Islamic Finance Regulatory Standards: The AAOIFI and IFSB Frameworks Explained — TGB Regulatory & Policy Brief May 2025

Two standard-setters, two mandates

The IFSB was officially inaugurated on 3 November 2002 and began operations on 10 March 2003. It issues global prudential standards and guiding principles for an industry it defines broadly to include banking, capital markets and insurance, and it is housed in Bank Negara Malaysia's Sasana Kijang building in Kuala Lumpur. As of August 2023 it had 188 members from 58 jurisdictions, made up of 81 regulatory and supervisory authorities, 10 international organisations and 97 market players. By its own count it had issued a total of 42 standards, guidance notes and technical notes. Its audience is the supervisor: an IFSB standard tells a central bank or securities regulator how to adapt capital, liquidity, governance and disclosure rules to Shari'ah-compliant balance sheets.

AAOIFI has a different audience. Its head office is in the Kingdom of Bahrain, where its Accounting Board met in April 2025. Its standards come from separate technical boards: the Shari'ah Board approves Shari'ah standards, such as the draft standard on sukuk, the Accounting Board approves financial accounting standards, and the Governance and Ethics Board issues governance standards, including those on Shari'ah governance. Each board consults the industry before a standard is final: the draft sukuk standard was put out for public comment, and the Accounting Board considered public consultation comments before approving its December 2023 standards. AAOIFI's standards speak mainly to the institution and its Shari'ah board: what a contract must contain to be valid, how it is booked and how it is governed.

The two bodies are complements rather than rivals, and their texts cross-refer. The IFSB's revised capital standard, for example, requires repurchase transactions to comply with AAOIFI Shari'ah standard no. 58. The two signed a memorandum of understanding to jointly undertake technical work on the development and revision of prudential, Shari'ah, accounting and governance standards.

The industry they cover is large and concentrated. Global Islamic financial services assets grew by 4% to USD3.38 trillion in 2023, according to the IFSB. Islamic banking made up 70.21% of that total, sukuk outstanding and Islamic funds 29.08% and Islamic insurance 0.71%. Islamic banking assets alone grew by 7.21% to USD2.37 trillion by Q4 2023. The Gulf Cooperation Council held over 52.50% of global Islamic finance assets, followed by East Asia and the Pacific at 21.80%, the Middle East and North Africa excluding the GCC at 12.70%, Europe and Central Asia at 8.30%, South Asia at 3.10% and Sub-Saharan Africa at 0.70%. The concentration in the Gulf explains why the regulatory choices of a handful of GCC central banks shape how both frameworks are applied in practice.

The IFSB prudential architecture

Capital: IFSB-23 and the treatment of investment accounts

The core of the IFSB framework for banks is IFSB-23, the revised capital adequacy standard issued in December 2021, which the IFSB recommends supervisors implement from 1 January 2023. Its stated objective is to align IFSB standards with global capital standards, following the Basel III final package that the Basel Committee issued in December 2017. It updates IFSB-15, which was issued in December 2013.

On the headline ratios IFSB-23 follows the global framework it was designed to align with. Common equity tier 1 (CET1) capital must be at least 4.5% of risk-weighted assets, Tier 1 capital at least 6% and total capital at least 8%. A capital conservation buffer of 2.5% applies on top of the minimum, so an Islamic bank needs at least 7% CET1 to meet both. Supervisors can set a countercyclical buffer in a range of 0–2.5% of risk-weighted assets, and the leverage ratio is set at 3%.

IFSB-23 minimum capital requirements and buffers

Source: Islamic Financial Services Board (IFSB), IFSB-23: Revised Capital Adequacy Standard for Institutions Offering Islamic Financial Services [Banking Segment], 31 December 2021.

