FOCUS                                                 Qatar’s Ban on Islamic Banking Wi...
FOCUS                                               Qatar’s Ban on Islamic Banking Wind...
FOCUS                                                Qatar’s Ban on Islamic Banking Win...
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Qatar Bank on Islamic Banking Windows: Good or Bad


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Article analysing the reasoning and justification of the Qatar declaration to ban Islamic banking windows and its impact on the Islamic Finance Industry

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Qatar Bank on Islamic Banking Windows: Good or Bad

  1. 1. FOCUS Qatar’s Ban on Islamic Banking Windows: Good or Bad for the Islamic Finance Industry? By Sayd FarookEarly in February, the Qatar Central Bank (QCB) issued a circular windows is the ability to offer Islamic services from the conventionalsaying it has decided to ‘terminate the activities of Islamic finance bank’s existing branch network without having to establish separateservices’ offered by conventional banks. The circular effectively branches for Islamic operations. This was considered more efficientterminates Islamic banking windows’ operations, giving a grace for some banks as it avoided having to invest in costly overheads suchperiod until year end for banks to comply with the requirements. as IT and security systems.The reasoning behind the move, and more importantly the effect of the Further, the marketing reach and network of the conventional bankban on Islamic windows, has been the subject of a wild speculation would presumably be much stronger than an Islamic bank. Forin the market. Some bankers have stated that such decisions taken instance, a bank in the UAE recently moved from an Islamic bankingon an ad-hoc basis may hurt Qatar’s top ranking as far as business subsidiary model to an Islamic window model offering Islamic servicestransparency is concerned. across their existing conventional branch network.The impact on the conventional banks with Islamic windows is fairly Finally, conventional banks that decide to offer Islamic servicessignificant. According to the Peninsula, a Qatar based newspaper, the initially cannot necessarily afford to invest in the significant set upconventional banks’ Islamic window branches (now amounting to 16) costs without testing the market for Islamic services. By requiringhave widened their customer base to some 80,000 individuals and conventional banks to set up new fully segregated Islamic banks, thecorporate entities. barrier to entry is significantly increased thereby limiting the appeal and attractiveness of Islamic finance, which could be argued to limit“The time given to us to wind up our Islamic banking activities is so competition and ultimately provide the most efficient services to theshort that we cannot even imagine how to recover our investments customer.and manage the credit portfolios,” said an industry source to thePeninsula. Counterpoint The flipside of this argument is, there is no clear monitoring of theIt is important to note that this circular relates to all conventional delineation the Islamic window’s that activities from its conventionalbanks with Islamic operations, even if the balance sheet is segregated. parent, and this is precisely what the QCB directive is aimed at. IfHowever, if a separately capitalized Islamic bank was licensed (even operations, marketing and potentially the balance sheet are mixed,if owned by a conventional bank), presumably it would not fall under then it is difficult to verify what business the Islamic window isthe regulatory ban. generating and how much costs/overheads are allocated to that unit.Limited access to international capital markets Further, a number of complications arise when dealing with customers.Some commentators have roundly condemned the move rather Do bank staff promote Islamic products or the conventional equivalentpatronisingly. They state QCB’s decision was poorly determined, when faced with a customer who is neutral? If you do not havewithout considering the impact on the market, and perhaps aimed to specialized Islamic finance staff to entertain prospective customersgive Islamic banks a free ride. They point to the fact that the major interested in Islamic finance products, then the conflict of interestinternational banks have been single handedly responsible for the heightens within staff.major innovations in the Islamic finance industry. In addition, if staff are not trained appropriately, they may not beOne commentator argued that international banks have sole access familiar with the salient features of Islamic banking products, suchto global capital markets which are currently inaccessible to Islamic as knowledge about contracts on which a product is built, legalbanks who will not be able to support transactions of the same documentation and implications over default and early settlement.magnitude that are financed in the region. Limiting competitionCounterpoint A number of the conventional banks and Qatar market commentatorsWithout going into details, it is important to point out that the QCB’s have stated that such a move could also limit competition. With thedirective is not directed only at international banks such as HSBC monopoly of existing Islamic banks controlling the full market, theor Credit Agricole, rather it is directed