Opening Remarks by Mr Jaseem Ahmed, Secretary-General of the IFSB at the Seminar on Islamic Finance - “The Real Economy and the Financial Sector”
Date posted: 24 May 2016
||24 May 2016
|Event / Venue
||Seminar on Islamic Finance | IE Business School, Madrid, Spain
||Mr Jaseem Ahmed, Secretary General, IFSB
I would like to begin by thanking our partners in this event, namely the IE Business School, and the Banco de España, the central bank of Spain.
We are delighted to be here in Madrid, and very much hope that this event today will lead to other events of a similar nature in the future.
The IFSB has had a series of such events in Europe over the years in which we were fortunate to receive the support and participation of some key European institutions including the Bank of England, the European Central Bank, and the Banque de France.
Our last event in Europe, the IFSB European Forum was hosted by the Banca d'Italia in 2013.
The IFSB welcomes the widening interest in Islamic finance in Europe which has included in recent years the issuance of licenses for Islamic banks, most recently in Germany.
There has also been the launching of Sovereign sukūk by the United Kingdom and Luxembourg.
We have had an on-going dialogue with the authorities in both of these countries over the years and, indeed, have received grant funding for our technical work from Luxembourg.
We are very pleased that the central banks, the Bank of England and the Banque centrale du Luxembourg are both members of the IFSB.
Ladies and Gentlemen:
Islamic finance has received much attention in the aftermath of the global financial crisis, as a result of the wide spread concern that conventional financial institutions had conducted themselves in ways that were highly imprudent, perhaps even unethical.
Many prominent commentators have touched on the loss of trust in the financial sector. Against this it was widely observed that Islamic financial institutions had not been exposed to the complex toxic assets at the heart of the financial crisis. Islamic banks had, and still have, low leverage. Their capital adequacy ratios are quite high, and their regulatory capital is about 90% in the form of common equity Tier 1.
The stress on the real economy, on high ethical conduct, and the avoidance of excessive debt, uncertainty and speculation that are key features of Islamic finance were, and are, rightly viewed as intrinsic strengths.
Another key feature is that of risk sharing in Islamic finance, which can contribute to greater loss absorbency and hence greater stability in financial systems.
The Managing Director of the IMF, Christine Lagarde has made these points a number of times, most recently last week in Washington when she spoke to us at a Conference on the Rule of Law and Financial Stability that I attended.
The IFSB values greatly the intrinsic strengths of what we call the embedded governance of Islamic finance.
At the same time, in line with our mandate, we see the need for a vigorous and accelerated set of reforms to strengthen the stability and resilience of Islamic finance through proactive measures that monitor risks through an effective system of regulation and supervision.
We have worked closely in this respect with our standard-setting counterparts, most notably with the Basel Committee for Banking Supervision, but also with the International Association of Insurance Supervisors and with IOSCO.
The IFSB’s mandate requires it to benchmark its standards with reference to the existing standards of our global counterparts, while taking into account the specific risks that are applicable to Islamic finance.
We believe that new jurisdictions will be well served by taking the time to understand the specific risk characteristics and balance sheet structures of Islamic financial institutions, as well as the pre-conditions for their effective performance, amongst which tax neutrality features in a pre-eminent way.
Let me now turn to two issues that shape the introduction and development of Islamic finance.
These two issues were posed as questions last week at the Conference I have mentioned at the IMF on the Rule of Law and Financial Stability, where I was asked to speak to the development of Islamic finance and the challenges, both legal and regulatory, to its effective regulation and supervision.
One question raised by the audience was this: why is there a need for a new form of finance when we already have a conventional financial system in place?
The second question asked how can jurisdictions that do not recognise Islamic law introduce Islamic finance into their national space, and regulate it appropriately?
So these are the why and the how of Islamic finance.
Let me begin with the why.
The introduction of Islamic finance in recent history was closely linked to the discovery of an unmet demand, and the recognition of a social if not a political imperative, which is to respond to the demand.
There was no market for Islamic finance about 50 years ago. It did not appear at that time to be a specific consumer need.
There were no commercial enterprises that had targeted this sector, as the sector did not exist. The emergence of Islamic finance thus represents the creation of a wholly new market segment and the recognition of a set of consumers who had not previously been identified or recognised.
But the unmet demand was there, and once the conceptual breakthrough had been achieved, a supply response followed, aided by strong public policy support.
This process is still working itself out in a variety of ways.
In an increasing number of countries Islamic finance has been integrated into national plans for economic development and financial inclusion. Malaysia is a very good example of this.
