KUWAIT: (From left) Acting Prime Minister and Foreign Minister Sheikh Sabah Al-Khaled Al-Sabah, Director General of the International Monetary Fund Christine Lagarde and Governor of the Central Bank of Kuwait Dr Mohammad Al-Hashel attend the Global Islamic Finance Conference yesterday. — Photo by Yasser Al-Zayyat
KUWAIT: (From left) Acting Prime Minister and Foreign Minister Sheikh Sabah Al-Khaled Al-Sabah, Director General of the International Monetary Fund Christine Lagarde and Governor of the Central Bank of Kuwait Dr Mohammad Al-Hashel attend the Global Islamic Finance Conference yesterday. — Photo by Yasser Al-Zayyat

KUWAIT: Governor of the Central Bank of Kuwait (CBK) Dr Mohammad Al-Hashel said yesterday that the Islamic finance can play a role in financial system based on principles that create jobs, drive growth, reduce poverty and achieve equality.

This came in Hashel’s speech at the opening of The Global Islamic Finance Conference, hosted by the State of Kuwait yesterday under the patronage of His Highness the Amir Sheikh Sabah Al-Ahmad Al-Jaber Al-Sabah, and with the presence of Acting Prime Minister and Foreign Minister Sheikh Sabah Al-Khaled Al-Hamad Al-Sabah, Deputy Prime Minister and Minister of Finance Anas Al-Saleh and Director General of International Monetary Fund (IMF) Christine Lagarde.

The Islamic finance also contributes to directing the credit to productive investments as well as investment promotion, he added. He pointed out that the conference, which witnessed the first time the International Monetary Fund’s participation, tackles Islamic financing and means of developing the sector.

Essential changes
Establishing a finance system based on Islamic Sharia requires essential changes not only in the financial sector but also in the way societies are working, thus building institutional capabilities is of a the prior importance, Hashel said.

Kuwait witnessed the establishment of Kuwait Finance House (KFH) – not only the first Islamic bank in Kuwait – but also one of the very first established anywhere in the world, Hashel told the conference. It was a humble start; with only four employees, KFH opened its doors to the public for the first time on 31 August 1978.

“I doubt anyone imagined that it would one day become a leading Islamic bank, with 8,000 employees and operations spanning across seven regions of the world,” he said. According to the CBK Governor, the growth of Islamic finance as an industry is equally impressive. “This is however hardly surprising, as the basic principles of Islamic finance deservedly have a universal appeal, irrespective of religious beliefs,” he said.

He noted that the golden rule of Islamic finance epitomizes the concept of justice which is “central to Islamic finance. Justice, in economic context, requires at least two things; proper allocation of resources for the welfare of the entire society, and sharing of risk and reward.”

This is the ‘golden rule’ of a good society, a principle that has been conveyed by almost every major religion and ethical tradition. It requires that anything that harms a society is prohibited, even if it is beneficial for the individual.

Since banks mobilize savings from a large group of people and lend to relatively fewer borrowers, there is an element of asymmetry in banks’ resource mobilization on the one hand, and resource allocation on the other, he said.

This necessitates that banks, in the world of Islamic finance, lend to those who can use these savings to benefit the whole of society – by making productive investments and creating more jobs. “However, in recent years, excessive liquidity amid unconventional monetary policies has mostly fueled asset growth, with limited impact on real economic activity.”

Inseparable link
Hashel said: “Islamic finance, by establishing an inseparable link between finance and the real economy, encourages economic risk taking that helps improve growth and create jobs. It requires that credit must be provided for productive investments, not for conspicuous consumption or speculative activities.” He pointed to three types of investment: First, currency based investments, which he considered ‘the most dangerous though investors mostly considered them safe’.

The second is ‘investments in assets like gold that never produced anything’, while “the third type is ‘investments in productive assets, whether businesses, farms or real estate’ – and this is precisely what Islamic finance also requires banks to do – to promote investments in productive assets so that the entire society can benefit.”

More importantly, Islamic finance goes a step further, as it also requires the sharing of profits and losses. That is not only important from the justice standpoint but also to ensure financial stability, he stressed.

Since the establishment of the first Islamic bank in Kuwait around four decades ago, “we now have five domestic Islamic banks that collectively account for 39% of domestic banking assets,” he said. This is the third highest share of Islamic banks operating in any country with a dual banking system – where conventional and Islamic banks operate in parallel.

Globally, Kuwait has the fifth largest share of Islamic banking assets and the third largest share of Islamic funds. And it is not only in Kuwait that the Islamic finance industry has taken off in recent decades.

According to Hashel, estimates suggest that the “global market for Islamic financial services, as measured by Sharia compliant assets, has crossed $2 trillion by now, a quantum leap from $150 billion in the mid-1990’s.”

