Islamic Viewpoint: The Future of Islamic Banking in Europe
Michael Foot, managing director of the UK Financial Services Authority explains
how prudential principle regulating conventional banking could be applied to Islamic
banking activities in Europe.
There are several firms already authorized in the UK are offering Sharia compliant
mortgages, there is already one FSA-authorized Islamic investment fund; and, perhaps
most interestingly, there is considerable well-researched interest in forming a UKbased Islamic bank.
There is similar interest (though we think it is generally on a smaller scale) elsewhere
in the European Union. When one looks at the statistics, it would not be surprising for
there to be interest around the EU. The UK has some 1.8 million resident Muslims as
well as at least a further 500,000 who also visit the UK regularly but who are resident
elsewhere. However, there are an even higher proportion of Muslims resident in
France and a broadly similar percentage to the UK in Germany and in a number of
smaller members.
We know from extensive discussions with relevant groups in the UK that many of
these individuals would like to be able to choose from a range of Sharia compliant
financial products. The task is how to do this in ways, which meet three key
objectives. The products and firms involved must meet the basic EU Directive
requirements that are set in place to protect consumers and investors.
Those involved – whether as shareholders or customers - must understand what
exactly is being offered. [There will only be long-term damage to the cause if
unrealistic expectations are created of what can be achieved.] Those providing the
services must be wholly professional and competent in what they do. There can be no
benefit to anyone (and certainly neither to devout Muslims nor to regulators!) from
the slightest suggestion that the probity and competence with which Sharia compliant
products are provided are in any way less than those of conventional financial
products.
Applying conventional objectives to Sharia compliant banking
The powers given to a bank within the EU are so considerable that, inevitably,
regulators need to spend a good deal of time and effort with an applicant bank, trying
to establish whether indeed it has the capital, the systems and the competence to run
the bank successfully. Most importantly, the regulator needs to spend considerably
more time with a prospective bank testing out these strengths than it would have to do
with a financial organisation that was set on providing a much more limited range of
financial services.
Many Sharia compliant financial products can and will be provided within the EU by
companies that are not banks. This is just as, in the conventional sector, many banks
offer residential or commercial mortgages but there are, equally, many mortgage
lenders who never have never have been and who have no interest in being a bank.
From the FSA’s point of view, it is fortunate that we are a single regulator – by which
I mean that we have responsibility for the regulation of the whole range of banking
insurance and investment products in the UK. This is “fortunate” in the sense that we
will be able to help address Muslim aspirations across the whole range of financial
services. In the pre-1998 days when a bank was regulated by one organisation,
securities by another, fund management by a third and personal investment by a
fourth, it would have been practically impossible for potential applicants to get the
whole picture.
What critically distinguishes a bank from another financial institution is basically that
only a bank takes “deposits” – a deposit being legally defined within the EU as a full
unconditional obligation upon the bank to repay the full amount of principal at
maturity.
There are essentially 3 different types of account in Islamic banks. The first of these –
the “Qard Hasan” is what I would understand as an interest-free loan from the
customer to the bank. It involves a full direct and unconditional obligation on the
bank to repay the full amount of principal on demand. That suggests that there is a
good case that such accounts are deposits in the legal sense used in the EU.
However, there are two other kinds of account that an Islamic bank may wish to offer,
where the position is less clear. I will address only the type which is least like a
conventional deposit account (which is what I know as an “unrestricted investment
account, UIA”) because the third is essentially only a compound of the UIA and the
Qard Hasan.
UIA are entitled to profit or loss sharing on a variable basis, after the manager’s
(Modarib’s) fee. That is some way away from a conventional deposit as defined
earlier. The challenge will be to find ways (such as through an unconditional
subordination of shareholder’s rights to those of the owner of the UIA) that would
produce the same effect as for a conventional deposit. In other words, we need to find
assurance that repayment in full of the UIA account will be made, provided that the
bank is not insolvent at the time but in a way that does not offend Sharia principles.
That challenge is already being actively taken up by the lawyers of those who have
already expressed active interest in a Sharia compliant banking license in the UK. As
and when we can find a resolution of this issue, I would hope that such a resolution
would also be usable elsewhere in the EU.