In still others it is seen as a useful complement, a viable and alternative source of financing for the government and for corporate expenditure.
Mr Haruhiko Kuroda, the Governor of the Bank of Japan, put the developmental case succinctly in 2006 when he spoke at the IFSB Global Summit of that year:
“Islamic finance is important for economic development and as a potential alternative financing route for projects. The special characteristics of Islamic finance can provide alternative means to reach under-served groups…. Islamic finance can be a catalyst for economic development and poverty reduction.”
Kuroda-san was my boss at the time, in his then capacity as the President of the Asian Development Bank, but his views have gained currency among the major multilateral institutions in the world, including the IMF and World Bank.
For Muslims the appeal of Islamic finance lies in its adherence to ethical principles and participatory and risk sharing characteristics that are based on the principles of Islamic law. But these principles also resonate with increasing numbers of non-Muslims many of whom are also attracted by the prospects for accessing deep funding sources in the Muslim world.
Let me turn now to the second question – how to introduce Islamic finance into a new jurisdiction.
The key consideration is the ability of the legal system to provide transparency and predictability to the enforcement of Islamic finance contracts that are specified in accordance with Islamic law.
Here it is relevant that Islamic finance transactions involve both Islamic and secular law.
We can distinguish between Sharīʻah-incorporated jurisdictions, and purely secular jurisdictions.
In a Sharīʻah-incorporated jurisdiction Islamic finance contracts will be enforced in accordance with Sharīʻah, because the governing law has already incorporated the Sharīʻah.
However, in a secular jurisdiction which does not give cognisance to the Sharīʻah, enforcement will take place as a matter of contract enforcement in accordance with the governing law of the land without reference to Islamic law.
The contract will be enforced in relation to its provisions, in the light of national law, and not the Sharīʻah. From this perspective, the contract is simply a form of private law, which many different kinds of legal systems are able to enforce.
The courts in such secular jurisdictions as the United Kingdom and the United States have been willing and able to enforce Islamic finance contracts despite being secular jurisdictions. We have also seen a number of recent cases in which the US Bankruptcy Court has supported complex bankruptcy restructurings in a chapter 11 filing on a Sharīʻah-compliant basis.
Let me know conclude with some observations on the opportunities and challenges presented by Islamic finance.
In terms of opportunities, first, it offers the prospect of providing access to finance to Muslim majority countries in which significant majoritities of adults often do not have a bank account. Many of those without access to finance in these countries have voluntarily excluded themselves from the formal interest based economy.
Second, the principles of risk sharing that Islamic finance advocates are well suited to promoting start-ups and SMEs, a major potential source of growth and innovation in both advanced and emerging markets.
Third, risk sharing can facilitate infrastructure financing, and the use of sukūk in recent years points towards a larger role that it could play in this important respect.
Fourth, risk sharing, whether in the form of investment accounts in Islamic banks or in Islamic housing finance, can also be source greater stability and resilience in the financial system.
Finally, in terms of opportunities, there are the high ethical principles espoused by Islamic finance, based on a consequentialist view of ethics that says that duty to shareholders must be balanced by concern over the consequences of ones actions.
This is something that has an immediate and wider relevance for ethical conduct in the financial sector.
But there are also many challenges of which the development of a robust legal and regulatory framework, and the broader financial infrastructure are of critical importance.
The development of deep and liquid Sharīʻah-compliant markets and instruments has only been achieved in a small number of jurisdictions.
This has implications for the stability and resilience of Islamic finance, especially when set against the global standards that are in place today in terms of HQLA.
It must also be said that the effective regulation and supervision of Islamic finance continues to be hampered by the absence of a full and comprehensive set of laws covering insolvency and resolution frameworks, to name just a few.
In this context, the standards and guidelines from the IFSB are helping to provide a common, international benchmark for regulators, and for the prudential regulation and supervision of Islamic finance.
The IFSB itself is a platform for networking and sharing of information and experiences that can facilitate the transition towards more robust supervisory frameworks, through a dialogue between the widest possible range of stakeholders drawn from both the public and private sectors.
Our presence here today in Madrid will, I hope, contribute to the development of a wider intellectual network in which ideas and information can be shared in a structured setting, and awareness raised.
With that, I would like to once again thank the IE Business School and the central bank of Spain, for partnering with us at this event. I am confident that the discussions today will be fruitful, and if I can mix the metaphor, provide all of us, the IFSB included, with much food for thought.
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