Financial stability by Dadang Muljawan

  Financial Stability Dr Dadang Muljawan

  Contents of discussion The basic The basic concepts concepts Sources of Sources of funds funds Financing Financing products products Other services Other services

  B Introduction Introduction

  1

I. Introduction

  A sound and efficient Islamic financial system is capable to:

  B

• Mobilize public funds
• Optimize resource allocation process
• Promote product innovation and flexibility
• Promote fair competition in the Islamic financial industry
• Facilitate the transactions of goods and services
• Provide adequate customer protection
• Promote good governance and risk management

I. Introduction

  B Sources of instability Internal factors External factors - Fraud

• - Currency volatility

  

Stability

• - Inefficiency
• - Price volatility

  

and

• - Illiquid market robustness - Imported inflation

• - No safety net - Panic

I. Introduction

  B Stable and robust Islamic fnancial system requires:

• Strong institutions and markets
• Efcient inarastructure
• Supporting policies
• Crisis management protocol

  B The pillars The pillars

  2

II. The pillars

  Islamic Islamic

  B

  banking banking Finance

  Finance Takaaul

  Takaaul co’y co’y

  Capital Capital Market and Market and

  Money Money market market

  Islamic Zakat Islamic

  Zakat pawn house institution pawn house institution

  Micro Micro

  Strong Islamic

  fnance fnance

  fnancial institutions and markets Competence, GCG and risk management, information system, market structure, supervision and customer protection

II. The pillars

  B Strong Islamic fnancial institutions and markets

1 Improving level of competence

• Develop standard aor training to promote technical competence (in terms oa fnancial and sharia aspects), integrity, and business ethics and sharia principles aor the players as and supervisors.
• Certifcation program aor Islamic fnancial proaessionals
• Regular review on the materials oa the training and certifcation program.

II. The pillars

  B

2 Good governance and risk management

• The implementation oa good governance principles aor the Islamic fnancial institutions.
• Standard guidance aor governance, risk management and business continuity plan which adopts the international accounting standards and IFSB prudential standards.
• Periodical review to adopt any developments including products and regulatory approach.

II. The pillars

  B

3 Information system

• The inaormation system should be capable in providing accurate and timely inaormation covering Islamic fnancial subsectors whenever required. The development oa the inaormational system is aimed at promoting efciency and accuracy oa the fnancial authority when making strategic decisions. This inaormation exchange would also improve the capability oa the system to conduct surveillance activities comprehensively.

II. The pillars

  B

4 Market structure

• The capability oa the Islamic fnancial institutions to play signifcant role in fnancial intermediation and risk management is also affected by the soundness, efciency and liquidity oa the market. The development process should be able to consolidate the development plan oa each sector and aocus on the fnancial deepening that maximizes the benefts oa the fnancial system to the real economic development program.

II. The pillars

  B

5 Regulation and supervision

• The development oa the supervisory system should accomodate the need aor cross-sectorial supervisory capability supported by appropriate system and man-power.
• Inaormation exchange program among fnancial authrities is very important, particularly as a aoundation aor establishing an early warning system that is capable oa aoreseeing potential disturbance to the fnancial system.

II. The pillars

  B

6 Customer protection

• Customers and investor protection program is aimed at minimizing the vulnerability to any fnancial disturbance caused by unverifable inaormation or destructive rumors.
• Transparency and fnancial peraormance are mutually reinaorcing.

  B Infrastructure Infrastructure

  3

III. Efcient infrastructure B

1 Deposit insurance

• Deposit insurance plays a very aundamental role in maintaining public confdence high by providing a certain level oa deposit repayment guarantee, particularly to the retail depositors, in the case oa bank closure.
• Public may not get well inaormed about the difference between underlying transactions applied in the deposit products and the investment products.
• Operationally, the deposit insurance company should take part in the supervisory activities to ensure systemic stability.

III. Efcient infrastructure B

2 Payment system

• A reliable and efcient payment system plays an important role to support development in an Islamic fnancial market and, subsequently, the economic development by aacilitating fnancial transactions among the economic players.
• The sistem designed should be able to minimize risks resulted arom the settlement process such as liquidity risk, credit risk, Herstatt risk and systemic risk.

