SlideShare a Scribd company logo
23©
28th
July 2014
SECTOR
FEATURE
The future of Islamic finance in the
global economy looks bright with
10 of the world’s 25 fastest growing
markets in Muslim majority countries.
According to EY, Islamic banking assets
with commercial banks globally crossed
US$1.7 trillion in 2013 suggesting an
annual growth of 17.6% over the last
four years. Despite this growth, leading
Islamic banks posted 19% lower return
on equity (ROE) compared to their
conventional peers. This would suggest
that there is a dire need of a policy
re-think and governance restructure by
the Islamic finance industry as a whole.
This is most evident in countries having
aspirations to become Islamic financial
centers but lack central bank directives
and regulations, for example the UK.
There are abundant opportunities for
Islamic finance to flourish in the UK —
the Muslim population is growing faster
than any other religious group. Muslims
have started to actively integrate
themselves in British society: in politics,
from parliament to local government,
in the armed forces, policing, the
professions, the arts and sports, and of
course in business. Muslims constitute
one of the youngest demographics in
the UK and the younger generation
is more religion conscious than their
predecessors wanting for example
Shariah compliant house financing
options.
The UK government has been pushing
to be an Islamic financial hub having
set-up a ministerial-led Islamic Finance
Task Force, jointly chaired by Baroness
Warsi and the financial secretary to
the Treasury. The recent issuance of a
GBP200 million (US$341.36 million)
sovereign Sukuk with a GBP2 billion
(US$3.41 billion) oversubscription also
points to this.
In the past, the UK especially London
has seen considerable Islamic capital
market activity with more than US$38
billion being raised through 54 Islamic
Sukuk issues. Major developments and
landmark projects in London such as
The Shard, Chelsea Barracks, Harrods,
Battersea Power Station and the Olympic
Village have in whole or in part used
Islamic financing.
Given all the aspects mentioned, Islamic
retail banking is yet to take off in the
UK given its potential. This is where
the policy re-think and governance
framework restructuring mentioned
above needs to take place globally
especially in the UK.
There are three facets that need
to be redressed — disclosure, risk
management and consumer relations.
Disclosure
One of the key concerns is insufficient
disclosure of Shariah governance in
Islamic financial institutions annual
reports. Issues such as conflict of interest
of Shariah board members within an
Islamic financial institution and with
other Islamic financial institutions among
other issues are largely ignored. As
shown in the table below, inconsistency
between jurisdictions aside, there
appears to be insufficient disclosure of
Islamic financial institutions’ Shariah
governance and other key disclosures in
annual reports.
Islamic financial institutions should set
additional requirements for disclosures
in their annual reports relating to
income purification and disbursement to
charities, due to the inherent sensitivities
associated with these funds. Additional
disclosures can include:
• Value of impermissible income and
late payment fees relating to the
period, including any contingent
amounts.
• Purification amounts that have been
disbursed during the period with
explanations for any non-disbursed
amounts.
• Reporting on the nature of the
charities supported and their social
impact.
• Disclosure of fees paid to Shariah
supervisory board (SSB) members
within the institution’s annual reports
(split by audit and non-audit), similar
to disclosures of fees paid to external
auditors.
• Related party transactions where
Islamic financial institutions have
close connections with any of the
receiving charitable organizations.
• Disclosure by all personnel involved
in the audit (SSB, ISCU members,
Corporate governance in the UK Islamic inance
industry
Despite anchoring itself in the Islamic finance space, the UK has yet to see its Shariah compliant retail banking
sector take off, prompting for a policy re-think and governance framework restructuring. MUJTABA KHALID
analyzes the current structures in place.
continued...
Bank Shariah regulation Comprehensive Shariah
advisor’s report
Related party
transactions
Statement of
Purification of Income
Shariah Board
Remuneration
Zakat
Meezan Bank —
Pakistan
Islamic Banking Department
guidelines — SBP
Yes Yes Yes Yes
Bank Islam —
Malaysia
