Islamic Financial Architecture
and Infrastructures:
Development and Challenges
Tariqullah Khan
Outline
1. Overview of International Financial Architecture
2. Defining Islamic Financial Architecture and Infrastructures
3. Building Blocks of Islamic Financial Architecture 4. Lessons drawn from Global Financial Crisis
5. Building Blocks of Islamic Financial
Infrastructures
6. Development: Challenges, Institutions and
Defnition of fnancial architecture
Financial architecture is …. the 1)
institutions, 2) markets, and 3) practices
that governments, businesses, and
individuals use when they carry out
economic and fnancial activities.
IMF (2000) - “Reforming the International Financial Architecture – Progress Through 2000”
Purpose: Enhancing financial sector
development & performance and
Pillars of Financial Architecture
Pillar-1: Objectives of fnancial
architecture
Pillar-2: Specialization of standard
setting and infrastructure
development institutions
Pillar-3: Functional relationships
1. Detecting and Monitoring External Vulnerabilities
2. Strengthening Financial System Performance and Stability
3. Observance of International Standards and Codes
4. Capital Account Issues
5. Pursuing Sustainable Exchange Rate Regimes 6. Involving the Private Sector in Forestalling and
Resolving Crises
7. Measures to Increase Transparency
8. Reform of IMF Financial Facilities and Related Issues
Pillar-1: Objectives
Pillar – 2: Specialized functional areas of standard setting and infrastructure development institutions
Specialized Standard Setting Bodies
Basel Committee for Banking Supervision (BCBS) International Organization of Securities
Commissions (IOSCO)
International Association of Insurance Supervisors (IAIS)
Multilateral Institutions World Bank
International Monetary Fund Regional Banks
Basel IOSCO IAIS
G7/G10
IMF
Development Banks
International Monetary and Financial
Financial Committee; Stability
Development Committee; Forum
G-7/G-10;
IMF, World Bank Executive Boards
Chart 1
Source: Evans (2000, p.27)
Developing Countries International Financial Architecture
Other Industrial Countries
Pillar-3: Functional Relationships between
specialized entities
1. Financial Sector Assessment Program (FSAP) of IMF and World Bank
2. Reports on Observance of Standards and Codes (ROSCs)
Pillar – 4: Financial Sector Development
& Performance Assessment
Coverage includes:
• Banking
Supervision,
• Data
Dissemination,
• Fiscal
Transparency,
• Monetary &
Financial
Transparency Policies
Operational nature:
• Joint World Bank
& IMF character
• Voluntary
participation
• Case-by-case
Components of Islamic Financial
Architecture
Local Component
↓
National
Financial
Infrastructures
(NFI)
Global
Component
↓
International
Financial
Architecture
Components of International
Islamic Financial Architecture
Universally acceptable
guiding principles of Islamic
economics and fnance
Internationally
credible & comparable best practices derived
from the guiding principles
National Islamic fnancial
infrastructures
Legal, regulatory, supervisory, tax and other enabling, support and enforcement facilities, instruments and resources
needed for implementation and compliance with the universally
acceptable Islamic guiding principles and best practices
At the across border level – regional and multilateral
institutions, arrangements and facilities for compliance with the
universally acceptable Islamic guiding principles and best
practices
N
at
io
na
l
C
ro
ss
B
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1. Establishing universally acceptable guiding principles for Islamic financial practices
2. Establishing best practices for Islamic financial services in areas of:
• Shariah and corporate governance
• Corporate ethics and social responsibility
• Transparency and disclosures
• Risk management
• Capital adequacy
• Accounting and auditing
3. Narrowing Fiqh Interpretations
4. Common regulatory and supervisory regime
5. Compliance with relevant international best practices
First Building Block of IIFA:
Guiding Principles of Islamic Economics and Finance
Rules governing prohibitions – Riba, Gharar, Qimar, etc. Consumption,
fnancing, production, and transaction of prohibited items
Principles governing what is permitted - sales, fnancing, investment, trade and commercial transactions
Norms guiding good behavior and dealings with others
Second Building Block of IIFA:
Shariah Standards (Accounting and Auditing
Organization for Islamic Financial Institutions - AAOIFI)
