MOHE Centre of Excellence

Professor Dr Rashidah Abdul Rahman Deputy Director, Accounting Research Institute (ARI) Universiti Teknologi MARA, Malaysia shidah@salam.uitm.edu.my

Global Development of Islamic Finance Development of Islamic Finance in Malaysia Corporate Governance Framework in Islamic Financial Institutions Risk Profile in Islamic Banks Empirical Findings

Islamic finance was first introduced into the mainstream global banking system in the early 1960s

Myt Ghamr Bank, Egypt (1963)

Pilgrimage Funds Management Board (Tabung Haji), Malaysia (1962)

And witnessed a period of accelerating growth between 1970s1990s. The millenium

Islamic Bank of Britain (2004) Islamic Dev. Bank, Jeddah (1973) Dubai Islamic Bank, UAE (1975) Faysal Islamic Bank, Sudan (1977) Kuwait Finance House (1977) Bahrain Islamic Bank (1979) Islamic Bank of Brunei (1992) Bank Islam Msia Berhad (1983) Bank Muamalat, Indonesia (1992) Islamic Bank of Thailand (2002)

Today, Islamic finance with operations in more than 300 financial institutions and more than 80 takaful operates globally

Estimated size of Islamic banking assets more than USD$1.0 trillion; Global market capitalization of DJMI>USD 10 trillion; 350 Shariah-compliant funds established globally;

Islamic finance growth is 15%-35% globally;

enormous potential business opportunities

COMMITMENT LEVEL
MALAYSIA, KUWAIT, SAUDI ARABIA, DUBAI, BAHRAIN

BUSINESS INNOVATION MARKET INNOVATION COMPETITOR MATCHING

CLUSTER 4
CLUSTER 3 CLUSTER 2 CLUSTER 1

BRUNEI, INDONESIA, SOUTH AFRICA, MOROCCO, TURKEY, QATAR, UNITED KINGDOM

SYRIA, LEBANON. GERMANY, USA, SINGAPORE

MINIMUM PRECENSE MONITOR DEVELOPMENT WAIT & SEE

CHINA, INDIA, HONG KONG, FRANCE

EXPLORE MARKET POTENTIAL

SPORDIC DEVELOPMENT

MARKET DEVELOPMENT ACTIVITIES

MARKET EXPANSION ACTIVITIES

MARKET REACH

Source: Creating & promoting the value propositions of Islamic Finance: Enter the next Phase by Dr. Mohamad Nedal Alchaar, Secretary General Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI)

Malaysian Islamic Banking & Finance Journey

Increase number of players, develop financial markets & enhance Shariah governance Market liberalisation, upgrading infrastructures, strengthen overall Islamic finance landscape

Building foundation of legal, regulatory & Shariah framework

Advanced stage Intermediate stage

Institutional building, stimulate competition, activity generation & market vibrancy

Inception stage
Instituting foundations of Islamic finance & financial inclusion

Visioning, comprehensive & international integration

Islamic Banking Act 1983 Takaful Act 1984 Government Funding Act 1983 1st full fledge Islamic bank 1st full fledge takaful company IIUM was established in 1983 1983 1993

Islamic windows 2nd Islamic bank 2nd takaful company Islamic money market Shariah Advisory Council at BNM

FSMP 10 year roadmap Foreign Islamic banks Islamic subsidiaries New takaful & retakaful licences Tax neutrality policy

IBFIM SIDC INCEIF ISRA BNM Act 2009 IIIBF, IIUM 2005

2001

2010 & beyond

8

FSMP Financial Sector Masterplan, IBFIM - Islamic Banking and Finance Institute of Malaysia, SIDC Securities Industry Development Corporation, INCEIF International Centre for Education in Islamic Finance, ISRA International Shariah Research Academy for Islamic Finance

Comprehensive Financial Landscape

Instituting Foundations for Islamic Finance Inception Stage (1983 1993)

Build solid foundation of legal, regulatory and Shariah framework

Facilitate establishment of Islamic banks Islamic Banking Act 1983

Thrusts Fulfill Muslims needs Mobilize funds for productive purposes

Facilitate establishment of takaful operators Takaful Act 1984 Over the years Proven to be a viable financial intermediation channel Fulfill needs of Muslims & nonMuslim Success enable expansion into new areas and products

Government Investment Act 1983 Facilitate Islamic money market

Governance
Legal & Regulatory
-Islamic Banking Act -Takaful Act -Government Funding Act -Capital Market Services Act -New foreign legal firm

Diversified Players
Islamic Bank & Takaful Companies Banking
Islamic Capital Market -17 Islamic banks -16 Islamic windows -3 International Islamic Banks -14 International Currency Business Units

Islamic Money Market

Shariah Advisory Council

-Central Banking Act

Dispute Resolution

-Judicial system:dedicated high court -KL Regional Centre for Arbitration -Financial Mediation Bureau

Labuan IBFC

Malaysian Financial System

Money Market

Capital Market

Takaful

Financial markets
Money Market
-Islamic interbank money market -Diverse shot-term Islamic money market instruments

Conventional Banks & Insurance Companies

-8 takaful operators -4 retakaful operators -1 International Takaful Operator -7 International Currency Business Units

Fund Management

Capital Market

-58% of outstanding bonds are sukuk -88% Shariah counters -143 Islamic unit trust fund