BNM guidelines No No Yes Yes
Bank Melli —
Iran
Central Bank of Iran banking
regulations
No No No Yes
Al Rajhi Bank —
Saudi Arabia
Central bank regulations (not
stringent)
No No No Yes
Islamic Bank of
Britain — UK
No central regulation No No No No
24©
28th
July 2014
SECTOR
FEATURE
etc.) of any interests such as
shareholdings, a relative/related
party working in a senior role in the
institution, commercial relationships
as a customer or supplier (either
with the individual or with a related/
linked company of which the SSB or
any relative may be a director), etc.
Risk management
The challenge going forward is for
Islamic banks to establish a cultural
mindset and operating framework that
embed balance sheet risk — something
beyond the regulatory requirements set
out under Basel III.
The distinct contractual relationship of
an Islamic financial institution’s balance
sheet are illustrated in the following
diagram:
Return on assets Investment returns
Assets Liabilities
Inventory
Real estates/
Automobiles
Current/Demand
deposits
Wadiah /Qard
Asset-backed
transactions
Murabahah/Ijarah/
Istisnah/ Salam
Unrestricted
investment accounts
Mudarabah
Restricted
investment accounts
Mudarabah
Profit Sharing
Transactions
Mudarabah/
Musharakah
Reserves
Fee-based services
Ujr
Equity
As regulations become more stringent
and the market becomes saturated,
banks need to enforce an inclusive
risk management ensuring effective
teamwork. Diagram 1 gives a brief
illustration of what might be needed for
Islamic banks to be more effective.
An important risk faced by Islamic
financial institutions is non-compliance
risk, which in-turn can lead to
reputational risk. As more complex deals
are being executed and more complicated
products being developed, if any
institution, inside or outside the Islamic
financial institution, deserves scrutiny, it
is the Shariah scholars. Therefore, apart
from a Shariah audit to check compliance
with the Shariah governance frameworks
provided by the Shariah board, I
propose a Fatwa audit. This would be
an independent audit carried out to
determine what Ijtihad was used by the
Shariah scholar or board in deeming a
deal, product or transaction as Shariah
compliant. This can be a revolutionary
step in tackling the creeping cynicism
about Islamic finance among Muslims.
Being suitably qualified requires both
a minimum level of knowledge and
skill as an entry criterion, and also the
need to have ongoing training. Shariah
scholars working as advisors to an
institution need also to consider the
risks of litigation over the advice they
provide as increasing litigation activity
related to Islamic finance is being seen in
courts. Initiatives in the Islamic finance
industry specifically addressing the issue
of competence include “fit and proper”
criteria set by industry regulators and
the Islamic Finance Council UK’s Scholar
Professional Development Program
developed exclusively for Shariah
scholars and those associated with the
Shariah assurance process.
Consumer relations
One aspect that is lagging especially in
Islamic banks based in the UK is effective
consumer relations policy. Aspects such
as anticipating a change in consumer
needs and how they will defer in the
next five years, how to respond to such
changes and how to target new consumer
groups.
Commercial transactions include
an element of trust. Research shows
that the quality of customer-facing
employees and the ease of doing day-
to-day business are the most important
elements in building or reinforcing trust.
Islamic financial institutions should
create service excellence on top of
operational excellence.
This requires proactive relationship
management: maintaining a dialogue
with customers, creating awareness
about Islamic finance among consumer
groups through conferences and
education programs, acting in their best
interests and coming up with solutions
for personal financial situations.
Islamic banks in the UK should also bear
in mind that, as mentioned above, most
of the Muslim demographic is young
and their consumer base would mostly
consist of Gen-Y individuals. These
individuals tend to be higher educated
and critical; they often have above
average incomes and are extensive users
of technology. Therefore effective use of
technology in terms of products which
are not only easy to understand but also
reduce effort and the use of social media
for marketing campaigns should be
employed effectively.
Mujtaba Khalid is a senior associate at the
UKIFC. He can be contacted at mkhalid@
ukifc.com.
Continued
Strategy

