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AGENDA
1.INTRODUCTION
2.COMPLIANCE WITH PILLAR 3
3.MARKET DISCIPLINE IN ISLAMIC
BANKING
4.CONCLUDING REMARKS
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1.
INTRODUCTION
a) Transparency and market discipline are closely
intertwined with corporate governance
b) Basel Pillar 3
i) Guiding principles of market discipline
ii) Complement Pillars 1 and 2
iii) Disclosure of information, consistent with how the
bank’s risks are measured (inclusive of capital
adequacy calculation)
b) By doing this, market discipline is reinfoced, and
banks are incentivised to behave prudently.
c) END Goal – a sound and safe financial system
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2. HOW TO COMPLY WITH PILLAR 3?
4 requirements
I. Level of disclosure
II. Frequency – disclosure every six months
III. Templates – to compare between banks
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2. HOW TO COMPLY WITH PILLAR 3? (CON’T)
4 requirements
IV. Basic principle of disclosure (13 tables on
info disclosure)
7. Credit risk mitigation techniques
disclosured
1.
Qual’tv and quan’tv info
2.
Capital structure info (analyse
capital adequacy of bank)
8.
Securitization – Size type and features
disclosed
3.
Capital allocation process info
(Pillar 2)
9.
Market risk – compare different types
of risks and institutions
4.
Overview of size and nature
credit risk exposures
5.
6.
Portfolios subject to
standardised approach (IRB)
and supervisory risk weights
Portfolios – IRB approaches
10. Market risk – IMA * approach for
trading of portfolios
11. Operational risk – disclosure of
regulatory capital approach
12. Equities – disclosure of banking book
positions
13. Interest Rate Risk in the Banking Book
(For IFIs, there is a rate of return risk)
*IRB – Internal Rating Based; IMA – Internal Models Approach
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MARKET DISCIPLINE IN ISLAMIC BANKING (IB)
What is market discipline?
• It refers to the use of market as a means of governance, as a
complement to regulation and supervision. The benefits and
drawbacks are:
Benefits
Drawbacks
Provide IBs the necessary
incentive to address corporate
governance issues & to behave
responsibly
Conflict of interest between regulators and the
market – e.g. strong market reactions toward a
weakened IB may result in unnecessary failures
causing instability of financial sector
Market reactions to early signs of Loss of confidence in one bank may cause a
distress in IBs provide impetus for “contagion” effect – resulting in systemic event
IBs to rectify problems, preventing in entire banking sector.
failures
Lower risk premiums in the
market place resulting from
transparency of operations
Potential time and cost savings
for regulators
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CONDITIONS FOR EFFECTIVE MARKET DISCIPLINE
• Andrew Crocket, former Bank for International Settlements (BIS)
general manager developed conditions for effective market discipline
which are also applicable to IBs.
• These are:
(i)
Information – market participants must have sufficient information
to reach informed judgments
(ii) Ability – market participants must have ability to process
information correctly
(iii) Incentive – market participants must have the right incentive to act
upon information
(iv) Mechanism – market participants must have the right mechanism
to exercise discipline.
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CONDITIONS FOR EFFECTIVE MARKET
DISCIPLINE, cont’d
• While all four prerequisites need to be developed, the author has
focused on the first two building blocks in this article.
(i) Information
(a) Pressing need to develop informational infrastructure to
promote transparency to understand the operations of IFIs.
(b) Transparency facilitates decision making, hence improves
allocation of resources
(ii) Ability
(a) Market participants (eg analysts, brokers, ratings agencies,
etc) need to have the ability to process correctly information
provided by Islamic finance industry to enable the industry
reached the required critical mass and eventually to be rated.
(b) Easier to develop market discipline in countries with
significant market penetration such as S. Arabia (20%),
Kuwait (16%), Qatar(13%), Malaysia (12%), Bahrain (10%)
and UAE (7%).
