Islamic Financial Services Board’s (IFSB) Strategic Performance Plan (SPP) for 2019-2021
The Islamic Financial Services Board (IFSB) is an international standard-setting organization that promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry, broadly defined to include banking, capital markets and insurance sectors.
Now Strategic Performance Plan (SPP) 2019-2021 formulated by IFSB aims to continue the enhancement of the IFSB’s standards development agenda and strengthen its initiatives to encourage the implementation of the IFSB Standards in member jurisdictions.
The SPP 2019-2021 comprises four Strategic Key Result Areas (SKRAs) as follows:
SKRA 1: Formulation and Issuance of Prudential Standards, Research and Statistics;
SKRA 2: Facilitating the Implementation of Prudential Standards and Capacity Development;
SKRA 3: Increasing Value in the IFSB Membership, Global Visibility and Attractiveness;
SKRA 4: Efficient Management of Resources.
SKRA 1 is related to the IFSB’s key mandate of Standards Development that focuses on increasing the efficiency to deliver timely and relevant standards, as well as addressing the expertise gap on a long-term basis.
SKRA 2 on the IFSB Standards Implementation and Adoption, looks the IFSB’s initiatives in comparison with other standard-setters, and proposes strategies to align the work of the IFSB with its comparators. With implementation being very high on the IFSB Council and member’s expectations, the SPP 2019-2021 envisages a bigger role for the IFSB RSA members. International Monetary Fund’s (IMF) recognition, in May 2018, of the IFSB’s Core Principles for Islamic Finance Regulation (CPIFR) for Banking in its surveillance program, is also expected to encourage and drive the implementation of the IFSB Standards in member jurisdictions in the coming years.
SKRA 3 focuses on Membership Satisfaction and the IFSB Attractiveness. The SKRA emphasizes collaboration and strategic partnerships to increase the visibility of the IFSB globally, and includes joint cooperation for events and publications, as well as proposes enhancements in communications, in both its form (use of technology and expanding means of communications) as well as the substance (content and key messages to be communicated).
SKRA 4 focuses enhancing the IFSB’s overall productivity and efficiency, through the effective management of human resources, pursuing financial sustainability and enhancing internal controls and governance.
The SKRAs are KPI’s based, and reflected in 12 Outcomes and 27 Outputs, which operationalize the organization’s strategic objectives as stated in the IFSB’s Articles of Agreement. They also embody the IFSB’s Core Values of Accountability, Collaboration, Responsiveness and Integrity.
Consumer Protection Strategies For Islamic Banking and Finance
The Global Financial Crisis (GFC) (2008-12) had laid bare questionable practices of misspelling of financial products and unfair treatments of customers by banks and financial advisers. Financial consumer protection gained prominence on the political agendas of governments and international standard-setters such as the Basel Committee on Banking Supervision, International Organization of Securities Commissions and International Association of Insurance Supervisors.
The issue was taken up by the Organization for Economic Co-operation and Development and the Group of Twenty (G20), which issued in 2011 the G20 High-level Principles on Financial Consumer Protection. The most important principles are transparency, impartiality and reliability. The G20 document is not binding, but it signals the consensus of the governments of the financially most advanced jurisdictions. This will become the benchmark for financial consumer protection in other parts of the world, including Muslim countries.
Neoclassical economic models of financial markets assumed well-informed and rational market players, but the persistence of widespread questionable practices made it obvious that retail investors and clients of financial advisers did not match the ideal. The combination of economics with psychology in behavioral economics was able to explain the actual behavior of consumers of financial services. Any regulation of financial retail markets has to take into consideration consumers’ limited skills and capabilities in the processing of information, as well as a host of deep-seated cognitive biases.
Most of these deficits could be overcome only in the long run (if at all); consumer protection cannot be confined to transparency and disclosure regulations (for better-informed consumer choices) only. To some degree, consumers have to be supported by the pre-processing of information (to facilitate easy comparisons of different offers) or impartial financial consumer advice.
The regulator (SBP and SECP in our case) may furthermore define requirements for basic financial products (taking example of simple Financial Products in the United Kingdom), which are structured such that consumers will not be cheated and normally get a reasonable deal. Products that meet the criteria set by the regulator can be marketed under a special label, which should signify to consumers their special quality. A stricter form of product regulation is mandatory minimum standards applicable to all products of a particular class. The most interventionist forms of product regulations are restriction of distribution channels (thus keeping specific products out of reach for “ordinary” retail clients) and the total ban of particular products (with destabilizing potentials such as short selling or credit default swaps) from the retail market.
