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Home > Regulation Best Practice > Identifying the Main Regulatory Challenges for Islamic Finance

Regulation Best Practice

Identifying the Main Regulatory Challenges for Islamic Finance

by Bilal Rasul

Table of contents

Executive Summary

  • Harmonization and standardization within the Islamic financial industry, as well as with the conventional banking and finance industry, are the biggest regulatory challenges.

  • Shariah rulings in Fiqh should be harmonized by central Islamic authorities such as the Islamic Fiqh Academy.

  • Pursuit is toward uniform regulatory frameworks which restrict shariah arbitrage.

  • Shariah advisers and advisery boards are indispensable in the regulation of Islamic financial institutions, but there is a dearth of expertise and there are not enough advisers to match the growing demand.

  • Shariah-compliant securities are relatively few and not liquid.

  • The Islamic Financial Services Board’s Ten-year Master Plan for Islamic financial services is a good starting point to tackle the regulatory challenges.


Globally, Islamic finance has exhibited its potential through the ever-increasing number of Islamic financial institutions (IFIs). Unofficial estimates figure Islamic financial assets of the IFIs at nearly a trillion dollars. The Islamic financial industry is still growing and is finding its niche in many Muslim as well as non-Muslim countries. The growth is swift, but it is accompanied by regulatory issues and challenges which will need to be addressed in order to facilitate and coordinate the innovation and diversity that it brings.

Islamic Finance: The Fundamental Difference

In order to understand Islamic finance it must be known that the underlying theme of Islamic finance is the niyah or “good intention”—the element that drives the Islamic socio-economic system for ensuring the enhancement of the welfare of society. The niyah may represent the Islamic philosophy of conducting life and business, but it is not restricted to Muslims. The tenet pertains to justice and fairness which can be practiced by all, Muslim and non-Muslim alike. The Islamic financial system, therefore, hinges on the niyah as an essential ingredient for every contractual transaction that is executed.1

For the layman, the fundamental difference between Islamic finance and conventional finance is the feature in the latter to put a cost on money in financial transactions, i.e. interest, or riba as it is known in the Islamic financial world. Basically, whatever is borrowed has to be returned but with an increment.

In Islamic finance one of the questions most often visited is: “Money has time value; how can it not have a cost?” The simplest answer is that in Islamic finance there is no concept of money as a commodity: There is always an underlying contract in the form of a partnership or venture that is entered into between the lender and the borrower, with the profits or losses and the risks all being shared. Therefore, a fixed return per se cannot be assured. This perspective of Islamic finance confers a “soul” to business activity. The motives are the welfare of the people; an egalitarian society; the opportunity for all to benefit without being exploited. Islamic finance covers the social aspect of being in enterprise. Above all, it is trust-based.


Harmonization and Standardization

The contracts prescribed in Islamic law provide a significant part of the principles and procedures explicitly laid down in the Fiqh or Islamic jurisprudence which must be observed for shariah compliance. For instance, the Qur’an is replete with passages that denounce riba as exploitative and against the norms of fairness. The problem arises where the principles and procedures for specifics are not so easily found and therefore have to be derived from the fatwas, or interpretations of the shariah scholars. The fatwas awarded on financial transactions differ amongst scholars and across jurisdictions, which produces the problem of pluralism in shariah interpretations.2 There are mainly five schools of thought in Islamic jurisprudence for example, Hanafi, Shafei, Hanbali, Maliki, and Ibadi amongst others. Each school of thought has its own set of muftis (scholars) on Islamic financial issues which, more often than not, creates conflict and ambiguity in decisions on the veracity of a transaction in terms of its compliance with the shariah. In this context the Quran states “As for those who divide their religion and break up into sects, thou hast no part in them in the least: their affair is with Allah: He will in the end tell them the truth of all that they did.” Al-Qur’an, Surah 6 (Al-Anaam) Ayat 159

So, the biggest challenge faced by the regulators of Islamic finance is harmonizing and standardizing these interpretations into a consistent and efficient regulatory framework that will ensure unimpeded Islamic financial intermediation amongst the participants.

The process of harmonization and standardization of transactions across and within borders is undoubtedly a daunting one and has to be comprehensive. In some jurisdictions certain transactions are considered shariah-compliant while in others they may not be accepted as so. It is extremely difficult to adjudge as to which is the closest to shariah. Consensus in the fatwas may be overcome by the centralization of the shariah rulings in a central Islamic authority such as the Islamic Fiqh Academy of the Organisation of the Islamic Conference (OIC), which is recognized by a large majority of scholars. In the event of disagreement the Academy can give its verdict.

The pursuit should be toward uniform regulatory frameworks based on principles and standards designed by universally accepted organizations such as the Islamic Financial Services Board (IFSB) and the Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI). The adoption of the guidelines drafted by these institutions is the panacea for the shariah arbitrage that exists otherwise.

Not secondary to this issue is the problem of emulating the conventional financial system and applying the BASEL II principles.3 Effective risk management measures applied to the conventional financial system need to be applied to Islamic finance, but with certain modifications and adaptations. The Islamic financial industry has to be adept with techniques and competitive products to improvise and emulate the conventional banking and finance industry. Only then can IFIs compete with the conventional giants and access the international markets while maintaining their Islamic identity.

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Further reading


  • Karim, Rifaat Ahmed Abdel, and Simon Archer. Islamic Finance: The Regulatory Challenge. Singapore: Wiley, 2007.
  • Mirakhor, Abbas. “General characteristics of an Islamic economic system.” In Baqir al-Al-Hasani, Bakir, and Abbas Mirakhor (eds), Essays on Iqtisad. Silver Spring, MD: NUR Corp., 1989, pp. 45–80.
  • Venardos, Angelo M. Islamic Banking and Finance in South-East Asia: Its Development and Future. 2nd ed. Singapore: World Scientific Publishing, 2006.


  • Akhtar, Shamshad. “Islamic finance: Its sustainability and challenges.” Journal of Islamic Banking and Finance 25:1 (2008).
  • Thomas, Abdulkader, and Sheikh Muhamed Becic. “Are sukuk Islamic?” Islamic Business and Finance 26 (January 2008). Online at:


  • Ainley, Michael, Ali Mashayekhi, Robert Hicks, Arshadur Rahman, and Ali Ravalia. “Islamic finance in the UK: Regulation and challenges.” Financial Services Authority, November 2007. Online at:
  • El-Hawary, Dahlia, Grais Wafik, and Zamir Iqbal. “Regulating Islamic financial institutions: The nature of the regulated.” World Bank Policy Research Working Paper 3227, March 2004.


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