Risk Perception in Islamic Banking

This first part of the interview analysis aims at the participants' opinions regarding risk management issues in Islamic banking. Questions 1, 2, 3 and 4 explore how the risk perception in Islamic banking differs from conventional banking, the unique risk characteristics of Islamic financial institutions (IFIs), the risks inherent in Islamic banking contracts, and the risk management techniques used by IFIs. Tables 9.1 to 9.6 present the findings from the focused coding analysis for Question 1 about the main risks facing Islamic banks. The results of the analysis for Question 2 are presented in Tables 9.7 to 9.9, while Tables 9.10 to 9.12 summarise the findings for Question 3, which asks the participants whether they believe that Islamic banking products are structured differently to conventional products.

As can be seen from Table 9.1, several weaknesses and vulnerabilities among IFIs have been identified by the respondents in the areas of risk management and governance, particularly in terms of the handling of asset–liability maturity mismatches, Shari'ah-non-compliance, reputational risk and real estate exposure and concentration risk. Respondents identified Shari'ah-non-compliance, liquidity, concentration, asset-liability management (ALM) and reputational risks as the main risk facing IFIs. Tables 9.2 to 9.6 examine the respondents' answers regarding each of these identified risks.

Some interviewees, particularly Shari'ah scholars and researchers, regarded Shari'ah-non-compliance as a major risk, as it can have a material impact on the IFIs' risk profile, and its ripple effect can create other risks, particularly reputational and legal risks. Islamic finance disputes in courts, especially in international deals, are decided by judges trained under common law and not particularly under Islamic jurisprudence. This requires an interface between Shari'ah and civil law, thus adding additional legal risks. Moreover, respondents widely felt that the application of Shari'ah compliance as a commercial and defensive legal tool, like the case where the distressed Investment Dar Company's own Shari'ah board retracted its approval, undermines the credibility and ethical ethos that underpins Islamic finance. Given the consequences of such reversals, it is key for the industry that the approval process be extensively documented, formalised and open to inspection. One Shari'ah scholar in interview 3 expressed the view that Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has taken some steps in this regard with its institutional certifications of Shari'ah compliance, but for a deeper, stable and more liquid market the concept needs to gain wider acceptance.

As depicted by Tables 9.3 and 9.4, several respondents recognised liquidity and ALM risks as the most severe risks facing IFIs and stated that IFIs need to factor liquidity more fully into risk management. Respondents believe that both liquidity and ALM risks are strongly correlated. In the absence of a wide pool of Shari'ah-compliant and sufficiently liquid investment vehicles (especially in fixed income), IFIs find it difficult to manage their balance sheet from an ALM perspective, especially with regard to liquidity and margin-rate risk. IFIs use cash from deposits and short-term liquid assets to finance long-term liabilities. As a result, the liability makeup affects their funding structures differently and reflects an institution's specific ALM policies. Most respondents therefore believe that IFIs' funding mix tends to be imbalanced, with the dominance of deposits, PSIAs and equity making IFIs' funding profile predominantly short-term at a time when the maturity of their asset classes is widening. To mitigate nascent maturity mismatches, some IFIs started issuing medium-term sukuk to lengthen the maturity profile of their funding, but sukuk still represent a minor share of total liabilities. Subordinated sukuk and hybrid instruments have not been used yet; these are more expensive funding sources and incentives to issue them are limited given the relative abundance of capital in the region. IFIs are also increasingly focusing on retail deposits to boost liquidity, due to the deposits' sticky nature. As a result, according to the responses given by the interviewees, the Islamic banking industry is faced with a conundrum: its institutions maintain high concentrations in current/short-term liabilities, but, at the same time, they are exposed to highly profitable, but illiquid, long-term assets (e.g. property and infrastructure, and sukuk), and they have limited access to long-term funding solutions.

As Table 9.4 shows, some respondents opined that IFIs tend to have a concentration base of assets and/or deposits; they face high concentration by name and sector, as well as high geographical concentration. This is inflated by the IFIs' limited geographic reach, as most IFIs are domestic players and only very few have material operations outside their home country. The limited scope of eligible assets creates asset concentration risk. Non-deposit liabilities could have concentration risk as well, due to the relatively small number of IFIs available to participate in the inter-bank market. There is also a limited range of Shari'ah-compliant instruments available for managing or transferring risks. Participants opined that the focus on tangibles had led to increased property-related financings at IFIs, affected by the relatively undiversified nature of the economies. As real estate markets are highly volatile in the GCC, the concentration risk is magnified. The recent crash in the property market has put several Islamic banks whose assets are heavily concentrated in real estate in dire straits.

