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Islamic Financial Architecture and Infrastructures: Development and Challenges

Islamic Financial Architecture and Infrastructures: Development and Challenges. Tariqullah Khan IRTI-GDLN World Bank Lecture, April 7, 2009. Outline. Overview of International Financial Architecture Defining Islamic Financial Architecture and Infrastructures

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Islamic Financial Architecture and Infrastructures: Development and Challenges

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  1. Islamic Financial Architecture and Infrastructures:Development and Challenges Tariqullah Khan IRTI-GDLN World Bank Lecture, April 7, 2009

  2. Outline Overview of International Financial Architecture Defining Islamic Financial Architecture and Infrastructures Building Blocks of Islamic Financial Architecture Lessons drawn from Global Financial Crisis Building Blocks of Islamic Financial Infrastructures Development: Challenges, Institutions and Initiatives

  3. Definition of financial architecture Financial architecture is …. the 1) institutions, 2) markets, and 3) practices that governments, businesses, and individuals use when they carry out economic and financial activities. IMF (2000) - “Reforming the International Financial Architecture – Progress Through 2000” Purpose: Enhancing financial sector development & performance and strengthening macroeconomic growth and stability

  4. Pillars of Financial Architecture Pillar-1: Objectives of financial architecture Pillar-2: Specialization of standard setting and infrastructure development institutions Pillar-3: Functional relationships between specialized stakeholders Pillar-4: Assessment and monitoring

  5. Pillar-1: Objectives Detecting and Monitoring External Vulnerabilities Strengthening Financial System Performance and Stability Observance of International Standards and Codes Capital Account Issues Pursuing Sustainable Exchange Rate Regimes Involving the Private Sector in Forestalling and Resolving Crises Measures to Increase Transparency Reform of IMF Financial Facilities and Related Issues (IMF 2000)

  6. Pillar – 2: Specialized functional areas of standard setting and infrastructure development institutions Specialized Standard Setting Bodies Basel Committee for Banking Supervision (BCBS) International Organization of Securities Commissions (IOSCO) International Association of Insurance Supervisors (IAIS) Multilateral Institutions World Bank International Monetary Fund Regional Banks Financial Stability Forum (Board)

  7. Pillar-3: Functional Relationships between specialized entities Evans, Huw (2000): “Plumbers and Architects: A Supervisory Perspective on International Financial Architecture”, Financial Supervisory Authority Occasional Paper Series No. 4; January

  8. Pillar – 4: Financial Sector Development & Performance Assessment Financial Sector Assessment Program (FSAP) of IMF and World Bank Reports on Observance of Standards and Codes (ROSCs) • Coverage includes: • Banking Supervision, • Data Dissemination, • Fiscal Transparency, • Monetary & Financial Transparency Policies • Operational nature: • Joint World Bank & IMF character • Voluntary participation • Case-by-case design

  9. Components of Islamic Financial Architecture Global Component ↓ International Financial Architecture (IFA) Local Component ↓ National Financial Infrastructures (NFI)

  10. Components of International Islamic Financial Architecture Universally acceptable guiding principles of Islamic economics and finance Internationally credible & comparable best practices derived from the guiding principles Individuals & Institutions that set best practices, use them, enforce them and monitor enforcement

  11. National Islamic financial infrastructures Legal, regulatory, supervisory, tax and other enabling, support and enforcement facilities, instruments and resources needed for implementation and compliance with the universally acceptable Islamic guiding principles and best practices National Cross Border At the across border level – regional and multilateral institutions, arrangements and facilities for compliance with the universally acceptable Islamic guiding principles and best practices

  12. Objectives of International Islamic Financial Architecture (IIFA) • Establishing universally acceptable guiding principles for Islamic financial practices • 2. Establishing best practices for Islamic financial services in areas of: • Shariah and corporate governance • Corporate ethics and social responsibility • Transparency and disclosures • Risk management • Capital adequacy • Accounting and auditing • 3. Narrowing Fiqh Interpretations • 4. Common regulatory and supervisory regime • 5. Compliance with relevant international best practices

  13. Building Blocks of IIFA

  14. First Building Block of IIFA: Guiding Principles of Islamic Economics and Finance Rules governing prohibitions – Riba, Gharar, Qimar, etc. Consumption, financing, production, and transaction of prohibited items Principles governing what is permitted - sales, financing, investment, trade and commercial transactions Norms guiding good behavior and dealings with others Rules Principles Norms

  15. Second Building Block of IIFA: Shariah Standards (Accounting and Auditing Organization for Islamic Financial Institutions - AAOIFI)

  16. Third Building Block of IIFA: Accounting Standards issued by AAOIFI

  17. Fourth Building Block of IIFA Shariah Governance Standards Standards Issued by AAOIFI Standard Issued by Islamic Financial Services Board “Guiding Principles on Corporate Governance for Institutions Offering Only Islamic Financial Services (Excluding Islamic Insurance (Takaful) Institutions and Islamic Mutual Funds - IFSB-3 -

