Accommodation of Islamic Banking in banking regulatory frameworks-Corporate Governance.

Board of Directors and Shariah Board

Regulatory frameworks typically do not prescribe distinct and separate corporate governance frameworks applicable only to Islamic banks. However, some regulatory frameworks deal with the additional responsibility and authority of the board of directors in relation to Shariah compliance, though, typically, the Shariah board has the ultimate responsibility and authority in advising on Shariah matters.

There is equal preference that the legal framework requires the setting up of a national/central Shariah board or setting up a Shariah board at the central bank (Afghanistan, Malaysia, Uganda, Pakistan, Palestine, Sudan, and Syria). Besides, a majority of jurisdictions require Islamic banks to have a Shariah board that has legal standing and its actions have legal implications (e.g., Iraq, Kuwait, Malaysia, and Sudan).

In most cases it seems that ultimate overall responsibility for an Islamic bank’s Shariah compliance lies with the Islamic bank’s board of directors, which typically delegates the responsibility for day-to-day Shariah compliance to senior management. Senior management is required to ensure Shariah compliance in line with Shariah board guidance, which implies that the relationship of an Islamic bank’s Shariah board vis-à-vis the Islamic bank is advisory.

Supervisory authorities should be aware of the risks when there is no requirement for an Islamic bank to have a Shariah board. In jurisdictions where there are no prescriptions relating to a Shariah board (e.g., Kenya, Tanzania, Tunisia, and Turkey), the supervisory authorities would consider it a possible case of mis-selling Islamic financial products if a purported Islamic bank did not have in place an appropriate function and internal controls to ensure Shariah compliance.

There appears to be heterogeneity regarding the bodies to which the Shariah board reports to. These may include: the board of directors of the bank , the general assembly of the bank, the top management of the Islamic bank and the executive committee of the Islamic bank. The best is to report to BOD or general assembly of the bank.

Shariah compliance function

The function and role of ensuring Shariah compliance within an Islamic bank is usually conducted by internal auditors or Shariah auditors. In specific jurisdictions where Shariah Law is the default source of all legislation (e.g., Iran, Pakistan, Saudi Arabia, and Sudan), including banking and financial legislation, an Islamic bank’s internal auditor has a statutory responsibility to ensure Shariah compliance by the Islamic bank. In other jurisdictions, an Islamic bank is required to have a dedicated Shariah auditor/Shariah compliance officer whose appointment is required to be approved by the bank supervisory authority.

The function and role of the external auditor in relation to Shariah compliance depends on legal frameworks. In jurisdictions where Shariah Law is the default source of all legislation, including banking and finance legislation, an Islamic bank’s external auditor has a statutory
responsibility to assess and verify Shariah compliance by the Islamic bank. However, in jurisdictions where Shariah Law is not the default source of banking legislation, the Islamic bank’s external auditor has no direct responsibility to assess and verify Shariah compliance by the Islamic bank. It is critical to have external auditor with statutory responsibility to assess shari'ah compliance even if after every three years to ensure robust Shari'ah controls are place and add wide range of experience on shari'ah compliance function.

Accommodation of Islamic Banking in banking regulatory frameworks-Licensing.

The effective prudential regulation of banks is as necessary and desirable in Islamic banking as it is in conventional banking. The risks of Islamic banking are those typical of financial intermediation. Accordingly, the objectives of applying prudential regulation and supervision to
Islamic financial activities are the same as the case of conventional banks: namely to pursue and maintain financial stability by ensuring the safety and soundness of banks, thereby preventing problems from having systemic repercussions.

There are various ways in which jurisdictions incorporate Islamic banking into their regulatory framework. A first approach is where the Basel Committee on Banking Supervision (BCBS) framework for bank regulation and supervision is considered the default regulatory and supervisory framework applicable to all banks (including Islamic banks) and, thus, no distinction is made regarding the regulatory framework between Islamic banks and conventional banks;

Under a second approach, the regulatory framework consists of a generic BCBS component, applied to all banks with references identifying provisions applying only to Islamic banks. In this case, the BCBS conceptual framework could be complemented by Islamic Financial Services Board (IFSB) prudential standards and guiding principles on Islamic banking, where considered appropriate, to give effect to Shariah law compliance;

Under a third approach, the separate regulatory framework accommodates Islamic banking. A wide range of approaches to regulatory framework for Islamic banking has evolved around those three approaches. Shariah compliance plays a role (explicitly or implicitly) in the supervision of Islamic banking. In the U.K., for example, the regulatory framework does not contain any prescriptions on Islamic banking or Shariah compliance.

