Publication Date

11-8-2006

Description

The achievements made by Islamic Finance Industry during the last few years have indeed been impressive. The growth rate of 15-20% annually, the evolution of sukuks, fixed income, equity, money market instruments and the attraction of Islamic products among a large variety of issuers and investors globally have been the salient features that have characterized the Islamic Finance Industry (IFI). What I propose to do this afternoon is to spell out the challenges that the industry has to meet during the next several years to integrate itself within the framework of global financial system. First, the host country leadership in resolving some of the legal and regulatory issues will remain absolutely critical. For example, some of the public sector issuers cannot lease or pledge the assets underlying the transaction. This legal issue needs to be satisfactorily resolved for larger volumes of public sector issues to take place. Another knotty issue is that the Islamic banks have to assume the ownership of the underlying assets even for a limited duration and they have to bear the risks associated with ownership. Buying insurance to protect themselves imposes additional costs. Who will pay for these costs? If it is passed on to the depositor or borrower it will appear as a lower rate of return or higher mark up putting the Islamic banks at a competitive disadvantage compared to the conventional banks. In case the banks absorb these costs, the profits earned by the shareholders will be lowered. Second, the legal and documentary expenses as well as distribution costs of Islamic products and services are also relatively higher than those offered by the conventional banks. This is because the Islamic banks focus on single transaction and therefore the Islamic banks have to find means to reduce the overall cost by developing master agreement frameworks. Under which individual transactions can take place. Third, there is a lack of standardization of Islamic products and instruments even among the banks in the same country. For further growth of IFI standard contracts should be developed across countries, regions as well as markets and different schools of thought. This improvement will help reduce the inherent unpredictability among the market players and also lower the transaction cost. Ex-ante approvals of each transaction by the Shariah Board are not only labor intensive but highly cumbersome.

Notes

Special key note address delivered at 2nd Pakistan Islamic Banking Conference held at Karachi on November 8, 2006.

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