Islamic Finance and Economic Development: Risk, Regulation, and Corporate Governance

PART Three

Regulatory Challenges

The existence, nature, and extent of financial regulation have been long-debated issues. There are those who believe that there are no major differences between financial and commercial activity and, accordingly, the former need not face more regulation than the latter. Then there are those who believe that the nature of financial activity calls for specific regulation and supervision to ensure orderly operations. It is sometimes a debate between views on fostering market vibrancy and concerns for financial stability.¹

Whatever the debates, increased regulation and supervision and periodical financial crises have been the hallmark of financial system history. Within countries and across the world, financial regulation has spread, especially in the wake of financial crises. However, markets have continued to lead financial innovation, leaving regulators in a permanent catch-up phase. Over certain periods, too stringent regulation has stifled financial development and accordingly prevented societies from benefiting from the beneficial impact of regulation on economic development. On other occasions, unbridled financial activity has led countries and sometimes the international economy to crashes.

Increasing internationalization of finance, contagion, and spillovers across borders have led the international community to seek to monitor financial developments and harmonize financial regulations across countries. The Basel agreements on banking regulation ...