Regulations

&
Supervision
of Islamic
Finance
Institution.

Islamic Banking and Financial System

Scope of Course

Overview of the Regulations of IFI

Rationale for the Regulations of IFI

Unique Characteristics of the Regulations of IFI

Capital Regulations

Regulatory & Supervision Authorities for the IF

a.rehman@uettaxila.edu.pk
 Overview Regulations of
IFIs
Among the features that distinguish the
Islamic financial system from the
Financial regulations are conventional system are the regulations
the laws and rules that
govern what financial that govern them as well as the
institutions can do to governance mechanisms that they
maintain the integrity of
the financial system, adopt. While conventional institutions
such as banks, brokers have been established and governed by
and investment
companies. secular, man-made laws and regulations
(whether under the civil law or common
law system), the IFIs must also adhere to
the divine rules and principles of
Sharīʿah. Islamic Banking and Financial System
Approaches 4
Towards Applying the same existing Amending existing legal
conventional legal framework framework (mainly through
Regulatory to Islamic finance subsidiary legislation)
Framework E.g.: Algeria, Canada, Saudi E.g.: Kenya, Bangladesh,
For Islamic Arabia, Singapore, USA Djibouti, Jordan

Finance
Creating a totally new and
Setting a full-fledged
separate legal framework
framework for Islamic finance
E.g.: Brunei, Indonesia,
E.g.: Sudan and Iran
Malaysia, UAE
 Single Integrated Single Integrated
Regulatory Framework Regulatory Framework
with No Reference to with Reference to Islamic
Islamic Finance Finance

Approaches to
Regulation of
Islamic Banking

Similar Regulatory
Framework, but Separate Two Separate Independent
for Areas that are Specific Regulatory Frameworks
to Islamic Finance
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Rationale Ensuring Compliance with the Shariah 6
for the
Regulation Protecting the Interest of Depositors as well
as Investment Account Holders
of Islamic
Finance
Maintain an efficient payment system and
mitigate the risk of disruption of payments.

Supporting the Integration of Islamic Financial

Institutions in the International Financial System
Rationale For The Regulations of
Islamic Finance
Chapra-Khan Theory, 2000;

1. General Systematic Considerations: to maintain an efficient

payment system & mitigate risks of disruption of payments.

2. Protecting Depositors & Investment Account Holder of IFI.

3. Ensuring Shariah compliance: how to maintain public confidence

in IFIS.

4. Integration of IFIs within the International financial System (IFS).

a.rehman@uettaxila.edu.pk
 Unique characteristics of the
Regulation of IFIs
– Shariah compliance, investment equity and displaced
commercial risk
– Need to address gaps in Basel Standards with respect to
the treatment of capital
– Recommendable IFSB standards as they covers cross
border supervision issues
– Need to set prudent capital adequacy requirements
reflecting inherent IF risks
a.rehman@uettaxila.edu.pk
 Basel III

○ Basel III: agreement on

reforms to strengthen
global capital and liquidity
Important Issue rules with the goal of
Capital ○ Identification of
promoting a more resilient
banking sector.

Regulation prudent minimum

capital adequacy
○ Basel III; the intention is to
achieve lower risk through
requirements more capital and liquidity
○ Islamic banks in general
are better capitalized
compared to conventional.
As a result, higher capital
Promote financial requirement in Basel III will
system stability affect more conventional
banks.
objectives ○ Islamic banks are less
exposed to derivative and
Fortify banks against
securitized products.
possible shocks;
internal or external to ○ IFSB has a prominent role
the system. in facilitating the
streamlining of the
standards; Revised
Capital Adequacy
Standard, 2013.
Capital Regulation

– Objective: to promote financial market

stability, fortify banks against shocks and
protect investors against consequential
losses
– As a paramount importance as, during the
event of insolvency, depositors may suffer
losses on the saving and investments

a.rehman@uettaxila.edu.pk
 Rationale for Capital Regulation
Basel III
Calls on banks to hold top-quality
capital (Core Tier- 1 capital)
Core Tier-1: consists of equity or
retained earnings worth at least 4.5% of
assets
: plus capital conservation buffer of
Common equity comprising 2.5% of
assets
: Counter-cyclical buffer range (0.0, 2.5)
a.rehman@uettaxila.edu.pk
Basel II
The IFSB issued Capital Adequacy
Standard (IFSB-2) based on Basel II
This standards incorporated features
similar to capital conservation buffer
and capital cyclical buffer of Basel III
It relates to particularly to IRR
(investment risk reserve) and PER
(profit equalization reserve)
Addresses the quantification of Capital
Adequacy of IFS against market, credit
and operation risks
 Three Main Role of
A Central Bank

Role of Price Stability or

Regulators first Stability in the value
in Islamic of money
(maintaining low rate
Finance of inflation)

secon A stable real

d economy: High
employment and
sustainable economic
growth

third
Financial stability:
smoothly-running
payment system.
 14
Malaysian Islamic Finance Regulatory Framework
gap
Regulatory & Supervision
Authorities for Islamic Finance
(Malaysian Experience)
Central Banks have different mandates in the
conduct of monetary policy and the regulation/
supervision of financial institutions; namely:

