How can the Islamic finance industry continue its remarkable growth? This is a question that continues to concern practitioners in the industry who are committed to the propagation of Islamic finance. In this regard, standardization of laws and regulations has been touted as a necessity in realizing the vision of a robust and competitive industry. Humayun Jamshed looks at the growth of the industry, its growing acceptability and future challenges and solutions.
A credible alternative for the banking industry
There is no doubt that Islamic banking has, and is, experiencing significant growth. In a very short span of time, the industry has grown from a community banking player to a fully grown mainstream banking proposition. It presently boasts an asset size in excess of USD 1.5 trillion globally, growing at an annual average rate of more than 20%. With this growth rate, Islamic banking & finance will cross USD3 trillion in 4 to 5 years. Islamic finance has always been viewed as a banking alternative for the Muslim community at large. However, with the progression and dynamism of the Islamic finance industry, it has gradually become equally popular among non-Muslim clients.
The recent global crisis in the banking industry subtly highlighted the inherent strengths of the Islamic banking model, where underlying Shari’a principles and laws protected the industry from the adverse financial impact of the global crisis. Prohibition of excessive risk transfer reduced exposure to the downturn and protected it from the impact of toxic assets. Even profitability was relatively higher for Islamic banks compared to their conventional counterparts. The global crisis promoted Islamic banking as a credible and less risky financial alternative to both investors and issuers alike; and financial pundits have started suggesting integrating Islamic finance principles and structures within major global financial systems. Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University, has suggested that Islamic finance demonstrates the advantages of more equity and risk-sharing over the conventional bias in favor of debt instruments.
As Islamic investments managed to project themselves
as a less risky and socially/ethically more responsible alternative compared to conventional investments, the demand for Shari’a-compliant solutions increased within all client segments across diversified geographies. In the early days of Islamic banking, the major product development efforts of Islamic financial institutions were on replicating the product and service offerings available in conventional banking. However, long gone are those days; as the demand for Islamic banking products and services grew so did product innovation efforts. All of a sudden there was an ample supply of effective Islamic banking products in the market: fee-based Islamic credit cards, which donot charge interest on the outstanding amount, is one example. Similarly, the growth of Islamic banking created a level of reliance and confidence among investors and bankers alike, and most of the Islamic banks started focusing on core banking businesses rather than typical niche areas.
Dynamic support from the public sector
The ever-growing market demand attracted considerable support from the public sector as well. New Regulations and taxation laws were enacted to accommodate the peculiarities of Islamic finance, which proved to be an effective enabler in advancing and refining the industry. Governments have made equity investments into Islamic financial institutions which gave a boost to the Islamic banking industry. Fresh capital brought into the industry not only contributed to
improving the financial health and stability of Islamic financial institutions but also helped them, symbolically, in terms of market reputation. Today IFIs boast a much larger capital base than previously. This dynamic transition from purely a private sector effort to a semi-public sector endeavour also contributed to the expansion of the industry to newer business areas and geographies, thus widening the global reach of Islamic banking. The market witnesses new ventures and products regularly in order to meet increasing client demand. Product innovation, public sector support and continuous injection of capital havehad a snowball effect and transformed the Islamic finance industry from a niche market player to a mainstream financial services provider.
Standardization of Islamic finance accounting, regulatory, contractual, risk management and corporate governance laws will be a vital business facilitator for the Islamic finance industry.
In the opinion of Islamic finance experts, the focus should move from Shari’a-compliant to Shari’a-driven form of banking. The industry should not only provide the most desirable products and services but also ensure the influx of trained and talented human capital to the industry.
Challenges of globalization
Although the rapid growth and expansion of the Islamic finance industry has presented fresh opportunities and prospects to existing, and new, players in the market, it has created a set of novel challenges on the one hand and has magnified the existing set of challenges on the other. These issues need to be addressed to ensure the sustainability and business continuity of Islamic banking & finance, which is undergoing rapid internationalization. There is a need for effective linkages between regulators in various geographies and Islamic financial institutions within these geographies to facilitate Islamic finance business. There is a need for more understanding of different jurisdictions to assist in the implementation of standardized laws and regulations in the localized environment. Standardization of Islamic finance accounting, regulatory, contractual, risk management and corporate governance laws will be a vital business facilitator for the Islamic finance industry. AAOIFI has come a long way in providing standardized accounting & auditing schemes for various modes of Islamic financing. However, all the Islamic Finance Service Board (IFSB) member countries offering Islamic banking products and services need to ensure as mandatory implementation of these standards in their respective countries. Necessary amendments and alterations are required wherever the legal and regulatory environment is not conducive for the mandatory implementation of such standards.
As harmonization of regulations is crucial at this juncture so is the convergence and interpretation of Shari’a laws and principles. Some of these laws and principles, though suitable for the local milieu, may also need standardization to make it a global fit. This will not only enhance the efficiency of the global Islamic finance market but will also create a comprehensible and transparent environment, essential for cross-border investment flows.
There has been a regular addition of innovative products and services to the industry over the past number of years. However, in order to sustain future growth, constant supply and spread of high-quality, diversified Islamic banking products and services is required. The focus should be on serving a wider range of client segments and facilitating international business practices. In this phase of globalization, Islamic finance needs to present standardized and comprehensive Shari’a-compliant solutions to facilitate complex transactions which can meet diversified client requirements, across geographies. In the opinion of Islamic finance experts, the focus should move from Shari’a-compliant to Shari’a-driven form of banking. The industry should not only provide the most desirable products and services but also ensure the influx of trained and talented human capital to the industry.
A leap forward
The future of Islamic banking & finance looks brighter than ever before. The industry has shown incredible growth in size and reach. Those who refused to acknowledge the phenomenon in the early days are now active participants and have contributed effectively in promoting the industry from a niche player to competing in the mainstream banking arena. However, the industry needs to equip itself to enter this new phase of development and is required to consolidate its present position by addressing the basic issues facing the industry today before leaping forward to new paradigms.
Humayun Jamshed is Senior Director of Islamic Banking & Finance at SAB International (SAB Group)
