Specialized Insolvency Regimes for Islamic Banks: Regulatory Prerogative and Process Design

Author: Hdeel Abdelhady 

Original Publication: World Bank Legal Review, Volume 5


 

Abstract

As Islamic banks grow in size and number, they will require enabling legal and regulatory environments to facilitate sustainable growth. Such an environment must include resolution regimes for Islamic banks. Islamic banks are not yet large or interconnected enough to pose systemic risk, but Islamic banking is too young to withstand the reputational damage and regulatory confusion that would flow from the poorly managed failure or one or more Islamic banks. Regulators, standard-setting bodies, and others that have considered insolvency regimes for Islamic banks have framed the issues, with a focus on achieving convergence of Shari’ah– and civil law-based insolvency rules. This approach falls short. Shari’ah insolvency rules developed and applied in the context of singe debtors, bilateral relationships, or insolvencies involving relatively small groups are not, by themselves, sufficient to inform regimes for the resolution of Islamic banks. Rather, Shari’ah insolvency rules must be interpreted in accordance with, and further the objectives of, Islamic legal and historical views of market regulation, which require the empowerment of regulators to, inter alia, ensure lawful market conduct, impose market discipline, promote transparency, and protect consumers. Similarly, it is not sufficient to examine conventional insolvency regimes applicable to only banks, as Islamic banking entails banking and capital markets activities.

 

This article favors the adoption of specialized, administratively managed resolution regimes for Islamic banks that harmonize banking and capital markets insolvency frameworks while providing for expeditious resolution. The Orderly Liquidation model recently adopted in the United States is discussed as a model of reference because it combines bankruptcy provisions applicable to banking and capital markets participants and substitutes judicial administration with administratively managed resolution to ensure the speedy resolution of failed financial companies.