Product regulations may protect consumers against products considered too “dangerous” (which could cause capital losses), but they do not ensure that consumers get the products most suitable for them. This is the prime objective of conduct regulations, which, ideally, shall synchronize the interests of service providers with those of the customers. A precondition is the proper determination of the financial needs and capabilities of customers. Conduct regulations were already in force in many jurisdictions long before the GFC, but they were seemingly not sufficient to prevent widespread mis-selling of products that primarily served the interest of the service provider and not that of the customers.
To give existing need assessment regulations more vigor, legal liability for the advice of financial service providers could be established. Such liability would give customers the right to proceed against banks and advisers if they felt they had been sold an inappropriate product or given inappropriate advice. It is in the interest of the bank or adviser to avoid costly lawsuits and therefore to provide appropriate services in the first instance. Regulators can even take more radical measures to synchronize the interests of service providers and customers, such as by changing the remuneration structure for advisers through the prohibition of commissions. Advisers then earn their income exclusively from fees charged explicitly to their clients, instead of from commissions paid by the producers of the products sold.
Should all these regulations fail and consumers are still not satisfied with the financial services they have received, regulators could enact fair treatment rules by mandating internal procedures for complaint handling. In cases where no internal settlement is reached, external dispute resolution schemes (e.g. Ombudsman systems) can be installed. Finally, regulators and legislators can improve consumers’ access to the court system and strengthen their position by allowing class actions.
Challenges for regulators are recent developments in unregulated capital markets and new forms of financial intermediation – for example, for community projects or through crowd funding platforms. The special features of these segments of the financial markets (e.g. the relatively small volumes and the particular profiles or motivations of the parties involved) have justified both exemptions from general regulations and specific requirements to limit the risk exposure of retail investors.
All measures for financial consumer protection in the conventional system are also applicable in Islamic finance with minor adjustments. But there is one additional dimension which regulators of Islamic finance have to consider – namely, the claim of Sharīʿah compliance as an essential and distinguishing product feature.
The objective of consumer protection requires that the regulator takes adequate measures to ensure that this claim is sufficiently justified. However, regulators face the problem that there are different views on the Sharīʿah compliance of products: while basic consumer products have been more-or-less standardized (in particular, by Accounting and Auditing Organization for Islamic Financial Institutions [AAOIFI] Sharīʿah standards), opinions on more complex consumer products diverge.
Some jurisdictions have established Sharīʿah committees or boards at the supervisory level with the authority to decide on the applicable Sharīʿah view. Other jurisdictions do not have such institutions, and the regulators do not want to take an own stance in Sharīʿah debates. That shifts the “burden of proof” to the financial institutions. The most effective instrument for ensuring Sharīʿah compliance in these jurisdictions is the implementation of a robust Sharīʿah governance system within the financial institutions.
However, even an elaborate Sharīʿah governance system does not guarantee identical Sharīʿah interpretations by all financial institutions, or ensure that interpretations are consumer friendly. There are two outstanding examples of financial products whose Sharīʿah compliance or fairness to customers can be challenged.
The first example of a debatable practice is the smoothing of profit payouts for unrestricted profit-sharing investment accounts (UPSIA). This practice is widespread and legally permissible in most jurisdictions, but it nevertheless has incurred substantial criticism from a Sharīʿah perspective as it converts Muḍārabah-based accounts into close substitutes of conventional interest-bearing deposits.
Malaysia is the only jurisdiction to have taken a decisive step and prohibited profit smoothing for UPSIA. Jurisdictions that do not follow Malaysia’s example should, in the interests of consumer protection, make better explanations and a detailed disclosure of their smoothing practices mandatory. Given that Muḍārabah contracts are pooling resources among risk-sharing partners, disclosure requirements could be structured in analogy to collective investment schemes, for which the IFSB has issued the Guiding Principles on Governance for Islamic Collective Investment Schemes (IFSB-7).
The second example is based on experiences during the financial crisis. The strict adherence to the letters of Islamic contracts such as debt-creating Murābaḥah sale contracts may lead to hardships for consumers and put them in a position that is considered unfair and worse than in a conventional setting. The rule which must be remembered and fully complied with is that murabahah transaction cannot be rolled over for a further period. In an interest-based financing, if a customer of the bank cannot pay at the due date for any reason, he may request the bank to extend the facility for another term. If the bank agrees, the facility is rolled over on the terms and conditions mutually agreed at that point of time, whereby the newly agreed rate of interest is applied to the new term. It actually means that another loan of the same amount is re-advanced to the borrower.