Accordingly, the authorities do not explicitly recommend a Shariah board or the segregation of Islamic banking funds from conventional banking funds within a bank. Nonetheless, the authorities take the issue of Shariah compliance into account, albeit indirectly, when considering issues such as consumer protection, internal controls, governance, and reputation risk.

Licensing.

Jurisdictions impose different licensing requirements on applicants wishing to establish Islamic banks. In non Shariah Law jurisdictions,
where Islamic and conventional banks are present, licensing requirements do not address specifically and explicitly the issue of Shariah compliance. However, the issue of Shariah compliance does play an important indirect and implicit role in the approval process.

Where Shariah Law constitutes (or is part of) the fundamental law of the country, Shariah compliance is a key pre-condition to (and determinant of) whether a proposed request for approval of a Islamic bank would be considered favorably. Different jurisdictions issue different types of licenses to Islamic banks. Some issue a stand-alone Islamic bank will be issued with an Islamic banking license. Other jurisdictions a single (generic) banking license is issued to a bank, irrespective of whether the bank is an Islamic or a conventional bank (in some of these jurisdictions the authorities are empowered to issue only an Islamic banking license). Typically, the regulatory framework contains one set of fit and proper criteria applicable to all banks.

Accordingly, the regulatory framework does not prescribe a distinct and separate set of fit and proper criteria applicable only to Islamic banks.
In many jurisdiction, the issue of fit and proper in relation to individuals that play a key role in a bank’s Shariah compliance does not yet appear to have received sufficient attention. For example, it is not always clear whether the bank supervisory authority is empowered to make pronouncements on the fitness of individuals responsible for Shariah compliance (e.g., members of the Shariah board, the Shariah accountant, the Shariah internal auditor, the Shariah compliance officer, and the Shariah external auditor).

Few jurisdictions apply fit and proper requirements to Shariah board members and Islamic bank personnel involved in Shariah compliance. Though some jurisdictions impose requirements such as piety, standing in the community and/or recognition as a Shariah scholar, few jurisdictions (if any) impose (secular) fit and proper requirements on candidates for a Shariah board.

To continue..

Consumer Protection in Islamic Finance

Source: Zawya.com

The 13th Islamic Financial Stability Forum (IFSF) was successfully organised by the Islamic Financial Services Board (IFSB) on 12 April 2016 as part of its Annual Meetings and Side Events 2016, which were held in Cairo, Egypt on 10-12 April 2016, hosted by the Central Bank of Egypt.
The theme of Forum was Consumer Protection in Islamic Finance, and the main presentation was by Professor Volker Nienhaus, Former President, University of Marburg, Germany, and IFSB Consultant. Ms. Nariman Abdulla Kamber Al Awadhi, Chief Manager, Consumer Protection Unit, Central Bank of the United Arab Emirates and Mr. Khairul Nizam, Chief Operating Officer, Finance Accreditation Agency, Malaysia, acted as discussants to the presentation.

In his Opening Speech, H.E. Mr. Tarek Amer, Governor of the Central Bank of Egypt, stated that with the growth and globalisation of Islamic finance, the need for consumer protection has become more important and should be an integral part of Islamic finance regulation. He highlighted that one lesson learned in the aftermath of the Global Financial Crisis is that consumer protection is directly related to financial stability. He also added that transparency, impartiality and liability are important features of any consumer protection regime and therefore should be put into the agendas of international organisations and supervisory authorities. Similarly, financial literacy also supports the cause of consumer protection. He pointed out that while there are existing standards for consumer protection, adoption of these standards is uneven across countries.

