Moving The Financial Industry To The Next Level of Shariah Compliance - Inceif

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Home > Research Bulletin > Volume2 > Moving the financial industry to the next level of Shariah
compliance
Moving the financial industry to the next level of Shariah
compliance
posted on March 11th, 2014
Moving the financial industry to the next level of Shariah compliance
By Assoc. Prof. Dr. Ahcene Lahsasna
The 2013 year was a significant milestone toward moving the financial industry to the next level,
particularly the Islamic finance industry. A few guidelines and regulations have been issued by the
official authority to strengthen the Islamic finance practice and make the banking activities strictly adhere
to the Shariah rules and principles through a close monitoring and supervision by the regulators, namely
Bank Negara Malaysia and Securities Commission Malaysia. The regulatory framework in Malaysia has
been enhanced and developed with the objective to promote financial stability and ensure Shariah
compliance in the business activities of the Islamic financial institutions. The recurrent enhancement is
regarded as major revise of the legal infrastructure in the Malaysian jurisdiction since 1983.
According to section 6 of IFSA 2013: The principal regulatory objectives of this Act are to promote
financial stability and compliance with Shariah and in pursuing these objectives, the Bank shall:
A. Foster
(i) The safety and soundness of Islamic financial institutions;
(ii) The integrity and orderly functioning of the Islamic money market and Islamic foreign exchange
market;
(iii) Safe, efficient and reliable payment systems and Islamic payment instruments; and
(iv) Fair, responsible and professional business conduct of Islamic financial institutions; and
B. Strive to protect the rights and interests of consumers of Islamic financial services and products.
Among the guidelines and regulations that have been issued and enforced in the financial market, Shariah
non-compliance reporting (March 2013) that emphasize on the Shariah non-compliance; the guidelines
put the industry under alert to strengthen their risk management framework and policy at different level to
ensure Shariah compliance throughout the course of the banking activities. By Looking at the legal
enhancement along with the entire guidelines it demonstrates the direction of the market toward more
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strict standards to foster the safety of the financial system and strictly compliance with Shariah rules and
principles. The current legal framework and guidelines status put the Shariah non-compliance risk
management as one of the main priorities in the Islamic financial institutions. Sharàh non-compliance
risk is regarded as a unique aspect of Islamic finance. But it is still at its early stages which requires more
awareness and training to address the gap.

The recent legal amendments in the Malaysian law represent a milestone that take the Islamic finance in
Malaysia to the next level. The new legislation gives emphasize on the Sharàh compliance and
establishes Sharàh certainty, responsibility, and accountability. As we know that the Islamic Financial
Services Act (IFSA 2013) has replaced both Islamic Banking Act (IBA) 1983 and Takaful Act1984
(Section 282). IBA enacted in 1983 (30 years ago) was based the old Banking Act of 1973. In 1989, the
Banking Act 1973 for conventional banks was replaced with the more comprehensive BAFIA 89.
However, IBA was never upgraded until the recent passing of the new law. Hence most of the laws are
new to the industry but largely already known in the form of regulations/guidelines from the central
banks. IFSA is generally similar to the FSA 2013 but with specific sections unique to cater for Islamic
banking business.
Previously, Islamic banking was defined by the IBA 83 as banking business whose aims and operations
do not involve any element that is not approved by the religion of Islam. Now under IFSA, it is defined
as:
Accepting Islamic deposit with or without the business of paying or collecting cheques. 1.
Accepting money under an investment account. 2.
Provision of finance. 3.
Such other business as prescribed under section 3 of IFSA (Section 2). 4.
The aforementioned are the major banking business activities carried out by the Islamic financial
institutions (IFI). However, Islamic banking business can be defined as the business banking activities
such as accepting deposit, collecting cheques, investment, provision of finance; and other business related
to the nature of the financial institution based on Sharàh rules and legal requirements prescribed by the
regulators.

Sharàh-Related Provisions
A licensed bank and an investment bank under the IFSA 2013 can still carry out Islamic banking business
subject to written approval from BNM (Section 8 (1)). Breach of Sharàh standards is one of the bases for
revocation of banking license (Section 18). For any discovery of breach of Sharàh:
1. Immediately notify BNM.
2. Immediately notify internal Sharàh Committee.
3. Immediately cease activities in breach.
4. Within 30 days submit rectification plan to BNM (Sec 28).
A financial group may apply to BNM for a single Sharàh Committee to oversees its Islamic financial
services and banking business if BNM is satisfied that the SC has the capability to ensure Sharàh
compliance (Section 30 (2)). Any appointment or termination of a Sharàh committee member must be
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. 3 6 16.04.2014 1:51
with prior written approval of BNM (Section 31 and 33). All information submitted to the Sharàh
committee shall be accurate, complete, not false or misleading in any material particular (Section 35).
Members of the committee are not liable to defamation suit for any statement made in discharge of its
duties without malice (Section 36). An external auditor may be appointed by BNM, or by the Islamic
bank under directive of BNM, to perform a Sharàh audit and to report to BNM on any findings and cost
to be borne by the Islamic bank (Section 37 and 38). The definition of Related Party Transactions is
now including Sharàh committee members (Section 57). The Board is obligated to give due regards to
any Sharàh committee decisions in relation to Islamic banking business before making its final decision
(Section 65). Maximum permissible holdings for Islamic banks may exceed 10 percent subject to prior
written approval of BNM (Section 104). Islamic bank mergers are no longer via Section 176 of the
Companies Act, because they are now provided for under IFSA 2013.

