Integrating Islamic Finance into Global
Finance
Draft Note for the G20
EXECUTIVE SUMMARY
With its emphasis on risk-sharing and asset-based financing, Islamic finance has the potential
to foster investment and infrastructure, and thus, to support the G20 strategy for raising
global economic growth. For this potential to be realized, a number of challenges need to be
addressed, which require policy actions at the national and global levels.
For countries that wish to further develop Islamic Finance, national policies should aim to
build an enabling environment and level the playing field with conventional finance. Actions
could include:

Further opening up to Islamic financial services, including by considering
grant of licenses to new Islamic financial institutions, and adapting regulatory
and supervisory frameworks to take into account the industry’s specific
features (national regulators) where deemed appropriate;

Exploring means for enhancing liquidity management of Islamic banks
(central banks);

Adapting tax systems to avoid Islamic finance instruments being at a
disadvantage (ministries of finance);

Tapping into Sukuk markets to finance investment through asset-pooling
schemes that could allow for regular issuance of tradable instruments while
strengthening public investment frameworks (ministries of finance);

Providing the right incentives to ease access to asset-based and equity-like
financing, particularly for SMEs (ministries of finance and regulators).
At the global level, actions could include:

Increasing the G20 membership in the Islamic finance standard setters,

Leveraging these institutions to further cooperation and experience-sharing
among the G20 members, and advance standardization, notably of Sukuk;

Granting membership to Islamic finance standard-setters in the consultative
groups of global standard-setters with the view to strengthen the emerging
cooperation between these institutions;

Systematically incorporating the industry’s features in global standards and
guidance, and developing accounting and statistics standards for Sukuk;

Stepping up the engagement of International financial institutions and
multilateral development banks (MDBs) in Islamic finance through analytical
work, policy advice, and capacity development;

