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Press Release > 2017

Speech by the Secretary-General of the IFSB at IFSB Seminar on Islamic Finance and Global Regulation: Moving Targets and New Horizons

Date posted: 4 April 2017

Date : 4 April 2017
Event / Venue : IFSB Annual Meetings and Side Events 2017  | Kuala Lumpur, Malaysia
Speaker : Mr Jaseem Ahmed, Secretary-General, IFSB

◈   2007-2017: A Decade of Challenges, Reforms and Opportunities

Ladies and Gentlemen, 2017 marks the tenth year since the onset of the global financial crisis of 2007-08. Looking back, this has been a crucial and decisive decade on a number of fronts.

Against the wide ranging impact of the crisis, which cascaded across the global economy, two factors stand out.

First, the global financial regulatory architecture has undergone a substantial reform led by the initiatives of the Group of Twenty (G20) and Financial Stability Board (FSB). The international standard-setting bodies, in line with their mandate, have revised their prudential principles and guidelines to incorporate more stringent capital, liquidity and disclosure requirements on financial institutions.

In many ways, these measures moved conventional finance towards the principles on which Islamic finance is based.

The international organisations such as the IMF, with responsibility for financial sector surveillance, have adopted the revised Standards in their assessments while placing increased emphasis on areas such as macroprudential supervision, cross-sector and consolidated supervision, and stress testing.

These are areas in which Islamic finance has much to do to bring it into line with international practices.

We are now in a period when the implementation of the new reform principles are gradually being put to effect.

Second, a striking aspect of the period immediately following the crisis of 2008-2014 was the sharp increase in growth in Islamic finance across its three main component sectors.

The Islamic banking assets expanded at a compounded annual growth rate (CAGR) of 14.2%; the sukūk outstanding expanded at an even higher 19.2% CAGR; while the Takaful contributions expanded at a CAGR of 15.02%.

However, the last two years of this decade has also experienced another shift in the global economic landscape.

A recovering US economy led to the ending of the quantitative easing programme by the US Federal Reserve, and a return to policy rate hikes. This resulted in a reversal in capital flows from developing economies, causing significant volatility in their financial markets. The international economy remains exposed to these cross currents unleashed by the domestically focused monetary policy imperatives of the crisis affected countries.

At the same time, the impediments to fiscal stimulus and the preference for austerity in crisis countries has increased the vulnerability of emerging markets struggling to contend with a more subdued global economy. The low prices for commodities and energy products, in particular, has contributed towards unprecedented fiscal deficits in a number of key jurisdictions for global Islamic financial assets in the Gulf region.

Hence, while a set of key characteristics of Islamic finance in the years after the global financial crisis had been strong and robust asset growth, geographical expansion, and increasing integration into the international economy, 2015 and 2016 marked two consecutive years of stagnant assets growth of the global Islamic financial services industry.

Fast forward to today, the global IFSI is nearly a USD 2 trillion industry that has active presence across not only the Middle East and Asia, but also in Europe as well as West and Sub-Saharan Africa.

The forthcoming IFSB IFSI Stability Report 2017 identifies at least 12 jurisdictions where Islamic finance has achieved domestic systemic importance in the banking sector.

The rapid growth of the IFSI in the earlier years, combined with recent growth moderation in an environment of greater uncertainties in the economic growth outlook, has posed a new set of challenges for the regulatory and supervisory authorities (RSAs) to ensure a sustainable and resilient performance of the institutions offering Islamic financial services (IIFS).

◈   Islamic Finance and Global Regulation: The Role of IFSB

For the IFSI, global reforms have major implications in terms of their competitive standing in national contexts in which typically both conventional and Islamic finance participate.

The IFSB, acting on its mandate, has responded with a series of prudential standards and guiding principles that align global regulatory developments with the specificities of Islamic finance, while also assisting national financial sector supervisors to provide a level playing field vis-à-vis their conventional counterparts.

In the banking sector, the Basel III capital and liquidity standards are complemented by the IFSB in its IFSB-15 Revised Capital Adequacy Standard for IIFS and IFSB GN-6 Guidance Note on Quantitative Measures for Liquidity Management of IIFS.

The Basel Core Principles for Effective Supervision is complemented by IFSB-17: Core Principles for Islamic Finance Regulation (Banking Segment).

There are also other examples of correspondence in our standards, which I will not elaborate on.

But let me stress that the Secretariats of both the BCBS and IFSB have collaborated with each other on numerous occasions, including in the preparation of IFSB Standards – for instance, a BCBS member was part of the working groups that prepared the IFSB-7 and IFSB-17 Standards.