This point apart, authorization of an Islamic bank in the UK would (from the
regulator’s view) raise many of the same issues as would a conventional bank. And,
while these hurdles are not negligible they are of known size and all can be jumped.
For example, such a bank – like a traditional bank - will need adequate capital. The
only specifically “Islamic” question I can see here is whether the nature of the
conditions required to be Sharia compliant introduce what we would otherwise call
new “legal” or “operational risks”. In areas such as mortgage lending I think that will
come down to need for reassurance that the way in which security is taken is as sound
as with a conventional mortgage.
An Islamic bank will also need to have shareholders of standing and management of
proven effectiveness. There may well be many Muslims in the UK and other EU
member states who want Sharia compliant products. But the fact is that the providers
and (to some extent the products) will be new. The reassurance of well-known
backers and senior management is likely to be an important aspect of turning potential
business into reality in these new ventures and of building up the scale of business
that will be needed.
There will also need to be adequate arrangements to ensure the liquidity of any new
Islamic bank. But I am hopeful that experience already gained in the Middle East
(especially experience with commodity Morabaha and the growing market for Sukuk
bonds) will make this an easier hurdle to overcome than it would have been even a
few years ago. It does, however, make even more important than would otherwise be
the case the need for an Islamic bank to be of undoubted high standing, to limit to a
minimum the risk of a liquidity run from depositors taking fright at some piece of bad
news.
There will also need to be the usual guards against misuse of a bank for purposes of
financial crime or terrorism. But I see no reason why the conditions that will need to
be met for Sharia compliance need make any more difficult than for a conventional
bank the key task of “knowing your customer” which is at the heart of most good
safeguards for banks against financial crime.
Finally there needs to be instruction for the potential customer in the nature of the
products he is buying. In the UK, the FSA has a role to play in improving customer
understanding of financial issues and in trying to ensure customers get adequate
disclosure during the course of the transaction.
We will no doubt continue to play that role in respect of Sharia compliant products
too (and in some case our rules will leave us no choice). However, I think it is also
true to say that we shall be looking for help from experts wherever we can find them.
And I should also add we shall have neither the ability nor the desire to monitor a
bank’s actual Sharia compliance. That has to be something for the Sharia board and
for the institution itself.
Putting in the hard work on the detail
It is one thing to talk in generalities, another to produce detailed plans that will work.
We in the UK have been very much aware of that and in respect of one product for
which there is thought to be considerable demand (an Islamic mortgage); we have
followed a path of detailed examination at the highest level. (This has involved a
Working Party chaired by the last Governor of the Bank of England and it may be that
this is a model for what we need to do in respect of other possible products too.)
The sad fact is that modern economic life is complicated. And even in the case of a
relatively simple product such as a mortgage, the reality is that a number of
Government departments are potentially interested and changes are needed to tax and
social security arrangements (to name just two areas) before a Sharia mortgage can
successfully be launched.
I am pleased to say that the main hurdle in the UK– which is that a Sharia compliant
mortgage may require the payment of stamp duty twice instead of the usual once –will
be eliminated with effect from November.
We regulators are doing our part, not least in examining ways in which Ijara
mortgages might qualify within the current Basel Capital Accord for a capital
weighting similar to a conventional mortgage. [On the face of it, an Ijara mortgage
will otherwise require a bank to keep twice the capital that a conventional mortgage
will require. Such a requirement, because of course banks have to earn profit on the
capital tied up in their balance sheet, currently makes an Islamic mortgage modestly
more expensive than a traditional one. There may be no way out of this, at least until
the new Basel Accord comes into effect at the end of 2006, but if there is we are
committed to finding it.
In addition, we are particularly encouraged by the launch of the Islamic Financial
Services Board, which we hope will help to harmonies standards and product
definition in this area. It is pleasing to note that work is already starting on some of
the knottier problems it has to address - such as capital adequacy and corporate
governance for Islamic banks. The FSA is playing its part here with participation in
both groups.
Similarly, we are committed to whatever detailed work it takes to find ways of
allowing the authorization and subsequent successful operation of Islamic banks and
of Islamic products provided through other (non-bank) channels. This is one reason
why we are supporting the work of the groups contributing to the Islamic Financial
Services Board. The ways we find must be consistent with our own and the wider EU
statutory requirements. However, I am confident that this can be done.
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