SPEECH: Opening Remarks by Mr Jaseem Ahmed, Secretary-General of the IFSB at the IFSB Public Hearing on Exposure Drafts (ED-17 and GN-6), Kuala Lumpur
Date posted: 16 December 2014
||16 December 2014
|Event / Venue
||IFSB Public Hearing on Exposure Drafts (ED-17 and GN-6), Kuala Lumpur, Malaysia
||Mr Jaseem Ahmed, Secretary-General, Islamic Financial Services Board
السلام عليكم ورحمة الله وبركاته and a very good afternoon to all of you.
It is indeed a great pleasure to welcome all of you to the second public hearing of the two Exposure Drafts (EDs) issued by the IFSB in October 2014. These two documents are ED17: Core Principles for Islamic Finance Regulation (Banking Segment), and GN-6: Guidance Note on Quantitative Measure for Liquidity Risk Management in Institutions Offering Islamic Financial Services. We had our first public hearing in Manama, Bahrain last month on 30 November.
Ladies and Gentlemen:
Following the global financial crisis, the IFSB launched a major work programme that seeks to provide a level playing field for the global Islamic financial services industry in the context of the new global regulatory architecture, represented principally by the Basel III capital and liquidity frameworks.
Thus, we have issued four Standards since 2012 directly responding to the post-crisis environment.
These standards are IFSB-12 (Liquidity Risk Management), IFSB-13 (Stress Testing), IFSB-15 (Revised Capital Adequacy Standard), and IFSB-16 (Revised Supervisory Review Process). I am encouraged by the take-up of these Standards, and will hope to see an acceleration in their adoption and implementation which we will monitor through the annual Survey of Implementation that the IFSB carries out.
The two EDs before you today extend our work programme, and do so in the context of the IFSB’s overarching goal, namely to: help strengthen the stability and resilience of Islamic finance in national jurisdictions, and facilitate its integration into the global economy.
Ladies and Gentlemen:
First, let me talk about Exposure Draft on Core Principles for Islamic Finance Regulation – ED-17. You will be aware about the Basel Core Principles for banking and the Core Principles issued by the IOSCO and IAIS for securities regulation and insurance respectively. These Core Principles have become a standard tool to guide regulators and supervisors in developing their regulatory regimes and practices. They also serve as a basis for assessing the strength and effectiveness of regulation and supervision – by either the regulatory and supervisory authorities themselves, or by external parties such as the International Monetary Fund (IMF) and the World Bank under their Financial Sector Assessment Programme (FSAP).
However, many supervisory authorities that are regulating and supervising the Islamic financial services industry face challenges in identifying applicable principles and benchmarks for assessing the gaps in their existing structures and policies in their jurisdictions, while addressing the specificities of Islamic finance.
The ED-17 aims to address these gaps and provides a set of Core Principles – along with associated assessment methodology – for the regulation and supervision of the Islamic banks, taking into consideration their specificities, thus complementing the Core Principles for Effective Banking Supervision issued by the Basel Committee on Banking Supervision (BCBS).
We have closely assessed the relevance of the Revised Basel Core Principles for application to Islamic finance, and have retained them in their entirety where this seemed appropriate, whilst providing additional guidance where this was relevant. Each of the Basel Core Principles has been examined individually, and where needed, appropriate wording was introduced to reflect the specificities of Islamic finance. We have also proposed additional Core Principles. Thus, against the 29 Core Principles issued by BCBS, the IFSB proposes 33 Core Principles for Islamic Finance Regulation (CPIFR). The expanded set of principles are needed, in our view, to address risk management aspects that are unique to Islamic finance. Perhaps the most far reaching contribution of the CPIFR is likely to be the detailed criteria we propose to facilitate their assessment by regulators.
The IFSB envisages that the CPIFR will be used by jurisdictions as a benchmark for assessing the quality of their regulatory and supervisory systems and for identifying future work to achieve a baseline level of sound regulations and practices for Islamic finance.
The CPIFR will promote further integration of Islamic finance with the international architecture for financial stability, while simultaneously providing incentives for improving the prudential framework across jurisdictions so that it is harmonised and consistently implemented across the globe.
