This paper aims at developing a better understanding of Islamic banking (IB) and provide policy recommendations to enhance the supervision of Islamic banks (IBs). It points out and discusses similarities and differences of IBs with conventional banks (CBs) and reviews whether the IBs are more stable than CBs. Given the risks faced by IBs, the paper concludes that they need a legal, corporate and regulatory framework as much as CB does. The paper also argues that it is important to ensure operational independence of the supervisory agency, which has to be supported by adequate resources, a sound legal framework, a well designed governance structure, and robust accountability practices.

Islamic banking (IB) has grown rapidly across several regions and is systemically important in key economies (Figure 1). 2 Indeed, the IB sector has expanded by over 15 percent per annum during the last five years and its assets are estimated to exceed US$1.5 trillion. Moreover, while IB is particularly large in many Muslim countries (and systemic in many countries including Iran, Sudan, Saudi Arabia, Kuwait, and Qatar), there is an increasing interest in Islamic finance in non-Muslim countries. Despite this expansion, IB remains unchartered territory for many practitioners and policy makers. That said, there is already significant literature that discusses key characteristics of IB and their implications for regulation and supervision. Based on a brief review of this literature, this note aims at developing a better understanding of IB and providing policy recommendations to enhance further the supervision and regulation of Islamic banks (IBs). The note is divided into six sections. Section II reviews the key characteristics of IB banking. Section III discusses whether IBs are more stable than conventional banks (CBs). Section IV discusses the legal, corporate and regulatory frameworks of IBs; whereas section V reviews supervisory issues. Section VI concludes.