Islamic Finance: The Regulatory Challenge

428 Pages·2007·4.85 MB·English

Islamic Finance:
The Regulatory
Challenge
Islamic Finance:
The Regulatory
Challenge
Edited by
Simon Archer
and
Rifaat Ahmed Abdel Karim
JohnWiley&Sons(Asia)PteLtd
Copyright©2007byJohnWiley&Sons(Asia)PteLtd
Publishedin2007byJohnWiley&Sons(Asia)PteLtd
2ClementiLoop,#02-01,Singapore129809
Allrightsreserved.
No part of this publication may be reproduced, stored in a retrieval system, or
transmittedinanyformorbyanymeans,electronic,mechanical,photocopying,
recording,scanning,orotherwise,exceptasexpresslypermittedbylaw,without
either the prior written permission of the Publisher, or authorization through
payment of the appropriate photocopy fee to the Copyright Clearance Center.
RequestsforpermissionshouldbeaddressedtothePublisher,JohnWiley&Sons
(Asia)PteLtd,2ClementiLoop,#02-01,Singapore129809,tel:[phone],
fax:[phone],e-mail:[email protected].
Thispublicationisdesignedtoprovideaccurateandauthoritativeinformationin
regard to the subject matter covered. It is sold with the understanding that the
publisherisnotengagedinrenderingprofessionalservices.Ifprofessionaladvice
or other expert assistance is required, the services of a competent professional
personshouldbesought.
Neithertheauthorsnorthepublisherareliableforanyactionspromptedorcaused
bytheinformationpresentedinthisbook.Anyviewsexpressedhereinarethose
oftheauthorsanddonotrepresenttheviewsoftheorganizationstheyworkfor.
OtherWileyEditorialOffices
JohnWiley&Sons,111RiverStreet,Hoboken,NJ07030,USA
JohnWiley&Sons,TheAtriumSouthernGate,ChichesterP0198SQ,England
JohnWiley&Sons(Canada)Ltd,5353DundasStreetWest,Suite400,Toronto,
OntarioM9B6HB,Canada
JohnWiley&SonsAustraliaLtd,42McDougallStreet,Milton,Queensland4064,
Australia
Wiley-VCH,Boschstrasse12,D-69469Weinheim,Germany
LibraryofCongressCataloging-in-PublicationData
ISBN 978-0-470-82189-3
WileyBicentennialLogo:RichardJ.Pacifico
Typesetin10.5/13ptPalatinobyLaserwordsPrivateLimited,Chennai,India.
PrintedinSingaporebySaikWahPressPteLtd.
10987654321
Contents
AbouttheEditors vii
AbouttheContributors ix
Foreword xvii
Preface xix
Acknowledgments xxi
1 Supervision of Islamic Banks and Basel II: The Regulatory Challenge
SimonArcherandRifaatAhmedAbdelKarim 1
Part 1 The Nature of Risks in Islamic Banking 9
2 BankingandtheRiskEnvironment HennievanGreuningandZamirIqbal 11
3 RiskCharacteristicsofIslamicProducts:ImplicationsforRiskMeasurement
andSupervision Dr.V.Sundararajan 40
4 Capital Structure and Risk in Islamic Financial Services WafikGraisand
AnomaKulathunga 69
5 Inherent Risk: Credit and Market Risks AbdullahHaronandJohnLeeHin
Hock 94
6 Operational Risk Exposures of Islamic Banks SimonArcherandAbdullah
Haron 121
7 Law and Islamic Finance: An Interactive Analysis YusufTalalDeLorenzo
andMichaelJ.T.McMillen 132
8 Supervisory Implications of Islamic Finance in the Current Regulatory
Environment HariBhambra 198
Part 2 Capital Adequacy 213
9 RiskandtheNeedforCapital CharlesFreelandandStevenFriedman 215
10 Measuring Risk for Capital Adequacy: The Issue of Profit-sharing
InvestmentAccounts SimonArcherandRifaatAhmedAbdelKarim 223
11 MeasuringOperationalRisk ElisabethJackson-Moore 237
12 SupervisoryImplicationsofIslamicBanking:ASupervisor’s
Perspective TobyFiennes 247
Part 3 Securitization and Capital Markets 257
13 SecuritizationinIslamicFinance AbdulkaderThomas 259
14 TheRoleofCapitalMarketsinEnsuringIslamicFinancialLiquidity
StellaCox 271
15 RegulatingIslamicCapitalMarkets RobertGrayandArshadIsmail 282
vi Contents
