ISSUES CHALLENGES SOLUTIONS & CURRENT DEVELOPMENTS IN ISLAMIC FINANCE

1. ISSUES CHALLENGESSOLUTIONS & CURRENT DEVELOPMENTS IN ISLAMIC FINANCE

2. Introduction of Facilitator SYED MUHAMMAD TAQI SHAH (DAIBP) GENERAL MANAGER MARKETING HABIB INSURANCE CO. LTD FORMER HEAD OF EMPLOYEE EXCELANCE NATIONAL DATA CONSULTANTS KARACHI FORMER COUNTRY MANAGER TRAINING T-24 & BRANCHES ROLLOUT BSIG, ALLIEDBANK CELL# 0300-8645314, E-mail= syedtaqishah14@yahoo.com

3. Issues / Challenges facing Islamic banking industry

4. Islamic Finance is the outcome of CSR derived from religion and applied to banking Corporate Social Responsibility Accountability to God Corporate governance “More-than-profit” mentality Ethical profits (rather than “profits-at-any-costs”) Business ethics Shari`a “code of ethics”

5. In all, the Islamic finance industry is developing a global reach… • Growth Engine • Awakening • Ripe for Growth • Future Markets Source: Standard and Poor’s “The Globalization of Islamic Finance”

6. The development of the Islamic finance industry has been fuelled by pioneering institutions and industry building organizations

7. Growth and drive is being led by customer demand Government driven Iran Sudan • Islamic Finance was not established by a royal decree or a presidential announcement, but it was the will of the people which created the industry. • Growth in the GCC Islamic banking markets are primarily driven by customer demand • Malaysia presents a near ideal regulatory and market-driven model for Islamic business Malaysia Bahrain Pakistan Brunei UK UAE Singapore Kuwait Qatar Bangladesh Saudi Arabia USA Sri Lanka Japan Indonesia China Turkey Key: Bubbles indicate illustrative size of Islamic banking assets Egypt Source: Central Bank, Reports, industry estimates Market driven

8. THE NEED FOR INTERNATIONAL FINANCIAL REFORM • INTERNATIONAL FINANCIAL CRISES • HOW TO PREVENT SUCH CRISES FROM TAKING PLACE IN THE FUTURE? • CALL FOR A “NEW ARCHITECTURE” FOR THE FINANCIAL SYSTEM • BASLE COMMITTEE ON BANKING SUPERVISION (BCBS)

9. Islamic Banking Risk • Does Islamic banking risk differ from Conventional banking risk? • Not different - just a very special case • Trade credit ? • Asset backed Secured or unsecured ? • Debt or equity ? • Leasing / Ijara • Repos / Murabaha ? • Fund management ?

10. THE 1988 BASLE CAPITAL ACCORD • BCBS, INTERNATIONAL CONVERGENCE OF CAPITAL MEASUREMENT AND CAPITAL STANDARDS (1988) • A SIMPLE STANDARDIZED APPROACH FOR ESTABLISHING MINIMUM CAPITAL REQUIREMENTS – BANKS TO MAINTAIN CAPITAL ON THE BASIS OF FIVE CLASSES OF BORROWERS (0%, 10%, 20%, 50% AND 100%) • DID NOT DISTINGUISH BETWEEN THE RELATIVE DEGREES OF CREDITWORTHINESS AMONG INDIVIDUAL BORROWERS • APPLIED INITIALLY TO INTERNATIONALLY ACTIVE BANKS IN THE G10 COUNTRIES

11. BASLE II - 1996 • GREATER FOCUS ON RISK MEASUREMENT AND CONTROL • THE “THREE PILLARS”

12. BASLE II (1) “PILLAR 1”: CAPITAL ADEQUACY • RISK ADJUSTED CAPITAL REQUIREMENTS • THREE OPTIONS • EXTERNAL-RATINGS BASED • INTERNAL-RATINGS BASED • MODELS-BASED

13. BASLE II (2) “PILLAR 2”: SUPERVISORY REVIEW • TO EVALUATE THE RISK PROFILES OF INDIVIDUAL BANKS • SPECIFY THE NEED FOR REMEDIAL MEASURES

14. BASLE II (3) “PILLAR 3”: MARKET DISCIPLINE • ENHANCING THE DEGREE OF TRANSPARENCY IN BANKS’ PUBLIC REPORTING AND THE DISCLOSURES THEY MUST MAKE TO LEND GREATER INSIGHT INTO THE ADEQUACY OF THEIR CAPITALIZATION

15. THE CORE PRINCIPLES (1997) • BCBS, CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION (1997) • SETS OUT 25 BASIC PRINCIPLES THAT ARE REQUIRED FOR AN EFFECTIVE SUPERVISORY SYSTEM

16. THE CORE PRINCIPLES (1) • PRINCIPLES 1-5 : LICENSING AND STRUCTURE • PRINCIPLES6-15: PRUDENTIAL REGULATIONS AND REQUIREMENTS • PRINCIPLES 16-20: METHODS OF ONGOING BANKING SUPERVISION

17. REGULATION AND SUPERVISION OF ISLAMIC FINANCIAL INSTITUTIONS (1) • TWO RESPONSIBILITIES: • TO APPLY THE INTERNATIONAL STANDARDS • TO COMPLY WITH THE SHARI‘AH

18. ISSUES INVOLVED • CAPITAL ADEQUACY • EVALUATION AND CONTROL OF RISKS IN THE DIFFERENT ISLAMIC MODES OF FINANCE: • CREDIT RISK, MARKET RISK, LIQUIDITY RISK, INTEREST RATE RISK AND OPERATIONAL RISK • MUDARABAH, MUSHARAKAH, MURABAHAH, SALAM, IJARAH, AND ISTISNA‘

