386 AN INTRODUCTION TO ISLAMIC FINANCE
the system by delivering the best services at the lowest cost to the consumer.
However, the fi nancial crisis has exposed the need to strengthen the stability
of the system, which has led to a consensus on the need for more regulation.
The current situation offers both opportunities and challenges for the
Islamic fi nancial industry. Industry stakeholders can infl uence policy for-
mulation at early stages to ensure that the new regulatory environment is
more “friendly” to Islamic fi nance and addresses some of the key issues in
regulating IFIs. These issues include the treatment of IAHs as stakehold-
ers, enhancing transparency in fi nancial disclosure, and standardization.
This will require active participation in the debate and the formulation of
the new regulatory environment at local and international forums.
The real challenge will be the enforceability of new rules and stand-
ards. Currently, IFIs operate for the most part in dual - system set - ups, which
impose additional responsibilities on the regulators to maintain regulatory
and supervisory standards for both conventional and Islamic institutions.
This practice is both resource - intensive and expensive. With stricter stand-
ards, the challenge will be to ensure that Islamic fi nancial institutions receive
due attention and priority in this process. At present, regulatory and super-
visory standards, including compliance with Basel II, are being developed
for IFIs, though their enforceability is in question. Since the majority of
IFIs operate in developing economies, it requires extra effort to enforce the
standards irrespective of how good the standards may be.
Islamic fi nancial institutions are perceived to have higher exposure to
operational risk because of the lack of proper risk systems and trained staff.
In the new fi nancial environment, there will be more reliance on risk moni-
toring and management. New techniques for monitoring credit and liquidity
risk will be introduced and old techniques such as VaR will be refi ned to
refl ect better exposures. IFIs should start addressing this issue by updating
their risk systems. At the same time, regulatory bodies should ensure proper
training for their staff as well as for fi nancial institutions. Regulators and
supervisors should also develop a better understanding of certain practices
of the fi nancial institutions in assessing and monitoring risks.
Going Beyond Banking
The distinction between traditional commercial banking and investment
banking is becoming blurred, and there is a global trend to mix fi nancial
services with non - banking services. Although this trend is prevalent in major
industrial economies, it has not been embraced by many of the emerging mar-
kets where Islamic fi nance is practiced. For example, an IMF study in 2003
ranked several countries in the Middle East according to their level of fi nan-
cial development and found that countries throughout the region had a weak
institutional environment and a poorly developed non - bank fi nancial sector.^12
There has not been much progress since then. Islamic fi nance has been domi-
nated by commercial banking, and the amount of investment banking, insur-
ance, asset management, SME fi nancing, and microfi nance is very small.