Time for the IMF to help strengthen Islamic Banking data

There an absence of internationally comparable data in Islamic finance which hinders the ability of stakeholders—those within the industry, those responsible for regulating it and most importantly customers and their advocates—to get an accurate picture of the stability of Islamic financial institutions.

Covering the gap—through greater participation of international institutions like the IMF as as suggested in the context of standards adoption by Bank Negara Malaysia governor Dr. Zeti Akhtar Aziz in Kuwait last week—will make the growing array of other tools even more useful. One of these tools is the bank-level tools provided by the WIBC Leaderboard which will be launched at the World Islamic Banking Conference.

One of the building blocks the IMF could support is the Islamic Financial Services Board’s Prudential & Structural Islamic Finance Indicators (PSIFI) which has compiled country-wide statistics on Islamic banks and Islamic windows. As an example, consider the idea of the total capital level of Islamic banks in the GCC (standalone banks only).

This metric is important for anticipating the future prospects of the entire sector and also provides the backdrop for assessments of any individual Islamic bank’s health. The aggregate capital level provides a metric of the susceptibility of the banking system to weather losses taken as a result of lower oil prices.

To get a clearer picture of the gaps that need to be filled, consider an analysis of GCC Islamic banks. Due to data limitations (the PSIFI only reports data for 2013 and does not include the UAE or Qatar), we use the individual bank-level data used to calculate the WIBC Leaderboard (derived from bank-level data as of year-end 2014) to partially fill the gaps to estimate the data that the PSIFI measures in 2014.

Using WIBC Leaderboard data to complement the existing PSIFI data shows the value of regular data for analyzing the macro backdrop that would be complemented if the IMF’s involvement could push for collection of the PSIFI data on a quarterly basis as it does with the Financial Soundness Indicators.

Looking at the overall GCC picture, Oman’s Islamic banks saw a large fall of capital from very high levels reflecting that it remains at an early stage having only recently been launched. Other GCC countries show that they remain resilient with capital levels in the mid-to-high teens but all show falling capital levels on the back of double digit percentage asset growth. To show one application of this type of macro data, consider the below chart from the WIBC Leaderboard of capital levels at GCC Islamic banks.

The chart above is useful for comparing banks relative to one another in the region where there is a similar bank structure of banks funded in large part by oil-exporting sovereigns and residents whose incomes are procyclical with the oil price.

However, the availability of country level data would help contextualize the data by highlighting the high capital levels of Saudi banks that makes Alinma or Al Rajhi more likely to be included in the top 10 because capital levels are higher across the Saudi market as a whole. On the other side, the lower level of capital levels at Islamic banks in Bahrain makes the inclusion of 3 Bahraini banks more notable.

Each tool has its own role in understanding the evolving Islamic banking market and measurement tools like the WIBC Leaderboard will be complemented by availability of more banking system wide data. The PSIFI database is a valuable contribution that would be greatly aided by IMF involvement to support the development of a more quantitatively measured Islamic banking system for all its stakeholders.

Do Sharia Supervision Boards help Islamic banks reach their ethical imperative?

Although there has been a substantial body of literature discussing the unique governance structure of Islamic banks due the role of their Shariah boards, there is only limited empirical research until recently that has tested that impact. Two researchers, Sabur Mallah and Mahbub Zaman, looked at the data in a new paper to identify the relationship between governance, board structure and performance of Islamic banks.

Shariah boards are a unique feature of Islamic banks and are considered to be a form of ‘supra authority,’ an added layer of governance compared with conventional banks which relies primarily on the board of directors to oversee the operations of the management. A Shariah board represents an additional layer of monitoring and oversight as well as a constraint on the operations of the management. The Shariah board is tasked with ensuring that the Islamic banks’ operations are conducted in a Shariah compliant manner which could easily include ethical and responsible banking practices as well.

The study tries to identify whether the impact of the Shariah board exists if it operates solely in an advisory capacity or if the impacts only arise as a result of its exercise of supervisory responsibility. This is a key issue for Islamic banks beyond just demonstrating how a stronger governance framework relative to conventional banks can improve the conduct of the bank. When expanding Islamic banks’ governance, being able to demonstrate a quantifiable benefit from having Shariah board members operating in a supervisory capacity will mitigate many issues that regulators in non-Muslim majority countries would have with a Shariah board operating in a supervisory capacity.

The key findings regarding the Shariah board is demonstrating a positive association with performance in both large banks and small banks as well as in large country and small country samples. The added governance responsibility that lies with the Shariah board in Islamic banking acts as a catalyst for better financial performance. The benefit from the Shariah board is statistically significant only when it was working in a supervisory capacity rather in just an advisory capacity.

This should allay any concerns from jurisdictions where concerns exist about an advisory-only Shariah board because they were shown to perform no worse than a conventional bank without this type of governance structure. If anything, the Shariah supervisory board role should be seen as an additive governance mechanism for Islamic banks.

Within the Islamic banking community, improving independence of the Shariah board and improving its level of monitoring and coordination with the boards of directors can improve the performance of Islamic banks. There is further scope for improvement in Shariah supervision via ensuring greater independence before putting more oversight responsibility on the Shariah boards.

The governance limitations of a Shariah board are not unique to Shariah boards and are akin to those faced by audit committees and other non-executive board committees. Moving forward, Islamic banks should not assume that they automatically have better governance than conventional banks and should work on the governance issues that remain in their Shariah board structure.

You can find the full results in Mollah, Sabur and Mahbub Zaman. “Shari’ah supervision, corporate governance and performance: Conventional vs. Islamic banks,” Journal of Banking & Finance 58 (2015) pp. 418-435.

Ethical Finance and its important linkage with Islamic Finance will be extensively covered during WIBC in the following sessions:

• Standing on the shoulders of responsible investing: How should Islamic finance engage with and benefit from the increasing size and influence of responsible investing and financial services? What market-driven strategies have worked and what needs to be done by regulators

• Does the current Islamic Financial landscape truly reflect the authentic value and doctrine of Islamic finance which is deep rooted upon ethical and socially responsible principles