The Malaysian government has codified in law the duality of its banking system — an Islamic financial system operating-side-by-side with a conventional banking system — cooperating but not inter-acting. Malaysia is the first country to go this way although the Dual Banking Model which Kuala Lumpur first introduced unofficially in 1983 has been followed by many countries including Bahrain, Qatar, the UAE, Pakistan, Indonesia, Turkey Brunei and Bangladesh.
This move, according to Zeti Akhtar Aziz, governor of Bank Negara Malaysia, the central bank, “is in view of the importance for Islamic finance to be supported by a robust legislative framework.” The new Central Bank of Malaysia Act 2009, she stressed to delegates attending the 4th Seminar on Legal Issues in the Islamic Financial Services Industry organized by the Islamic Financial Services Board (IFSB) at end September 2009 in Kuala Lumpur, “explicitly codifies the duality of the Malaysian financial system which shall consist of the Islamic financial system and the conventional financial system.”
“This statement of law is supported by a comprehensive legal framework already put in place for the regulation of Islamic finance in Malaysia, encompassing the banking, Takaful (Islamic insurance) and Islamic capital market industries. The legal recognition of the distinct features of Islamic financial transactions and the availability of a dispute settlement mechanism capable of applying these distinctive features reduces the legal risks as well as risk of non-compliance with Shariah principles,” she explained.
Zeti who has steered the Malaysian Islamic financial system into global recognition as the most advanced and efficacious Islamic banking jurisdiction in the Asian country almost to the letter, agrees that a robust legal framework in Islamic finance instills public confidence in the Islamic financial system. It also provides an enabling platform for practitioners to develop more innovative and complex financial products to meet the increasingly multifaceted consumer demands. In addition, it provides the mechanism for dispute settlement that takes into account the distinct features of Islamic financial transactions.
Zeti is perhaps the most senior regulator in international finance and is widely respected worldwide. She has championed the cause of Islamic finance in international meetings such as the World Bank/IMF annual meetings; the Basel Committee, the United Nations; the Islamic Development Bank Annual meetings; the IFSB annual summit; and even at the meetings of finance ministers where she was invited about three years ago to address the major Western finance ministers on Islamic finance and its rapid growth. Had Malaysia been a member of the G20, which many ordinary Muslims would like to see, she would have articulated the case of Islamic finance to be at the top table of the G20 and to play a role in the global financial system especially in mitigating the sort of crisis the global financial system has been experiencing over the last two years.
Zeti is confident that Islamic finance has continued to expand and demonstrate its resilience in the current challenging international financial environment. This advancement has been in terms of the increased range of Islamic financial products and services, the development of the Islamic financial infrastructure and institutions, the greater maturity of the Islamic financial markets and the more comprehensive supporting legal and regulatory framework. More recently, the international dimension of Islamic finance has gained significance with the move to further liberalize domestic Islamic financial system and the strengthening of the international Islamic financial architecture.
In Malaysia, she revealed, Islamic banking assets at the end of the second quarter of this year, constitute close to 19 percent of total banking assets. Total financing now amounts to 118 billion ringit and accounts for 20.1 percent of the total financing portfolio of the banking industry.
Net non-performing financing remains low at 2.4 percent. Islamic securities have also maintained its dominance in the Malaysian bond market, accounting for 58 percent of total bond market. And almost two-thirds of the equity market comprises Shariah-compliant securities.
Similarly, she added, there has also been growth in the Takaful sector in which the funds asset has registered an increase by 8.2 percent. This recent decade has also seen the increase in number of Islamic financial institutions including full-fledged Islamic banks, development financial institutions that engage in Islamic banking, takaful, re-takaful and capital market intermediaries. Several of these players have strategic partnerships with foreign players.
In April next year, as part of the liberalization initiatives announced, new mega-Islamic banking licenses and up to two family takaful licenses will be issued. On the global front, Islamic financial assets are projected to grow to $1.6 trillion by 2012 while the global sukuk outstanding is valued to date at approximately $152.8 billion.
Zeti reminded that the current international financial crisis has demonstrated the importance of recognizing that the rapid transformation of the functioning of the international financial system had to be accompanied by the need to ensure that regulatory and legal framework was aligned with these developments. “The relevance of legal framework is essential to providing certainty and predictability to the financial transactions and to the innovative products, thus promoting public confidence in the financial system. This is equally important for the Islamic financial services industry in which this recent decade has seen a rapid evolution in terms of the innovation and in terms of its expansion. This is where the legal services industry has a vital role in providing sound legal solutions in Islamic finance. It, therefore, provides an important “bridge” between Shariah and legal parameters, thus enabling the operationalization of Shariah principles into legally enforceable Islamic finance practices.”