Part 4 Corporate Governance 293
16 CorporateGovernanceforBanks HamidYunis 295
17 SpecificCorporateGovernanceIssuesinIslamicBanks SimonArcherand
RifaatAhmedAbdelKarim 310
18 Corporate Governance and Supervision: Basel Pillar 2 ChizuNakajima
andBarryA.K.Rider 342
19 TransparencyandMarketDiscipline:BaselPillar3 DaudAbdullah(David
Vicary) 366
Part 5 Conclusion 379
20 HumanResourceManagementofIslamicBanks:ResponsestoConceptual
andTechnicalChallenges VolkerNienhaus 381
21 ConcludingRemarks SimonArcherandRifaatAhmedAbdelKarim 400
Index 409
About the Editors
SimonArcherwasProfessorofFinancial ManagementattheUniver-
sity of Surrey, U.K., where he continues to supervise Ph.D. students.
Previously, he was Midland Bank Professor of Financial Sector
Accounting at the University of Wales, Bangor. After his studies
inphilosophy,politics,andeconomicsatOxfordUniversity,hequal-
ified as a Chartered Accountant with Arthur Andersen in London
and then moved to Price Waterhouse in Paris, where he became
PartnerinchargeofManagementConsultancyServicesinFranceand
Scandinavia.Hisacademiccareerthusbeganafterworkingasaprac-
titioner, mainly in management consulting. Professor Archer’s main
research interests are in international accounting, accounting theory,
and accounting for banks, including the financial reporting, capital
adequacy, risk management, and corporate governance of financial
institutions.HisrecentworkfocusesonIslamicfinancialinstitutions.
He is also co-author of the International Accounting and Financial
Reporting Standards Guide, as well as co-editor of Miller European
Accounting and Islamic Finance: Innovation and Growth (London:
EuromoneyBooks,2002).
Rifaat Ahmed Abdel Karim is the Secretary-General of the Islamic
Financial Services Board (IFSB), a post he has held since the IFSB
began operations in 2003. Prior to his current post, he was the
Secretary-General of the Accounting and Auditing Organization for
Islamic Financial Institutions. He is a member of both the Standards
Advisory Council of the International Accounting Standards Board,
nowservinghissecondthree-yearterm,andtheConsultativeAdvisory
GroupoftheInternationalAuditingandAssuranceStandardsBoard.
Professor Rifaat has been Visiting Professor at the University of
Surrey (U.K.) since 1996, and is an Honorary Professor at Monash
University in Australia. He is the co-author of Islamic Finance:
Innovation and Growth (London: Euromoney Books, 2002) and
BusinessandAccountingEthicsinIslam(London:MansellPublishing
Co., 1991). He is the first recipient of the Euromoney Outstanding
Contribution to the Development of Islamic Finance Award, and a
recipientofotherdistinguished awards.
vii
About the Contributors
Daud Abdullah (David Vicary) is the Managing Director of Hong
Leong Islamic Bank. His work experience has taken him to some
32 major countries in Europe, Asia-Pacific, the Middle East, and
Latin America during the last 34 years. Daud has developed an
extensive international experience in the field of banking operations
andconsulting,havingassistedbanksintheirrestructuringforgreater
efficiency, cost control, and to better meet customer expectations.
Since December 2003, he has been an Auditing and Accounting
Committee Board Member of AAOIFI (Accounting and Auditing
Organization for Islamic Financial Institutions). Daud is also a well-
known Islamic finance speaker at IFSB (Islamic Financial Services
Board) and global Islamic banking seminars, particularly on matters
relatingtothegrowthanddevelopmentoftheindustry.
