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Wednesday, 27 June 2012

IFSB summit to focus on global crisis, internal reforms

ISTANBUL — Members of the governing council of the Islamic Financial Services Board (IFSB), the prudential and supervisory standard setting body for the global Islamic financial industry, and delegates have started converging here for the two-day board’s 9th annual summit starting Wednesday.

Central Bank of Turkey is hosting the event for the first time.

Jaseem Ahmed, the soft-spoekn IFSB Secretary General and formerly a senior executive of the Asian Development Bank, will indeed have much on his mind. Never mind the challenges in the global economy and the impact of the global financial crisis and its attendant resultant pending reforms a la Basel III. The IFSB as an institution itself is faced with calls for reform and the Islamic financial industry it serves similarly is faced with huge challenges inspite of its phenomenal growth over the last decade or so. 

Warnings against complacency are in abundance. In the Sukuk market for instance, Dr. Nik Ramlah Mahmood, Deputy Chief Executive of the Securities Commission Malaysia, the securities regulator, could not be more to the point in her keynote speech recently to the Islamic Bonds (Sukuk) Outlook Conference in Kuala Lumpur. “While the outlook for Sukuk remains bright not only in Malaysia but also globally, we cannot and must not rest on our laurels reminiscing about past achievements. Efforts to broaden the base of both issuers and investors of Sukuk must be more vigorously pursued. Further innovation is not an option but a necessity as issuers seek the most optimal structures to meet their respective needs while addressing the investors’ preferences,” she advised. 

To be fair to Ahmed, he has been in the top IFSB job for just over a year, and this will be merely his second annual summit in charge of the board. But be warned. His quiet demeanour belies a gritty technocratic determination to get things done. The ideas for reform are there, but the only major hurdle could be the politics of the institution and the industry.

What indeed are the challenges for the IFSB over the next few years? Perhaps it is coincidental or uncanny that the theme of this year’s summit is ‘Global Financial Reforms: The Changing Regulatory Model and Islamic Finance’. The theme could not be more topical in the context of the ongoing turmoil in the global economy and financial system and markets.

The summit, says the IFSB is aiming “to evaluate whether reforms in financial regulation structure and prudential standards equally equip the Islamic financial services industry in addressing its future challenges as well as identifying the priority areas in the prudential regulation of Islamic finance that may need focus and attention by regulators and market players alike”.

As recent elections in the UK, France, Germany and Greece have shown, austerity drives at the expense of economic growth are not popular with the electorate in general. At the same time, Mervyn Rees, Governor of the Bank of England, has effectively ruled out any blame in its role and handling of the country’s burgeoning budget deficit and global financial crisis which has propelled the UK economy into a double dip recession. 

The Queen’s speech at last week’s opening of a new parliamentary term was extremely light on regulatory and financial reform. It was left to Socialist French president-elect Francois Hollande to promise to rein in the excesses of the financial sector. 

In the context of the above developments, the IFSB summit assumes a timely importance and a challenging new dimension. This is because it offers an alternative approach to financial intermediation and its prudential regulation and supervision based on Islamic ethical principles that connects financial services to the real economy, and at the same time consistent with international standards and best practice. It also explores a potential contributory role for Islamic finance to contribute to financial stability and economic growth. 
The challenges for the IFSB in addition include organizational ones and market structural ones. 

IFSB is under severe constraints regarding resource mobilization. Its current membership fee-based system of generating revenues is simply inadequate. This is reflected in the banality of the IFSB even charging hard-pressed research students to pay to attend the summit albeit at a reduced rate. 

Perhaps it is time for the IFSB to transition to an equity subscription-based membership which may give it much more resource stability albeit subject to the dynamics it may unleash in terms of voting rights etc. The other alternative is to transform the IFSB into a non-profit trust (Waqf) with countries volunteering to donate decent endowments which would be invested and the organization financed from the investment proceeds of the endowments. This can be complemented by other revenue streams such as fees for the various standards adopted by the board; income from research reports and technical advisory services. 

Another challenge for the IFSB is its organizational reach. Its events give the impression of an indecent body politic with very little engagement or interaction with the very market it is supposed to serve. 

Events are not geared to the market which suggests a lost opportunity cost. The IFSB ideally should be a direct multifunctional platform where policy-makers can talk to industry players; where key legislators can interact with industry players; where regulators can discuss with industry players; and where they can all talk to each other.

This will lead to a culture of transparency and engagement between some of the most important stakeholders in the Islamic finance industry. This is the sea change the IFSB should strive for in its engagement policy with the various stakeholders.

