BANK RAKYAT SCHOOL OF BUSINESS AND ENTREPRENEURSHIP

RZB4303 ISLAMIC LAW OF CONTRACTS

MALAYSIAN LEGAL FRAMEWORK PERTAINING TO ISLAMIC FINANCE AND THE DEVELOPMENT OF THE SHARIAH GOVERNANCE FRAMEWORK

BY: MOHAMED NOORULLAH BIN YUSUF IBRAHIM KLC1160027

1.0 Introduction.

Today, we have a comprehensive Islamic financial landscape underpinned by strong institutional infrastructure and effective legal, regulatory and Shariah framework1

It could not be denied that Malaysia has achieved a tremendous growth in developing Islamic banking industry locally as well as internationally. This achievement adheres much on the comprehensive approach of the authorities as well as the players themselves especially to its legal aspects. Hence, this article tries to explore the effectiveness of the existing legal framework of Islamic banking in Malaysia. In tackling this topic, the preceding discussion will be divided into four parts. Part 1 refers to the introduction. Part 2 explains brief historical background of the Islamic banking in Malaysia. Part 3 elaborates the effectiveness of the legal framework. Part 4 concludes the discussion. This paper is intended to provide a general overview on the existing legal infrastructure on the implementation of Islamic banking, current practice and to what extent it works.

1.Tan Sri Dr. Zeti Akhtar Aziz. Governor Bank Negara Malaysias Speech at the Official Launch of AmIslamic Bank Berhad. Menara AmBank. Kuala Lumpur. 18 May 2006.

2.0 BRIEF HISTORICAL ON SHARIAH LAW The main statute that sets out the jurisdiction of the courts in Malaysia is the Federal Constitution 1957 (FC). Article 121 of the FC establishes the jurisdictions of courts in Malaysia, and dictates that the civil court has no jurisdiction over matters within the jurisdiction of the Shariah Court. The jurisdiction of the civil courts covers all matters conferred by federal and state law, except for the personal law of Muslims. The civil courts jurisdiction is specifically laid down in List I Federal List, Ninth Schedule of the FC. This includes matters on civil and criminal procedure and the administration of justice, contracts, mercantile laws, arbitration and so on. This will obviously include banking and financial laws. On the other hand, the Shariah courts jurisdiction is laid down in Para 1 of List II State List of the Ninth Schedule. However, the jurisdiction of the Shariah court is limited to matters in Para 1 only, and it has no jurisdiction over any criminal offenses, except as provided by federal law.

In essence, Para 1 includes matters pertaining to Islamic law, and personal and family law of persons professing the religion of Islam, including divorce, wakaf, succession, and offenses against the religion of Islam (except which is in the federal law). Based on the above provisions in the FC, it can be concluded that the jurisdiction over Islamic banking and finance matters rests with the civil court, as it is within List I of the Ninth Schedule on mercantile law. Furthermore, the legislations on Islamic banking and finance are all federal legislations that are subject to the civil courts jurisdiction. There has not been any state legislation on Islamic banking and finance matters. This conclusion is further supported by the decided cases in Malaysia, where the civil courts have heard and decided on Islamic banking and finance matters.

Examples are Tinta Press v Bank Islam Malaysia Berhad [1986] 1 MLJ 474; Bank Islam Malaysia Berhad v Adnan bin Omar [1994] 3 CLJ 735; and Dato Hi Nik Mahmud bin Daud v BIMB [1996] 1 CLJ 576 (High Court); [1998] 3 MLJ 396 (Supreme Court). In all these cases, the civil courts had used the civil law and procedures in reaching their decisions. Apparently, the civil courts did not consider whether the application of the existing law and would have contradicted the Shariah or affect the validity of the documents.

3.0 LEGAL FRAMEWORK PERTAINING TO ISLAMIC FINANCE

3.1 Islamic Banking Act 1983 (IBA)

Introduced to govern the operations of Malaysian Islamic bank(s), it was the first legal infrastructure to facilitate Islamic banking in Malaysia. There was also an amendment to the Government Investment Act 1983 to facilitate both (Islamic) statutory reserves and liquidity reserve requirements, which were to be interest-free. This was followed by the enactment of the Takaful Act 1984 (TA) to allow for the licensing and operation of Islamic insurance (Takaful) companies in Malaysia. Then, there was the amendment in 1996 to section 124 of the Banking and Financial Institutions Act 1989 (BAFIA) to allow banks licensed under the Act to introduce Islamic banking business.

The IBA mainly provides for the licensing and regulation of Islamic banks and Islamic banking business in Malaysia. Subsequently, the IBA was amended in 2003, and became the Islamic Banking (Amendment) Act 2003.An analysis of the provisions in the IBA shows that the Act is regulatory in nature and does not provide for the substantive law for Islamic banking. There have not been specific thoughts of meeting the requirements and expectation of the Shariah since the clauses used are mainly derived from the conventional banking practices and the existing banking laws. Moreover, the main legislative framework for Islamic banking in Malaysia is actually based on civil laws and falls within the jurisdiction of the civil courts.

