Regulation of Islamic Financial Institutions 315
may be looking for custodial services only, while others may need to place
funds for performing day - to - day transactions and therefore do not exhibit
much risk appetite. Similarly, there may be a class of depositors that is less
risk - averse and would like the IFI to deploy its savings for a longer term.
A visionary design consistent with the founding principles of Islamic
fi nance could see an IFI structured as a group of fairly independent entities,
each designed to optimize the functional demands of its clients. This view
is presented by El - Hawary, Grais and Iqbal (2004), who argue that institu-
tions offering Islamic fi nancial services can be viewed as three distinct seg-
ments (see Table 14.5), which can then be regulated individually for greater
stability and transparency.
Segment A is designed to handle funds for depositors who are highly
risk - averse and require a high level of liquidity; who would use the funds
for daily transactions; or would prefer to keep savings in safe assets where
their capital (principal) is preserved. This segment would invest funds in
asset - based securities with fi xed-income characteristics and the IFI would
intermediate by screening and monitoring such opportunities and making
sure that credit and operational risks are contained. The concept is similar
to narrow banking and would require a similar approach in its regulation.
Segment B is designed to cater to depositors with the next level of risk
appetite who are willing to take some risk in the expectation of a higher
return, with capital preservation and liquidity less high on their agenda. The
IFI would deploy these funds in medium - to long - term instruments, such
as ijarah or istisna’, or may prefer to invest on a mudarabah basis directly
with the entrepreneur or through mudarabah certifi cates. If there is a well -
developed secondary market for mudarabah - based funding, then the form
of intermediation taken by the IFI will be very similar to mutual funds where
the IFI will manage and invest the depositors’ money in different mudarabah
funds. Since the contractual agreement with the depositors would be similar
to the fi duciary responsibility of a mutual fund in a conventional system, the
same regulatory principles would apply.
TABLE 14.5 A segmented view of an IFI
Assets Liabilities
Asset - based/Trade Financing
Minimal Risk
Segment (A) Depositors (Risk - averse
Investors)ijarah, istisna’, mudarabah
Low–Medium Risk
Segment (B) Depositors (Low Risk
Takers)Partnership/Profi t and Loss Sharing
musharakah, mudarabah
Venture Capital
Private Equity
Medium - High Risk
Segment (C) Depositors (Investors with
Risk Appetite)Source: El - Hawary, Grais and Iqbal (2004)