  18. Fifth Building Block of IIFA Prudential guidelines and standards for Islamic financial services IFSB-7: Capital Adequacy Requirements for Sukuk, Securitisations and Real Estate investment IFSB-6: Guiding Principles on Governance for Islamic Collective Investment Schemes Guidance Note In Connection with the Capital Adequacy Standard: Recognition of Ratings IFSB-5: Guidance on Key Elements in the Supervisory Review Process IFSB-4: Disclosures to Promote Transparency and Market Discipline IFSB-3: Guiding Principles on Corporate Governance IFSB-2: Capital Adequacy Standard IFSB-1: Guiding Principles of Risk Management

  19. Lessons drawn from global financial crisis & strengths of the IIFA Lesson-1: Incentive structures; replacement of interest with profit sharing introduces fundamental changes in incentive systems Lesson-2: Excessive leverage; strong linkages between financing and real economic transactions controls leverage Lesson-3: Controlling speculation; “don't sell what you don’t own” rule limits speculation Lesson-4: Pyramid of debts; prohibition of sale of debt eliminates debt pyramids Lesson-5: Regulation failure; Shariah supervision reduces the risk of failure of regulation Lesson-6: Social responsibility; Ethical screening of investment opportunities strengthens social responsibility of wealth managers Hence, IIFA has the inherent features and inbuilt characteristics that ensure productive utilization of financial resources and financial stability

  20. Pillars of & Building Blocks of Sound Financial Infrastructures

  21. Pillars of a sound national financial infrastructure • Pillar I—Macroprudential surveillance and financial stability analysis by the authorities to monitor the impact of potential macroeconomic and institutional factors (both domestic and external) on the soundness (risks and vulnerabilities) and stability of financial systems • Pillar II—Financial system supervision and regulation to help manage the risks and vulnerabilities, protect market integrity, and provide incentives for strong risk management and good governance of financial institutions • Pillar III—Financial system infrastructure: – Legal infrastructure for finance – Systemic liquidity infrastructure – Transparency, governance, and information infrastructure FSAP: A Handbook, Chapter -1 • Pillar IV – Shariah Supervisory Framework and Governance System

  22. Building blocks of national Islamic financial infrastructures & challenges of enhancing them Building Block-1: Shariah Supervisory Systems Building Block-2: Legal, Regulatory and Tax Framework Building Block-3: Application of AAOIFI & IFSB standards of best practices for the Islamic financial services Building Block-4: Supervisory framework Building Block-5: Lender of last resort facility & systemic liquidity infrastructure Building Block-5: Deposit protection system Building Block-6: Human capital Building Block-7: Knowledge and professional services

  23. Connections & Interactions Between International & Islamic Financial Architecture

  24. Islamic Financial Architecture - Challenges of Development Enabling Environment Effective Shariah Supervision and Governance Balancing speed and genuineness Application of AAOIFI and IFSB Standards Safeguarding against systemic risks of conventional system Preventing risk transmission from conventional to Islamic financial institutions Preventing risk transmission within Islamic funding source Systemic liquidity and safety-net infrastructures FSAP and Assessment Issues

  25. Institutional Initiatives in developing IIFA

  26. References IMF & World Bank, Financial Sector Assessment – A Handbook (http://web.worldbank.org/WBSITE/EXTERNAL/WBI/WBIPROGRAMS/FSLP/0,,contentMDK:20656885~pagePK:64156158~piPK:64152884~theSitePK:461005,00.html) IRTI/IFSB, IFSI Development: 10 Year Framework and Strategies (http://ibisonline.net/En/Policy_Dialogue/TenYearFrameworkAndStrategies.pdf) Chapra, M.U and Tariqullah Khan, Regulation and Supervision of Islamic Banks, IRTI (http://irtipms.org/PubSearchOutE.asp?lang=e&mode=allwords&search=regulation) Khan, Tariqullah and Ahmed Habib, Risk Management – An Analysis of Issues in Islamic Financial Industry, IRTI (http://irtipms.org/PubDetE.asp?pub=91&search=risk&mode=allwords) Khan, Tariqullah and Muljawan, Dadang, Islamic Financial Architecture: Risk Management, Regulation and Supervision, IRTI (http://irtipms.org/PubSearchOutE.asp?lang=e&mode=allwords&search=regulation) Zubair, Ahmed, Macro Perspectives on Islamic Financial Architecture, Internal IDB Policy Paper

  27. Thanks tariqullah.khan@isdb.org http://www.google.com/search?sourceid=navclient&ie=UTF-8&rlz=1T4GFRD_enSA306SA306&q=tariqullah+khan

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