Reflecting this cooperation, we are pleased to have Mr. William Coen, the Secretary General of the Basel Committee for Banking Supervision among our line of stellar speakers for tomorrow’s 9th Public Lecture on Financial Policy and Stability.

He will then give the main presentation at the 15th Islamic Financial Stability Forum which takes place on 6 April at Lanai Kijang.

In the capital market sector, the International Organization of Securities Commissions (IOSCO)’s revised Objectives and Principles of Securities Regulation are being complemented by the IFSB in its new Standard on Core Principles for Islamic Finance Regulation [Islamic Capital Market Segment] that is expected to be completed and issued next year.

The IFSB has also previously partnered with IOSCO and Securities Commission Malaysia to jointly organise a high-level Roundtable on Disclosure Requirements for Islamic Capital Market Products in September in 2012 in Kuala Lumpur. This Roundtable had formed the basis for the IFSB’s latest Standard on Disclosure Requirements for Islamic Capital Market Products which we will be submitting to the IFSB Council for adoption day after tomorrow.

In the takāful sector, The IFSB plans to launch a new Standard on Takāful Core Principles next year to complement the International Association of Insurance Supervisors (IAIS)’s revised Insurance Core Principles.

The IFSB has a longstanding partnership with the IAIS with whom we have published two joint research papers – the recent one being in November 2015 entitled: The IFSB-IAIS Joint Paper on Issues in Regulation and Supervision of Microtakāful (Islamic Microinsurance) – and also earlier in August 2006: Issues in Regulation and Supervision of Takāful (Islamic Insurance).

The high-level of effort here at the IFSB to respond to international developments and align global regulatory frameworks with the specificities of Islamic finance is reflected in the recent discussion of proposals on Islamic banking by the International Monetary Fund (IMF) Executive Board.

As you may all be aware, the Executive Board of the IMF held its first formal discussion on Islamic banking earlier this year in February and reviewed a set of proposals put forward by the staff of the IMF contained in the paper “Ensuring Financial Stability in Countries with Islamic Banking”.

This paper importantly notes that the application of IFSB and BCBS standards together create a comprehensive prudential framework for regulating and supervising Islamic banking.

The IMF Executive Board announced that it expects to consider, before end-April, a formal recommendation for its endorsement of IFSB-17, the Core Principles for Islamic Finance Regulation, Banking Sector, as a global standard under the IMF/WB Review of Standards and Codes.

The IFSB Secretariat stands ready to extend cooperation and support to the IMF to help formally incorporate IFSB-17 Core Principles under its Standards and Codes Initiative.

The IFSB will also continue to assist its member national regulatory and supervisory authorities in the implementation of IFSB Standards through its various workshops and technical assistance initiatives, as permitted under its resource envelope.

The number of RSAs that are members of the IFSB has been expanding over the years. It now stands at about 70 out of a total of 188. This has contributed to stronger implementation of the IFSB’s standards.

The IFSB’s Annual Implementation Survey for 2016 shows that there has been a relatively quicker take up of the most recent “second generation” standards on capital adequacy and liquidity coverage, as the countries strive to catch up with the international developments.

However, important challenges remain, including to strengthening knowledge of Islamic finance, and introducing changes needed to the legal and regulatory systems to facilitate and support the industry.

To address the key challenges, the IFSB has an on going programme of implementation activities, including a workshop series and technical assistance which are aimed at increasing the understanding and adoption of the IFSB Standards.

Finally, on the issue of stability, a milestone initiative by the IFSB has been the annual Islamic Financial Services Industry Stability Report.

The IFSB’s IFSI Stability Report series, which was first launched in 2013, has since become an important benchmark publication, providing an assessment of the growth, developments and stability of the IFSI. The objectives of this flagship Report is anchored in the IFSB’s mandate to promote the development of a prudent and transparent Islamic financial services industry.

This year, the 5th edition for 2017 will be launched next month in May, and in addition to its core focus on growth and stability issues, the Report will look into aspects related to stress testing Islamic banks as well as FinTech in Islamic finance.

The results from the IFSB Annual Implementation Survey for 2016, which I referred to earlier, will also be part of the Stability Report 2017.

◈   Moving Targets and New Horizons

Ladies and Gentlemen, my remarks so far have touched upon issues related to global regulations and Islamic finance. In the last part of my speech, I will concentrate on ‘Moving Targets and New Horizons’.

In this respect, the questions for all of us are: what is left to do and what lies ahead?