at all conventional banks with quality of services provided would thereby be reduced. They also argueIslamic windows. The circular is not discriminatory towards international that the existing Islamic banks will have serious difficulty in managingbanks versus local banks. All conventional banks are affected. Further, the service flows from the new businesses.the ban does not necessarily (at least this is not explicitly stated)preclude arranging and advisory services that international banks “Since 2005, there has been a lot of improvement in Islamic bankingconduct, even where they have no Islamic operations. services as a result of QCB’s liberalized policy of permitting commercial banks to offer Shariah compliant banking services,” said one sourceEfficiency is wholly ignored to the Peninsula. But given the monopoly returning, the services canAnother criticism is that it prevents banks from choosing the most only be expected to deteriorateefficient business model for their needs. The benefit of Islamic continued... © Page 25 9th March 2011
  2. 2. FOCUS Qatar’s Ban on Islamic Banking Windows: Good or Bad for the Islamic Finance Industry? (continued)But with the monopoly returning, services can only be expected to In contrast, the pure Islamic banks have been able to largely avoiddeteriorate rather than improve. The QNB Islami branch has no less dubious practices due to their conservative nature, and some wouldthan 45,000 customers generating profits of around QAR900 million argue, constant Shariah supervision, oversight, and risk management(US$247 million) last year. Having to forego such a significant part of that prevent dubious practices seeping through the cracks of thetheir business would certainly not be appealing to these conventional Shariah compliance controls.banks who have invested significant effort to build their Islamicfranchises. By requesting all banks to establish separately capitalized Islamic banks or subsidiaries, Shariah governance is better monitored and “With the monopoly of existing therefore establishes a stronger environment for transparency. Each institution can have their own independent internal Shariah reviewer Islamic banks controlling the full and auditors in place and thereby vet and maintain control of all practices within the institution. market, the quality of services Some have argued that such an extreme measure to ban all operations provided would thereby be is not necessarily the only option to ensure proper Shariah governance. Sheikh Taqi Usmani argues that as long as there is appropriate Shariah reduced” governance in the form of a permanent Shariah unit in addition to the Shariah supervisory board and a complete separation of accounts,Counterpoint staff, office and funds, then it would not be mandatory that a separateThe impact on the conventional banks will be significant and Islamic bank has to be formed.substantially unfair. To counter this loss in opportunity, theconventional banks can seek to negotiate with the QCB if it is possible Perhaps the reason the QCB initiated this directive was because they,for them to set up independent Islamic banks that have completely as a central bank, were having difficulties monitoring the Islamicsegregated operations and accounting from the conventional parents, banking business of the conventional banks as there may not havewith separate licensing requirements. been clear delineation of the conventional and Islamic arm.This would, ideally speaking, ease the concern of the QCB, while One could argue that they could specify ex-ante regulations thatallowing the conventional banks to retain their Islamic finance market require Islamic banking windows and units to have their own Shariahpenetration. However, the extent to which the QCB will accept such audit units, independent operations and separate balance sheetsa solution and allow for new licences for new Islamic banks is yet as subsidiaries if they wanted to achieve the aim of appropriateunknown. monitoring.Benefits of the decision LeakageThat said, while the short-term impact of the decision may be damaging Besides the argument that Islamic banking windows are hard toto the country’s conventional banks, the QCB’s move may be seen as monitor, banning windows ensures that Islamic funds do not leakforesight in a region where regulation usually follows bad practice. out into the conventional system, thereby strengthening the base of authentic Islamic finance. Islamic banking windows can take IslamicWeak Shariah governance funds and then recycle it within the conventional banking system.It has long been a concern of some Shariah advisors and commentatorsthat Islamic banking windows are the cause of a number of serious Fully capitalized banks or subsidiaries of conventional banks withShariah compliance failures. They point to the many ‘innovative’ new distinct balance sheets however can only accept money that theyproducts that have actually been detrimental to the reputation of will invest in their own assets (through Wakalah and Mudarabah).Islamic finance and have sustained the criticism that Islamic finance Whereas, windows can accept money and then reinvest that moneyis a wrap around solution for conventional finance. into conventional markets since the first transaction with the customer who is depositing is merely a sale (Murabahah) and therefore, theFor instance, the Murabahah based deposit is sometimes accepted other