Islamic Banking & Finance 12-05-2017 - FINANCIAL-24
Conduct of monetary policy with Islamic banking
The majority of countries where Islamic banks are becoming important have fixed exchange rate regimes. This has important implications for the conduct of monetary policy: in those countries, the exchange rate is the main nominal anchor and liquidity management and the control over the systemic liquidity is a key determinant of the effectiveness of monetary policy and the sustainability of the exchange rate. Yet, Islamic banks in many of these countries are typically in surplus liquidity. Excess liquidity need to be managed properly to enhance monetary policy transmission through the Islamic banking system. When the interest rate channel is effective, monetary transmission can operate from the conventional to the Islamic segment of the financial system. However, such transmission may not be accepted by all Shari'ah scholars and depends on several factors including consumers and Islamic banks behavior and their reaction to changes in interest rates as well as the degree of development of Islamic money markets. In dual financial systems, a dual approach to monetary policy may be considered whenever the Islamic segment of the financial sector is not as developed as the conventional segment. Incorporating Islamic banks in the monetary policy framework is a complex task not only because of the need of compliance with Islamic finance core principles but also due to the heterogeneity of financial systems and monetary policy frameworks of countries where Islamic banking exists. Several layers of difficulties confront monetary policy in most countries where Islamic banking is present, including shallow financial markets, pegged exchange rate regimes, fiscal dominance, and interest rate controls and directed lending. Delineating the specific difficulties associated with Islamic banking from a host of other issues is indeed quite challenging but necessary. Designing strong monetary policy frameworks for countries with Islamic banks requires careful study and striking a balance among several factors. The coexistence of conventional and Islamic banks calls for a prompt development of strong and resilient dual monetary policy frameworks. For this, the evidence available suggests that the orderly development of Islamic domestic interbank markets may facilitate the liquidity management of Islamic banks. While several initiatives to develop liquidity management instruments for Islamic banks have been undertaken, substantial efforts in standardizing these instruments, reducing their Shari'ah-compliance risk and developing Central Banks operational frameworks are still necessary. The design of effective liquidity management frameworks for Islamic banks is based on the orderly development of Islamic domestic Shari'ah-compliant interbank and government Sukuk markets. Those markets cannot develop without coordination and strong commitment of the Central Bank and the fiscal authority as well as the necessary regulatory change needed to facilitate their development. The importance of domestic government Sukuk markets not only for the implementation of an Islamic monetary policy but also for the profitability and viability of Islamic banks calls for a more proactive role of Central Banks in the development of these markets.
Islamic banking and GCC in the current scenario
The economic slowdown experienced by the GCC countries following the oil price decline and consequent fiscal tightening will continue to apply pressure on asset growth and profitability of banks including Islamic banks in 2017 and 2018, according to rating agency Standard & Poor's (S&P).
S&P forecasts oil prices will stabilize at $50 per barrel in 2017 and 2018, with unweighted average GDP growth in the six GCC countries at 1.9 per cent in 2017 and 2.4 per cent in 2018, after 2.3 per cent in 2016.
Asset growth stabilized at 6.4 per cent in 2016 for Islamic and conventional banks, compared with 6.6 per cent and 6.9 per cent respectively in 2015. "In our base-case scenario, we assume that asset growth will drop to about 5 per cent as governments' spending cuts and revenue-boosting initiatives, such as tax introductions, reduce opportunities in the corporate and retail sectors," says S&P Global Ratings Head of Islamic Finance Dr. Mohammad Damak.
Analysts expect region's banks to become more cautious and selective in chasing high-quality lending opportunities resulting in lower asset growth. However analysts say the story is not the same for all Gulf Cooperation Council (GCC) countries. Although the economic slowdown was and will remain more pronounced in Saudi Arabia, Islamic banks' growth accelerated there in 2016, thanks to their strategy to increase their foray into the corporate and small and mid-size (SME) sectors.
By contrast, the slowdown was deeper in Qatar, where a mix of lower liquidity and government spending cuts prompted banks to curtail their pace of expansion. Asset growth was about nil in Kuwait over the past year, hit by the depreciation of some foreign currencies and the ensuing impact on the financials of some leading Kuwaiti Islamic banks. Despite the tepid economy and the drop in real estate prices in the UAE, Islamic banks continued to expand at high single digit figure.
Asset quality of GCC banks in general are strongly correlated to the economies in which they operate. According to S&P the asset quality indicators of GCC Islamic banks remain on a par with those of their conventional counterparts. Both Islamic and conventional banks are well entrenched in their local real economies in the GCC.
"As the economic cycle turns, we think that asset quality indicators will continue to deteriorate in 2017-2018. The weakening that has already occurred was not noticeable in 2016 because - as is typical - banks started to restructure their exposures to adapt to the shift in the economic environment. Therefore, we saw an increase in restructured loans in the GCC in 2016, but we didn't observe a marked increase in nonperforming loans (NPLs) or cost of risk," said Damak.
