IFSB issued the eighth edition of the financial stability report on the Islamic financial services industry. The report covers the key growth trends, the analytical and structural outlook, the resilience of the Islamic financial services industry against the COVID-19 shock, and the emerging risk factors across Islamic banking, Islamic capital markets, and Islamic insurance (takāful) segments. Various initiatives of IFSB (since the last report) have been highlighted, including standards development, research, working papers, implementation of IFSB standards, and industry collaborations. The report also tracks initiatives of other international financial standard-setting bodies, with an emphasis on aspects that relate to the complementary role played by IFSB. To analyze the Islamic banking sector, the report utilizes data from the Prudential and Structural Islamic Financial Indicator (PSIFI) database of IFSB.
The report reveals that the Islamic banking segment retained its dominance in the global Islamic financial services industry. Liquidity continues to be a concern among several jurisdictions with Islamic banking assets. Liquidity risk is highlighted as a risk priority for Islamic banks, particularly in South-East Asia and North Africa where Islamic banks cited liquidity risk as their most important risk for the coming years. The impact of COVID-19 on liquidity position will be particularly challenging and more serious for Islamic banks. This is because they have more exposure to retail and small businesses, most of which have had to shut down and with the possibility that some may not return to business. The PSIFI data revealed that many member jurisdictions are yet to implement the latest liquidity standards—liquidity coverage ratio (LCR) and net stable funding ratio (NSFR). Only seven jurisdictions reported the LCR of their Islamic banks, among which are four GCC countries—namely, Oman, Qatar, Saudi Arabia, and Kuwait. The capital adequacy ratios, however, remain stable and relatively unchanged from the previous analysis period when Iranian banking data are excluded. With the outbreak of the COVID-19 pandemic, it is likely that the ratios may decline below minimum thresholds in some jurisdictions. While in the short term, reduction in credit risk-weights for financing to small and medium enterprises, for instance, as part of measures to ease the effect of the pandemic would allow Islamic banks to provide more financing without much infringement on the Capital Adequacy Ratio, the implication may be severe where there is no credible restoration plan, especially if the pandemic prolongs, causing NPFs to build, and value of collateralized assets deteriorates.
In addition, cyber-security threats continue to occupy important regulatory attention, especially the attendant increased systemic risks due to financial interlinkages and the high propensity toward digital banking and financing. Regulators are expected to increase the frequency of simulation exercises on emerging technology risks and to strengthen focus on internal cyber-security activities by requesting data on cyber threats. Islamic banks will need to further adapt to the latest technological innovations, enhance their preparedness, and boost resilience against the consequential and peculiar operational risks, as these will be crucial especially for post-COVID-19 pandemic economic recovery process. This is possible through Islamic digital banking, given that it allows disruptive players to reproduce superior customer value and experience while being able to do so without being subjected to stringent regulatory requirements and huge capital investments. Bank Negara Malaysia (BNM), for instance, announced that it will be issuing up to five licenses to applicants to establish either digital conventional or Islamic banking business. The response to transforming to digital Islamic banking seems heterogenous across jurisdictions, with incumbent Islamic banks exploring options to either collaborate or compete with new-entrant Islamic financial service disrupters. Furthermore, regtech and suptech in Islamic finance are aimed at enhancing the transparency, consistency, and standardization of regulatory processes in a way that promotes proper interpretation of regulatory standards and at a lower cost and ensures risk-based supervision for Islamic banks’ regulators.
Keywords: International, Banking, Insurance, Securities, COVID-19, Financial Stability Report, Islamic Banking, Basel, Liquidity Risk, Regtech, Suptech, Fintech, Regulatory Capital, IFSB
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