Date: April 21st, 2003

Title: The implications of globalisation for Islamic finance

Author: Professor Rodney Wilson, University of Durham, UK

Does globalisation of financial markets therefore undermine the legitimacy of Islamic finance if the price of money is similar to that which is conventionally determined? Should the economies of the Muslim world impose capital controls and introduce regulations preventing domestic banks from dealing with foreign banks, with perhaps limited exceptions for trade financing? Responses are more likely to reflect political ideology, whether favouring freer markets, or a greater role for the state, rather than religious piety. It can be argued it is not the rate of return or the cost of financing that makes Islamic finance distinctive, but rather the nature of the facilities and products offered.

Most Muslim countries apart from the GCC member states maintain controls over capital movements and some payments restrictions for import transactions. IMF structural adjustment policy encourages member states to eliminate multiple exchange rates and float currencies so that an equilibrium currency rate can be determined in the foreign exchange market, potentially facilitating the reduction of external deficits. In practice the results of such policies have been mixed in the Muslim world, but in the longer term the dismantling of foreign exchange controls seems likely for most countries. This will create additional opportunities for Islamic banks to offer murabaha trade financing facilities as well as leasing, ijara, and project financing, istisna. With foreign exchange liberalisation the pricing of Islamic financing products has to be internationally rather than simply nationally competitive.

The Basel Accords, the rating of Islamic banks and FSAP financial monitoring
Like conventional banks Islamic banks are not only regulated by the central banks of the countries in which they are based, but they are also potentially subject to the scrutiny of international monitoring agencies, notably the Bank of International Settlements (BIS) in Basel. National regulation by central banks is also subject to international inputs, an example of this being the IMF and World Bank intervention through the Financial Sector Assessment Program (FSAP), which was started as a response to some of the issues raised by the Asia financial crisis of 1997. The annual reports of Central Bank Governors of Asian countries such as Malaysia and Indonesia are monitored and disseminated by the BIS, including their reviews of Islamic banking developments. In addition there is also continuing assessment of both Islamic and conventional banks by other commercial financial institutions, a process facilitated by the work of the ratings agencies.

Although there is no obligation to adhere to the BIS minimum requirement of 8 percent of capital to risk weighted assets, Islamic banks that are seen as being adequately capitalised are more likely to have their trading instruments recognised, and can negotiate better terms for their assets which are managed by other banks. Capital therefore can be a constraint on Islamic bank growth, especially when the bank has been successful in rapidly building up its deposit base. Often it has taken longer for Islamic banks to identify profitable lending opportunities than build up their deposit base, which implies lower initial profitability. This may delay stock market quotation to increase the capital base, or where the bank is already a quoted company, it may preclude rights issues to raise additional capital.

Page 6

See for example Tan Sri Dato’ Dr Zeti Akhtar Aziz, “Economic and monetary developments in Malaysia for 2001”, BIS Review, 21/2002, p. 2. Dr Aziz, the Governor of the Central Bank of Malaysia, (Bank Negara Malaysia) reported that Islamic assets of the Malaysian system grew by 25.2 percent in 2001, and accounted for 8.2 percent of the total by the end of the year.