LEGAL AND REGULATORY FRAMEWORK OF IBT IN MALAYSIA

Central Bank of Malaysia Act

Provides for the function of CBM as financial regulator in Malaysia.
Definition Section 2(1) ‘Islamic financial business’: any financial
business in ringgit/other currency, subject to laws
enforced by the Bank & consistent with Shariah.
In CBMA, this covers Islamic banking, takaful
business, takaful broking and re-takaful, Islamic
financial advisory etc.
Financial system Section 27 The financial system in Malaysia consists of the
conventional financial system and Islamic
financial system. (dual financial system)
SAC Section 51 - 58 Consists of sections relevant to the Shariah
Advisory Council.
Power of BNM Section 59 Bank’s power to issue circulars, guidelines or
notices on any Shariah matter.
Section 60(1) Section 60(1) Bank shall develop and promote Malaysia as
international Islamic financial centre, in
cooperation with govt, any govt agency, statutory
body, supervisory authority or international or
supranational organisation.
Islamic Financial Services Act
Provides for regulation and supervision of Islamic financial institutions, payment systems
and other relevant entities, oversight of Islamic money market & financial stability
Definition Section 2(1) Licensed Islamic bank is a person licensed under
section 10 to carry on Islamic banking business
and includes a licensed international Islamic bank.
Islamic banking business is the business of:
(a) Accepting Islamic deposits on current,
deposit, savings or other similar accounts,
with or without business of paying/collecting
cheques drawn by or paid in by customers
(b) Accepting money under investment account
(c) Provision of finance
(d) Such other business as prescribed under s 3
Provision of finance is entering or arranging for
another person to enter into, business or activities
which are in accordance with shariah, including:
(a) Equity or partnership financing
(b) Lease-based financing
(c) Sale-based financing
(d) Currency exchange contracts
(e) Fee-based financing including wakalah
(f) Purchase of bills of exchange, certificates of
Islamic deposit, other negotiable instruments
(g) Acceptance or guarantee of any liability,
obligation or duty of any person
 Statutory Section 21(1) Requirement #1:
requirements for A person who is to be licensed to carry on IBB or
licensing takaful shall be a public company.
Section 12(1) & Requirement #2:
Schedule 1 and 2 No person shall be granted a licence if its capital
of IFS Order 2013 funds or surplus of assets over liabilities is less
than minimum amount prescribed by Minister for
licensed person, or the Bank for approved person.
Section 23(1) & Requirement #3:
Schedule 1 of Must pay an authorisation fee or annual fee and
IFSF Regulation processing fee as prescribed by BNM.
Licensing Section 8 No person or institution shall carry on any
procedure authorised business unless licensed by Minister
upon recommendation of BNM.
Section 9 Application to BNM with supporting documents as
required by BNM.
Section 10 License to be granted by Minister upon
recommendation by BNM and upon licence grant,
the person shall commence business within the
prescribed period.
Shariah Section 27 ‘Institution’ is a licensed or approved person or
Compliance operator of a designated payment system.
Section 28 (1) Institution shall at all times ensure its aims
and operations, business, affairs and activities
comply with Shariah.
(2) Compliance with any ruling of SAC of any
particular aim and operation, business, affair
or activity shall be deemed in compliance.
(3) Institution must notify BNM on any non-
Shariah compliant activity, immediately stop
and submit rectification plan within 30 days.
(4) Bank may carry out assessment if necessary.
(5) Penalty: imprisonment not more than 8 years,
fine not exceeding RM25 mil or both.
Differentiate between (1) and (2) by referring to
specific documents in BNM website for which
provision they were legislated for.
Section 29 (1) BNM may specify standards with SAC advice
(2) BNM may specify standards…
(3) Complies with Shariah standards by BNM.
(4) Institution shall at all times–
(a) Ensure internal policies are consistent
(b) Manages its business, affairs & activities
in manner not contrary to Shariah.
