Week 4: Challenges to the Growth of Islamic Financial Markets

Week 4: Challenges to the Growth of Islamic Financial Markets

“Introduction … Need for a Regulatory and Legislative Framework … Market Structure and Practices … Development of Supporting Institutions … The Use of Financial Engineering & Training and Interaction to Promote Growth”
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Summaries

  • Week 4: Challenges to the Growth of Islamic Financial Markets > Introduction > Unit
  • Week 4: Challenges to the Growth of Islamic Financial Markets > Need for a Regulatory and Legislative Framework > Unit
  • Week 4: Challenges to the Growth of Islamic Financial Markets > Market Structure and Practices > Unit
  • Week 4: Challenges to the Growth of Islamic Financial Markets > Development of Supporting Institutions > Unit
  • Week 4: Challenges to the Growth of Islamic Financial Markets > The Use of Financial Engineering & Training and Interaction to Promote Growth > Unit

Week 4: Challenges to the Growth of Islamic Financial Markets > Introduction > Unit

  • Hello, and welcome to the chapter Challenges to the Growth of Islamic Financial Markets.
  • Islamic capital markets are very new and are still evolving.
  • In contrast, conventional capital markets have reached an advanced state of maturity, which is the result of years of trial, error, and innovation.
  • Now these markets have established various reliable guidelines, processes, and procedures that can help to further enhance their growth and minimize risks.
  • The Islamic capital markets can use conventional capital markets as models and emulate aspects such as transparency, market discipline, and technology acceptance.
  • The Islamic capital markets can accelerate their development and quickly get on a par with the conventional capital markets.
  • These challenges are mainly the result of factors such as the state of the existing regulatory and legislative framework, the micro-structure of the market, market practices, and the range of products that the market covers, design of the incentive in corporate governance systems, culture of listed companies, brokers and investors, absence or restricted use of reliable supporting institutions, which can help define market standards and benchmarks for performance evaluation, and finally the degree of integration with external markets.

Week 4: Challenges to the Growth of Islamic Financial Markets > Need for a Regulatory and Legislative Framework > Unit

  • We will now talk about the need for regulatory and legislative framework.
  • A regulatory and legislative framework can help instill and maintain investor’s confidence in a capital market.
  • For Islamic capital markets this framework needs to fulfill one additional criteria, it has to be Shari’a hcompliant.
  • Most Islamic countries still lack sound regulatory and legislative frameworks for Islamic capital markets they improvise and apply local regulations and laws to these capital markets as well.
  • In some Islamic countries the local regulations and laws might disallow government bodies to lease operating assets.
  • To avoid this, Islamic countries should define regulatory and legislative frameworks that conform to the requirements of Islamic capital markets.
  • When customizing regulatory and legislative frameworks for Islamic capital markets, Islamic countries should consider three aspects.
  • All Islamic countries should standardize their legislative frameworks.
  • If these laws are used in their original formats to control Islamic capital markets ambiguities and inconsistencies can result.
  • The laws of one Islamic country might allow the issue of Islamic financial product on the market.
  • Standardization can prevent ambiguities and inconsistencies across Islamic capital markets and help minimize legal expenses.
  • Islamic countries should insure that the guidelines and procedures for resolving disputes regarding Islamic financial products are included in the existing dispute resolution system for conventional products.
  • It can help save the money and efforts required to maintain a separate dispute resolution system for Islamic financial products.
  • The action can also enhance investors’ confidence in Islamic capital markets.
  • Strengthening the regulatory guidelines can help promote the development of Islamic capital markets.
  • Very few Islamic capital markets strictly follow these guidelines.
  • To ensure strict application Islamic countries should set up powerful independent and trustworthy regulatory agencies and their affiliates.

Week 4: Challenges to the Growth of Islamic Financial Markets > Market Structure and Practices > Unit

