WASHINGTON: The International Monetary Fund (IMF) has approved a plan to incorporate Islamic finance into its financial sector assessments of select countries starting from January 1, 2019.
The Core Principles for Islamic Finance Regulation (CPIFR), endorsed this week by the IMF executive board, provides a set of principles for “the regulation and supervision of the Islamic banking industry and are designed to take into consideration the specificities of Islamic banks,” the IMF announced.
The IMF noted that the Islamic finance has over $2 trillion of assets globally and is offered in over 60 countries, including Pakistan and the industry has become systemically important in 13 jurisdictions across the globe, it added.
The latest PricewaterhouseCoopers (PwC) study indicates that global Islamic finance assets increased from $2tr in 2016 to $2.6tr in 2017. The sector registered a strong 13-15pc growth last year and is expected to cross the $3tr mark by 2020, “potentially creating massive opportunities in this rapidly growing industry. The Middle East and North Africa region and Asia will account for a large part of that growth,” the PwC report adds.
The core principles approved by the IMF executive board were prepared by the Malaysia-based Islamic Financial Services Board (IFSB) with the participation of the secretariat of the Basel Committee on Banking Supervision (BCBS). The Basel committee, established by the central bank governors of the Group of Ten countries in 1974, frames guidelines and standards for the banking sector.
IMF directors “saw merit” in maintaining close cooperation between the IFSB and the BCBS to ensure their respective standards remain consistent.
The Fund noted that CPIFR endorsed by its executive board will “complement the international architecture for financial stability, while providing incentives for improving the prudential framework for Islamic banking industry across jurisdictions.”
The directors noted that the CPIFR standard and assessment methodology will be used in fully Islamic banking systems and as a supplement to the Basel Core Principles for Effective Banking Supervision (BCP) in dual banking systems where Islamic banking has a significant market share of 15 per cent or more.
Where a jurisdiction has both significant Islamic banking and significant conventional banking sectors, the IMF will assess both sectors at the same time using the CPIFR and BCP standards and assessment methodologies respectively, which would also reveal the relevant linkages between the Islamic banking and its conventional counterpart as well as their implications for financial stability, the IMF report added.
On May 24, the IMF released a staff paper “The Core Principles for Islamic Finance Regulations and Assessment Methodology,” which identifies the key principles of Islamic banking as:
1) Principle of equity: This is the rationale behind the prohibition of predetermined payments (riba), with a view to protecting the weaker contracting party in a financial transaction and promoting fair treatment. The term riba, which means “hump” or “elevation” in Arabic, describes an increase in wealth that is not related to engaging in a productive activity.
The principle of equity is also the basis for prohibiting excessive uncertainty (gharar) as manifested by contract ambiguity or elusiveness of payoff. Transacting parties have a moral duty to disclose known information before engaging in a contract, thereby reducing information asymmetry; otherwise, the presence of gharar would nullify the contract.
2) Principle of participation: Although commonly known as interest-free financing, the prohibition of riba does not imply that capital is not to be rewarded. Investment return has to be earned in tandem with participation in the productive activity and not with the mere passage of time, which is also the basis of prohibiting riba.
Thus, return on capital is legitimised by risk-taking and determined ex-post based on asset performance or project productivity, thereby ensuring a link between financing activities and real activities. This principle lies at the heart of Islamic finance, ensuring that increases in wealth accrue from productive activities.
3) Principle of ownership: The rulings of “do not sell what you do not own” (for example, short-selling) and “you cannot be dispossessed of a property except on the basis of right” mandate asset ownership before transacting. Islamic finance has thus come to be known as asset-based financing, forging a robust link between finance and the real economy. It also requires preservation and respect for property rights, as well as upholding contractual obligations by underscoring the sanctity of contracts.
The IMF directors noted that Islamic banks undertake distinct operations with risk profiles and balance sheet structures that differ in important respects from conventional banks, with associated financial stability implications.
They called for stronger efforts to strengthen the regulatory and supervisory frameworks to take into consideration the specificities of Islamic banking to promote financial stability and sound development, particularly in countries where it has become systemically important.
The directors warned that the approach to regulating and supervising Islamic banks “should reflect the nature of risks to which they are exposed” and the financial infrastructure needed for effective regulation and supervision. They noted that this requires additional or different regulation and supervisory practices to address risks inherent in the Islamic banking operations.
IMF further noted that the CPIFR will “complement the international architecture for financial stability,” while simultaneously providing incentives for improving the prudential framework for the Islamic banking industry across jurisdictions. The directors also hoped that the use of CPIFR would help strengthen even-handedness and consistency in surveillance, programme design and technical assistance.
Published in Dawn, May 29th, 2018