Risk Management in
Islamic Financial Instruments
44
recommended that the Core Principles for Effective Deposit Insurance System , or Core
Principles, be used as a benchmark for changes in deposit insurance systems (IFSB 45-47).
In 2011, the FSB along with the World Bank and International Monetary Fund made
recommendations to emerging markets and developing economies (EMDE) for enhancing
financial stability. The recommendations focused on the application of international financial
standards, the promotion of cross-border supervisory cooperation, the expansion of
regulatory and supervisory authority, the management of foreign exchange risks, and the
development of domestic capital markets. The recommendations are relevant to the IFSI, since
most of the countries employing Islamic finance are considered as EMDE, and they work
closely with the FSB, World Bank and IMF.
3.1.2 Banking Infrastructure
After the financial crisis, there has been increasing pressure to regulate large banks known as
systemically important financial institutions (SIFIs), whose actions have the capability to
create ripple effects throughout the overall system. However, since no IIFSs meet the
standards to be classified as a SIFI, such regulations do not apply to the IFSI. On the other hand,
the regulations on SIFIs are also beginning to be applied, but with more leniencies, to banks
considered domestic systemically important banks, or D-SIBs. In October 2012, the Financial
Stability Board and Basel Committee on Banking Supervision created a framework to identify,
manage, and prevent the failure of D-SIBs. D-SIBs will be required to adhere to a higher loss
absorbency requirement, based on their degree of systemic importance. Governments are
expected to implement the D-SIB framework starting in January 2016. IFSB is reviewing the D-
SIBs framework and their analysis will be published in the revised IFSB-2 (IFSB 50-52.)
The Basel III is a capital and liquidity framework created in 2012. The framework was created
to improve the quality and quantity of capital by converting debt to equity-based capital and
introducing a new leverage ratio. The new standard for the liquidity coverage ratio will not
impact IIFS greatly, since Shariah already limits the debt-to-equity ratio to not exceed 33%.
However, the new recommendations on liquidity may have varying effects on the IFSI. This
impact is due to the lack of Shariah compliant liquidity instruments that will meet the Basel III
standards. Islamic liquid instruments are not currently designed to be long-term. Furthermore,
there is a lack of standardization of Islamic liquidity instruments, and a cross-border transfers
of funds is difficult. Additionally, there is an over-reliance on retail funding.
On the one hand, the new standards may force Islamic banks to diversify their products,
develop products with longer-term features, and better align assets and liabilities in Islamic
banks, all of which would affect the industry positively. On the other hand, the liquidity
standards could concentrate risk to a few products and, thus, increase bank financing rates in
an environment with already rising borrowing costs (IFSB 53-59).