“Islamic financial transactions must be both lawful and ethical”

Jaseem Ahmed

Jaseem Ahmed was appointed secretary-general of the Islam­ic Financial Services Board (IFSB) in May last year. Before joining the IFSB, he was a director at the Asian Development Bank and led the bank’s response in the Southeast Asia region to the global economic crisis. Here, he explains some of the key dif­ferences between Islamic and conventional banking and speculates on the future development of the sector 

Global: What are the basic principles and origins of Islamic banking?
Jaseem Ahmed: Islamic finance is based on principles that stress the importance of a direct linkage between finance and the real economy. Financial transactions must contribute to production, while promot­ing social justice and equity. Profit and risk sharing are encouraged. Returns in the absence of risk or returns in the absence of an underly­ing productive activity are prohibited. 

How does Islamic finance differ from its conventional counterpart?
I would start with what it shares with conventional finance. The underlying values of Islamic finance are universal and common to Judeo-Christian beliefs, and are derived from the body of Islamic law – known as shariah. Islamic financial transactions must comply with shariah, and thus must be both lawful and ethical. 

One way in which Islamic finance differs is that there is a ‘nega­tive list’ of what is prohibited by shariah, and this includes contracts that involve selling things that are not owned by the counterparties (hence no short selling), gambling, hoarding and dealing with un­lawful goods and services, which would include alcohol and pornog­raphy. A central difference is the prohibition on interest or usury, and this is linked to the idea that money cannot generate money – that there must be an underlying productive activity or real investment that generates a return. 

Amongst the most significant differences in the two systems is the attitude towards debt and the burden it places on individuals and societies. Islamic finance does not prohibit debt, but it con­strains debt and requires that it be encompassed by ethical con­siderations that impose obligations on both borrower and lender. Loans must be without interest; there is an obligation to return loans, but there is also an obligation on the part of the creditor to take the borrower’s circumstances into account. This is relevant for today’s post-crisis world in which the global economic recovery is weighed down by the huge burden of consumer debt. 

What is the role of the IFSB? Where does its authority come from and which institutions are subject to it?
The principal role of the IFSB is to contribute to the soundness and stability of the Islamic financial services industry through the issu­ance of standards and guiding principles for prudential supervision and regulation of the industry. 

In this sense, our role is essentially similar to the roles played by the three global standard-setters for conventional finance: the Basel Committee for Bank Supervision, the International Organization of Securities Commissions and the International Association of Insur­ance Supervisors. The difference is that we combine the roles of the three bodies into one organisation. At the same time, we have a mandate to promote cooperation in our member jurisdictions. We also have a major work programme to assist in the implementation of the standards we issue. 

When the IFSB was established in 2002, it had nine founding members. Today, we have 189 members across 43 jurisdictions. One third of our members are regulators or supervisors, while two thirds are private sector institutions, so we capture the broad base of the global Islamic finance industry and help to provide a com­mon frame of reference. However, we do not have formal authority over our members – implementation of our standards is voluntary. 

The IFSB is headed by a council that comprises 21 members, of whom 20 are governors of central banks. This is similar to the structure of the Basel Committee and underscores the intent to put Islamic finance on a comparable footing in terms of its global fi­nancial architecture to conventional finance. I should add that the Bank for International Settlements is a member of the IFSB, as are the IMF, the World Bank and the Islamic Development Bank. 

How does the IFSB establish common standards? What constraints do you operate under?
Conformity with shariah governs all our standards. In practice, we begin by looking at the fundamental standards that exist for conven­tional finance – such as that for capital adequacy of banks – and we adapt these standards for the specific characteristics of Islamic finan­cial institutions. But we also develop standards that are new – for example, for takaful, which is a mutual-based form of risk sharing that corresponds to, but is not identical with, conventional insurance. Even when we are working in areas that have no counterpart in con­ventional finance, our work draws on universal principles. 

In terms of constraints, the diversity of economic, institutional and market development in our member jurisdictions shape the way our standards are framed. We have to take into account the latest regulatory developments, whilst recognising that some coun­tries are not ready for such systems. So our standards have to be general enough that they can be adopted in part, or in full, depend­ing on the state of readiness of the country concerned. 

Other than that, we are a small organisation with a wide mandate in a rapidly expanding industry with global reach. Hence, there are internal issues of focusing our limited resources in a consistent and efficient manner. We are trying to address this by adopting more modern methods of allocating resources. 

How can a mechanism be established that ensures the common enforcement of shariah by different institutions and across borders?
This is a very important area, but perhaps also one which is easy to misunderstand. Muslims worldwide recognise the unity of their faith but there is also recognition of diversity reflected. 

The IFSB does not have a mandate on shariah issues, per se. At the national level, history and the institutional structure are very impor­tant, with some countries more willing, and able, to adopt centralised structures for shariah than others. Therefore, there is no ‘one-size-fits-all’ solution. At the global level, where cross-border financing is needed to link Islamic capital markets and give them scale and depth, there is a need for a clearer and wider consensus on shariah issues. 

I think the way forward is to recognise that there will be irre­ducible differences in shariah approaches, but that it is possible to work towards an expanding consensus. At the same time, there is also a process of market-determined outcomes that shape the shariah decisions that investors and issuers appeal to. More impor­tantly, we are seeing Islamic financial institutions looking carefully at their target markets and adapting their financing modalities to conform to shariah rulings in those jurisdictions. This is a process that is bound to lead to greater convergence. 

How can Islamic financial institutions develop products that are consistent with shariah at the same time as being competitive in the conventional market?
I think the rapid growth and expansion of Islamic finance has dem­onstrated that it is a viable industry offering viable products. The real challenge ahead is that it is becoming too large to ignore and is acquiring systemic importance in a number of countries. That is why a significant part of the IFSB’s work programme is on stability issues such as liquidity risk management and stress testing. How­ever, its competitiveness will be enhanced through greater stand­ardisation of documentation and legal structures, as well as other measures for transparency and disclosure that serve to strengthen consumer and investor confidence. 

What is the outlook for the Islamic financial sector over the next 20 years? Where can we expect to see the largest areas of growth?
I think the outlook is bright. Over the long term, I expect the shifts in the global economy, with expanding populations and long-term growth prospects for emerging economies, will boost the demand for Islamic finance in Africa, Asia and the Middle East. This process will be further strengthened by the impact of supply-side measures in terms of product innovation and in terms of stronger legal and regulatory frameworks as reform measures planned or under way are completed. 

A significant number of the IFSB member organisations have plans to implement the IFSB standards over a three- to five-year time frame, which will strengthen this process and help promote deepening pools of shariah-compliant savings globally. These savings will help to meet an increasing portion of the infrastructure and economic development needs of emerging countries, and perhaps also the needs of Europe and North and South America. As the industry matures, over the next 10 to 20 years, the broader availability of shariah-compliant financial services will translate into greater financial and social inclusion in our emerging market members. 

The largest areas for growth will vary across countries, and in the economies with large populations it is likely to come initially from wider access to finance through retail, SME [small and medium enterprise] and micro-finance applications. In addition, Islamic housing finance is a promising option to meet the needs of expand­ing populations with rising incomes. Asset management and pri­vate equity are nascent areas today, but will certainly develop into more significant activities. In sum, from financing infrastructure and housing to banking the unbanked, there is much that Islamic finance can help to achieve during the next 20 years.

About the author:

Jaseem Ahmed is the Secretary- General of the Islamic Financial Services Board


Sorry, the comment form is closed at this time.

Amnesty International