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TRANSPA
RENCY AND
MARKET DIS
CIPLIN
E:
BASEL PILL
AR 3
CHAPTER 1
9: ISLA
MIC F
INANCE T
HE REGULA
TORY
CHALLENGE
DAUD ABDULL
AH (DAV
ID V
ICARY)
BY: CHEAH P
ING Y
EAN & R
AJA S
HAHRIDAT
UL DEW
A
1
AGENDA
1.INTRODUCTION2.COMPLIANCE WITH PILLAR 33.MARKET DISCIPLINE IN
ISLAMIC BANKING4.CONCLUDING REMARKS
2
1. INTRODUCTION
a) Transparency and market discipline are closely intertwined with corporate governance
b) Basel Pillar 3
i) Guiding principles of market discipline
ii) Complement Pillars 1 and 2
iii) Disclosure of information, consistent with how the bank’s risks are measured (inclusive of capital adequacy calculation)
b) By doing this, market discipline is reinfoced, and banks are incentivised to behave prudently.
c) END Goal – a sound and safe financial system
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I. Level of disclosure
II. Frequency – disclosure every six months
III.Templates – to compare between banks
2. HOW TO COMPLY WITH PILLAR 3?
4 requirements
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IV. Basic principle of disclosure (13 tables on info disclosure)
2. HOW TO COMPLY WITH PILLAR 3? (CON’T)4 requirements
1. Qual’tv and quan’tv info
2. Capital structure info (analyse capital adequacy of bank)
3. Capital allocation process info (Pillar 2)
4. Overview of size and nature credit risk exposures
5. Portfolios subject to standardised approach (IRB) and supervisory risk weights
6. Portfolios – IRB approaches
7. Credit risk mitigation techniques disclosured
8. Securitization – Size type and features disclosed
9. Market risk – compare different types of risks and institutions
10. Market risk – IMA * approach for trading of portfolios
11. Operational risk – disclosure of regulatory capital approach
12. Equities – disclosure of banking book positions
13. Interest Rate Risk in the Banking Book (For IFIs, there is a rate of return risk)
*IRB – Internal Rating Based; IMA – Internal Models Approach
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MARKET DISCIPLINE IN ISLAMIC BANKING (IB)
What is market discipline?
• It refers to the use of market as a means of governance, as a complement to regulation and supervision. The benefits and drawbacks are:
Benefits Drawbacks
Provide IBs the necessary incentive to address corporate governance issues & to behave responsibly
Conflict of interest between regulators and the market – e.g. strong market reactions toward a weakened IB may result in unnecessary failures causing instability of financial sector
Market reactions to early signs of distress in IBs provide impetus for IBs to rectify problems, preventing failures
Loss of confidence in one bank may cause a “contagion” effect – resulting in systemic event in entire banking sector.
Lower risk premiums in the market place resulting from transparency of operations
Potential time and cost savings for regulators
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CONDITIONS FOR EFFECTIVE MARKET DISCIPLINE
• Andrew Crocket, former Bank for International Settlements (BIS) general manager developed conditions for effective market discipline which are also applicable to IBs.
• These are:
(i)Information – market participants must have sufficient information to reach informed judgments
(ii)Ability – market participants must have ability to process information correctly
(iii)Incentive – market participants must have the right incentive to act upon information
(iv)Mechanism – market participants must have the right mechanism to exercise discipline.
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CONDITIONS FOR EFFECTIVE MARKET DISCIPLINE, cont’d• While all four prerequisites need to be developed, the author has focused on the first
two building blocks in this article.
(i) Information
(a)Pressing need to develop informational infrastructure to promote transparency to understand the operations of IFIs.
(b)Transparency facilitates decision making, hence improves allocation of resources
(ii) Ability
(a)Market participants (eg analysts, brokers, ratings agencies, etc) need to have the ability to process correctly information provided by Islamic finance industry to enable the industry reached the required critical mass and eventually to be rated.
(b)Easier to develop market discipline in countries with significant market penetration such as S. Arabia (20%), Kuwait (16%), Qatar(13%), Malaysia (12%), Bahrain (10%) and UAE (7%).
