Christian Noyer: Global stability, the future of capital markets and
Islamic finance in France
Speech by Mr Christian Noyer, Governor of the Bank of France, at the Euromoney Seminars,
Islamic Paris Conference, Paris, 29 September 2009.
* * *
Ladies and Gentlemen,
It's a great pleasure for me to address such a distinguished audience today.
While conventional economies are still suffering from a deep crisis and some of our
traditional economic thought is being challenged, this meeting is a great opportunity to
discuss how alternative finance, and especially Islamic finance, can contribute to the
economic recovery.
In the past two years, the French authorities, in active cooperation with the industry, in
particular via Paris-Europlace, have introduced substantial reforms to make it possible to
allow Shariah' compliant finance into France. As Governor of the Banque de France, which is
in charge of the licensing of French banks, I would like to specifically highlight ongoing work
aimed at licensing Islamic banks in a secure framework. I will come back to this point later...
To focus on the matter I was invited to speak about, I would like to address several issues:
•
first, the links between the current overhaul of financial regulation and Islamic finance;
•
second, the role Islamic finance could play in France;
•
the third, the relationship between Islamic finance and financial stability;
•
Finally, I would like to mention the conditions Islamic banks need to meet to ensure
that their establishment in France is consistent with the smooth functioning of the
banking system.
♦♦♦
The current crisis has illustrated the rapid contagion effect fostered by financial globalisation.
However, it is important to emphasise that financial globalisation is not in itself the cause of
the crisis, which has rather revealed failures in financial regulation. Indeed, the crisis has
highlighted the need to better assess and prevent risks in the financial system as a whole, in
addition to simply monitoring the risks of each individual institution. It has also shown that
some features of the regulatory regime have had an amplifying effect on the economic cycle
instead of mitigating it.
That is why the G20 has launched an ambitious agenda to reform financial regulation,
covering four main areas: the strengthening of prudential standards, the redefinition of the
scope of regulation, the revision of accounting standards and the strengthening of risk
management. We will see later that these areas find a strong echo in Islamic finance, which
has also to deal with issues linked to lack of transparency, of a level playing field and
harmonised regulation. Thus, the overhaul of regulation in conventional finance should be an
opportunity for Islamic finance to tackle these issues, and to better integrate into financial
globalisation.
In France, in particular, Islamic finance has a role to play, which could be beneficial both to
Islamic investors and to the French economy.
Indeed, the French economy offers major and diversified investment opportunities for Islamic
investors in the financing of a wide network of often innovative firms and projects, or in real
estate. These sovereign funds, corporates or wealthy individuals should have the opportunity
to invest, either directly in individual assets or projects, or indirectly through funds or
collective vehicles. It is up to banks to offer to these investors the type of Shariah compliant
products and investment or financing tools they might wish to have.
Let me make a brief point on sovereign wealth funds (SWFs) and their link with Islamic
finance. SWFs have attracted much attention recently but the oldest ones were set up back
in the 1970s. Their expansion accelerated about a decade ago, when many emerging
countries started to accumulate sizeable foreign exchange reserves, due to high oil and gas
prices and to the conjunction of macroeconomic factors and foreign exchange policies. With
assets managed by SWFs estimated at 3,000 billion dollars, this category of investors
represents twice the value of assets managed by hedge funds.1 It is estimated that they will
continue to grow in the future, to reach from 12,000 to 15,000 billion dollars, depending on
estimates, in 2015. Consequently, they play and will continue to play an increasing role in the
global financial system.
As SWFs have long-term and diversified investment strategies and are not subject to sudden
fund withdrawals by customers, they are usually considered to have a stabilising effect on
the global financial system, despite their lack of transparency. Consequently, developed
countries have an interest in attracting their investments. During the crisis, the behaviour of
SWFs has differed according to the country of origin, but in general, it appears that their
tendency to invest more than before in domestic and regionally close markets during the first
stage of the crisis has come to an end, and that they have now resumed investing principally
in OECD economies.2 This is particularly true for Gulf sovereign funds, where diversified
domestic investment opportunities are scarcer than for Asian sovereign funds, for example.
In the first quarter of this year, Europe was by far the leading destination for Middle-Eastern
and North African SWF investment.3 Muslim countries, in particular oil-exporting ones,
represent as much as 51% of total sovereign wealth funds' assets. While these funds do not
invest only in Islamic finance products, being able to offer a large range of the latter would
nevertheless represent a significant comparative advantage for the attractiveness of France.
Another possible development of Islamic finance comes from the retail sector, through
investment of French residents of Muslim origin in banking or saving products which are
Shariah
compliant and distributed by local Islamic banks. It is difficult to assess the potential
demand for Islamic retail banking products in France. Nevertheless, the potential target
population in France, which is estimated at approximately 4 million Muslims, seems
promising: this population is 2 or 3 times bigger than in Great Britain, where Islamic finance
has been growing for several years. Moreover, according to a survey,4 more than half of the
respondents expressed their interest in Islamic financial products to finance their homes,
cars and businesses.
