Islamic Finance in the UK: Confronting Financial Crime Challenges
The UK has steadily emerged as one of the most prominent global hubs for Islamic finance due to a growing base of Shariah-compliant banks and investment vehicles, the relatively open regulatory environment, and being an attractive capital market. Many institutions are playing central roles in providing Shariah-compliant financial services and these often serve not only UK residents but also international clients seeking banking alternatives and investments which reflect their personal beliefs. However, balancing religious principles with modern financial crime prevention obligations is not always easy. Recent enforcement action and regulatory scrutiny have exposed vulnerabilities in the UK's Islamic financial institutions, underscoring the need for robust compliance frameworks that are both Shariah-compliant whilst meeting regulatory expectations.
Three common mistakes we see firms making and how you can stop making them too
Islamic finance is grounded in ethical principles, including the prohibition of riba (interest), gharar (excessive uncertainty), and maysir (gambling). While these principles are meant to foster transparency and social justice, they do not automatically shield institutions from financial crime. Through our consulting work, we see firms making the same mistakes which we set out here, alongside some solutions:
1. Not recognising, recording and reacting to the financial crime risks which Islamic finance institutions are more exposed to
Not identifying risks has regulatory, reputational, operational, and ethical connotations – all of which is damaging in the context of Islamic finance, where trust and integrity are key. To prevent this happening, firms should:
Really understand the product complexity of Islamic finance products and the associated financial crime risks. For example, Murabaha can involve multiple parties and transaction steps, increasing the risk of the obfuscation of funds, customers may operate in regions with weaker AML regimes or limited transparency (e.g. cash-based economies) and documentation norms may vary to what we typically see in the UK (e.g. customers lacking conventional ID). This can lead to adapted controls such as bespoke Transaction Monitoring scenarios, adjusted KYC frameworks and tailored training for front-line staff which examines specific red flags.
Clearly record risk assessments and internal discussions. For example, by having a comprehensive Business-Wide Risk Assessment which allows firms to demonstrate that the inherent risks these products and customer types pose are well understood, the controls to mitigate the risks are tailored and effective and where residual risk remains, clear action plans are in place to further reduce this. Furthermore, internal discussions should be documented to evidence important business decisions being made, such as financial crime risk considerations during product approval meetings.
2. Not learning from other’s mistakes
In 2023, the Financial Conduct Authority (FCA) fined Al Rayan Bank £4 million for failures in its AML controls between 2015 and 2017. It emphasized that Islamic financial institutions must comply with the same compliance obligations as conventional banks. The FCA highlighted significant shortcomings in risk assessments, due diligence, and monitoring practices. Despite the bank’s co-operation and subsequent remediation efforts, the case should have served as a wake-up call. However, we still see too many firms not taking a proactive stance and formally reviewing and learning from key regulatory publications. To address this, firms should:
Keep on top of regulatory publications such as Enforcement notices and Dear CEO letters as these often contain rich insight into the thoughts and priorities of Regulators and almost become pseudo-rules in their own right. We distil the key messages of some of the most important regulatory publications for you within free, no obligation templates, which are intended to help make your life easier. Here is the Al Rayan gap analysis, and if you haven’t looked already, we’d strongly recommend you do.
Have a strong horizon scanning process to help identify what’s coming and importantly, whether existing systems and controls need to be adapted to reflect new regulation, a market shift or risk typology, ideally before it lands. This will allow you to not play ‘catch up’, and by preparing and adapting proactively (rather than reactively), you’ll be ahead of peers.
3. Lack of sufficient oversight from senior management
In Sharia compliant institutions, the focus of senior management can be angled strongly towards ensuring that products comply with Islamic legal principles, but with limited involvement in financial crime risk oversight. This creates a potential disconnect between ethical guidance and regulatory compliance. To overcome this, firms can:
Regularly assess and update their risk appetite statement to include specific references to jurisdictional risks, product risks, and customer typologies associated with Islamic finance, and crucially, ensure senior management sign-off on and understand these thresholds;
Use internal audit or another independent third party to test information flows, decision-making structures, and escalation protocols between Shariah and compliance/risk teams; and
Have senior leaders support and communicate the importance of financial crime compliance alongside Shariah compliance for example by publicly championing AML/CFT and regulatory ethics within the firm’s core values.
Self-assessment questions
Effective financial crime frameworks are not only regulatory necessities but essential to maintaining the ethical credibility of the Islamic finance sector. By investing in robust, integrated, and culturally aware financial crime controls, the UK can safeguard its position as a leading and trusted Islamic finance hub for years to come. Take the opportunity to critically assess, both individually and collectively within your firm, how well you understand, implement, validate, and align Islamic finance products within regulatory expectations.
Is senior management actively involved in overseeing financial crime risks, as well as Shariah compliance? If no, how can we rectify this? If yes, how can we demonstrate this? For example, does the Board / Executive Committees receive regular reporting on financial crime risks specific to Islamic finance products and are these discussions clearly recorded in the meeting minutes?
How well integrated are our Shariah governance frameworks with our risk management and compliance functions?
Have we conducted in-depth gap analysis reviews in response to applicable regulatory enforcement actions, such as the FCA’s fine of Al Rayan Bank? If no, who will we assign this action to, to complete as a priority and what senior management forum will this be presented to? If yes, have these led to updates within our own AML/CTF controls and processes?
How are lessons learned from regulatory actions embedded into staff training and policy updates?
Can we demonstrate we have performed tailored product risk assessments for each Islamic finance product (e.g., murabaha, mudarabah, sukuk), rather than using generic templates?
How can we evidence that we can trace and verify transaction flows and ultimate beneficial ownership in complex or multi-layered Islamic financial structures?
How do we adapt our customer due diligence (CDD) to account for clients from jurisdictions with weaker AML regimes or different financial documentation norms?
How does our KYC framework reflect the specific cultural and jurisdictional nuances of our client base, especially from underbanked or high-risk regions?
How are we monitoring the source of wealth and funds appropriately for customers engaging in complex Islamic finance transactions?
How often do we review and update our business-wise risk assessment to accurately reflect the Islamic finance offerings we have the effectiveness of the corresponding control environment?
How can we evidence that our transaction monitoring systems are capable of detecting suspicious patterns unique to Islamic banking products?
How can we be completely confident our financial crime systems and controls would meet expectations if an FCA visit happened tomorrow?
Get in touch
If you'd like to explore how we can support you in addressing financial crime challenges, get in touch at contact@avyse.co.uk — we're here to help.