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Ethical edge of Islamic finance

Posted by cvbasheer on September 13, 2009


How and to what extent are Basel II principles and techniques applicable to the regulation and supervision of Islamic banks, and what are the problems to be overcome in this context? These questions find answers in Islamic Finance: The Regulatory Challenge edited by Simon Archer and Rifaat Ahmed Abdel Karim ( www.wiley.com ).

At least two factors make the book topical. One, the rapid development of Islamic banking since the early 1990s. ‘Islamic Banking a Western Success,’ says Lahem al Nasser in an article dated April 14 (http://aawsat.com).

“When the British government stated that it was considering issuing a sovereign Islamic bond, or sukuk, it also issued a Treasury consultation document so that specialists and experts could consult and exchange views over this important step,” Nasser observes.

The second factor, according to Archer and Karim, is the fact that international financial authorities such as the World Bank, the IMF (International Monetary Fund) and BCBS (Basel Committee for Banking Supervision) have understood the ‘desirability of building bridges between Islamic (Shari’ah-compliant) financial institutions and the conventional (non-Shari’ah-compliant) financial sector.’

On a related note, a story dated April 14 in www.bernama.com.my speaks of a recent Moody’s report titled, ‘Islamic Banking in East Asia — Growing But Not Without Challenges.’ Christine Kuo, the report’s analyst and author has been quoted for the view that there exists a natural business potential for Islamic banking services in Malaysia as approximately 60 per cent of its population is Muslim. “But it is government reforms during the past 20 to 30 years which have really helped develop the necessary legal and regulatory framework and institutions for the industry to flourish.”

Also, while Islamic banking has achieved relatively high market penetration in Brunei and asset growth in Indonesia has been rapid, Islamic banking services available in the Philippines, Singapore and Thailand remain very small in terms of asset size, says Kuo.

Divided into five parts, the well-produced book elaborately discusses capital adequacy, securitisation and capital markets, corporate governance, and the nature and risks in Islamic banking.

Accountants may wish to know that the IFRS (International Financial Reporting Standards) are considered deficient when applied to Islamic banks. And that, to meet this lacuna, the Accounting and Auditing Organisation for Islamic Financial Institutions, created in 1991, has issued 18 Financial Accounting Standards (FASTs). “In spite of the high quality of these standards, however, they have been adopted in only a handful of countries,” fret Archer and Karim.

They highlight how in countries with highly developed markets a typical problem is of legal definitions. For example, deposits have ‘the legal status of debt contracts’ and are ‘capital certain,’ whereas ‘Islamic banks accept deposits as profit-sharing/which cannot be capital certain.’ If the profit-sharing pool in which the funds are invested incurs a loss, the investment account holders must accept their share of the loss, the book explains.

“From the narrow perspective of banking law, Islamic banks may better be termed finance houses rather than banks ‘stricto sensu’, but they perform the economic function of banks to the Islamic community and may therefore quite reasonably wish to call themselves banks for marketing reasons,” the editors suggest.

They bemoan that some ideologists of ‘free markets’ fail to acknowledge that markets do not exist in a pure economic space, but are part of a societal structure of which the law and the administration of justice are key components, along with education and business ethics.

A major advantage of the Shari’ah, the book argues, is the insistence on the ethical dimension of business. “We hope that the coming decade will see important advances in the adaptation of legal systems, in education and training, in regulation and supervision, and in other relevant aspects of institutional development, so that Islamic finance may fulfil its true potential,” the editors conclude.

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