PROMISE OF ISLAMIC FINANCE

Kuwait 2016 | FINANCE | GUEST SPEAKER

Christine Lagarde, Managing Director of the International Monetary Fund (IMF), on priorities for expanding Islamic finance and unlocking the segment's full potential.*

Christine Lagarde
BIOGRAPHY
Christine Lagarde is Managing Director of the IMF. She was appointed in July 2011. A national of France, she was previously French Finance Minister from June 2007, and had also served for two years as France’s Minister for Foreign Trade. She also has had an extensive and noteworthy career as an anti-trust and labor lawyer, serving as a partner with the international law firm of Baker & McKenzie, where the partnership elected her as chairman in October 1999.

We at the IMF are keen to participate, listen, collaborate, innovate, and develop the promise of Islamic finance in a sound and sustainable way, by managing risks appropriately and ensuring financial stability. We should recall what promise Islamic finance holds—to foster inclusive growth and support the livelihood and aspirations of the people in the region and beyond. And we know, inclusion is key to promote invigorating, reinforcing growth and shared prosperity.

While Islamic Finance is not new and has been practiced for centuries around the world, it has gained in popularity of late. Total Islamic finance assets are estimated at around $2 trillion, practically a ten-fold increase from a decade ago, and outperforming the growth of conventional finance in many places. Islamic finance has the potential to contribute to higher and more inclusive economic growth by increasing access of banking services to underserved populations. To this day, a large segment of the Muslim population—who are a primary, but not the only, market for Islamic finance around the world—remain financially underserviced, with only one-quarter of adults having access to bank accounts. In addition, Islamic finance's risk-sharing features and the strong link of credit to collateral means that it is well-suited for SMEs and startup financing—which we know can promote inclusive growth. For the same reason, Islamic finance has shown its value in infrastructure investment, which can spark productivity gains and catalyze high value-added growth.

Secondly, Islamic finance has, in principle, the potential to promote financial stability because its risk-sharing feature reduces leverage and its financing is asset-backed and thus fully collateralized. In addition, besides deposits, Islamic banks offer profit-sharing and loss-bearing accounts that can help mitigate losses and contagion in the event of banking sector distress. This leads, de facto, to higher total loss-absorbing capital, one of the key objectives of the new global regulatory reform.

To unlock the full potential of Islamic finance, the first priority is to level the playing field and create an enabling environment for Islamic finance to develop, while being mindful of risks. This means adapting financial regulations that take into account the defining features of Islamic finance and do not disadvantage Islamic banks. For example, capital requirements for banks should be adapted to account for Islamic finance's risk-and-profit sharing model—which allows for some loss-bearing by investors and reduces risk weights applied to equity-like financing.

Leveling the playing field also means harmonizing the tax treatment of Islamic finance products with similar conventional contracts. Income tax systems typically recognize interest gains on debt instruments as a deductible expense. This debt bias puts Islamic finance at a competitive disadvantage and discourages risk-shared financing.

The second priority for policymakers is to further develop the industry and markets. Many countries could encourage further improvements in Islamic banking to boost financing for small- and medium-sized enterprises.

In addition to strengthening the industry, many countries could further develop Islamic financial markets. Think of the growth potential of sukuk. Over the past decade, total outstanding sukuk assets have seen a ten-fold increase to about $300 billion. Most of these assets remain concentrated in the Gulf states and Malaysia. But interest has been growing in other parts of the world. Luxembourg, Hong Kong, South Africa, and the UK are among a growing number of other countries that have issued sukuk bonds in recent years.
More regular sovereign issuance is needed at different maturities to help establish benchmarks and develop secondary markets. Sovereign sukuk plans need to be embedded in governments' debt management strategies. And the market needs to be supported by strong legal and regulatory frameworks. The latter would help address persistent uncertainty over investors' rights.

From the IMF's perspective, we are also looking to raise our game. As you know, financial stability lies at the heart of the IMF's work. We have, over the past year, done a large amount of analytical work to deepen our understanding of Islamic finance's implications for financial stability and economic growth. We are keen to pursue this agenda and to further strengthen our policy advice by incorporating best practices for Islamic banking and finance Together, we can foster a 21st-century version of Islamic finance that can deliver on all its promises. That is to promote financial inclusion and stability, meet the needs of financially underserved populations, lift potential growth, and create better opportunities of all people.