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TRANSPARENCY: A VIRTUOUS CYCLE
Standards
Regulatory
Information
Disclosure
Regulation
and
Enforcement
As market discipline
develops, the market
demands more
information
Industry
Growth
Voluntary Information
Disclosure
Attract Market Participants
and Maintain Confidence
Transparency
Good Corporate
Governance
Other Factors
• Risk Management
• Product
Development
• Skilled workforce
• Marketing
• Efficiency
• Industry
Infrastructure
Virtuous Cycle of Transparency – a cycle that embraces all aspects of
regulation, disclosure, transparency, corporate governance, market discipline
and the growth of Islamic banking industry.
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THE ROLE OF REGULATORS
Standards
Regulatory
Information
Disclosure
Regulation
and
Enforcement
As market discipline
develops, the market
demands more information
Industry
Growth
Voluntary Information
Disclosure
Attract Market Participants
and Maintain Confidence
Transparency
Good Corporate
Governance
Other Factors
• Risk Management
• Product Development
• Skilled workforce
• Marketing
• Efficiency
• Industry
Infrastructure
Standards setting – regulators develop coherent regulatory disclosure
requirements which are useful both on national and international basis.
Enforcement – at country level whereby central bank enforce regulations
by monitoring the implementation & compliance of IFIs to the disclosure
requirements.
Vigilance – regulators need to be vigilant about –ve signals sent by the
market as early warning distress in individual FIs.
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CRITERIA FOR GOOD INFORMATION DISCLOSURE
Standards
Regulatory
Information
Disclosure
Regulation
and
Enforcement
Transparency
Voluntary Information
Disclosure
As market discipline
develops, the market
demands more information
Industry
Growth
Attract Market Participants (ratings
agencies, analysts and institutional
investors) and Maintain Confidence
Criteria for good information disclosure by IFIs –
quantitative & qualitative useful, accurate, complete
and credible.
Good Corporate
Governance
Other Factors
• Risk Management
• Product
Development
• Skilled workforce
• Marketing
• Efficiency
• Industry
Infrastructure
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CRITERIA FOR GOOD INFORMATION DISCLOSURE,
cont’d
• Good information disclosure by IFIs both quantitative and
qualitative that meets the criteria of useful, accurate, complete and
credible
• Useful – it depends on what the market discipline aims for e.g.:
(i) Satisfactory financial performance - IFIs have to provide
financial statements and comparative analysis (e.g. changes in
financial statement’s items over several accounting periods to
detect trends in the operations and results)
(ii) Good risk management – provide information on how it
manages risk exposures
(iii) Shariah compliance – show Shariah certification in annual
reports and accounts and highlighting Shariah review program
(iv) Resolution of conflict regarding Investment Account Holders
(IAH) – due to the fiduciary role, IFIs need to provide
information to both assets allocation and profit allocation.
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CRITERIA FOR GOOD INFORMATION DISCLOSURE,
cont’d
•
Accurate, Complete and Credible – to meet these criteria, all of the
previously mentioned information need to be applied.
-Good information disclosure lends itself to enhancing transparency
in the marketplace.
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THE ROLE OF MARKET PARTICIPANTS
Standards
Regulatory
Information
Disclosure
Regulation
and
Enforcement
As market discipline
develops, the market
demands more information
Industry
Growth
Voluntary Information
Disclosure
Attract Market Participants and
Maintain Confidence
Transparency
Good Corporate
Governance
Other Factors
• Risk Management
• Product Development
• Skilled workforce
• Marketing
• Efficiency
• Industry Infrastructure
Disciplining institutions – Reward & punish IFIs based on information
disclosure to motivate good behavior among IFIs. Reward good IFIs by
placing funds with them and punish those IFIs that did the opposite thing.
Soliciting information – market relays the information needed and over
time IFIs develop potential for voluntary information disclosure as market
demand increases.
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CONCLUSION
• Islamic Finance industry has the products and infrastructure to
compete with conventional institutions.
• Growth rates in some markets outstripped conventional markets
• To move forward, standard setters and regulators need to work
together to build strong and practical corporate governance
framework.
• Good corporate governance framework promotes transparency via
information disclosure by institutions that must be credible to inspire
confidence and promote market discipline.
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THANK YOU
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