Islamic banks need more regulation: industry body

KUALA LUMPUR (Reuters) - Islamic banks need closer monitoring by regulators to avoid taking on too much risk, an industry body said on Monday, amid concern that the sector's fragmented regulatory framework could increase its exposure during times of crisis.

Islamic finance has grown into a $1 trillion industry, built on a belief of moderate and ethical investing under sharia law, but recent poor earnings by Gulf Islamic banks due to huge exposure to the ailing property sector have thrown regulation of the business into the spotlight.

Governed by national authorities, and if they so choose by industry bodies, sharia banks are subject to a patchwork of commercial and religious rules that differ across jurisdictions, reflecting the varied and fragmented nature of the industry.

As more money pours into Islamic assets, there are growing calls for more supervision. Some bankers say the sector is more vulnerable than traditional banking as lenders share in the losses of business ventures instead of only giving out loans.

"Every financial institution requires close supervision, regardless of whether it is conventional or Islamic," Islamic Financial Services Board (IFSB) secretary general Rifaat Ahmed Abdel Karim said in an interview during the Reuters global Islamic Banking and Finance Summit.

"There are no exceptions in Islamic finance. For example, you cannot have excessive leveraging and significant mismatches."

He cited risk management and corporate governance as areas that needed to be looked into, noting reverse murabaha transactions could cause banks to have excessive leveraging.

Reverse murabaha is a transaction where a bank in need of funds approaches another lender, which buys an asset from a supplier and sells it to the first bank at cost plus profit. The first bank takes title but not delivery of the asset and immediately sells it to an end-purchaser and takes the proceeds.

The Kuala Lumpur-based IFSB is one of two Islamic finance standards-setting body and issues guidelines on the banking, capital markets and insurance sectors.

The other is the Accounting and Auditing Organization for Islamic Financial Institutions in Bahrain, which traditionally issued guidelines on accounting standards but has recently ruled on Islamic bond structures.

Compliance with both bodies' guidelines is voluntary.

"The legal risk may be one of the most significant risks in the industry," Rifaat said.

Most Islamic financing structures have not been tested in courts but lawyers expect this to change as the global downturn sparks a rise in defaults.

A lack of standardization makes it hard to craft a global or even regional regulatory framework.

Religious scholars, who rule on the validity or otherwise of sharia contracts, are divided on some interpretation of Islamic law, with the differences especially glaring between the Gulf and Malaysia.

(Editing by Kim Coghill)