Enhancing Crisis Management Frameworks and Supervision of the Islamic Financial Services Industry

Rashid Al Ghassani

04 Jul, 2024

Excerpts from remarks delivered by H.E. Mr. Rashid Zayid Al Ghassani during the 44th Islamic Financial Services Board (IFSB) Council Meeting, Djibouti City, Djibouti, on 2 July 2024.

I am grateful to the IFSB Secretary General, Mr. Ghiath Sabsigh, for inviting me to share some thoughts at this Tour De Table session of the IFSB Council. In my comments, I will begin with some lessons drawn from various financial crises in the last three decades in various regions and then highlight what lessons the Islamic financial services industry and all of us sitting around this table can draw for our markets.

Crisis Management in the Banking Sector

While the Islamic financial services industry has thus far been fortunate to avoid a large-scale crisis, valuable lessons can be learned from conventional finance in order to effectively manage any potential future challenges. Until now, the Islamic finance sector has a good track record of successfully resolving isolated issues at the national level in a timely and measured manner. This experience provides a strong foundation upon which to build robust crisis management protocols.

The nature and pace of a crisis can vary significantly depending on the affected sector and the level of interdependence within that system. Banking crises, for instance, tend to unfold rapidly due to the vital role of liquidity. The ease with which assets can be withdrawn and the resulting impact on confidence further accelerates such financial emergencies.

While the last three decades have witnessed a multitude of such events, a closer examination reveals both common threads and crucial distinctions.

One common element across these crises is the erosion of trust in financial institutions.  This can be triggered by excessive risk-taking, a mismatch between assets and liabilities, or external economic shocks. When confidence declines, deposit withdrawals escalate, creating a liquidity crisis that can quickly spiral out of control.  The speed and severity of this phenomenon is often magnified by the interconnectedness of the modern financial system.

A common element across crises is the erosion of trust in financial institutions.

However, the specific triggers and the subsequent effects of these crises can differ markedly.  The Asian financial crisis of the late 1990s, for example, was primarily driven by a combination of currency devaluation and unsustainable current account deficits.  In contrast, the 2008 global financial crisis originated within the complex web of securitized products and lax regulatory oversight. Similarly, in 2023, banking crisis in the US and EU stemmed from an overreliance by some banks on short-term funding sources, leading to liquidity issues and bank failures when interest rates rose. The rise of technology has also played a transformative role.  While it offers efficiency and innovation, it can also exacerbate vulnerabilities through high-frequency trading and interconnected algorithmic systems.

Crisis Management Framework for Islamic Financial Services Industry

The first element of crisis management framework in Islamic banking industry is “recovery and resolution planning”.  IFSB has published valuable work in this area, and this is the time all the central banks sitting on this table should consider applying the IFSB guidelines on this subject in their own recovery and resolution regimes for the banking sector.

Resolving crises in Islamic finance presents unique challenges.  Smaller Islamic finance sectors might face situations where all institutions are simultaneously offloading assets in a distressed market. Additionally, a lack of well-developed Shari’ah-compliant liquidity support mechanisms from central banks can hinder crisis response. 

Even intra-group support within Islamic financial institutions can be complex due to the need to adhere to Shari’ah principles for transactions and limitations on certain contract types.  Regulatory interventions also require careful consideration to ensure compliance with Shari’ah, especially when dealing with equity-like capital instruments, debt-based contracts and asset ownership claims.  Finally, resolving failing institutions through asset sales or transfers, as well as managing troubled assets within profit-sharing structures, necessitates upholding Shari’ah governance and ensuring Shari’ah-compliant practices throughout the process.

Resolving crises in Islamic finance presents unique challenges.

The second element of crisis management framework is deposit insurance. A well-developed deposit insurance framework is considered an indispensable component of financial stability regimes in the post-crisis world. As highlighted in various IFSB publications, extending conventional deposit insurance protection to Islamic banks presents several challenges. These include: (1) issues in the underlying principles of conventional deposit insurance (excessive gharar, ribā and so on); (2) the treatment and insurability of deposits accepted under profit-sharing contracts; (3) the priority of claims on the deposit insurance scheme of different types of deposits collected by Islamic banks; and (4) the role of the deposit insurance fund in resolution.

The IFSB surveys have shown that progress by central banks and deposit insurance providers to offer such schemes on Shari’ah-compliant basis is rather slow and only 6-7 central banks have actually launched such scheme.

In Oman, our Central Bank High Shari’ah Supervisory Authority (HSSA) has approved a Shari’ah-compliant deposit insurance scheme based on takaful. We plan to implement this scheme for our Islamic banks and windows after the approval of a new deposit insurance law.

The third and final element of crisis management framework is lender of last resort and liquidity management framework. For Islamic banks, central bank liquidity support on Shari’ah-compliant basis can provide a critical buffer, injecting essential funds into the system to maintain a smooth flow of credit.

In Oman, we are in the process of introducing Shari’ah-compliant liquidity management products that will cover all key aspects of liquidity management support by the Central Bank. These solutions include: Shari’a-compliant money market placement facility in USD and OMR, standing liquidity facility, lender of last resort support and intraday liquidity product.

In addition, we have developed products for Islamic treasury bills (t-bills) and certificates of deposits (CDs). We have already launched Shari’ah-compliant money market placement facility in USD, which has drawn a very positive market response.

After the development of online treasury system, which is currently under development, we plan to gradually launch these products for our Islamic banks and windows in near future.

By acknowledging both the commonalities and the unique characteristics of past banking crises, we can refine our approach to financial regulation and supervision – both for conventional and Islamic financial institutions. The most important consideration is to promote a culture of risk management within regulated financial institutions, continuously adapting regulations to address emerging threats, and utilizing the potential of technology – while mitigating its risks.  These combined efforts will ensure that the financial system we regulate remains resilient in testing times and serves as a cornerstone for sustainable economic growth and financial sector development.

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