This is the last in this series. I hope you have found it useful and informative. 

Since the late 1990s the Islamic banking world has stepped up efforts to standardize regulation and supervision. The Islamic Development Bank is playing a role in developing internationally acceptable standards and procedures and strengthening the sector’s architecture in different countries. Several other international institutions are working to set Shari’a-compliant standards and harmonize them across countries. These include the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the Islamic Finance Service Board (IFSB), the International Islamic Financial Market, the Liquidity Management Center and the International Islamic Rating Agency.

Accounting Standards

A number of countries and institutions have adopted accounting standards developed by the AAOIFI, which are designed to complement the International Financial Reporting Standards. The IFSB aims to promote the development of a prudent and transparent Islamic financial services industry and provides guidance on the effective supervision and regulation of institutions offering Islamic financial products. The IFSB has recently finalized standards on capital adequacy and risk management, and has made progress in developing standards on corporate governance. Once developed and accepted, these international standards will assist supervisors in pursuing soundness, stability, and integrity in the world of Islamic finance.

Liquidity Management

Another issue concerns the design of Islamic instruments for monetary operations.  In countries with a dual banking system, the lack of non-interest bearing securities has limited the scope of monetary management.  The liquid nature of banks’ liabilities, related to the predominance of deposits of short-term maturities, predisposes the system to hold substantial liquid assets and excess reserves.  This, in turn, inhibits financial intermediation and market deepening. Difficulties in defining rates of return on these instruments have also constrained the development of money and interbank markets.

Developing these markets is indispensable for the conduct of monetary policy and financial market deepening.  The inadequate development or absence of these markets in many countries constrains central bank intervention through indirect instruments and has occasionally encouraged the use of direct controls on credit. The absence of well-organized, liquid interbank markets, that can accept banks’ overnight deposits and offer them lending to cover short-term financial needs, has exacerbated banks’ tendencies to concentrate on short-term assets.  Effective liquidity management requires the adoption of a comprehensive, integrated approach to developing money and securities markets.

Areas for future development

Other issues include the lack of aggregate data making it virtually impossible to compare Islamic banks across countries, which, together with the absence of common reporting and accounting standards, complicates the work of supervisors.

The markets for Islamic instruments and government securities remain shallow and an organized international Islamic financial market is still nascent.  The sector must improve the range and sophistication of asset and liability classes and develop new instruments and financial techniques that would enable Islamic banks to diversify their balance sheets.

Finally the adoption of a common position on certain financial instruments would help develop Islamic finance and improve its competitiveness globally.  For example, a number of issues relating to speculation and the use of derivatives must be resolved before a fully functioning Islamic stock market can evolve. While arbitrage and short selling are not acceptable under Shari’a, other financial transactions appear to be, in practice, subject to varying interpretations. For instance, transactions involving the purchase and sale of debt contracts in secondary markets are permissible only in Malaysia.

The Future

The Islamic financial services sector should continue its recent compound annual growth for some time to come. It is a valuable addition to the more conventional, Western, style of financial services. Because of the nature of the products issued, it should also have some appeal beyond the Muslim community and some of its products could well be adopted by the financial community at large.

There are, however, many issues to be faced. Most of these issues are related to the relative immaturity of the market and the steep learning curve being faced by all participants in the market: the institutions, the regulators (including the interpreters of Shari’a) and the consumers, many of whom are uncertain of which products may comply with their interpretation of Shari’a.

For the foreseeable future, supervisory authorities will continue to face the dual challenges of understanding the industry and striking a balance between providing effective supervision and facilitating the industry’s legitimate aspirations for further growth and development.  These conditions would create a level playing field and provide the infrastructure needed for the industry’s market-driven development.  A sound, well-functioning Islamic financial system can pave the way for the regional financial integration of the countries involved. It can also contribute to their economic and social development, by financing the economic infrastructure and creating job