Saturday, September 03, 2005

New paper on Islamic banking corporate governance and regulation

I have just posted a new paper to my website entitled
"Islamic Bank Corporate Governance and Regulation: A Call for Mutualization".

The abstract follows:

Sheikh Kamel does not fancy the word customer or depositor and prefers to use the term ‘partner’. “Those people who place their money in Al-Baraka bank or any other Islamic bank are considered shareholders of these banks. This means if these banks prosper so will they”.

The Daily Star (Monday, August 15, 2005), by Osama Habib,
“Saudi businessman tackles task of polishing Islam's image”

The rhetoric of Islamic banking – exemplified in this opening quote by one of the industry’s most prominent pioneers – is derived from its historical evolution as a model of two-tier silent partnership. In fact, Islamic banks have mimicked conventional bank assets – from receivables to bonds, with credit sale and lease-backed debt instruments. In the meantime, Islamic banks have continued to rely for the bulk of their liabilities on “investment accounts”, which have a peculiar quasi-equity structure. Contrary to the opening quote, holders of those investment accounts in fact are not shareholders of Islamic banks. In this paper, I analyze different means of reverse engineering a debt-structure for Islamic banks’ liabilities, which would resolve the corporate governance and regulatory problems posed by the investment account structure (wherein holders of those accounts lack internal corporate protection through representation on the board of directors, and lack legal and regulatory protection as creditors and first claimants to the banks’ assets). However, adopting those measures – similar ones having been suggested in the earliest stages of industry development – likely would be rejected by industry practitioners, as they would negate the perceived unique nature of Islamic banking upon which the industry was built. I also suggest that the current mutual-fund model of investment accounts, which is favored by industry practitioners and theorists is fundamentally unsuitable for banking in the narrow sense. I propose mutuality as a solution to the corporate governance and regulatory problems currently unresolved due to the peculiar investment account structure. I show that mutual banking would be closer to the religious tenets enshrined in the prohibition of riba, and thus would strengthen the brand-name of Islamic banking by re-focusing it on the nature of finance and its objectives, and away from formal-legalistic contract mechanics. Moreover, mutual banking is well understood by regulators and economists, and thus the corporate governance and regulatory frameworks for mutuality-based Islamic banking may easily be adopted from western best practices.


As always, comments and suggestions would be greatly appreciated.


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