Hari Bhambra currently works for the Dubai Financial Services
Authority(DFSA),theindependentregulatoryauthorityfortheDubai
International Financial Centre, where she has been one of the key
developers of the regulatory framework for Islamic finance for the
DFSA. She has over seven years’ experience in financial services,
from both a regulatory and industry perspective. Previously, Hari
worked with Goldman Sachs International in London, after which
she continued to assist the industry by joining a compliance consul-
tancypracticewheresheadvisedFinancialServicesAuthority’s(FSA)
regulatedfirmsonallaspectsofitsrequirements,aswellasassisteda
number of firms to obtain FSA authorization. She holds a Bachelor’s
and Master’s degree in law and a diploma in legal practice from The
CollegeofLaw,London.
StellaCoxhasworkedinIslamicfinancesince1985andisManaging
DirectorofDDCAPGroup,thejointventurebetweenDawnay,Day,
and IPGL. Prior to 1998, she was a Director of Dresdner Kleinwort
BensonwhereshewasresponsiblefortheMiddleEasternandIslamic
financial marketplaces. Stella is a member of the Islamic Financial
Services Board Task Force on Markets and Instruments for Shariah
Compliant Liquidity Management. She also serves on the Board of
Governors of the U.K. Institute of Islamic Banking and Insurance,
and is a member of the BMA’s project team for the development of
ix
x AbouttheContributors
Islamic commodity markets. Stella speaks regularly at international
conferences and contributes to many publications. In 2005, she co-
authored the Euromoney publication, Structuring Islamic Finance
Transactions.
YusufTalalDeLorenzoisascholarofIslamictransactionallawwhose
30-yearcareerhasbeennotedinTheFinancialTimes,TheNewYork
Times, Fortune, The Wall Street Journal, The Middle East Banker,
andothers.BasedintheWashington,D.C.area,heservesasaShari’ah
advisor to international financial entities, including index providers,
institutional investors, mutual funds, hedge funds, real estate funds,
private equity funds, home finance providers, and investment banks.
ShaykhYusufistheauthorofthethree-volumeCompendiumofLegal
OpinionsontheOperationsofIslamicBanks,thefirstEnglish/Arabic
reference on the fataway issued by Shari’ah boards. In addition, he
wrote the introduction to Islamic Bonds, the 2003 book that intro-
duced sukuk and transformed the world’s Islamic capital markets.
His work has appeared in journals and newsletters and as chapters
in books, including Islamic Asset Management (Euromoney Books,
2004),IslamicRetailFinance(EuromoneyBooks,2005),andIslamic
Finance:Innovation&Growth(EuromoneyBooks,2002).Hisentries
on the terminology of Islamic finance appear in The Oxford Dictio-
naryofIslam.
Toby Fiennes currently works as a Special Advisor at the Reserve
BankofNewZealand,advisingonchangestothefinancialregulatory
landscape. Prior to that, he worked in Barclays Bank for 10 years,
before becoming a banking supervisor, first at the Bank of England
and then at the U.K.’s Financial Services Authority (FSA) from its
inceptionin1998until2005.Tobycontinuestotakeanactiveinterest
inIslamic bankingandwas,formanyyears,theFSA’sprimarypoint
of contact for the industry by helping with the authorization of the
Islamic Bank of Britain, the first such bank in Europe. He has a
Master’sdegreeineconomics fromCambridgeUniversity,U.K.
CharlesFreelandisDeputySecretary-GeneraloftheBaselCommittee
on Banking Supervision at the Bank for International Settlements
in Basel, Switzerland. As well as acting as the principal secretary
for the Basel Committee itself, and being responsible for the overall
coordination of Basel Committee publications, Charles has chaired
several ofthe Committee’s task forces and currently chairs two ofits
AbouttheContributors xi
working groups, on cross-border banking and the non-G10 liaison
group on Basel II. He often represents the Basel Committee at the
meetings of regional banking supervisory committees and heads the
organization of its biennial world banking supervisory conferences.
Charles holds an M.A. from St Andrews University and spent his
earlyprofessionalyearsattheBankofEngland.