“In addition, by ensuring that the legal parameters are in compliance with Shariah parameters and the regulations, it also becomes a risk mitigator,” she explained.
The legal aspects in Islamic finance also represents an important “bridge” between the governing Shariah principles and the practice of Islamic finance. The application of Shariah principles in the light of the governing laws and regulations in each Islamic financial transaction are interpreted through legal advice, in legal documentation of the financial transactions, and dealing with disputes.
“In documenting financial transactions based on specific Shariah principles that underlie a financial product, the legal documentation reflects the tenets of Shariah and that it is in full compliance with the laws and regulations governing the financial transactions. Varying interpretations of Shariah in particular between countries adds to the complexity when cross-border transactions are involved,” she added.
Malaysia was the first to pioneer the concept of a centralized National Shariah Council at the central bank which sets the Shariah rules for the entire sector. Individual banks can have their own in-house Shariah boards, but the ultimate arbiter of Fiqh Al-Muamalat is the National Shariah Council. This role has even been set in Malaysian law, which once again underlines Kula Lumpur’s systemic approach to Islamic finance.
In July this year, the Malaysian Parliament (Dewan Rakyat) approved a law that gives Bank Negara Malaysia’s National Shariah Advisory Council the legal status as the final arbiter in matters relating to Shariah issues in Islamic finance.
The move also springs from the debacle earlier this year in a turf war between a lower court and the Appeal Court relating to the Shariah validity of the Bai Bithaman Ajil (BBA) deferred payment sale used widely to finance Islamic mortgages in the Malaysian market. The aim is to give greater clarity in Fiqh Al-Muamalat (Islamic Law relating to Financial Transactions) and for the Council to effectively act as Shariah Authority of Last Resort.
At the same time the Securities Commission of Malaysia (SC), the securities regulator, has simplified its guidelines for Shariah Advisories to the Islamic capital market. The latter can now through a single registration offer advice on all Shariah-based products and services approved by the SC. Previously, the Shariah advisories had to register separately for each product and service.
Indeed, as Zeti rightly stresses more jurisdictions including Pakistan, the UAE and Turkey are considering a central Shariah Council as the ultimate decision making body on Shariah matters. However, across jurisdictions, there has been greater engagement thus bringing about increased covergence.
Mutual recognition of the interpretation of Shariah principles across countries, maintained Zeti, will contribute to the sustained growth of Islamic finance.
To promote consistent application of Islamic financial contracts in Malaysia, Bank Negara Malaysia has issued “Shariah Parameters” aimed at promulgating a standard point of reference on Shariah for Islamic finance practitioners. The Shariah Parameters outline the main Shariah requirements in the contracts and provides examples, methods and models for practical application of such contracts. The first Shariah Parameter on Murabahah that was recently issued aimed to promote consistent interpretation and application of Shariah views and opinions on Murabahah contracts.
In providing legal services, the Islamic finance industry has an important role of bridging the Shariah parameter with the legal parameters of the Islamic financial contracts. This, explained Zeti, is in particular important in preparing the legal documentation of Islamic financial transactions so as to avoid ambiguity, inconsistency and to avoid the risk that the legal document be considered void by a court of law on the grounds of contravention with Shariah.
Islamic financial transactions have their own unique risk characteristics that need to be managed. Risk areas that are unique to Islamic finance transactions include the legal risk of losses due in the event of lawsuits and non-compliance with relevant laws, the risks associated with non-compliance of Shariah principles and the fiduciary risk arising from failure to perform contractual obligations based on the underlying Shariah principles.
“The introduction of new, more innovative and complex products and financial transactions enables the disaggregation and repackaging of risks in ways that has not been explored. Shariah advisors would require the collective expertise including legal practitioners, to identify and understand the permissibility of a given structure. Islamic financial institutions in turn would need to address the attendant implications,” she warned.
According to Bank Negara, institutional structure that is determined by the legal and administrative framework is the first pillar of competitiveness. The ability to execute financial transactions efficiently, with sufficient certainty and enforceability, and a clear process for resolving ambiguities and possible breaches of the contract will enhance competitiveness, both at the institutional level as well as for the financial system as a whole.
In Malaysia, Islamic finance disputes are adjudicated in civil courts and not the Shariah courts where the jurisdiction is limited to matters relating to individual Muslims.
“If the dispute concerns a point on the ascertainment of Shariah, the courts and arbitrators are required to refer to the Shariah Council at Bank Negara Malaysia to facilitate the ruling. The Shariah Council’s authority is the ultimate body responsible for Shariah in banking and financial matters that is within the purview of Bank Negara Malaysia. This referral system provides an enabling platform for preserving consistency and predictability in interpretation and application of Shariah principles for financial transaction in Malaysia,” explained Zeti.