III. Efcient infrastructure B

3 Fatwa resolution

• aatwa resolution is very essential to maintain public confdence through providing legal certainty to the players. In some countries that operates Islamic fnancial institutions, aatwas have been compiled and standardized to improve efciency.

  B Supporting policies

Supporting policies

  4

IV. Supporting policies B

  1 Monetary policy

  The monetary policy is made to provide clear signals to the market by using conventional as well as sharia compliant instruments.

  2 Fiscal policy

  The government can also participate in the development oa Islamic fnance by a regular issuance oa Islamic government securities or sukuk locally and internationally.

  B

Crisis management

protocol

  Crisis management protocol

  5

V. Crisis management protocol B

  Financial policies should be set based on two possible condition: normal business and during the period oa crisis.

• The CMP serves as the anticipatory action to maintain the operational soundness oa the fnancial system even ia it operates under a signifcant fnancial pressure so that the intermediary aunction can always be peraormed.
• The CPM should promote possible prompt corrective actions to stabilize the system whenever necessary.

V. Crisis management protocol B

  Business continuity plan (BCP) – The fnancial

  authorities require the Islamic fnancial institutions to have business continuity plan to anticipate signifcant fnancial disturbance. The BCP should also be supported by qualifed human resource and adequate inaormation technology that allows the management to take right actions whenever necessary.

  Framework for coordination – Setting up a solid

  legal aoundation aor the coordination activities among the parties involved in the CMP decision making process. This includes procedures aor decision making process, roles and responsibilities, fows oa inaormation and sets oa possible prompt corrective actions to be taken during the crisis.

V. Crisis management protocol B

  Early warning system – The inaormation system

  that is capable to indicate fnancial turmoil is very essential in the implementation oa CMP. Accurate inaormation about the market allows the authority to defne the critical period based on the thresholds set by the fnancial stability committee and decide the actions to be taken.

  Stress test – The fnancial authority may require the

  fnancial institutions and also themselves to conduct stress test. Proper stress test can improve mutual understanding among the market participants and regulator. It also allows them to regularly identiay weak areas that need to be improved.

  B Solvency regime Solvency regime

  6

VI. The solvency regime At product level At product level

  B

  Sharia contracts Sharia contracts

  Expected residual value Expected residual value

  Types oa claims Types oa claims

  Accounting standards Accounting standards

  Classifcation oa fnancial products that are compliant to aatwas issued

  Classifcation oa fnancial products that are compliant to aatwas issued

  Accounting treatments leading to the sound fnancial practices

  Accounting treatments leading to the sound fnancial practices

  Financial classifcation describing the types oa claims and possesion oa the assets

  Financial classifcation describing the types oa claims and possesion oa the assets

  The basis aor aurther calculation like risk management

  The basis aor aurther calculation like risk management

VI. The solvency regime

  B

  Risk management Risk management

  Expected loss Expected loss

  Objectiv es Objectiv es Micro: Operational sustainability Micro: Operational sustainability Macro: Minimizing potential systemic costs Macro: Minimizing potential systemic costs

  Deposit insurance Deposit insurance

  Fiscal constraints Fiscal constraints

  Cost minimizing Cost minimizing

  Exit policy Exit policy

  Networth level Networth level

  At institution and macro level At institution and macro level

VI. The solvency regime B At institution and macro level At institution and macro level

  The networth and optimal stopping time: _ NW lim NetWorth ( A ( t )) _A   _{t   }

    Min C ( 1 ) C dt

    _{BO M}     

   _t  

  , C where , C and  represent the potential oa having a _{BO M} bail-out, the cost resulted arom a bail-out process,a maintenance cost and discount rate respectedly. The frst operator expresses the expected bail-out cost; whilst, the second operator expresses the present value oa the expected menyatakan maintenance cost drawn arom t to infnity. The supervisor selects the independent variables that are ,...x ,x ). It considered infuencing the two possible events :(x _{1 n-1 n} is assumed that the operational sustainability oa Bank A is Read! In the Name oa your Lord, Who has created (all that exists), B Has created man arom a clot.

  Read! And your Lord is the Most Generous, Who has taught (the writing) by the pen, Has taught man that which he knew not.

  Thank you for your kind attention and support