The distinctive part of the standard is not the ratios but the denominator. Under the standard formula, where a bank does not smooth profit payouts to investment account holders, risk-weighted assets funded by profit-sharing investment accounts (PSIA) are excluded from the capital ratio for credit and market risk, leaving only operational risk. Under the supervisory discretion formula, used where banks smooth returns to unrestricted account holders and so carry displaced commercial risk, a proportion of those assets, denoted alpha, is added back, with alpha set at the national supervisor's discretion. The choice of alpha can move a reported capital ratio materially without any change in the underlying balance sheet, which is why cross-border comparison of Islamic banks' capital ratios requires care. IFSB-23 also takes a firm line on leverage. It describes reverse commodity murabahah-based deposits as a form of leverage which, together with commodity murabahah term financing, has the potential to create unlimited debt in the system, and it considers it prudent for supervisors to apply the leverage ratio to Islamic banks.

Liquidity and the core principles

Liquidity: the shortage of Shari'ah-compliant HQLA

Liquidity is where the framework meets the limits of the market. The IFSB's technical note TN-5 of August 2023 notes that Islamic banks cannot hold interest-bearing deposits with other institutions or interest-bearing high-quality liquid assets (HQLA), and cannot borrow through the conventional interbank market. In many jurisdictions they cannot find enough Shari'ah-compliant HQLA for their liquidity buffers. An IFSB survey in 2013 found that most Islamic banks could meet minimum liquidity coverage requirements, but that their HQLA consisted mainly of coins, banknotes and central bank reserves. A decade later, the IFSB's stability report makes a similar point: Islamic liquidity management instruments remain scarce, and Islamic banks often rely heavily on cash as part of their HQLA to meet regulatory requirements.

Core principles and the IMF and World Bank

The IFSB's Core Principles for Islamic Finance Regulation (CPIFR) largely follow the order of the Basel Core Principles, with five additional principles specific to Islamic banking. Nine Basel principles are retained unamended and nineteen are amended at the level of assessment criteria. The five additions cover the treatment of PSIA and investment account holders (CPIFR 14), the Shari'ah governance framework (CPIFR 16), equity investment risk (CPIFR 24), rate-of-return risk (CPIFR 26) and Islamic windows (CPIFR 32). The IMF Board discussed and endorsed the CPIFR on 9 May 2018, and the World Bank proposed applying it in fully Islamic systems and, alongside the Basel principles, in dual systems where Islamic banking is significant, using the IFSB threshold of 15% of domestic banking assets. This gives the IFSB's principles a formal route into IMF and World Bank financial sector assessments.

AAOIFI: Shari'ah, accounting and governance standards

AAOIFI's influence runs through three channels: Shari'ah standards that define permissible contracts, financial accounting standards (FAS) that define how they are reported, and governance standards for Shari'ah boards. The accounting work has been especially active in recent years.

A rebuilt accounting framework

AAOIFI's Accounting Board deferred the effective date of the revised FAS 1, its general presentation and disclosure standard, from 1 January 2023 to 1 January 2024 after institutions reported practical difficulties, including the lack of illustrative financial statements and the changes needed to accounting and IT systems. The takaful standards FAS 42 and FAS 43, issued in 2022, became effective for periods beginning on or after 1 January 2025.

The most consequential change for banks is the overhaul of investment account reporting. At its 36th meeting on 25-26 December 2023 the Accounting Board approved FAS 44, 45, 46 and 47, completing its revision of FAS 27 on investment accounts and FAS 21 on transfers of assets. FAS 45 sets the principles for reporting instruments classified as quasi-equity, such as investment accounts, and FAS 46 covers off-balance-sheet assets under management; together they supersede FAS 27. Both take effect for periods beginning on or after 1 January 2026, and FAS 46 must be adopted at the same time as FAS 45. In December 2024 AAOIFI added FAS 48 on promotional gifts and prizes, FAS 49 on hyperinflationary economies and FAS 50 on Islamic investment institutions, including investment funds, which replaces FAS 14.

Governance standards for Shari'ah boards

In December 2024 AAOIFI's Governance and Ethics Board issued five governance standards on Shari'ah governance: a revised GS 1 on the Shari'ah governance framework, GS 19, GS 20 and GS 21 on the appointment, functions and reporting of Shari'ah supervisory boards, and GS 22 on Islamic finance subsidiaries and associates. It also issued GS 18 on the Shari'ah decision-making process, to be read with Shari'ah Standard 29.