Reputational risk is the last among the top risks facing IFIs as identified by interviewees. Some participants, principally conventional bankers, indicated that reputational risk can have a material impact on the risk profile of an Islamic bank because the industry is still at the infancy stage of development.

Finally, it is interesting to note that the analysis of Question 1 revealed that the views of Islamic bankers, conventional bankers and rating agency analysts were quite similar. Shari'ah scholars and researchers, on the other hand, had different perceptions, which tend to be more academic in nature. Some respondents also expressed the view that due to the nature of Islamic finance contracts, risks are strongly bundled together.

Question 2 examines the difference in risk management perceptions in Islamic banking versus conventional banking. The results obtained are summarised in Tables 9.7 to 9.9.

As Table 9.8 shows, most interviewees believe that Islamic banking in its current state can be riskier than conventional banking because of the additional risk management and mitigation challenges and constraints the industry faces. As stated by the interviewees, since the risk management needs of Islamic banking are not yet being met, the system is not functioning at its full potential.

As depicted in Table 9.9, interviewees believe that no financial system is perfect. Although Islamic banking by default enjoys better risk management practices built into its principles, these principles tend to be ignored in favour of mimicking conventional risk solutions. Islamic banking products display unique features relating to credit, funding, liquidity and other risks that need to be considered and which have an impact on risk management. Moreover, most interviewees asserted that IFIs paradoxically suffer from weak risk management practices. In fact, IFIs face a number of challenges in terms of risk management. Many sukuk are structured to resemble conventional bonds, meaning the risks of ownership are transferred to the issuer rather than shared by the investors. Whereas risk management is practiced widely in conventional financial markets, it is underdeveloped in Islamic finance. This gives rise to an array of risks which are not well-comprehended yet.

Most respondents agreed that Islamic banking products display unique features, and that developing risk management tools and practices is one of the biggest challenges for Islamic banks. This challenge also offers some opportunities to develop unique solutions that do not suffer from the weaknesses in the conventional banking model. In addition, respondents criticised adopting risk models from the conventional banking practice or making minor adjustments to best practices as this poses major challenges. Participants indicated that, unfortunately, most IFIs closely mimic Western products, and hence IFIs are being exposed to similar risks to their conventional counterparts. Practitioners of Islamic finance to date have been mimicking conventional products. This mimicking has resulted in a close correlation between the two systems. With the absence of advanced risk management and mitigation tools, and with the bundling of risks in Islamic finance contracts, Islamic banking ends up being more risky than the conventional model.

In addition, participants indicated that through Shari'ah-compliant engineering most conventional contracts can be copied, at least conceptually. Some interviewees opined that if IFIs continue to mimic conventional products, they will weaken the uniqueness of their value proposition and the powerful nature of their natural factors of differentiation. Participants recognise that Islamic banking might find it difficult to innovate because it exists in a deeply-rooted conventional system. However, they strongly recommended that Islamic banks should start innovating Shari'ah-based solutions because if the industry is not innovating authentic products according to genuine Shari'ah principles, it might end up with the same failures as conventional banking. Results for Question 4 are depicted in Table 9.13.

As depicted in Tables 9.14 and 9.15, interviewees, particularly Shari'ah scholars and consultants, agree that while Islamic banking is asset-based and centres on risk-sharing, in practice IFIs vary in terms of the level of risk-sharing. For example, on the funding side Profit-Sharing Investment Accounts (PSIAs) are being replaced in several IFIs by time deposits based on reverse murabahah transactions. These deposits do not have the risk-sharing features of PSIAs, since the return is almost guaranteed. On the asset side, risk-sharing is the exception rather than the rule. Most financing is in the form of murabahah or wakala, making the IFIs' activities similar to those of conventional banks. Interviewees recommend that practitioners should not create instruments and investments that are identical in substance to conventional ones by combining a redundant succession of trades and labelling them with ‘new’ Arabic names. The emphasis should be placed on innovation that encourages and favours particular types of investment (such as more tangible risk-sharing ones) and funding that is closer to Shari'ah principles. The tendency by some IFIs to blindly replicate and repackage some exotic products of conventional finance through cosmetic changes to make them Shari'ah-compliant should be curbed. Respondents expressed their worry that some initiatives to design some forms of ‘Shari'ah-compliant' subprime instrument had been undertaken before the crisis happened – fortunately there was enough wisdom among Shari'ah boards that these instruments did not really see the light.

