Today Islamic finance attracts both Muslims as well as non-Muslims. According to Kuwait Finance House Research (KFHR), Islamic financial assets represent approximately 1% of the global financial market, growing at 10-15 per cent per annum―a growth rate that continues to be much greater than traditional (conventional) finance. Both practitioners and observers consider it as one of the most exciting things that is happening in the Muslim world.
The worldwide market for Shari‘ah-compliant Islamic financial products is estimated to be greater than $1 trillion.
Islamic finance is also seen as an experiment that will test the compatibility of the Shari‘ah with the changing circumstances of the modern world. The popularity, scope, dimension and diversity of Islamic finance have expanded a lot since its inception some 40 years ago.
According to some estimates, within the next 8-10 years the Islamic banking industry will capture half the savings of the world’s Muslim population.
The current global financial crisis has given a boost to Islamic finance. Even the Vatican, at the outburst of the global financial crisis, called upon Islamic finance principles to be relied upon. It seemed that Islamic finance is stronger than conventional finance because it was far less impacted by the negative effects of the crisis than the conventional sector. Among the reasons for its insulation from the crisis are fundamental prohibitions by the Shari‘ah against riba (interest) and gharar (uncertainty) on one side, and the immaturity of Islamic finance on the other.
In a recent report entitled ‘Islamic Finance: Corner Stone to the New Financial Order,’ KFHR asserted that: “By operating in accordance with the Shari’ah principles, the Islamic financial system draws strengths from its close linkage to productive economic activities.” The report also goes on to say that since the financial turmoil – which began in 2008 – proponents of Islamic finance “have begun championing the sector as a safe haven or an alternative method of providing services under a unique set of disciplines.”
Many proponents of Islamic finance advocate that now is the opportunity for Islamic Finance to come out from the shadows of conventional finance and offer to investors financial products which are in line with Shari’ah. Despite the enormous growth of the industry in the recent times, the industry still faces several issues and problems of technical and organizational nature which may hinder its development and future growth. One of those challenges is the lack of unified Shari’ah guidelines for the industry which gives rise to legal risk.
According to Islamic Financial Services Board (IFSB) secretary-general, Rifat Ahmed Abdel Karim, legal risk may be one of the most significant risks in the [Islamic financial] industry.In order to help the Islamic financial industry’s growth, some sort of standardization is a must. This issue has been pointed out time and again. Yet, it is still one of the major issues faced by the Islamic financial industry.
Standardization is a must for everyone’s sake; institutions’ and investors’ alike.
Benefits of standardization
Some argue that we do not need standardization saying that differences of opinion reflect the beauty of Islam and, as such, they are not threats to the Islamic financial industry. They say that the Islamic finance industry (IFI) has developed tremendously over the last couple of years with over US$1 trillion in assets. This is a fact that cannot be disputed. However, the question is: What would have happened and how big would it be if we had standardized it?
Furthermore, how long can we afford not to standardize it before competitiveness and reputation of the industry suffer? Take for example the instance when Japan Bank for International Cooperation wanted to issue its first Sukuk in May 2008. Citibank of Dubai and CIMB of Malaysia were entrusted with the task of arranging the deal. However, Shari’ah boards of the two banks disagreed on whether the Sukuk was Shari’ah-compliant and, thus, the transaction needed to be restructured from its initial Murabahah structure to Musharakah structure. This added to the costs of the transaction, lengthened the time period initially prescribed for the transaction, and of course, contributed to the frustration of the issuer. The detriments of such a situation for the entire Islamic finance industry are more than obvious and can deter potential capital market players from trying out Islamic finance.
Shari’ah opinions on many financial transactions are not subject to unified guidelines in all Muslim countries. Hence, Islamic financial institutions were left with the task of searching and selecting, on their own, Shari’ah experts who would make up the Shari’ah board of a particular bank. Expectedly, Shari’ah boards of different financial institutions have different perspectives and approaches to assessing Shari’ah compliance of different transactions and products. Consequently, many different opinions and ruling are floating in the air.
It is no accident then that the term “fatwa shopping” surfaced – referring to a situation where a bank looks for a scholar who will endorse a particular transaction which was previously deemed non-Shari’ah compliant by another scholar. That is why standardization is an essential step forward for the industry.
