Whether to Prohibit Islamic Windows

Aarij Wasti and Peter Hodgins explore the continued debate around regulatory frameworks for Islamic financial institutions, and discuss whether conventional financial institutions should be allowed to operate Islamic branches and windows.

Islamic finance has continued to expand globally, including in the GCC, over the last few years. The Institute of International Finance (IIF) estimated in its latest report that Islamic banking industry assets in the GCC reached US$314 billion by the end of 2011, representing about 19% of the total assets of GCC banks. The IIF also estimated that assets of Islamic banks globally amount to US$1.6 trillion.

The IIF expects the industry to grow at an annual rate of 15 to 20%, driven mainly by reforms in applicable regulatory framework, high oil prices and the increase in demand for Islamic products.

The IIF’s recent report noted that the region’s Islamic financial institutions will continue to attract new players and further boost the sector. The report underpinned the need for the Islamic banking industry to introduce regulatory reforms to further boost the banking sector.

However, there is a continuing debate around regulatory frameworks for Islamic financial institutions and their relationship to regulatory frameworks for conventional financial institutions, particularly with respect to allowing conventional financial institutions to operate Islamic branches and Islamic windows.

In terms of the regulatory approach to allowing Islamic windows of conventional finance institutions, certain jurisdictions allow this practice while others require Islamic institutions to operate on a standalone basis.

In February 2011, the Qatar Central Bank (QCB) for example announced that it would prohibit conventional banks from operating Islamic branches. Qatar’s approach is consistent with the approach being advocated in a number of other territories in the region. For example, in the UAE the Takaful regulations issued by the UAE Insurance Authority in 2010 prohibit windows and Bahrain likewise has a similar prohibition. The QCB is believed to have based this decision on both supervisory and monetary policy considerations.

In undertaking an assessment of the international regulatory coverage for conventional financial institutions that operate Islamic branches or Islamic windows, it is apparent that there are both advantages and disadvantages to these models.

In broad terms, these include:


  • Islamic finance windows are able to leverage off the experience and operational systems of conventional finance. There is potentially the broader advantage for windows of being able to leverage off internal training and expertise. A continuing theme at industry conferences is the lack of properly trained/skilled staff and the lack of diversity of products. It would appear that there is greater scope for product development/development of staff at larger international players than in what are often niche Islamic counterparts. Another additional advantage of retaining the current model is that the commingling of activities and services may provide an opportunity for regulators to study the provision of Islamic financial services side by side with the more familiar conventional system. This, in the long run, will allow global financial regulators to tailor well developed rules in relation to Islamic banking.
  • Liquidity support can be provided to the Islamic window by the conventional operations of the institution, particularly for banks.
  • Islamic windows provide competition to standalone Islamic institutions which can improve products and services and potentially lower costs.
  • Windows are a proven way of allowing conventional players to decide if they wish to establish an Islamic operation. For example, Swiss Re started its Islamic operations via a window in Malaysia in 2006 (we understand that the viability of this operation having been proven, it converted into a separate branch in 2009 and subsequently a separate company has now been established). The need to establish, license and capitalise a separate entity is a significant bar to entry for new players in the market. In the context of insurance, it is highly unlikely that a conventional insurer considering whether to enter a market would be prepared to establish both a conventional operation and a Takaful operation given the scale of most markets.

Using Takaful as an illustrative sector, Takaful operations currently generate significantly less return on equity than their conventional counterparts (according to the Ernst & Young World Takaful Report 2012) and therefore, in the absence of the economies of scale that a window operation can bring, there is a deterrent for new players if Islamic windows are not permitted to operate.

In addition, the risk that a Takaful operator cannot pay Qard Hasan in the event of deficit in the Takaful fund is, arguably, greater than for many conventional insurers with Islamic windows.

Finally, the size of most individual markets makes it unlikely that many players will be prepared to set up a Takaful operation to compete with conventional insurers. The opportunity is simply too limited (in our experience there are very few places in the region that international insurers consider to have sufficient market opportunity to warrant the expense of a standalone Takaful operation).


  • The overlapping nature of non-Islamic and Islamic activities of conventional financial institutions and the commingling of their activities and services make it difficult for regulators to properly supervise the risks encountered by these institutions.
  • Difficulties in applying the same oversight instruments and prudential ratios to institutions exposed to both Islamic and conventional operations whose risks are integrated in a single financial risk position.
  • The nature of non-Islamic and Islamic activities of conventional finance institutions makes it difficult and complex for them to prepare integrated financial reports given that each type of business is subject to separate international reporting standards.
  • Differences between the legal frameworks governing Islamic finance and conventional finance would create uncertainties regarding the orderly resolution of conventional banks that operate an Islamic window.
  • The capital adequacy requirements under the Islamic Financial Services Board differ from the Basel capital adequacy standards for banks and thus make it difficult to combine these two approaches.

There are also issues with regard to potential conflicts of interests that arise in window operations. However, such issues can usually be addressed through the establishment of clear policies and procedures.

Notwithstanding the above advantages and disadvantages, we can see the rationale and basis for disallowing Islamic windows, particularly given the international policy position on reducing regulatory arbitrage within a state.

In general, the decision on whether to permit Islamic windows requires the delicate balance of state policy with Shariah principles — in the context of the fast evolving world of financial regulation.
As stated above, Islamic finance is continuing to expand. This in itself is one significant reason to allow conventional firms to operate Islamic finance windows — to allow the sector to grow.

Allowing Islamic finance to become more mainstream and developed before its segregation would give Islamic finance providers the benefit of developing a considered and developed niche, drawing experience from the more established conventional system.

Premature segregation may stall development of the Islamic finance sector, to the detriment of not just the sector but the financial consumers who in greater numbers are demanding Shariah compliant services.



Aarij Wasti is a senior associate and Peter Hodgins is a partner at Clyde & Co.

This article first appeared in Islamic Finance News (19 December 2012, Volume 9, Issue 20, Page 20 - 21). For more information, please visit