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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.
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

that IBs are managed in a sound and safe manner . Many basic elements of a conventional licensing process are fully applicable also in an IB framework, although modifications are needed to take into account certain specific features of IB ( Box 8 ). Box 8. Modifications to Licensing Requirements Business Plan . The plan should include, inter alia, details on the IB’s strategy to attain and maintain profitability, including the funding plan and the management of the PSIA. Capital Requirements . Minimum levels (both in absolute and as a proportion of risk

Aledjandro Lopez Mejia, Suliman Aljabrin, Rachid Awad, Mr. Mohamed Norat, and Mr. In W Song

CB. Few countries have comprehensively addressed these issues ( Song and Oosthuizen, 2014 ). V. The Supervision of Islamic Banking in Practice 20 As is the case in conventional banking, prudential supervision in an IB framework is key to ensure safety and soundness of individual IBs and help reduce risks to the stability of the financial system. The conduct of banking supervision needs to be undertaken in a manner that addresses the special characteristics of Islamic banks. Thus, supervisors need to understand the challenges inherent in IB and the