  • Let’s now talk about market structure and practices.
  • Two ways to set up the desired structure and practices are; enforcing compliance with Shari’ah requirements and allowing the inclusion of foreign Islamic securities in the market.
  • Many brokers invested interests in Islamic capital markets indulge in practices such as short selling and margin account maintenance.
  • To enhance and expedite its growth, an Islamic capital market needs to diversify, that is, it needs to attract borrowers from multiple Islamic countries and gain access to liquid markets in those countries.
  • The regulatory agency for each Islamic capital market should encourage foreign countries to list Islamic securities on the market.
  • Most foreign investors lack confidence and are reluctant to invest in Islamic capital markets.
  • This is primarily because Islamic capital markets often lack transparency and expose participants to wrong market practices.
  • To kindle cost the in Islamic capital markets, regulatory agencies should enforce transparency and on the issuance and training of securities.
  • They should outlaw wrong market practices and conduct regular audits to identify the people who indulge in these practices.
  • One of the main reasons for higher operating costs in Islamic capital markets is the tax framework for these markets.
  • In these countries, this framework is more demanding on investors than the tax framework for any conventional capital market.
  • In Islamic capital markets investors in real estate and other underlying assets end up paying more to their governments in the form of a higher percentage of capital gains tax, an income tax and double stamp duty.
  • To begin with, the policy makers can waive additional stamp duties and other additional expenses the investors have to incur in Islamic capital markets.
  • In addition to attracting retail investors, it is important to encourage business and financial institutions to participate in Islamic capital markets.
  • A few countries have already formalized tax breaks and incentives for Islamic capital markets.
  • A year later, the Malaysian government announced that all transactions in Islamic capital markets would have the same tax structures and incentives as transactions in conventional capital markets.

Week 4: Challenges to the Growth of Islamic Financial Markets > Development of Supporting Institutions > Unit

  • The main purpose of an industry association is to promote the development and trading of new Islamic financial products.
  • A rating agency in contrast is an independent body that evaluates, rates, and predicts the future performance of Islamic financial institutions and products.
  • A standard setting agency helps set standards and best practices for Islamic capital markets.
  • Many countries have successfully set up supporting institutions for their Islamic capital markets.
  • The International Islamic Financial Market or IIFM is an industry association that was set up in Bahrain in November 2001 and became operational on April 1, 2002.
  • It is a front for at least 265 Islamic banks and financial institutions from around the globe.
  • One of the main aims of the IIFM is to enable the listing and acceptance of Islamic financial products on stock exchanges worldwide.
  • The GSSC helps review and certify new Islamic financial products.
  • Through the GSSC, the IIFM has already certified global Islamic bonds issued by Bahrain and other countries, such as Qatar and Malaysia.
  • The LMC helps consolidate the assets of various governments and businesses and financial institutions and issue them as Sukuk.
  • In addition to performing regular rating tasks, the IIRA assesses Islamic financial institutions and products for Shari’ah compliance.
  • These standards mainly help to check whether Islamic financial institutions and their products satisfactorily comply with the Shari’ah or Islamic law.
  • It is an association of central banks, monetary authorities, regulatory and supervisory bodies for Islamic capital markets and financial institutions.
  • In 2005, the IFSB released capital adequacy and risk management standards for Islamic financial institutions.
  • Considering these special accounting needs of Islamic financial transactions, the Islamic Development set up the Accounting and Auditing Organization for Islamic Financial Institutions or AAOIFI in Bahrain in March 1991.
  • Islamic financial institutions globally adopt these standards that are developed by AAOIFI and take into account both Shari’ah principles and international standards and practices.
  • The AAOIFI also works to ensure that the Shari’ah supervisory boards of all Islamic financial institutions are aligned in their interpretation and use of Shari’ah standards.
  • So it also prepares, issues, and interprets Shari’ah standards for Islamic financial institutions.
  • The Shari’ah standards it has issued to date for Islamic transactions, such as Mudaraba, Bai’Salam and Istisna, have already been adopted by many Islamic financial institutions worldwide.
  • The governments of many Islamic countries have recognized and adopted the standards defined by the AAOIFI.

Week 4: Challenges to the Growth of Islamic Financial Markets > The Use of Financial Engineering & Training and Interaction to Promote Growth > Unit

  • Securitization helps satisfy the long term needs of capital markets, it is a means to pool and repackage financial assets, and then sell them to investors, and so it can generate both long term and short term cash reserves.
  • They need to have advanced technical knowledge about these markets as well as conventional capital markets, that is they require detailed knowledge of principles, practices and laws related to finance, accounting and taxation.
  • There is still a dearth of such professionals, and this has led to the slow pace of research and development in Islamic capital markets.
  • To grow at a faster pace and equal or even surpass the conventional capital markets, Islamic capital markets need a large pool of trained professionals.
  • Some of the ways to increase this existing pool are encouraging training providers in financial and business institutions worldwide, to collaborate extensively, and develop and conduct training programs that focus on Islamic capital markets, encouraging greater interaction between Shari’ah scholars and market professionals, and funding research on Islamic finance generously.
  • To do this, authorities should design contracts that can be sold and purchased internationally across regions and markets.

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