Perspective of a European banking supervisory authority Michel CARDONA – General Secretary of the Credit Institutions and Investment Firms Committee (CECEI) Banque de France Islamic finance conference Rome - November 11th 2009

2 n European rules have not taken into account the specifics of islamic banking n No islamic bank status  Islamic banks must meet the usual licensing criteria  Islamic banks are subject to the same prudential supervision and the same reporting requirements  No specific regulation  Islamic banks must comply with standard supervisory regulations  No Islamic money market  Islamic banks must deal with the current conventional framework for monetary operations Introduction (1)

Introduction (2) n How to best accomodate Islamic banking:  Non discrimination  Level playing field  Smooth functioning  Four avenues for reflexion:  Governance and transparency  Legal qualification of Islamic products  Liquidity management  Other regulatory questions

The Sharia board - Composition.  The composition of the Sharia board is independant from the board of the company. It’s a separate entity - Role towards the bank management  The Sharia board is solely in charge of certificating products and processes  It has no implication in the management 1.Governance and transparency

1.2. Compliance with Sharia board rulings - Audit Sharia  There is a need of Sharia audit distinct from conventional audit  The Sharia board is responsible for Sharia audit - Legal compliance  Compliance audit ensures the respect of legal provisions  No interference of compliance audit with Sharia compliance 5

1. Governance and transparency 1.3 Transparency towards consumers/counterparts - Reputation risk  Customers choose an Islamic bank taking into consideration its Sharia compliance and the reputation of its scholars  Lack of consensus among islamic scholars may represent a potential risk - Disclosure and risk mitigation  Full disclosure of Sharia board rulings and of Sharia audit could be a way to minimize this risk 6

2. Legal qualification of Islamic products 2.1 On the liability side  The legal qualification of ressources collected from customers. Some should be considered as « deposits »  The treatment vis-à-vis the deposit guaranty scheme  Many scholars estimate this legal obligation is compliant with Sharia’s principles under some conditions  The lack of harmonization of saving products 7

2. Legal qualification of Islamic products 2.2 On the asset side  The legal status of financing operations  The prudential implication: prudential treatment depends on the legal and accounting classification  The consumer protection (for retail banking): how to meet legal requirements ? 8

3. Liquidity management 3.1 Day to day management  No access to an islamic money market and no liquid sukuk market  Islamic banks have to use specific products such as commodities murabahas; but those instruments are difficult to negociate  Only a few large banks are able to deal with Islamic banks because of the lack of expertise  There’s a gap between large institutions and small Islamic banks 9

3. Liquidity management 3.2 Liquidity stress management  No acces to an Islamic central bank facility; European central banks facilities are non Sharia’s compliant  Eligible collateral: In principle, it seems possible for some Islamic financing operations (e.g. ijaras)  But specific contracts are needed to evaluate their eligibility; the question is still under review 10

3. Liquidity management 3.3 Prudential consequences  liquidity buffers: Islamic banks may be required to hold larger amounts of liquid assets  credit lines: securized credit lines from parent company and/or first rank banks may be required  liquidity ratio: calculation of the previsional ratio will be asked in the licensing process 11

4. Other regulatory questions Definition of prudential own funds  The question of investment accounts based on risk sharing  Standard approach for own funds calculation is to be used Operational risks  Islamic banking is based on a chain of legal contracts  The question of the underlying assets and risks attached Concentration risks  On liquidity: shortage of instruments (sukuks, commodities muhabara…) implies speculative risks on small markets  On sectorial concentration (real estate, geographic...) 12

As a tentative conclusion: n Cooperation is needed with:  International Islamic Institutions  Domestic Islamic supervisory authorities  Other European supervisory authorities 13