As investors pin their hopes on Islamic banking systems as safer models in times of crisis than the western banks hard hit by the economic crunch, Islamic banks need to improve level of supervision and deal with the looming threat of forced consolidation as the industry expands, experts said at a global summit Tuesday.
Islamic banking systems could become the new model for global banking if they take on the challenges of disclosure levels to improve the industry's growth potential, said experts at Reuters Islamic Banking and Finance Summit being held simultaneously in Dubai, Manama, London and Kuala Lumpur.
In demand but un-uniform
Western financial analysts are increasingly pointing to the failures of “old capitalism” and communism banking models. And Western banks have tapped into the Islamic banking system, setting up instruments that enable the world’s 1.3 billion Muslims to invest while still complying with their belief system.
Centers in Paris and London are competing to become the Islamic financial hubs for western markets especially since potential assets that comply with Islamic law are estimated at between $700 million and $1 trillion.
However lack of a standardized Islamic finance system and mismanagement of bonds because of lack of supervision are obstacles to the future of the industry. Currently, sharia banking systems are open to various interpretations because of the open-ended nature of Islamic law. This makes the standardization of the industry's practices across jurisdictions – necessary to decrease risk, difficult without closer monitoring.
An example of this lack of uniform application is the bai bithaman ajil (deferred payment sale) which are approved by Malaysian regulators but rejected by those in the Middle East.
Sohail Zubairi, chief executive of Dar al-Sharia consultancy, a firm set up by Dubai Islamic Bank last year, said that Islamic banks have reported some $10 to 15 billion Islamic bond losses since the beginning of the financial crisis because the banks were structuring them incorrectly from the start.
Threat of consolidation
Zubairi said forced consolidation may be the future of the Islamic banking industry if lack of liquidity from the economic crisis hits the growing sharia-based sector.
“Anything is possible in this scenario. There is a real threat to the business of Islamic banking,” Zubairi said, referring to the Islamic lending sector overall. “If the liquidity does not return, we will not be able to continue doing our business."
Zubair predicts that lack of liquidity is bound to hit retail Islamic banks, forcing a possible bank collapse and suggested mergers and acquisitions as a way out of the potential crisis scenario.
“Islamic banks will not take any voluntary measures at all; [they] need to get bigger and one way could be a merger,” Zubair explained, adding that governments would need to put pressure on banks to make mergers possible, as in the case of Bank of America’s acquisition of Merrill Lynch. Otherwise banks would close down as in the case of Lehman Brothers, which closed as a result of the global financial crisis.
"What you put on the balance sheet, what's off your balance sheet, how do you treat an account, profit distribution, all those issues have to be put on the front burner now, and be looked at again in light of the real practice," Mohamad Nedal Alchaar, secretary general of Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) said at the summit in MANAMA.
Alchaar added that body that sets standards for Islamic banking is considering issuing separate standards for real estate investments and investments in equities and Islamic bonds, which are called sukuk.
AAOIFI -- the Accounting and Auditing Organization for Islamic Financial Institutions -- is an influential standard setting body for the Islamic finance industry and hopes are that in a few years time it will limit its focus on reviewing and modifying standards.