Kosher finance: Effective governance needed to grow Islamic banking

An Islamic banking ordinance must be promulgated if this sector is to thrive.

KARACHI:

One point needs to be made clear from the outset regarding the ongoing growth of Islamic banking in Pakistan. If it is to prosper, maintain competitiveness, ensure sustainability, preserve efficiency and remain profitable, then external and internal regulatory and governance frameworks must be strong, effective, transparent and stringent.

In Pakistan, there are five fully-fledged Islamic banks with another 13 conventional banks offering Islamic banking services. The share of Islamic banking in the sector now exceeds 7.5%, and there are prospects for future growth in this area. While Islamic banking is expanding rapidly, misconceptions about Islamic banking remain widespread. This calls for a coherent and comprehensive framework for Shariah governance for Islamic banks.

At present, the State Bank of Pakistan (SBP) is responsible for assuring that the banks offering Islamic banking services comply with Shariah requirements. However, there are areas in which there is need for further improvement. This article makes some practical recommendations for the improvement of the authenticity of Shariah advice and its implementation by individual banks.

Central to regulation of Islamic financial services is an effective Shariah governance framework, in the absence of which the confidence of the general public may deteriorate in this alternative form of banking and finance. Leaving Shariah assurance to market forces may lead to the dilution of quality of Shariah applications to banking and finance, and may in some cases result in the development of products that offer no distinct value unique to Islamic banking. In Pakistan, the SBP conducts annual Shariah audits of the banks offering Islamic banking to ensure that the principles of Shariah are upheld.

Shariah governance can be defined as a system in a given financial jurisdiction ensuring that all institutions offering Islamic financial services, which include both fully-fledged Islamic financial institutions and conventional financial institutions involved in Islamic banking through their window operations, comply with the internationally (or nationally) recognised Shariah requirements in developing, offering and executing Islamic financial products and services, as part of their operations.

There are two important pillars of Shariah governance, control and management.

Shariah control comprises the following:

1. Development of Islamic financial regulation by financial regulator;

2. Recognition of Shariah advisory function as a part of Islamic               financial regulation;

3. Compilation of Shariah opinions and creation of Shari’a standards       by an independent body, preferably set up by government; and

4. Development of an independent Shariah audit framework for the          institutions offering Islamic financial services.

Shariah management comprises the following:

1. Assurance of compliance with Shariah requirements by the banks      offering Islamic banking services; and

2. Development of human resources on all levels of management.

An effective Shariah governance framework includes benefits like assurance of Shariah authenticity and promotion and protection of the rights of all stakeholders among others.

Shariah control requires an active role of the government in creating a legislative framework for the functioning of Islamic banking in a country. It requires legislative developments, which would be implemented by financial regulators.

An effective Shari’a control function must include a legal framework in the form of an act or equivalent legislation allowing Islamic banking to operate in the country as well as the setting up of a central Shariah supervisory body in the form of a national Shariah advisory board. It also includes, or must include the development of Shariah standards either on a national level or subscription to international Shariah standards (eg Shariah Standards of Accounting from the Bahrain-based Auditing Organisation for Islamic Financial Institutions – AAOIFI).

In Pakistan, it is only the SBP that plays an active role in assuring that individual players achieve Shariah compliancy. Given the growing size and importance of Islamic banking in the country, it is now important that an Islamic Banking Act is promulgated, which would galvanise the government to be more involved in Islamic banking.

The role of the Ministry of Religious Affairs and Auqaf should be expanded to bring Shari’a governance under its umbrella of activity.

The writer is an economist and PhD  from Cambridge University.

Published in The Express Tribune, February 13^th, 2012.