Comparing standards is an interesting problem

Lack of standardisation in financial reporting, legal frameworks and Sharia supervision are all commonly blamed for stifling the growth of Islamic banking. Yet it is precisely the industry’s fast acceleration and increasing interconnectivity that has drawn attention to these discrepancies, writes Dan Alderson

Differences in the three main Islamic banking hubs – Malaysia, the Gulf and the UK – often owe less to Sharia than they do to cultural idiosyncrasies. However, some can be material and make it difficult to compare financial institutions. Even highly regulated UK Islamic banks must prove they are standardised.

“One of the challenges of being a Sharia-compliant bank is that you are perceived to be very different to conventional institutions,” says Richard Williams, finance director at Bank of London and the Middle East (BLME).

“Yet BLME is a UK authorised institution and our accounts are drawn up under IFRS [International Financial Reporting Standards], so they look much the same as any other UK bank.”

IFRS are permitted in more than 100 countries, but were designed with conventional finance in mind. IFRS’s compatibility with Sharia runs into trouble due to its calculation of money’s time-value with interest rates. Interest is forbidden under Islam.

The Bahrain-based Accounting and Auditing Organisation for Islamic Finance Institutions (AAOIFI) has pursued a specialised alternative, but not achieved universal application. Kuala Lumpur’s Islamic Financial Services Board’s (IFSB) standards are applied more often in South-East Asia.

While differences in Islamic reporting are common, they are not necessarily a show-stopper for the industry

Financial services firm KPMG has called for the International Accounting Standards Board (IASB) and Islamic finance bodies to work together more closely to address the concerns.

“The UK is in a good position as you can compare like with like,” says Samer Hijazi, a director at KPMG. “However, across the global industry, you are talking about 300 institutions in 75 countries that you need to be able to compare.”

AAOIFI and IFSB have undertaken to make Islamic standards as close to IFRS as possible. But many participants think the best hope for banks would be if IFRS produced its own additional standard specifically for Islamic finance products.

“The Islamic finance world hasn’t made up its mind what it wants,” says Mr Hijazi. “But if IFRS was to be replaced by the Islamic accounting standards of AAOIFI, then comparability with the rest of the world goes out of the window.”

While differences in Islamic reporting are common, they are not necessarily a show-stopper for the industry, Mr Hijazi believes.

“Islamic finance has come a long way,” he says. “Adopting standards is a way of banks communicating with their shareholders – the industry can just get a bit smarter and snappier about how it does that.”

Adherence to IFRS and a globally recognised legal framework benefits UK Sharia banks, but post-crisis financial regulations have added challenges. One is that the banks’ religious prohibition on holding interest-bearing debt securities makes fulfilling Basel III’s liquid coverage ratios all but insurmountable.

The Basel Committee’s Group of Governors and Heads of Supervision (GHOS) has taken note and says national supervisors have the discretion to define Sharia-compliant products, such as sukuk [Islamic bonds], as suitable high-quality liquid assets, but only for Islamic banks.

“We welcome the recognition of these compliance issues by the GHOS as this is a positive step towards bringing Sharia banks into the Basel framework,” says Brandon Davies, chairman of the audit, risk and compliance committee at Gatehouse Bank in London. “However, full compliance with many jurisdictions’ liquidity frameworks is not sufficient on its own; we hope that we will also be allowed Sharia-compliant central bank deposits.”