Islamic Finance Moves Toward Common Standards

Regulation should help provide a basis for the industry's expansion.

Islamic finance is one of the fastest growing segments of international financial markets. Currently, total sharia-compliant assets amount to an estimated $1.125 trillion to 1.275 trillion, with an annual growth rate of 15-20%. The global credit crunch has not left it unscathed, and recent capital market growth has been hampered by conflicting interpretations of the sharia compliance of specific wholesale product structures (sukuk). Nevertheless, the outlook for the sector is positive.

AAOIFI. Efforts to standardize Islamic financial products should enhance the sector's prospects. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) plays an important role in this regard:

--Originally subscribed by an alliance of domestic and international Islamic banks as well as the Islamic Development Bank, industry-sponsored AAOIFI has since extended its membership categories to include authorities that regulate and supervise Islamic financial institutions.

--It also offers observer member status to conventional financial institutions that operate Islamic 'windows' (special facilities offered by conventional banks to provide services to Muslims who wish to engage in Islamic banking).

Standards. AAOIFI’s Sharia Standards 2010 contains 41 standards, including 11 new stipulations pertaining to gharar (uncertainty) in financial transactions, arbitration, zakat (alms giving) and online financial transactions among others. Additionally, its Accounting, Auditing and Governance Standards 2010 contains 40 standards covering the areas of accounting, auditing, ethics and the governance of Islamic financial institutions.

National adoption. These standards are primarily targeted at individual Islamic financial institutions, but they have also been adopted at a national level:
--The AAOIFI's standards have been made mandatory for Islamic financial institutions in Bahrain, Dubai International Financial Centre, Jordan, Sudan, Syria and Qatar.

--Last month the State Bank of Pakistan announced that it had begun selectively to implement AAOIFI Sharia Standards and has advised Islamic banks to prepare for the phasing in of further standards in the near future.

--In other countries, including Indonesia, Lebanon, Malaysia, Saudi Arabia and the United Arab Emirates, AAOIFI standards have been incorporated into national guidelines and are adhered to by AAOIFI member institutions.
Standardization issues. The lack of standardization of Islamic financial products has been a major barrier to the cross-border sale of Islamic financial products. The AAOIFI and its sister standard-setting organization, the Kuala Lumpur-based Islamic Financial Services Board (IFSB)--primarily tasked with developing capital adequacy rules for Islamic financial institutions--have become key players in the construction of the emerging international framework that governs Islamic finance. The AAOIFI has over 200 members from 45 countries while the IFSB has 193 members operating in 39 jurisdictions.

More intrusive regulation. So far the compliance of member institutions with the standards can neither be enforced nor fully monitored, unless they are mandated at country level and then enforced by domestic regulators. Last month, the AAOIFI announced a timetable for taking a more intrusive approach to regulating Islamic financial products, including plans to create a watchdog committee--composed of sharia scholars and market practitioners--by the second half of 2010. However, increasingly different trajectories of Islamic banking and Islamic capital market development could in turn affect the further standardization of Islamic financial products.
Challenges. There are two major challenges to the further growth prospects and pace of development of the industry. Both could benefit from enhanced standardization and the AAOIFI's work more generally:

--Interpretation of Islamic law. Given the absence of a highest religious authority in majority Sunni Islam, assessing the Sharia quality of Islamic financial products depends on a number of representatives from different legal schools with sometimes widely varying interpretations.

--Scarcity of qualified sharia scholars. To address the shortage of scholars well versed in both sharia and finance, a number of programs have sprung up that offer degrees in Islamic finance.

Outlook.Overall, the outlook for Islamic finance remains positive. Recent efforts to develop common standards for Islamic financial institutions should help to provide a sound basis for the expansion of the industry.

Source: Forbes

Islamic Finance is Booming

Edited by Elisabeth Eaves and Michael Noer

At least $500 billion in assets around the world are managed in accordance with Sharia, or Islamic law, and the sector is growing at more than 10% per year.

In spirit, Islamic finance seeks to promote social justice by banning exploitative practices. In reality, this boils down to a set of prohibitions--on paying interest, on gambling with derivatives and options, and on investing in firms that make pornography or pork.

No one can say for sure how many of the world's 1.3 billion Muslims will demand Sharia-compliant financial products, but if even a fraction do, the world's largest banks will be happy to oblige.

But just 20 men (and, yes, they are all men) are the gatekeepers to this lucrative realm. These are the top-tier Islamic scholars whose stamp of approval is required before the world's banks can market a new financial product as being consistent with Islamic law.

Why so few? First of all, it can take 15 years of studying Islamic law--and years more of financial training--before one can make a ruling with any authority. There are probably no more than 260 scholars, worldwide, that have the necessary knowledge. And only a handful of these have the combination of business savvy and linguistic skills needed to work with top-tier financial institutions like Citigroup (nyse: C - news - people ), Barclays (nyse: BCS - news - people ) or HSBC (nyse: HBC - news - people ).

"It's a limited specialization with limited practitioners, and even among the people with the specialization only a handful are suitable for working with international financial institutions," said Yusuf Talal DeLorenzo, a U.S.-based scholar who is one of the chosen few. "A passing knowledge of English is generally not enough when a scholar has to wade through hundreds of pages of a prospectus or legal documents."

Additionally, major banks prefer to--and in some cases are required to--turn to people who are already well established.

"Western institutions tend to go with big names who have been working with them and have built up a reputation over the past 15 or 20 years partly because their risk management systems require them to do so," explained Humayon Dar, chief executive of BMB Islamic, a London-based consultancy.

As a result, the top scholars can sit on anywhere from 10 to 40 "Sharia compliance" boards each. The limited supply of experts is reflected in their outsized compensation. Estimates of compensation for each board seat range from between $10,000 to $1 million annually, meaning top-tier scholars are likely earning eight-figure incomes.