There are also ambiguities in the Islamic Banking Act 1983. For example, there is no definition of banking business in the IBA. By way of comparison, BAFIA provides a definition of banking business in section 2(1), which provides: (a) the business of (i) receiving deposits...; (ii) paying or collecting cheques; (iii) provision of finance...

In addition, the term Religion of Islam has not been defined. This may give rise to ambiguity as to the position of the Islamic legal schools (madhhab) in the interpretation of the catch-all phrase approved by the Religion of Islam used in IBA. This difficulty is somewhat mitigated by the existence of a Shariah advisory body (SAB) for the Islamic bank as required by the IBA, essentially to safeguard and ensure Shariah ompliance. The general rule to be observed in IBF is ensuring that there is no contravention of any Shariah principles in the transactions; for example, all transactions must be free from the elements of usury, dubiousness and gambling. A new section was also added to the IBA in the 2003 amendment. Section 13A provides: (1) An Islamic bank may seek the advice of the Syariah Advisory Council on Syariah matters relating to its banking business and the Islamic bank shall comply with the advice of the Syariah Advisory Council. (2) In this section, Syariah Advisory Council means the Syariah Advisory Council established under subsection 16B(1) of the Central Bank of Malaysia Act 1958. This amendment enables Islamic banks to seek the advice of the Shariah Advisory Council (SAC) of Bank Negara Malaysia (BNM); and it is mandatory for the Islamic banks to comply with the advice given by the SAC pursuant to such request. This indicates that the SAC has advisory powers over the Islamic banks, where liaison and common understanding between the SAB and SAC are expected. This will also ensure that Shariah compliance is always strictly observed and adhered to by the Islamic bank with the advice of the SAC.

The liaison with the SAC can also facilitate a shorter time frame in endorsing any new products in IBF. Nonetheless, nothing in the IBA provides for a minimum qualification of lawyers who are involved in IBF documentation and litigation. There is no specific requirement that lawyers dealing with Islamic banking transactions should have the relevant qualifications in drafting the documents. Generally, this lack of necessary knowledge of the Shariah and Islamic law could lead to mistakes in drafting and also risks on the legality of the documents, especially for noncompliance with the Shariah principles
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3.2 Banking and Financial Institutions Act 1989 (BAFIA)

Conventional banks licensed under BAFIA are allowed to carry out IBF business in addition to their conventional banking business, provided that they consult BNM. According to section 124 of BAFIA, a licensed institution may carry on Islamic banking business or Islamic financial business, provided that BNM is consulted before Islamic banking and financial business is carried out. Under BAFIA, Islamic banking business has the same meaning as that in the IBA, while Islamic financial business is defined in section 124(7) (c) as: ... any financial business, the aims and operations of which do not involve any element which is not approved by the Religion of Islam. Section 124(3) and (4) of BAFIA further provide that any licensed institution carrying on Islamic banking business or Islamic financial business may refer to BNMs SAC and shall comply with the directions on Islamic banking business or Islamic financial business issued by BNM in consultation with the SAC. However, it should be noted that under section 124(5) of BAFIA, the licensed institutions under the Act are not Islamic banks but conventional banks offering IBF services. Previously, these IBF services were known as Skim Perbankan Tanpa Faedah (SPTF) windows. Now, they are known as Islamic banking divisions.

3.3 Central Bank of Malaysia Act 1958

The Central Bank of Malaysia Act 1958 (CBA) provides for the establishment of the National Shariah Advisory Council (SAC) at BNM. An amendment was made to the CBA in 2003 to enhance the power and integrity of the SAC. The SAC is now the authority for ascertainment of Islamic law for the purposes of Islamic banking business, Islamic financial business, Takaful business, Islamic development financial business and any other business that is based on Shariah principles and is supervised and regulated by BNM. The amended CBA also provides that no member of the SAC can be a member of any Shariah body, or act as a Shariah consultant or Shariah adviser with any banking institution or other financial institution.

Further, the CBA provides that any court or arbitration proceedings involving Shariah issues may refer to BNMs directive or refer to the SAC for ruling. The ruling by the SAC may be considered by the court, and is binding in an arbitrator. Under the CBA, Islamic banking business has the same meaning as that in the IBA whereas Islamic financial business has been defined in section 16B(12) to mean financial business whose aims and operations do not involve any element which is not approved by Syariah.

