New standard launched for Islamic finance deals

Industry works to diversify range of solutions as it aims for $2trn business by 2015
New standard launched for Islamic finance deals
(Photo for illustrative purposes only)
By Reuters
Tue 04 Jun 2013 09:09 AM

A standard contract template for Islamic inter-bank transactions was launched on Monday as the industry works to diversify the range of liquidity management solutions available.

The latest standard is part of efforts being made to harmonise industry practices by the Bahrain-based International Islamic Financial Market (IIFM), a non-profit industry body which develops specifications for Islamic finance contracts.

It is hoped the standard will displace commodity murabaha, a common cost-plus-profit arrangement in Islamic finance, with a risk-sharing structure called wakala, that is favoured by industry purists.

"The main objective of this documentation standard is to reduce over-reliance by the financial institutions on commodity murabaha and to encourage greater use of unrestricted wakala," the IIFM said in a statement.

Wakala is an agency agreement where an investor authorises an agent to manage a pool of assets following religious principles such as a ban on interest and monetary speculation.

Despite being a well known sharia-compliant structure, the absence of documentation with clear guidance has limited its broader use, although the industry is being urged to diversify its money markets transactions.

"The industry will find this memorandum very useful whereby it explains how the standard is to be used and in addition to that it provides very comprehensive recommendations," said Ijlal Ahmed Alvi, IIFM's chief executive.

Islamic money markets have expanded in the last few years along with sharia-compliant banking asets, which reached $1.55trn worldwide at the end of 2012 and are projected to exceed $2trn by 2015, according to Ernst & Young.

Commodity murabaha dwarfs other money market instruments used, but it also faces opposition from some Islamic scholars on the boards which oversee banks' activities.

The practice is criticised as not sufficiently based on real economic activity, a key principle in Islamic finance.

Discontent has even prompted Oman's regulator to go so far as to ban commodity murabaha altogether, when the Sultanate released its Islamic banking framework in December of last year.

The wakala standard could also speed-up the convergence of Islamic finance practices across its various regions, according to Khalid Hamad Abdul-Rahman Hamad, executive director-banking supervision at the Central Bank of Bahrain and IIFM chairman.

"This much-awaited documentation standard is another milestone in the standardisation and harmonisation of the Islamic finance industry."

The new documentation would encourage the industry to address accounting and regulatory requirements in their respective jurisdictions, he added.

The Islamic finance industry has its main centres in the Middle East and southeast Asia, but the regions have for the most part developed independently of each other.

While this is not the first wakala standard in the market - a template was launched by Malaysia's association of Islamic banks in 2009 - the IIFM could benefit from wider geographical backing.

The IIFM started operations in 2002, founded by the Jeddah-based Islamic Development Bank and the central banks and monetary authorities of Bahrain, Brunei, Indonesia, Malaysia and Sudan. Additional members include the State Bank of Pakistan and the Dubai International Financial Centre.

Last year IIFM launched a standard contract template for Islamic profit rate swaps, and is currently working on others including cross-currency swaps and foreign exchange forwards.

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