Accountancy giant Deloitte calls for tightening of Sharia finance rules

Islamic finance needs more regulation to boost the detection of risk and restore its reputatio , says Deloitte & Touche.

The Islamic finance industry has been tipped for further growth.

Islamic finance needs more regulation to boost the detection of risk and restore its reputation after a series of financial troubles within the industry's GCC heartland, says Deloitte & Touche. A "sizeable" number of Sharia-compliant financial companies were not following industry best practices, the international accounting company found in a survey of the Middle East.

A multilateral framework of rules controlling Islamic finance in the region was needed if the industry was serious about entering new markets, said Hatim el Tahir, the director of Deloitte's Islamic finance knowledge centre in Bahrain. "Failure cases have triggered interest in more transparency and disclosure," he said. "Increased corporate governance is needed within the management of Islamic finance products."

With assets of about US$1 trillion (Dh3.67tn) already under management, the Islamic finance industry has been tipped for further growth as it attracts more funds from the world's Muslim population. Yet defaults and other financial problems involving Gulf companies have shaken investor confidence and led to questions about regulatory oversight within the industry. First came a default by the Kuwaiti company, The Investment Dar, on a $100 million Islamic bond in May last year.

Another Sharia-compliant lender, Kuwait Finance House, was downgraded by the ratings agency Standards & Poor's (S&P) in May due to a deterioration in its asset quality and profitability. "Although Islamic finance is expected to continue its growth path, the development of the industry's infrastructure and regulatory framework is of high concern to most executives who took part in this survey," said Mr el Tahir.

Only half the firms responding to the survey said they had risk management systems in place to manage Islamic financial product requirements. Sixty-four per cent of participants agreed that Islamic finance was lagging on the implementation of risk management systems. Deloitte said some institutions had failed to develop risk management systems addressing Islamic financial products. It recommended Islamic finance should adopt robust disclosure procedures to identify important areas in which it could develop a comprehensive risk management system.

Regulators, including those in the GCC, are already examining ways to improve the assessment of risks of Islamic banks, sukuk and other Sharia-compliant products to raise their appeal to global investors. The absence of a standard legal framework for Islamic financial contracts recognised as Sharia-compliant by scholars from outside the sector was a barrier to enabling the industry to grow internationally, Rasheed al Maraj, the governor of Bahrain's central bank, said in June.

Nonetheless, the industry is expected to gradually build its presence worldwide. The Islamic financial services board in Malaysia has estimated the industry's assets under management could quadruple to $2.8tn by 2015 from about $700 billion in 2005. Although Malaysia is considered the foremost global base for Islamic banking, both the UAE and Bahrain are vying as regionally important centres for the industry. In the UAE, the assets of Islamic banks last year stood at $65.8bn, representing 16 per cent of the total banking system. Bahrain's Islamic bank assets were $26bn last year, accounting for 11 per cent of the total banking industry.

Mr el Tahir said there was room for both countries to offer complementary services within Islamic finance. While Bahrain was focused more on Islamic funds, the UAE was looking to establish itself as a centre for Islamic capital, he said. @Email:[e-mail]