Capital Adequacy for Islamic Banks

This section, through Questions 5, 6, 7 and 8, examines the suitability of the Basel II and III standards for IFIs, compares capital requirement levels between Islamic and conventional banks, and assesses the credibility of Basel II after it failed to prevent one of the most damaging of financial crises. The results obtained are given in Tables 9.16 to 9.28.

Interviewees had varying views about the suitability of Basel II and potentially Basel III to Islamic banking. In general, respondents, particularly bankers and rating agency analysts, agree that with a few amendments Basel II becomes applicable to IFIs. The results of the focused coding analysis are summarised in Tables 9.17 and 9.18.

As demonstrated by Table 9.18, Shari'ah scholars and consultants interviewed shared the belief that conventional capital adequacy standards do not fully understand and appreciate certain aspects of IFIs, principally the fiduciary aspect, and that Basel II methodologies do not recognise the need for a different approach to capital adequacy calculation. Another problem mentioned by Islamic bankers related to the lack of ratings in IFIs and their corporate customers, and the fact that there is no historical data to implement Basel II. However, as Table 9.17 depicts, the majority of bankers and analysts interviewed believed that Basel II standards could be applied to Islamic banking with a few amendments to accommodate its unique model. They argue that, although there are some important differences between Islamic and conventional banks that must be properly understood and considered, these can be incorporated within the existing Basel framework. With Basel II being widely applied consistently across the globe, some regulators hesitate to apply bespoke capital rules to Islamic banks in order to ensure a level playing field for all banks.

Question 6 examines the participants' perception regarding the level of capital reserves that IFIs should hold in comparison to capital held by conventional banks. Looking at the theme in Table 9.19 and the respondents' answers in Tables 9.20 and 9.21, it is evident that most interviewees believe that IFIs should hold higher capital levels than their conventional counterparts because the Islamic banking business model in its current state carries more risks.

In theory, the risk-sharing principles inherent in Islamic banking should make IFIs less vulnerable to economic shocks and thus IFIs should need to reserve less capital than their conventional peers as they could ‘pass through’ economic losses to PSIAs. This is the view expressed by some participants, such as Shari'ah scholars and Middle Eastern consultants, as Table 9.20 shows. Unfortunately, the theory is a long way from fact in the current practice, as argued by the participants' views shown in Table 9.21. This submerges the inherent stability within IFIs, rendering them riskier than conventional banks, and hence requiring higher capital buffers. In addition, several bankers and consultants interviewed revealed that many IFIs do not have an internal performance management approach to measure the cost of liquidity and capital in their business decisions. This can lead to suboptimal choices being made by management teams. IFIs thus need to change how they measure performance by taking into consideration actual cost of liquidity and capital. By adjusting for true cost of liquidity and capital, the profitability picture can change considerably. As indicated by the respondent from interview 11, capital levels among IFIs have increased compared to prior years and are at levels much higher than their global peers. However, that extra capital buffer should not be taken for granted and IFIs need to be mindful of rising non-performing loans. Moreover, some interviewees warned that, with the tightening of new Basel III capital standards, IFIs have to pay greater attention to capital management as profitability will be impacted.

It is interesting to note that despite a general lack of absolute clarity about Basel III and its potential impact on IFIs, as indicated by Table 9.22, most interviewees agreed that Basel III is a fact that is here to stay. There is also a general belief among respondents that although Basel III is more demanding than Basel II with regard to addressing systemic risk, it may not be the last of the Basel series. This is mainly because risk is inherent in the complex global financial markets of increasing sophistication. Participants were generally divided among three groups, as summarised by Tables 9.23 to 9.25. The general theme agreed upon by most interviewees is that Basel III will affect all banks; however, its impact on conventional banking will be higher than on Islamic banking.

The first group believed that the Basel III new regulatory standards are still fresh and have a prolonged implementation timeline. No clear idea has yet been formed of their potential effects on IFIs. This group consists mainly of analysts at rating agencies and consultants.

Table 9.24 summarises the views of the second group of interviewees, which argued that the counter-cyclical capital buffer concept introduced by Basel III (as opposed to Basel II, which has been widely criticised for encouraging pro-cyclicality) has been at the heart of Islamic banking via profit and loss sharing (PLS) financing. IFIs will be less impacted by Basel III because of smaller market and counterparty risk exposures and lower levels of debt. They are expected to meet the more stringent requirements without raising additional capital. This group was dominated by Islamic bankers.