The deterioration in asset quality is expected to be more visible in 2017-2018. Although some market participants maintain that Islamic banks will fare much better than their conventional counterparts due to the asset backing principle inherent to Islamic finance. However, S&P expects both conventional and Islamic banks will be on equal footing when it comes to impairments because bankruptcy laws remain underdeveloped, and the foreclosure of underlying assets remains generally difficult in most GCC countries, especially because the predominant type of collateral is real estate.
Typically, asset quality issues in the banking sector show up with a lag. As subcontractors, small and medium enterprises (SMEs), and expatriate retail exposures will bear the brunt of the turning economic cycle and are expected to contribute to the formation of new NPLs in 2017 and 2018.
Despite the emerging challenges analysts see as positive the buffers that GCC Islamic banks have built in previous years, when the cycle was more supportive. The ratio of NPLs to total loans was 3.1 per cent on average at year-end 2016, with an average coverage ratio of 133.9 per cent. "Under our base-case scenario, we think NPLs could increase to 4 per cent to 5 per cent over the next two years," said Damak.
Islam is not only a religion in the ordinary sense of the word, but a complete system of life. While other religious codes provide guidance only for the relation between man and his Creator, Islam guides man in his relationship with God and gives him the norms which govern his temporal existence, since Islam is concerned with the spiritual, political, social economic, moral and all other material aspects of the human being.
Islamic banking is banking or banking activity that is consistent with the principles of Islamic law (Shariah) and its practical application through the development of Islamic economics. Shariah prohibits the fixed or floating payment or acceptance of specific interest or fees (known as Riba or usury) for loans of money. Investing in businesses that provide goods or services considered contrary to Islamic principles is also Haraam (forbidden). While these principles were used as the basis for a flourishing economy in earlier times, in the late 20th century that a number of formal Islamic banks were formed to apply these principles to private or semi-private commercial institutions within the Muslim and Non-Muslim Communities.
How Lender of Last Resort facility (LOLR) from Central Banks (CBs) can be provided to Islamic banks
In times of systemic crisis, CBs may use unconventional measures in the context of impaired Market to Market (MTM), or deflation and recession risks. Under their financial stability mandate, monetary authorities have also the discretion to respond to idiosyncratic needs for liquidity, when no other sources are available to individual banks. The dividing line between conventional and unconventional monetary policy is becoming blur, but the distinction between a systemic and Results based on the IFSB survey that includes regulatory and supervisory authorities of the 32 countries: Afghanistan, Bangladesh, Brunei, China, Egypt, Indonesia, Iran, Japan, Jordan, Kazakhstan, Korea, Kuwait, Lebanon, Luxembourg, Malaysia, Maldives, Mauritius, Morocco, Nigeria, Oman, Pakistan, Palestine, Philippines, Qatar, Saudi Arabia, Senegal, Singapore, Sudan, Tajikistan, Turkey, UAE, Zambia.
Issuance of CB or Gov securities Deposit facilities, outright purchases/sales, Repo & Reverse Repo, Collateralized Lending/borrowing (auction) Credit facilities, Term deposits (auction) for liquidity support are more straightforward. However in terms of best practices, LOLR support is usually provided at a penalty rate, to solvent and viable entities, assessed on an ongoing basis, and whose shutdown would create financial stability risks. Banks resort to LOLR when they have exhausted all other funding options available to them, including money markets funding, CB conventional funding and the stock of monetary policy eligible collateral. LOLR is temporary and institutions granted. LOLR should be subject to supervisory intrusion and conditionality to reduce moral hazard and insure that the loan can be repaid and the funding appropriately used. When designing a Shari'ah-compliant LOLR framework (SLOLR), it is necessary to separate the LOLR from the regular operational framework. LOLR is a bilateral collateralized lending at counterparty's initiative but at CBs' discretion, performed under the financial stability mandate, in exceptional circumstances, with broader collateral than conventional monetary policy. Despite the risk-sharing principle and the high liquidity typical of Islamic banks, weak banks experiencing idiosyncratic liquidity shocks may find difficulties to absorb those shocks in the absence of liquidity management instruments and money markets. It is therefore recommended to establish a SLOLR. The use of SLOLR should be clearly regulated and should not become an additional tool for increasing Islamic banks liquidity. LOLR can be extended to Islamic banks as long as it is Shari'ah-compliant. The main complications for this reside on the interest-bearing loan, and especially the reference to the penalty rate, as well as the need for a broader collateral. To be compliant with the Shari'ah, the LOLR structure should be interest rate free and the collateral used needs to comply with the Shari'ah rules. According to the IFSB, only 25 percent of the regulatory and supervisory authorities surveyed have developed a Shari'ah-compliant LOLR framework for IIFS using different types of structures (Mu?arabah, Musharakah, Murabahah). In Pakistan it was recommended by the (Editor) when he was in the SBP to use Musharakah, as already in use for providing funds to the Islamic Banks in case of Export Refinance Scheme.
