Rasheed Mohammed Al Maraj: Challenges facing Islamic financial
institutions
Speech by His Excellency Rasheed Mohammed Al Maraj, Governor of the Central Bank of
Bahrain, at the 14th Annual World Islamic Banking Conference 2007, Manama,
9 December 2007.
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Fellow Governors, Excellencies, distinguished guests, ladies and gentlemen. On behalf of
the Central Bank of Bahrain, may I welcome you all to the Inaugural Plenary Session of
today's conference. May I take this opportunity to thank the sponsors and organisers of this
Conference which this year concentrates on the mechanisms to encourage the growth of the
Islamic banking industry whilst containing its risks.
Over the last 20 years we have seen the establishment of several of Islamic banks and
financing companies as well as Islamic banking windows as banks have rushed to satisfy the
appetite of investors and consumers for Sharia compliant products to finance assets from
cars and houses to aircraft and project finance. However as banks have flourished in
number, there is increasing evidence that banks will find it difficult to maintain the pace of
innovation that marked the 1990s. Islamic banks seem to be increasingly focused on real
estate and asset finance but not moving into other financial or liquid instruments with active
secondary markets. Perhaps we can take this opportunity to look at the challenges facing
Islamic banking and see how the industry, its regulators and stakeholders may respond.
The first challenge is the success of Islamic Banking. The sensational growth that has
brought Islamic banks such high profits over the past five years coupled with high levels of
liquidity have meant that Islamic banks have not had to fight for funding or ideas. The result
is that we are seeing too many Islamic banks with the same business models and structures.
The availability of plentiful liquidity coupled with the explosion of real estate projects in the
MENA region have conspired to breed a level of, dare I say it, complacency in some Islamic
banks. Many Islamic investment banks are project-driven and do not have a steady source of
"bread and butter" revenue to tide them over any slumps in economic activity. This is in
contrast to many of the major conventional banks with loan books, overdraft and credit card
facilities to provide steady revenue to cover overheads.
Another challenge facing Islamic banks is the multiplicity of Sharia boards and judgements.
This leads to a lack of homogeneity for some products on the one hand, and a lack of
uncertainty by clients as to whether a product developed in one jurisdiction is Sharia
compliant in a neighbouring jurisdiction. Islamic financial products need some level of
harmonisation in terms of product features to gain mass acceptance. We at the Central Bank
of Bahrain are working with the International Islamic Financial Market to set certain standards
on some capital and money market products, but banks themselves could work more closely
to establish common disclosure standards for the costs of financing.
Additionally, we at the Central Bank have noted the continuing need for high quality human
resources within Islamic banks. Islamic banking has been growing so fast that it has been
difficult for banks to find enough skilled or qualified staff. This is why the CBB has
participated with Islamic institutions in Bahrain in setting up the Waqf fund to provide financial
and technical support in upgrading current training programs and introduce new ones. It is
hoped that we will begin to see a larger number of financiers qualified in Sharia - related
subjects in the near future. Such initiatives can only be to the benefit of Islamic banking and I
urge more institutions to participate in the funding and support of the fund and its works.
I think at this point I should talk about governance challenges facing Islamic financial
institutions.
A major issue which is growing in importance is Sharia compliance and how to provide a
satisfactory framework to assure investors and other stakeholders that the activities of the
bank are within the permitted scope of Sharia. Islamic banks have various mechanisms to
ensure Sharia compliance in the products and activities of the institution. The first and most
obvious body is the Sharia Supervisory Board. This body produces judgements or fatwas on
products or structures that the bank intends to provide. The next body is the Internal Sharia
Review function which performs post-facto reviews of the activities of a bank. The last body
is the external auditor which, in addition to verifying the accounts of the bank, also checks to
ensure that the bank correctly followed AAOIFI Sharia standards.
There are differing perceptions about the respective scope of authority of these three bodies
and therefore there is a need to reach consensus on the functions of these respective
bodies. This is clearly an area where the institutions, Sharia scholars and the standard
setters need to agree upon what constitutes best practice and set an agreed set of
standards.
The next challenge is that of accounting standards. There are currently some 60 AAOIFI
accounting, auditing, governance and Sharia standards. This body of work is testimony to the
commitment and continuing efforts of AAOIFI since its establishment in 1990 to the
development of accounting and auditing standards for Islamic institutions. However, products
continue to develop rapidly and concepts such as "fair value" have come to centre stage.
Conventional accounting standards have responded accordingly. Two such examples are
IAS 39 and IFRS 7. Corresponding modifications to existing AAOIFI standards have not yet
been made. This means that, for rating purposes or competitive reasons, Islamic banks may
need to follow IFRS where AAOIFI standards do not fully cover the concerned product or
disclosure. This lack of equivalent AAOIFI standards is making difficulties in producing
financial statements for Islamic banks. Additionally, both AAOIFI and IFSB standards need to
be adopted by more institutions and regulators to reinforce their status as the benchmark
standards in Islamic finance.
I trust that the above challenges need to be addressed by regulators, Islamic banks and the
support organisations to consolidate the position of Islamic finance. Please accept my best
wishes for a rewarding and stimulating conference.
Thank you.