A roadmap for the Islamic financial industry
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Transcript of A roadmap for the Islamic financial industry
A ROADMAP FOR THE
ISLAMIC FINANCIAL INDUSTRY
Sami Al-SuwailemIslamic Development Bank
COFFIS Conference Paris, France
Rabie II, 1433H - February, 2012
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Lessons from the Crisis “We cannot afford to keep stumbling from
one crisis to the next.” We have to build “a new global financial market architecture”Angela Merkel, Chancellor, Germany
“Fundamental reforms of the international prudential framework for banks are urgently needed”Financial Services Authority, UK
“What we need is a new paradigm”Jean-Claude Trichet, President, ECB
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Types of Risk Risk might be exogenous (earthquakes,
tsunamis, etc.) It also might be endogenous, arising from
the actions and decisions of agents Financial crises are largely endogenous Endogenous risks are twice as costly as
exogenous risks We need to build the Islamic financial
industry to be resilient to both types
Cost of Financial Crises
Average recession periodWith financial stress = 27 months
Without = 12 months
Average cumulative loss of real GDP
With financial stress = 14%Without = 5%
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Trends in Financial Industry Homogeneity Indebtedness Shortsightedness
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Homogeneous Industry Before the crisis conventional financial
industry was practically homogenous: Mergers and acquisitions Deregulations No more borders
The industry became highly concentrated and highly inter-connected Top 10 banks control 50% of industry in 2003
vs. 25% in 1990 About 70% of the financial sector’s activities
were within the sector not for the end user,
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Heavy Indebtedness Every dollar of financial sector profits was
supported by: 13 dollars of debt in 1975-1980 33 dollars of debt in 2002-2007
For the nonfinancial business sector: 9 dollars in 1975-1980 13 dollars in 2002-2007
For every dollar borrowed by households and nonfinancial business, financial sector borrowing quadrupled during 1978-2007
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Short-Sightedness 25% (or $1 trillion) of liabilities of major
investment banks was rolled-over on daily basis
Shadow banking system in 2007 exceeded commercial banking: $10.5 trillion vs. $10 trillions
System is vulnerable to bank-runs without commercial banking regulation
Overlooking the shadow system by regulators was a “fundamental failure” (Lord Turner)
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Risk Concentration Homogenous industry is vulnerable to shocks When a shock hits, the entire industry moves
in lockstep Liquidity evaporates when every one wants
to sell at the same time Homogeneity leads to heavier reliance on
short-term debt—the industry becomes fragile
Maturity mismatch creates high endogenous risks
Recurrence of financial crises
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Diversity Diversity makes the system resilient to
external shocks Diversity creates complementarity and
thus improves productivity and healthy innovation
Liquidity = Diversity
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Resilience Industry shall be less dependent on debt Must better align maturities of assets and
liabilities Together, the industry becomes resilient
to both exogenous and endogenous risks
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Islamic Finance Integrated with real economy Debt is tamed with economic output Diversity of economic activities is
reflected in financial activities Institutional structure should be adapted
to the nature of IF
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Islamic Financial Industry Commercial banks 74% Investment banks 10% Sukuk 10% Investment funds 5% Takaful accounts for 1%
(IFSL, 2010)
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IFI Architecture IFI should follow new trends in
international financial architecture The industry should be structured
according to the ability to absorb risk At one end is equity: maximum shock-
absorbing ability with highest value created
At the other is short-term debt: minimum shock-absorbing ability with lowest value
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Integrated Value Chain Equity markets Venture capital Leasing Long- and medium-term debt Short-term debt and money markets Overnight repos …
Value Chain
Long and medium-term debt
Leasing (real estate, machinery, …)
Equity (stock markets, venture capital, …)
Money markets
High shock-
absorbance & value
Low shock-
absorbance & value
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A Roadmap for IFI Put primary emphasis on equity and
leasing segments Banks need to be supplemented by other
specialized finance to function productively
Misplaced order results in unfair demands and unrealistic expectations
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How to Create Boundaries? No diversity without boundaries Not all boundaries create diversity! Boundaries must be economically viable
not arbitrary Natural boundaries:
Economic activities Regulatory boundaries:
Time-horizon (long-term, medium-term, short-term)
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Time Horizon The most critical dimension is time-
horizon Reason: maturity mismatch creates
endogenous fragility of the financial system
Aligning assets and liabilities is essential for avoiding systemic risks
Setting boundaries based on time-horizon of aligned assets and liabilities
Balance-sheets must be “balanced”
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Maturity-Matching Borders
Short term assets & liabilities
Long-term assets & liabilities
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Two Birds with One Stone! By preserving boundaries between
financial institutions, diversity is protected
By choosing boundaries based on asset-liabilities harmony, systemic fragility is minimized
Together, both endogenous risk and exogenous risk are better neutralized
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Conclusion IFI needs to be build on high equity and
high risk-absorbing base The industry has to be well diversified
and integrated Creating boundaries based on maturity-
matching could help achieve diversity and stability
THANK YOU!