The Islamic Financial Services Board (IFSB) has published new guidelines on liquidity and stress-testing, seeking to reduce the balance sheet risk of Islamic financial institutions in line with a tightening of standards in conventional banking.
The guidelines are the first published by the Malaysia-based body, which sets global standards for Islamic finance, since December 2010. The guidelines are not mandatory – it is up to national regulators to decide whether to adopt them – but the IFSB said it expected regulators to begin using them in 2013.
Under one set of new guidelines, the IFSB calls for closer scrutiny of maturity mismatches, more attention to avoiding excessive concentration of funding sources, and better measurement of unencumbered assets, or assets on which there are no claims.
Over-concentration of funding sources has been a problem for some Gulf companies which have relied on a small number of debt issues without raising equity. Kuwaiti investment firm International Investment Group said last month that it had agreed in principle with most creditors on the main terms of a plan to restructure a $200 million exchangeable sukuk which represents over 75 percent of its liabilities.
A second set of IFSB guidelines covers stress-testing of Islamic financial institutions, offering 29 principles that cover risks specific to Islamic banks; they are designed to complement international best practices.
The IFSB’s new standards are part of a series of initiatives in the last several months to address the issue of risk in the industry. Early this month the Accounting and Auditing Organization for Islamic Financial Institutions, another standard-setting body based in Bahrain, proposed more detailed accounting standards for real estate while increasing disclosure for Islamic banks’ investment accounts. Last month the Bahrain-based International Islamic Financial Market and the International Swaps and Derivatives Association launched a standard contract template for Islamic profit rate swaps, which can be used to hedge risk.
The Malaysia-based International Islamic Liquidity Management Corporation plans to issue a new set of liquidity management products this year, which it hopes will give banks a greater choice of instruments with which they can meet liquidity requirements.
The IFSB’s latest guidelines may indicate a shift of approach for the body. Founded in 2002, its standards were initially generic and criticized for lacking details, as the IFSB focused on winning wide support for its positions.
Now, however, the IFSB appears to be prepared to issue more detailed guidance in response to the global financial crisis, a trend towards tightening regulation of conventional financial markets, and the opening of North Africa to Islamic finance in the wake of last year’s Arab Spring uprisings.
In a statement on its latest guidelines, the IFSB said the “looming challenge is to attain scale and depth in financial markets through strengthened regulatory frameworks”.
The IFSB’s next annual summit, to be held in Turkey in May, will focus on “The Changing Regulatory Model and Islamic Finance”, the organization has announced, Reuters reported.