Islamic banks seek new regulatory formula

18 November 1994

Islamic banks are set for substantial growth in the next decade, but need to create a more effective regulatory framework, bankers said at a 6-7 November Islamic banking conference in Dubai.

International mechanisms such as the Basle-based Bank for International Settlements (BIS) capital adequacy ratios were criticised as being unsuited to regulating Islamic banks. Rifaat Abdel-Karim, adviser to the Bahrain- based Financial Accounting Organisation for Islamic Banks and Financial Institutions, said the Basle ratio 'is irrelevant to Islamic banks because it does not accommodate one of the major instruments - investment accounts - through which Islamic banks mobilise funds.'

Farah Fadil, adviser to the Kuwait-based The International Investor (TII), said that central banks should regulate Islamic institutions. 'Leaving Islamic deposit-takers unregulated and outside the protective net of the central bank is not consistent with its responsibility towards the currency and the maintenance of financial stability,' he said.

Abdel-Karim says Islamic banks should develop their own controls, but it is unclear whether a single regulator could be established. 'There is no broad consensus between Islamic sharia scholars on what constitutes an Islamically sound product or service,' Abdel-Karim said.

The Islamic banking industry is growing by about 15 per cent each year, TII chairman Adnan al-Bahar said: 'It is my belief that Islamic banking will be responsible for managing up to 50 per cent of savings in the Islamic world in the coming five to 10


Leasing, istisna and similar instruments will see more rapid development in the next decade than existing debt-based contracts, such as murabaha, Bahar said. 'Istisna is also becoming even more important as central banks start to look at way of using the discount window with Islamic banks, and ways to provide liquidity to those banks when needed.'

He envisages futures contract trading of processed commodities and new currency hedging techniques. Hedging can be developed by trading commodities in different forms and denominating these transactions in different currencies, Bahar said.

'Equity investment will remain quite restrictive and in my view profit and loss-sharing agreements will see substantial growth in their use, especially in the project finance area,' Bahar said.

Islamic banks, which lack a central bank lender of last resort, may suffer from a lack of sufficient short-term liquidity. 'This exposes them and their depositors to adverse competition in the money market,' Fadil said. He recommended the use of liquid Islamic products by central banks - advised by religious experts - as official instruments in case of reserve shortages.

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