1.Price stability (maintain value of money. i.e.

inflation)
2.Real economic stability (macroeconomic. i.e. High
employment)
3.Financial stability (maintain an efficient payment
system & prevent financial crises)
1. Bank Negara Malaysia (BNM): the CBA Act
1958 has been repealed by CBA 2009 to:
 Acknowledge dual financial systems
i.e.,Islamic/conventional financial system.
 Establish mandatory power of the National
Shari'ah Advisory Council (NSAC) as the highest
Shari'ah authority in Islamic finance.
 Commit to promote and position Malaysia as
an international Islamic financial center.

a.rehman@uettaxila.edu.pk
Malaysia and Dual Financial System
 Islamic Capital Market

Capital Market Service Act Shariah Resolutions Guidelines

2007
• To give uniformity in the interpretations of
• Strengthen the capital market • Guidelines on Unlisted Capital
the fundamental Shariah rules.
regulatory framework. Market Products under the Lodge
• To serve as a guide for Islamic capital
and Launch Framework
• Strengthen compliance to market product development.
• Guidelines on Issuance of Private
shariah • Among Shariah resolutions that have
Debt Securities and Sukuk
• Improves market integrity been issued: • Prospectus Guidelines
and systemic stability • Asset Securitization • Guidelines on Disclosure Documents
• Enhance investor protection • Regulated Short Selling and • Guidelines on Trust Deed
Securities • Guidelines on the Offering of Asset-
• Islamic Benchmark Bond back Securities

• Crude Palm Oil Futures Contract

• Preference Shares
• Call warrants
 Central Bank Act 2009
2
elevates SAC-BNM 0
Shariah
which empowers the
SAC-BNM resolutions
In 2017, BNM launched
Governance In 2017, BNM issued an
the Certified Shariah
Advisors and Certified
Exposure Draft on Shariah Practitioner
Shariah Governance programmes
gap
Framework. To reinforce
the Shariah governance
from the aspect of
governance, compliance
and risk management gap
 ○ BNM in
Definition collaboration with
Value-Based An intermediation function that VBI Community of
Intermediation aims to deliver the intended Practitioners, have
(not described outcomes of Shariah through consulted key
practices, conduct and offerings stakeholders in
in the book)
that generate positive and developing several
sustainable impact to the
strategies that aim
economy, community and
to strengthen the
environment, consistent with
the shareholders’ sustainable roles of Islamic
returns and long-term interests banking
institutions.

Fintech
(not described in the book)
○ BNM established
Financial Technology
Definition
Enabler Group (FTEG),
Fintech is a which will be
portmanteau of responsible for
financial technology formulating and
that describes an enhancing regulatory
emerging financial policies to facilitate
services sector in the the adoption of
21st century. technological
innovations in the
Malaysian financial
services industry.
 - Established by the Central Bank
Governors of the Group of Ten (G-10)
Basel Committee countries
for Banking - Objective: to enhance understanding of
Supervision key supervisory issues, improve the
banking supervision quality.
- Known for its international standards on
capital adequacy

International International - World’s most important international

cooperative forum for securities
Organisation of
Standard- Securities
regulatory agencies
- Role: setting international standards
Setting Commissions for securities regulation, identifying
Organisation issues affecting global markets,
making recommendations

- Represents insurance regulators and

International
supervisors in nearly 140 countries.
Association of - objectives: promote effective and
Insurance consistent supervision of the insurance
Supervisors industry and contribute to global
financial stability
 - International standard-setting body
that interested in ensuring the
soundness and stability of the
Islamic financial services industry.
International - Has issued prudential and
Standard- Islamic Financial governance framework in the form
Services Board of Standard, Guiding Principles and
Setting
Technical Notes.
Organisation
For Islamic
Finance Accounting and
Auditing - Non-for-profit organization that
Organization for prepares accounting, auditing,
Islamic Financial governance, ethics and Shariah
Institutions standards for IFI.
- Role: to enhance the confidence of
users of the financial statements of
the IFI and to encourage users to
invest or deposit in IFI.
 - It is an international organisation
established by central banks,
monetary authorities and
International Islamic multilateral organisations to create
Standard- International and issue Shari’ah-compliant
Liquidity financial instruments to facilitate
Setting Management effective cross-border Islamic
Organisation liquidity management.
For Islamic
- IIFM is a standard-setting body of
Finance International
the Islamic financial services
Islamic Financial
industry focusing on
Market
standardization of Islamic financial
contracts and product templates
relating to the Islamic Capital,
Money Market, Corporate Finance
and Trade Finance segments of
the IFSI.
 first Lack of Prudential Database

secon Cost of Haphazard Policy

d Decisions and Lack of a Level
Issues and Playing Field

Challenges
third Anti-Money Laundering and
Counter Financing of Terrorism

fourth Fintech

fifth Consumer Protection

sixth Cross Border Enforceability