The Islamic banking and finance sector risks losing a golden opportunity to demonstrate an alternative system that could prevent a future credit crunch and share risks. With the conventional banking sector slowly coming to terms with its high-profile collapses and bailouts, and the Islamic sector suffering only mild aftershocks, why are savers and investors not flocking to sharia-compliant banking? Could Islamic finance lack a certain degree of credibility? And if so, why?
The conventional banking sector has many years of experience, regulation and business culture behind it, whereas the Islamic sector has, without such a background, reached about $1000bn in assets worldwide in only 20 years. That certainly looks impressive, but it still represents less than 1% of banking assets globally, which makes the question of why many investors are still lacking trust in the system all the more important.
Islamic banking is regulated by sharia advisors, who are supposedly jurists specialising in Islamic law and economics. Their job is to direct, review and supervise activities related to Islamic finance to ensure that they are in compliance with sharia principles. However, they are not accountable for their actions - that is the responsibility of the banks that employ them. Sharia board members' responsibilities, qualifications, ethos, commitment and social responsibility can therefore be unknown or questionable, when they should be identified, regulated and accountable, both to the organisation they represent and to those affected by their decisions, which ultimately shape the Islamic finance system.
One problem is the opaque manner in which advisors are appointed. It is based largely on recommendations and friendships and there is little in the way of checks on qualifications or ability. But as they will rarely have to make an important decision, this hardly matters, as we shall see.
Spread too thin
Another problem is that such a small number of advisors is expected to serve an expanding sector. Instead of training new, young talent, the existing members are spreading themselves thinly around the world's sharia boards: more than 70 boards each in several cases. Financial institutions use these 'celebrity' names in their marketing materials to boost the self-importance and supposed credibility of both parties. Inevitably, the decision-making process is being squeezed in terms of time and commitment because it would be impossible to give a reasonable amount of time to so many boards. Important decisions will go on being rubber-stamped until a major change takes place, and it will not happen from within as long as board membership is such a lucrative business.
So who has the power to change the system? Corporate governance of Islamic banking is torn between the Islamic banks' national central banks, the Accounting and Auditing Organization for Islamic Financial Institutions, the Islamic Finance Services Board (IFSB) and appointed sharia board members. The IFSB recently produced a detailed draft on governance that has no mention of accountability, which sums up the state the sector is in and explains why many Western bankers see Islamic institutions as a risk too far.
Conventional banking may have taken a battering recently, but it remains years ahead in terms of transparency, due diligence and legal adherence. Excessive and inappropriate activities do of course take place in conventional banks but if they are detected, the result to individuals and institutions can be dire. Islamic board members, accountable to no one, can continue with impunity so long as they remain within the laws of the lands in which they operate. As well as the economic impact of such a relaxed attitude, there is the risk that devout Muslims are being misled when they are told that their accounts are run with strict sharia adherence at the forefront.
The system must be changed; there are enough brilliant minds throughout the Islamic world and global finance to make a difference. The most pressing remedial measure is to limit the number of boards a member can sit on to one, and attendance should be part of the deal. Second, board membership should not be a guaranteed job for life; members' continued employment should be dependent on biennial elections. Third, board members must have a noticeable effect on the bank's organisation; this can include product development and training. Fourth, corporate governance should be strengthened to include sharia board members' accountability, just as boards of directors are accountable. And finally, the veil of secrecy needs to be lifted on members' appointment, qualifications, activity and performance; relevant information must all be openly accessible and transparent.
Does the Islamic banking sector have the nerve and the will to enact the massive changes necessary, given that the existing system is of immense benefit to the sector's narrowly based leadership? If enough serious thinkers begin to make themselves heard, perhaps the bankers will realise that the party is over. They will have to choose whether to be part of the change or to move on before the pace of change overtakes them.
Dr Aly Khorshid is an Islamic finance consultant and sharia scholar at Academy UK, and was previously a sharia board member at Al-Barakah International Bank UK
