Suggestions to Establish An Islamic Financial Institution

You are asked for advice by the government of a small country that wants to establish an Islamic financial institution. What advice would you give? (10 marks)

Establishing an Islamic financial institution (IFI) requires comprehensive planning and consideration of several factors. Among the factors that need to be factored in are the existing financial system, social composition, economic and business environment, current legislations and the country’s political structure. As far as planning is concerned, a short term, medium and long term development progress should have clear objectives and concrete strategies in achieving the mission so that the IFI concerned will have a prosper growth and well rounded development. In pursuing the effort to establish an IFI, the following suggestions should be considered:-

1)        Develop and enact regulation on Islamic financial institution

The first step that the government should do is to develop and enact an Islamic Banking/Financial regulation to govern, regulate and guide the orderly development of the IFI. The regulation also acts as the control instrument for strong governance, adherence to Shariah principles as well as protects the IFI’s future growth.

2)        Employ talents with Islamic economic and financial knowledge

One of the success factors for the IFI is to have the managements and employees who have knowledge on Islamic economic and modern financial system. This is because IFI must be managed and operated in accordance with Islamic rules and regulations. The talents are responsible to create innovative products and services, promoting and explaining the concepts of Islamic products to the customers.

3)        Establishing a regulatory and supervisory body on IFI and Shariah principles

The government concerned should be supervising and monitoring the IFI activities, managements, governance and their business practices. For example the country’s Central Bank could assume these roles. Another critical body such as the Shariah Advisory Council can be put under the Central Bank in looking after the Shariah rules, guidelines and applications matters.

4)        Supportive towards Innovative Islamic financial products and services

The IFI innovate, develops, promotes and markets the products and services. As for the roles of the government are to support, foster and facilitate the innovations. For example, the government may consider giving more encouragement for equity-based product development to stimulate entrepreneurships in the economy by providing incentives to the IFI. At the same time giving ways for the expansion of debt-based Islamic products.

5)        Friendly and supportive taxation system for new IFI

The new IFI may require assistance from the government to stay afloat at the beginning. Therefore, the government could lend the support by giving tax incentive, maybe for the first five years of operation. In addition to that, the government can allow full rebate allowance for zakat paid or capital allowance for setting up of the new IFI company. Tax exemption could also be given for employees training on Islamic financial systems.

6.         Supportive legal framework and friendly government policy

Effective, supportive and friendly government policies are equally important to ensure the success of the IFI. For example, a speedy judiciary is essential for fair treatment of IFI because its investment risk is greater than that of a conventional financial institution and the IFI’s dealings are on profit and loss sharing.

7.         Establish an Islamic financial standard or joining the international standard body

The Islamic financial institution should apply the global Islamic financial standards such as the accounting, auditing and financial reporting as well as the code of conducts standard so that it can grasp the latest development in the Islamic financial system and stay competitive at all times.

In conclusion, to conclude my opinion, a gradual implementation or a step-by-step approach is the best way to set up an IFI that will eventually become part of Islamic financial system.

The government should take a preliminary step to provide for a strong foundation of IFI development by developing and enacting a regulation framework such as the Islamic Banking Act or Islamic Financial Act followed by the establishment of the IFI. Thereon, the IFI to develop products, services and other Islamic financial instruments as their offerings and alternative for the market. Once, the IFI has shown a positive growth they have to expand. The government may consider setting up a new platform to support the IFI’s expansion such as the Islamic Capital Market. The development of IFI and the Islamic financial system should be on a continuous effort for improvement, as new challenges will emerge as the time move forward.

Author: saupee @ All copy rights reserved 2013.