In a speech at the Islamic Finance Conference in Kuwait on Wednesday, Lagarde said regulation, governance, education and tax were all areas requiring additional efforts.
The appeal of Islamic finance was rooted in “inclusivity” and its suitability for small and medium-sized businesses and start-ups, she said.
“To this day, a large segment of the Muslim population – who are a primary, but not the only, market for Islamic finance around the world – remain financially underserviced, with only one-quarter of adults having access to bank accounts.”
Credit to collateral
“In addition, Islamic finance’s risk-sharing features and the strong link of credit to collateral means that it is well-suited for Small and Medium-Sized Enterprise (SME) and start-up financing – which we know can promote inclusive growth.”
Islamic finance must comply with Islamic – or Sharia – law. In short, the Qur’an bans making money from money, so contracts between financial institutions and the individuals are usually set up to share the risk equally.
Islamic financial assets are currently worth $2trn, which the IMF says represents a tenfold increase from 10 years ago.
Levelled playing field
Lagarde said in order for Islamic finance to reach its full potential the playing field must first be levelled.
She said this meant greater consistency of financial regulation of Islamic banks and governance across jurisdictions, adjusting capital requirements in the banking sector to account for Islamic finance’s risk and profit-sharing model – which allows for some loss bearing by investors and reduces risk weighting to equity-like financing – and bringing the tax treatment of Islamic finance products in line with conventional contracts.
In order to develop in the SME space, better information was required about their creditworthiness, bank knowledge on lending to small businesses and better trained staff would all help grow this sector.
In addition, Lagarde said Islamic finance could reach into new markets.
She gives the example of Sukuk bonds, which in the past 10 years have grown global assets to around $300bn, yet most are concentrated in the Gulf States and Malaysia.
Luxembourg, Hong Kong, South Africa and the UK have been issuing bonds in recent years and Lagarde has called for more regular sovereign issuance to help the market reach its full potential.
Raising the game
From the IMF’s perspective, we are also looking to raise our game. As you know, financial stability lies at the heart of the IMF’s work.
We have, over the past year, done a large amount of analytical work to deepen our understanding of Islamic finance’s implications for financial stability and economic growth. We are keen to pursue this agenda and to further strengthen our policy advice by incorporating best practices for Islamic banking and finance into our surveillance work.
