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Introduction of Facilitator SYED MUHAMMAD TAQI SHAH (DAIBP) GENERAL MANAGER MARKETING HABIB INSURANCE CO. LTD FORMER HEAD OF EMPLOYEE EXCELANCE NATIONAL DATA CONSULTANTS KARACHI FORMER COUNTRY MANAGER TRAINING T-24 & BRANCHES ROLLOUT BSIG, ALLIEDBANK CELL# , = 2

Issues / Challenges facing Islamic banking industry Today, more than 500 Islamic Financial Institutions are operating throughout the world. Western banks are also doing Islamic banking, through their Islamic Units in U.K, Germany, Switzerland, Luxembourg and other countries. The industry is growing at a rate of roughly 15 percent per year, and could serve 40 to 50 percent of the world's Muslim population within a decade. 3

Islamic Finance is the outcome of CSR derived from religion and applied to banking Corporate governance Corporate Social Responsibility Business ethics Ethical profits (rather than “profits-at-any- costs”) Accountability to God “More-than-profit” mentality Shari`a “code of ethics” 4

Growth Engine Awakening Ripe for Growth Future Markets In all, the Islamic finance industry is developing a global reach… Source: Standard and Poor’s “The Globalization of Islamic Finance” 5

The development of the Islamic finance industry has been fuelled by pioneering institutions and industry building organizations 6

Islamic Finance was not established by a royal decree or a presidential announcement, but it was the will of the people which created the industry. Growth in the GCC Islamic banking markets are primarily driven by customer demand Malaysia presents a near ideal regulatory and market-driven model for Islamic business Government driven Growth and drive is being led by customer demand Market driven Source: Central Bank, Reports, industry estimates Key: Bubbles indicate illustrative size of Islamic banking assets Malaysia UAE Qatar Saudi Arabia Turkey Egypt Indonesia China Japan USA UK Singapore Sri Lanka Bangladesh Sudan Iran Pakistan Bahrain Kuwait Brunei 7

8 THE NEED FOR INTERNATIONAL FINANCIAL REFORM INTERNATIONAL FINANCIAL CRISES HOW TO PREVENT SUCH CRISES FROM TAKING PLACE IN THE FUTURE? CALL FOR A “NEW ARCHITECTURE” FOR THE FINANCIAL SYSTEM BASLE COMMITTEE ON BANKING SUPERVISION (BCBS)

Islamic Banking Risk Does Islamic banking risk differ from Conventional banking risk? Not different - just a very special case Trade credit ? Asset backed Secured or unsecured ? Debt or equity ? Leasing / Ijara Repos / Murabaha ? Fund management ? 9

10 THE 1988 BASLE CAPITAL ACCORD BCBS, INTERNATIONAL CONVERGENCE OF CAPITAL MEASUREMENT AND CAPITAL STANDARDS (1988)  A SIMPLE STANDARDIZED APPROACH FOR ESTABLISHING MINIMUM CAPITAL REQUIREMENTS – BANKS TO MAINTAIN CAPITAL ON THE BASIS OF FIVE CLASSES OF BORROWERS (0%, 10%, 20%, 50% AND 100%)  DID NOT DISTINGUISH BETWEEN THE RELATIVE DEGREES OF CREDITWORTHINESS AMONG INDIVIDUAL BORROWERS  APPLIED INITIALLY TO INTERNATIONALLY ACTIVE BANKS IN THE G10 COUNTRIES

11 BASLE II GREATER FOCUS ON RISK MEASUREMENT AND CONTROL THE “THREE PILLARS”

12 BASLE II (1) “PILLAR 1”: CAPITAL ADEQUACY  RISK ADJUSTED CAPITAL REQUIREMENTS  THREE OPTIONS  EXTERNAL-RATINGS BASED  INTERNAL-RATINGS BASED  MODELS-BASED

13 BASLE II (2) “PILLAR 2”: SUPERVISORY REVIEW  TO EVALUATE THE RISK PROFILES OF INDIVIDUAL BANKS  SPECIFY THE NEED FOR REMEDIAL MEASURES

14 BASLE II (3) “PILLAR 3”: MARKET DISCIPLINE  ENHANCING THE DEGREE OF TRANSPARENCY IN BANKS’ PUBLIC REPORTING AND THE DISCLOSURES THEY MUST MAKE TO LEND GREATER INSIGHT INTO THE ADEQUACY OF THEIR CAPITALIZATION

15 THE CORE PRINCIPLES (1997)  BCBS, CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION (1997)  SETS OUT 25 BASIC PRINCIPLES THAT ARE REQUIRED FOR AN EFFECTIVE SUPERVISORY SYSTEM

16 THE CORE PRINCIPLES (1)  PRINCIPLES 1-5 : LICENSING AND STRUCTURE  PRINCIPLES6-15: PRUDENTIAL REGULATIONS AND REQUIREMENTS  PRINCIPLES 16-20: METHODS OF ONGOING BANKING SUPERVISION

17 REGULATION AND SUPERVISION OF ISLAMIC FINANCIAL INSTITUTIONS (1) TWO RESPONSIBILITIES :  TO APPLY THE INTERNATIONAL STANDARDS  TO COMPLY WITH THE SHARI‘AH

18 ISSUES INVOLVED  CAPITAL ADEQUACY  EVALUATION AND CONTROL OF RISKS IN THE DIFFERENT ISLAMIC MODES OF FINANCE: CREDIT RISK, MARKET RISK, LIQUIDITY RISK, INTEREST RATE RISK AND OPERATIONAL RISK MUDARABAH, MUSHARAKAH, MURABAHAH, SALAM, IJARAH, AND ISTISNA ‘

