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CHAPTER 3: ISLAMIC FINANCIAL INFRASTRUCTURE
Globalization in the financial landscape is impacting the Islamic financial industry in a manner
similar to its conventional finance counterpart; Islamic financial institutions and Islamic
capital markets are becoming more and more interconnected across different jurisdictions.
Islamic funds in one country making investments in other countries are becoming
commonplace. Under such a dynamic financial landscape, coherence among the cross-country
financial architectures and infrastructures has evolved as a pivotal issue for the future growth
of the Islamic financial industry in general. Besides, the 2007 global financial crisis also
emphasizes the need for cross-country cooperation among the regulators and prudential
authorities.
As Islamic finance co-exists with conventional finance in most country jurisdictions, the
industry is subject to both the prevailing financial architecture and infrastructure for
conventional finance and the legal framework of Shariah laws.
Following the 2007 global financial crisis, the FSB has initiated regulatory reforms on the over-
the-counter (OTC) derivatives market in 2010, resolution regimes in 2011, and deposit
insurance systems in 2012 that are also relevant to the Islamic finance industry. Although OTC
derivatives are an underdeveloped and underutilized instrument amongst IIFS, there is a
potential for the IIFS to utilize OTC derivatives to hedge their risk exposure. The ISDA/ IIFM
Tahawwut (Hedging) Master Agreement establishes the legal framework for the use of OTC
derivatives in the Islamic market.
The sudden collapse of Lehman Brothers and the following financial crisis have increased the
pressure to regulate large banks known to be systemically important financial institutions
(SIFIs). As the Islamic financial institutions generally do not meet the standards to be classified
as a SIFI, such regulations do not apply to the IFSI.
Basel III is a capital and liquidity framework created in 2012 to improve the quality and
quantity of capital by converting debt to equity-based capital and introducing new leverage
ratios. Although the new standard for the liquidity coverage ratio will not impact IIFS greatly,
as Shariah already limits the debt-to-equity ratio to not exceed 33%, the new
recommendations on liquidity may have varying effects on the IFSI. The new standards may
force Islamic banks to diversify their products, develop products with longer-term features,
and better align assets and liabilities in Islamic banks, all of which would affect the industry
positively.
The International Association of Insurance Supervisors (IAIS) provides a platform for
insurance supervisors to exchange ideas and information; it has revised the Insurance Core
Principles, Standards, Guidance and Assessment Methodology (ICP) in October 2011 to improve
the global insurance supervision. The IFSB included some of the revised standards, especially
in regards to corporate governance, in its own recommendations in ED-14: Standard on Risk
Management for Takaful (Islamic Insurance) Undertakings.