Last year, the sukuk market witnessed debut issuances from the governments of four non- OIC (Organization of Islamic Cooperation) countries-the UK, Hong Kong, Luxembourg, and South Africa which indicates the growing popularity of sukuk beyond the Muslim world.

As these trends highlight that Islamic finance is neither a novelty nor is it restricted to Muslim countries only. Over the past decade, the industry has transformed itself from being a niche market to a viable alternative for consumers of conventional finance, irrespective of their religious beliefs.

Today Islamic banks serve millions of customers across the Middle East, SouthEast Asia and beyond, offering a variety of Sharia-compliant products and services. While it is indeed a remarkable achievement, Islamic finance has significant potential for further growth, the CBK Governor said.

Three areas
In this regard, he point out three such areas: First, both within Asia and the Middle East and North Africa (MENA), the regions where Islamic finance has a greater footprint, there is substantial scope for investments in infrastructure. These investments are invariably backed by tangible real assets and thus ideal candidates for Islamic finance.

Second, the world is increasingly recognizing the importance of investments that are socially responsible and environmentally sustainable. And given the similarity in their business philosophies, Islamic finance can be a natural choice for socially responsible investments, the CBK Governor told the IMF-CBK conference.

Third, in many developing countries a majority of the public still remains hugely underserved by a formal financial system, if not entirely unbanked. For instance, World Bank data on financial inclusion for 2015 reveals that only 45.5 percent of the adult population has a bank account in South Asia, and merely 14 percent in the MENA region – incidentally, these two regions are home to more than 1.3 billion Muslims, around 82 percent of entire Muslim population.

These numbers collectively highlight that Islamic banks have the potential to reach millions of un-served customers. A banking model inspired by the philosophy of social justice can ill-afford to ignore its responsibility in serving the millions which are otherwise possibly at the mercy of exploitative, informal money lenders, he said.

Hashel then turned to the future of Islamic finance. Prediction is more difficult, if it is about the future of finance, he said. “So, instead of attempting to predict the future, I would like to discuss what needs to be done to help the Islamic finance industry reach its potential. In this regard, the role of four types of institutions is critical not only in providing an enabling environment for a sustainable and resilient industry, but also in bringing current practices closer to the true spirit of Islamic finance,” he said.

The Muslim societies were once recognized for their contribution to various academic disciplines, ranging from alchemy to astronomy and mathematics to medicine. However, at present “the scholarly work being produced in our societies is more of an individual effort than anything at the institutional level.”

Due to this lack of capacity building at the institutional level, efforts of otherwise dedicated individuals have remained divergent and fragmented. Many with profound knowledge of Islamic jurisprudence know little about modern finance.

Top ten scholars
Hashel referred to a study revealing that the top ten scholars in Islamic finance account for 67 percent of all chairman positions of Sharia boards. No wonder then that Islamic banks struggle to find candidates for their Sharia boards who can suitably guide them in offering innovative products.

He referred to effective regulation of Islamic finance which is a “daunting task, particularly in a dual banking system.” Additionally, the peculiar nature of Islamic finance poses its own challenges in terms of designing a robust regulatory regime.
“Take the case of Basel III reforms for example, where detailed guidance has been provided by the Basel Committee for Banking Supervision (BCBS) for the implementation in a conventional setting. However, for Islamic financial institutions, limited relevant guidance is available, if at all,” he said.

This undoubtedly requires the use of discretion by respective regulators. But the greater use of discretion is bound to create differences across countries and may increase the risk of regulatory arbitrage, yet importantly such reforms were meant to foster a high level of convergence among regulatory regimes.

The CBK Governor noted that high responsibility falls on Islamic financial institutions to make efforts in offering products and services that reflect the spirit of Islamic finance and are not just merely compliant with Sharia requirements.

“This requires building capacity to do better research and offer innovative services. Moreover, Islamic financial institutions need to operate with the aim of promoting social justice in their allocation of resources,” he said.

Given these challenges, it is not possible for any one of these four types of institutions to make a meaningful difference on its own. Each institution, from academic to regulatory and legal to financial, has a distinct yet mutually reinforcing role to play.
While individually insufficient, collectively these institutions provide the very foundation for a dynamic and resilient Islamic finance industry and are thus the pre-requisites for its sustainable growth.

In conclusion, the CBK Governor noted that current economic and financial trends are a constant reminder that the world needs a better system. “The inherent fragility of modern finance is quite evident. And in recent years, the unfolding of events like manipulating currencies, rigging LIBOR and miss-selling mortgages has intensified the debate about the role of incentive structures and ethics,” he said. – KUNA