(5) Director, officer or member shall at all times
comply with procedures under ss (1) or (2)
(6) Penalty: imprisonment for 8 years or fine not
exceeding RM25 mil or both.
 Shariah Section 30 - 36 Refer to later discussion on SC and SAC.
Governance (Division 2)
Audit on Shariah Section 37 (1) BNM may require institution to appoint any
Compliance person to carry out audit on compliance.
(2) Person appointed shall have duties and
functions specified by BNM & submit report.
(3) Remuneration and expenses of appointed
person is borne by the institution.
(4) Person appointed shall not be liable for a
breach of duty of confidentiality.
Section 38 (1) BNM may appoint person to conduct audit:
(a) If institution fails to appoint such person
(b) In addition to the person appointed
(c) Under any other appropriate circumstance
(2) Person appointed shall have duties and
functions specified by BNM & submit report.
(3) Person appointed shall not be liable for a
breach of duty of confidentiality.
Prudential Section 57 (1) BNM may specify standards to promote:
Requirements (a) The sound financial position of an
institution
(b) Integrity, professionalism and expertise in
the conduct of business, affairs and
activities of an institution
(2) Prudential standards include standards
relating to capital adequacy, liquidity,
corporate governance, risk management,
related party transactions, maintenance of
reserve funds, takaful funds, prevention of an
institution from being used for criminal acts.
Section 58(1) At all times, an Islamic bank must:
(a) Comply with standards under s 57(1)
(b) Ensure internal policies and procedures are
consistent with s 57(1)
(c) Manage its business, affairs and activities in a
manner consistent with sound risk
management and governance practices which
are effective, accountable and transparent
Business Conduct Section 135(1) BNM may specify standards on business conduct
to a financial service provider to ensure it is fair,
reasonable and professional in dealings.
Section 135(2) Standards may include:
(a) Transparency and disclosure requirements
(b) Fairness of terms in a consumer contract
(c) Promotion of financial services/products
(d) Provision of recommendation or advice
including assessment of suitability of services
or products offered to consumers
(e) Complaints & dispute resolution mechanism
Business Conduct Section 136(1) Financial service provider shall not engage in
prohibited business conduct set in Schedule 7.
Section 136(4) Any person contravening (1) shall be liable to
imprisonment not more than 5 years, fine not
exceeding RM10 million or both.
Schedule 7 Examples of prohibited business conduct:
1. Misleading or deceptive in relation to any
financial service or product
2. Inducing or attempting to induce a financial
consumer to do or omit to do an act in relation
to any financial service or product
3. Exerting undue pressure, influence, or using
or threatening to use harassment, coercion, or
physical force relating to financial consumer
4. Demanding payments from a financial
consumer for unsolicited financial services or
products
5. Exerting undue pressure/coercing financial
consumer to acquire a service or product as a
condition to acquire another product
6. Colluding with any person to fix or control
features or terms of any financial service or
product to detriment of the consumer
Financial Section 138 § Regulations may be made to require financial
Ombudsman service provider to be a member of the FOS to
Scheme (FOS) ensure effective and fair handling of
complaints and enable resolution of disputes.
§ Where a dispute has been referred to a FOS,
eligible complainant is not entitled to lodge a
claim on such dispute under the CPA 1999.
Enforcement and Part XVI Powers of BNM to investigate, take administrative
Penalties action, impose monetary penalty, take civil action
in court, compound and publish information in
relation to any enforcement action taken.
Financial Services Act
Provides for regulation and supervision of conventional financial institutions.
Note: section 14(1)(a) of IFSA allows licensed banks and investment banks under FSA to
carry on IBB subject to approval by BNM.
Approval Section 15(1)(a) Approval for a conventional bank, either licensed
bank or investment bank, to carry on IBB.
Statutory Section 15(2) (a) Provisions of IFSA in Part IV, VI, IX, X and
requirements XIII of the Act, insofar as those provisions
(b) Any standards, notices, directions, conditions,
specifications or requirements specified or
made under Act relating to business such
person is approved to carry on.
