31 March 2016, Kuala Lumpur – The Islamic Financial Services Board (IFSB) is pleased to announce the issuance of a Working Paper on ‘Strengthening the Financial Safety Net: The Role and Mechanisms of Sharī`ah-Compliant Deposit Insurance Schemes (SCDIS)’ (WP-06) today.
IFSB WP-06 sheds light on the principles, and existing institutions, through which deposit insurance schemes (DIS) are provided on a Sharīʻah-compliant basis. DIS are considered an indispensable component of the new global financial stability framework post-financial crisis, in which the role of financial safety nets in the banking sector have gained widespread acceptance. DIS have been instituted explicitly in at least 113 jurisdictions worldwide. WP-06 observes a major shift in the DIS design features, post-financial crisis, as a number of elements advocated in the past literature were found to be detrimental to financial stability and were among the factors judged to have undermined depositors’ confidence.
WP-06 states that extending conventional DIS protection to Islamic banks presents several key challenges, which include (1) issues in the underlying principles of conventional deposit insurance (excessive Gharar, Riba, amongst others); (2) the treatment and insurability of deposits accepted under profit-sharing contracts; (3) the priority of claims of different types of deposits collected by Islamic banks; and (4) the role of the deposit insurance fund in resolution.
Drawing upon survey results conducted across 27 IFSB member regulatory and supervisory authorities (RSAs), WP-06 identifies four jurisdictions where SCDIS are already implemented and in effect. Additionally, a fifth jurisdiction has drafted its modality and corresponding law for an SCDIS and this is expected to be in operation in the very near future. The IFSB survey and follow-up communications with these five jurisdictions have also indicated variations in the operational practices of these respective SCDIS including, among others, the governance structures, investment strategies, risk assessment frameworks and coverage limits of the deposits protected.
WP-06 goes on to identify the differences in the treatments of SCDIS coverage for profit-sharing investment accounts (PSIA). Subject to various terms and conditions, one out of the five jurisdictions with SCDIS does not provide any coverage to PSIAs; two out of five jurisdictions cover only unrestricted PSIAs and not restricted PSIAs; and the last two jurisdictions cover both unrestricted and restricted PSIAs. There are also important differences in terms of rules related to the parties (i.e. IIFS, Central Banks, depositors’, etc.) that will pay the contributions for coverage to the SCDIS.
Overall, WP-06 highlights the current Sharīʻah-compliant models of deposit insurance schemes that are being implemented in different jurisdictions and the operational and Sharīʻah challenges that need to be considered in the implementation of these schemes. The paper also considers the Sharīʻah perspectives that support the provision of funds protection to the IFSI in general, and to depositors in particular, in the interest of achieving financial stability and resilience in the system. The paper raises awareness on the importance of having SCDIS; highlights the existing modalities and practices of SCDIS in different jurisdictions; and identifies key design challenges from both Sharīʻah and operational perspectives for developing SCDIS.
The paper concludes that the role of a DIS is relevant in the global IFSI, which has achieved rapid growth, transforming into a multi-trillion dollar industry. Aside from the Sharīʻah considerations above, due care needs to be given to ensure that SCDIS comply with international principles for effective deposit insurance systems, taking into consideration the modifications necessary to cater to the specificities of Islamic finance.
WP-06 is the second part of the series of IFSB working papers on financial safety nets as previously, WP-01 on ‘The Role of Shari`ah-compliant Lender-of Last-Resort (SLOLR) Facilities as an Emergency Financing Mechanism’ was released in April 2014. The IFSB is now embarking on a third paper in this series related to the resolution and recovery of insolvent Islamic banks.
The publication is available for download from the IFSB www.ifsb.org.