The third group of participants, comprising of consultants and solicitors, opined that the tightening of capital, leverage and liquidity requirements will affect all banks, Islamic and non-Islamic alike, while the definition of capital and the deductions in capital calculations are less likely to affect IFIs as their capital structures tend to comprise mainly core Tier 1 capital.

Question 8 aims to get the interviewees' perceptions of the failure of Basel II to prevent the recent crisis and of whether the newly proposed Basel III standards will help to prevent similar crises. Despite divergence among the participants' views, the theme as shown in Table 9.26 is that the shortcomings in Basel II are definitely addressed in Basel III. Participants expressed their doubt that Basel III will succeed in preventing another major crisis because crises are part of business cycles.

There was unarguably divergence among respondents regarding the question on the potential capacity of Basel III to prevent a major crisis such as the recent one and whether Basel II had failed in preventing the crisis. As the results in Table 9.26 show, those in the West are focusing on the need for increased buffers for both capital and liquidity, while those in the East are focusing on comprehensive coverage of risk management, enhanced stress-testing and the need for risk and capital management to align and be a core part of a bank's strategy. In general both camps agree that supervisory discretion will influence detailed implementation and leave scope for some jurisdictions to apply a more rigid interpretation of Basel III than elsewhere. Political issues and the debate around the implementation and operation of supervisory challenges mean ongoing fear of an uneven playing field. If different jurisdictions implement Basel III in different ways, issues seen under Basel I and Basel II with respect to international regulatory arbitrage may continue to disrupt the overall stability of the financial system. Moreover, compared with the implementation of Basel II, this enhanced level of dynamism, complexity and interdependency within the global regulatory landscape will add significant challenges to the implementation of Basel III.

A number of respondents, particularly researchers and consultants, believe that the Basel III proposals are unlikely to be the last word on reforms of the banking industry following the credit crunch. Interviewees asserted that Basel III is sometimes sold as the solution to the outstanding issues left by Basel I and II. Some stated that while history does not repeat, it sure does show similarities, and it is very unlikely that Basel III will be the answer to all banking problems. Banks must therefore retain flexibility to accommodate years of fine tuning and future reforms.

During the current tumultuous economic times, a higher capital buffer will generally reduce volatility and improve the intrinsic financial strength of banks. Increased capital requirements, increased cost of funding, and the need to reorganise and deal with regulatory reform will put pressure on margins and operating capacity. Investor returns will decrease at a time when banks need to encourage enhanced investment to rebuild and restore buffers. This will drive banks to go up the risk curve to make up for lost profitability.

Islamic Banking and the Global Credit Crisis

A lot has been said about Islamic finance being resilient in the wake of the global financial crisis, but once the dust of the financial crisis settled, it has become clear that everything is not necessarily well in Islamic finance. The assumption at one point early in the crisis was that Islamic banking would be totally unaffected and would sail through the crisis. However, the crisis has flushed out the false premise that Islamic banking is disconnected from conventional banking, and that it is immune to economic crises.

Questions 9 and 10 aim to explore the market feedback regarding the long-debated issue of whether IFIs are recession proof. Is Islamic banking actually more resilient than conventional banking? Could the crisis have occurred under an Islamic banking system? The results of the focused coding analysis are presented as follows. Results for Question 9 are illustrated in Table 9.29, while Tables 9.30 and 9.31 provide the Focused Coding analysis for Question 9. Results for Question 10 are depicted in Table 9.32, while Tables 9.33 to 9.35 provide the Focused Coding analysis for Question 10.

As depicted in Table 9.33, respondents agreed that the credit crisis has allowed the Islamic banking industry some time for reflection. They gave examples of a number of renowned players in the management of Islamic funds, such as The Investment Dar (TID) and Global Investment House (GIH), that suffered major losses during the crisis and have become technically insolvent. Some IFIs had to undertake a painful restructuring process, and the legal battles are still to be fought. The global sukuk market is seeing smaller issuance and increasing defaults, led by the bankruptcy of the US-based sukuk issuer East Cameron Gas, followed by the Al Gosaibi and Saad Groups of Saudi Arabia.