Furthermore, the CPIFR may also assist IFSB member jurisdictions in carrying out self-assessments of their compliance, as well as facilitate peer reviews under a variety of frameworks. In particular, it may be relevant to examine the utility of the CPIFR for use by the IMF and the World Bank in their FSAPs.
A high degree of compliance with the CPIFR should foster overall financial system stability, although this will not guarantee it.
Liquidity Management for IIFS
Ladies and Gentlemen:
It is well known that Islamic banking faces challenges in liquidity management. This is the result of a number of factors, including the relative absence of liquid markets, in particular for inter-bank markets, in which highly rated securities can be traded. The excess liquidity maintained by many IIFS, principally in the form of cash, is a reflection of these underlying issues. In particular, there is a general lack of securities that meet the requirements of High Quality Liquid Assets (HQLA) that feature prominently in the BCBS proposals.
In the IFSB’s dialogue with the BCBS in 2012, prior to the rules issued by BCBS on the new liquidity framework in January 2013, we had stressed the importance of providing to Islamic finance jurisdictions the same flexibility accorded to Emerging Markets and Developing Economies (EMDEs), in which a broadly similar set of issues and constraints feature. In the Liquidity Coverage Ratio (LCR) document which was published in January 2013, the BCBS highlighted this issue in paragraph 68 under "Treatment for Sharī`ah-compliant banks". In recognising the issues, the BCBS has developed a framework for Alternative Liquidity Arrangements (ALA), which would provide a way of meeting such requirements till the time HQLA are available in sufficient supply, with deep and active secondary markets.
The final rules for the LCR were announced in January 2013. In October 2014, the BCBS introduced the Net Stable Funding Ratio (NSFR), which will require banks to maintain a stable funding profile in relation to the composition of their on-and off- balance sheet activities on a longer-term basis.
GN-6 aims to provide guidance on these issues, and it establishes a minimum level of liquidity for IIFS for both full-fledged IIFS and Islamic windows of conventional banks on an individual and a consolidated basis. The parameters of LCR and NSFR in the Guidance Note are built upon BCBS proposals with a number of additions and adjustments to meet the specificities of IIFS. These include categorisation of HQLA and treatment of investment accounts under LCR, and description of available and required stable funding under NSFR.
Sukūk issued by Sovereign and quasi-sovereign entities, and by multilateral development banks and other international institutions, feature prominently in GN6, in which we address the issue of HQLA from the perspective of what the BCBS calls Level 1 and Level 2 assets. This is an important distinction as Level 1 assets can constitute an unlimited share of the pool, and do not normally have a haircut attached to them.
GN-6 has provided the option to regulatory authorities to treat Sukūk issued or guaranteed by sovereigns, central banks, public sector entities (PSEs), multilateral development banks (MDBs) or relevant international organisations which are assigned a 0% or 20% risk weight under IFSB-15 in either Level 1 or Level 2A categories, as they deem appropriate.
From a liquidity management perspective, it is advantageous if securities are recognised as collateral by central banks. In addition, securities that are eligible for investment in central bank’s foreign currency reserves will also offer additional degrees of freedom. As a case in point, the securities issued by IILM may be treated as Level 1 HQLA, as is the case in Malaysia. Thus, IILM Sukūk is eligible for reserve management purposes, and also as collateral for standing facilities. At the same time, IILM is also eligible for treatment under the Option 2 of ALA framework which permits the use of foreign currency HQLA to cover domestic currency liquidity needs.
The relevant factors are that IILM Sukūk are backed by assets which are originating from sovereign or central bank assets, and that its issues have received a rating A-1 by S&P, which is the highest rating for the short term instruments. These qualities make these Sukūk eligible for consideration as Level 1 or Level 2A assets.
A key issue is the absence of secondary markets that provide a “proven record of being a reliable source of liquidity at all times”, which are qualifying criteria for any instrument to be considered part of the HQLA. As LCR is primarily calculated in the respective domestic currencies, any HQLA issued in a foreign currency may require the application of an additional haircut of 8%, though GN-6 provides the option to supervisory authorities to waive this requirement.
Ladies and Gentlemen,
We hope that these two initiatives will help to further strengthen the IFSI moving forward, promote the stability and resilience of the industry and help integrate it with the global surveillance framework for the financial sector.
With that, Ladies and Gentlemen, I wish you very productive deliberations and discussions in what follows.
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