Some Islamic banks or financial institutions, who misunderstood the concept of murabahah and took it as merely a mode of financing analogous to an interest-based loan, started using the concept of roll-over to murabahah also. If the client requests them to extend the maturity date of murabahah, they roll it over and extend the period of payment on an additional mark-up charged from the client which practically means that another separate murabahah is booked on the same commodity. This practice is totally against the well-settled principles of Shariah.
Lessons from Islamic Banking and Finance in Malaysia
A banking expert has defended the Malaysian practice of Islamic banking and financing (IBF) against critics who say it does not adhere to proper shariah procedures. Zulkarnain Muhamad Sori, a professor and deputy director at the International Centre for Education in Islamic Finance, argues that IBF in Malaysia is on track to full compliance. Speaking to FMT after a panel discussion at the World Bank Conference for Corporate Governance of Islamic Financial Institutions, he said the belief that Islamic banking is not really Islamic was probably rooted in false public perception.
“The shariah banking industry is improving,” he said. “There is no issue of non-compliance with the shariah.” He claimed that the detractors were in the minority. “That’s why our growth rate is almost 20% and the assets owned by Islamic banks are growing from year to year,” he said. “Of course, during the first few years or the first decade of IBF implementation, we made mistakes. We overlooked certain things. But we kept improving over time. It is a process. “We have a shariah advisory council at Bank Negara Malaysia (BNM), which regulates everything, and BNM is a very responsible regulator.”
He said regulation wasn’t easy because of the presence in Malaysia of all four Sunni schools of jurisprudence. Despite this, he added, IBF in Malaysia was on the right track although constant improvements were still necessary. He spoke of the Bai’ al-‘Innah, one of the methods used for personal financing. It has always been perceived as a close substitute of interest-based conventional loan, which is not permissible under shariah law because it is considered usurious. He said BNM had considered the feedback on the method and come up with newer products. “That shows how serious BNM is in ensuring everything is shariah compliant.”
Ahamed Kameel Mydin Meera, a former dean of the Institute of Islamic Finance at the International Islamic University Malaysia, had a different view. He acknowledged that IBF in Malaysia had seen some progress but said it had a long way to go to be fully shariah compliant. He spoke of IBF as the solution to the economic problems brought about by conventional banking, but not in the way it is practiced today. According to him, one of the problems with contemporary Islamic banking in Malaysia is that it is one of the money creators in the system. “When you create money out of nothing, you’re creating inflation.” He said IBF, in its truest form, would deal only with tangible money and assets.
He also said the shariah scholars being consulted for Islamic compliance had a conflict of interest in that they are paid by conventional banks.
Central Bank of Bahrain host to the largest concentration of Islamic financial institutions in the Middle East
In recent years, Bahrain has rapidly become a global leader in Islamic finance, playing host to the largest concentration of Islamic financial institutions in the Middle East. Presently, there are 7 Islamic insurance companies (Takaful) and 2 Re-Takaful companies operating in the Kingdom. In addition, Bahrain is at the forefront in the market for Islamic securities (sukuk), including short-term government sukuk as well as leasing securities. The Central Bank has played a leading role in the introduction of these innovative products.
The growth of Islamic banking in particular has been remarkable, with total assets in this segment jumping from US$1.9 billion in 2000 to US$25.4 billion by August 2012, an increase of over 12 times. The market share of Islamic banks correspondingly increased from 1.8% of total banking assets in 2000 to 13.3% in August 2012. Islamic banks provide a variety of products, including Murabaha, Ijara, Mudaraba, Musharaka, Al Salam and Istitsna’a, restricted and unrestricted investment accounts, syndications and other structures used in conventional finance, which have been appropriately modified to comply with Shari’a principles.
The Central Bank of Bahrain has installed a comprehensive prudential and reporting framework, tailor-made for the specific concepts and needs of Islamic banking and insurance. The rulebook for Islamic banks covers areas such as licensing requirements, capital adequacy, risk management, business conduct, financial crime and disclosure/reporting requirements. Similarly, the insurance rulebook addresses the specific features of takaful and re-takaful firms. Both rulebooks were the first comprehensive regulatory frameworks that dealt with the Islamic finance industry.
In addition to the numerous Islamic financial institutions active in its financial sector, Bahrain also plays host to a number of organizations central to the development of Islamic finance, including: i) the Accounting and Auditing Organization for Islamic Financial Institutions (‘AAOIFI’); ii) Liquidity Management Centre (‘LMC’); iii) the International Islamic Financial Market (‘IIFM’), iv) and the Islamic International Rating Agency (‘IIRA’) and v) Sharia Review Bureau.
The Central Bank of Bahrain has also recently established a special fund to finance research, education and training in Islamic finance (the Waqf Fund); and is active in working with the industry and stakeholders in developing industry standards and the standardization of market practices.