Islamic Financial Architecture and
Infrastructures:
Development and Challenges
Tariqullah Khan
IRTI-GDLN World Bank
Lecture, April 7, 2009
Outline
1. Overview of International Financial Architecture
2. Defining Islamic Financial Architecture and
Infrastructures
3. Building Blocks of Islamic Financial Architecture
4. Lessons drawn from Global Financial Crisis
5. Building Blocks of Islamic Financial
Infrastructures
6. Development: Challenges, Institutions and
Initiatives
Definition of financial architecture
Financial architecture is …. the 1) institutions, 2)
markets, and 3) practices that governments,
businesses, and individuals use when they carry out
economic and financial activities.
IMF (2000) - “Reforming the International Financial
Architecture – Progress Through 2000”
Purpose: Enhancing financial sector
development & performance and
strengthening macroeconomic growth and
stability
Pillars of Financial Architecture
Pillar-1: Objectives of financial architecture
Pillar-2: Specialization of standard setting and
infrastructure development institutions
Pillar-3: Functional relationships between
specialized stakeholders
Pillar-4: Assessment and monitoring
Pillar-1: Objectives
1.
Detecting and Monitoring External Vulnerabilities
2.
Strengthening Financial System Performance and Stability
3.
Observance of International Standards and Codes
4.
Capital Account Issues
5.
Pursuing Sustainable Exchange Rate Regimes
6.
Involving the Private Sector in Forestalling and Resolving Crises
7.
Measures to Increase Transparency
8.
Reform of IMF Financial Facilities and Related Issues
(IMF 2000)
Pillar – 2: Specialized functional areas of standard setting
and infrastructure development institutions
Specialized Standard Setting Bodies
Basel Committee for Banking Supervision (BCBS)
International Organization of Securities Commissions
(IOSCO)
International Association of Insurance Supervisors (IAIS)
Multilateral Institutions
World Bank
International Monetary Fund
Regional Banks
Financial Stability Forum (Board)
Pillar-3: Functional Relationships between
specialized entities
Chart 1
International Financial Architecture
Basel
G7/G10
IOSCO
IAIS
Other Industrial
Countries
Developing
Countries
IMF
Development Banks
International Monetary and
Financial
Financial Committee;
Stability
Development Committee;
Forum
G-7/G-10;
IMF, World Bank Executive
Boards
Evans, Huw (2000): “Plumbers and Architects: A Supervisory Perspective on International
Source: Evans (2000, p.27)
Financial Architecture”, Financial Supervisory Authority Occasional Paper Series No. 4; January
Pillar – 4: Financial Sector Development &
Performance Assessment
1. Financial Sector Assessment Program (FSAP)
of IMF and World Bank
2. Reports on Observance of Standards and
Codes (ROSCs)
Coverage includes:
• Banking Supervision,
• Data Dissemination,
• Fiscal Transparency,
• Monetary & Financial
Transparency Policies
Operational nature:
•Joint World Bank &
IMF character
•Voluntary
participation
•Case-by-case design
Components of Islamic Financial
Architecture
Global Component
↓
International
Financial Architecture
(IFA)
Local Component
↓
National Financial
Infrastructures (NFI)
Components of International Islamic
Financial Architecture
Universally acceptable
guiding principles of
Islamic economics and
finance
Internationally credible &
comparable best practices
derived from the guiding
principles
Individuals & Institutions
that set best practices,
use them, enforce them
and monitor enforcement
Cross
Border National
National Islamic financial
infrastructures
Legal, regulatory, supervisory, tax and other
enabling, support and enforcement facilities,
instruments and resources needed for
implementation and compliance with the
universally acceptable Islamic guiding principles
and best practices
At the across border level – regional and
multilateral institutions, arrangements and
facilities for compliance with the universally
acceptable Islamic guiding principles and best
practices
Objectives of International Islamic Financial
Architecture (IIFA)
1. Establishing universally acceptable guiding principles for
Islamic financial practices
2. Establishing best practices for Islamic financial services in
areas of:
• Shariah and corporate governance
• Corporate ethics and social responsibility
• Transparency and disclosures
• Risk management
• Capital adequacy
• Accounting and auditing
3. Narrowing Fiqh Interpretations
4. Common regulatory and supervisory regime
5. Compliance with relevant international best practices
Building Blocks of IIFA
First Building Block of IIFA:
Guiding Principles of Islamic Economics and Finance
R
u
l
e
s
Rules governing prohibitions – Riba, Gharar,
Qimar, etc. Consumption, financing, production,
and transaction of prohibited items
P
Principles governing what is permitted - sales,
r
i
financing, investment, trade and commercial
n
transactions
c
i N
p o Norms guiding good behavior and dealings with
l
others
e r
s
m
s
Second Building Block of IIFA:
Shariah Standards (Accounting and Auditing Organization for Islamic
Financial Institutions - AAOIFI)
1.Trading in
Currencies
2. Debit Card,
Charge Card
and Credit
Card
3. Default in
Payment by a
Debtor
4. Settlement of
Debt by SetOff
5. Guarantees
7. Hawala
13. Mudaraba
19. Loan (Qard)
8. Murabaha to the
Purchase Orderer
14.
