IMF’s move augurs well for Islamic banks

IMF adds IF to market surveillance. In this 2nd and final part series, Chatta looks at what to expect on the regulatory front


Islamic finance (IF) is witnessing some major breakthroughs. As discussed yesterday, one of them took place last month when the executive board of the International Monetary Fund (IMF) endorsed a proposal on the use of Islamic Financial Services Board (IFSB) Core Principles for Islamic Finance Regulation (CPIFR) and its methodology, as part of the standards used in assessing the banking regulatory and supervisory regimes of relevant member jurisdictions, under the Financial Sector Assessment Programme (FSAP) and the Reports on Observance of Standards and Codes (ROSCs).

Since CPIFR standard and assessment methodology will be used by the IMF-World Bank in relevant assessments and ROSCs initiated after Jan 1, 2019, in my view, there are four interlinked steps that can be implemented by supervisory authorities in dual banking systems where Islamic banking has a significant market share to prepare themselves for the assessment in future.

1) Formal unit to oversee IF

As IFSB has noted in its work that in many jurisdictions, Islamic banks are being supervised through existing arrangements or departments. In such jurisdictions, one of the first things to be done by the supervisors regulating Islamic banking is to ensure that there is formal dedicated unit/section/department for the supervision of Islamic banks.

This unit can ensure that there is capacity and adequate skill sets to formulate and issue regulations, and oversee the implementation in practice of Shariah principles. For this, a proper level of knowledge in IF is a prerequisite by the staff in order for the unit to perform in a proper way, in particular performing self-assessment using CPIFR. Without this formal structure, the effectiveness of the prudential regulation and supervision is difficult to sustain in the long term. This unit should be mandated to work closely with other departments in order to integrate IF into the financial system.

This approach can be an integral part of establishing the IF ecosystem, in particular, when the IMF-World Bank FSAP is carried out, the IMF will need experts from relevant supervisory authorities to participate in missions to undertake and support the quality of the assessments.

2) Self-assessment using IFSB CPIFR

An assessment of a jurisdiction’s compliance with CPIFR is a useful tool in the implementation of an effective system of banking supervision for Islamic banks.

The IFSB CPIFR and its assessment methodology includes a set of essential and additional assessment criteria for each principle, which can be used in multiple contexts such as for self-assessments performed by banking supervisors themselves, the IMF and World Bank FSAP, reviews conducted by private third parties such as consulting firms and peer reviews. Therefore, the starting point for any jurisdiction going for IMF assessment, is to have self-assessment, which is a highly useful input to an external party assessment and is a requirement for IMF-World Bank FSAP. In conduct- ing a self-assessment, supervisory authorities can seek to benchmark their own supervisory system against CPIFR, with the ultimate goal of enhancing the effectiveness of supervision, and identification of the nature and extent of any weaknesses in the banking supervisory system.

This assessment can allow the supervisory authorities to initiate a strategy or action plan to improve the banking supervisory system, as necessary. However, adequate attention should be paid on the planning and execution of self-assessment as it is not a one-person job.

Hence, there are necessary conditions, which can ensure the credibility and objectivity of the self-assessment such as, the explicit commitment of the supervisory authority’s senior management and the creation of a qualified team of assessors who possess know- ledge in IF, and have practical and relevant experience. And there should be clear terms of reference of the team, the time frame for the assessment and the review process.

The Basel Committee has published a guide for self-assessment, which can be useful in implementing CPIFR.

3) Action plan to address regulatory gaps

Based on the self-assessment using CPIFR, supervisors can prepare a necessary action plan to address regulatory gaps and identified weaknesses.

Essentially, this action plan can be prioritised (eg immediate/short term, medium term), and necessary technical studies or concept notes can be undertaken by the staff/unit overseeing IF, prior to issuing regulations. These studies can help the authorities when the IMF and World Bank make assessments of the quality of supervisory systems — for example, in the context of FSAP.

In addition, given the identified regulatory gaps, jurisdictions can request IMF technical assistance or IFSB assistance (to promote its standards implementation) to enhance their capabilities, to identify and monitor emerging risks, to under- stand the linkages that might exist with other sectors and to ensure effective supervision with a risk-based approach, which involves a systemic and macroprudential dimension.

4) Role of international bodies for capacity building

Capacity building and the development of the supervisory resources is one of the areas, which should receive more attention from supervisors, which will have critical role in ensuring the compliance with CPIFR.

To effectively deal with the challenges of the implementation of CPIFR, the regulators should consider developing human resources capacity in terms of number and quality, given the peculiar nature of risks in Islamic products and services.

This means supervisors’ greater emphasis on ensuring that they have the adequate resources and skill sets (whether in-house or outsourced) to deal with CPIFR. One way to ensure is having concerted efforts by international bodies such as IFSB and Islamic Development Bank for capacity building of member countries for IF.

This would entail these institutions to update their work plan and reflect the arrangement to assist the supervisory authorities. This might include revisiting the resource envelope.

Concluding Remarks

The IMF’s endorsement of the IFSB CPIFR is a historic milestone for the IF industry, which will have a positive effect on the financial stability of the jurisdiction where Islamic banks operate and it will, among others, strengthen financial inclusion, deepen financial markets including funding diversification and achieving the Sustainable Development Goals.

The implementation of the IFSB CPIFR has great potential to serve supervisory authorities in enhancing banking supervision oversight on Islamic banks operations within the jurisdiction. This will help the authorities to integrate regulatory and supervisory primacies more effectively, including prudential framework for Islamic banking.

The onus is on the central banks or supervisory authorities regulating IF to have in place a formal structure, where an IF unit is well-integrated with other organs such as policies, supervision and surveillance, financial stability and consumer protection of the supervisory authority.

The self-assessment of CPIFR, driven by in-house expertise by the supervisory authorities, is the first and crucial step to review the adequacy and robustness of the existing regulatory framework for IF before the IMF provides its formal assessment and grading on the effectiveness of the framework.

  • Dr Jamshaid Anwar Chattha is chief banking researcher and IF expert at the Central Bank of Kuwait. He is an ex-staff member of IFSB and also advises the IMF on Islamic banking supervision. The views expressed in this article are those of the author.