This means that there must be a very high priority placed on sound management and risk management practices at Islamic financial institutions, a senior official yesterday said. Rasheed M Al Maraj, Governor of the Central Bank of Bahrain (CBB), in his opening remarks at the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and World Bank Annual Conference 2008, said: “While Islamic financial institutions have been largely sheltered from the present crisis, there is no room for complacency.
It is inevitable that they will be affected to certain extent, as they are part of the wider global economic system.” “The unprecedented growth of the Islamic industry in recent years, combined with high levels of liquidity, have meant that Islamic banks have not needed to fight for funding or ideas. “In recent months, as the global financial crisis has deepened, there have been many commentators who have pointed to the relative success of the Islamic financial sector.
So far, Islamic financial institutions have escaped relatively unscathed from the severe downturn.” “Islamic banks are prohibited from interest-based transactions, encourage business and trade activities that generate fair and legitimate profit. The prohibition on speculative activity also helps to ensure that there is a close link between financial flows and productive activities,” he said.
These intrinsic properties of Islamic finance contribute towards insulating it from the potential risks resulting from excess leverage and speculative financial activities. The new entrants in Islamic banking and finance industry have merely tended to copy the strategies they see being successfully pursued by their more established rivals.
A very high percentage of Islamic banks have a strategy that is heavily weighted towards real estate and asset finance. The downturn in global economic conditions will provide these business models with a stern test.
Project-driven business strategies will be affected by the reduction in global liquidity and the slowing of global economic growth. Islamic financial institutions will need to plan and prepare for these more challenging operating conditions, he said. “The industry needs to respond to this challenge by developing a greater diversity of business models, more diverse and stable income sources, and more rigorous risk management and stress testing techniques to assess its preparedness to deal with any downturn in economic activity,” the governor said. “The essential consideration in Islamic finance, as in all forms of finance, is to find the right balance between business development and risk management.
There are certain measures that the CBB can take to assist Islamic financial institutions in this process. We have recently launched an Islamic Sukuk liquidity instrument, which is a repurchase agreement that enables financial institutions, both conventional and Islamic, to access short-term liquidity against the Government of Bahrain Ijara Sukuk,” he added. “The principles and standards developed by AAOIFI provide Islamic financial institutions with a sound basis on which to manage their activities. There is a continuing need for high quality human resources in the industry.”