Need of Islamic banking and finance-education & trainings
Islamic banking faces an increasing problem of Human Resources with the start of the perspective to open Islamic banks, according to a careful estimate more than 50000 Islamic financial professional are needed in Islamic Financial industry. The need of human resources is growing indeed but the Human Resources are not growing in line with the opening of Islamic banks. It is a fact that a person cannot become an Islamic banker just by studying a few books or One week training, it needs many things in collective. To become an Islamic banker, one needs to spend life in this field and gain experience. We do not have enough trained professionals in the field of Islamic banking and finance but we also need to replace the conventional staff from Islamic Banks, so that Islamic Bank can be performed accordance to Islamic principles. We need suitable people and it will take time to the problem to be solved, the human capital can be trained in this field in accordance with the demand. Education will indeed raise standards in Islamic finance.
Currently, in accordance with a careful approximation, around 40 Universities all over the world are providing Post Graduate, PhD and Bachelor level programs on Islamic Banking and Finance, these universities are producing approximately 5000 professional every year while the demand of the Islamic Financial professional are 10 times high, it is an immediate need to fulfill the demand and supply gap from the Islamic Financial Industry. Some renowned international institutions who are providing Islamic financial education are , International Institute of Islamic Banking and Finance (IIIBF), La Trobe University, IIUM Institute of Islamic Banking and Finance (IIIBF), Durham University, Effat University, The Markfield Institute of Higher Education, Qatar Faculty of Islamic Studies, London School of Business and Finance, Salford University, University College of Bahrain, The University of Bedfordshire, Aston Business School, Islamic Research and Training Institute(IRTI), Bangor Business School at Bangor University, University of Reading, University Of Wales, The University of East London, Paris-Dauphine University, The International Centre for Education in Islamic Finance (INCEIF) Malaysia, Monash University Australia, University College of Bahrain, University Islam Sultan Sharif Ali (Unissa) - Brunie, College of Business UUM - Malaysia, University of Sharjah, MDIS Uzbekistan, University of Wales UK, Selangor International Islamic University College (KUIS) Malaysia.
With reference to Pakistan, almost 10 institutions are offering masters level program in Islamic Banking and Finance. IBA, Dadabhoy Institute of Higher Education, KASBIT, Sheikh Zayed Islamic Center, International Islamic University Islamabad, Riphah International University, AlHuda Center of Islamic Banking and Economics (AlHuda CIBE) and PAF Karachi Institute of Economics & Technology are some well-known name of institutions in Pakistan.
Several approaches can be used in order to produce the quality Human Resource for Islamic Banking and Finance industry. The approaches and techniques can be:
n University Degree Programs
n Specialized Trainings and Workshops
n Distance Learning Programs
n Publications, Webinars & other Media
As stated earlier, different Universities and Colleges are providing the education facility in the field of Islamic Banking and Finance. There is a need of more institutes providing degrees in this field with an aim of enabling the candidate to deeply understand the Islamic Banking operating system and the concepts of Islamic Finance.
In addition to this, training is an effective tool for Human Resource Development (HRD) as well as for achieving the goals of an organization. Islamic banking is a Shari'ah-based interest-free banking system. It has to operate in a way that benefits society as a whole. Its features and functional procedures are quite distinctive than that of the traditional banking system. To satisfy the objectives of the Islamic banking and to face the challenge of the next century, the job of Islamic banking is becoming more complicated and more technical day by day. The personnel of Islamic banks require special Attitude, Skill and Knowledge, which can be developed through proper training. It is obvious that a large number of appropriately trained employees would result in increased output and reduced costs, further resulting in maximum utilization of human resources, which will ultimately benefit the entire nation.
Many institutions are providing Distance Learning Program on Islamic Banking and Finance. Through this mode, masses can be educated in a flexible and convenient manner. As Muslim are not only limited in Asia or Africa but they also reside in all over the world, so we can educate the Muslims and Finance professional globally through Distance learning programs. In addition to this, publications can also be used as a medium to educate masses about the latest news and updates on Islamic Banking and Finance.
We are sure that Islamic Banking system can be strengthened in better way by promoting Islamic Banking Education and Trainings. But for that we have to find experienced teachers and to change curriculum in the light of market requirements. But unfortunately we see most of the teachers of high profiles with no market or banking experience. This needs to be corrected.