-9 licensed Islamic fund management companies -35 fund management companies with Islamic mandates

is a set of organisational arrangements whereby the actions of the management of institutions offering Islamic financial services are aligned, as far as possible, with the interest of its stakeholders; provision of proper incentives for the organs of governance such as the BOD, Shariah Supervisory Board and management to pursue objectives that are in interests of stakeholders and facilitate effective monitoring, thereby encouraging IIFS to use resources more efficiently; and comply with Islamic Shariah rules and principles (IFSB, 2006, pp.33)

Conduct financial business in accordance with prohibition of Riba & Gharar

Enhance Islams social objectives in particular the promotion of social behaviour

Development and promotion of integrated Islamic Financial System

Allah the Almighty

Ethical Values Islamic Banks

Shariah Board

Corporate Governance

Internal Arrangement

External Arrangement

Functional role of Islamic banks

Legal & Regulatory arrangement

Financial Information Infrastructure

Agency Solution provider

Trustee/ guarantor

Fund Manager/ Agent/Mydarib

Mudaraba facilitator

Shareholder

Current accounts (CA)

Restricted Investment Account (RIA)

Unrestricted Investment Account (UIA)

Depositor

Stake Holder

Islamic banks shall establish:

a comprehensive governance policy framework reporting of their financial and non financial information acknowledge the right of investment account holders adopt a sound investment strategy mechanism for Shariah scholars applying fatawa and monitoring make adequate and timely disclosure

Shariah Governance Framework Model for Islamic Financial Institutions by Bank Negara (Central Bank) Malaysia

the issuance of fatwa via collective ijtihad supervision (raqabah)

review (mutabaah)

UNIQUE

SHARIAH NON-COMPLIANCE RISK

DISPLACED COMMERCIAL RISK EQUITY INVESTMENT RISK

RATE OF RETURN RISK

ISLAMIC BANK

GENERIC

CREDIT RISK

OPERATIONAL RISK

MARKET RISK

LIQUIDITY RISK

Strategic

Legal

Fiduciary

Reputation

Transparency

Regulatory compliance
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IFSB CLASSIFIED SHARIAH COMPLIANCE RISK AS PART OF OPERATIONAL RISK

OPERATIONAL RISK Risk of losses resulting from inadequate of failed internal process, people and systems or from external events, which includes legal risk and Shariah compliance risk, but excludes strategic and operational risk. SHARIAH COMPLIANCE RISK The risk that arises from the Banks failure to comply with the Shariah rules and principles determined by the relevant Shariah regulatory councils. Liquidity Risk Market Risk SHARIAH COMPLIANCE RISK Operational Credit Risk

Rate of Return Risk

SIX CATEGORIES OF RISK

Equity Investment Risk

Shariah Compliance cuts across the six categories of risk

Based on IFSB

Reference: IFSB Guiding Principles On Risk Management (December 2004)

20

SHARIAH NON-COMPLIANCE RISK MAY OCCURS IN OPERATIONAL RISK FIELDS

INTERNAL PROCESS
Policy/ procedures Documentation

PEOPLE
Employee negligent Communication

SYSTEM
o System support o System monitoring o System design

EXTERNAL EVENT
Regulation Political Outsourcing Fraud (External fraud)

Marketing/
Selling Control framework

Knowledge/ skill
Unauthorized activities

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IFSBS GUIDING PRINCIPLES OF RISK MANAGEMENT

15 guiding principles which cover: 1. 2. 3. 4. 5. General requirement for an effective risk management process (1) Credit risk (4) Equity Investment Risk (3) Market Risk (1) Liquidity Risk (2)

6.
7.

Rate of Return Risk (2)

Operational risk (2)

22

Mala ysia Mean Pakis tan Mean

5.83 6.09 5.64

Risk Management Practices Understanding Risk Management Risk Identification

5.77 5.88 5.43

Risk Mitigation (Assessment and Analysis)

Risk Monitoring

5.93 6.02

5.85 5.93

Mean of TBoth Test SigLevel 5.80 5.97 5.52 5.89 5.97

Risk management practices

0.5

0.00 0.01

0.27 0.15

VARIABLES

MALAYSIA

PAKISTAN

OVERALL

Coefficient
CONSTANT URM RI RAA RM Adjusted R2 F-statistic Prob. (Fstatistic) 3.33 0.713 0.317 0.421 0.446 0.357 3.163** 0.000

Prob.
0.050* 0.113

Coefficient
3.29 0.708

Prob.

Coefficient Prob.
0.011** 0.150 0.031** 0.045** 0.543

0.034** 3.65 0.122 0.670

0.002** 0.247 0.031** 0.352 0.201 0.448 0.356 3.139** 0.000

0.010** 0.342 0.051* 0.315 0.671 0.446 0.357 3.165** 0.000

119

165

284

Abdul Rahman , Syed and Dean (2013), J of Islamic Economics, Banking & Finance, forthcoming

Mean Variables Malaysia Egypt Total Sample

T-test Sig. Level Skewness Kurtosis

Boards involvement in risk management

Process of risk management

5.39

4.83

5.32

0.03

-0.163

-0.072

5.92

5.02

5.81

0.00

-1.508

2.378

Risk management practices

5.85

5.00

5.74

0.00

-1.200

1.371

Abdul Rahman , Syed and Ismail, submitted to Spanish J of Finance and Accounting

ME: Process of Risk Management

Significant

Significant

Significant IV: Boards involvement in risk management

Step 3, Path c

Step 4, Path c Significant, but lower effect than Path c

DV: Risk Management Practices

Figure 1:The Expected Results from Four Hierarchical Regressions (Where, ME= mediator variable, IV=independent variable, DV=dependent variable)

Thank you