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CHAPTER
14
Regulation of Islamic Financial Institutions
Financial Institutions
INTRODUCTION
Firms in the fi nancial services industry, especially banks and insurance
companies, are subject to various forms of regulation. As the industry has
advanced, the regulation of it has also become more experienced, complex
and dynamic. The nature of regulation of any industry can be understood
by asking the questions: Why is regulation required? What needs to be regu-
lated? How should this be done? The rationale for regulation (the “Why?”)
is the same for IFIs and conventional fi nancial institutions alike, but there
are clear differences in the “What?” and “How?” questions.
Diverse views on the need for regulation in conventional fi nance range
from positions of almost total opposition to any regulation, to the justifi ca-
tion of broad, intrusive regulation. The arguments for the regulation of con-
ventional fi nancial services include the public good, mitigation of systemic
risk, the protection of depositors, and the integrity of fi duciary contracts.
The Public Good
One view of regulation is that it provides a public good that the market can-
not supply on its own. The objective of prudential regulation is to mitigate
risks taken by the stakeholders (for example, depositors) unable to under-
take the necessary due diligence to enable them to assess these risks. Some
stakeholders have suffi cient investment savvy to develop these assessments
on their own and would not, in principle, need in the same degree the support
of public regulation, except for transparency and disclosure requirements
necessary to conduct their due diligence. Consequently, from the public - good
perspective, the design of prudential regulation would call for a clear sense
of the type, quality and quantity of the public good to be delivered, as well as
the nature of the risk and risk exposure or values at risk involved.
An Introduction to Islamic Finance: Theory and Practice, Second Edition
by Zamir Iqbal and Abbas Mirakhor
Copyright © 2011 John Wiley & Sons (Asia) Pte. Ltd.