Regulation of Islamic Financial Institutions 301
In contrast, the promotion of economic development may be beyond
the role that should be assigned to fi nancial regulation. Expansion and
growth is promoted by increased trust in the fi nancial system that regu-
lation can provide. However, its design to explicitly promote develop-
ment may distort its objectives of ensuring soundness and stability, and
pose diffi cult challenges for regulators in having to choose between pro-
moting economic development and ensuring the stability of the fi nan-
cial system.
(ii) Protecting the interests of demand depositors. The protection of
demand depositors is envisaged in the two - windows model of an Islamic
fi nancial intermediary, which asks for the maintenance of 100 - percent
reserves against demand deposits.
(iii) Ensuring compliance with the Shari’ah. The relationship between civil
and religious law varies across national jurisdictions. Where there is a
strong separation of the two, it is diffi cult to justify assigning to public
authorities the role of ensuring that fi nancial intermediation activities
comply with the Shari’ah. This is considered a private religious matter
that does not call for public intervention. The issue of truth in disclo-
sure and in advertising, however, remains and gives stakeholders legal
redress. This is not, however, a matter of fi nancial regulation, but one
of broad institutional infrastructure for business. In jurisdictions where
the distinction between civil and religious law is less pronounced, one can
well see a public policy choice for assigning to a public regulator the
role of ensuring that banking activity complies with the Shari’ah.
(iv) Supporting the integration of IFIs in the international fi nancial system.
Integration would develop from the participation of IFIs in the fi nanc-
ing of international trade and international payments. Counterparts
would want to be satisfi ed with the ability and commitment of IFIs to
fulfi ll the contracts they enter into. In this respect, national and inter-
national regulation can be grounded in the public good and needs to
ensure orderly participation in international payments and the integrity
of fi duciary contracts.
DISTINCTIVE FEATURES OF REGULATING IFIS
Having considered the “Why?” of fi nancial regulation, we now turn to the
“What?” and the “How?” It has been often argued that the case for intro-
ducing regulation to protect the value of deposits of IFIs fully abiding by
risk-sharing principles is less compelling than for conventional fi nance. IFIs
are different from conventional banks in several respects, which makes their
regulation somewhat different. The areas of difference are as follows.
The Nature of Intermediation
The fi nancial intermediation undertaken by IFIs is based on the principal–
agent model and the contractual relationship is based on the profi t/loss - sharing