Faith in Finance: Risk, Competition, and Religion in the Regulation of Islamic Finance

Abstract

The Islamic finance industry has grown over the last 30 years as a pious alternative to conventional finance, integrating religion and business. The incorporation of religion makes Islamic finance fundamentally different from Western systems, necessitating separate regulations. How do risk, competitiveness and religion influence the regulation of Islamic finance? Although religion does influence the integration of Sharia law in regulation, I argue that Islamic finance regulations are motivated by competitiveness and risk. Analyzing an original dataset, I found that 68% of states involved in Islamic finance passed regulations following an increase in sovereign risk, and 54% regulated following a decrease in sovereign competitiveness. Looking more closely at industry-leading states, the United Kingdom and the United Arab Emirates confirm the competition and risk dynamics. Malaysia over-regulates in an attempt to bolster a national Muslim identity, influenced by popular demand and trade. These patterns show that Islamic finance can expect global-level regulations in the future.