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International Monetary Fund
This paper discusses the need for ensuring financial stability in countries with Islamic Banking (IB). IB continues to grow rapidly, in size and complexity, posing a challenge to supervisory authorities and central banks. The legal environment within which IBs operate can be complex and challenging and may have implications for financial stability. IBs operate in diverse legal environments, some of which are more evolved than others in providing strong legal underpinnings for IB. International governance standards apply to IB but need to be customized to consider IBs’ distinct governance features. Significant progress has been achieved in developing prudential standards for IB, although broader implementation and more consistent application are needed. Progress has been slow in developing IB’s liquidity management and money markets. In recent years, hybrid financial products in IB have emerged that replicate aspects of conventional finance in an IB context, raising financial stability concerns. The IMF has played an important role in promoting financial stability in IB jurisdictions, working closely with IB standard setters, and international organization to shape IB standards and promote best practices.
International Monetary Fund

principles of IF include: (i) emphasis on the minimization of disputes, deception, and unfair trade practices (Gharar); and (ii) market determination of prices. 8. The provision of banking services in line with Islamic jurisprudence results in operations and balance sheet structures that are distinct from conventional banks . IBs, like conventional banks, play a financial intermediary role, mobilizing deposits and channeling them to investors and undertaking maturity transformation. However, IB activities can extend beyond the traditional role of financial

Aledjandro Lopez Mejia, Suliman Aljabrin, Rachid Awad, Mr. Mohamed Norat, and Mr. In W Song
This paper aims at developing a better understanding of Islamic banking (IB) and providing policy recommendations to enhance the supervision of Islamic banks (IBs). It points out and discusses similarities and differences of IBs with conventional banks (CBs) and reviews whether the IBs are more stable than CBs. Given the risks faced by IBs, the paper concludes that they need a legal, corporate and regulatory framework as much as CB does. The paper also argues that it is important to ensure operational independence of the supervisory agency, which has to be supported by adequate resources, a sound legal framework, a well designed governance structure, and robust accountability practices.
Aledjandro Lopez Mejia, Suliman Aljabrin, Rachid Awad, Mr. Mohamed Norat, and Mr. In W Song

percent of the jurisdictions that allow IBs have tailored their conventional banking regulations for IB activities ( Song and Oosthuizen, 2014 ). There are several dimensions of the regulatory framework that need to take into account the special characteristics of IB. These dimensions are discussed below. Licensing Several elements of an appropriate licensing process are common to IBs and CBs, but certain modifications are needed to take into account the nature of IB. In particular, in countries where Shariah law constitutes (or is part) of the fundamental law of

Mr. In W Song and Carel Oosthuizen

protection. The windows could hinder the establishment of effective corporate governance and risk management systems. The management and board of a conventional bank may not be sufficiently attuned to the unique risks inherent in IB activities. As such, their ability to oversee the risk management of the IB window may be compromised. If fit and proper criteria for conventional and Islamic intermediation should exist in CBs’ operating windows, it is likely that many CBs will be unable to meet these criteria (for the Islamic banking part). Shariah boards might be unable to

Mr. In W Song and Carel Oosthuizen
The growing presence of Islamic banking needs to be accompanied by the development of effective regulation and supervision. This paper examines the results of the survey conducted by the International Monetary Fund to document international experiences and country practices related to legal and prudential frameworks governing Islamic banking activities. Although a number of countries have made considerable progress in creating legal, regulatory, and supervisory frameworks that accommodate Islamic banking, there are substantial differences. This paper also identifies a number of challenges faced by regulatory and supervisory agencies regarding Islamic banking.
International Monetary Fund. Middle East and Central Asia Dept.

that offer Islamic products through windows should also be required to provide proof of systems and procedures that separate IB activities from conventional ones. Fit and proper requirements for Shari’ah board members or advisors within IBs should include an appropriate level of knowledge of IF. For countries that allow IBs to invest in properties, the licensing tool should be applied to ensure that corporate structures are transparent and facilitate effective supervision. Jurisdictions continue to take different approaches to the application of capital adequacy

International Monetary Fund. Middle East and Central Asia Dept.
This paper presents country experiences with reforms to strengthen regulatory oversight of the Islamic banking sector. Based on the selected country experiences, a number of important lessons and policy options can be drawn that have implications for the stable and sound development of Islamic banking. An enabling regulatory and institutional framework and a level playing field for conventional and Islamic banks is critical for the sound and stable growth of the Islamic banking industry. The country experiences also underscore the importance of providing an enabling framework while letting market forces determine the size of the industry.
Mr. Jemma Dridi and Maher Hasan

affected their conventional competitors and triggered the global financial crisis. These include toxic assets 11 , derivatives, and conventional financial institution securities. Appendix I discusses IBs’ assets and liabilities in greater detail. C. What are the Implications for Risks, Regulations and Supervision? Like CB contracts, IB contracts involve credit and market risks, and IB activities create liquidity, operational, strategic, and other types of risks. Interest-rate-type risk is very limited, but hedging instruments are also largely unavailable

Mr. Jemma Dridi and Maher Hasan
This paper examines the performance of Islamic banks (IBs) and conventional banks (CBs) during the recent global crisis by looking at the impact of the crisis on profitability, credit and asset growth, and external ratings in a group of countries where the two types of banks have significant market share. Our analysis suggests that IBs have been affected differently than CBs. Factors related to IBs‘ business model helped limit the adverse impact on profitability in 2008, while weaknesses in risk management practices in some IBs led to a larger decline in profitability in 2009 compared to CBs. IBs‘ credit and asset growth performed better than did that of CBs in 2008-09, contributing to financial and economic stability. External rating agencies‘ re-assessment of IBs‘ risk was generally more favorable.