Expanding MDBs’ operations to include Islamic finance instruments.
This paper presents policy issues related to Islamic finance for consideration by the G20
members.1 It provides policy recommendations at the national and international levels to
better integrate Islamic finance into global finance.
I. INTRODUCTION AND BACKGROUND
Islamic finance emphasizes financing real economic transactions through trade
financing, leasing, and asset-backed and risk-sharing finance. This industry has grown
rapidly over the past decade, outpacing conventional finance, fuelled by demographics and
large savings accumulated by many oil-exporting countries that are seeking to invest in these
instruments. It has also expanded in terms of its geographic coverage and diversity of
services, encompassing banking, capital markets, insurance, trade finance, investment funds,
equity markets and micro-finance etc. (see Figures 1 and 2).
Islamic finance has the potential to foster investment and infrastructure, and thus, to
support strategies for raising economic growth. For example, Islamic finance’s emphasis
on real economic transactions and its risk-sharing feature mean that it could provide adequate
support for wide range of financing particularly the small and medium–sized enterprises
(SME), and hence, broaden financial inclusion, which could also be supported by the
provision of financial services that cater for the needs of large unbanked populations. Its
asset-backed securities (Sukuk) are well-suited to investment in public infrastructure and
could contribute to closing the infrastructure funding gap, as some structures resemble
Public-Private Partnerships whereby investors finance the assets, own them, transfer them at
maturity to governments, and thus, share some risks with governments. Finally, both its
asset-backed and risk-sharing features, and prohibition of speculative behavior suggest that
Islamic finance may, in principle, pose less systemic risk than conventional finance, and
would help maintain financial conditions supportive for investment and growth.
For this potential to be realized, however, and to allow this industry to develop in a safe
and sound manner, a number of challenges need to be addressed. For example, despite
the efforts of Islamic finance standard-setters and other stakeholders, regulatory and
supervisory frameworks, in many countries, do not fully take into account the industry’s
specific features and risks, often leading to replicating products of conventional finance, thus
compromising asset-backing and risk-sharing aspects, and increasing complexity of products
1
This note is jointly prepared by the International Monetary Fund and the World Bank with inputs from the
Islamic finance standard-setters and the Islamic Development Bank. It is based on Kammer et al., “Islamic
Finance: Opportunities, Challenges and Policy Options’, IMF Staff Discussion Note, April 2015, and the World
Bank’s note to the IIWG’s meeting in May 2015 titled “Comments on Standardized Pooling Vehicle for PPPs
proposal and its applicability to Islamic finance”.
and, sometimes, of corporate structures. The industry is still largely a nascent one, lacking
economies of scale, and operating mainly in countries where legal and tax rules, financial
infrastructure, and access to financial safety nets and central bank liquidity are either absent
or, if available, are under-developed and may not appropriately take into account the distinct
characteristics and risks of Islamic finance. The supply of Sukuk still falls short of demand,
and sovereign issuance, except in very few jurisdictions, is done on an ad-hoc basis without a
comprehensive strategy for developing the domestic market.
The following two sections aim to identify key actions at the national and international levels
to address these challenges.
II. NATIONAL POLICIES
Building an enabling environment for Islamic finance and ensuring a level playing field
with conventional finance are critical to develop this industry. To achieve these,
regulation, liquidity management, and taxation are key policy areas for change:
1. Regulatory and supervisory frameworks could further open up for Islamic finance
industry, notably banking, capital markets and insurance. Wherever the industry has a
significant presence, national authorities should ensure that these frameworks take
into account its unique risks such as exposure to equity and displaced commercial
risks, complexity of products, uncertainties over insolvency, defaults and nonperforming loans, lack of derivatives contracts, and highly concentrated portfolios, so
as to safeguard financial stability.2 This could be achieved, for instance through
adoption and implementation of standards developed by the Islamic Financial
Services Board (IFSB) and the Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI). For banking, in particular, regulators should ensure
that the loss-absorbency features of profit -sharing investment accounts are
adequately reflected in capital adequacy in line with the IFSB guidance (as in
Turkey), and pay sufficient attention to better disclosure and enforcement of
