Islamic banking in Qatar well integrated within the local financial system

Islamic financial services (IFS) have come a long way in a relatively short period. According to the Islamic Financial Services Board (IFSB), the international body that acts as the global regulator for the sector, $1.89trn of assets were managed in sharia-compliant structures internationally in 2016. As the sector grows, so do the demands placed upon it, meaning greater regulatory oversight and supervision is required. In the early years of IFS growth, a degree of variance in terms of standards and framework prevailed, but more recently the sector has begun to coalesce around a much smaller selection of operating and regulatory structures. GLOBAL REGULATORS: The situation within Qatar is no different. At the level of international cooperation, the Qatari authorities participate in both of the main standard-setting bodies for Islamic finance – the IFSB and the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). Based in Malaysia and founded in 2002, the IFSB serves as the standard-setting body for the regulatory and supervisory agencies responsible for the IFS sector in its various member states. At present, the governor of the Qatar Central Bank (QCB) sits on the IFSB’s council, alongside members from 56 other jurisdictions.

The IFSB has made significant progress in the 15 years since its inception in establishing a broad and comprehensive framework for the governance of IFS. The IFSB currently has a total of 26 standards to guide principles and technical notes, which work together to provide a regulatory framework for the sector. These include basic technical standards, such as risk management and capital adequacy – standards whose conceptual basis differs little from conventional banking – to measures which are more specific to IFS, such as guiding principles on sharia-governance systems and core principles for Islamic finance regulations.

In contrast to the IFSB, the AAOIFI, which is based in Bahrain and was founded in 1990, produces standards for accounting, auditing, governance and ethics for Islamic financial institutions, and is seen more as an industry-led body. It has proven key in developing internal procedures and standards for sharia-compliant banks, particularly with regards to financial reporting, as well as developing a certification system for individual practitioners, such as the Certified Sharia Advisor and Auditor, and the Certified Islamic Professional Accountant. AAOIFI standards are mandatory within Qatar, which is currently one of only a few countries to insist on such compliance. Evidently, Qatar is at the forefront of global efforts to standardise Islamic finance.

In terms of organising the sector on a domestic level, two basic models of IFS oversight have emerged over the years: countries may mandate a single supervisory authority to regulate and oversee both conventional and Islamic banks, or alternatively, there may be separate supervisory units to deal with the different sectors. Qatar falls under the former model, with the QCB responsible for the regulation and supervision of both the conventional and sharia-compliant sectors. SETTING STANDARDS: Moving beyond supervisorial organisation, there is another important distinction among different jurisdictions concerning the accommodation of Islamic banking within broader regulatory frameworks, specifically the Basel Committee on Banking Supervision, which now sets global standards for banking regulations. An IMF report produced in 2014 that was based on a survey administered to countries with established IFS sectors revealed that 11 out of 31 nations applied a single integrated regulatory framework to all banks, with no distinction made between conventional and Islamic financial institutions. However, 10 countries, including Qatar, applied a single integrated regulatory framework in addition to applying specific references to Islamic banks. This model recognises Islamic banks as a special category, or sub-category, of conventional banks in that they are occasionally subject to additional considerations, but are not intrinsically different. This is in contrast to the remaining jurisdictions: three out of 31 regulate Islamic banks using an entirely separate framework, while seven out of 31 follow a “mixed” approach, whereby a single regulatory framework is modified by separate guidelines or regulations for Islamic banks.

In The Same Boat

The particular regulatory model followed by Qatar is in many respects in keeping with the way in which Qatar’s Islamic financial institutions look upon themselves in relation to their colleagues in the conventional sector. Rather than view themselves as a separate or “boutique” sector, operating in isolation from conventional banks, most of Qatar’s Islamic banks consider themselves as fully commercial entities: doing business within the same market, often competing over the same customers, yet operating under different conditions. Such a scenario could be described as one of differentiation, rather than separation, and its development has arguably been a consistent policy of the regulator for a number of years. Indeed, the most substantial policy to establish this state of affairs arrived in 2011, when the QCB informed local conventional banks that they would no longer be allowed to operate “Islamic windows” within their services, referring to the offering of sharia-compliant products from within a broader conventional banking environment.

At the time, the argument against Islamic windows was seen as helping to avoid the possibility that sharia-compliant funds might mingle with non-compliant ones, such as interest-bearing funds. In reality, as the IMF report noted, there are a number of reasons why Islamic windows might be seen as bearing additional risk for IFS development. These include hindering the establishment of effective corporate governance, encouraging regulatory arbitrage or unfair practices, hindering effective financial oversight and reducing the ability to monitor sharia-compliant liquidity.

Supervisory Boards

Another area where Qatar has proceeded in accordance with emerging international best practice is corporate governance, and specifically the mandating of sharia supervisory boards (SSBs). As a relatively new industry, there are a number of open questions surrounding which Islamic financial products may qualify as being sharia-compliant.

To address this issue, many Islamic financial institutions have tended to delegate such decisions to SSBs, whose members are typically scholars learned in Islamic jurisprudence. As of 2015, and in line with recommended guidelines from the IFSB, the QCB has mandated all Islamic banks to establish an SSB with a minimum of three qualified scholars, alongside a sharia auditor and an audit committee, to rule on the compliance of the bank’s products.

It is not yet clear whether the QCB has institutionalised its own SSB to coordinate a consistent sector-wide policy on products. Some industry figures claim that such a board was introduced at the end of 2015, however, the QCB’s own communiques have made no reference to utilising an internal or external supervisory board to draw up IFS-dedicated policy.

Moving Forward

Looking ahead, future regulatory challenges to the IFS sector are unlikely to differ substantially to those facing conventional finance. In particular the continuing movement towards implementing Basel III requirements on liquidity and capital will impact Islamic finance in equal measure to conventional ones. In some respects the characteristics of Islamic banks favour an easier transition to the slightly more onerous requirements of Basel III. For instance, as noted by the IMF, there is evidence that Islamic banks tend to have higher loan-to-deposit ratios, better asset quality and higher capitalisation than conventional banks.

Conversely, the new liquidity coverage ratio (LCR) requirements of Basel III entail banks to hold a diversified portfolio of what are known as high-quality liquid assets (HQLAs), and in this respect Islamic banks are at something of a disadvantage. As the IMF has noted, the HQLAs of Islamic banks are typically highly concentrated in sovereign debt, and currently there is not the depth in alternative instruments that is available to conventional banks. In an effort to address this, the latest Basel LCR rules promote sharia-compliant products, such as sukuk (Islamic bonds) as HQLAs.

Equally, the entry of new accounting standards within conventional banking will find its counterpart in Islamic finance. The International Accounting Standards Board has been engaging with the AAOIFI on the modifications necessary to the new standard to comply with sharia norms, and it is expected that the latest regulations from the AAOIFI will reflect this consultation process.

In conclusion, it would seem that Islamic finance in Qatar is fully participating in the wider global trend towards regulatory consolidation, whereby practices and standards are slowly but steadily converging towards a unified framework. In the long run this may see growth levels in the sector more closely follow those in conventional finance, but as with the latter, greater uniformity may also lead to a deepening of cross-border markets and capital flows. By remaining at the forefront of these trends, Qatar’s Islamic banks will be better placed to further benefit from them.