More Related Content

What's hot

The different models of regulating islamic securities
The different models of regulating islamic securitiesThe different models of regulating islamic securities
The different models of regulating islamic securities
Lyla Latif
 
Unsgsa plenary of the financial action task force
Unsgsa   plenary of the financial action task forceUnsgsa   plenary of the financial action task force
Unsgsa plenary of the financial action task force
Dr Lendy Spires
 
Vskills basel iii professional sample material
Vskills basel iii professional sample materialVskills basel iii professional sample material
Vskills basel iii professional sample material
Vskills
 
StubbsGazette Anti-Money Laundering Workshop presentation
StubbsGazette Anti-Money Laundering Workshop presentationStubbsGazette Anti-Money Laundering Workshop presentation
StubbsGazette Anti-Money Laundering Workshop presentation
StubbsGazette
 
2 dalton
2 dalton2 dalton
2 dalton
mihaboyz
 
Payments Operations Potentials for Modernizing the Check Process
Payments Operations Potentials for Modernizing the Check ProcessPayments Operations Potentials for Modernizing the Check Process
Payments Operations Potentials for Modernizing the Check Process
David Walker
 
28-31
28-3128-31
Banking industry overview 2016
Banking industry overview 2016Banking industry overview 2016
Banking industry overview 2016
Peter Armand
 
Vietnam _Merger and Acquisition
Vietnam _Merger and AcquisitionVietnam _Merger and Acquisition
Vietnam _Merger and Acquisition
Dr. Oliver Massmann
 
StubbsGazette Anti Money Laundering E Book
StubbsGazette Anti Money Laundering E BookStubbsGazette Anti Money Laundering E Book
StubbsGazette Anti Money Laundering E Book
James Treacy
 
Ethiopia dfs presentation ignacio mas
Ethiopia dfs presentation ignacio masEthiopia dfs presentation ignacio mas
Ethiopia dfs presentation ignacio mas
Ntalemu
 
2013 China Financial Industry Trends and Outlook
2013 China Financial Industry Trends and Outlook2013 China Financial Industry Trends and Outlook
2013 China Financial Industry Trends and Outlook
Kapronasia
 
HRM-Staffing-B.V.Raghunandan
HRM-Staffing-B.V.RaghunandanHRM-Staffing-B.V.Raghunandan
HRM-Staffing-B.V.Raghunandan
SVS College
 
EY-Banking-in-emerging-markets-Investing-for-success
EY-Banking-in-emerging-markets-Investing-for-successEY-Banking-in-emerging-markets-Investing-for-success
EY-Banking-in-emerging-markets-Investing-for-success
Karl Meekings
 
State of Fintech in East Africa
State of Fintech in East AfricaState of Fintech in East Africa
State of Fintech in East Africa
Ali Mohammed
 
Trends in the microfinance ecosystem
Trends in the microfinance ecosystemTrends in the microfinance ecosystem
Trends in the microfinance ecosystem
Tulasi Ram
 
FTI: Financial Statement Frauds - Chinese-Style (Article)
FTI: Financial Statement Frauds - Chinese-Style (Article)FTI: Financial Statement Frauds - Chinese-Style (Article)
FTI: Financial Statement Frauds - Chinese-Style (Article)
asianextractor
 
financial accounting2 (accounting from islamic perspective)
financial accounting2 (accounting from islamic perspective)financial accounting2 (accounting from islamic perspective)
financial accounting2 (accounting from islamic perspective)
Ariyda Eiyda
 

What's hot (18)

The different models of regulating islamic securities
The different models of regulating islamic securitiesThe different models of regulating islamic securities
The different models of regulating islamic securities
 
Unsgsa plenary of the financial action task force
Unsgsa   plenary of the financial action task forceUnsgsa   plenary of the financial action task force
Unsgsa plenary of the financial action task force
 
Vskills basel iii professional sample material
Vskills basel iii professional sample materialVskills basel iii professional sample material
Vskills basel iii professional sample material
 
StubbsGazette Anti-Money Laundering Workshop presentation
StubbsGazette Anti-Money Laundering Workshop presentationStubbsGazette Anti-Money Laundering Workshop presentation
StubbsGazette Anti-Money Laundering Workshop presentation
 
2 dalton
2 dalton2 dalton
2 dalton
 
Payments Operations Potentials for Modernizing the Check Process
Payments Operations Potentials for Modernizing the Check ProcessPayments Operations Potentials for Modernizing the Check Process
Payments Operations Potentials for Modernizing the Check Process
 
28-31
28-3128-31
28-31
 
Banking industry overview 2016
Banking industry overview 2016Banking industry overview 2016
Banking industry overview 2016
 
Vietnam _Merger and Acquisition
Vietnam _Merger and AcquisitionVietnam _Merger and Acquisition
Vietnam _Merger and Acquisition
 
StubbsGazette Anti Money Laundering E Book
StubbsGazette Anti Money Laundering E BookStubbsGazette Anti Money Laundering E Book
StubbsGazette Anti Money Laundering E Book
 
Ethiopia dfs presentation ignacio mas
Ethiopia dfs presentation ignacio masEthiopia dfs presentation ignacio mas
Ethiopia dfs presentation ignacio mas
 
2013 China Financial Industry Trends and Outlook
2013 China Financial Industry Trends and Outlook2013 China Financial Industry Trends and Outlook
2013 China Financial Industry Trends and Outlook
 
HRM-Staffing-B.V.Raghunandan
HRM-Staffing-B.V.RaghunandanHRM-Staffing-B.V.Raghunandan
HRM-Staffing-B.V.Raghunandan
 