Recent AAOIFI financial accounting standards and effective dates

Source: Al Baraka Islamic Bank B.S.C. (c), Interim condensed consolidated financial statements, 31 March 2025 (reviewed), 13 May 2025.

The work continued into 2025. At its 42nd meeting on 22-23 April 2025 the Accounting Board approved FAS 51 on participatory ventures in principle. It also resolved in principle to withdraw FAS 26 on investment in real estate, on the premise that generally accepted accounting principles adequately cover property investments, and agreed that further industry consultation was needed on its discussion paper on tawarruq and commodity murabaha. The planned withdrawal of FAS 26 is a sign that AAOIFI is willing to defer to general accounting standards where it sees no Shari'ah-specific need, which narrows the practical gap with IFRS.

Where Islamic banking is systemic

The pattern of adoption is best read against where Islamic banking is systemic. The IFSB treats Islamic finance as systemically important where Islamic banking assets exceed 15% of domestic banking assets, and the number of such jurisdictions has been constant at 15 since 2020. Those 15 jurisdictions account for around 92.14% of global Islamic banking assets. In two of them, Iran and Sudan, the banking system is entirely Islamic, and in Saudi Arabia, Brunei and Kuwait Islamic banks hold more than half of banking assets. These are the systems where the World Bank's approach would apply the CPIFR, and where the choice between AAOIFI, IFSB and national standards matters most for financial stability.

How jurisdictions apply the frameworks

Gulf: three different models

Bahrain, AAOIFI's home, applies its accounting standards directly: Central Bank of Bahrain rules require the adoption of all FAS issued by AAOIFI, with IFRS used for matters FAS does not cover. The United Arab Emirates took the Shari'ah route instead. Under a resolution of the Higher Shari'ah Authority at the Central Bank of the UAE, notified on 4 July 2018, AAOIFI Shari'ah standards became binding on the internal Shari'ah supervision committees of Islamic financial institutions from 1 September 2018, as minimum requirements. The requirement covers existing AAOIFI Shari'ah standards and those AAOIFI will amend or issue in future. Qatar follows a third model: IFRS is mandatory for all banks, conventional or Islamic, while the Qatar Central Bank describes the work of the IFSB and AAOIFI as an essential component of its prudential framework for Islamic finance. Qatar also does not allow conventional banks to operate Islamic windows.

Asia: national Shari'ah authorities and IFRS-based reporting

Malaysia shows that a large Islamic banking market can run on national rather than AAOIFI standards: Islamic banks held 32.14% of Malaysian banking assets in Q4 2023. Islamic financial institutions there must prepare accounts under the Malaysian Financial Reporting Standards, fully converged with IFRS from 1 January 2012, and must follow rulings of Bank Negara Malaysia's Shariah Advisory Council on the applicability of their accounting principles. Bank Negara Malaysia's Shariah governance policy document, issued on 20 September 2019 and effective from 1 April 2020, defines Shariah non-compliance risk by reference to Shariah Advisory Council rulings, the Bank's own Shariah standards and the decisions of each institution's Shariah committee. Indonesia also uses national standards, with Sharia accounting standards issued by its own Shariah accounting standards board. Pakistan sits between the models: Islamic banks there follow two national Islamic financial accounting standards, IFAS-1 on murabaha and IFAS-2 on ijarah, and the State Bank of Pakistan issued a Shariah governance framework in 2015, revised in 2018. Islamic banking held a 20.2% share of Pakistan's banking assets at 31 December 2022, and the State Bank's 2021-25 strategic plan targets a 30% share of both assets and deposits by 2025. A sector growing towards that target will make the choice of accounting and Shari'ah standards more consequential for the system as a whole.

Africa: direct adoption in smaller markets

In Nigeria the central bank and monetary agencies require non-interest banks to comply with AAOIFI's financial accounting standards. Sudan implements AAOIFI standards on accounting and auditing, Shari'ah and governance, with more focus on accounting, alongside the IFSB's corporate governance standard IFSB-3. For smaller or newer markets, adopting an external rulebook can be quicker than building national standards, which may help explain why direct AAOIFI adoption is common outside the largest Asian markets.