Standardization of Shari’ah rulings and having uniform guidelines would make life easier for Islamic financial institutions because it would lead to more efficient capital market and Islamic money market. Under a uniform guidelines regime, Islamic financial institutions would find it easier to navigate between the money market instruments – for example –and at the same time the efficiency of interbank money market would also improve. Currently, Malaysia is the only country which has a functioning Islamic money market. It would also provide a platform for establishing a global Islamic money market.
Standardization would further eradicate inherent barriers associated with different Shari’ah practices. Some products, for example BBA, while being acceptable in Malaysia, it is not acceptable in the Middle East region and elsewhere. We believe that the standardization of practices and rulings would also help these practices and rulings to transcend borders more easily.
Unifying Shari’ah rulings and coming up with a certain guidelines for the industry will also contribute to higher investor confidence because it will provide more certainty when it comes to investing in (sometimes) complex Islamic financial products.
Transparency will improve as investors will know upfront what the rules and Shari’ah requirements of a particular investment are, and hence they will be more informed and will be able chose more efficiently. Increased certainty and transparency may encourage reluctant investors to venture into investing in Islamic financial products. Uniform Shari’ah code would drastically reduce legal risk in Islamic finance. Islamic institutions and investors alike would be protected from the situations like AAOIFI’s pronouncement in 2008 which deemed the majority of Sukuk issued before 2008 as Shari’ah non-compliant.
In brief, what we need for the future prosperity of the IFI is to come up with unified, standardized and comprehensive guidelines. These guidelines will serve as reference for the Shari’ah advisory board of each and every bank. Furthermore, these guidelines would take into consideration all the restrictions and jurisdictions. Shari’ah advisory board shall make sure that the core principles are upheld while, at the same time, they will have enough room for accommodating specific requirements demanded by each and every region or jurisdiction.
Common Misconceptions about Standardisation
The issue of standardization is unjustly marginalized and misunderstood within realms of the IFI. The following are certain misconceptions about the standardization:
- Standardization limits Shari’ah – Whenever the issue of standardization is raised at conferences or other forums, many participants (mostly Shari’ah scholars) raise their voices against it. For example, during the International Shari’ah Scholars Forum – a forum held in conjunction with GIFF and organized by ISRA and IRTI – Abdulbari Mashal, general manager of Raqaba for Islamic Financial Consultations, said that there is a need for unification of standards.
Shari’ah scholars present at the forum rejected the idea. Their main argument is that Shari’ah was never standardized and that having difference of opinions is something desirable, as mentioned above. Opponents of the standardization say that this process would restrict Shari’ah and thus slow down future development and innovations. Furthermore, they argued that dynamics of the financial system require for the dynamic approach to the rising Shair’ah issues within the IFI. Obviously, they take this proposal literally and consider it as a close-ended process, i.e. once settled it cannot be changed or amended.
However, proponents of the standardization (including the authors) consider the standardization as “work-in-progress.” This means that we would standardize already existing products and issues that are commonly agreed upon. At the same time, new issues will be raised and discussed. As new issues are settled, new standards and guidelines will be issued and if needed, the old one will be amended accordingly. Hence, there will be enough room for future development and innovation within the industry.
- If we have a standardization of Sahri’ah rulings, we do not need Sahri’ah boards – Another misconception about the call for standardization is that there will be no need for Shari’ah advisory boards (SAB) within the Islamic financial institutions. While having unified, standardized guidelines for IFI may reduce dependence on SAB, the two are not mutually exclusive. These guidelines that would take into consideration all the restrictions and jurisdictions will simply serve as reference (or starting point) for SAB of each and every financial institution. It would help SAB when addressing already existing products and issues while, at the same time, they will have enough room for accommodating specific requirements demanded by each and every region or jurisdiction. Hence, instead of reinventing the wheel, they can focus on new arising issues, thus contributing to the future development of the industry.
Moody’s Investors Service predicts that the assets held by Islamic financial institutions may rise to $5 trillion in the near future. As IFI is growing worldwide and attracts more and more people – both Muslims and non-Muslims – it is important for us to simplify products as much as possible. Currently, many products seem to be more complicated than conventional ones. One way out is through coming up with unified, standardized and comprehensive guidelines that will take the industry to the next level. While we all have the same goal, development and success of IFI, individually we may not reach it even close. Driving the industry train together on the same track is a way forward. If nothing else, this is a strong enough reason to standardize the rules and practices – otherwise we might end up with a big train wreck.