EY-Banking-in-emerging-markets-Investing-for-success
EY-Banking-in-emerging-markets-Investing-for-successEY-Banking-in-emerging-markets-Investing-for-success
EY-Banking-in-emerging-markets-Investing-for-success
 
State of Fintech in East Africa
State of Fintech in East AfricaState of Fintech in East Africa
State of Fintech in East Africa
 
Trends in the microfinance ecosystem
Trends in the microfinance ecosystemTrends in the microfinance ecosystem
Trends in the microfinance ecosystem
 
FTI: Financial Statement Frauds - Chinese-Style (Article)
FTI: Financial Statement Frauds - Chinese-Style (Article)FTI: Financial Statement Frauds - Chinese-Style (Article)
FTI: Financial Statement Frauds - Chinese-Style (Article)
 
financial accounting2 (accounting from islamic perspective)
financial accounting2 (accounting from islamic perspective)financial accounting2 (accounting from islamic perspective)
financial accounting2 (accounting from islamic perspective)
 

Similar to IFN Corporate Governance and Risk Management Report - 28 July 2014

Challenges of islamic banking by prof haqiqi
Challenges of islamic banking by prof haqiqiChallenges of islamic banking by prof haqiqi
Challenges of islamic banking by prof haqiqi
Alhuda Centre of Islamic Banking & Economics
 
Islamic Banker Asia - Shariah Compliance and Audit - February 2015
Islamic Banker Asia - Shariah Compliance and Audit - February 2015Islamic Banker Asia - Shariah Compliance and Audit - February 2015
Islamic Banker Asia - Shariah Compliance and Audit - February 2015
Mujtaba Khalid
 
Islamic finance
Islamic financeIslamic finance
Islamic finance
AsadullahQais2
 
Foreign equity investment
Foreign equity investmentForeign equity investment
Foreign equity investment
Muhammad Zeeshan Baloch
 
Global Business Issue_Islamic Finance_Article critique
Global Business Issue_Islamic Finance_Article critiqueGlobal Business Issue_Islamic Finance_Article critique
Global Business Issue_Islamic Finance_Article critique
Wafeeqa Wafiq
 
A Comparative Literature Survey Of Islamic Finance And Banking
A Comparative Literature Survey Of Islamic Finance And BankingA Comparative Literature Survey Of Islamic Finance And Banking
A Comparative Literature Survey Of Islamic Finance And Banking
Scott Donald
 
Financial reforms in response to the global financial crisis
Financial reforms in response to the global financial crisisFinancial reforms in response to the global financial crisis
Financial reforms in response to the global financial crisis
mimie1234
 
Law and Regulations for Private and Retail Banking (Asia-Pacific, Hong Kong),...
Law and Regulations for Private and Retail Banking (Asia-Pacific, Hong Kong),...Law and Regulations for Private and Retail Banking (Asia-Pacific, Hong Kong),...
Law and Regulations for Private and Retail Banking (Asia-Pacific, Hong Kong),...
Raul A. Lujan Anaya
 
Global Fin Crisis Islamic Perspective.pdf
Global Fin Crisis Islamic Perspective.pdfGlobal Fin Crisis Islamic Perspective.pdf
Global Fin Crisis Islamic Perspective.pdf
mar yame
 
Advantages of Islamic Banking and Finance | AIMS, UK
Advantages of Islamic Banking and Finance | AIMS, UKAdvantages of Islamic Banking and Finance | AIMS, UK
Advantages of Islamic Banking and Finance | AIMS, UK
Academy for International Modern Studies (AIMS)
 
islamic banking
islamic bankingislamic banking
islamic banking
Prabhat Mani Tripathi
 
CHAPTER 2 - Legal and Regulatory Framework.pptx
CHAPTER 2 - Legal and Regulatory Framework.pptxCHAPTER 2 - Legal and Regulatory Framework.pptx
CHAPTER 2 - Legal and Regulatory Framework.pptx
Mohd Adib Abd Muin, Senior Lecturer at Universiti Utara Malaysia
 
Iqbal Khan Presentation20070201
Iqbal Khan Presentation20070201Iqbal Khan Presentation20070201
Iqbal Khan Presentation20070201
ISEConsult
 
Adoption of Islamic Finance in India
Adoption of Islamic Finance in IndiaAdoption of Islamic Finance in India
Adoption of Islamic Finance in India
Arjun Udayashankar
 
Islamic FINANCE AND BANKING SYSTEM Philosophies, Principles & Practices.pdf
Islamic FINANCE AND BANKING SYSTEM Philosophies, Principles & Practices.pdfIslamic FINANCE AND BANKING SYSTEM Philosophies, Principles & Practices.pdf
Islamic FINANCE AND BANKING SYSTEM Philosophies, Principles & Practices.pdf
ccccccccdddddd
 
