Indonesia on Financial Inclusion and Islamic Finance
The Islamic Financial Services Board (IFSB) and Bank Indonesia successfully conducted a joint public seminar and workshop on financial inclusion and Islamic finance on 11 December 2018, in Surabaya, Indonesia. The seminar was themed as “Broadening Economic Frontiers and Reducing Income-Gaps through Inclusive Finance.”
The seminar stressed on the importance of improving the economic conditions of the Muslim-majority countries where in many instances, high levels of poverty persist. A particular observation in these countries is also often high levels of financial exclusion, and with voluntary exclusion due to religious beliefs often being cited as a factor.
Mr. Agusman, the Executive Director of Communications at Bank Indonesia, agreed upon the importance and relevance of the topic at hand, and appreciated IFSB’s efforts in attempting to provide meaningful regulatory and supervisory guidelines to support financial inclusion efforts through Islamic finance. He further highlighted Indonesia’s various initiatives aimed at addressing the financial inclusion challenge, including its collaborations with international partners to support development of Islamic social finance policies such as zakah and waqf core principles.
Dr. Prayudhi Azwar, Economist at Bank Indonesia Institute invited the panelists to identify the root cause of financial exclusion and provide solutions to address economic inequalities. The key takeaways from the panel discussion included highlighting appropriateness of financial inclusion to enhance living standards and alleviating poverty, addressing suspicion and reluctance of the low-income segments from availing formal financial services, developing practical roadmaps for enhancing capacity and competitiveness of Islamic financial inclusion products, and also reinforcing social objectives of the Islamic economy and finance with a view to addressing challenges of the poor.
It was agreed that practical measures to enhance Sharīʻah-compliant financial inclusion activities are provided in line with guidance from the IFSB’s Exposure Draft of Technical Note 3 (TN3) on Financial Inclusion and Islamic Finance. Discussion points included permissible and impermissible activities, cost effectiveness of products and operations, critical success factors for enhancing financial inclusion, utilization of Islamic social finance for supporting financial inclusion, and also on the importance of regulatory coverage for financial inclusion activities by non-banks and other types of institutions.
However it was agreed that the aim of TN3 is to provide guidance on good practices in regulating the financial sector to enhance financial inclusion through Islamic finance, while also considering proportionality in balancing the benefits of regulation and supervision against the risks and costs. The TN3 underscores the importance of financial inclusion, due to its intricate connection with economic growth, shared prosperity and poverty reduction, while furthering an understanding of how financial inclusion policies and regulatory initiatives can support Islamic microfinance/savings/investment activities. The TN3 also covers recent developments in enhancing financial inclusion through digital finance and financial technology (FinTech) platforms, while further identifying the current main challenges and emerging issues, as experienced by the market players and regulators, in microfinance and financial inclusion related to Islamic financial services. Finally, the TN3 explores practical modalities for the integration of social finance modes in Islamic finance (e.g. zakah, sadaqah, waqf) with the commercial IFSI to promote financial inclusion.
Based on the above, the key proposed objectives of this TN 3 are:
- To provide international benchmark guidelines on regulatory and supervisory policies to support financial inclusion initiatives in the IFSI.
- To provide guidance to RSAs on the application of the proportionality principle so that the benefits of regulation and supervision can be balanced against the risks and costs.
- To factor in recent developments in enhancing financial inclusion through Shari’ah-compliant mechanisms by digital finance and FinTech platforms.
- To consider a modality for the integration of modes of Islamic social finance (e.g. zakah, sadaqah, waqf) with the commercial IFSI.
- To highlight challenges in, and propose solutions to, emerging regulatory issues in microfinance and financial inclusion activities in the IFSI.
The TF further notes the currently limited involvement of commercial banks in financial inclusion activities and the active involvement of different types of non-bank financial institutions (NBFIs) in the propagation of financial inclusion that includes microfinance. Overlaps of regulatory functions on financial inclusion activities, often between banking sector and capital market regulators, have also been discussed by the TF Note of IFSB.
Based on these deliberations, the TF resolved that the TN is to extend its scope beyond the banking sector and cover the role of NBFIs and the Islamic capital market in promoting financial inclusion, where needed. In addition, the TN will cover microfinance activities, which current evidence suggests represent a majority of the Shari’ah-compliant financial inclusion efforts.