investors’ rights, including those related to payouts and reserves. The different nature
of Islamic banking, notably the mix between deposit-taking and investment activities,
calls for developing cross-sectoral supervision and effective frameworks for
resolution and crisis management. Strong consumer protection frameworks, including
ensuring Islamic Law (Shari’ah)-compliance, should also be put in place for all
segments of the Islamic finance industry.
2
See, for instance, Kammer A., M. Norat, M. Piñón, A. Prasad, C. Towe, Z. Zeidane, and an IMF Staff Team
(2015), “Islamic Finance: Opportunities, Challenges, and Policy Options”, IMF Staff Discussion Note, No.
SDN/15/05.
2. National policies should ensure that the appropriate infrastructure for assetbacked securities is in place. Further deepening Sukuk markets would require
developing the necessary infrastructure, including securitization frameworks (e.g.,
trust laws), increased transparency, enhanced clarity over investors’ rights (e.g., true
securitization of assets), insolvency regimes, and dispute resolution frameworks. This
would require close cooperation among capital market regulators, markets
participants, and other stakeholders. Depth and liquidity of Sukuk markets should
also be improved, notably by stepping up regular sovereign issuance of tradable
Sukuk, as part of public debt management strategies (e.g., Malaysia and Turkey), to
provide a benchmark for the private sector and to increase the supply of high-quality
liquid assets (HQLA) to help Islamic finance banks satisfy the Basel III liquidity
coverage ratio (LCR).
3. Central banks might opt to develop, in the case of a growing role of Islamic
banking, necessary inter-bank and monetary policy instruments to better help manage
banking liquidity, and ensure a smooth functioning of the payment systems. This may
help to also reduce the overreliance of Islamic banks on cash and increase their
competitiveness, while supporting Sukuk market liquidity. Moreover, developing a
Shari’ah-compliant lender-of-last-resort facility would strengthen financial stability in
countries where Islamic banks are considered systemically important.
4. Tax systems should level the playing field between conventional and Islamic finance.
In particular, the tax treatment of sales and additional layers of transactions in some
instruments should be based on economic substance and eliminate double taxation.
This could be done either by amending tax laws (as in the UK, Ireland and Malaysia)
or issuing explanatory notes (e.g., France). Furthermore, the debt-bias taxation should
be reduced (e.g., through an allowance for corporate equity3) to avoid discriminating
against the equity-type of financing that Islamic finance provides.
National authorities could consider further tapping into Sukuk markets to finance their
public investment. Experience has shown that regular sovereign Sukuk issuance on existing
assets is constrained by the availability of these assets (identification might take longer) and
the legal impediments surrounding the transfer of their ownership. The assets class for Sukuk
issuance could be broadened through pooling of existing assets or developing Sukuk-funded
new assets as part of the implementation of public investment programs (e.g., sufficiently
large projects or a pool of small-scale projects4). For countries interested in fostering depth
3
See De Mooij, “Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions”, IMF Staff Discussion
Note, 2011.
4
See also the paper on “Concept of Pooling Small-scale PPP Infrastructure Projects”, prepared by the German
Federal Ministry of Finance for the IIWG’s meeting in May 2015.
and liquidity of Sukuk markets, the focus should be on stepping up new assets financing
through pooling-based issuance of tradable Sukuk. This could be achieved by establishing an
autonomous special purpose entity of the government that would enter into business with the
government through sales and lease transactions, depending on the types of assets to be
acquired as part of the investment program, pool these assets, and raise their financing from
investors through partnership-type Sukuk. With this model, Sukuk could be regularly issued
at different maturities, would generate return depending on the performance of the
underlying assets, and would be tradable (Figure 3).5 Increased use of Sukuk to finance
public investment requires further strengthening the financial infrastructure (as mentioned
above) and should be underpinned by sound public financial management, including clear
guidelines for the treatment of Sukuk instruments and SPVs in terms of budget planning and
execution, and fiscal risks associated with these instruments. It will also require a strong
public investment framework that helps to identify a robust pipeline of attractive investment
projects.
National policies could provide the right incentives to ease SMEs’ access to Islamic
finance. In particular, policy actions should be taken to ensure that risk-weights and taxation
do not unduly discriminate against risk-and-profit-sharing financing, which is well-suited to
SMEs. These instruments require further strengthening financial infrastructure, notably