Documentary
Credit
20. Commodities
in Organized
Markets
9. Ijarah and Ijarah
Muntahia Bittamleek
15. Jua’la
21. Financial
Papers (Shares
and Bonds)
22. Concession
Contracts
27. Indices
23. Agency
6. Conversion of a
Conventional
Bank to an
Islamic Bank
12. Sharika
(Musharaka) and
Modern Corporations
29. Stipulations and
Ethics of Fatwa in
the Institutional
Framework
30. Monetization
(Tawarruq)
10. Salam and Parallel 16.
Salam
Commercial
Papers
11. Istisna’a and
17. Investment
Parallel Istisna’a
Sukuk
18. Possession
(Qabd)
24. Syndicated
Financing
25. Combination of
Contracts
26. Islamic
Insurance
28. Banking
Services
Third Building Block of IIFA:
Accounting Standards issued by AAOIFI
1. Objectives of Financial
Accounting for Islamic
Banks and Financial
Institutions
2. Concepts of Financial
Accounting for Islamic
Banks and Financial
Institutions
7. Disclosure of Bases for 13. Provisions and Reserves
Profit Allocation
Between Owners’
Equity and Investment
Account Holders
8. Equity of Investment
14. General Presentation and
Account Holders and
Disclosure in the Financial
Their Equivalent
Statements of Islamic
Insurance Companies
3. General Presentation
9. Salam and Parallel
and Disclosure in the
Salam
Financial Statements of
Islamic Banks and
Financial Institutions
4. Murabaha and Murabaha 10. Ijarah and Ijarah
to the Purchase Orderer
Muntahia Bittamleek
5. Mudaraba Financing
11. Zakah
6. Musharaka Financing
19. Investment
20. Islamic Financial
Services offered
by Conventional
Financial
Institutions
15. Disclosure of Bases for
21. Contributions in
Determining and Allocating
Islamic Insurance
Surplus or Deficit in Islamic
Companies
Insurance Companies
16. Investment Funds
22. Deferred
Payment Sale
17. Provisions and Reserves in 23. Disclosure on
Islamic Insurance
Transfer of Assets
Companies
12. Istisna’a and Parallel 18. Foreign Currency
24. Segment
Istisna’a
Transactions and Foreign
25. Consolidation
Operations
Fourth Building Block of IIFA
Shariah Governance Standards
Standards Issued by AAOIFI
1. Governance
2. Shariah Supervisory Board: Appointment, Composition and Report
3. Shariah Review
4. Internal Shariah Review
5. Audit and Governance Committee for Islamic Financial Institutions
6. Independence of Shariah Supervisor Board
7. Statement on Governance Principles for Islamic Financial Institutions
8. Code of Ethics for Accountants and Auditors of Islamic Financial
Institutions
9. Code of Ethics for the Employee of Islamic Financial Institutions
Standard Issued by Islamic Financial Services Board
“Guiding Principles on Corporate Governance for Institutions Offering Only
Islamic Financial Services (Excluding Islamic Insurance (Takaful) Institutions
and Islamic Mutual Funds - IFSB-3 -
Fifth Building Block of IIFA
Prudential guidelines and standards for Islamic financial services
1. IFSB-7: Capital Adequacy Requirements for Sukuk,
Securitisations and Real Estate investment
2. IFSB-6: Guiding Principles on Governance for Islamic
Collective Investment Schemes
3. Guidance Note In Connection with the Capital Adequacy
Standard: Recognition of Ratings
4. IFSB-5: Guidance on Key Elements in the Supervisory Review
Process
5. IFSB-4: Disclosures to Promote Transparency and Market
Discipline
6. IFSB-3: Guiding Principles on Corporate Governance
7. IFSB-2: Capital Adequacy Standard
8. IFSB-1: Guiding Principles of Risk Management
Lessons drawn from global financial crisis & strengths of the IIFA
Lesson-1: Incentive structures; replacement of interest with profit
sharing introduces fundamental changes in incentive systems
Lesson-2: Excessive leverage; strong linkages between financing and real
economic transactions controls leverage
Lesson-3: Controlling speculation; “don't sell what you don’t own” rule limits
speculation
Lesson-4: Pyramid of debts; prohibition of sale of debt eliminates debt
pyramids
Lesson-5: Regulation failure; Shariah supervision reduces the risk of failure of
regulation
Lesson-6: Social responsibility; Ethical screening of investment opportunities
strengthens social responsibility of wealth managers
Hence, IIFA has the inherent features and inbuilt
characteristics that ensure productive utilization of
financial resources and financial stability
Pillars of & Building Blocks of
Sound Financial Infrastructures
Pillars of a sound national financial infrastructure
• Pillar I—Macroprudential surveillance and financial stability
analysis by the authorities to monitor the impact of potential
macroeconomic and institutional factors (both domestic and
external) on the soundness (risks and vulnerabilities) and
stability of financial systems
• Pillar II—Financial system supervision and regulation to help
manage the risks and vulnerabilities, protect market integrity,
