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. * * * 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

for financial crisis management. good progress has been made as a result of the recommendations of the brouwer report. notably, the banking supervision committee has concluded a memorandum of understanding on cooperation and information - sharing in crisis management situations between all central banks and banking supervisors of the eu. global issues at international level, examples of how effective crisis management and resolution is hindered by the absence of a common legal framework are well documented. however, a common legal framework is only one important element required for the orderly pursuit of international finance. another would be a concrete enforcement mechanism, but this is possibly inconceivable in the context of sovereign states. indeed, contractual arrangements are increasingly aimed at compensating for the lack of a common regulatory and enforcement framework. the response of the international community to coordination problems includes efforts in crisis prevention and crisis resolution. in the context of crisis prevention, the promotion of international standards and codes is a promising avenue. the policy response to alleviate crisis resolution has covered all three aspects involved : domestic adjustment, official financing and private sector involvement. although all three are crucial to a successful crisis resolution, let me focus here on the last. as regards private sector involvement, several proposals have been put forward, including the sovereign debt restructuring mechanism ( sdrm ) proposed by the international monetary fund ( imf ). this legally binding mechanism was based on the idea that some elements of bankruptcy mechanisms applicable in the domestic context to private or public sector entities could be used in a sovereign context. the idea of creating an sdrm has been put aside for the time being, mainly because of concerns over the potential adverse effect on borrowing costs. a second proposal, supported most enthusiastically by the private sector and by a number of sovereign issuers, is based on the use of collective action clauses ( cacs ). these clauses, which facilitate coordination among creditors by creating clear rules for reaching a binding agreement over a debt restructuring proposal, would become a regular feature of all new international bond issuance. cacs have the advantage of being easily integrated into market practices and having a straightforward structure, which makes them a powerful coordination tool for creditors holding debt of the same issuance. however, their contribution to solving coordination problems at the level of the total stock of outstanding debt of a country is less clear. finally, a third proposal - and this is actually one i myself suggested at the imf and world bank annual meetings in washington in september 2002 - currently being studied by the group of twenty is to have a