"They are certainly pricey by reputation but they never talk about remuneration," said Joseph Connolly, professor of Islamic finance at the École Nationale des Ponts et Chausées in Paris.

The scarcity of scholars poses major ethical challenges, argues Connolly. While it is not entirely unusual in the U.S. for prominent corporate executives to sit on multiple boards, they are not spread nearly as thin as their Islamic scholar colleagues. By way of comparison, there are more than 50,000 directors of public companies in the U.S. Just over 200, or less than one-half of 1%, sit on six or more boards.

"If you are on the board of the bank that is bidding on a multibillion-dollar banking deal, which is being financed according to Sharia law, and you sit on the board of a competitor that is also bidding, there is a real concern about insider information," said Connolly.

So far the dearth of scholars doesn't seem to have held back growth of the industry. "The banks are using these scholars very effectively," said Connolly.

Specialized consultancies such as BMB Islamic and Sharia Capital have sprung up, which do a large part of the groundwork on the products and help banks liaise with the scholars.

But with Islamic finance projected to grow to up to $1 trillion within the next few years, according to McKinsey & Company, an American consultancy, banks are very aware of the importance of bringing in new scholars. "Banks would like to see the number of scholars double within the next year or two," said Connolly.

Rather than training new students in Islamic law, banks are pushing for finance programs targeted at existing Sharia scholars. Connolly will be launching a course in capital markets and treasury products, at the American University in Cairo, specifically targeted at Islamic scholars. The one-week intensive course will be held in Europe, most likely in Switzerland, this summer, with sponsoring banks putting up their own candidates. Connolly is expecting around 25 scholars to take part.

"We will explain complex financial instruments to them and we can leave it up to them to decide whether these are sinful or not," he said.

Source : Forbes.com

The Harvard Islamic Finance Information Program

The Islamic Finance Project (IFP) is the continuation of the Harvard Islamic Finance Information Program (HIFIP), which was established by the Center for Middle Eastern Studies in 1995. IFP is now part of the Islamic Legal Studies Program (ILSP) at Harvard Law School. It aims to study the field of Islamic finance from the legal and shari'a points of view by analyzing contemporary scholarship, inducing collaboration among scholars within and outside the Muslim world, and increasing the interaction between theory and practice in Islamic finance.

Drawing on resources in the fields of law, economics, business, and Islamic studies, IFP compiles specialized bibliographies with the primary goal of acting as a point of convergence for information about Islamic finance and economics for academics, researchers, and industry professionals, not only to serve researchers but also to promote dialogue for better understanding of the field. IFP DataBank is a premier source of information for researchers and practitioners.

Over the last ten years, the subject of Islamic finance has attracted growing interest among academics, students and professionals around the globe. The Islamic Investment Study, conducted by Professor Frank E. Vogel at the Law School and Professor Samuel Hayes, III, at the Business School culminated in the 1998 publication of Vogel and Hayes' Islamic Law and Finance: Religion, Risk, and Return. This landmark study, which has been well received by scholars and students alike, underscores Harvard's leadership role in the field.

IFP, through its wide array of activities, seeks to build upon these contributions. Since its transfer to the law school, IFP has conducted research on the effects of 9/11 on the Islamic finance industry, has hosted a seminar featuring the world renown economist Professor Jeffrey Sachs on the long-term economic perspectives of the Middle East, and it is already in the final stages of preparation for what is perhaps the first seminar that brings together the key players of Islamic financial institutions and regulatory agencies in the United States government. And this is just part of the many activities that IFP has undertaken in its quest to study the growing field of Islamic finance. As these activities demonstrate, IFP at the law school is poised to offer the field of Islamic finance a much needed academic thrust.

IFP seeks to develop an increased awareness and understanding of Islamic finance both within the Muslim world and in the West. To this end, the Project sponsors seminars, workshops, lectures, and forums on topics relevant to Islamic finance. Most noteworthy is the Harvard University Forum on Islamic Finance, organized and hosted by HIFIP since 1997. IFP publishes the proceedings of the conference and seminars, an original contribution to the growing scholarship in this field.

Research: IFP conduct original research as well as participate within Harvard for projects relating to Islamic finance. This includes theses/dissertations, case studies, as well as term papers. The Project also assists students and other researchers outside Harvard with advice and direction to the best resources. The ILSP Visiting Research Scholars Program also encourages scholars to study Islamic finance topics from legal standpoint. Interested candidates are encouraged to contact ILSP directly (see the above web link).

Research Assistance: IFP allows researchers in Islamic finance and economics access to its vast store of information through its DataBank. Researchers throughout the world are encouraged to login to IFP DataBank to obtain information needed to facilitate their work. Researchers and professionals are encouraged to submit online their publications both published and un-published for consideration to be included in the DataBank.

Present Researchers: IFP employs several students, drawn mainly from Harvard Law School, Harvard Business School, Harvard College, but also from the Harvard graduate schools. It is these students who carry out the enormous task of research topics, compiling and updating the DataBank as well as organizing the Forum.

Career Opportunities: In the years since its inception, HIFIP has helped create career opportunities for the students it has employed. IFP continues this service to Harvard graduates. Having graduated, many of the associates of the Project are now employed in prominent institutions, including several leading financial and consulting firms, both within and outside the Islamic financial industry.
Information Sessions: IFP organizes information sessions (formal and informal) throughout the year for members of the Harvard community interested in Islamic banking and finance. At its offices, IFP has held informal discussions with students from Harvard Law School, Harvard Business School, Harvard College, and the Graduate School of Arts and Sciences. The Project plans to continue offering session and colloquium in future forums.