Incentive Based Regulation for Islamic Banks

Recent calls by prominent Islamic scholars to shift the focus of Islamic Finance away from bond-like sukuk have been met with great unease by bankers in the industry. Islamic Financial Institutions (IFIs), which hold the majority of all sukuk issued, face deposit side constraints on the types of returns they distribute, due to a need to match returns to market based deposit interest rates. Hence, it is in their interest to hold assets that provide stable benchmark based returns. The purpose of this paper is to provide an outline of an original incentive based regulatory mechanism to encourage Islamic banks to reconcile their intended normative structure (profit and loss sharing) with the operational and pragmatic realities within which Islamic banks exist