Rasheed Mohammed Al Maraj: Challenges for Islamic finance
Keynote address by His Excellency Rasheed Mohammed Al Maraj, Governor of the Central
Bank of Bahrain, at the World Islamic Banking European Summit, London, 8 July 2008.
* * *
Your Excellencies, Ladies and Gentlemen: Good Morning.
It is a pleasure to be here at the inaugural World Islamic Banking European Summit in
London. As His Excellency, Shaikh Mohammed, has already mentioned, Bahrain has been
home to the World Islamic Banking Conference for the past fifteen years.
Throughout that time Central Bank of Bahrain has been - and remains - a strong supporter
of the WIBC. We very much welcome this inaugural European summit, which we regard as
yet a further indication that Islamic finance is rapidly moving into the financial mainstream.
There is no need for me to repeat the facts and figures about the stunning growth of Islamic
finance that Shaikh Mohammed has already referred to. Let me say, however, that I strongly
endorse his view that the Islamic financial industry continues to offer enormous opportunities
for both Muslims and non-Muslims alike. We at the CBB have a continuing commitment to
facilitating the development of the Islamic financial services industry. We issued the first
sovereign sukuk in 2001. We were the first regulator in the world to issue a comprehensive
set of prudential regulations tailored to the needs of Islamic financial institutions. More
recently, we have introduced an innovative approach to the application of Basel II, Pillar 1
requirements to our Islamic banks. We will continue to ensure that all financial institutions in
Bahrain adhere to the very highest international standards. Where necessary we will play our
part in adapting those standards to the needs of the Islamic financial services industry. In
developing this framework we are assisted by the presence in Bahrain of a number of the
leading standard setting bodies for the industry. These include AAOIFI, the Accounting and
Auditing Organisation for Islamic Financial Institutions and the IIFM, the International Islamic
Financial Market, which is doing sterling work in developing standard contracts and
associated documentation. Building sound underpinnings, in the form of an appropriate
framework of regulation, accounting and contract standardization, is a very important
challenge. But it is by no means the only one that the industry must confront as the result of
its success.
I would like to take this opportunity to look at some of the other challenges that the industry
currently faces as it moves into the financial mainstream. A long-standing issue relates to the
multiplicity of Shari'a boards and judgements. This has led to both a lack of homogeneity for
some products, and a lack of certainty by clients about the cross-border acceptability of
Shari'a rulings. Additionally, there is a continuing need for high quality human resources
within the industry. It has been growing so fast that it has been difficult for institutions to find
enough skilled or qualified staff. In recognition of this need the CBB established a special
Waqf fund in 2006 to finance and publish research and to support training workshops and
other educational initiatives. We have also been working with the Bahrain Institute of Banking
and Finance to develop new courses on Islamic finance. Despite the importance we attach to
each of these challenges, there are three in particular that I would like to highlight today.
The first concerns corporate governance. All financial institutions - whether conventional or
Islamic - need high standards of corporate governance as they are entrusted with other
people's money. However, this need is particularly great in Islamic financial institutions due
to several issues that are specific to their business model. Decisions on profit distribution, for
example, require the careful balancing of the interests of multiple stakeholder groups - not
just shareholders, as in conventional banks, but the interests of holders of investment
accounts as well. Investment account holders are exposed to many of the same risks as
shareholders, but lack the same control rights - such as the ability to vote for board
members - that are attached to equity ownership. Balancing these different stakeholder
interests requires the adoption of strong corporate governance practices, and the standards
developed both by AAOIFI and by the Islamic Financial Services Board are vital components
of the solution.
The second issue concerns Islamic banks' ability to manage their liquidity. At the CBB we are
in the process of developing an Islamic Sukuk Liquidity Instrument. This will be a repurchase
agreement which will enable financial institutions, both conventional and Islamic, to access
short term liquidity against Government of Bahrain Ijara sukuk issued by the CBB. We have
also encouraged the IIFM to develop contracts and documents that can be used for
conducting transactions through commodity murabahas. Even so, there is a continuing need
for more depth and liquidity in Sharia-compliant money markets and the CBB intends to
remain at the forefront of such initiatives. The final challenge is to ensure that the industry's
undoubted success does not turn into complacency. The sensational growth of the industry
in recent years combined with high levels of liquidity has meant that Islamic banks have not
needed to fight for funding or ideas. Newer entrants to the industry have merely tended to
copy the strategies they see being successfully pursued by their more established rivals. If I
may say so, there is a high degree of "cloning" of business models.
As a result, a very high percentage of Islamic banks have a strategy that is heavily weighted
towards real estate and asset finance. They tend to be project-driven and do not have a
steady source of "bread and butter" revenue to tide them over any downturns in economic
activity. This contrasts with conventional banks with their extensive loan books, overdraft and
credit card facilities which provide steady revenue to cover their overheads even in today's
challenging markets. The "cloning" of business models leads to financial institutions
becoming exposed to the same economic and industrial sectors. The Islamic banking sector
as a whole is highly exposed to the property sector - real estate, commercial property and
construction - and as events in the advanced markets have recently reminded us, this sector
can and does experience significant cycles of activity.
The asset-based business models favoured by many Islamic banks have not been tested in
a downturn. We need to remember that a business model which looks robust in conditions of
rising asset values and abundant liquidity may not be so when the economic environment
changes. The industry needs to respond to these challenges by developing a greater
diversity of business models, more diverse and stable income sources, and more rigorous
risk management and stress testing techniques to assess its preparedness to deal with any
downturn in economic activity. As a central banker I am inevitably preoccupied by risk,
especially when it could potentially impact on a significant sector of the financial industry.
However, the challenges that I have highlighted are very much the result of the industry's
recent success. We all share of the aim of ensuring that the industry remains successful, and
this is why it is so important that we recognize and address these challenges.