Islamic Banking & Finance Page 20-04-2019

Regulators are required to come up with fair Conduct of Takaful Business

The conduct of business of providers and intermediaries of insurance products (including takāful) in relation to consumers is a matter of widespread regulatory attention.

The literature shows that a number of characteristics of retail insurance products can create conditions for providers or intermediaries to take advantage of consumers, potentially undermining consumer confidence in the sector. Issues and practices with this potential include asymmetry of information, product quality, price, distribution and promotion practices and some specific features of takāful products.

Information asymmetry is a recognized issue in the field of insurance. The product typically has many conditions and features, setting out for example the levels of cover, exclusions, optional extras, and the duties of the policyholder. In the case of takāful, the contract has further complexities compared to conventional insurance products, for example in the remuneration structure for the operator. Consumers typically lack the ability to assess a financial services contract, or to negotiate its terms to their advantage. This inequality between the provider and the consumer serves as a significant justification for regulation.

In addition to access to information and ability to interpret it, providers may also, in the absence of regulation, be able to control how information is framed and presented to the consumers by varying the explanation or the relative prominence of product features, and so influence consumer decisions contrary to the consumer’s own requirements.

Much consumer takāful is sold through intermediaries rather than directly. The activities of intermediaries can range from promoting takāful awareness to identifying the suitability of products for consumers’ needs, and delivering takāful products. Consumer protection concerns may arise from distribution practices that promote adverse consumer outcomes, perhaps due to conflicting incentives or failure to exercise due skill. The traditional basis of remunerating intermediaries on a commission basis may work against fairness to consumers, particularly where the seller has a significant advisory role to play in the consumer’s choice of product. Regulation can set minimum standards for objectivity and quality of advice, or prohibit particular incentive structures.

Promotional activities conducted by providers or intermediaries may affect consumers’ perceptions of products and influence their behavior. Misleading advertising or product brochures can impair the consumer’s ability to make an informed decision. Advertising and other promotional materials should therefore be fair, clear and not misleading. In takāful, further issues may arise. For example, using surplus distribution as a selling point in general takāful raises the risk of creating unrealistic expectations as to future financial performance.

Evolving business models and the use in takāful of emerging technologies can create additional opportunities for consumer detriment to occur, and require regulatory consideration. Growth in digital services is changing customer expectations, preferences and the intermediary interactions with customers. These developments can challenge the adequacy and effectiveness of traditional regulatory and supervisory frameworks in respect of conduct of business.

Consumer confidence is essential for the sound development of the personal lines takāful sector. To maintain this confidence, regulators in all jurisdictions (SECP in case of Pakistan) should pay attention, though in different ways and with different levels of intervention, to matters such as the comprehensibility of products, the actions taken by operators and intermediaries to assess suitability, the impact on consumers of practices in pricing and contract terms, disclosures, the fairness of complaints and claims handling and the appropriateness of marketing materials. Approaches range from the principles-based, whereby rules are set within which operators and intermediaries must operate, and emphasis is placed on governance, with compliance verified by the supervisor, to interventionist approaches where some or all of contract terms, prices and marketing materials are prescribed or subject to regulatory pre-approval or filing. In practice, the literature suggests that supervisors adopt a mix of principles-based and prescriptive elements.

Growth of Islamic Banking in Bangladesh- Case example for Pakistan

Bangladesh is one of the largest Muslim countries in the world where masses are committed to live their economic lives in accordance with the principles of Islam. With this in perspective, in August 1974, Bangladesh signed the charter of Islamic Development Bank and committed itself to reorganize its economy and financial system according to Islamic Shariah. Bangladesh’s economy has grown around 6% per year since 2005. Although more than half of the GDP is generated through the services sector, almost half of Bangladeshis are employed in the agriculture sector, with rice as the single most important product. Garments being the backbone of Bangladesh’s industrial sector accounts for a significant share of total exports.

