National and Global Islamic Financial Architecture:
Prolems and Possible Solutions for the OIC Member Countries
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3. Islamic Financial Architecture: Key Components and Framework
As discussed in Chapter 1, WB and IMF (2005:5) identify pillars of financial system
architecture that can promote the stability and development of the financial sector as being
macro-prudential surveillance and financial stability analysis, sound financial system
supervision and regulation, and financial system infrastructure. The latter includes legal
infrastructure for finance, systemic liquidity infrastructure and transparency, governance and
information infrastructure, payments and securities settlement systems, creditors’ rights, the
provision of incentives for strong risk management and good governance, credit reporting
systems, etc. All the elements of the financial architecture apply to the stability and
development of the Islamic financial sector.
Some of the elements of financial architecture are neutral and apply to both Islamic and
conventional finance. These include sound and sustainable macroeconomic policies, effective
market discipline, well-regulated payment and clearing systems, etc. However, there are
certain unique features in the Islamic financial sector that may not be covered by conventional
architectural institutions and require specific attention. The elements of the Islamic financial
architecture that need special attention can be divided into seven categories: legal, regulations
and supervision, Shariah supervision, liquidity, information and transparency, consumer
protection and human capital. Specific infrastructure issues that arise due to unique features
arising from Shariah compliance in each of these categories are discussed below.
3.1. Legal Infrastructure
WB and IMF (2005) identify three broad elements of the legal infrastructure for the financial
sector. Firstly are the laws that set the legal and regulatory framework for the industry. The
laws under this category include central banking laws, banking laws, tax laws and laws related
to safety nets. The second set is the commercial laws under which banks operate. The relevant
laws under these would be company law, including corporate governance law or regulations,
land laws, contract laws, consumer protection laws, and creditors’ rights and insolvency laws.
The final element is the judicial system that involves courts and rule of law related issues. A
well-functioning judicial system reduces legal risks and provides remedies to parties in case of
disputes and bankruptcies.
3.1.1. Supporting Islamic Finance Laws
Laws provide the framework for establishing appropriate institutions and markets in three key
financial sectors: banking, insurance and capital markets. The key laws necessary for each of
these financial sectors are not only those that enable the formation and operation of financial
institutions and markets but also those that enable the formation of a central bank to carry out
monetary policy and establish and give authority to certain public bodies to regulate and
supervise financial institutions and markets (WB and IMF 2005: 223). In many countries, the
central bank plays the regulatory and supervisory roles and the central banking law authorizes
it to perform these functions. The financial institutions' laws provide the legal basis to
establish specific financial institutions, define their scope of operations and governance, and
include issues related to the protection of different stakeholders. For example, the banking law
specifies the requirements to establish a bank and defines the banking activities that these
institutions can undertake. The law covers various operational issues such as governance