Most interviewees agree that IFIs should therefore ensure that they do not overlook the lessons to be learnt from the financial crisis. As shown in Table 9.35, respondents believe that since the global economy is still recovering and the growth rate is much slower, IFIs should take this opportunity to clean up the house and tighten up the loose ends.

Interviewees argued that when the financial crisis erupted in mid-2007, the Islamic finance industry remained relatively healthy and insulated, and recorded robust performance. Some commentators wrongly labelled Islamic finance as a ‘risk-free’ sector. However, the significant defaults of TID and Gulf Finance House (GFH) since early 2009 and the growing difficulties of the rest of the Islamic investment banking community makes this assessment dubious, as the structural weaknesses of the Islamic financial industry started to become more obvious. Responses depicted in Table 9.35 reflect that the crisis was a unique opportunity for the industry to prove that it had the capacity and ability to react to and absorb shocks, although this did not apply to all its sub-segments. Some interviewees from rating agencies explained that, while the commercial banking sector seems to have emerged from the crisis relatively unscathed, the investment banking sector could not have been more different, as it suffered a very sudden and sharp dip in performance as losses mounted. And yet, until 2007, IFIs were portrayed by market participants as having significant potential, benefiting from cheap funding, high liquidity, exceptional profits and robust capitalisation. At the time, the combination of these four factors led them to pursue investments in riskier markets and asset classes – such as private equity, infrastructure or real estate, mostly in emerging markets ranging from the Maghreb to Southeast Asia. Some business was also booked in the private equity markets in Europe and the US. While GFH focused more on infrastructure, Arcapita invested heavily in private equity, and both were eager to improve their asset-management capabilities. Moreover, some other Shari'ah-compliant investment banks were beginning to discover the merits of unfunded business lines. Respondents gave the examples of Liquidity Management House (LMH, the investment banking subsidiary of leading Kuwait Finance House) and Al Rajhi Capital, which further enhanced their advisory and structuring services, until they eventually became significant players in the GCC's debt and capital markets. However, when the region's economy started to fracture under the stresses of the global liquidity drought, the pro-cyclical nature of IFIs became more pronounced. The illiquid nature of their investments contributed to rapid asset-value decreases at a time when their wholesale and short-term funding features were rapidly damaging their liquidity profile. This structural feature of IFIs' ALM – which was once a benefit when ample liquidity was chasing too few assets – started to turn negative when too many impaired assets were available to serve massive liquidity withdrawals.

Some interviewees explained that lower volumes, shrinking margins and deteriorating asset quality will all weigh on IFIs' profitability and ultimately their capitalisation. However, the impact is more manageable than for conventional banks. Fortunately, IFIs have been very profitable in the past and had therefore accumulated large amounts of capital, making them capable of absorbing these sorts of shocks. Strangely enough, IFIs' reputation has generally benefited from the crisis as it has exposed the weakness of a debt-based financial system. It is therefore the most fortunate time for Islamic banking to re-emphasise its equity-based approach. Interviewees think that this will help the industry to expand not only in the Muslim world but also in the West.

Some researchers interviewed stated that this is not the first time IFIs were tested with a systemic crisis, although previous crises were all on a regional scale. However, the recent crisis, with its unprecedented scale and scope, is the first global crisis to hit Islamic finance. The experiences of Kuwait Finance House in surviving the Kuwait Souq al-Manakh crisis in 1982, of Bank Islam in navigating the Asian financial crisis in 1997–1998, and of a Turkish participation (Islamic) bank in coming out of the economic crisis (2000–2001) should all convey a clear message that Islamic finance does have some inherent qualities that contribute to its resilience. Most interviewees, including non-Islamic bankers, actually see the Islamic financial industry emerging stronger from the crisis, provided some conditions are met as shown in Table 9.35.

In general, most interviewees opined that IFIs will probably be the big winners when the crisis ends. As a sub-set of ethical finance, IFIs are now considered not so much niche businesses standing at the margins, but rather as representatives of a credible, viable and sustainable alternative business model for sound, ethical and socially responsible banking. Many interviewees believe that mainstream finance has moved too far into excess leverage, meaningless innovation and value-destroying investments and therefore IFIs will undoubtedly find their reputations strengthened.