 Statutory Section 15(3) (a) Establish and maintain a minimum amount of
requirements Islamic banking fund at all times to fund the
operations of its IBB
(b) Keep all assets and liabilities of IBB separate
from other assets and liabilities as may be
specified by the Bank
Section 15(4) Assets of Islamic banking fund shall in 3(a) shall–
(a) Be funded from capital funds of licensed bank
and other sources of funds as specified
(b) Be segregated from capital funds of licensed
bank for operations of its licensed business
Section 15(5) Assets of licensed bank shall not be–
(a) Used to fund the operations of its licensed biz
(b) Subject to the debts or other obligations of the
licensed bank in relation to its licensed biz
Section 15(7) Board of director of the bank must respect the
advice of its Shariah Committee relating to IBB.
Section 15(9) Without approval, imprisonment for a term not
exceeding 10 years, fine not exceeding RM50 mil
or both.
Shariah Section 15(2) Provisions of IFSA are applicable.
compliance Section 27 – 36 of IFSA.
Development Financial Institutions Act
Applicable for development financial institutions (DFI) with special mandate relating to
country’s development, i.e. agriculture, infrastructure & import-export
List of DFIs 1. Bank Pembangunan Malaysia Berhad
2. Bank Perusahaan Kecil & Sederhana
Malaysia Berhad (SME Bank)
3. Export-Import Bank of Malaysia Berhad
(EXIM Bank)
4. Bank Kerjasama Rakyat Malaysia Berhad
5. Bank Simpanan Nasional
6. Bank Pertanian Malaysia Berhad
Definition Section 33A(1) Islamic financial business is a business or activity
in accordance with Shariah which is a prescribed
institution is approved to carry on under paragraph
33B(1)(a) or (b).
Approval Section 33B(1) Nothing in DFIA or IFSA shall prohibit or restrict,
once approved, any prescribed institution from–
(a) Carrying on its entire business or activity in
accordance with Shariah; or
(b) Carrying on business or activity in accordance
with Shariah, in addition to its existing
conventional business
 Statutory Section 33C(1) Prescribed institution which is approved shall–
requirements (a) Establish and maintain at all times such
minimum amount specified to fund IFB
(b) Keep assets & liabilities of IFB separate from
other assets & liabilities
Section 33C(2) Fund established under 33C(1)(a) shall–
(a) Be funded from capital funds of prescribed
institution and other sources of fund
(b) Segregated from capital funds of institution
for operations other than the IFB
Section 33C(3) Unless otherwise specified, assets of a prescribed
institution relating to IFB shall not be–
(a) Used to fund operations of conventional biz
(b) Subject to debts or other obligations relating
to its conventional biz
Shariah Section 33D – Duty, powers and matters regarding compliance
compliance 33L with Shariah.
Audit on Shariah Section 33M & Refer to act.
compliance 33N
Transaction Laws
Application of Islamic banking and takaful involves various aspects of transactions.
Bank Kerjasama Rakyat Malaysia Bhd § Although BBA is an Islamic banking facility,
v Emcee Corporation Sdn Bhd law for conventional banking is applicable.
§ It is the same law, same order that would be,
if made, and same principles to be applied.
(1) Contracts Act 1950 § Must follow requirements for valid contract.
§ Observe elements of contract and remedies
for proper enforcement of contract.
§ Provisions in compliance with ‘aqd apply in
IBT agreements.
(2) National Land Code § Law relating land, land tenure and
registration of title to land and land dealings.
§ Relevant for IBT involving dealings on land.
(3) Real Property Gains Tax Act § Provides for imposition, assessment and
collection of tax on gains or profits derived
from disposal or acquisition of real property
or shares in real property companies.
§ Relevant for purchase and sale of real
property in IBT, and layers of transaction
subject to multiple payment of tax.