Growth of economy thorough islamic banking
Growth of economy thorough islamic banking Growth of economy thorough islamic banking
Growth of economy thorough islamic banking
Hamail A Ahmed
 
Global Trends in Regulation
Global Trends in RegulationGlobal Trends in Regulation
Global Trends in Regulation
NICSA
 
McGregor Boyall - Compliance & Financial Crime Market Update
McGregor Boyall - Compliance & Financial Crime Market UpdateMcGregor Boyall - Compliance & Financial Crime Market Update
McGregor Boyall - Compliance & Financial Crime Market Update
Amreet Rai
 
Islamic Finance : Research Directions for Young Researchers
Islamic Finance : Research Directions for Young ResearchersIslamic Finance : Research Directions for Young Researchers
Islamic Finance : Research Directions for Young Researchers
Mahmoud Sami Nabi
 
Islamic Asset Management A new Iceberg
Islamic Asset Management A new IcebergIslamic Asset Management A new Iceberg
Islamic Asset Management A new Iceberg
drishtipuro1234
 

Similar to IFN Corporate Governance and Risk Management Report - 28 July 2014 (20)

Challenges of islamic banking by prof haqiqi
Challenges of islamic banking by prof haqiqiChallenges of islamic banking by prof haqiqi
Challenges of islamic banking by prof haqiqi
 
Islamic Banker Asia - Shariah Compliance and Audit - February 2015
Islamic Banker Asia - Shariah Compliance and Audit - February 2015Islamic Banker Asia - Shariah Compliance and Audit - February 2015
Islamic Banker Asia - Shariah Compliance and Audit - February 2015
 
Islamic finance
Islamic financeIslamic finance
Islamic finance
 
Foreign equity investment
Foreign equity investmentForeign equity investment
Foreign equity investment
 
Global Business Issue_Islamic Finance_Article critique
Global Business Issue_Islamic Finance_Article critiqueGlobal Business Issue_Islamic Finance_Article critique
Global Business Issue_Islamic Finance_Article critique
 
A Comparative Literature Survey Of Islamic Finance And Banking
A Comparative Literature Survey Of Islamic Finance And BankingA Comparative Literature Survey Of Islamic Finance And Banking
A Comparative Literature Survey Of Islamic Finance And Banking
 
Financial reforms in response to the global financial crisis
Financial reforms in response to the global financial crisisFinancial reforms in response to the global financial crisis
Financial reforms in response to the global financial crisis
 
Law and Regulations for Private and Retail Banking (Asia-Pacific, Hong Kong),...
Law and Regulations for Private and Retail Banking (Asia-Pacific, Hong Kong),...Law and Regulations for Private and Retail Banking (Asia-Pacific, Hong Kong),...
Law and Regulations for Private and Retail Banking (Asia-Pacific, Hong Kong),...
 
Global Fin Crisis Islamic Perspective.pdf
Global Fin Crisis Islamic Perspective.pdfGlobal Fin Crisis Islamic Perspective.pdf
Global Fin Crisis Islamic Perspective.pdf
 
Advantages of Islamic Banking and Finance | AIMS, UK
Advantages of Islamic Banking and Finance | AIMS, UKAdvantages of Islamic Banking and Finance | AIMS, UK
Advantages of Islamic Banking and Finance | AIMS, UK
 
islamic banking
islamic bankingislamic banking
islamic banking
 
CHAPTER 2 - Legal and Regulatory Framework.pptx
CHAPTER 2 - Legal and Regulatory Framework.pptxCHAPTER 2 - Legal and Regulatory Framework.pptx
CHAPTER 2 - Legal and Regulatory Framework.pptx
 
Iqbal Khan Presentation20070201
Iqbal Khan Presentation20070201Iqbal Khan Presentation20070201
Iqbal Khan Presentation20070201
 
Adoption of Islamic Finance in India
Adoption of Islamic Finance in IndiaAdoption of Islamic Finance in India
Adoption of Islamic Finance in India
 
Islamic FINANCE AND BANKING SYSTEM Philosophies, Principles & Practices.pdf
Islamic FINANCE AND BANKING SYSTEM Philosophies, Principles & Practices.pdfIslamic FINANCE AND BANKING SYSTEM Philosophies, Principles & Practices.pdf
Islamic FINANCE AND BANKING SYSTEM Philosophies, Principles & Practices.pdf
 
