Islamic Financial Intermediation and Banking 169
and more akin to a universal bank. However, unlike conventional universal
banks, Islamic banks do not erect fi rewalls to separate, legally, fi nancially
and managerially, their investment and commercial banking services. As a
result, funds in investment accounts are not “ring - fenced” from the funds of
others, including the equity holders. This is one of the most critical devia-
tions in the practice of Islamic banks and one that poses a tough challenge
to regulators because different stakeholders need to be regulated under dif-
ferent regulating principles and therefore taking a one - size - fi ts - all approach
becomes restrictive and may defeat the whole objective of regulation in this
case. This is further elaborated and discussed in the chapter on the regula-
tion of Islamic fi nancial institutions.
Investors’ Rights and Governance
Another divergence between principle and practice, related somewhat to
the foregoing issues, is the status of the investment accounts. Although they
are supposed to be operating on profi t and loss principles, actual practice
differs. IFIs have faced criticism when they write down the value of assets,
because they do not in practice write down the value of deposits. This
implies that losses on the asset side are absorbed by either other deposit
holders or by the equity holders. This practice raises a question on their
degree of transparency and information disclosure. It also raises the issue
of the need to separate asset types to match them closely to liabilities, either
through fi rewalling or through segmentation.
This deviation leads to the question of the governance rights of the
investment account holders. Large investment accounts serve as sources of
capital to fi nance pools of investments and assets of the fi nancial institution,
but their holders are not granted any participation in the governance or
monitoring process. The majority of investment account holders are individ-
uals who may not organize themselves collectively to perform the necessary
monitoring. Under such circumstances, the responsibility of the regulators
and the Shari’ah boards increases further, to ensure that adequate monitor-
ing mechanisms are in place to protect the rights of the investment account
holders.
CRITICAL ISSUES WITH CURRENT PRACTICE
Illiquidity
Predominantly, the transactions on the assets side of Islamic banks consist
of customized or tailor - made transactions between the bank and its client.
There is no organized market to securitize the bank’s assets and to trade the
securities in the market, severely limiting the liquidity of the fi nancial insti-
tutions. As a result, Islamic banks have limited themselves to a small set of
asset classes, which constrain their opportunities for portfolio diversifi cation