The International Monetary Fund (IMF), especially under the current administration headed by Christine Lagarde, is a proactive supporter of Islamic banking, and together with the World Bank has declared this industry a priority for its operations in countries where Islamic banks operate.
In a recently released report titled “Ensuring Financial Stability in Islamic Banking Countries,” the IMF proposed an action plan that, if approved, will have significant implications for industry regulation and development, thus further promoting financial stability.
The report acknowledges the significant progress made in the development of prudential standards for Islamic banking, but also concludes that the current framework governing the global industry “contains many shortcomings that need to be addressed through the development of a comprehensive environment that ensures the financial stability and development” of the industry.
Prudential standards for conventional banks can generally be applied to Islamic banks, but there are also certain gaps that reflect the specificities of Islamic banking and their associated risks. Prudential standards for Islamic banking have been developed to complement international standards, including, among others, those on capital adequacy, IFSB core principles, as well as supervisory processes.
Special attention should be paid to the development of the deposit insurance and protection system and the lender of last resort function that the central bank should have, as well as instruments for managing the liquidity of Islamic banks. Likewise, the emergence of complex hybrid Islamic financial institutions and products, according to the IMF, is a regulatory challenge, with potential consequences for financial stability. The Islamic banking industry has grown very prolifically over the past three decades in terms of size, complexity of products and services, and its demographic reach.
Islamic banking is now available in more than 60 countries on all continents, and according to the IMF, it has become systemically important in 14 countries. This implies that Islamic banking comprises 15 percent or more of the market share of the total banking sector. In some countries, the figure is 40 percent, while in others, such as Malaysia, it is around 26 percent. The goal of the Government of Malaysia is for this share to be 30 percent by 2020. The number of countries where Islamic banking is systemically important should increase to 20 in the near future, according to the OIC’s goals. This should not be difficult to achieve either, as many countries are looking for new ways to raise funds for development and infrastructure investment.
In the published report, the IMF proposes and formally recognizes the principles adopted by the International Financial Services Board as an international standard for the supervision and regulation of Islamic banks, so that these standards can now be formally used by the IMF and the World Bank, as well as various regulators on state level. This is important as it represents the first independent assessment of the principles of supervision and regulation of Islamic banks. Three years ago, Malaysia was the first and only country to invite the IMF to assess the supervision of the Islamic banking sector in that country. The IMF and the World Bank have confirmed that Malaysia has the most advanced system of regulation and supervision of the Islamic banking industry, as well as the Shariah governance framework. Malaysia’s approach can serve as a model for other countries that seek to provide their citizens with adequate alternatives to the interest-based financial system.