Growth of economy thorough islamic banking
Growth of economy thorough islamic banking Growth of economy thorough islamic banking
Growth of economy thorough islamic banking
 
Global Trends in Regulation
Global Trends in RegulationGlobal Trends in Regulation
Global Trends in Regulation
 
McGregor Boyall - Compliance & Financial Crime Market Update
McGregor Boyall - Compliance & Financial Crime Market UpdateMcGregor Boyall - Compliance & Financial Crime Market Update
McGregor Boyall - Compliance & Financial Crime Market Update
 
Islamic Finance : Research Directions for Young Researchers
Islamic Finance : Research Directions for Young ResearchersIslamic Finance : Research Directions for Young Researchers
Islamic Finance : Research Directions for Young Researchers
 
Islamic Asset Management A new Iceberg
Islamic Asset Management A new IcebergIslamic Asset Management A new Iceberg
Islamic Asset Management A new Iceberg
 

More from Mujtaba Khalid

Leveraging Shariah Compliance and Technology
Leveraging Shariah Compliance and TechnologyLeveraging Shariah Compliance and Technology
Leveraging Shariah Compliance and Technology
Mujtaba Khalid
 
IF Education Landscape IFN 2017 Report
IF Education Landscape IFN 2017 ReportIF Education Landscape IFN 2017 Report
IF Education Landscape IFN 2017 Report
Mujtaba Khalid
 
Crisis Management - An Islamic Perspective
Crisis Management - An Islamic PerspectiveCrisis Management - An Islamic Perspective
Crisis Management - An Islamic Perspective
Mujtaba Khalid
 
IFN Beyond Halal - 16 Dec 2015
IFN Beyond Halal - 16 Dec 2015IFN Beyond Halal - 16 Dec 2015
IFN Beyond Halal - 16 Dec 2015
Mujtaba Khalid
 
Islamic Finance Review - GFIF 2015
Islamic Finance Review - GFIF 2015Islamic Finance Review - GFIF 2015
Islamic Finance Review - GFIF 2015
Mujtaba Khalid
 
Waqf an sri insturment - final
Waqf   an sri insturment - finalWaqf   an sri insturment - final
Waqf an sri insturment - final
Mujtaba Khalid
 
Mujtaba Khalid - Treatment of Operational Risk by IFIs
Mujtaba Khalid - Treatment of Operational Risk by IFIsMujtaba Khalid - Treatment of Operational Risk by IFIs
Mujtaba Khalid - Treatment of Operational Risk by IFIs
Mujtaba Khalid
 
Islamic Structured Products by Mujtaba Khalid
Islamic Structured Products by Mujtaba KhalidIslamic Structured Products by Mujtaba Khalid
Islamic Structured Products by Mujtaba Khalid
Mujtaba Khalid
 
IFN New Rating Methodology Special Report - 11th June 2014
IFN New Rating Methodology Special Report -  11th June 2014IFN New Rating Methodology Special Report -  11th June 2014
IFN New Rating Methodology Special Report - 11th June 2014
Mujtaba Khalid
 
ISFIRE Risk Management for IFIs - Nov 2014
ISFIRE Risk Management  for IFIs - Nov 2014ISFIRE Risk Management  for IFIs - Nov 2014
ISFIRE Risk Management for IFIs - Nov 2014
Mujtaba Khalid
 
IFN Takaful M&A Challenges - 13 August 2014
IFN Takaful M&A Challenges - 13 August 2014IFN Takaful M&A Challenges - 13 August 2014
IFN Takaful M&A Challenges - 13 August 2014
Mujtaba Khalid
 
IFN SIB Cover Story - 14 May 2014
IFN SIB Cover Story - 14 May 2014IFN SIB Cover Story - 14 May 2014
IFN SIB Cover Story - 14 May 2014
Mujtaba Khalid
 

More from Mujtaba Khalid (12)

Leveraging Shariah Compliance and Technology
Leveraging Shariah Compliance and TechnologyLeveraging Shariah Compliance and Technology
Leveraging Shariah Compliance and Technology
 
IF Education Landscape IFN 2017 Report
IF Education Landscape IFN 2017 ReportIF Education Landscape IFN 2017 Report
IF Education Landscape IFN 2017 Report
 
Crisis Management - An Islamic Perspective
Crisis Management - An Islamic PerspectiveCrisis Management - An Islamic Perspective
Crisis Management - An Islamic Perspective
 
IFN Beyond Halal - 16 Dec 2015
IFN Beyond Halal - 16 Dec 2015IFN Beyond Halal - 16 Dec 2015
IFN Beyond Halal - 16 Dec 2015
 
