Fu­ture of Is­lamic Insurance

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The con­cern of the State Bank of Pak­istan over the dearth of Shari­ah­com­pli­ant hedg­ing prod­ucts re­flects the sig­nif­i­cance of Is­lamic fi­nance with ref­er­ence to its im­mensely grow­ing in­ter­na­tional mar­ket. Ac­cord­ing to SBP, the Is­lamic bank­ing in­sti­tu­tions are at a dis­ad­van­tage as com­pared to con­ven­tional prod­ucts due to this. and neg­a­tively im­pacts the mit­i­ga­tion of risks aris­ing out of gen­uine busi­ness trans­ac­tions.

Is­lamic fi­nance has de­vel­oped mainly in two di­rec­tions, namely Is­lamic bank­ing and Taka­ful. The lat­ter is the Is­lamic al­ter­na­tive to con­ven­tional insurance. While in­for­ma­tion about Is­lamic bank­ing is be­ing in­creas­ingly dis­sem­i­nated, the fea­tures, mod­els and struc­tures of Taka­ful are lit­tle known, par­tic­u­larly in Pak­istan.

Is­lamic fi­nan­cial risk man­age­ment is based on the con­cept of so­cial sol­i­dar­ity, co­op­er­a­tion and mu­tual in­dem­ni­fi­ca­tion of losses of par­tic­i­pants. It is a pact among a group of in­di­vid­u­als who agree to jointly in­dem­nify the loss or dam­age that may be in­flicted on any of them, out of the fund they ac­cu­mu­late col­lec­tively. There­fore, the Is­lamic risk man­age­ment con­tract in­volves the con­cept of do­na­tion for ben­e­fit of oth­ers and mu­tual shar­ing of losses with the over­all ob­jec­tive of elim­i­nat­ing the el­e­ment of un­cer­tainty.

The ris­ing de­mand of Is­lamic fi­nan­cial prod­ucts has led the State Bank of Pak­istan to in­crease the share of Is­lamic bank­ing sys­tem from the ex­ist­ing 7 per­cent to 12 per­cent. The sig­nif­i­cance of Is­lamic fi­nan­cial risk man­age­ment can be in­ferred from the views of Dr Ishrat Hus­sain that the Is­lami­sa­tion of the eco­nomic sys­tem, if adopted and prac­ticed in its true form, will strengthen the econ­omy, par­tic­u­larly in­come dis­tri­bu­tion and poverty al­le­vi­a­tion which have proved elu­sive un­der the present western eco­nomic model. He re­gards it as a tool to elim­i­nate sources of in­sta­bil­ity, vi­o­lence and ten­dency to­wards ex­trem­ism aris­ing from a sense of de­pri­va­tion in the re­gion.

Sta­tis­tics re­veal that by 2010, there were over 500 Is­lamic fi­nan­cial in­sti­tu­tions with a to­tal size of $1.2 tril­lion, over 250 Shariah-com­pli­ant mu­tual funds hav­ing $300 bil­lion worth of funds, over 133 Taka­ful com­pa­nies with $8.8 bil­lion in con­tri­bu­tion and some 207 in­ter­na­tional Is­lamic Sukuks is­sued till 2007 with a 73 per cent growth in com­par­i­son to 2006.

With the growth of Is­lamic fi­nance, a num­ber of stan­dard set­ting bod­ies and agen­cies have been brought to the fore to har­monies and stan­dard­ize preva­lent prac­tices. The most important ones are an Ac­count­ing and Au­dit­ing Or­gan­i­sa­tion for Is­lamic Fi­nan­cial In­sti­tu­tions (AAOIFI); Is­lamic Fi­nan­cial Ser­vices Board (IFSB); In­ter­na­tional Is­lamic Fi­nan­cial Mar­ket (IIFM); Liq­uid­ity Man­age­ment Cen­tre (LMC) and In­ter­na­tional Is­lamic Rat­ings Agency (IIRA).

As part of stan­dard­iza­tion, the Is­lamic bank­ing team at SBP has tai­lored Risk Man­age­ment guide­lines for Is­lamic Bank­ing In­sti­tu­tions (IBIs), is­sued by the Is­lamic Fi­nan­cial Ser­vices Board (IFSB) in Pak­istan. The guide­lines of­fer the fol­low­ing spe­cific cat­e­gories of risk drawn from in­dus­try prac­tices; • Credit risk • Eq­uity in­vest­ment risk • Mar­ket risk • Liq­uid­ity risk • Rate of re­turn risk • Op­er­a­tional risk

All the Is­lamic Bank­ing In­sti­tu­tions are ex­pected to un­der­take a mean­ing­ful assess­ment and im­ple­men­ta­tion for each risk cat­e­gory. First, se­nior man­age­ment at the in­sti­tu­tions is re­quired to draw up an emer­gency and con­tin­gency plan to deal with un­fore­seen events. IBIs are also en­cour­aged to­ward risk mea­sure­ment by es­tab­lish­ing mod­els that quan­tify risk pro­files. The re­sults of these mod­els should be as­sessed by in­de­pen­dent risk re­view func­tions. Ac­cord­ing to the guide­lines, the IBIs should also develop a mech­a­nism which should, to the pos­si­ble ex­tent, mon­i­tor that funds pro­vided by them were uti­lized for the same pur­pose they were ad­vanced.

Ac­cord­ing to Yaseen An­war, Deputy Gover­nor State Bank of Pak­istan, the ab­sence of stan­dard­ized doc­u­men­ta­tion in­vari­ably re­sults in sig­nif­i­cantly higher trans­ac­tion costs thus mak­ing the trans­ac­tion un­vi­able. It should be ex­plic­itly un­der­stood that such in­stru­ments should cover the gen­uine risks aris­ing due to real busi­ness and eco­nomic trans­ac­tions and should in no way al­low trans­ac­tions for spec­u­la­tive mo­tives. This guide­line is in ac­cor­dance with the Ta­hawwut (hedg­ing) Mas­ter Agree­ment (TMA), which was de­vel­oped by IIFM in col­lab­o­ra­tion with In­ter­na­tional Swaps and De­riv­a­tives As­so­ci­a­tion (ISDA). TMA is a frame­work risk mit­i­gat­ing doc­u­ment for hedg­ing trans­ac­tions and is de­vel­oped for the en­tire Is­lamic fi­nance in­dus­try es­pe­cially for Is­lamic fi­nan­cial in­sti­tu­tions (IFIs) as well as for Is­lamic win­dows.

Is­lamic fi­nan­cial risk man­age­ment has been grow­ing at a con­sid­er­able rate as com­pared to the global av­er­age growth of con­ven­tional insurance. A large num­ber of Is­lamic Insurance com­pa­nies ex­ist in the Mid­dle East, Far East, Iran, Tur­key, and Su­dan and even in some non-Is­lamic coun­tries. Malaysia has de­vel­oped Re-Taka­ful busi­ness as well. Is­lamic insurance (Taka­ful) has proved its vi­a­bil­ity in only two decades to meet the needs of all sec­tors of the econ­omy, both at in­di­vid­ual as well as cor­po­rate level

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