Financial soundness indicators and the objectives of Shari’ah in assessing the stability of Islamic banks

Abstract EN

The financial crisis has motivated the impetus for authorities around the world to rethink about the effectiveness of existing prudential regulatory and supervisory frameworks.

In the absence of widely accepted core set of financial stability indicators, the development of financial soundness indicators proposed by the International Monetary Fund could be considered most reliable as a basis for analyzing the current health and stability of the financial system.

Despite its constructive role in identifying risk exposures and pointing to actions that mitigated the consequences of the recent global crisis, the existing financial stability indicators have limitations in the Islamic financial system context.

Financial stability indicators are viewed to be insufficient to be adopted in the system assessment, as they do not capture its unique contractual arrangements and risk features in meeting the noble objectives of Islamic law in Islamic economic transactions.

Taking the Islamic banking specificities into consideration, the similar effort undertaken by the Islamic Financial Services Board to construct the prudential and structural Islamic finance indicators complementing the financial stability indicators has only focused on financial or wealth soundness of Islamic bank.

The prudential and structural Islamic finance indicators leave the preservation of other social benefits indicated in the objectives of Islamic law unmeasured or only qualitatively assessed.

Therefore, this study attempts to review the existing financial stability indicators and assess their relevance for Islamic banks.

The assessment will be based on the theory behind their inherent stability, their unique risks which can contribute to their vulnerabilities as well as the objectives of Islamic banking stability from the objective of Islamic law perspective.

The study concludes by proposing that integration between financial stability indicators and the objectives of Islamic law in evaluating and measuring banking stability is necessary.

Accordingly, a different set of financial indicators that reflect the above proposal is demanded.

The study will fill the gap of similar strand of literature as it incorporates the introduction of a set of indicators that reflects the stability of Islamic banks and the fulfillment of the objectives of Islamic law which will become part of components in macro prudential surveillance and financial stability analysis.