Islamic Finance Review - GFIF 2015
Islamic Finance Review - GFIF 2015Islamic Finance Review - GFIF 2015
Islamic Finance Review - GFIF 2015
 
Waqf an sri insturment - final
Waqf   an sri insturment - finalWaqf   an sri insturment - final
Waqf an sri insturment - final
 
Mujtaba Khalid - Treatment of Operational Risk by IFIs
Mujtaba Khalid - Treatment of Operational Risk by IFIsMujtaba Khalid - Treatment of Operational Risk by IFIs
Mujtaba Khalid - Treatment of Operational Risk by IFIs
 
Islamic Structured Products by Mujtaba Khalid
Islamic Structured Products by Mujtaba KhalidIslamic Structured Products by Mujtaba Khalid
Islamic Structured Products by Mujtaba Khalid
 
IFN New Rating Methodology Special Report - 11th June 2014
IFN New Rating Methodology Special Report -  11th June 2014IFN New Rating Methodology Special Report -  11th June 2014
IFN New Rating Methodology Special Report - 11th June 2014
 
ISFIRE Risk Management for IFIs - Nov 2014
ISFIRE Risk Management  for IFIs - Nov 2014ISFIRE Risk Management  for IFIs - Nov 2014
ISFIRE Risk Management for IFIs - Nov 2014
 
IFN Takaful M&A Challenges - 13 August 2014
IFN Takaful M&A Challenges - 13 August 2014IFN Takaful M&A Challenges - 13 August 2014
IFN Takaful M&A Challenges - 13 August 2014
 
IFN SIB Cover Story - 14 May 2014
IFN SIB Cover Story - 14 May 2014IFN SIB Cover Story - 14 May 2014
IFN SIB Cover Story - 14 May 2014
 

