On April 21, the central bank governors of Bahrain, Indonesia, the Islamic Republic of Iran, Kuwait, Lebanon, Malaysia, Pakistan, Saudi Arabia, Sudan, and the United Arab Emirates and senior officials from the Islamic Development Bank and the Accounting and Auditing Organization of Islamic Financial Institutions agreed to create an organization to promote good regulatory and supervisory practices and uniform prudential standards for Islamic financial institutions. That decision follows extensive consultation, coordinated by the IMF with the collaboration of the Islamic Development Bank and the Accounting and Auditing Organization of Islamic Financial Institutions.
Over the past decade, Islamic financial institutions have seen an impressive growth in assets worldwide, including in internationally active banks. Their financial products, based on the principles of Sharia’a (Islamic law), avoid interest payments and rely on contracts (including some based on profit and loss sharing) linked to real transactions. These products carry unique risks. The mixture of credit, market, and operational risks varies according to the design of the contract and the nature of the underlying real transactions. Contracts involve both current and future delivery and thus require careful identification, measurement, monitoring, and control of the underlying risk profiles. In addition, the markets for short-term and liquid instruments are underdeveloped, which has increased liquidity risks for these institutions and constrained the central banks’ ability to manage systemic liquidity.
National supervisory authorities have been trying to adapt existing international standards to the specific risk characteristics of Islamic financial institutions and to design new asset-backed instruments for liquidity management. During the IMF-World Bank Annual Meetings in Prague in September 2000, central bank governors and senior officials of Islamic financial institutions asked the IMF to help them form a standard-setting body. In the ensuing consultative process, V. Sundararajan and David Marston of the IMF’s Monetary and Exchange Affairs Department spearheaded a series of meetings with central bank governors, as well as several technical meetings that helped work out the details of the organization.
The product of this work—the Islamic Financial Services Board (IFSB)—will be based in Kuala Lumpur, Malaysia, and will complement the efforts of the Accounting and Auditing Organization of Islamic Financial Institutions, which sets accounting and disclosure standards. The IFSB will maintain close ties with other bodies being set up to promote Islamic financial instruments and markets. To help strengthen and harmonize prudential standards, the IFSB will also
set and disseminate standards and core principles—as well as adapt existing international standards— for supervision and regulation, consistent with the Sharia’a principles, for voluntary adoption by member countries;
serve as liaison for and promote cooperation with other standard setters in the areas of monetary and financial stability; and
promote good practices in risk management in the industry through research, training, and technical assistance.
Participating governors and senior officials asked Dr. Zeti Akhtar Aziz, Governor, Bank Negara Malaysia, to head a steering committee that would oversee the establishment and inauguration of the IFSB.