While we wait to hear the distinguished panellists and speakers in the sessions that follow, in my remarks I will focus briefly on three issues.

1.   Orderly implementation of reforms in the IFSI and structural support

The gradual implementation of revised post-financial crisis prudential standards has begun and it is now the responsibility of the national regulatory and supervisory authorities (RSAs) to provide an enabling framework that can facilitate market players in adopting these new rules and regulations.

While the new regulatory framework applies to both conventional financial institutions and IIFS, IIFS are often found to have been disadvantaged due to a lack of structural support to meet these new requirements.

For example, to meet the new Basel III Liquidity Coverage Ratio (LCR) requirements, while the conventional banks have an array of capital and money market instruments at their disposal to facilitate liquidity generation, Islamic financial institutions in many jurisdictions are still at a disadvantage due to the limited availability of Sharīʻah-compliant liquidity management options.

An earlier IFSB Quantitative Impact Study linked to IFSB GN-6 found that most Islamic banks were able to meet LCR requirements, but by primarily relying on cash and central bank placements as their main liquidity management tools. This indicates a significant lack of Shari’ah-compliant high-quality-liquid-assets (HQLA) that meet LCR requirements.

This is one area of concern but many others exist including provision of Sharīʻah-compliant lender-of-last-resort (SLOLR) facilities, Sharīʻah-compliant deposit insurance schemes (SCDIS), resolution and recovery processes for IIFS, and so on.

2.   Embracing change and decoding new developments – The Challenge of Fintech

The concept of Fintech encompasses a wide range of models, and these include the distributed ledger technology, and P2P or crowdfunding innovations, amongst many others.

Not surprisingly, the growth of FinTech channels and crowdfunding platforms has given rise to a new set of challenges for financial stability and regulatory approaches.

In addition, for Islamic finance there is also the issue of Sharīʻah-compliance.

From the Sharīʻah perspective, there are two complementary principles at stake: first the principle that in fiqh al-muʿāmalāt innovations are allowed unless they fall under an explicit prohibition, and second, the rather detailed requirements of Islamic law for the validity of exchange contracts. Contractual uncertainty may pose a challenge in many Fintech cases.

At the same time, subject to conformity with Sharīʻah principles, solutions from other FinTech areas such as blockchain and smart contracts may help to improve operational efficiency in Islamic finance.

The Sharīʻah compliance challenge is in identifying the perimeter of permissible innovation, when the formal requirements of classical contracts are not met, whilst elucidating the modifications that would permit access to the new technology on a Sharīʻah -compliant basis.

In this context, it is up to the RSAs, international standard-setting bodies and other international organisations, working in cooperation with Shariah scholars and the private sector, to decode these developments with a view to identifying different avenues of risks to financial stability and resilience, and to attaining the objective of consumer protection in the marketplace, within the wider framework of Sharīʻah compliance.

3. Financial Inclusion

The last issue I will touch on is the role Islamic finance can play in widening financial and social inclusion.

While Islamic finance has established a strong basis as an alternative source of funding for the commercial sector, as well as for governmental expenditure programmes for infrastructure, its full potential as a means to achieving greater financial inclusion is still to be realised.

Progress is being made, however, in a number of countries including Bangladesh, Indonesia and Pakistan – however there are still widespread levels of financial exclusion in a number of OIC Member States, particularly in those where income levels are the lowest.

To better understand these issues from a regulatory perspective, the IFSB later this year will be launching a new Technical Note on Financial Inclusion. We hope this may contribute towards policies that will expand financial inclusion in a broad range of countries.

We will be examining in the TN how financial inclusion can be fruitfully furthered, and social goals attained, within a consistent regulatory and stability framework.

Widening the regulatory perimeter and applying a proportionate approach that allows innovation to flourish – whether for Fintech or financial inclusion, or rather for both Fintech and financial inclusion - requires careful consideration of the balance of risks and benefits.

A number of jurisdictions have adopted this approach to financial inclusion, and still others have taken up the concept of “regulatory sandbox” or “safe place” where innovations can be permitted to be tested without the full force of the regulatory weight and application.

I hope that the IFSB’s Technical Note on Financial Inclusion will draw upon the experiences of innovative jurisdictions such Malaysia, Abu Dhabi, Indonesia and others like Bangladesh and Pakistan, which are taking up supportive policies to widen financial inclusion whilst also pursing financial stability through proportionate regulation where this is merited.

On that note, I would like to end my remarks and I wish you very productive deliberations and discussions in what follows.

Thank You.


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