A strategic design of Islamic banking regulations

A set of prudential regulations are essential for the sound operation of the Islamic banking system. Such regulations should not just protect and promote fundamentals of Islamic banking. They should also bridge the gap between the Islamic and the conventional banking systems. The two systems have a lot in common. This makes it easier to apply some principles of conventional banking supervision to Islamic banks. While devising the regulatory framework for Islamic banks, regulators must also recognize the difference between the theory and practice of Islamic banking. This paper proposes two objectives for prudential regulations for Islamic banks. Firstly, the regulations should accommodate the issue of practicality. This is so that the soundness of Islamic banking operations, which have moved away from their true form, can be promoted. Secondly, the regulations should provide the right incentives so that Islamic banking in its true form can be embraced by the players in the future.