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Regulation Checklists

Regulatory and Capital Issues under Shariah Law

Checklist Description

This checklist considers some of the main implications of the development of financial market regulations on Islamic finance

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Following the early development of Islamic finance in the Middle East, the growth in shariah-compliant financial services over the last decade has been dramatic. Local and national banks in predominately Muslim countries have sought to introduce compliant products and services to their customers. International banks also have been quick to recognize the potential in adding Islamic products to their range.

The relentless advance of shariah-compliant finance has generated debate on how Islamic finance should respond to developments in the international financial regulatory environment. Although at first glance amended regulatory standards and governance requirements may seem unworkable in the context of Islamic finance, in many instances, the amended standards and expectations can be easily integrated. In fact, the biggest challenge towards achieving greater compatibility between international regulatory and capital standards and Islamic finance is frequently how to change providers’ attitudes to greater integration.

The Dubai Financial Services Authority provides a good example of how a new regulatory framework can be developed to be compatible with both mainstream and Islamic finance companies. Dubai, a major centre for sukuk investment, has created a common law-based legal system and a regulatory environment which is based on existing international structures, yet is supportive of the key aspects of Islamic finance. Given its leading position in the sukuk market, the Emirate also enforces high standards of disclosure and transparency.

Product and industry trade bodies have shown the value of international collaboration on regulatory progress. Given rising interest in Islamic derivative trading over recent years, the International Swaps and Derivatives Association (ISDA) has been working with the International Islamic Financial Market (IIFM) towards the goal of creating a guideline framework for the industry. The work under development is to be called the ISDA/IIFM ta’hawwut (hedging) master agreement and, as at January 2009, is on course to be the standard contract for international cross border Islamic derivatives transactions. However, despite the progress towards these standard contracts, the ISDA has stressed the need for individual Islamic jurisdictions to strengthen their own regulatory and legislative environments to ensure that the agreed transactions are legally enforceable. The ISDA has also highlighted that issues related to regulatory capital, and accounting policies surrounding Islamic derivatives transactions, need to be addressed by local regulators.

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  • Improved regulatory and capital structures can play an important role in the ongoing success of Islamic finance.

  • Increased transparency and better governance should boost the uptake of new financial products.

  • Collaboration between states and organizations can result in major advances to promote the growth of Islamic finance.

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  • Conventional Western risk management often views Islamic finance as carrying very specific risks related to issues such as the lack of consistent shariah compatibility standards. Particular concerns have been raised over the application of the Basel II Accord/capital adequacy requirements which were originally created for mainstream Western banks, with no regard to the very specific risks faced by Islamic institutions.

  • Regulatory attitudes between Western and Islamic systems can differ greatly. For example, a Western regulator may question whether a shariah board’s role is advisory, and if it has executive powers.

  • Difficulties can arise for regulators as to how to classify some Islamic financial products. For example, musharaka home purchase products may not be approved as a regulated mortgage product.

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Action Checklist

  • Recognize the compatibility between many aspects of Western and Islamic systems. In other aspects, differences may not be as stark as they first appear. For example, Islamic corporate governance standards may appear weak by formal western standards, but some could argue that in practice, these are underpinned by the Islamic emphasis on integrity and sense of fair play.

  • Appreciate that excessively tight regulatory structures could hamper the development of innovative new products.

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Dos and Don’ts


  • Acknowledge that improved regulatory structures can only be achieved where a supportive political backdrop for change exists.

  • Consider whether Islamic product providers products could also appeal to non-Muslims.

  • The increasing overlap of Western and Islamic finance could be demonstrated when a non-Muslim country eventually issues sukuk. Mooted for some years by the UK government, the form of any future issue could be worthy of close scrutiny as Western sovereign issuers look to tap into massive demand for shariah-compliant investment products.


  • Don’t expect regulation to generate product innovation.

  • Don’t expect a true “single market” for Islamic products.

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Further reading


  • 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:


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