Islamic financial institutions need to play important role in minimizing Global and Domestic financial crisis
A number of banking and financial institution crises have occurred after the collapse of the Bretton-Woods system in the 1970s. These included the Latin America debt crisis (1980s) and the Asian financial crisis (1997–8). Financial safety nets – namely, lender-of-last-resort (LOLR) facilities and deposit insurance schemes (DIS) – garnered the attention of policymakers and regulatory bodies as a result of these periods of volatility.
The global financial crisis (GFC) (2007–8) and the subsequent high-profile collapse of banks and financial institutions, such as Bear Stearns and Lehman Brothers (US), Kaupthing (Iceland) and the liquidity crisis faced by Northern Rock (UK), shifted the regulatory focus onto another safety net – namely, recovery and resolution. The financial contagion caused by the collapse of a banking or other financial institution can have serious and prolonged ramifications for the wider economy. The impact of the GFC is still being felt globally a decade on. The systemic importance of banks and other financial institutions, which can lead to issues of moral hazard with regards to financial safety nets, is a key focus area for the global regulatory framework.
The aim of recovery and resolution planning is to enable banks and other financial institutions to restore viability through their own actions, prior to the need for a regulatory authority intervention to enforce specific recovery and/or wind-down powers.
Recovery from financial crisis includes recapitalization and other reorganization and restructuring concepts that are included in “bankruptcy” (as opposed to pure “insolvency” regimes). The resolution aspect of the framework is for authorities to be able to plan how best to stabilize or wind down a firm that is no longer viable or is likely to become non-viable (as per the Financial Stability Board’s Key Attributes) while ensuring minimal disruption to the wider financial system. A key principle underlying the global recovery and resolution framework is to address the “too big to fail” moral
On 15 September 2008, Lehman Brothers filed for bankruptcy protection following the sub-prime-mortgage-induced Global Financial Crisis. Similarly, other mortgage-related bankruptcies and foreclosures on a massive scale as a result of the housing bust in the United States rendered many financial institutions illiquid and/or insolvent. Although the US government’s support to some “too big to fail” financial institutions was intended to avoid further collapse and to restore public confidence, the sharp rise in credit risk and the sudden decrease of the capital base of the financial institutions resulted in a pervasive credit squeeze and interbank lending failures. The immediate solvency measures, such as the government’s bail-outs, were not entirely successful in restoring consumer and business confidence, and consumption and investment activities continued to decline. Though the crisis was centered in the US, the contagious effects spread around the globe and their implications for the roles of monetary and fiscal authorities were, and continue to be, far reaching.
Following these events, the G-20 leaders rightly emphasized the need for stringent regulation of financial institutions and took the initiative by establishing the Financial Stability Board as the successor to the Financial Stability Forum with a broader mandate of promoting financial stability. In 2014, the FSB developed the Key Attributes of Effective Resolution Regimes for Financial Institutions, which set down core elements of recovery and resolution planning for financial institutions.
The FSB’s Key Attributes framework recommends that resolution authorities should have operational independence and unimpeded access to financial institutions. The general resolution powers of the resolution authorities highlighted by the Key Attributes are their abilities to:
- Remove and replace the senior management and directors and recover monies from the responsible persons.
- Appoint an administrator to take control of and manage the affected firm.
- Operate and resolve the firm, including powers to terminate contracts, continue or assign contracts, purchase or sell assets, and write down debt.
- Ensure continuity of essential services and functions by requiring other companies in the same group to continue to provide essential services to the entity in resolution, any successor or an acquiring entity.
- Override rights of shareholders of the firm in resolution.
- Transfer or sell assets and liabilities, legal rights and obligations to a solvent party.
- Establish a temporary bridge institution to take over and continue operating certain critical functions and viable operations of a failed firm.
- Establish a separate asset management vehicle.
- Conduct bail-ins as a means to achieve, or help achieve, continuity of essential functions.
- Temporarily stay the exercise of early termination rights.
- Impose a moratorium with a suspension of payments to unsecured creditors and customers.
- Affect the closure and orderly wind-down of the institution.
Now here comes the role of Islamic finance in resolution of such or any financial crisis. In this respect the basic premise of a bank is the same throughout the world, but how they function can be completely different. In the case of Islamic finance, banks must abide by the rules of Shariah law. The bank is more than just a business that operates to make a profit in Islam; it is seen as a form of justice. Everyone is supposed to give and take under the same rules and interest does not play a role, as it an unfair rule that only one side gets to benefit from.