§ Amended to avoid double taxation on IBT.
(4) Stamp Act § Regulates liability of instruments to stamp
duty, including IBT documents.
§ Types of IBT documents subject to stamp:
(1) Principle documents – ad valorem stamp
(2) Subsidiary documents – minimum stamp
 (5) Hire-Purchase Act § Regulates the form and contents of hire-
purchase agreements, rights and duties of
parties to such agreements.
§ Protects hirers and guarantors against
unscrupulous dealers who directly handle the
transaction.
§ Promote justice and avoid oppression while
engaging in a commercial transaction.
(6) Anti-Money Laundering Act § BNM regulates and enforces law against
financial institutions and/or Islamic financial
institutions under its supervision.
Dispute Resolution
Resolution #1: Article 121(1A) § Civil courts have no jurisdiction over matters
Court of FC within Shariah court jurisdiction.
Adjudication § Reference to List I (Federal List):
Contracts & mercantile laws including
banking and finance.
Practice Direction § Established special commercial division in
1/2003 High Court of KL (only) to hear cases on
Islamic banking and finance.
§ Court is required to refer to SAC rulings.
§ Any ruling made by PAC pursuant to referral
from court is binding on the court.
Resolution #2: Arbitration § i-Arbitration Rules 2018 exclusively for
Alternative handling Islamic financial cases.
Dispute § Arbitrator is required to refer to SAC ruling
Resolutions for ascertainment of shariah issues.
Mediation § Governed by Mediation Act 2012.
§ Can utilise course-annexed mediation to help
disputing parties resolve disputes.
Financial § Scheme for resolution of disputes between an
Ombudsman eligible complainant and a financial service
Scheme provider of financial service or product.
SUMMARY OF APPLICABLE LAWS
Type Governing Authorisation Provision for Provision for
Law for IBB authorisation shariah
Development DFIA 2002 Approval Section 33B(1) Section 33D –
(a) OR (b) 33L, DFIA
Commercial FSA 2013 Approval Section 15(1)(a) Section 15(2),
FSA; Section
27 – 36, IFSA
Investment FSA 2013 Approval Section 15(1)(a) Section 15(2),
FSA; Section
27 – 36, IFSA
Islamic & IFSA 2013 Licence Section 10 Section 27 – 36,
International IFSA
Islamic
 SHARIAH FRAMEWORK OF ISLAMIC BANKING

Introduction Process of formulation of ijtihad:

§ Islamic banking and finance or Islamic a) Al-Quran
commercial law is part of Shariah. Islamic law of contract starts with
§ It is introduced to remedy or reform the Quranic verses containing rudimentary
ills of economic and financial system. elements of nominate contracts and
§ Basic concepts: certain contractual maxims.
a. Wealth is a trust from God b) Hadith
b. Prohibition of unjust and Supplements the Quranic groundwork
oppressive practices and expands the application of
c. Promotion of honesty, general injunctions.
transparency, justice & fairness c) Ijtihad of Muslim jurists
Laws (general principles) were later
Components of Shariah developed by jurists using mechanism
of usul al-fiqh.
§ There are three components:
1) I’tiqadiyyah (belief)
Ijtihad in Islamic banking
a. Pillars of Islam
b. Pillars of Iman § Process of systematic reasoning to
2) ‘Amaliyyat (dealings) reveal the rule of law by searching for
a. Between humans and Creator legal status based on sources of law.
b. Between humans § Scholars may derive different ruling on
o Politic the same issue due to differences of
o Social methodology or sources utilised.
o Economy (IB & finance) § Results in different practices of Islamic
3) ‘Akhlaqiyyah (morality) finance, but similar basic principles.
a. Between humans and Creator § Range of Islamic financial products is
b. Between humans and Creation open to expansion & re-interpretation
o Human beings by the scholars, guided by the Shariah.
