The biggest challenge facing the Islamic finance industry’s integration into the global financial system was harmonising standards to sustain its continued rapid growth, central bankers and executives said on Wednesday.
The fifth Islamic Financial Services Board summit attended by top bankers, regulators and central bankers, was told that the financial sector, whose assets are growing at an annual pace of 20 percent, required the adoption of global standards of risk management and governance.
Zeti Akhtar Aziz, central bank governor of Malaysia, which seeks to become a global hub for Islamic finance in competition with Dubai and London, said this was essential to shield the industry from future instability.
“The enhanced international dimension of Islamic finance has brought a new set of challenges. That need to be taken into account to ensure it has the capacity to manage risks and regulatory authorities have the necessary tools to respond to any destabilising implications,” Zeti said.
Zeti cited “developing robust international best practices in the prudential and supervisory framework that will ensure the resilience and long term sustainability of the industry.”
The challenge was pressing as the industry was seeing more cross border transactions, with increasing sophistication and a wider product range of Islamic bonds or sukuk, Islamic securitization and Islamic private equity.
Islamic financial principles stipulate that deals must be based on tangible assets and require tight controls on debt levels, features analysts say offer some protection to investors and ensure corporate accountability.
Islam bans the payment of interest and stipulates that deals must be based on tangible assets — money cannot be made from money alone.
Islamic financial assets are expected to hit $2 trillion in 2010 from the current $900 billion, fuelled in part by a flood of petrodollars generated by the rise in energy prices.
Other participants said globalisation would raise risks that have so far made Islamic finance relatively insulated from the downturn in Western financial markets.
Rifaat Ahmed Abdel Karim, secretary general of Kuala Lumpur based Islamic Financial Services Board , the international standard setting body of regulatory and supervisory agencies for the Islamic financial services industry, sounded a warning note.
“The current global credit and liquidity crunch in the conventional financial system due to the collapse of the U.S. subprime mortgage market has led to huge bail outs and, more importantly, new lessons be learned to prevent the occurrence of similar financial crises in the future,” Karim said.
Containing the “inevitable risks required strengthening domestic financial markets, fostering regional integration of these markets, and adopting internationally accepted standards”, the top industry regulator added.
The absence of standardised documentation and practices has been repeatedly highlighted by the Islamic finance industry as one of the key constraints on growth.
Shamshad Akhtar, governor of the State Bank of Pakistan, told participants Islamic finance should position itself to cope with the coming challenges which greater integration posed.
“It has to be recognised that financial globalisation can have unintended negative consequences..,” Akhtar said.
Although Islamic banks’ ability to withstand risk was higher than conventional banking with its transactions based on real economic activity than speculation, it would still be hurt from a global recession, he added.
Mitigating the negative impact of wider exposure to the international financial system required promotion of different types of risk sharing methods with greater equity and asset backed financing, Akhtar said.
Akhtar said the greater internationalisation of sukuks would not only widen the integration of Islamic finance into the global financial system but meet the growing project finance needs of Islamic countries.
Meeting these challenges would allow Islamic finance to better compete with conventional financial institutions by drawing a bigger share of the Arab Gulf’s investable petrodollars that now exceeds $2.3 trillion, Akhtar added.