The reasons for this are more implicit and important than it may suggest. Take for instance the authorization model for Islamic banks and financial institutions. Currently the present mandate supposedly prevents the IFSB to issue a standard regarding authorization of Islamic banks. This is because the IFSB supposedly only deals with prudential and supervisory issues. 

This is non-argument because the risks associated with the absence of a legal and regulatory framework for Islamic banks and financial institutions, but where such institutions are licensed anyway under a motley of other legal provisions, are indeed real.

How can Saudi Arabia be taken as a serious Islamic banking player when the government and the central bank, SAMA, are not adopting a dedicated Islamic banking law? This is against the very guidelines of the IFSB which has championed the specificities of Islamic finance, for instance the nature of deposits in Islamic banking which differs diametrically to those in conventional interest-based banking. Either the IFSB council acknowledge these serious anomalies and change the mandate of the board or the institution will merely continue to contradict its own guidelines and aspirations. 

The impact of the provisions of the Basel III process on Islamic financial institutions (IFIs) cannot be overstated. As IFSB’s Ahmed emphasized in his speech at the 11th Annual Euromoney Islamic Finance Summit in London earlier this year, as far as capital is concerned, “the increase in banks’ capital quality, consistency and transparency does not affect IFIs because the Hybrid and Tier III capital that are affected by the changes have not played a significant role in IFIs’ capital structures.” 

The capital structure of the majority of IFIs is dominated by Tier I capital and common equity. In Tier II capital, the issue is how IFIs will meet Shariah requirements before meeting the regulatory requirements for instruments such as subordinated debt, hybrid capital, convertible contingent capital (CoCos) and Sukuk that can be considered as capital.
On the other hand, liquidity is one area, suggested Ahmed, where Islamic banks are likely to be significantly affected, principally due to the lack of liquid Islamic instruments. Indeed, an IFSB survey last year revealed that most supervisory authorities and IFIs expect difficulties in complying with Basel III requirements, although the IFSB has come up with a robust response to Basel III to level the playing field.

Most notedly, implementation of standards is vital whether on a voluntary adoption basis or otherwise. The Basel Committee has been highly successful in reaching agreement on implementation of standards through joint, voluntary measures. Indeed, according to Ahmed, Basel’s strength in not in its rule-making capacity, but “in the way it has served as a platform for cooperation and sharing of experiences between supervisors and regulatory authorities.” This has been achieved through a close network of personal and institutional relationships between them. This he maintained is also the objective of the IFSB.

However, Ahmed’s suggestion on voluntary adoption whereby the IFSB recognizes the different capacities and stages of development amongst its members may turn out to be a recipe for inertia and obfuscation on the part of member countries. “In recognizing these differences, and in taking the more consensual route, it is entirely appropriate to utilize to the utmost, as in Basel, the platform for cooperation that the IFSB provides,” he concluded.
True voluntary adoption is closely linked to systems of political governance. The Basel process has long been dominated and led by those key member countries (the G7) who are all liberal democracies, As such they have a vested interest in debating, adopting and ratifying Basel and Bank of International Settlement (BIS) directives through their parliaments before the final royal or presidential assent. 

The IFSB member countries do not have this luxury because their governance structures vary widely. In this respect the IFSB may be right in pursing its consensual approach albeit far from ideal and efficacious. Standards, however, are meaningless if they are not implemented or adopted by those toward whom they are targeted. 

Nevertheless, the main summit sessions are comprehensive and include ‘International Regulatory Initiatives to Enhance Global Financial Stability’; ‘Impact of International Regulatory Initiatives on the Islamic Financial Services Industry’; ‘Regulatory Harmonisation and Cross-border Linkages in Islamic Finance’; ‘Global Financial Infrastructure of Islamic Finance’; and ‘Global Regulatory Reform and the Prospects for the Islamic Financial Services Industry.’

The IFSB has attracted a list of prominent speakers and participants led by Dr. Mahmoud Mohieldin, Managing Director, World Bank, which last year declared Islamic finance as a priority in its financing for Muslim member countries. 
The summit will also see the participation of seven key financial regulators from Turkey, Malaysia, the UAE, Nigeria, Pakistan, Palestine and Luxembourg, which is the sole European Union (EU) member of the IFSB. 

The IFSB summit has grown in stature to the extent that it is imperative for international agencies to be regular participants. Apart from the World Bank’s Dr. Mohieldin, William Coen, Deputy Secretary General, Basel Committee on Banking Supervision, Bank for International Settlement, and Dr. Ghiath Shabsigh, chief of Middle East and Central Asia Division, Monetary & Capital Markets Department, International Monetary Fund (IMF) are also speaking at the summit. 

They will be complemented by a host of speakers from multilaterals, stock exchanges, education providers and market players. 

(Saudi Gazette / 14 May 2012)

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