Regulation and Supervision of Islamic Banks

This paper seeks to develop a better understanding of Islamic banking (IB) and provides policy recommendations to enhance the supervision of Islamic banks. It points out and discusses similarities and differences of Islamic banks with conventional banks and reviews whether Islamic banks are more stable than conventional banks. The paper finds that given the risks faced by Islamic banks, they need a legal, corporate, and regulatory framework as much as conventional banks do. It also suggests 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. The paper recommends supervisors to:

• Continue adapting the CAMELS (Capital-Asset-Management-Earnings-Liquidity-Sensitivity) rating system to the risks associated with IBs, particularly regarding capital adequacy, asset quality, management, and liquidity;
• Employ stress testing techniques that take into consideration the risk specificities of IBs;
• Apply strict controls and enhance supervisory oversight in jurisdictions where Islamic windows operate to help reduce risks associated with Shariah compliance and provide adequate consumer protection;
• Help ensure adopting enhanced transparency and disclosure requirements;
• Strengthen supervisory capacity on issues related to Islamic banks and increase focus on cross-border and consolidated supervision.