372 AN INTRODUCTION TO ISLAMIC FINANCE
infrastructure leads to the development of fi nancial markets and fi nancial
stability. The development of a robust fi nancial sector is essential for any
country, but the rapid growth of institutions offering Shari’ah - compliant
fi nancial products and services is posing challenges to the policymakers to
develop a fi nancial system supportive of such institutions. Other factors that
will infl uence the design of such a system include continuing globalization, a
growing emphasis on market discipline based on a regulatory environment,
a shift towards a risk - focused supervisory approach, and increased com-
petition from conventional fi nancial institutions. The unique risk/reward
characteristics of Islamic fi nancial intermediation must also be incorporated
into the design of fi nancial architecture to promote a sound regulatory envi-
ronment and to develop seamless integrations with the broader fi nancial
landscape.
The infrastructure of the fi nancial system can be classifi ed into three
categories:
■ (^) Systemic liquidity infrastructure, which covers institutional arrange-
ments for money and government securities markets, settlement sys-
tems, monetary and foreign exchange operations, and liquidity risk
management
■ (^) Information and governance infrastructure, which includes accounting
and disclosure standards and corporate governance arrangements for
fi nancial institutions
■ (^) Insolvency regime and safety - net infrastructure, which includes lender -
of - last - resort arrangements, deposit insurance, and the legal framework
governing bank insolvency, loan recovery, and creditors’ rights.^3
Financial architecture refers to the legal and institutional arrangements
for a sound and well - functioning fi nancial services industry. Financial
infrastructure is a subset of the architecture and is often referred to as the
underlying foundation to facilitate the preconditions for the functioning of
the industry and the effectiveness of supervision and regulation of different
segments.
At the national level, fi nancial architecture includes legal and institu-
tional arrangements for the regulation and supervision of the Islamic fi nan-
cial services industry. A robust legal infrastructure to defi ne and enforce
contracts, insolvency, and fi nancial safety nets is essential. It should also
include a framework for macro prudential surveillance, arrangements for
effi cient systemic liquidity, and a transparent and information - rich gov-
ernance infrastructure.^4 At the international level, fi nancial architecture
improves coordination among various national policies and promotes
fi nancial and technical cooperation. This includes institutions such as the
International Monetary Fund, the World Bank, the Bank for International
Settlements, regional development banks such as the Asian Development
Bank and Islamic Development Bank, international standards - setting insti-
tutions such as International Accounting Standards, and international