related to credit and market information, collateral, and insolvency regimes. Improvements in
these areas would also facilitate securitizing SMEs financing to issue Sukuk and increase the
resource base for SMEs funding, as well as using other alternative modes of financing such
as secondary market and crowd-funding. These policies could be supplemented by public
support, in form of Shari’ah-compliant guarantee schemes for startups and SMEs financing.
III. GLOBAL COOPERATION
Further cooperation and experience-sharing among the G20 members will be
important. Development of Islamic finance is uneven among the G20. Its size is significant
and rising in Saudi Arabia, Indonesia and Turkey. The UK and South Africa have a presence
of Islamic banking, and have recently issued sovereign Sukuk. The UK has also developed a
guarantee mechanism for Sukuk (already used by an airliner to buy a part of its fleet), and is
working on strengthening its liquidity management framework. Other members have started
developing an enabling environment, for instance through reviewing regulatory and tax
frameworks. Increased cooperation and knowledge-sharing among the G20 members are
highly warranted, as they will help individual countries strengthen their policy frameworks,
better design Islamic finance instruments for infrastructure projects and SMEs, standardize
approaches, and cope with increased cross-border operations and their implications on
5
For a version of this model, see the Islamic Development Bank’s note on “Sukuk: Challenges and Prospects
for new Designs”, June 2015. This model would institutionalize asset-pooling for PPP to finance public
investment.
financial stability and tax issues. It is worth noting that cooperation between some members,
supported by international financial institutions, has led to the establishment of specific
standard-setters and an international corporation for liquidity management. These bodies
would greatly benefit from increased membership from G20 countries, and could be
leveraged to support international cooperation on Islamic finance, notably in furthering
standardization and harmonization
Emerging cooperation between global and Islamic finance standard-setters is welcome
and should be further strengthened. A positive step was consideration by the Basel
committee in its LCR guidance -in consultation with the Islamic Financial Services Board
(IFSB) - of challenges facing Islamic banks in terms of the scarcity of HQLAs.6 It is
important that the Basel committee continues, in partnership with the IFSB, to systematically
incorporate Islamic banking features in preparing new standards and guidance to regulators,
while reviewing some of the existing standards that address specific features of Islamic
finance, such as risk-sharing instruments. The International Organization of Securities
Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS)
should also formalize their cooperation with the IFSB, and ensure that they take into account
the specificities of Islamic finance ahead of issuing their standards. Overcoming the barriers
for implementing the International Financial Reporting Standards (IFRS) will require
stepping up dialogue between the International Accounting Standards Board (IASB) and the
AAOIFI. The International Monetary Fund (IMF) and the International Public Sector
Accounting Standards (IPSAS) should also collaborate with the AAOIFI to develop
international standards for accounting and statistics of Sukuk. The World Bank and the IsDB
have proposed to develop a comprehensive database of various segments of Islamic finance,
and it is important that key stakeholders of the Islamic finance industry support the project
and collaborate with the Bank. In this area, the IMF and the IFSB could also join efforts to
develop specific Financial Soundness Indicators for macroprudential supervision. Finally, the
FATF and the IFSB should develop a better understanding of the money laundering and
terrorist financing risks in Islamic finance, including through dialogue with supervisors and
practitioners, with a view to develop, if needed, appropriate mitigating measures.
International financial institutions and multilateral development banks could play an
instrumental role in helping realize the potential of Islamic finance. Under the Turkish
G20 presidency, the IMF, the World Bank Group (WBG) and the Islamic Development Bank
(IsDB) were requested to provide inputs. The IMF has delivered a staff discussion note,
organized a high-level seminar during the Spring Meetings and plans to hold a global
conference in Kuwait on November 11, 2015. For its part, the World Bank has provided a
note on standardized asset pooling for Public Private Partnerships (PPPs) and is working on a
6
The IFSB has recently updated its standards to incorporate new capital, liquidity and supervisory standards
issued by Basel Committee.
joint report with the Islamic Development Bank on Islamic financing of SMEs. The Bank is
working on a paper exploring the use of Islamic finance for municipality finance. The Bank
also plans to hold, through its Istanbul-based Islamic Finance Center, two events on
