Regulation of Islamic Financial Institutions 313
exposure to displacement or withdrawal risks. Diversifi cation on the asset
side can reduce the variance in the returns that accrue to the claimhold-
ers of the fi nancial intermediary. The geographical spread of products
can further help an IFI mitigate its credit risk by selecting borrowers
of the best credit quality and avoiding those with weak credit quality.
Further diversifi cation benefi ts can come from economies of scope by
extending the line of products and services.■ (^) Investment in Risk Management Infrastructure: Establishing risk -
assessment and measurement systems often becomes an expensive
proposition, as it requires sophisticated models, software and technolo-
gies, and skilled human resources who can understand the nature of
the risks and prepare models accordingly. Measurement and control
of the operational risk are still evolving. Given the small average size of
Islamic fi nancial institutions, establishing such a framework at the
organization level may not be possible. IFIs and supervisory authori-
ties should work together to fi nd a reasonable solution to this problem.
REGULATION OF IFIS: LOOKING FORWARD
The legal and regulatory practice governing IFIs varies across countries (as
illustrated in Table 14.4). Indonesia, Iran, Lebanon, Malaysia, Pakistan, Sudan,
Turkey, the UAE, and Yemen have enacted Islamic banking laws. However,
these laws may not always take full account of the unique characteristics of
Islamic banking. For example, the Malaysian Islamic Banking Act (1993)
refers to banking as a “lending business” and investment accounts are consid-
ered to be liabilities. In Iran, IFIs accept customer investments on the basis of
the wikala agency contract,^4 not the mudarabah contract as is the case in other
countries. In Saudi Arabia and Egypt, no laws have been enacted to regulate
IFIs, which operate under the same laws governing conventional banks.
TABLE 14.4 Diversity in legal, regulatory and supervisory arrangements
Country
Banking
System
AAOIFI
Standards
Islamic Banking
Law
Existence
of Shari’ah
Boards Supervision
Iran Islamic No Yes No No
Jordan Dual IAS Yes Yes Consolidated
Kuwait Dual IAS Considered Yes Consolidated
Sudan Islamic Yes Yes Yes –
Yemen Dual No Yes Yes No
Malaysia Dual IAS Yes Yes Consolidated
Source: Compiled from Zaher and Hassan (2001), Chapra and Khan (2000),
El - Hawary, Grais and Iqbal (2004)