azerbaijan: emerging market islamic banking and finance

ACADEMIC ARTICLE
NEWHORIZON October–December 2008
Playing catch-up
While excess liquidity has driven the growth of Islamic finance, investor confidence has grown
correspondingly. Mark Stanley, assistant manager of the Islamic Financial Services Group (IFSG)
at Ernst & Young, Bahrain, considers how the implementation of the right corporate governance
procedures can ensure the long-term sustainability of Islamic finance.
Liquidity – a catalyst for growth
Over the past three decades Islamic finance
has successfully carved out a niche within
the global financial system. It has done
so by reconciling the financial and
theological needs of an expanding pious
Muslim population. One of the largest
concentrations of this growth has been in
the Middle East region, where the industry
has been invigorated by liquidity owing to
inflows of petrodollars from record high oil
prices.
Excess liquidity has thus far been a major
contributor to the success of Islamic finance
in the Middle East and investor confidence
has correspondingly grown. This confidence
has in turn ensured relative financial
stability in an emerging market place that
is still considered politically unstable.
However, Islamic financial institutions (IFIs)
Figure 1 Collective investment schemes and IFIs
should remain conscious of the economic
boom-and-bust cycles that have historically
plagued development in a region that
continues to rely heavily upon petroleum
for much of its GDP. Liquidity cannot be
indefinitely relied upon as a foundation for
growth and Islamic finance must instead
focus on fundamentals if it is to offset the
effects of an economic downturn.
The long-term sustainability of Islamic
finance must therefore be based upon the
public’s trust and confidence and aim to
avoid systematic risk through the
establishment and implementation of
regulatory frameworks that embrace
transparency, accountability and
enforceability. Major corporate scandals in
the past have had a detrimental effect on
conventional finance (the Bank of Credit
and Commerce International scandal is a
famous example). Islamic finance, by its
very nature, has a responsibility to enact
preventative measures that are specific to
its unique structure.
A mismatch in the role of
corporate governance
According to the Organisation for
Economic Cooperation and Development
(OECD), corporate governance is ‘the
system by which companies are directed
and controlled, in the interest of
shareholders and other stakeholders, to
sustain and enhance value’. Conventional
governance standards seek to address the
separation of ownership and management –
known as the ‘agency problem’ or
‘principal-agent problem’ – by ensuring
that the actions of the management are
kept in line with the interests of
shareholders and stakeholders. Within
Islamic finance, too, the fundamental
teachings of the Quran and the Sunnah,
which form the basis of the Shari’ah and
Islamic jurisprudence that governs the
industry, emphasise the importance of
honesty, transparency, documentation,
accountability and ethics. The conventional
governance standards can therefore be
paired with Shari’ah requirements to create
a corporate governance structure that is
suited to Islamic finance.
However, there is a difference between
conventional and Islamic finance that adds
another dimension to corporate governance
and relates to the equally weighted
importance of ‘other stakeholders’. In
IFIs there are two types of owners, the
shareholders, as in conventional institutions,
and the investment account holders, or
46 IIBI www.newhorizon-islamicbanking.com