?Tapping into private wealth management.? This is how, last Tuesday in Parliament Assembly, the Finance minister, Rama Sithanen, revealed one of his major expectations from the introduction of Islamic banking. If, as stressed by the VPM, Islamic banking, in accordance with the sharia, would help Muslims to come to terms with their beliefs, the system would not only be open to non-Muslims, but also act as a regional framework for Islamic finance and investments from foreign customers ? in Middle-East and Southeast Asia.

Yet, a strong supervisory system must be implemented. ?There is no need to have a separate body of laws.? But some regulations will be implemented within the existing framework. A steering committee including, among others, the two main regulatory institutions, the Bank of Mauritius and the Financial Services Commission, is working on the subject.

On the other hand, commercial banks are addressing the new perspectives and getting ready. Barclays Bank corporates will be briefed today on the basics of Islamic banking by a well-versed consultant. ?We are closely watching the situation and waiting for the regulations?, said a source from Mauritius Commercial Bank.

At HSBC, which offers Islamic banking facilities ?in downtown London?, Patrick Grant comments: ?As an international bank, already offering Islamic banking services in different countries, we would certainly be keen to assess the feasibility of offering the services here, within an appropriate legal framework. This would be an important addition to the range of global business financial services that Mauritius offers.?

In Parliament, minister Sithanen mentioned the visit of a Malaysian expert who has studied the local context and submitted his report. Small and medium enterprises should benefit from this system. ?Because of profit shares?, the Islamic system may be more advantageous than the traditional system, says the Finance minister. Interest may be banned but the operation mode is favourable to profit making and joint ventures.

Management of foreign private wealth and investment seems to be the priority, however, for the benefit of the economy. But small reforms should be introduced. Not only a suitable regulatory framework but also institutional arrangements to provide ?an enabling operational environment for Islamic finance?.

<B>Complexity and risk</B>

On the international scene, the recent setting up of the Islamic Financial Services Board, facilitated by the International Monetary Fund (IMF), has addressed these needs. A fund, Alee Limited worth Rs 20 million and quoted on the Stock Exchange, already follows the sharia. It has grown well over four years and benefits non-Muslims.

Because of its peculiarities, Islamic banking needs individual consideration concerning one kind of services or the other. According to an IMF working paper (Islamic Financial Institutions and Products in the Global Financial System: Key issues in Risk Management and Challenges ahead, available on its website, though not IMF official policy), there are ?special challenges for the identification, measurement, monitoring and control of underlying risks? in the global context.

In profit and loss sharing (PLS), Islamic banks may be vulnerable to risks. ?While PLS financing may shift direct credit risk of Islamic banks to their investment depositors, they may also increase the overall degree of risk of the assets of banks? balance sheets?, says the report. This is more obvious when dealing with ?risks normally borne by equity investors rather than holders of debt?.

PLS administration under Islamic banking is more complex than in conventional banking, with activities like the determination of ratios on investment projects, must be tackled rationally. So does funding. ?When Islamic banks provide funds through PLS facilities, there is no recognizable fault on the part of the agent-entrepreneur until PLS contracts expire.? If the project delivers lower than expected profit or none or a loss, ?the lower profit or loss is shared between parties?. The financed individual is thus totally free to run his enterprise to his best judgement. Blessing or hazard?

Non PLS financing modes carry risks that should be recognized. In investment deposits, Islamic banks manage depositor?s funds at their discretion under the unrestricted Mudaraba contract. The authors of the Working Paper consider that this can increase the potential for moral hazard and creates an incentive for risk-taking and operating financial institutions without adequate capital.

Mauritius, which enjoys a good reputation in conventional world finance, has to address this issue. For such issues, the authors recommend that ?the framework allows bankers to have adequate amounts of their own capital at risk?. In most cases, the option of implementing adequate capital and loss-offsetting reserves as well as appropriate pricing and risk control seem to give the reachable frame of solutions.

Some conventional tools (options, futures, forwards) are not available in current Islamic finance, except in Iran and Sudan. A promising practical approach to address lender of last resort facilities while avoiding interest-based transactions, has been set up by Bank Negara Malaysia. It is an inter-bank investment facility where Islamic financial institutions or departments can access short-term funds from each another through PLS.

This system can become more efficient as the central bank and the government develop such operations. As it is, Islamic banking and finance can be introduced in individual existing institutions or departments. The success of the Alee Fund is a good signal that benefits can be shared among all. Now it is the time to think well about the legal framework.