leg can be anything as long as the funds promised as the saleby the Islamic banking windows without any ensuing Murabahah price are paid.transaction taking place once the Islamic bank client deposits themoney. At the end of the period, the Islamic bank client receives As a result, the ensuing argument from Islamic finance purists goeshis deposit plus a return, allegedly earned from a deferred payment that by allowing such window operations, a lot of Islamic bankingMurabahah transaction. assets are being funnelled into the conventional system rather than being placed back into the Islamic finance ecosystem.There have been countless anecdotal reports of these sorts of practicesoccurring in conventional banks. However, it has been very difficult to This can also be evidenced in the management of reserves in Islamicverify or refute as there is no requirement for an independent Shariah window operations. The conventional treasury department usuallyauditor for these conventional banks. handles money market operations. Daily surpluses are usually passed on to the conventional treasury for overnight transactions for earningSimilarly, the dual promise to circumvent the forward contract was some marginal income.developed by a prominent Islamic banking window of a global bank. continued... © Page 26 9th March 2011
  3. 3. FOCUS Qatar’s Ban on Islamic Banking Windows: Good or Bad for the Islamic Finance Industry? (continued)Sometimes, treasuries may not have enough surpluses from Islamic The views expressed in this article are his own and do not represent inreserves to cover its positions. In these instances, it would use the any way the views of his employer.proceeds from sale of conventional papers to cover the Islamic depositobligations at maturity. Dr Sayd Farook Global head of Islamic capital marketsIf a separate subsidiary with a separate independent treasury is Thomson Reutersestablished, the Islamic bank would not have to commingle funds with Email: conventional treasury. Further, all the funds accepted would have Dr Sayd Farook leads up Thomson Reuters Islamic financeto be directed at Islamic funds. transactions initiative as global head of Islamic capital markets.Conclusion The February Circular makes reference to Circular 74/2010, whichThe decision by the QCB to limit the Islamic banking operations of we understand was issued in late August 2010 (the August Circular).conventional banks came as a huge blow to the conventional banks Among other things, the August Circular states that conventionalin Qatar. Commentators considered it an imprudent move to limit banks operating in Qatar were not permitted to open any additionalcompetition in the high growth Islamic banking market of Qatar while branches for Islamic banking or to allocate more than 10% of theirlimiting access to global markets. issued capital to Islamic banking operations. Banks were given until the end of 2011 to comply.Despite the short-term impact on the affected banks, it is the author’sview that it is for the overall benefit of the Islamic finance industry, The August Circular has been interpreted as a move by the QCBparticularly in Qatar. The ban would alleviate the serious governance/ to encourage the growth of dedicated Islamic banking institutions.control failures that plague Islamic operations in conventional bankswhile it would also prevent the leakage/mixing of Islamic funds withconventional funds, a practice which has drawn the ire of scholars and The February Circular Among other things, the February Circular supersedes the Augustexternal cynics alike. Circular. In particular, the February Circular requires conventional banks with immediate effect:Now it is up to the QCB to decide on which course of action the • not to accept new Islamic depositsconventional banks should take. It would be advisable, subject to • to reimburse Islamic term depositors at their agreedpolicy restrictions, that the QCB allow the conventional banks to apply maturity date,for new Islamic banking licences for their Islamic windows. Where this andis not possible, conventional banks should at least be able to merge • not to enter into any new Islamic finance transactions duringtheir Islamic assets and create two to three fully segregated Islamic the Grace Period, although they should continue to collectbanks. payments from their customers in accordance with their existing arrangements.Regardless, the decision by the QCB will be observed closely byregulators elsewhere in the region to ascertain the impact on the Following the end of the Grace Period, conventional banks withgrowth and transparency of the Islamic finance industry in their Islamic operations will be required to consolidate their Islamicjurisdictions. If it does and given the support from Shariah scholars, portfolios until all payments are collected in accordance with theirit is likely that some of these jurisdictions will consider such a move. agreed terms and conditions. In the meantime, conventional banksMalaysia has required the same of its conventional banks and it was are permitted to transfer all or part of their Islamic portfolios toconsidered a pioneer when it did. Given the potential move towards existing Islamic banks in Qatar.such requirements, conventional banks should therefore consider (Source: Simmons and Simmons)whether their operating models are optimal going forward. Contact or call +603 2162 7800 © Page 27 9th March 2011