1.Trading in
Currencies 7. Hawala 13. Mudaraba 19. Loan (Qard) 25. Combination of Contracts 2. Debit Card,
Charge Card and Credit Card
8. Murabaha to the
Purchase Orderer 14. Documentary Credit 20. Commodities in Organized Markets 26. Islamic Insurance
3. Default in
Payment by a Debtor
9. Ijarah and Ijarah
Muntahia Bittamleek 15. Jua’la 21. Financial Papers (Shares and Bonds)
27. Indices
4. Settlement of Debt by Set-Off
10. Salam and Parallel
Salam 16. Commercial Papers
22. Concession
Contracts 28. Banking Services
5. Guarantees 11. Istisna’a and
Parallel Istisna’a 17. Investment Sukuk 23. Agency 29. Stipulations and Ethics of Fatwa in the Institutional Framework 6. Conversion of a
Conventional Bank to an Islamic Bank
12. Sharika
(Musharaka) and Modern Corporations
18. Possession
Third Building Block of IIFA:
Accounting Standards issued by AAOIFI
1. Objectives of Financial Accounting for Islamic Banks and Financial Institutions
7. Disclosure of Bases for Profit Allocation Between Owners’ Equity and Investment Account Holders
13. Provisions and Reserves 19. Investment
2. Concepts of Financial Accounting for Islamic Banks and Financial Institutions
8. Equity of Investment Account Holders and Their Equivalent
14. General Presentation and Disclosure in the Financial Statements of Islamic Insurance Companies
20. Islamic Financial Services offered by Conventional Financial
Institutions 3. General Presentation
and Disclosure in the Financial Statements of Islamic Banks and Financial Institutions
9. Salam and Parallel Salam
15. Disclosure of Bases for Determining and Allocating Surplus or Deficit in Islamic Insurance Companies
21. Contributions in Islamic Insurance Companies
4. Murabaha and Murabaha
to the Purchase Orderer 10. Ijarah and Ijarah Muntahia Bittamleek 16. Investment Funds 22. Deferred Payment Sale 5. Mudaraba Financing 11. Zakah 17. Provisions and Reserves
in Islamic Insurance Companies
23. Disclosure on Transfer of Assets 6. Musharaka Financing 12. Istisna’a and Parallel
Istisna’a
18. Foreign Currency
Transactions and Foreign Operations
Fourth Building Block of IIFA
Shariah Governance Standards
1. Governance
2. Shariah Supervisory Board: Appointment, Composition and Report 3. Shariah Review
4. Internal Shariah Review
5. Audit and Governance Committee for Islamic Financial Institutions 6. Independence of Shariah Supervisor Board
7. Statement on Governance Principles for Islamic Financial Institutions 8. Code of Ethics for Accountants and Auditors of Islamic Financial
Institutions
9. Code of Ethics for the Employee of Islamic Financial Institutions
Standards Issued by AAOIFI
Standard Issued by Islamic Financial Services Board
“Guiding Principles on Corporate Governance for Institutions Offering Only Islamic Financial Services (Excluding Islamic Insurance (Takaful) Institutions and Islamic Mutual Funds -
-Fifth Building Block of IIFA
Prudential guidelines and standards for Islamic fnancial services
1. IFSB-7: Capital Adequacy Requirements for Sukuk, Securitisations and Real Estate
investment
2. IFSB-6: Guiding Principles on Governance for Islamic Collective Investment Schemes
3. Guidance Note In Connection with the Capital Adequacy Standard: Recognition of Ratings
4. IFSB-5: Guidance on Key Elements in the Supervisory Review Process
5. IFSB-4: Disclosures to Promote Transparency and Market Discipline
6. IFSB-3: Guiding Principles on Corporate Governance
7. IFSB-2: Capital Adequacy Standard
Lessons drawn from global fnancial crisis & strengths of the IIFA
Lesson-1: Incentive structures; replacement of interest with
proft sharing introduces fundamental changes in
incentive systems
Lesson-2: Excessive leverage; strong linkages between
fnancing and real economic transactions controls
leverage
Lesson-3: Controlling speculation; “don't sell what you don’t own” rule limits speculation
Lesson-4: Pyramid of debts; prohibition of sale of debt eliminates debt pyramids
Lesson-5: Regulation failure; Shariah supervision reduces the risk of failure of regulation
Lesson-6: Social responsibility; Ethical screening of investment opportunities strengthens social responsibility of wealth managers
Hence, IIFA has the inherent features and inbuilt characteristics that ensure productive utilization of
Pillars of & Building Blocks
of Sound Financial
Pillars of a sound national fnancial
infrastructure
• Pillar I—Macroprudential surveillance and fnancial
stability analysis by the authorities to monitor the impact of potential macroeconomic and