leveraging Islamic finance for SMEs and Sukuk for long-term investment financing in
October and November 2015 respectively. Going forward, the IMF and the World Bank, in
consultation with the Islamic standard-setters and the Islamic Development Bank, should
continue to provide advisory services to member countries (for example, policy advice,
technical assistance, training, and assessment of the financial sector) to strengthen Islamic
finance and public investment management frameworks. In line with their commitments,
during the recent Addis-Ababa conference, to further develop new financing mechanisms in
support of achieving the Sustainable Development Goals, the WBG, the IsDB and other
regional development banks should continue to expand their portfolio of Islamic finance
operations using the right mix of debt, equity, and guarantee instruments.
Figure 1. Growth of Islamic Finance
Islamic finance assets have grown rapidly in volume…
2,000
Islamic Finance Assets (2008-14)
($US in billions)
Bank
Takaful
1,500
…also in its geographical coverage
Islamic Finance Markets by Systemic Significance (2014)
Sukuk
Funds
1,000
500
0
2008 2009 2010 2011 2012 2013 2014
Systemic Importance
Potential Systemic Importance in Medium-Term Given Current Growth
Present, but nonsytemic
So
ur
ce
s
The banking sector dominates, followed by the Sukuk
market…
:
Composition of Islamic Banking Assets (2014)
(Percent)
Se
g
oe
UI
-S
i
ze
18
C
h
(S art
ub T
ti itl
t
l
e- e
Se
go
Banking,
79%
Sukuk, 16%
Other,
21%
eU
I - Ba
S
i
zenk i
18ng
)
Islamic Funds, 4%
Takaful, 1%
Chart Title
Sukuk Islamic Funds
(Sub title -Segoe UI -Size 18)
Takaful
Ot
he
r
Growth of Islamic banks has surpassed that of conventional
banks…
Compound Annual Growth Rate (2009-13)
(Percent)
…and banking assets are concentrated in Malaysia and MENA
region, particularly the GCC
Islamic Banking Assets Growth Trend (2008-14)
($US in billions)
1600
GCC
MENA (excl. GCC)
1400
Sub-Saharan Africa
1200
Asia
Others
1000
800
600
400
200
0
2008
2009
2010
2011
2012
2013
2014
…increasing Islamic banking penetration rate
Market Share of Islamic Banking (2014H1)
(Percent of banking system assets)
Saudi Arabia
Indonesia
Turkey
Turkey
Indonesia
Saudi Arabia
South Africa
Malaysia
UK
MENA
Islamic
Conventional
Global
0
5 10 15 20 25 30 35 40 45 50
Sources: Annual reports, central banks, Bloomberg, KFHR, Ernst & Young.
Malaysia
MENA Avg.
Global
0
20
40
60
80
100
Figure 2. Sukuk Growth and Distribution
The Sukuk market has registered strong growth led by South East Asia and the Middle East
Global Sukuk Issuance (2001-14)
($US in billions)
800
Sukuk Issued (right scale)
700
Cumulative amounts issued since 2001
600
200
500
125
400
100
300
75
Cumulative Global Sukuk Issuance (2001-14)
($US in billions)
800
Turkey
700
Indonesia
UAE
600
Saudi Arabia
500
Malaysia
400
MENA (excl. Saudi Arabia and UAE)
All Others
300
200
50
200
100
25
100
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
0
2003
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
0
2001
0
2002
150
2001
175
Sovereigns have dominated Sukuk issuance, but corporates are significant, led by banks who are also major investors
Issuance by Sector (2014M10)
(Percent)
20%
19%
61%
Sovereign
Quasi-sovereign
Private
Investor Base for Selected Sukuks
(Percent of total)
90
80
70
60
50
40
30
20
10
0
Banks
Funds
Insurance
Republic of Turkey
Central
Banks/
Gov't
State of Qatar
Others
Dubai
Malaysia
Most issues are in Malaysian Riggit, followed by U.S. dollars, and international issues are increasing, albeit from a low base
Issuance by Industry (2014M10)
(Percent)
2% 2%
2%
4%
Total Infrastructure Sukuk Issuance (2001-14)
($US in millions)
30,000
7%
25,000
20,000
15,000
22%
61%
10,000
5,000
2013
2014E
2012
2011
2010
2009
2008
2007
2006
Other
2005
Transportion
Sources: HSBC, KFHR, IFSB, IIFM, IFIS, Bloomberg, and Zaywa.
2004
Construction
Real estate
2003
Utilities
2002
Financials
2001
0
Government
12
Figure 3. The Structure of the Proposed Sukuk Model
Asset-based
financing from
the Fund
through sales
and lease
contracts
Service payment
of the financing
(Could include
rents of
unfinished assets)
Flow of assets
Financial flows
Administration (e.g., fund management, primary market,
and transactions with the government and its suppliers};
Investor services (e.g., registry and to secondary markets)
Issuance of
Open-ended fund
With fixed-income assets composed of:

Sales contracts, which could include sales with
mark-up and deferred payments, future contracts
on goods and services with spot or deferred
payments

Lease contracts (ownership of physical assets,
value should represent the majority of the fund
assets)
The fund’s size should remain close to the outstanding of
Sukuk and investors should have claims on the global
assets pool, but not any specific asset.
shares to
equity-like
Sukuk or
participatory
finance the
fund assets
Cash payment
Return/Dividend
& Capital
Source: Adapted from IMF TA reports and the Islamic
Development Bank sovereign sukuk model
Sukuk Investors
Ministry of Finance
(Possibly one or more federal or local government units)
Special Purpose Vehicle
As a government (or sub-governments) entity with
independent legal, organizational, and financial status