Shariah prohibits usury, speculation, gambling, and unethical predatory practices. These things are, ironically, the very causes of what rots and eats away at the foundations of countries that operate under the rules of Western banks.
While studying the financial crises and Islamic finance, we must consider another reason, and that is relationship. The citizens’ relationships with conventional banks are always in the form of a creditor to debtor, unlike Islamic banks. Everything revolves around interest rates and credit worthiness. This prevents any real relationship with a bank, thus its lack of contribution to the communities around them. Islamic banking has to provide an equal service and maintain a trust with the community in order to prosper.
When one deposits their money into a conventional bank with the intent to save and earn an interest, that bank must pay back those monies in the event of a financial collapse. This is law under the FDIC minimum. Islamic banks do not have such a law, nor do they have the guaranteed interest for keeping said money in a savings account. This may seem bad for the customer, but it is also what allows their banking industry to prosper with confidence.
Unlike Western countries, Islamic finance does not see money as a commodity in of itself to be sold or traded at a higher value than what it is printed at. Money is merely a tool to promote economic activity and freedom to exchange goods more efficiently, as money does. Islam sees other valuable commodities, like silver, gold, and raw materials as money, but important food staples, like rice, wheat, and salt will not be tolerated.
Instead of growing bank’s reserves through all the frauds, scams, and predatory practices that are common in conventional banks, Islamic banks grow their profits by investing in tangible businesses. This creates more growth in the economy, while turning a profit from the initial investment. It’s a win-win for banks and their stakeholders. Conventional banks are mostly looking for short-term returns on their investment, so it is rare to see banks make large investments with their own money in the West.
So, during financial crisis, Islamic financial institutions prosper because of all of these reasons. Public trust with conventional banks continues to fall, especially when lending practices have not improved with the public, despite economic growth. When banks follow a law that is built around justice, they don’t invest all their resources into earning more from less, everyone prospers.
The way forward, therefore, for both Islamic and conventional finance is, inter alia, greater reliance on risk sharing to inject more discipline in the system; the establishment of a strong and comprehensive regulatory body to safeguard the resilience of the system; and the integration of Zakat, Awqaf and other voluntary institutions into the financial system to cater for the financial needs of the poor.
In current financial crisis of Pakistan all stakeholders are required to find those links that are missing. Prominently among them are no legislation for Islamic Banking, reliance of Islamic Banks on consumer financing, No liquidity management products and altogether no support of SBP in case of dire needs of funds, Courses on Islamic Banking in control of Taqleedi scholars with nothing to further research and find solutions. Currently the size of Islamic banking is just 13% of total banking assets achieved in last 10 years. So with this speed 100% target cannot be achieved even in 22nd century with the blessings of the government and regulators.
Latest Information’s on Islamic Banking and Finance
- Islamic finance is today a $2.2 trillion industry spread over more than 60 countries with the bulk of it concentrated in very few markets. Data compiled by the Union of Arab Banks’ research department shows that just 10 countries account for 95% of the world’s Shariah compliant assets. Iran leads the way with 30% of the total market followed by Saudi Arabia (24%), Malaysia (11%), the United Arab Emirates (10%), Qatar (6%), Kuwait (5%), Bahrain (4%), Bangladesh (1.8%), Indonesia (1.6%) and Pakistan (1%). These countries drive the growth of Islamic finance, set industry standards and foster innovation. Over the past decade, Islamic finance grew at an exponential yearly pace of 10%–12%. Reuters expects total Islamic assets to reach $3.5 trillion by 2021 but that scenario is tied to the economic well-being of these 10 markets.
- As part of its yearly strategy to support the development of the agricultural sector, the State Bank of Pakistan has raised the disbursement target for Islamic banking institutions fivefold to PKR100 billion, out of an overall target of PKR1.25 trillion for fiscal year 2018-19. SBP has also urged Shariah compliant financial institutions to develop bespoke financing products that meet the agricultural sector’s needs.
- Having planned to foray into Islamic finance since 2011 to capture Pakistan’s largely untapped agricultural market, Zarai Taraqiati Bank Limited has now secured a license from the State Bank of Pakistan, moving the regulator closer to its targeted 15% Islamic banking market share in 2018. The bank, with assets amounting to PKR82.81 billion at the end of 2016, intends to become the sixth full-fledged Islamic bank operating in Pakistan, but will start its operations by offering Shariah compliant financing products on a branch basis.