Islamic banking system in Pakistan
The conventional financial and banking system was exposed for its flaws during and following the epic failure of global financial system in 2007-08. But, at the same time, Islamic banking remained largely unaffected and displayed unique resilience.
Since then, Islamic banking has boomed around the world and is projected to continue improving its market share in the future. However its share is still very low in the total Banking assets around the world and still it has to go a long way
In Pakistan, Islamic banking Industry (IBI) has witnessed consolidation and its network of pure Islamic banks has significantly improved. The market share of IBI has witnessed tremendous growth of Rs 65 billion during last quarter from October to December 2016. Besides, deposits of IBI grew by Rs97 billion. In addition, the market share of Islamic banking and deposits in overall industry stands at 11.7 and 13.3 % respectively.
Even though consumers in search of a Halal alternative to conventional finance found solace in advent of new Islamic products, large fraction of consumers have refrained from indulging in Islamic banking largely sighting the fixed nature of returns on deposit, analogous to conventional system.
State Bank of Pakistan (SBP), along with the Islamic banks, has been continuously making efforts but still their work is not based on research and looking cosmetic.
In an attempt to persuade and convince consumers on the use of Shariah compliant products, State Bank of Pakistan has exempted the Islamic banks from using the interest based benchmark for some of its financing products. This has given the Islamic banks liberty to device products based on pure Islamic rules and regulations.
But, majority of potential and existing consumers have remained skeptical and confused about the status of Islamic banking. People have long raised the questions regarding the legitimacy of the system. This piece is an attempt to answer some of the relevant questions and clear the ambiguity surrounding the legality and permissibility of the Islamic banking products particularly opening of saving accounts.
The common notion against the IB is that since the rates/returns on both Islamic banking and conventional banking are fixed, how we could believe in its legitimacy. The problem is a lack of knowledge and expert individuals/bankers in Islamic banking who fail to convince the potential customers on legitimacy of Islamic banking. There is a huge difference in operational mechanism of Islamic banking as compared to conventional banking.
One must acknowledge that Islamic banks invest the money only in businesses that are legal and exclusively follow Islamic doctrines. There is no investment in non-trading fixed and other assets such as land, building, furniture, computers, IT systems, etc. Deposits are invested only in legally permissible trading businesses unlike the conventional banks which invest indiscriminately without consideration for Sharia doctrines.
In current circumstances, as conventional banking continues to hold the majority of the world market share, customers are used to securing high returns. Islamic banking has to counter the existing market leaders and the best way forward for them is to ensure the returns on nearly fixed rates. This does not mean that Islamic banks will be acting analogues to conventional banks. Rather, they have devised policies and practices which could certainly impact the profit and loss distribution. For example, Islamic banks have established a Profit Equalization Reserve (PER) out of the Net Income (NI) of the pool. The monthly share towards the PER must not exceed over 2% of net income and accumulated balance should not exceed the threshold level of 30%. Therefore, Islamic banks in order to compete with traditional banks and persuade the potential customers are allowed to improve the returns to their depositors during those periods when the profits witnessed are below the expectations of the savers in the Islamic banks.
One of the most fascinating products of Islamic banking is Mudarba arrangement with Islamic banks. In such arrangement, depositors act as Rubbulmal, while the bank acts as a Mudarib. The bank performs the business activities for Rubbulmal which must accept losses and profits. In case of losses, the latter have to incur all losses and the former will only incur loss of time and resources used for investment of the Rubbulmal. Under the Islamic doctrines, trade is allowed as it has equal chance of profit and loss. Mudarba arrangement is a practical example of such doctrines. Customers face no such scenarios under conventional banking and expect the predetermined returns, which makes it haram.
At this rather early stage of Islamic banking, banks do not want to discourage the customers from switching to Islamic banking. Therefore, under current the Mudarba arrangement, in order to absorb the losses, Islamic banks have created Investment Risk Reserve (IRR) to cover the future investment losses. In case of losses, after the deductions of Mudarib (bank), the rest is contributed towards the IRR out of the up to 1% of the total profit available for distribution among the depositors.
People may show discontent for Islamic banking based on presumptive attitude but still Islamic banking is looking potent and legal alternative to conventional banking. It must be embraced with open heart and should be given time to develop fully and play its part in encouraging equity and fair play in society replicating the Islamic teachings in true sense.
Editorial
Lot of Conferences on Islamic Banking and Finance are under way like some TV channels are now planning to enter in to the arena. However the objectivity of all these conferences is still under question which is to mint money for the organizers and to bring fame to their sponsors but what the people are getting. Nothing!
We are trying to organize CAIF in a way where Islamic Banking should practically side with the people of Pakistan. It is a difficult way but we are not going to compromise for that.
Muhammad Arif Chairman CAIF marifsbp@yahoo.com, mediafocuspakistan@gamil.com.
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