The currently fragmented system of deposit insurance for accounts and other assets held at Islamic banks is now set to get clearly defined standards and guidelines to which the Islamic finance sector can be aligned. The Switzerland-based International Association of Deposit Insurers and the Islamic Financial Services Board (IFSB) on August 6 in Kuala Lumpur signed a memorandum of understanding to set up a joint working group which would develop and promote technical standards for the implementation of effective and comprehensive Islamic deposit insurance systems.
“What we will do is to create Islamic core principles for effective Islamic deposit insurance systems and provide guidance for the members of both organisations and the deposit insurance sector in general,” said Bello Lawal Danbatta, secretary-general of the IFSB. The agreement will also provide for workshops, conferences, seminars, forums and programmes for banks and financial institutions to promote the new system, as well as provide technical assistance and knowledge-sharing, Danbatta added.
The “core principles” will then enable Islamic deposit insurance providers to identify gaps in their existing deposit insurance practices, while also provide an international standard-setting benchmark to facilitate independent assessment on the effectiveness of a bank’s Shariah-compliant deposit insurance system.
Actually, it was about time that a comprehensive system for Islamic deposit insurance is being set up. The current practices are very diverse and differ from country to country, even from bank to bank.
In principle, an Islamic deposit insurance system is an arrangement to protect insured depositors against the loss of their insured Islamic deposits placed with Islamic banking institutions in the event of the failure of the latter. Its purpose is the same as conventional deposit insurance schemes, i.e. to repay depositors for their losses in case a bank becomes illiquid up to a certain threshold.
To that end, in both systems, banks are required to pay into a deposit insurance fund which may or may not be guaranteed by a country’s central bank or be managed by a government-backed or private institution. The difference of Islamic deposit insurance to conventional is that the former is structured under Shariah-compliant contracts such as safe-keeping (wadiah) and profit-sharing (mudharabah). In this system, deposits are held in trusts and utilised by banks at their own risk. The deposit insurers levy an annual premium based on the contributory institution’s total insured deposit base. The deposit insurance trust’s assets may be invested in sukuk or similar vehicles according to Shariah principles, or held in a respective takaful structure.
The new clear guidelines should reduce the complexity that arises for Islamic deposit insurance from the risk-sharing principle in Islamic finance and the fact that – by and large – account holders at Islamic banks are regarded as profit- or loss-sharing investors rather than depositors, except when a safe-keeping contract is the underlying scheme.
But Islamic deposit insurance system seeks to go beyond that by granting the insurability of profit-loss sharing investment accounts.
The concept of deposit insurance in the Islamic financial industry is relatively new, and few countries have implemented it, despite the rapidly growing asset base of Islamic banks all over the world.
Bahrain was the first to introduce an Islamic deposit insurance scheme in 1993, Sudan followed in 1996, thereafter Kuwait and Jordan developed schemes of their own, and Malaysia did so in 2005. Turkey’s Islamic deposit insurance system, developed in 2001, was absorbed into its conventional system in 2005, while Qatar back in 2014 recognised the need for such a safety net given the increasing scale of operations of its Islamic banking sector and began developing its own, takaful-based Islamic deposit insurance scheme.
The Indonesia Deposit Insurance Corp also announced plans to introduce a Shariah-compliant protection system.
The new core principles by the IFSB will certainly be helpful to achieve higher standards of Islamic deposit protection.