Islamic finance, future challenges (page 1 of 3)

Islamic financial institutions need to consider undertaking internal changes in order to prepare for a much more stringent US and global regulatory environment. Thus they would do well to adopt compliance regimes, establish internal compliance timetables, establish procedures for basic and enhanced due diligence, aggressively manage it and review existing contracts and relationships.

This was the message to the audience of the International Islamic Finance Forum in Geneva from Jonathon Winer, of Alston and Bird (and formerly US Deputy Assistant Secretary of State for International Law Enforcement.)

"Banks should consider appointing a compliance officer responsible for establishing a global compliance regime that is applicable to all units, policies, procedures and training," said Mr Winer. The industry should also consider the checking of all accounts and customers against the UN, US and EU sanctions list, think about shielding other profit and loss sharing arrangements from the risk of these accounts.

"It is also important to enter into appropriate contracts with intermediaries at foreign financial institutions and to aggressively manage FATF [Financial Action Task Force] problems."The fundamental essence of new US financial institutions regulation such as the Patriot Act is about enhancing due diligence and encouraging a much greater level of transparency, explained Mr Winer. And while the regulatory framework of the global financial community may have changed since 11 September, even before this time, the move towards greater transparency and accountability was already well underway.

"The US has gone through a radical change since 9/11 in terms of regime and the EU is going in a similar direction," said Mr Winer noting that the direction is broadly the same as that of the Financial Action Task Force (FATF). This change has led to a heightened concern about procedures and documentation and one which perhaps highlights the difference between Islamic and conventional finance.

"There is a partnership between the Islamic financial institution and the customer which allows for flexibility and results in higher liquidity which is not the case with conventional banks. And in conventional banking it is important to get lots of documents and make sure that they're clear and they tell the full story. Loyalty programs on the Islamic side lead to a different regulatory regime and system."

Increasingly, and with the US Patriot Act, all countries wishing to deal with the US financial markets will have to adopt a heightened sense of the importance of sound regulations. Anonymous accounts for example, will become a thing of the past as the KYC (Know Your Customer) principle becomes the norm although Swiss based numbered accounts, said Mr Winer, will remain acceptable (since the account holder is known to certain members of management).

Regarding Islamic banking, Mr Winer noted that the development of the trust relationship with the client has sometimes been to the detriment of a more rigorous system of procedures and disclosures. "Islamic banking is poorly suited to provide conventional disclosures - this creates a hazardous interface. There is now greater systemic risk and a move to know the sources of customers funds and not just to identify customers."

Moreover, pointed out Mr Winer, increasingly stringent regulations now relate to all financial institutions such as insurance companies and hedge funds and not just banks.