credit, market, and operational risks are equally relevant to Islamic finance. In this context, I wish to point out that the Shariah compliant financial activities of Saudi banks have not been a hindrance in their adoption of the International Financial Reporting Standards. Similarly, in our view, the international standards for corporate governance apply equally to Shariah compliant financial institutions. There also, should be no dilution or watering down of international standards when they are applied to Islamic financial institutions although their special characteristics and requirements should be accommodated. In fact in 1981, a Committee of experts from Supervisors and the Senior Executives of the Islamic banking industry, under the umbrella of the Islamic Development Bank, looked at the challenges and constraints faced by the IFI's. It's main conclusion and recommendation was not to single out IFI's in a manner that could isolate them from the international financial system, but only to note their special requirements for Shariah compliance. Otherwise, the Committee agreed that they should be treated the same way as other financial institutions.

A major challenge for Islamic banks is to find ways to place their excess liquidity in the interbank market or with the Central banks. This is because of a lack of sufficient short term Shariah compliant investment instruments. Consequently, an important component of the institutional infrastructure for Islamic finance requires that these financial institutions have full access to systemic liquidity infrastructure and payment and settlement systems. In the near future, we expect to see a wider range of Shariah compliant instruments for liquidity as the market develop and the investor base widens.

Over the last two decades, a number of Islamic institutions have emerged with varying degrees of relevance and impact on Islamic Financial Institutions (IFIs). They have contributed greatly in promoting Islamic finance. In this regard, I would specially acknowledge the work of the Islamic Research and Training Institute (IRTI) of the Islamic Development Bank, which has been a great source of research and training for the Islamic financial industry. Also, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in Bahrain since 1991 has contributed greatly to the development of banking standards and best practices. More recently, the Islamic Financial Services Board (IFSB) in its brief history has made a significant contribution in propagating Islamic finance and developing high quality standards for banking supervisors and the IFIs.

The existing financial infrastructure for Shariah compliant finance both at the national and the international levels requires further strengthening and enhancement. Certainly, Islamic finance, like conventional finance, is affected by the rapid changes in the global environment. These include the impact of globalization and the rapid technological changes that are enhancing delivery channels and mechanism. Also, the capacity of institutions to manage and control risk by use of advanced technology is rising sharply. In addition, IFIs are confronted with changes in global regulatory requirements which continue to seek more transparency and corporate governance. Finally, they are also under pressure to innovate and broaden the range of their products and services including Sukuk, securitization and hedging.

Hopefully, over the next five years, Shariah compliant financial services will be able to provide meaningful and creative alternatives for depositors and investors. The rapidly changing markets and regulatory requirements will compel IFIs to broaden their businesses in a more stringent and transparent regulatory environment.

In conclusion, I would like to acknowledge that Islamic finance has come a long way from its nascent state only a couple of decades ago. However, there are challenges for the industry in terms of unifying the code of common practice and addressing the scarcity of qualified Shariah scholars and experts as well as trained professionals with in-depth knowledge of the IFI specialties. This is important for sustaining the current rate of growth in the industry.

Thank you for your attention. --(Nikkei)

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