Sharàh Compliance in IFSA 2013
IFSA 2013 shifted the legal framework and legislation in Malaysia to the next level, it marks a new face
in the history of the Islamic banking and finance legislation in Malaysia.
The objectives of IFSA are as follows:
The IFSA and the Sharàh governance framework (SGF) represent milestones in promoting
Sharàh governance and Sharàh compliance in Malaysia.
To promote financial stability and Sharàh compliance in the banking activities.
To strengthen the foundations for the entire business banking model, the IFSA is end-to end with
Sharàh governance and compliance
To support the Sharàh compliance contracts in the Islamic financial products and services.
To give strong warning followed by penalties in case there is a failure to comply with Sharàh
mandate.
To align legal and regulatory principles with Sharàh precepts, while promoting greater legal
operational certainty.
To emphasize the significant role of the central bank of Malaysia BNM as regulator
To entrench Sharàh principles and the Sharàh advisory-council rulings in the Islamic finance
industry.
To enforce Sharàh compliance status on the market, and drive the Islamic financial institution
toward more Sharàh compliance activities through a close monitoring and by imposing penalties.
To appreciate the Sharàh non-compliance risks, and manage them in a very effective manner,
which compliments the Sharàh non-compliance reporting and other aspects as mentioned in the
Sharàh governance framework.
To imposes strict and severe offences and penalties as result of failure to comply with Sharàh
compliance.

Duty of institution to ensure compliance with Sharàh.
IFSA 2013 highlights the duty of institutions to ensure compliance with Sharàh. In section 28 (1) An
institution shall at all times ensure that its aims and operations, business affairs, and activities are in
compliance with Sharàh. In section 28 (2),for the purposes of this Act, a compliance with any ruling of
the Sharàh advisory council with respect of any particular aim and operation, business affair, or activity
shall be deemed to be in compliance with Sharàh with respect to the aims and operations, business
affairs, or activity. With regards to non-Sharàh compliance and the process of rectification, the Act has
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highlighted that the non Sharàh compliance cases should be reported to the regulators. According to
Section 28 (3),where an institution becomes aware that it is carrying on any of its business affairs or
activity in a manner that is not in compliance with Sharàh or with the advice of its Sharàh committee
or the advice or ruling of the Sharàh advisory council, the institution shall:
Immediately notify the bank and its Sharàh committee of the fact. 1.
Immediately cease from carrying on such business, affair or activity and from taking on any other
similar business, affair or activity.
2.
Within 30 days of becoming aware of such non-compliance or such further period as may be
specified by the bank, submit to the bank a plan on the rectification of the non-compliance.
3.
The bank may carry out an assessment as it thinks necessary to determine whether the institution
has rectified the non-compliance referred to in subsection (3).
4.
Any person who contravenes subsection (1) or (3) commits an offence and shall, on conviction, be
liable to imprisonment for a term not exceeding 8 years or to a fine not exceeding 25 million ringgit
or to both.2
5.
As a summary of Section 28, which determines the duty of an institution to ensure compliance with
Sharàh rules and principles:
An institution shall at all times ensure that its aims and operations, business affairs, and activities
are in compliance with Sharàh. This can be shown in the vision, mission, tag-line statement of the
IFI, and demonstrated in their practices and operations.
Compliance with the resolutions of SAC of BNM shall be deemed to be compliance with Sharàh.
In case the institution becomes aware that it is carrying on any of its business affairs or activity in a
manner that is not in compliance with Sharàh or the resolutions of its Sharàh committee or the
resolutions of SAC of BNM the institution shall:
a. Immediately notify BNM and its Sharàh committee of the fact.
b. Immediately cease from carrying on such business affairs or activity and refrain from taking on any
other similar business affair or activity.
c. Within 30 days of becoming aware of such non-compliance or such further period as may be specified
by BNM, submit to BNM a plan of rectification of the non-compliance.
Plan on the rectification of the non-Sharàh compliance.
Any person who contravenes this section commits an offence and shall, on conviction, be liable to
imprisonment for a term not exceeding eight years or to fine not exceeding 25 million ringgit or
both.
The above mentioned are some of key points in IFSA 2013 which shows the importance of the new
legislation which gives emphasize on the Sharàh compliance, Sharàh certainty, responsibility, and
accountability.
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