The rapid expansion of Islamic financial institutions (IFIs) in recent years has resulted in them becoming increasingly entrenched in their domestic, regional and global markets, says Moody's Investors Service in a new Special Comment.

But, this has also brought with it a number of challenges, according to the report.

Moody's credit ratings can play a role in helping these institutions respond to these challenges, as is the case for their conventional counterparts.

'Islamic financial institutions share many characteristics with conventional institutions. However, the Shari'ah-compliant asset classes managed by IFIs may sometimes differ from those of conventional banks, not so much in their economic substance, but more in their financial form,” said Moody's vice-president/senior credit officer and co-author of the report Anouar Hassoune.

“Indeed, Islamic banks and those essentially conventional financial entities that also offer Islamic services must abide by a series of rules and principles without which a transaction would not be deemed to be in line with financial Islam.'

Many of the challenges faced by IFIs stem from the accelerated pace of their successful inclusion within more competitive and interrelated, if  not integrated, financial markets across borders. For financial intermediaries globally, robust governance, enhanced transparency, consistent communication, sufficient credibility, fortress reputation, financial flexibility, swift access to diversified funding sources and strong liquidity have become of utmost importance.

Moody's Special Comment - entitled 'The Benefits of Ratings for Islamic
Financial Institutions and What They Address' - explains the ways in which the rating agency's independent, globally consistent and recognised opinions on the relative creditworthiness of securities and issuers, can play a role in helping IFIs achieve such demanding goals and accompany them in their attempts to further establish themselves in the mainstream financial industry, not only at home but also beyond the natural borders
of the Muslim world.

Moody's report also explains what ratings specifically address in the case of IFIs, and provides details as to the different types of rating that would be assigned to different Islamic financial institutions depending on the category of their liabilities.

For Islamic banks, Moody's will generally use issuer ratings and financial strength ratings
to describe the overall creditworthiness of the IFI. In some circumstances, where the funding of the Islamic bank is similar to that of a conventional bank in its own market, Moody's will assign deposit ratings to allow easy comparison of creditworthiness among peers.

It should be noted that Moody's analysis does not extend to forming an opinion on whether or not a transaction, a security, or an issuer, is in compliance with Shari'ah law, and therefore credit ratings should not be interpreted as addressing this issue per se.

'Overall, Moody's rating process for assigning ratings to IFIs and to the various classes of their funding instruments does not materially differ from that applicable to conventional banks. The criteria and methodology used by Moody's to form its credit opinions on financial institutions globally are flexible enough to encompass the subtle characteristics of Islamic banks, and the differences they may display in terms of their
funding structures,' noted vice-president/senior credit officer and report co-author Khalid Howladar. - TradeArabia News Service