Financial and banking legislation in the Middle East and the GCC member states in particular has made tremendous strides over recent years. New banking laws providing for specific provisions governing conventional and Islamic banking and finance have been issued in the UAE and Egypt and similar provisions are under review in Qatar.
Furthermore, legislators and regulators have taken steps to further standardize the regulation and supervision of Islamic banks and finance institutions. However, the COVID-19 pandemic has shifted the focus of governments. Over the course of 2020, regulators have scrambled to adapt regulations and processes to address rising pressures on the conventional and Islamic finance industry caused by the economic crisis triggered by restrictions imposed by governments in response to the COVID-19 pandemic.
Consequently, important reforms of banking and finance laws and regulations have been postponed.
Review of 2020
Government responses to the COVID-19 pandemic have impacted all sectors. While the banking and finance industry may have not been directly affected by restrictions imposed, secondary effects have been felt in the industry. In particular, the expected rise in borrowers’ default on loans poses considerable risks for Islamic and conventional lenders alike.
Furthermore, in the wake of the economic downturn caused by measures imposed by governments around the world in response to the COVID-19 pandemic, transactions and investments are expected to decrease. This will have negative impacts on the banking and finance industry and put further pressure on the sector.
Moreover, regulators have eased equity requirements and other stability measures to allow financial institutions to sustain their business despite the economic downturn and to support companies in distress.
These measures, however, increase the risks of banks and other financial institutions eroding their financial basis and thereby increasing the risk of financial institutions coming under financial distress.
Thus, while authorities loosening regulatory oversight over financial institutions may serve the Islamic and conventional banking industry to sustain its business in the short term, it will leave the industry less resilient.
Preview of 2021
Over the course of 2021, we will likely still see the COVID-19 pandemic and government responses impact the world economy in general including the financial sector. Still, regulators will have to take steps to address the rising instability in the financial sector.
Regulatory restraints loosened in response to pressures on the financial sector will have to be dialed back to stabilize the industry again. Furthermore, governments may have to take further steps such as bailouts or provide other forms of financial relief to support individual banks or the industry at large.
It remains to be seen how long this process will take. The longer we will have to deal with the fallout from governments’ responses to the COVID-19 pandemic, the longer we will have to wait for legislative and regulatory reforms needed to modernize the Islamic finance sector. Efforts of standardization initiated by governments throughout the Middle East to increase trust and stability in the Islamic finance industry are of vital importance for the sector.
In particular, after the highly publicized scandals such as the Dana Gas case have eroded trust in the Islamic finance industry, standardization of regulation and oversight over Islamic finance products are needed to regain trust.
Furthermore, new opportunities for asset-based lending offered by the growing implementation of public–private partnerships (PPP) require dedicated legislation and regulatory reform in the public procurement sector. It remains to be seen when regulators and legislators will shift their focus back from COVID-19-related measures to reforms to further develop the Islamic finance sector.
The direction legislators and regulators will take over the coming months will have substantial impacts on the future development of the Islamic finance industry. The Islamic finance industry has shown substantial growth prior to the COVID-19 pandemic. Whether this trend can be sustained will depend at least in part on how quickly and how effectively regulators and legislators will get back to reforms they initiated prior to the crisis. If these reforms are postponed too long, the momentum we have seen in the Islamic finance sector over recent years may be lost.