Steven Friedman has been a member of the Secretariat of the Basel
Committee on Banking Supervision since August 2005 while on
a secondment from the Federal Reserve Bank of New York. At
the Secretariat, Steven specializes in the advanced approaches to
regulatory capital for credit risk under Basel II, as well as in credit
risk modeling practices. Prior to joining the Secretariat, Steven spent
five years on the trading desk at the Federal Reserve Bank of New
York. He holds a Master’s degree in internal relations from the
Paul H. Nitze School of Advanced International Studies at the Johns
HopkinsUniversityinWashington,D.C.
Wafik Grais is a senior advisor at the World Bank. He heads the
Financial Sector Assessment Program and oversees developments in
Islamicfinancialservices.Previouslyhewasdirectorofprivate-sector
andfinanceprogramsfortheMiddleEastandNorthAfrica(MENA).
In 1997–98, he represented the Government of Egypt on the team
settinguptheBankforCooperationandDevelopmentinMENA.He
holdsaPh.D.anddegreesineconomicsandpoliticalsciencefromthe
UniversityofGeneva,Switzerland.
Robert Gray is Chairman of Debt Finance and Advisory of HSBC
Bank plc. He joined HSBC in May 1994 as Chairman of HSBC
Markets Ltd., responsible for developing HSBC’s capital markets
capabilities worldwide. In addition, he serves as Chairman of HSBC
Financial Services (Middle East) Ltd., HSBC Saudi Arabia Ltd., and
HSBC Securities (Japan) Ltd., and as a Director of HSBC Bank
Egypt SAE and British Arab Commercial Bank. He is also the Vice-
Chairman of the International Capital Market Association (ICMA)
and Chairman of the ICMA Regulatory Policy Committee. Robert
graduated from St John’s College, University of Cambridge with an
Honorsdegreeinhistory.
AbdullahHaronisAssistantSecretary-GeneraloftheIslamicFinancial
ServicesBoard.Previously,hewasaProjectManagerwherehismain
area of work was the preparation of guidance on risk management
xii AbouttheContributors
and the supervisory review process. He has also participated in task
forcesontakafulregulationandsupervision,aswellasacompilation
guideonprudentialdatabaseofIslamicfinancialservicesinstitutions.
His prior experience includes the development of a risk management
and measurement framework, and insurance prudential regulation
andsupervision.AbdullahreceivedaBSLASinactuarialsciencefrom
theUniversityofIllinoisandanMBAfromOhioUniversity.
Zamir Iqbal works as Principal Financial Officer with the Quantita-
tive Strategies, Risk and Analytics department in the Treasury of the
WorldBankinWashington,D.C.HeearnedhisPh.D.ininternational
finance fromthe George Washington University where he also serves
as adjunct faculty of international finance. He has published several
articles on Islamic finance in reputed journals and has presented
papersatinternationalforums.Hehasextensiveexperiencewithcap-
ital markets, exotic derivative products, risk management, financial
sector development, and financial modeling. His research interests
include Islamicfinance, financial engineering, structured finance, and
internationalbanking.
ElisabethJackson-MooreisaformerManaging Director ofMoody’s
Investors Service Financial Institutions Group, based in Cyprus. She
spent over eight years in this position, and was responsible for
Moody’s bank ratings in nearly 30 countries in the Middle East,
Africa, Eastern Europe, and South Asia. She retired at the end of
2003andiscurrentlyaconsultantinthefinancialservicesfield.Before
joiningMoody’s,ElisabethwasManagingDirectorofCapitalIntelli-
gence (CI), a specialist rating agency covering banks in the emerging
markets of the Middle East, Europe, and Asia. Her early career was
spent researching in the fields of agriculture, pharmaceuticals, and
socialscience intheU.K.
Anoma Kulathunga is a doctoral student at the George Washington
University Business School, in the United States, and a consultant at
the World Bank. Her research interests are financial sector develop-
mentandIslamicbanking.
John Lee Hin Hock is a Partner of KPMG Malaysia. John is KPMG
GlobalLeadforIslamicFinance,theASPACregionHeadofFinancial
Risk Management, and the Head of Financial Services for Malaysia.
He has extensive knowledge of strategic consulting, banking, capital