institutional factors (both domestic and external) on the soundness (risks and vulnerabilities) and stability of fnancial systems
• Pillar II—Financial system supervision and
regulation to help manage the risks and
vulnerabilities, protect market integrity, and
provide incentives for strong risk management and good governance of fnancial institutions
• Pillar III—Financial system infrastructure:
– Legal infrastructure for fnance – Systemic liquidity infrastructure
– Transparency, governance, and information infrastructureFSAP: A Handbook, Chapter -1
Building blocks of national Islamic
fnancial infrastructures & challenges of
enhancing them
Building Block-1: Shariah Supervisory Systems Building Block-2: Legal, Regulatory and Tax
Framework
Building Block-3: Application of AAOIFI & IFSB standards of best practices for the
Islamic fnancial services
Building Block-4: Supervisory framework
Building Block-5: Lender of last resort facility &
systemic liquidity infrastructure
Building Block-5: Deposit protection system Building Block-6: Human capital
Areas of Standards Key Agency(s) in the International
Financial Architecture Corresponding Agency(s) in Islamic Finance
1. Accounting International Accounting Standards Board (IASB), International Federation of
Accountants (IFAC), Committee on Banking Supervision (BCBS)
AAOIFI
2. Anti-Money Laundering / Combating the Financing of Terrorism
Financial Action Task Force (FATF) Common
Auditing International Federation of Accountants
(IFAC) AAOIFI
3. Banking Committee IFSB
4. Corporate Governance OECD, Basel Committee, World Bank AAOIFI and IFSB
5. Data Dissemination IMF Common
6. Fiscal Transparency IMF Common
7. Insolvency and Creditor
Rights Systems World Bank, United Nations Commission on International Trade Law (UNCITRAL), International Bar Association (IBA)
Not yet addressed but
especially critical for Islamic financing as it is based on risk sharing
8. Insurance Regulation International Association of Insurance
Supervisors (IAIS) Not yet addressed but within the mandate of IFSB 9. Monetary & Financial
Transparency Policies IMF Common
10. Payments Systems Committee on Payment and Settlements
Systems (CPSS) Common
11. Securities Market Regulation International Organization of Securities
Commissions (IOSCO) Not yet addressed but within the mandate of IFSB
Islamic Financial Architecture - Challenges of Development
1. Enabling Environment
2. Effective Shariah Supervision and Governance
3. Balancing speed and genuineness
4. Application of AAOIFI and IFSB Standards
5. Safeguarding against systemic risks of conventional
system
6. Preventing risk transmission from conventional to Islamic
financial institutions
7. Preventing risk transmission within Islamic funding source
# Institution Mode of contribution
to IIFA &
Infrastructures
1 Islamic Development Bank (1976) TA, equity support and collaboration with IFSB, IMF and World Bank & others
2 The Islamic Research and Training Institute (IRTI) (1981)
Research, training & Information services 3 The Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI) (1991)
Standard setting and training
4 International Islamic Financial Market
(IIFM) (2001) Product development and training 5 The General Council of Islamic Banks
and Financial Institutions (GCIBFI) (2001) Product development, training and research 6 The International Islamic Rating Agency
(IIRA) (2002)
Rating services
7 The Islamic Financial Services Board
(IFSB) (2002) Standard setting and training
8 International Islamic Centre for Reconciliation and Commercial Arbitration, (IICRACA) (2005)
Dispute resolution
References
IMF & World Bank, Financial Sector Assessment – A Handbook (
http://web.worldbank.org/WBSITE/EXTERNAL/WBI/WBIPROGRAMS/FSLP/0,,
contentMDK:20656885~pagePK:64156158~piPK:64152884~theSitePK:461005 ,00.html
)
IRTI/IFSB, IFSI Development: 10 Year Framework and Strategies (http://
ibisonline.net/En/Policy_Dialogue/TenYearFrameworkAndStrategies.pdf)
Chapra, M.U and Tariqullah Khan, Regulation and Supervision of
Islamic Banks, IRTI (http://
irtipms.org/PubSearchOutE.asp?lang=e&mode=allwords&search=regulation)
Khan, Tariqullah and Ahmed Habib, Risk Management – An Analysis of
Issues in Islamic Financial Industry, IRTI (http://
irtipms.org/PubDetE.asp?pub=91&search=risk&mode=allwords)
Khan, Tariqullah and Muljawan, Dadang, Islamic Financial
Architecture: Risk Management, Regulation and Supervision, IRTI (
http://
Thanks
tariqullah.khan@isdb.org
http://