The implementation gap

Adoption of IFSB standards remains well short of complete. The IFSB's 2023 implementation survey of 46 regulators responsible for Islamic banking found a completion rate of 42%. The Shari'ah governance standard was the most widely implemented, by 28 regulators or 61%, followed by corporate governance at 54%, risk management at 50% and capital adequacy at 48%. On those figures, fewer than half of the regulators surveyed had implemented the IFSB capital standard.

The IFSB attributes the gap to capacity as much as to policy. Its surveys consistently identify a shortage of Islamic finance expertise among supervisory staff as a significant obstacle. In some jurisdictions the legal framework for Islamic institutions is not distinct from that of conventional banks, so national rules need to be modified to create parallel requirements. Where Islamic finance is small, regulators see less urgency, and the IFSB recommends applying its standards in proportion to the size, nature and complexity of the sector.

Reported soundness indicators do not suggest that the gap has left the sector undercapitalised. The IFSB put average capital adequacy and Tier 1 ratios for Islamic banks at around 19.10% and 17.83% in 2023, and said the leverage ratio stayed above the 3% requirement in all regions. Liquidity coverage and net stable funding ratios stayed above 100% in most reporting jurisdictions. The IFSB nonetheless urged regulators to complete implementation of its risk management, capital adequacy and disclosure standards and to make progress on recovery and resolution frameworks. The risk, in our reading, is less about today's ratios than about whether supervisors can measure them on a comparable basis when markets come under stress.

Where convergence has stalled

Two episodes show the limits of coordination between the standard-setters. Both came after the two bodies had committed, in a memorandum of understanding announced in November 2018, to jointly develop and revise prudential, Shari'ah, accounting and governance standards. AAOIFI and the IFSB jointly issued an exposure draft of a Revised Shari'ah Governance Framework that, once final, would have replaced in full or in part earlier standards of both bodies. The joint working group was later concluded, with the two bodies agreeing to review and, where necessary, issue Shari'ah governance guidance separately within their own areas of focus. AAOIFI then issued its own set of Shari'ah governance standards in December 2024. The practical outcome is that Shari'ah governance continues to be covered by separate AAOIFI and IFSB texts rather than a single joint standard.

The second is AAOIFI's draft Shari'ah Standard No. 62 on sukuk. The Shari'ah Board resolved to release the draft at its 87th meeting on 28-30 September 2023, after a process that began in 2019, and invited comments by 31 December 2023. It planned hearings in Bahrain, Saudi Arabia, the UAE, Malaysia and Pakistan. The deadline for comments was extended to 31 March 2024 and then to 31 July 2024. On 28 April 2025 AAOIFI said the standard was still in draft, had not been finalised and remained subject to extensive consultation, and that its Shari'ah Board was amending the first published draft in the light of industry comments.

The stakes are high because the sukuk market is large and because some regulators adopt AAOIFI Shari'ah standards automatically. Sukuk outstanding reached USD850 billion in 2023. In the UAE, AAOIFI Shari'ah standards bind Shari'ah committees as minimum requirements, including standards that AAOIFI issues or amends in future. A final version of Shari'ah Standard No. 62 would therefore apply in that jurisdiction without a separate national decision, which is why issuers and arrangers have reason to follow the redrafting closely.

Implications for banks and supervisors

For bank executives, the immediate task is accounting rather than capital. Banks reporting under AAOIFI standards face FAS 45 and FAS 46 from 1 January 2026, which change how investment accounts and assets managed off balance sheet are presented, together with FAS 48 and FAS 49 from the same date. FAS 50 follows for Islamic investment institutions from 1 January 2027. Because investment accounts are the funding base whose treatment drives the IFSB capital formula, the new reporting could make the alpha choice and displaced commercial risk easier for investors to assess.

