Vol 10, No 4 - Financial Planning Association of Malaysia

isk of failure in any Islamic institution /
instrument can lead to greater systemic
risk, much more damaging to the similar
failure in the conventional system.
This is where syariah governance comes
into play. Syariah compliance is the core
purpose of Islamic banking and finance and
therefore gives legitimacy to the practices
of the Islamic financial institutions. With
this compliance in place, the confidence of
the shareholders and public is assured as
all the practices and activities of the Islamic
financial institutions are halal. Existence of
any non-Syariah element would not just
affect the public confidence in the Islamic
financial institutions, but would also
expose these institutions to fiduciary and
reputational risks.
The call for standardisation of opinions
is not something new. All scholars and
researchers are in agreement that new
standards are required to apply the best
practices in Syariah governance for Islamic
financial institutions, with no single model
being applicable to all. This application will
vary from country to country, depending
on the pace of development each country
is going through.
The alternative financial system
Other than stricter corporate governance,
the failure of the debt-based financial
framework calls for an alternative financial
system and the Islamic financial system
has been identified as the most suitable
candidate.
A full-fledged Islamic framework would
include, inter alia, sanctity of contract
(explicit and implicit); property rights;
trust; rules of behaviour in governance;
existence of markets; rules regarding
allocation, production, and distribution
of resources, income and wealth; rules
governing the behaviour of market
participants; and rules regarding postmarket
distribution (Mirakhor, 2009).
Such a system, advocates an equitybased,
risk-sharing financial system.
Mirakhor constructed a theoretical
model in 1990 demonstrating that a
full-fledged equity-based system has
desirable features that improves the
shock-absorption adjustment capacity
of the economy. The rate of return in this
model is derived from the real sector,
providing an interactive process from the
financial and real sectors. vi
However, such a system can only exist
if Islamic finance operates on its own
regulatory-supervisory framework.
Mirakhor suggested that such a
framework has to be unified, uniform and
multinational, covering all economies that
has adopted, however little, any form of
Islamic finance.
Conclusion and Recommendations
The recent events created a great
opportunity for the Islamic finance industry
as the alternative financial system. However,
this opportunity must not be lost. There
is no room for complacency. If marketplayers
want to make the most of this timely
opportunity, there is a need to ensure the
lessons of the crisis are well learned.
Risk management: Good risk management
practice in financial institutions means
efforts must be made to efficiently manage
risks, shifting those that can be transferred
and avoiding other risks by simple business
practices. The introduction of new products
to the Islamic financial landscape must also
be accompanied by a clear understanding
of such products so that any new risks that
arise could be assessed and controlled
accordingly.
Towards equity-based funding: Learning
from the credit growth and leverage lesson
above, it appears as if equity-funding
is the next best alternative. An equitybased
system would be linked to the real
economy. The role of debt should not
be a predominant one, but a measure
of last resort. Chapra (2008) mentioned
conditions that need to be met, as clearly
laid down by syariah, to prevent excessive
debt expansion:
• The asset transacted must be real,
not imaginary nor notional
• The seller must own and possess the
goods being sold/leased (qabd)
• The transaction must be a genuine
one, with intention of delivery
(dhaman)
• The debt cannot be sold and must be
born be the creditor himself (ghorm),
i.e. risk cannot be transferred.
Enhanced standards and disclosure
requirements: In terms of transparency
and accountability, there is a call for
enhanced standards and disclosure
requirements for Islamic financial
instruments, especially for new
innovations. AAOIFI and IFSB not only
have to ensure that they are keeping
in pace with the rapid development of
Islamic financial products but also with
the U.S. and international standard setters
who are reviewing their own standards in
response to the crisis.
Corporate and Syariah Governance:
The strength of Islamic finance over the
conventional system in the crisis was asset
quality, as Islamic principles safeguarded
parties from investing in low-quality assets
that were not so transparent. However,
there still remains lack of transparency
and weak corporate governance across
the Islamic financial sector. In particular,
more knowledge and tougher regulation
are required in profit sharing investment
accounts where merely “converting” a
readily available conventional model is
just not good enough. Presently there is
great demand for high quality investment
products but this means the financial
institutions need to manage the liquidity
challenges, as profitability is affected. At
a recent IFSB meeting vii , the needs of the
industry were identified – to develop
financial instruments with triple A rating
for sukuk as well as the secondary market
so that liquidity too can be managed.
Enhancement of the Islamic finance
profession: One of the key strategies in line
with enhanced standards is the enrichment
of the Islamic finance professionals,
within the industry, in terms of quality
and quantity. Many academic courses
/ qualifications offered are essentially
to “convert” the professionals within the
Islamic finance industry to Islamic-based
technical skills and knowledge. This is
essential as most personnel of newly
established Islamic financial institutions
have just been redeployed from their
18 The 4E Journal