168 Regulatory Issues
those assets for regulatory capital purposes and therefore the amount of free
liquid capital that must be held by the institution in respect of them (eg, the
principal credit risk that IFIs are exposed to in respect ofmudarabaoffered
to customers is the risk of impairment of capital invested in respect of the
IFI’s share of the capital invested in the event that those investments do not
lead to the return of capital envisaged).
In addition, in respect of the supervisory review under Pillar 2, the fact
that IFIs and conventional financial institutions offeringIslamic products
and services may, respectively, be subject to different and additional risks
in respect of their businesses means that theirminimum capital require-
ments calculated under Pillar 1 may be subject toadjustmentdepending
upon the risks associated with the relevant business lines. The fact that the
Pillar 2 supervisory process may be of particular relevance to IFIs has been
expressly acknowledged by the FSA, which stated that:“[if], in practice, certain risks affected Islamic institutions more
than conventional firms, the FSA would expect these to be
identified and quantified under Pillar 2...where this is no possible
or capital is not an appropriate mitigating tool, then other ways
of managing these risks would need to be identified.”Future developments
Historically, the prudential and governance arrangements of IFIs have been
governed by best practice guidelines (including, in particular, those
published by AAOIFI and the IFSB). As the amount of formal regulation of
Islamic financial businesses grows, it is likely that the legal and regulatory
challenges in carrying on Islamic financial business will give rise to new
challenges for both bankers,lawyers and others operating in the industry.