Islamic Banks Need to Be Customized

The current framework governing Islamic banking contains many gaps that need to be closed through the development of a more comprehensive and enabling environment that ensures financial stability and sound development, according to the executive board of the International Monetary Fund.

In a recently adopted staff paper “Ensuring Financial Stability in Countries with Islamic Banking”, the IMF calls for further strengthening of the legal and regulatory environment and institutional framework in countries that have Islamic banking, Arabian Business reported.

“Islamic banking continues to grow rapidly, in size and complexity, posing a challenge to supervisory authorities and central banks. While accounting for a small share of global financial assets, Islamic banking has established a presence in more than 60 countries and has become systemically important in 14 jurisdictions,” the IMF study said.

Islamic finance principles underpin Islamic banking and involve operations, balance sheet structures, and risks that differ from their conventional banking counterparts.

The legal environment within which Islamic banks operate can be complex and challenging and may have implications for financial stability. Islamic banks operate in diverse legal environments, some of which are more evolved than others in providing strong legal underpinnings for Islamic banks.

“Legal clarity and certainty for Islamic banking are important to promote confidence in the industry, as well as to mitigate the potential risk of regulatory arbitrage and strengthen supervision,” the IMF Staff Paper said.

International governance standards apply to Islamic banks but need to be customized to take into account their distinct governance features. These relate to decision-making structures, Sharia compliance, and the rights of investment account holders.