and provide incentives for strong risk management and good
governance of financial institutions
• Pillar III—Financial system infrastructure:
– Legal infrastructure for finance
– Systemic liquidity infrastructure
– Transparency, governance, and information infrastructure
FSAP: A Handbook, Chapter -1
• Pillar IV – Shariah Supervisory Framework and Governance
System
Building blocks of national Islamic financial
infrastructures & challenges of enhancing them
Building Block-1:
Building Block-2:
Building Block-3:
Building Block-4:
Building Block-5:
Building Block-5:
Building Block-6:
Building Block-7:
Shariah Supervisory Systems
Legal, Regulatory and Tax Framework
Application of AAOIFI & IFSB standards of
best practices for the Islamic financial
services
Supervisory framework
Lender of last resort facility & systemic
liquidity infrastructure
Deposit protection system
Human capital
Knowledge and professional services
Connections & Interactions Between International &
Islamic Financial Architecture
Areas of Standards
Key Agency(s) in the International
Financial Architecture
International Accounting Standards Board
(IASB), International Federation of
Accountants (IFAC), Committee on Banking
Supervision (BCBS)
Financial Action Task Force (FATF)
Corresponding Agency(s)
in Islamic Finance
AAOIFI
International Federation of Accountants
(IFAC)
Committee
OECD, Basel Committee, World Bank
AAOIFI
5. Data Dissemination
6. Fiscal Transparency
7. Insolvency and Creditor
Rights Systems
IMF
IMF
World Bank, United Nations Commission on
International Trade Law (UNCITRAL),
International Bar Association (IBA)
8. Insurance Regulation
International Association of Insurance
Supervisors (IAIS)
IMF
Common
Common
Not yet addressed but
especially critical for Islamic
financing as it is based on
risk sharing
Not yet addressed but within
the mandate of IFSB
Common
1. Accounting
2. Anti-Money Laundering /
Combating the Financing of
Terrorism
Auditing
3. Banking
4. Corporate Governance
9. Monetary & Financial
Transparency Policies
10. Payments Systems
11. Securities Market Regulation
Committee on Payment and Settlements
Systems (CPSS)
International Organization of Securities
Commissions (IOSCO)
Common
IFSB
AAOIFI and IFSB
Common
Not yet addressed but within
the mandate of IFSB
Islamic Financial Architecture - Challenges of
Development
1. Enabling Environment
2. Effective Shariah Supervision and Governance
3. Balancing speed and genuineness
4. Application of AAOIFI and IFSB Standards
5. Safeguarding against systemic risks of conventional
system
6. Preventing risk transmission from conventional to Islamic
financial institutions
7. Preventing risk transmission within Islamic funding
source
8. Systemic liquidity and safety-net infrastructures
9. FSAP and Assessment Issues
Institutional Initiatives in developing IIFA
#
Institution
Mode of contribution to
IIFA & Infrastructures
1
Islamic Development Bank (1976)
2
The Islamic Research and Training Institute (IRTI)
(1981)
The Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI) (1991)
International Islamic Financial Market (IIFM)
(2001)
The General Council of Islamic Banks and Financial
Institutions (GCIBFI) (2001)
The International Islamic Rating Agency (IIRA)
(2002)
The Islamic Financial Services Board (IFSB) (2002)
International Islamic Centre for Reconciliation and
Commercial Arbitration, (IICRACA) (2005)
TA, equity support and
collaboration with IFSB, IMF
and World Bank & others
Research, training &
Information services
Standard setting and training
3
4
5
6
7
8
Product development and
training
Product development,
training and research
Rating services
Standard setting and training
Dispute resolution
References
IMF & World Bank, Financial Sector Assessment – A Handbook
(http://web.worldbank.org/WBSITE/EXTERNAL/WBI/WBIPROGRAMS/FSLP/0,,contentMDK:206568
85~pagePK:64156158~piPK:64152884~theSitePK:461005,00.html)
IRTI/IFSB, IFSI Development: 10 Year Framework and Strategies
(http://ibisonline.net/En/Policy_Dialogue/TenYearFrameworkAndStrategies.pdf)
Chapra, M.U and Tariqullah Khan, Regulation and Supervision of Islamic Banks, IRTI
(http://irtipms.org/PubSearchOutE.asp?lang=e&mode=allwords&search=regulation)
Khan, Tariqullah and Ahmed Habib, Risk Management – An Analysis of Issues in Islamic Financial
Industry, IRTI (http://irtipms.org/PubDetE.asp?pub=91&search=risk&mode=allwords)
Khan, Tariqullah and Muljawan, Dadang, Islamic Financial Architecture: Risk Management,
Regulation and Supervision, IRTI
(http://irtipms.org/PubSearchOutE.asp?lang=e&mode=allwords&search=regulation)
Zubair, Ahmed, Macro Perspectives on Islamic Financial Architecture, Internal IDB Policy Paper
Thanks
tariqullah.khan@isdb.org
http://www.google.com/search?sourceid=navclient&ie=UTF8&rlz=1T4GFRD_enSA306SA306&q=tariqullah+khan