The issue of Islamic bond market and its role in providing short-term liquidity to Islamic finance industry dominated the first day of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) conference being held in Bahrain.

The event, which opened on Sunday at the Crowne Plaza, is being held in partnership with the World Bank and under the auspices of Central Bank of Bahrain (CBB).

'The principle of risk sharing is at the core of the Islamic financial industry,' said CBB Governor Rasheed Al Maraj.

'It changes the nature of risks faced by Islamic financial institutions and their customers. Unlike ordinary depositors, the holders of unrestricted investment accounts in theory share some of the risks that in a conventional institution would be borne exclusively by the shareholders of the bank.'

'While the principles of Islamic finance are very different to those of conventional finance, Islamic financial institutions are still subject to same kinds of risks and to the same laws of economics as are conventional ones.'

'Borrowing short to lend long is, of course, fundamental to the business of banking,' he remarked.

'Even so, there comes a point at which the degree of maturity mismatching is no longer prudent, and we saw with conventional financial institutions that the boundary between prudent and imprudent business conduct had been crossed,' the Governor said.

'If we look at the trends in Islamic banking in the years prior to the crisis, we can see that there are important similarities between the practices of Islamic financial institutions and those of conventional ones,' Al Maraj stated.

'Just like conventional institutions, Islamic financial institutions increasingly funded long-term assets with short-term funding.'

'Although the assets and liabilities were structured in a Sharia-compliant manner, the degree of maturity mismatching was just as great as was practised by conventional institutions,' he noted.

'In some cases where the asset involved a long-term development project, the degree of maturity mismatching was significantly greater than that practised by conventional financial institutions.'

'The conventional financial industry received a wake-up call during the crisis concerning the importance of understanding, monitoring and controlling liquidity risks,' said the Governor.

'The Islamic financial industry must recognise that it also needs good liquidity risk management. However, Islamic financial institutions find it difficult to manage their liquidity risk given the relative lack of short-term money market instruments in which they can invest.'

'The CBB has been at the forefront of innovation in assisting Islamic financial institutions to manage their liquidity, but more still needs to be done both by regulators and the industry.'

'Obviously, Islamic financial institutions cannot invest in interest-based products. This makes the specific liquidity requirements of Basel III difficult to apply to them.'

'There is also the complication that the outstanding stock of sukuk is not sufficiently large to enable all Islamic financial institutions to meet a liquidity ratio comparable to that mandated under Basel III,' said Al Maraj.

'Finally, the markets for sukuk are not always as liquid as those for conventional government bonds and therefore even if an Islamic financial institution invests in them it might not always be able to find a ready buyer when the need occurs,' he remarked.

'Regulators of Islamic financial institutions also need to pay careful attention to the ability of capital structures to absorb losses on an ongoing basis,' he added.

AAOIFI board chairman Shaikh Ebrahim bin Khalifa Al Khalifa praised the work of the outgoing secretary-general Dr Mohammed Nedal Alchaar and his role over the past nine years in setting standards for the industry.

He said that so far AAOIFI has set 86 standards in areas of accounting, auditing, ethics and governance including a number of new standards set this year.

World Bank financial and private sector development network representative Abayomi Alawode said that AAOIFI's role in setting standards had been commendable either through setting new standards or adapting conventional standards to Sharia-compliant ones,' he added.-TradeArabia News Service