Future of Islamic Finance Sami Al-Suwailem Islamic Development Bank Group Raie I, 1431H – March, 2010

Lessons from the Crisis Risk can be exogenous (earthquakes, tsunamis, etc.) It also can be endogenous, arising from the actions of banks and traders Financial crises are largely endogenous We need to build the Islamic financial industry to be resilient to both types

Financial Industry Before the crisis it was practically homogenous Most are trading the same securities and follow same strategies When a shock hits, the entire industry moves in lockstep Liquidity evaporates when every one wants to sell at the same time

Diversity A stable system must be sufficiently diverse Diversity makes the system resilient to external shocks Diversity creates complementarity and thus improves productivity Diversity = Liquidity

Islamic Finance Integrated with real economy Since real economy is diverse by nature, IF becomes diverse as well IF encourages specialization which improves productivity creativity IF is also diverse in terms of modes of finance: musharakah, ijarah, salam, deferred sale

Islamic Financial Industry Commercial banks 74% Investment banks 12% Sukuk 11% Investment funds 2% Takaful accounts for 1% (IFSL, 2009)

IFI Landscape IF industry has to be diversified and integrated The industry should be organized according to the ability to absorb risk At one end is equity-based institutions: maximum shock absorber with maximum value created At the other is short-term debt: the least absorber with lowest value created

Integrated Value Line Equity markets Venture capital Investment funds Leasing companies Long-term debt-financing institutions Medium-term & short-term— commercial banks Money markets

Transformation of Risk Lowest risk and value Commercial banks Investment and leasing companies Equity market and institutions Money markets Maximum risk and value

Strategy for Building Islamic Financial Industry Emphasize first equity and leasing segments, then move to commercial banks and money market Banks need to be supplemented by other specialized finance to function productively Misplaced order results in unfair demands and unrealistic expectations

Legal Framework Diversity requires boundaries Boundaries must be economically viable and not ad hoc Boundaries might be based on: Area of specialization (manufacturing, trade, etc.) Type of contract (equity, leasing, debt, etc.) Time-horizon (long-term, medium-term, short-term)

Time Horizon The most important dimension is time- horizon Reason: maturity mismatch creates endogenous fragility of the financial system Aligning assets and liabilities is essential for avoiding systemic risks Time-horizon induces the choice of specialization and type of contracts

Conclusion 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

والحمد لله رب العالمين