Future of Islamic Insurance
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