Professor Nienhaus, in his presentation, which was based on IFSB Working Paper 03, Financial Consumer Protection in Islamic Finance, stated that while most of the issues in consumer protection - such as preventing systemic financial risks, selling of unsuitable financial products, unfair treatment by the financial institutions - cover both conventional and Islamic segments of the financial system, there are some issues and risks pertinent to Islamic finance sector, such as Shariah non-compliance risk. He stressed that regulators and supervisors in Islamic finance should focus on these unique risks in line with the progress taking place to address the common issues applicable to both sectors. He then expounded the main neo-classical and behavioural theories, as well as the precepts of Fiqh al-Muamalat, which justify policy interventions to protect the consumers. He stressed that regulation is necessary due to information asymmetries, limited information-processing capacities, cognitive biases and other behavioural factors. Apart from regulation, policies towards improving the financial capacity of consumers, setting up mechanisms to increase information dissemination and financial education are also important. He stressed that Shariah governance framework is of crucial importance to address unique issues and risks of consumer protection in Islamic finance.

Ms. Nariman Abdulla Kamber Al Awadhi of the Central Bank of the UAE, mentioned that the consumer protection issues have multiple facets and due to their complexity, are therefore not easy to put into a policy agenda. She added that the key challenge is integrating trust and faith into the financial system. She underlined that the Central Bank of the UAE covers consumer protection issues in conventional and Islamic finance under a single regulatory framework. She pointed out that for Islamic banks, the issues related to early settlement are the major area of customer complaints. She concluded her presentation by underlining that financial literacy should be an indispensable element of consumer protection policies.
Mr. Khairul Nizam of the Finance Accreditation Agency, Malaysia, touched the topic from the lens of Islamic finance consumers. He stated that one of the most important concerns in an Islamic banking from the point of the view of a consumer is Shariah compliance of the deposits and investment accounts. Here, perceptions of reputation and integrity of the Islamic banks come into play, and he underlined that convincing consumers on the banks Shariah compliance, as well as the fairness and equity on the rate of return depends on the perceptions, and competency, of the regulators. He also pointed out that the consumers can be very irrational and these cognitive biases should be taken into account by regulators.

The IFSF is a high-level platform open to regulatory and supervisory agencies, and international multilateral organisations, from among the IFSB members to discuss current and pertinent regulatory issues faced by the Islamic financial services industry. The Forum is held twice annually in conjunction with the meetings of the IFSB Council.

ISDA/IIFM launches Islamic FX forward standards.

By: Reuters.


The International Islamic Financial Market (IIFM) launched standard templates on Monday for sharia compliant foreign exchange forwards, the latest effort by the industry body to improve hedging practices in the sector.

Islamic finance is expanding beyond its core centres in the Gulf and Southeast Asia, prompting the need for more cost effective tools to manage foreign currency risks.

The Bahrain-based IIFM, a non-profit organisation which develops specifications for Islamic finance contracts, outlined two templates to accommodate the main industry practices, although it expects one of them to eventually gain more favour.

The standards involve use of either one or two unilateral promises, known as wa'ad, which are committed separately by each counterparty, with the latter providing greater credit security.

"Based on market requirement and feedback, our assessment is that the use of two unilateral wa'ad structure will increase," chief executive Ijlal Ahmed Alvi told Reuters.

"Certain other FX products can now be explored under two unilateral wa'ad concept, which IIFM may look into in the future."

There are several hedging tools used in Islamic finance, some based on a cost-plus-profit arrangement known as murabaha, but these tend to be cumbersome and expensive, said Alvi.

Islamic finance follows religious principles which ban the charging of interest and shun ambiguity in contracts.

This means Islamic banks are precluded from traditional forwards as these become legally binding at the outset, leaving counterparties exposed to an overtly uncertain outcome in the eyes of scholars.

In an Islamic forward, the exchange rate is fixed at the outset but remains a promise until offer and acceptance is completed at the forward date, which is when the transaction becomes a contract.

The choice of wa'ad also means Islamic banks don't have to employ their balance sheets for their hedging needs, compared to previous practices under murabaha.

"These standards using the wa'ad structure will overcome this constraint and lead the way to handling other off-balance sheet hedging structures," said Naveed Khan, vice chairman of IIFM.

The IIFM, which developed the standards together with the International Swaps and Derivatives Association (ISDA), has previously launched templates for cross currency and profit rate swaps and the Islamic equivalents to repurchase agreements.

The body started operations in 2002, founded by the Islamic Development Bank and the central banks and monetary authorities of Bahrain, Brunei, Indonesia, Malaysia and Sudan. (Reporting by Bernardo Vizcaino; Editing by Kim Coghill).

Get the standards at:http://www.iifm.net/published-standards