GRM 2010 GRM 2011

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In recent years following the financial crisis 2008/09, efforts to strengthen the financial system have been focused on the development of macroprudential orientation of regulatory and supervisory framework. Macroprudential policy seeks to maintain financial stability by explicitly accounting for the ‘externalities’ arising from the behaviour of individual institutions as well as the structure of the financial system. Moreover, macroprudential approaches to regulation considers the systemic implications of the collective behaviour of financial firms. Such approach and policy can be used both to limit the ex-ante externalities that lead to an excessive build-up of systemic risk, and the ex-post externalities that can generate inefficient failures of otherwise sound institutions specifically in a crisis.

Efforts to strengthen the financial system have been focused on the development of macroprudential orientation of regulatory and supervisory framework for financial stability. Macroprudential policy is increasingly seen as a way of dealing with the different dimensions of systemic risk. Macroprudential approaches are widely adopted by many central banks and regulators for supervision and regulation in order to maintain financial stability and, ultimately, improve social welfare by aligning private incentives with social objectives. The literature on financial stability has made a distinction between micro and macroprudential perspectives on financial institutions. Borio (2003) argues that the macro and microprudential perspectives change towards their objectives and their understandings about the nature of risk.

Macroprudential measures are defined as regulatory policies that aim to reduce systemic risks, ensure stability of the financial system as a whole against domestic and external shocks, and ensure that it continues to function effectively (BIS, 2010). The main purpose of the macroprudential regulation focuses on the financial system overall welfare, while the traditional microprudential regulation is focuses on increasing the security and stability of the individual financial institutions. However, research to address the issue of financial stability and macroprudential is limited particularly pertaining to Islamic financial institutions. Without deeper understanding on these issues, understanding and analysis are insufficient that can creates the condition for ill-informed policy decisions. The research is intended to fill the gap in the academic literature and policy implementation concerning macroprudential policy in a dual banking system. The research provides a deeper understanding of the issues with respect to the specific macroprudential policy and regulation as well as tools that could be employed to mitigate systemic risks for both conventional and Islamic financial institutions.

This paper synthesizes the growing literature on macroprudential policy in particular countries with a dual banking system namely Malaysia, Indonesia, and GCC. In a dual banking system, both conventional and Islamic financial institutions operate side-by-side, but specific laws and regulations have been introduced for the Islamic financial institutions. Based on the analysis there is no “one size fits all”; different models might be effective depending on the country specifics. The choice among the different macroprudential models is mostly influenced by traditions, current institutional frameworks for other policies and political economy considerations. Furthermore, none of these countries differentiates between conventional and Islamic financial institutions in practice when implementing macroprudential policy and measures. The main reason is to avoid regulatory arbitrage between these two financial institutions. In addition, Islamic bank is still small in scale relative to conventional bank and not significantly different from conventional bank, which largely composed of mark-up-based or debt-based instruments in its operation.