19. ACCOUNTING STANDARDS • INTERNAL CONTROLS AND EXTERNAL AUDIT • GREATER TRANSPARENCY • DEPOSIT INSURANCE • SHARI‘AH AUDIT

20. Issues / Challenges • SHORT‐TERM LIQUIDITY MANAGEMENT • REGULATORY AND TAX REFORMS • STAMP DUTIES • TAX INCENTIVES FOR INVESTORS • REGULATORY RESERVES AND CAPITAL REQUIREMENTS • HUMAN CAPITAL • INVESTMENT AVENUES • STANDARDIZATION OF CONTRACTS • PERCEPTION OF USERS • BENCHMARK

21. Key Recommendations • Dedicated R & D efforts to develop viable short term liquidity products for the industry • Dedicated learning centers at University level to train and develop competent workforce and Shariah Scholars • Collective mass awareness campaign by Islamic banks • State Bank should take measures for uniformity of Islamic banking contracts and products • Dedicated research and product development teams should be developed at all Islamic Financial Institutions.

22. ConclusionIslamic banking risk issues • Liquidity– under developed money market • Interest rate Risk  • Commodity Risk • Communication Risk • Equity risk – fund management or banking? • Operational risk • Religious – Hallal or Haram? • Language Risk - English, Arabic, Malay or Urdu

23. SBP “Strategic Plan for- Islamic Banking Industry of Pakistan 2014 – 2018”

24. FOCUS ON KEY AREAS

25. ENABLING POLICY ENVIRONMENT

26. B. SHARIAH GOVERNANCE & COMPLIANCE • The focus in this area will remain on standardization and harmonization of Shariah practices, as well as on creating distinct Islamic banking products and services. C. AWARENESS & CAPACITY BUILDING • Efforts will be made for coordination and collaboration amongst internal and external stakeholders, enhancing awareness about Islamic finance, and building capacity of the stakeholders

27. D. MARKET DEVELOPMENT • Initiatives will be undertaken for product diversification and financial inclusion with the collaboration of stakeholders.

28. A. ENABLING POLICY ENVIRONMENT Legal Framework • Separate chapter in Banking Company Ordinance(BCO) 1962 • Necessary changes in SBP Act 1956 • Recovery of Finance Ordinance 2001 • Microfinance Institutions Ordinance 2001 • Engagement in Real trade Real Estate Commodities • Investment banking Business • Act as Modarba Management Company • Reaching on consenses of necessary initiation in Legal and Regulatory Frame work during next 5 years.

29. Alternate Dispute Resolution mechanism • By devising customized dispute resolution mechanism • Regulations and Guidelines • Prudential Standards • Guidelines for Development Finance Institutions (DFIs) • Rationalization of Minimum Capital Requirement (MCR) • On-site Inspection Manual • Liquidity Management Framework • Tax Neutrality • Financial Accounting & Reporting

30. SHARIAH GOVERNANCE & COMPLIANCE • Adoption of Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI) Shariah Standards • Issuance of Comprehensive Shariah Governance Framework • Product Standardization and Harmonization • Guidelines for Treasury Operations/Products of IBIs • Restricted use of “Agency”, “Hiba” & “Waad” in Islamic Banking Transactions

31. AWARENESS AND CAPACITY BUILDING Coordination and Collaboration amongst Stakeholders • Building of stakeholders, to make Islamic banking industry distinct and acceptable by masses, following initiatives are identified as major components of Strategic Plan. • Given the evolving nature of Islamic finance and multi-faced issues faced by the industry, effective collaboration and co-operation mechanism amongst all the key stakeholders is critically important for sustaining the growth momentum. The plan thus envisages constitution of an Islamic Banking and Finance Consultative Group (IBFCG) under the lead of SBP with representation of IBIs, Securities & Exchange Commission of Pakistan (SECP), Institute of Chartered Accountants of Pakistan (ICAP), etc. This group will be responsible for developing and implementing strategies for development of Islamic Banking & Finance in the country. • Moreover, for the sustainable growth of Islamic Banking and Financial Industry, an active and efficient Islamic capital market and Takaful industry are essential components. The joint forum of SBP and SECP on Islamic banking and finance will be actively utilized for collaboration between the two financial sector regulators to synergize their efforts for facilitating development of the industry on sound footings.

32. Similarly the cooperation and collaboration with International Islamic Infrastructure Institutions like Islamic Financial Services Board (IFSB), IIFM, AAOIFI, and Islamic Research and Training Institute (IRTI) will be strengthened for improving the policy and business environment and capacity building of the industry. • Further, being an important and active player of global Islamic finance having ample technical expertise and resources in this field, technical and intellectual assistance will be extended to the countries who are new entrants into Islamic banking & finance. SBP in collaboration with NIBAF will also design and offer customized training programs for international participants from central and Islamic banks of other countries, especially GCC and Central Asian countries. Efforts will also be made to market NIBAF’s Islamic Banking Certification Course (IBCC) as an internationally recognized certification for Islamic banking professionals.

33. MARKET DEVELOPMENT • Product Diversification • Financial Inclusion • Agriculture Financing • Small and Medium Enterprises (SMEs) Financing • Low Income Housing • Islamic Microfinance (MF) • Refinance Schemes • Market Share • Alternate Delivery Channels (ADC)

34. Way Forward Legal, Regulatory and Supervisory Framework Enabling Policy Environment

36. Liquidity Management Framework

37. Taxation Regime

38. Financial Accounting and Reporting Framework

39. Shariah Governance and Compliance

40. Awareness and Capacity Building

41. Awareness Enhancement

42. Capacity Building

43. Market Development

46. QUESTIONANSWERSESSION