Let me now address the question of the relationship between Islamic finance and financial
stability, which is not an obvious one.
In the current context of economic crisis, some experts argue that the very nature of Islamic
finance is an effective shield against excessive exposure, providing a much higher degree of
security to the economy.
I doubt there is a definitive answer to the question as to whether Islamic finance in general
and Islamic banking in particular, is, by nature, conducive or not to financial stability. Without
claiming to be exhaustive on such an ambitious subject, particularly in front of an audience of
distinguished Islamic finance specialists, it seems to me nevertheless useful to briefly recall
the following points:
• The of Islamic finance can be seen in different ways as far
fundamental principles
as financial stability is concerned.
As you well know, Islamic finance prohibits the payment and receipt of interest at a fixed or
predetermined rate. Instead, profit-and-loss sharing arrangements, purchase and resale of
goods and services, and the provision of services for fees are the basis of Islamic finance
contracts. Islamic finance is therefore systematically backed by real assets. Moreover, it
prohibits speculation and the financing of production or trade in specific sectors.
On the one hand, these principles can be considered to provide stability for the financial
system. Indeed, in Islamic finance, unbacked expansion of credit is precluded, and banks
cannot initiate or accentuate a speculative process. Credit is based on real savings and
savings can only earn a return if directly invested in creating activities. Finance and the real
economy are closely linked. In the Islamic system, banks can neither carry highly leveraged
exposures nor acquire risky financial structured products. By the way, even if the Islamic
nature of their finance is not the only explanation, we can note that Islamic finance countries,
compared with those of conventional finance, have been relatively less impacted by the
crisis.
But on the other hand, Islamic banks pose risks to the financial system that in many regards
differ from those posed by conventional banks, with respect, for example, to liquidity,
operational and legal risks.
Indeed, Islamic banks face specific obstacles in liquidity management, as the prohibition of
interest has led to the underdevelopment of funding sources.
Moreover, operational risk and legal uncertainty can be amplified by the lack of product
standardization and the lack of harmonization of Islamic standards, with for example possible
differences between Shariah scholars' interpretations, accounting standards, and so on.
In the same way, prohibition from financing specific sectors limits the kind of eligible assets
for investment, which contributes to increasing the risk of concentration in potentially cyclical
sectors such as real estate. This is what happened in certain Gulf countries.
•
As the analysis of the principles of Islamic finance does not settle the issue of the
relationship between Islamic finance and financial stability, it needs to be
supplemented by an empirical analysis.
In fact, there is relatively little empirical analysis regarding the role of Islamic banks in
financial stability. Nevertheless, a working paper of the International Monetary Fund was
published at the beginning of 2008.5
The findings of this paper are to be viewed as preliminary. Nevertheless, it has the
advantage of being, as far as I know, the first and, up to now, only cross-country empirical
analysis of Islamic banks' impact on financial stability.
Even if the situation may in principle differ from country to country and even from bank to
bank, the paper finds that:
- (i) small Islamic banks tend to be financially stronger than small commercial banks,
- (ii) large commercial banks tend to be financially stronger than large Islamic banks,
- (iii) small Islamic banks tend to be financially stronger than large Islamic banks.
One of the plausible explanations given by the paper is that it is significantly more complex
for Islamic banks to adjust their credit risk monitoring system as they become bigger. Given
their limitations in standardisation in credit risk management, monitoring the various
profitloss-arrangements rapidly becomes much more complex as the scale of the banking
operation grows.
These findings are based on evidence drawn from banking systems with a substantial
presence of Islamic banking. Therefore, they are not strictly transposable to France.
Nevertheless, precisely because France is a conventional environment, I would like now to
conclude my speech with some remarks on conditions Islamic banks need to meet to ensure
that their establishment in France offers sufficient safety for their customers and is
compatible with the smooth functioning of the French banking system.
This is primarily in Islamic banks' own interest and is also in the interest of the banking
system!
Regarding licensing, the Credit Institutions and Investment Firms Committee (Comité des
Etablissements de Crédit et des Entreprises d'Investissement - CECEI) will assess the same
criteria as for any conventional bank: financial resources and suitability of the shareholders;
integrity, qualifications and suitable experience of managers; level of own funds; business
plan; capacity of the bank to achieve its development objectives and so on. Indeed, there is
no specific criteria or requirement for Islamic banks in the French licensing framework.
But beyond these standard licensing criteria, banking authorities need to ensure that Islamic
banks will interact with their conventional environment in France as soundly as possible.
Therefore, some key issues need to be tackled before licensing an Islamic bank, regarding
especially:
- their governance, with for example the role of the Shariah' Board,
- the legal classification of profit-sharing investment accounts and its consequences in
terms of coverage by the French deposit guarantee scheme,
- and liquidity management and access to the Eurosystem funding, especially the issue
of assets eligible as collateral.
Let me stop here. I would like to thank you very much, Ladies and Gentlemen, for your
attention.