3.4 Stamping and taxation

An amendment was made in 1989 to section 14A of the Stamp Act 1949 to avoid double stamp duty for Islamic financing documents. Further orders were issued to give equal status to Islamic financing documents in terms of stamp duties Stamp Duty (Exemption) Order 1996; the Stamp Duty (Remission) (No 4) Order 1996; the Stamp Duty (Exemption) (No 6) Order 2003; the Stamp Duty (Exemption) (No 2) Order 2004; the Stamp Duty (Exemption) (No 3) Order 2004; and the Stamp Duty (Remission) Order 2004. An amendment was also made in 1985 to the Real Property Gains Tax Act 1979 to avoid double taxation on IBF transactions. In another recent development, the tax chargeable on all Islamic leasing or Ijarah financing will be at par with conventional leasing.

3.5 New developments on shariah law . Islamic banking and finance is likely to continue its growth trajectory next year despite the outlook of a challenging year ahead and the slowdown in global economy. The robust achievement recorded throughout the year coupled with the safe-haven investment sentiment among investors will be the main reasons for the industry to remain favorable. In the Economic Report 2012/2013 by the Ministry of Finance, the Islamic banking business was stated to have continued to expand in the first seven months of this year with total assets increasing 20.6% to RM469.5 billion, representing 24.2% of the countrys banking systems assets. In 2011, it expanded by 24.1% to RM436.1 billion, reflecting 23.7% of the total banking system assets. RHB Islamic Bank Bhd Managing Director Abdul Rani Lebai Jaafar said Islamic finance in Malaysia was ready to move on to the next stage and compete more aggressively in the global financial market. He said Islamic finance seemed to have been also equally accepted by both Muslims and non-Muslims due to continuous awareness programmes and customer experience. He, however, said 2013 could be a challenging year as the issue of funding versus financing has remained within the industry where the question of sourcing for funds to generate financing from very limited resources locally needs to be addressed. Among the challenges will be the limited number of trained and knowledgeable Islamic bankers available in the market to cater for the growing segment. Although several Islamic banking learning centers such as Islamic Banking and Finance Institute Malaysia (IBFIM) and International Center for Education in Islamic Finance (INCEIF), have been set up by the authorities and training programs held for fresh graduates by the industry players to tackle the problem, more concerted efforts are needed, Abdul Rani said.

INCEIF Chair of Islamic Finance Prof Dr Abbas Mirakhor said the authorities must have a strong commitment in a way that appeals to a pluralistic society to ensure progress for Islamic finance. It must be framed, communicated and explained to the society in a way that all segments of the society will understand its benefits and no segment is threatened by either the commitment or the progress, he said, adding that innovation in products would be also important. Malaysia is seen to be in the drivers seat when it comes to Islamic Banking. Innovation is a key factor to push Islamic banking to a higher level.

4.0 THE DEVELOPMENT OF THE SHARIAH GOVERNANCE FRAMEWORK. 4.1 The importance of Shariah governance The principles of Islamic finance place great emphasis on strong corporate governance values and structure, transparency, disclosure of information and strict adherence to Shariah principles. The Shariah governance framework is a set of organizational arrangements through which Islamic nancial institutions ensure effective oversight, responsibility and accountability of the board of directors, management and Shariah committee. The framework serves as a guide towards ensuring an operating environment that is compliant with Shariah principles at all times. Shariah principles provide the foundation for the practice of Islamic nance through the observance of the tenets, conditions and principles propagated by Islam. Comprehensive compliance with Shariah principles would bring condence to the general public and the nancial markets on the credibility of Islamic nance operations. In Malaysia, the Bank has established the necessary mechanism for the Islamic nancial system to operate in a manner consistent with Shariah muamalah principles, with a clearly defined institutional arrangement within Islamic nancial institutions regulated by the Bank. A two-tiered Shariah governance structure has been established, comprising an apex Shariah advisory body at the Bank and a supervisory Shariah committee formed at the respective Islamic nancial institutions.

4.1 Establishment of individual Shariah committee at Islamic nancial institutions.

The Islamic Banking Act 1983 and Takaful Act 1984 require the establishment of an independent Shariah committee within each Islamic nancial institution. In 2004, the Guidelines on the Governance of Shariah Committee for the Islamic Financial Institutions (the Guidelines) was issued outlining the role, duties and responsibilities of Shariah committee and its members and the relationship and working arrangement between the Shariah committee at individual institutions and the SAC at the national level. The Guidelines, among others, prohibit individuals from sitting in more than one committee within the same industry. While the underlying rationale for the prohibition is to avoid a conict of interest, the rule served as a catalyst in expanding the pool of Shariah talent within the Islamic nancial industry and, at the same time, increasing its diversity in terms of the experience and expertise of Shariah experts. Today, the total number of Shariah experts has increased to more than 100 individuals from a small number of scholars when the Guidelines were rst issued in December 2004. Although the current Shariah governance structure has increased the prominence of the role of the Shariah committee within the Islamic nancial industry, the further enhancements to the Guidelines are needed to take into account the rapid developments in Islamic nance in this recent few years. These include, the enhancements relating to the governance arrangements of the board and management in respect to the Shariah compliance process, the independence and accountability of the Shariah committee in the decision making process, the strengthening of internal research capacity, compliance and the risk management processes.