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Standards
Regulation and Enforcement
Regulatory Information Disclosure
Attract Market Participants and Maintain Confidence
Industry Growth
Good Corporate Governance
Transparency
Other Factors •Risk Management•Product Development•Skilled workforce•Marketing•Efficiency•Industry Infrastructure
Voluntary Information Disclosure
As market discipline develops, the market demands more information
TRANSPARENCY: A VIRTUOUS CYCLE
Virtuous Cycle of Transparency – a cycle that embraces all aspects of regulation, disclosure, transparency, corporate governance, market discipline and the growth of Islamic banking industry.
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Standards
Regulation and Enforcement
Regulatory Information Disclosure
Attract Market Participants and Maintain Confidence
Industry Growth
Good Corporate Governance
Transparency
Other Factors •Risk Management•Product Development•Skilled workforce•Marketing•Efficiency•Industry Infrastructure
Voluntary Information Disclosure
As market discipline develops, the market demands more information
THE ROLE OF REGULATORS
Standards setting – regulators develop coherent regulatory disclosure requirements which are useful both on national and international basis.Enforcement – at country level whereby central bank enforce regulations by monitoring the implementation & compliance of IFIs to the disclosure requirements.Vigilance – regulators need to be vigilant about –ve signals sent by the market as early warning distress in individual FIs. 10
Standards
Regulation and Enforcement
Regulatory Information Disclosure
Attract Market Participants (ratings agencies, analysts and institutional investors) and Maintain Confidence
Industry Growth
Good Corporate Governance
Transparency
Other Factors •Risk Management•Product Development•Skilled workforce•Marketing•Efficiency•Industry Infrastructure
Voluntary Information Disclosure
As market discipline develops, the market demands more information
CRITERIA FOR GOOD INFORMATION DISCLOSURE
Criteria for good information disclosure by IFIs – quantitative & qualitative useful, accurate, complete and credible.
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CRITERIA FOR GOOD INFORMATION DISCLOSURE, cont’d • Good information disclosure by IFIs both quantitative and
qualitative that meets the criteria of useful, accurate, complete and
credible• Useful – it depends on what the market discipline aims for e.g.:
(i) Satisfactory financial performance - IFIs have to provide financial
statements and comparative analysis (e.g. changes in financial
statement’s items over several accounting periods to detect trends in
the operations and results)
(ii) Good risk management – provide information on how it manages
risk exposures
(iii)Shariah compliance – show Shariah certification in annual reports
and accounts and highlighting Shariah review program
(iv)Resolution of conflict regarding Investment Account Holders (IAH)
– due to the fiduciary role, IFIs need to provide information to both
assets allocation and profit allocation.12
CRITERIA FOR GOOD INFORMATION DISCLOSURE, cont’d
• Accurate, Complete and Credible – to meet these criteria, all of the
previously mentioned information need to be applied.
- Good information disclosure lends itself to enhancing transparency
in the marketplace.
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Standards
Regulation and Enforcement
Regulatory Information Disclosure
Attract Market Participants and Maintain Confidence
Industry Growth
Good Corporate Governance
Transparency
Other Factors •Risk Management•Product Development•Skilled workforce•Marketing•Efficiency•Industry Infrastructure
Voluntary Information DisclosureAs market discipline
develops, the market demands more information
THE ROLE OF MARKET PARTICIPANTS
Disciplining institutions – Reward & punish IFIs based on information disclosure to motivate good behavior among IFIs. Reward good IFIs by placing funds with them and punish those IFIs that did the opposite thing.Soliciting information – market relays the information needed and over time IFIs develop potential for voluntary information disclosure as market demand increases. 14
CONCLUSION
• Islamic Finance industry has the products and infrastructure to compete with conventional institutions.
• Growth rates in some markets outstripped conventional markets
• To move forward, standard setters and regulators need to work together to build strong and practical corporate governance framework.
• Good corporate governance framework promotes transparency via information disclosure by institutions that must be credible to inspire confidence and promote market discipline.
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THANK YOU
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