For supervisors, the agenda is implementation. The IFSB's survey shows that fewer than half of the regulators it covered had implemented its capital standard, and its own stability report calls for completing the risk management, capital adequacy and disclosure standards. In systemic jurisdictions, the CPIFR's place in IMF and World Bank assessments gives supervisors an external benchmark against which that progress can be measured. Capacity building, rather than new standard-setting, is likely to determine how quickly the gap closes. Liquidity remains the area where standards outrun the market: the IFSB's technical work shows that a shortage of Shari'ah-compliant HQLA leaves Islamic banks holding cash.

For investors, the main point is that "Islamic bank" does not describe a single regulatory regime. The same product can be governed by AAOIFI accounting in Bahrain, AAOIFI Shari'ah standards in the UAE, and national Shariah rulings under IFRS-converged standards in Malaysia. Reading capital ratios, profit distribution and Shari'ah risk across borders requires knowing which of these combinations applies.

Primary sources: Islamic Financial Services Board (IFSB), Islamic Financial Services Industry Stability Report 2024, 30 September 2024; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), AAOIFI Accounting Board holds its 42nd meeting and approves FAS 51 “Participatory Ventures” in principle (PR/07/2025), 5 May 2025; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), AAOIFI Accounting Board holds its 36th meeting and approves issuance of four financial accounting standards (announcement), 31 December 2023; Islamic Financial Services Board (IFSB), Implementation Guidelines Report 2023, 31 December 2023; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), The AAOIFI Governance and Ethics Board (AGEB) issues five governance standards on Shari’ah governance (PR/028/2024), 29 December 2024; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Press Release from AAOIFI regarding Draft Shari’ah Standard No. 62, 28 April 2025; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), AAOIFI Shari’ah Board Ratifies Landmark Sukuk Standard Draft, Solicits Banking and Regulatory Sector Feedback (announcement), 8 November 2023; Al Baraka Islamic Bank B.S.C. (c), Interim condensed consolidated financial statements, 31 March 2025 (reviewed), 13 May 2025; Bank Negara Malaysia, Policy Document: Financial Reporting for Islamic Banking Institutions (BNM/RH/PD 033-9), 29 April 2022; Islamic Financial Services Board (IFSB), IFSB-23: Revised Capital Adequacy Standard for Institutions Offering Islamic Financial Services [Banking Segment], 31 December 2021; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Islamic Finance Standard-Setting Bodies AAOIFI and IFSB Join Forces to Strengthen the Development and Resilience of the Islamic Financial Services Industry (announcement), 14 November 2018; Islamic Financial Services Board (IFSB), TN-5: Technical Note on Sharī`ah-compliant Liquidity-Risk-Management Tools, 31 August 2023; World Bank, The Core Principles for Islamic Finance Regulations and Assessment Methodology (Board paper), 31 May 2018; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), AAB decides to defer effective date of AAOIFI FAS 1 “General Presentation and Disclosures in the Financial Statements” to 1 January 2024 (announcement), 17 October 2022; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), AAOIFI Accounting Board issues four financial accounting standards (FASs), namely FAS 44, FAS 45, FAS 46 and FAS 47 (announcement), 31 December 2023; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), The AAOIFI Governance and Ethics Board (AGEB) issues Governance Standard (GS) 18 “Shari’ah Decision-Making Process” (PR/029/2024), 30 December 2024; Central Bank of the UAE (CBUAE), Notice CBUAE/BSD/N/2018/1369: The Higher Shari’ah Authority Resolution No. 18/3/2018 (adoption of AAOIFI Shari’ah Standards), 4 July 2018; Bank Negara Malaysia, Policy Document: Shariah Governance (BNM/RH/PD 028-100), 20 September 2019; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), The AAOIFI and IFSB jointly issued exposure draft of “IFSB-AAOIFI Revised Shari’ah Governance Framework for Institutions Offering Islamic Financial Services (RSGF)” (announcement), 7 April 2022; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), IFSB and AAOIFI conclude the joint work on Shari’ah governance and agree on the way forward (announcement), 9 November 2023; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Deadline extension for industry feedback on exposure draft of Shari’ah Standard No. 62 “Sukuk” (first extension), 28 December 2023; Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Deadline extension for industry feedback on exposure draft of Shari’ah Standard No. 62 “Sukuk” (second extension), 27 May 2024.