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4.2 A new Shariah framework

The new Shariah Governance Framework for Islamic Financial Institutions 2011 introduced by Bank Negara Malaysia (BNM) last October would be a catalyst in bringing the country's Islamic finance industry forward, says a researcher.

International Shari'ah Research Academy for Islamic Finance (ISRA) executive director Dr Mohd Akram Laldin said the framework is aimed at enhancing and strengthening the Syariah element in Islamic financial institutions and for them to attain a syariah-based operating environment.

"This framework is a catalyst to bring about progress for the industry and t ensure that the syariah institutions are being properly operated by all the parties,"

Mohd Akram was one of the panelists at a dialogue session here on the Shariah Governance Framework for Islamic Financial Institutions organised by Zaid Ibrahim & Co.

On the framework, he said it had been issued at the right time considering that the country's Islamic finance industry was on the expansion mode.

The framework replaced the previous Guidelines on the Governance of Shariah Committee for Islamic Financial Institutions (2004). It regulates the governance of syariah committee of Islamic financial institutions. The new framework has enhanced the roles of the key organs of an Islamic financial institution including the board of directors, syariah advisory committee and management in ensuring compliance. The framework also provides a comprehensive guide in discharging matters relating to Islamic principles and outlining and clarifying the functions of syariah review, audit, risk management and research .All Islamic financial institutions in Malaysia have been given until June this year to comply with the new framework.

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CONCLUSION An effective legal framework requires serious involvement of all individuals and institution, Islamic financial institution as the key player, government as the regulatory body, and also to other persons related such as auditors, accountants, lawyers and consumers. A comprehensive legal framework is a vital component to guarantee a success on the implementation of any Islamic banking system. Generally, we can say that Malaysia has adopted a very effective legal framework that covers regulatory and syariah aspects as well as measures to the viability of the Islamic financial industry. As regard to the future development of Islamic banking industry in Malaysia, we could not deny that we must be ready with more effective and comprehensive legal framework. The phenomena of globalization require us to mobilize all of our resources in maintaining 14 the growth of Islamic banking sector that we have today. Beside, Malaysia should also liberalize its Islamic banking policy so as to attract global players to have cooperative framework to promote Islamic banking, particularly in mobilizing financial resources to meet the needs of the Muslims With the rapid expansion of Islamic nance in Malaysia, the establishment of a comprehensive and holistic governance structures and processes is being continually enhanced to remain dynamic and relevant at all times. The Shariah governance framework in Malaysia has evolved with the changing market conditions, whereby the governance structure at both the overall Islamic nancial system and the individual Islamic nancial institutions have been enhanced and strengthened to ensure the observance of Shariah. The effective implementation of the new Shariah governance framework will further promote stakeholders condence and the integrity of the Islamic nancial industry thereby reducing Shariah non-compliance risks and, over the medium term, contribute towards maintaining nancial stability.

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BIBLIOGRAPHY http://www.bnm.gov.my/guidelines/05_shariah/02_Shariah_Governance_Framework_20101026. pdf http://www.islamicfinancenews.com/listing_article_ID.asp?nm_id=28485

http://zulkiflihasan.files.wordpress.com/2008/07/the-effectiveness-of-legal-framework.pdf

Ahmad Ibrahim, Legal Framework of Islamic Banking, IKIM Law Journal, Vol.1 (1): 1997

Mohamed Ismail bin Mohamed Shariff, Salient Features of Islamic Banking Act 1983 and Banking and Financial Institutions Act 1989, working paper presented during Seminar on Shariah and Legal Aspects of Islamic Banking Practice, BIMB Institute of Research and Training, Kuala Lumpur, 1996. Tan Sri Dr. Zeti Akhtar Aziz. Governor Inaugural speech in 3rd Annual Islamic Finance Summit London. 13th January 2004. Tan Sri Dr. Zeti Akhtar Aziz. Governor of Bank Negara Malaysias Speech at the Official Launch of AmIslamic Bank Berhad. Menara AmBank. Kuala Lumpur. 18 May 2006. Cases Bank Islam v. Adnan Omar [1994] 3 CLJ 735; [1994]3 AMR 44 Dato Nik Mahmud Bin Daud v. Bank Islam Malaysia Berhad [1996]4 MLJ 295 (HC); [1998]3 MLJ 393 (CA) Acts The Islamic Banking Act 1983 (Act 276) The Banking and Financial Institutions Act 1989 (Act 372) The Central Bank Act 1958 The National Land Code 1965 The Stamp Act 1949 (Act 378).

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