5-O Agency : Together We Share, We Learn

~ Who Regulates The Islamic Finance Industry?

Posted by faisalrenzo on July 5, 2011

Here is some information about the main bodies tasked with overseeing the sector and the challenges they face.

SINGAPORE/NEW DELHI  : Overseen by a patchwork of regulators and religious authorities, the Islamic finance industry has taken major steps to standardise products and reduce the regulatory uncertainty that is seen as impeding development of the market.

The debate over regulations flared last year when compliance of some Islamic bonds with syariah was thrown into question by the industry auditor, the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI).

Differing interpretations of the syariah also make regulation across jurisdictions a tricky task. For example, some Islamic contracts such as the bai bithaman ajil (deferred payment sale) are approved by Malaysian regulators but rejected by those in the Middle East.

Here is some information about the main bodies tasked with overseeing the sector and the challenges they face.


Islamic Financial Services Board (IFSB)

The international standard-setting organisation issues guiding notes on standards and principles for the industry’s banking, capital markets and insurance sectors.

Its 175 members include 42 regulatory and supervisory authorities, six international inter-governmental organisations and 127 market players and professional firms.

The IFSB working groups, which include representatives from central banks and national monetary authorities, work with other international bodies, such as the International Association of Insurance Supervisors, to streamline the rules around integration of Islamic products such as takaful or Islamic insurance, for example.

Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)

AAOIFI’s standards have been adopted in Bahrain, the Dubai International Financial Centre, Jordan, Lebanon, Qatar, Sudan and Syria; while its standards are used for guidelines issued by authorities in Australia, Indonesia, Malaysia, Pakistan, Saudi Arabia, and South Africa, according to the auditor’s website.

In 2001, AAOIFI and the Bahrain Monetary Authority developed a regulatory framework known as PIRI – the Prudential Information and Regulatory Framework for Islamic Banks.

Created in consultation with the industry, it aims to help Islamic banks become more than niche players by integrating standards with the Basel Committee on Banking Supervision, established by central bank governors of the Group of Ten countries in 1974.

Despite these steps, analysts say there are still gaps in the industry’s financial reporting and accounting.

AAOIFI ruled last year that repurchase undertakings – a pledge found in most Islamic bonds that the borrower would pay back their face value at maturity – violates the duty to share risk in sukuk, mudaraba and musharaka.


In Sudan, Pakistan and Iran, where Islamic banking is the national system, financial products conform to the syariah as it is defined by local authorities.

In countries where Islamic finance runs in parallel to the conventional system, such as Malaysia and Bahrain, Islamic banks are regulated separately from conventional banks.

Not all such states have applied IFSB guidances, however. This has led to criticisms that the legal and regulatory frameworks are uncoordinated and inadequate.

Insufficient syariah convergence between countries is another factor. While Gulf and Malaysian models are said to be gradually converging, differences of opinion remain between scholars.

Other state regulators have worked with Islamic financial institutions to include them in existing regulatory frameworks.

In the UK, for example, both the Bank of England and the Financial Services Authority were involved in the establishment of the first syariah-compliant retail bank in Europe or the US, the Islamic Bank of Britain, in 2004.


Islamic banks are structured to include a special syariah supervision board made up of scholars.

Analysts say the industry’s more general problem – a shortage of qualified people – shows up at this level, with some of the top 20 scholars appearing on syariah compliance boards for dozens of different institutions.

Becoming an authority can take 15 years of Islamic legal studies, then years more in financial training. Forbes magazine estimates there are only 260 such scholars in the world, of whom only a handful also have the requisite grip on complex financial instruments to sit on a bank’s board.

Specialised academic centres have been set up to address this, such as the Harvard Law School’s Islamic Finance Project.

Conventional banks which have added new Islamic services keep syariah-compliant products separate from other products.

Consultancies can help banks liaise with syariah scholars, who sit on supervisory boards. – Reuters



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