IFN Corporate Governance and Risk Management Report - 28 July 2014

  • 1. 23© 28th July 2014 SECTOR FEATURE The future of Islamic finance in the global economy looks bright with 10 of the world’s 25 fastest growing markets in Muslim majority countries. According to EY, Islamic banking assets with commercial banks globally crossed US$1.7 trillion in 2013 suggesting an annual growth of 17.6% over the last four years. Despite this growth, leading Islamic banks posted 19% lower return on equity (ROE) compared to their conventional peers. This would suggest that there is a dire need of a policy re-think and governance restructure by the Islamic finance industry as a whole. This is most evident in countries having aspirations to become Islamic financial centers but lack central bank directives and regulations, for example the UK. There are abundant opportunities for Islamic finance to flourish in the UK — the Muslim population is growing faster than any other religious group. Muslims have started to actively integrate themselves in British society: in politics, from parliament to local government, in the armed forces, policing, the professions, the arts and sports, and of course in business. Muslims constitute one of the youngest demographics in the UK and the younger generation is more religion conscious than their predecessors wanting for example Shariah compliant house financing options. The UK government has been pushing to be an Islamic financial hub having set-up a ministerial-led Islamic Finance Task Force, jointly chaired by Baroness Warsi and the financial secretary to the Treasury. The recent issuance of a GBP200 million (US$341.36 million) sovereign Sukuk with a GBP2 billion (US$3.41 billion) oversubscription also points to this. In the past, the UK especially London has seen considerable Islamic capital market activity with more than US$38 billion being raised through 54 Islamic Sukuk issues. Major developments and landmark projects in London such as The Shard, Chelsea Barracks, Harrods, Battersea Power Station and the Olympic Village have in whole or in part used Islamic financing. Given all the aspects mentioned, Islamic retail banking is yet to take off in the UK given its potential. This is where the policy re-think and governance framework restructuring mentioned above needs to take place globally especially in the UK. There are three facets that need to be redressed — disclosure, risk management and consumer relations. Disclosure One of the key concerns is insufficient disclosure of Shariah governance in Islamic financial institutions annual reports. Issues such as conflict of interest of Shariah board members within an Islamic financial institution and with other Islamic financial institutions among other issues are largely ignored. As shown in the table below, inconsistency between jurisdictions aside, there appears to be insufficient disclosure of Islamic financial institutions’ Shariah governance and other key disclosures in annual reports. Islamic financial institutions should set additional requirements for disclosures in their annual reports relating to income purification and disbursement to charities, due to the inherent sensitivities associated with these funds. Additional disclosures can include: • Value of impermissible income and late payment fees relating to the period, including any contingent amounts. • Purification amounts that have been disbursed during the period with explanations for any non-disbursed amounts. • Reporting on the nature of the charities supported and their social impact. • Disclosure of fees paid to Shariah supervisory board (SSB) members within the institution’s annual reports (split by audit and non-audit), similar to disclosures of fees paid to external auditors. • Related party transactions where Islamic financial institutions have close connections with any of the receiving charitable organizations. • Disclosure by all personnel involved in the audit (SSB, ISCU members, Corporate governance in the UK Islamic inance industry Despite anchoring itself in the Islamic finance space, the UK has yet to see its Shariah compliant retail banking sector take off, prompting for a policy re-think and governance framework restructuring. MUJTABA KHALID analyzes the current structures in place. continued... Bank Shariah regulation Comprehensive Shariah advisor’s report Related party transactions Statement of Purification of Income Shariah Board Remuneration Zakat Meezan Bank — Pakistan Islamic Banking Department guidelines — SBP Yes Yes Yes Yes Bank Islam — Malaysia BNM guidelines No No Yes Yes Bank Melli — Iran Central Bank of Iran banking regulations No No No Yes Al Rajhi Bank — Saudi Arabia Central bank regulations (not stringent) No No No Yes Islamic Bank of Britain — UK No central regulation No No No No
  • 2. 24© 28th July 2014 SECTOR FEATURE etc.) of any interests such as shareholdings, a relative/related party working in a senior role in the institution, commercial relationships as a customer or supplier (either with the individual or with a related/ linked company of which the SSB or any relative may be a director), etc. Risk management The challenge going forward is for Islamic banks to establish a cultural mindset and operating framework that embed balance sheet risk — something beyond the regulatory requirements set out under Basel III. The distinct contractual relationship of an Islamic financial institution’s balance sheet are illustrated in the following diagram: Return on assets Investment returns Assets Liabilities Inventory Real estates/ Automobiles Current/Demand deposits Wadiah /Qard Asset-backed transactions Murabahah/Ijarah/ Istisnah/ Salam Unrestricted investment accounts Mudarabah Restricted investment accounts Mudarabah Profit Sharing Transactions Mudarabah/ Musharakah Reserves Fee-based services Ujr Equity As regulations become more stringent and the market becomes saturated, banks need to enforce an inclusive risk management ensuring effective teamwork. Diagram 1 gives a brief illustration of what might be needed for Islamic banks to be more effective. An important risk faced by Islamic financial institutions is non-compliance risk, which in-turn can lead to reputational risk. As more complex deals are being executed and more complicated products being developed, if any institution, inside or outside the Islamic financial institution, deserves scrutiny, it is the Shariah scholars. Therefore, apart from a Shariah audit to check compliance with the Shariah governance frameworks provided by the Shariah board, I propose a Fatwa audit. This would be an independent audit carried out to determine what Ijtihad was used by the Shariah scholar or board in deeming a deal, product or transaction as Shariah compliant. This can be a revolutionary step in tackling the creeping cynicism about Islamic finance among Muslims. Being suitably qualified requires both a minimum level of knowledge and skill as an entry criterion, and also the need to have ongoing training. Shariah scholars working as advisors to an institution need also to consider the risks of litigation over the advice they provide as increasing litigation activity related to Islamic finance is being seen in courts. Initiatives in the Islamic finance industry specifically addressing the issue of competence include “fit and proper” criteria set by industry regulators and the Islamic Finance Council UK’s Scholar Professional Development Program developed exclusively for Shariah scholars and those associated with the Shariah assurance process. Consumer relations One aspect that is lagging especially in Islamic banks based in the UK is effective consumer relations policy. Aspects such as anticipating a change in consumer needs and how they will defer in the next five years, how to respond to such changes and how to target new consumer groups. Commercial transactions include an element of trust. Research shows that the quality of customer-facing employees and the ease of doing day- to-day business are the most important elements in building or reinforcing trust. Islamic financial institutions should create service excellence on top of operational excellence. This requires proactive relationship management: maintaining a dialogue with customers, creating awareness about Islamic finance among consumer groups through conferences and education programs, acting in their best interests and coming up with solutions for personal financial situations. Islamic banks in the UK should also bear in mind that, as mentioned above, most of the Muslim demographic is young and their consumer base would mostly consist of Gen-Y individuals. These individuals tend to be higher educated and critical; they often have above average incomes and are extensive users of technology. Therefore effective use of technology in terms of products which are not only easy to understand but also reduce effort and the use of social media for marketing campaigns should be employed effectively. Mujtaba Khalid is a senior associate at the UKIFC. He can be contacted at mkhalid@ ukifc.com. Continued Strategy