Tuesday 28, February 2017 by Matthew Amlôt

IMF to strengthen the financial stability in countries with Islamic banking

On February 3, 2017, the Executive Board of the International Monetary Fund (IMF) held its first formal discussion on Islamic banking, and adopted a set of proposals on the role that the Fund should play in this area.

These proposals, and the case for adopting them, are contained in the staff paper Ensuring Financial Stability in Countries with Islamic Banking and the accompanying country case studies paper.

Islamic banking continues to grow rapidly, in size and complexity, contributing to financial deepening and inclusion in many countries, but also posing a challenge to supervisory authorities and central banks. While accounting for a small share of global financial assets, Islamic banking has established a presence in more than 60 countries and has become systemically important in 14 jurisdictions. Islamic banking involves operations, balance sheet structures, and risks that differ from their conventional banking counterparts. Accordingly, there is a need for putting in place an environment that promotes Islamic banking financial stability and sound development, including legal, prudential, financial safety nets, anti-money laundering and countering the financing of terrorism, and liquidity management frameworks.

The IMF has been providing technical advice, as needed, to member countries on Islamic banking issues for the past 20 years and has been cooperating with relevant standards setters and international organisations on efforts to develop supplementary standards for Islamic banking in areas that are not covered by existing international standards. In recent years, the number and complexity of Islamic banking issues arising during IMF country surveillance and the demand for policy advice and capacity development in this area have increased, requiring a more formal IMF involvement.

Executive Board Assessment

Executive Directors welcomed the opportunity to consider the staff's proposals to strengthen the Fund's engagement on Islamic banking and related financial stability implications. Directors concurred that Islamic banking presents an opportunity for many member countries to enhance financial intermediation and inclusion and mobilise funding for economic development. At the same time, they noted that the growth of Islamic banking and its complexities pose new challenges and unique risks for regulatory and supervisory authorities. Against this background, Directors called for stronger efforts to establish a policy framework and environment that promote financial stability and sound development of Islamic banking, particularly for countries in which Islamic banking has become systemically important.

Directors expressed support for staffs proposed approach to developing and providing policy advice on Islamic banking-related issues in the context of Fund surveillance, programme design, and capacity development activities. They also called for staff's continued support to the work of the relevant international standard setters and other international bodies to help address current gaps in the international regulatory framework for Islamic banking. Directors saw merit in considering a proposal to formally recognise the "Core Principles for Islamic Finance Regulation for Banking," prepared by the Islamic Financial Services Board, as a standard under the Fund/Bank Standards and Codes Initiative. They looked forward to receiving a formal proposal for Board endorsement in the context of a forthcoming paper before end-April 2018.

Directors welcomed the progress that has been made in developing legal and governance frameworks, and regulatory and supervisory standards for Islamic banking, to complement the international norms and standards that apply beyond Islamic banks. Building on the progress made, Directors called for full implementation and consistent application of the standards, and for strengthening supervisory capacity with respect to Islamic banking. 

Directors emphasised the importance of having in place robust Islamic banking-specific resolution regimes and other financial safety nets for countries in which Islamic banking operates. Noting the slow progress achieved in these areas, they underscored the importance of additional work in collaboration with relevant international bodies on the design of legal regimes and institutional arrangements for effective Islamic banking resolution, deposit insurance schemes and AML/CFT, as well as adapting the conventional lender-of-last-resort framework to cover Islamic banking. 

Directors agreed that the availability of high-quality liquid assets for Islamic banking is important for effective liquidity management and financial stability, and for the sustainable development of the Islamic banking industry. In this context, they called for increased efforts to deepen the government Sukuk markets. Directors also noted the importance of having in place relevant central banking liquidity facilities and instruments.

Directors agreed that the emergence in recent years of hybrid financial products in Islamic banking, which replicate the relevant aspects of conventional finance, may have brought some benefits, but also raise financial stability concerns. Such concerns include the emergence of new complex risks, the applicability of existing prudential regimes, governance and consumer protection concerns, and reputational risk. Directors encouraged additional work, by staff and other relevant international bodies and standard setters, to better understand the nature of these activities and how they can be effectively regulated.

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