19  ACCOUNTING STANDARDS  INTERNAL CONTROLS AND EXTERNAL AUDIT  GREATER TRANSPARENCY  DEPOSIT INSURANCE  SHARI‘AH AUDIT

SHORT‐TERM LIQUIDITY MANAGEMENT REGULATORY AND TAX REFORMS I. STAMP DUTIES II. TAX INCENTIVES FOR INVESTORS III. REGULATORY RESERVES AND CAPITAL REQUIREMENTS HUMAN CAPITAL INVESTMENT AVENUES STANDARDIZATION OF CONTRACTS PERCEPTION OF USERS BENCHMARK 20

Dedicated R & D efforts to develop viable short term liquidity products for the industry Dedicated learning centers at University level to train and develop competent workforce and Shariah Scholars Collective mass awareness campaign by Islamic banks State Bank should take measures for uniformity of Islamic banking contracts and products Dedicated research and product development teams should be developed at all Islamic Financial Institutions. 21

Conclusion Islamic banking risk issues Liquidity – under developed money market Interest rate Risk Commodity Risk Communication Risk Equity risk – fund management or banking? Operational risk Religious – Hallal or Haram? Language Risk - English, Arabic, Malay or Urdu 22

SBP “Strategic Plan for- Islamic Banking Industry of Pakistan 2014 – 2018” To augment the existing growth momentum and to lead the industry to the higher level of professionalism The plan focuses on initiatives necessary for improving public perception of Islamic banking Promoting it as a distinct and viable system to address the financial services need of the public in general and business community in particular 23

FOCUS ON KEY AREAS Enabling Policy Environment Shariah Governance & Compliance Awareness and Capacity Building Market Development 24

LegalRegulatorySupervisory Financial accounting & reporting framework Taxation regime Liquidity management framework 25

B. SHARIAH GOVERNANCE & COMPLIANCE The focus in this area will remain on standardization and harmonization of Shariah practices, as well as on creating distinct Islamic banking products and services. C. AWARENESS & CAPACITY BUILDING Efforts will be made for coordination and collaboration amongst internal and external stakeholders, enhancing awareness about Islamic finance, and building capacity of the stakeholders 26

D. MARKET DEVELOPMENT Initiatives will be undertaken for product diversification and financial inclusion with the collaboration of stakeholders. 27

A. ENABLING POLICY ENVIRONMENT Legal Framework Separate chapter in Banking Company Ordinance(BCO) 1962 Necessary changes in SBP Act 1956 Recovery of Finance Ordinance 2001 Microfinance Institutions Ordinance 2001 Engagement in Real trade Real Estate Commodities Investment banking Business Act as Modarba Management Company Reaching on consenses of necessary initiation in Legal and Regulatory Frame work during next 5 years. 28

Alternate Dispute Resolution mechanism By devising customized dispute resolution mechanism Regulations and Guidelines Prudential Standards Guidelines for Development Finance Institutions (DFIs) Rationalization of Minimum Capital Requirement (MCR) On-site Inspection Manual Liquidity Management Framework Tax Neutrality Financial Accounting & Reporting 29

SHARIAH GOVERNANCE & COMPLIANCE Adoption of Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI) Shariah Standards Issuance of Comprehensive Shariah Governance Framework Product Standardization and Harmonization Guidelines for Treasury Operations/Products of IBIs Restricted use of “Agency”, “Hiba” & “Waad” in Islamic Banking Transactions 30

AWARENESS AND CAPACITY BUILDING Coordination and Collaboration amongst Stakeholders Building of stakeholders, to make Islamic banking industry distinct and acceptable by masses, following initiatives are identified as major components of Strategic Plan. Given the evolving nature of Islamic finance and multi-faced issues faced by the industry, effective collaboration and co-operation mechanism amongst all the key stakeholders is critically important for sustaining the growth momentum. The plan thus envisages constitution of an Islamic Banking and Finance Consultative Group (IBFCG) under the lead of SBP with representation of IBIs, Securities & Exchange Commission of Pakistan (SECP), Institute of Chartered Accountants of Pakistan (ICAP), etc. This group will be responsible for developing and implementing strategies for development of Islamic Banking & Finance in the country. Moreover, for the sustainable growth of Islamic Banking and Financial Industry, an active and efficient Islamic capital market and Takaful industry are essential components. The joint forum of SBP and SECP on Islamic banking and finance will be actively utilized for collaboration between the two financial sector regulators to synergize their efforts for facilitating development of the industry on sound footings. 31

Similarly the cooperation and collaboration with International Islamic Infrastructure Institutions like Islamic Financial Services Board (IFSB), IIFM, AAOIFI, and Islamic Research and Training Institute (IRTI) will be strengthened for improving the policy and business environment and capacity building of the industry. Further, being an important and active player of global Islamic finance having ample technical expertise and resources in this field, technical and intellectual assistance will be extended to the countries who are new entrants into Islamic banking & finance. SBP in collaboration with NIBAF will also design and offer customized training programs for international participants from central and Islamic banks of other countries, especially GCC and Central Asian countries. Efforts will also be made to market NIBAF’s Islamic Banking Certification Course (IBCC) as an internationally recognized certification for Islamic banking professionals. 32

MARKET DEVELOPMENT Product Diversification Financial Inclusion Agriculture Financing Small and Medium Enterprises (SMEs) Financing Low Income Housing Islamic Microfinance (MF) Refinance Schemes Market Share Alternate Delivery Channels (ADC) 33

Legal, Regulatory and Supervisory Framework Enabling Policy Environment Way Forward 34

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Liquidity Management Framework 36

Taxation Regime 37

Financial Accounting and Reporting Framework 38

Shariah Governance and Compliance 39

Awareness and Capacity Building 40

Awareness Enhancement 41

Capacity Building 42

Market Development 43

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