YBhg Dato’ Zarinah Anwar, Chairman,
Securities Commission Malaysia
IFSB Seminar on Rating of Institutions Offering Islamic
Financial Services and Islamic Financial Instruments
20 February 2008
Conference Hall, Securities Commission Malaysia
Professor Rifaat Ahmed Abdel Karim, Secretary-General of the Islamic Financial Services Board,
Ladies and Gentlemen,
Let me begin by congratulating IFSB for organising this seminar and for bringing together very key speakers on a range of topics relating to the very important area of rating of institutions offering Islamic financial services and instruments. On behalf of the Securities Commission Malaysia, I would like to say how pleased we are to be able to host this seminar. I would also like to extend a warm welcome to all participants and to welcome our foreign guests to Malaysia.
This seminar is indeed timely given the current turmoil affecting the financial services industry in the U.S. and Europe. It is interesting and re-assuring to note that so far, the Islamic financial services industry has largely been protected from the global credit crunch and the U.S. sub-prime crisis.
Concerns about Current Risks and Rating Standards
This however is no excuse for complacency. The collapse of the U.S. sub-prime market, and its far-reaching consequences across the global financial market, have raised important implications and concerns among regulators. For regulators in markets with a sizeable Islamic financial services industry, a key priority is to ensure that the industry continue to remain strong and inspire the confidence of the ever-increasing number of investors, issuers and intermediaries that participate in the industry world-wide.
We must therefore continue to ensure that current risk standards are adequate and proper, given the fact that most of the conventional banks affected by the sub-prime crisis are no small players, but instead, are of international standing, have high ratings, practice good governance and possess high calibre management capabilities.
It is therefore crucial that the industry, supervisory institutions and regulators all play their part in bringing about comprehensive and effective initiatives which will further improve market transparency and risk management practices. I am glad to see many of these parties among the audience today as this seminar will give us the right opportunity to come together and formulate the necessary methodologies and measures to ensure that the rating of Islamic financial service providers are comprehensive and reflective of the strength and capabilities of the rated institutions.
Growth of Islamic Financial Services Industry
Over the last decade or so, the industry has achieved remarkable growth. We read of new products, new markets and new linkages almost on a daily basis. Markets are linked as never before. Notwithstanding these frenetic developments, it is encouraging to note that risk management practices among the Islamic financial services providers, through efforts by IFSB, has continued to grow in importance. We have also witnessed considerable progress in the efforts of intermediaries at enhancing their risk management capabilities, particularly in traditional areas such as market, credit and liquidity risks.
Limitations of Risk Measurement Methodologies
There are however limitations. We assume that financial risks are predictable and assessable through the use of historical data. While, history is indeed a useful starting point for recognizing and assessing risk, risk trends do not necessarily follow historical patterns. Most instances of sudden deterioration in the credit standing of a corporate borrower for example, are not predictable. This reflects fundamental weaknesses in economic or financial structures that are not captured by the available data. The current sub-prime crisis is a good example. As for the Islamic financial services sector, there is the added reality that available history is too short to provide a good base for an assessment of risk trends.
Determining Shariah Compliance
We can however take comfort in the fact Islamic financial services and products have inherent strengths in that the transparency requirements differ greatly from conventional finance. Ensuring Shariah compliance necessarily demands a more robust disclosure regime which requires a thorough evaluation and analysis of products and processes, prior to any approval. As a result, every stage of a transaction is comprehensively assessed to ensure compliance with shariah requirements. In theory therefore, shariah compliant products or operations pose lower probabilities of submerged weaknesses. The challenge therefore is how to further strengthen the operational aspect of ensuring shariah compliance.
Managing Competition and Measuring Strength
In today’s business environment, the ability to process information on risks and returns on investment opportunities, will determine the strength, soundness and efficiency of capital mobilisation and allocation capabilities. In short the market needs to be guided by standards that measure such qualities of the institutions. Thus, as the Islamic financial services providers compete with and complement each other in financial intermediation, their ability to manage capital efficiently will determine their competitive edge.
Unique Risks in Islamic Financial Services Businesses
The Islamic financial services industry must not only deal with risks unique to the industry, but also with risks, arising from new products and structures. These include risks associated with risk sharing arising from the nature of the underlying contracts as well as possible variations in shariah application with respect to these contracts. Therefore these institutions are not only expected to be well equipped with the skills, but also well informed on all aspects of shariah application and its implications.
In the past, we have only seen the use of less risky contracts such as murabahah and ijarah as the primary contracts for capital raising or mobilisation. Today, participatory contracts such as musharakah or mudharabah, with profit-and-loss sharing or profit sharing structures, are becoming widespread. Furthermore, these contracts now appear not only in their traditional structures, but also in composite forms as structured products.
Evaluating Shariah Safety and Soundness
Aside from addressing the adequacy of capital, quality of assets, capability of the board of directors and management, the quality of earnings and adequacy of liquidity, this evaluation must also be able to determine the safety and integrity of the institutions. This goes beyond just taking into account the managerial, operational, financial and performance factors, but also the capability and integrity of the shariah management team. In other words shariah safety and integrity can be taken as a separate component.
As Islamic financial services industry advances to become an integral component of the international financial system, continuous efforts are needed to further develop measures and methodologies on rating that are appropriate to meet the changing requirements of a highly dynamic and rapidly evolving environment. In our quest to build a viable and sustainable Islamic financial system, the aim is to contribute to the channeling of capital flows to productive investments, create wealth and promote economic activities, that conform to the principles and values of shariah. With this, the Islamic financial system will ultimately bring benefit not just among Muslims but with the rest of humanity, Insya Allah.