Risk Mitigation in Islamic Banking

Risk mitigation is currently one of the most contentious issues in Islamic banking. The unique nature of risks faced by Islamic banks, combined with the restrictions added by Shari'ah, makes risk mitigation for Islamic banks a difficult and complex process. There are risks that Islamic banks, like their conventional counterparts, can manage and control through appropriate risk policies and controls that do not conflict with the Shari'ah principles. However, there are other risks that banks cannot eliminate and that can be reduced only by transferring to or selling those risks in well-defined markets. These risks can generate unexpected losses that need capital insulation, and hedging can help to restrict the impact of unexpected loss. In this section of the interview analysis, the participants' opinions and perceptions were sought regarding risk mitigation in Islamic banking. Looking at the theme in Table 9.36 and the respondents' answers in Tables 9.37 and 9.38 shows that risk mitigation has become a must in Islamic banking, provided that it is used merely for hedging and not for speculation.

Respondents almost unanimously agreed that the unique nature of risks faced by IFIs, combined with the restrictions added by Shari'ah, make risk mitigation for IFIs a difficult and complex process. However, there was clear disparity among respondents regarding the applicability of Shari'ah-compliant hedging solutions. Although derivatives were originally designed to manage or mitigate risks, they have been mutated to trade risks. Some respondents did not have a clear demarcation between the two. They stated that before the crisis, Islamic finance had been criticised because it could not freely hedge its risks using derivatives instruments. Today, this feature has been proven to be truly a blessing in disguise. In addition, the bankers interviewed asserted that even with the Shari'ah-approved structures, Islamic hedging currently costs much more than normal conventional hedging; it is documentation intensive and banks have to do dual murabahahs, rather than a single standardised transaction. Shari'ah-compliant tools are available; they need to be signed and accepted quicker and cheaper.

In general, most interviews reveal that there is growing demand for hedging and Shari'ah-compliant derivatives, which should be used merely for hedging and not speculation. Risk mitigation within Islamic banking is still to a large extent a grey area and work in progress.

The Dichotomy Between the Theory and Practice of Islamic Banking

This section examines the proposition that Islamic banking has been diverting from its roots by mimicking conventional banks. The theme in Table 9.39 indicates that although, in theory, the Islamic financial system is more resilient to economic shocks than the debunked Wall Street model, unfortunately the theory is a long way from fact in Islamic banking's current financial practice. The findings from the analysis through focused coding are presented in the following tables.

As Tables 9.40 and 9.41 show, most interviewees criticised Islamic banking for trying to ‘shoe-horn’ Shari'ah principles into conventional product structures; where Islamic products replicate conventional products they are being exposed to the same risks. IFIs are also shying away from being sufficiently socially responsible. A number of respondents are of the view that some IFIs deviated to a great extent from the fundamental basis of Islamic finance; they have succumbed to the influence of conventional banking. Shari'ah scholars interviewed therefore emphasised that there is an internal logic to Shari'ah principles, which IFIs will see only if they stop trying to duplicate conventional structures.

The Next Chapter in Islamic Banking

In this last part of the interview analysis, the participants' opinions and perceptions were sought on the future of IBF with a particular focus on risk management-related issues. The theme in Table 9.42 indicates that various strategies have been suggested by interviewees in order to achieve profitable growth and to enhance IFIs' competitiveness. However, participants asserted that while asset growth is important, addressing risk issues needs to be in place to support sustainable growth. Therefore, strategic focus needs to be timed, with risk management being implemented first, followed by growth. The findings from the analysis through focused coding are presented in Tables 9.43 to 9.46.

As the findings in Tables 9.42 depict, recommendations given in terms of strategies that Islamic banks should focus on over the coming decade as catalysts for the growth of Islamic banking are numerous and diverse. Many challenges still lie ahead, as is clear from the interviews. However, the ongoing improvements in banks' risk management and mitigation techniques and prudential frameworks for Shari'ah-compliant banking give reasonable hope that the Islamic banking industry's growth will contribute positively to broader financial and economic stability, especially after the financial crisis has proved Islamic finance to be a more ethical and sustainable banking alternative than the debunked Wall Street model.

In particular, IFIs need to improve their liquidity management and diversify their activities from what is mostly a real estate and ‘vanilla’ lending play, to offer a comprehensive service suite including advanced treasury services, innovative asset-management and securitisation services. This will allow them to address the needs of underserved market segments such as sovereign wealth funds and private wealth clients. The bankers interviewed recommended that there is also a lot to be done in trade finance, which used to be the staple of Islamic finance but for many years has been unfashionable. The corporate finance and liability management areas are also open for huge expansion. IFIs should also exploit consolidation in order to benefit from economies of scale as well as enhancement of scope. Both approaches offer diversification benefits.