Islamic banking was first introduced in Bangladesh in 1983 by foreign investors from Saudi Arabia and Kuwait. With a workforce of more than 32,000 people, Islamic banking covers a significant market share of the entire banking sector in terms of deposits and investments. After the 1990s, the Islamic banking sector gained further momentum and now it accounts for more than a one-fifth share of the entire banking system. As of June 30, 2018, eight full-fledged Islamic banks are operating with 1,178 branches: Total deposits in the Islamic banking industry reached BDT 2.25 trillion (US$ 26.44 billion). The share of total deposits of Islamic banks in overall banking accounted for 23.21% during the period. Total investments in the Islamic banking sector stood at BDT 2.17 trillion (US$ 25.5 billion), representing 23.93% of the total banking industry in Bangladesh.

Regulatory Environment Bangladesh does not have a dedicated Islamic finance and banking regulation but the nation has an impressive growth story. Driven mainly by the private sector, domestic players have adapted to the conventional regime (Banking Companies Act and Companies Act), which has marginal Shariah adjustments. The central bank, Bangladesh Bank (BB), has in recent years taken measures to consolidate and develop the sector by creating a more conducive environment for banks: it issued Islamic banking guidelines in 2009, which covers licensing and conversion requirements as well as financial reporting and investment. Despite a relatively developed market, industry players are still calling for a comprehensive Islamic banking legislation, especially in the areas of debt capital markets, which analysts opine could be a big opportunity for Bangladesh if tapped. Capital market activities and insurance, Islamic and conventional, are governed by the Securities and Exchange Commission and Insurance Development & Regulatory Authority Bangladesh, respectively.

There are 11 takaful operators (eight life and three non-life) in the country, out of 77 insurance firms. Over a dozen conventional insurers offer takaful products on a window basis. As of 2017, the volume of takaful assets stand at approximately more than US$1 billion which is nearly 20% of the insurance industry, according to IFN Annual Guide 2018.

Bangladesh’s microfinance sector comprises of four Islamic banks, 20 small Islamic microfinance institutions and an Islamic microfinance program of a conventional microfinance institution. Islamic microfinance is another segment of high potential for Bangladesh, which was one of the earliest adopters of Shariah microfinance (considering it is the home of Grameen Bank, which introduced the concept of microcredit in 1976). Approximately 12.9% of Bangladesh’s population lived below the national poverty line in 2016, according to the World Bank, a dramatic drop from 31.5% in 2010. The alleviation of poverty has largely been credited to the growth of micro and SME financing which falls under the purview of the Microcredit Regulatory Authority (MRA). The two-year project to expand financial inclusion in the South Asian nation through Islamic microfinance, launched in September 2014 by Islamic Relief Bangladesh (IRB), is still ongoing. The IRB intends to create a favorable environment for Shariah microfinance as well as register an Islamic microfinance institution with the MRA to directly serve 10,800 low-income entrepreneurs by the end of 2019.

Bangladesh has experienced extraordinary growth in Islamic banking following strong public demand for the system. Since its inception, the Islamic banking industry has recorded a strong performance and the industry now accounts for more than a 20% market share of the entire banking industry in Bangladesh. The Islamic banking industry in Bangladesh has contributed greatly in spurring economic growth and generating employment in the country. (Source SBP publications)

A glance over 4 full fledged Islamic Banks in Pakistan as of Dec 2018

In Pakistan total Islamic business as of Dec 2018 reflect Rs 2,658 as compared to Rs 2,458 billion in Dec 2017, Deposits as of Dec 2018 reflect Rs 2,203 billion as of Rs 1,885 billion in Dec 2017, Financing as of Dec 2018 reflect Rs 1,511 billion as compared to Rs1, 365 billion as of Dec 2017, Total branches as of Dec 2018 show numbers as 2851 as compared to 2581 in Dec 2017. Profit before taxation reflects as of Dec 2018 Rs 34 billion as compared to Rs 23 billion in Dec 2017. These 4 banks almost reflect almost 50% business as compared to two other full fledged Islamic banks and other 16 conventional banks having Islamic banking windows. Overall the picture is like Pakistan’s economy with lot of ifs and buts. This is due to the fact that Islamic banking business has not been exactly modeled on true Islamic principles incorporating due changes required for financial institution working in 21^st century. SBP has drastically failed in bringing them in line with Islamic principles in the current economic conditions.