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Home > Regulation Best Practice > Identifying the Main Regulatory Challenges for Islamic Finance

Regulation Best Practice

Identifying the Main Regulatory Challenges for Islamic Finance

by Bilal Rasul

Table of contents

Shariah Expertise

The lack of shariah expertise is also one of the challenges that face the regulators of the Islamic financial industry. Due to the infancy of the system, very few institutions have produced the desired skill set for the Islamic financial and banking industry. While there are plenty of Islamic jurisprudence experts, there is a dearth of Islamic financial experts with a knowledge of the dynamics of conventional finance and its transformation to an Islamic/shariah-compliant system. Due to the regulatory obligation of instating shariah oversight, IFIs employ less-experienced shariah scholars, as only a limited number of professionals are available, and they are usually attached to more than one IFI concurrently.

The transition to Islamic finance is highly technical and complex. A balance has to be maintained in order to provide, on the one hand, an adequate return and to remain, on the other hand, within the boundaries of the Qur’an and Sunnah, which cannot be done without quality shariah supervision. In order to achieve this, regulators of the capital and money markets will have to encourage the development of educational institutions that offer programs and syllabi for Islamic financial technical skills. INCEIF (International Centre for Education in Islamic Finance) in Malaysia is an example that has designed an outstanding course—namely, CIFA (Chartered Islamic Financial Analyst), which prepares the student for a specialized course in Islamic finance.

Shariah-Compliant Securities

The limited number of shariah-compliant securities emanates from the lack of both harmony and Islamic financial prowess, and poses yet another problem in the development of the industry. Due to the paucity of available instruments in the market, investors are constrained to take their funds elsewhere. The limited choices also affect the liquidity of the securities as there is a limited market for them. The buying and selling of such securities is not as lively as in the conventional securities market, possibly due to their non-speculative nature. Nevertheless, investors are eager to place their funds in shariah-compliant securities, even for a comparatively lower return, provided that a reasonable degree of assurance can be given with regard to their nearness to shariah. The market for shariah-compliant securities, in terms of buyers and sellers, quite certainly exists, but it awaits the introduction and innovation of new Islamic instruments. Much of the apprehension that exists in the market with regard to shariah-compliant securities, or Islamic banking and finance for that matter, is owed to the slow pace of development of products and awareness-creating endeavors. In this context, the Liquidity Management Centre and the International Islamic Financial Market (IIFM) have a huge mandate and are vigorously involved in bridging the gaps in terms of investment of surplus funds of IFIs and creating Islamic financial markets.

“The combination of services offered by operating IFI and the prevailing practices compound the difficulties of designing a regulatory framework to govern them.”4

Case Study

The Case of Sukuk

Sukuk, the plural of suk meaning Islamic bond, are a case that particularly highlights the divergence in views of Islamic scholars. One of the most popular Islamic financial instruments, the sukuk have questions looming over them. The renowned shariah scholar Sheikh Muhammad Taqi Usmani believes that the guarantee to pay back the invested capital in sukuk undermines the tenets of the shariah by compromising on the risk and profit/loss sharing philosophy. Sheikh Usmani contends that the investment must be consequential to the investor where profits and losses both have to be anticipated. The views of Sheikh Usmani are difficult to oppose, but in giving impetus to the Islamic financial industry certain exemptions are in order, for which AAOIFI may well have the solution.5

Making It Happen

The solution to the harmonization problem is to design regulatory frameworks that are standard. Thus, all criteria relating to the formation of Islamic financial institutions, the induction of shariah experts, the risk management measures, and the various codes should conform with a standard document, such as an enabling Islamic financial services law, which prescribes common Islamic financial accounting standards, corporate governance practices, and prudential regulations for risk management for the industry, and which interfaces with the IFSB’s Ten-year Master Plan for Islamic Financial Services.

To bolster the Islamic securities market, companies listed on the stock exchanges (financial or manufacturing) should be encouraged to pursue shariah compliance. To achieve these objectives the role of the regulator(s) is emphasized.


A purely Islamic financial system would be ideal—one in which the niyah and trust are predominant so that a self-perpetuating regulatory system prevails. There would be minimal regulatory interference—only for transparency and disclosure. In such a system, issues of compliance diminish directly with the prevalence of a coherent and trustful financial environment in which profits and risks are authentically disclosed and equitably distributed.

While a conventional financial system cannot evolve into an Islamic one overnight, praiseworthy efforts are being made in terms of bringing the diverging interpretations to a common platform and attempting to accord them congruence. In this context, the contributions of AAOIFI and the IFSB, as conduits for bringing solutions to the problems of standardization and harmonization, and as cornerstones of change and adaptation, must not be undermined in any way. The IFSB’s Ten-year Master Plan for Islamic Financial Services is an excellent precursor to the type of regulatory environment that should prevail in jurisdictions offering Islamic finance.

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Further reading


  • Karim, Rifaat Ahmed Abdel, and Simon Archer. Islamic Finance: The Regulatory Challenge. Singapore: Wiley, 2007.
  • Mirakhor, Abbas. “General characteristics of an Islamic economic system.” In Baqir al-Al-Hasani, Bakir, and Abbas Mirakhor (eds), Essays on Iqtisad. Silver Spring, MD: NUR Corp., 1989, pp. 45–80.
  • Venardos, Angelo M. Islamic Banking and Finance in South-East Asia: Its Development and Future. 2nd ed. Singapore: World Scientific Publishing, 2006.


  • Akhtar, Shamshad. “Islamic finance: Its sustainability and challenges.” Journal of Islamic Banking and Finance 25:1 (2008).
  • Thomas, Abdulkader, and Sheikh Muhamed Becic. “Are sukuk Islamic?” Islamic Business and Finance 26 (January 2008). Online at:


  • Ainley, Michael, Ali Mashayekhi, Robert Hicks, Arshadur Rahman, and Ali Ravalia. “Islamic finance in the UK: Regulation and challenges.” Financial Services Authority, November 2007. Online at:
  • El-Hawary, Dahlia, Grais Wafik, and Zamir Iqbal. “Regulating Islamic financial institutions: The nature of the regulated.” World Bank Policy Research Working Paper 3227, March 2004.


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