Abstract
The role of regulation extends beyond ensuring stability and confidence in the financial system, as it is also a behavioral shaper of market players. The laws, standards, and guidelines issued are instrumental in creating an incentive structure for market players to behave in certain ways. Using incentive audit approach, this paper attempts to examine the efficacy of the evolving Malaysian regulatory and supervisory framework for Islamic banking, in preserving financial stability as well as supporting the growth of the financial system and real economy. The findings suggest that the present framework unintentionally misaligns incentives and discourages Islamic banks from fully embracing risk sharing as the underlying principle for their financial instruments. The findings of this paper call for reconfiguration of the regulatory/supervisory framework to better promote risk sharing.
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Notes
- 1.
Risk transfer is defined as the shifting of risk from one party to another. Examples include the use of credit enhancements such as Wa’ad, collateral, and guarantees as conditional requirements imposed on counterparties as part of the financial contracts. The main objective of these credit enhancements is to effectively shift the risks of one party to the counterparty with or without the knowledge of the latter. The rationale for the origination of credit enhancements is believed to have been motivated by the need to achieve the same effect of conventional products.
- 2.
Risk sharing is permissible and highly encouraged in Islam. Unlike risk transfer, risk sharing requires the contracting parties to mutually share the risk and the reward of a contract and that all parties do not violate the Islamic property rights principles. Property rights would be violated when the claim on a property is attained without commensurate work such as in the case of dishonesty, theft, bribery, interest, and gambling.
- 3.
Mirakhor 2012, Shari’ah Compliant Macroeconomic Policy, 2nd ISRA Colloquium
- 4.
The assessment on Malaysia was conducted in April 2012 and the report was published in 2013. It provides a credible assessment as it is benchmarked against the Basel Core Principles for Effective Supervision (BCP). The assessment was considered rigorous as it was based on several sources: (1) self-assessment prepared by BNM; (2) interview with BNM staff; (3) review of laws, regulations, and other documentation on the supervisory framework and the structure and development of Malaysia’s financial industry; and (4) meeting with individual banks, the banking association, and an external auditor.
- 5.
Alternative dispute resolution mechanisms in Malaysia are the Kuala Lumpur Regional Centre of Arbitration (KLRCA) governed by the Arbitration Act 1952, Financial Mediation Bureau (FMB) whose decisions are binding on the financial institution but not on the customer, Corporate Debt Restructuring Committee (CDRC) providing negotiation platform for corporate borrowers and creditors, and Credit Counsel and Debt Management Agency providing consultancy to private individuals on personal debt management.
- 6.
Banks as public interest entities are subject to financial reporting standards set by the Malaysia Accounting Standards Board (MASB). Its standards comply with the IFRS both in content and implementation schedules. The accounts of the banks are required to be audited annually by approved auditors for which the reports and procedures are governed by the National Auditing Standards which comply with the International Standards on Auditing.
- 7.
Payment systems in Malaysia include a real-time gross settlement system for interbank fund transfer known as RENTAS, a security settlement system and a scriptless security depository for all unlisted debt instruments.
- 8.
These include powers to reduce systemic risks that emanate from regulated or nonregulated entities, as well as to address institutional or market liquidity shocks.
- 9.
IFSB-5 Guidance on key elements in the supervisory review process of institutions offering Islamic financial services (IIFS) [excluding Islamic insurance (Takaful) institutions and Islamic mutual funds]. It was superseded by IFSB-16 since March 2014 taking into account enhancements on Pillar 2 of Basel II by BCBS.
- 10.
The key elements of IFSB-5 are necessary conditions for effective supervision, regulatory capital requirements, risk management and corporate governance, related party transactions, transparency, and market discipline as well as consolidated and home-host supervision.
- 11.
- 12.
INCEIF, CIFP module on Islamic finance regulation and governance: intervention by the regulatory authority p. 322.
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Lajis, S.M., Bacha, O.I., Mirakhor, A. (2016). Regulatory Framework for Islamic Finance: Malaysia’s Initiative. In: Zulkhibri, M., Ismail, A., Hidayat, S. (eds) Macroprudential Regulation and Policy for the Islamic Financial Industry. Springer, Cham. https://doi.org/10.1007/978-3-319-30445-8_11
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