o Non-human beings
Differences with conventional
§ Sources of Shariah: Islamic bank Conventional bank
1) Primary: Quran & Sunnah Operates based on Operates based on
2) Secondary: Shariah principles man-made law
a. Ijma’ (consensus) Absence of interest- Practice of interest-
b. Qiyas (analogy) based transaction based transaction
c. Istihsan (‘juristic preferences) Avoidance of Only aims at
d. ‘Urf (customary practice) oppressive activities maximising profit
e. Maslahah (public interest) Payment of zakat & Giving loans on
f. Istishab (presumes continuity prohibition of haram compounding
g. Others goods & services interest
Cleansing of tainted Penalty for defaults
Formulation of legal rulings amount goes to bait goes into bank’s
§ There are two ways: mal & charities org. profit
a) Shariah à decisive texts à Concerns viability Concerns
applied as is à ruling of project when customer’s credit
b) Shariah à non-decisive texts à investing based on worthiness when
ijtihad according to usul al-fiqh à partnership giving loans
fiqh ruling
 Banking Models
§ There are two main banking models:
1) Conventional banking model
o Commercial banking
o Universal banking
2) Islamic banking model
(A) Commercial banking
§ Based on pure financial intermediation
model.
§ Foley v Hill:
o About borrowing and lending
o Promises deposit products
borrowed by interest rate
o Loan products are charged with
interest rate
o Rate is accrued daily and added
into account as at month end
o Every new month, the additional
interest becomes a new principle
§ Banking services are based on fees, and
not its core business.
§ Prohibited from trading & owning
equity
(B) Universal banking
§ Based on interest.
§ Allowed to hold equity and carry out
operations like trading and insurance,
which is beyond commercial banking.
§ Finance customers through a combo of
shareholding and lending.
§ Allowed to do direct trade.
(C) Islamic banking
§ Provides fund on the basis of trading
and investment, whilst riba-free.
§ Relationship between bank & customer:
a) Trading: buyer and sellor/lessor
and lessee
b) Investment: partners
§ In trading or leasing, customer is
obliged to pay the consideration or
price which consists of cost plus
markup or profit to the bank.
§ In investment, bank and customer share
the profit and losses of partnership.
§ Islamic bank manages surplus-deficit in
society based on actual economic
activities – asset-based and trading.
Salient features of Islamic banking
§ Founded on the principles of shariah.
§ Observation of contract requirements.
§ Avoidance of riba, gharar, maysir and
prohibited commodities or services.
§ Hybrid contracts in Islamic banking
instruments.
§ Requirement of mutual consent (taradi)
§ Prohibition of fraud and deception.
§ Legal contractual relationship depends
on the nature of the contracts.
§ Products are based on various types of
contract which are shariah compliant.
§ Profits are derived from shariah
compliant contract.
Salient features of Islamic banking
§ Section 2(1) of IFSA:
Islamic banking business means the
business of:
a) Accepting Islamic deposits on
current, deposit, saving or other
similar accounts, with or without
business of paying or collecting
cheques drawn by or paid in by
customers
b) Accepting money under investment
account
c) Provision of finance
d) Other business under section 3
§ Section 2(1) of CBMA: dates for dates, salt for salt; exactly
o Islamic financial business is any equivalent for equivalent, hand to
financial business in ringgit or hand.”
other currency which is subject to § Rationale for prohibition:
the laws enforced by the bank and 1) Prevent exploitation of wealth
consistent with the Shariah. 2) Create equality in the dealings
o Islamic financial institution is a between contracting parties
financial institution carrying on 3) Causes economic hardship to
Islamic financial business. borrower and never-ending cycle
of debt
Fulfilment of contract requirements § Types or classification of riba:
Conditions of valid contract: 1) Riba al-nasiah (deferred riba)
1) Contractual expression o Charging interest on loan or
Offer and acceptance with clarity, stipulation for deferment of
consensus and correspondence. delivery.
2) Contracting parties o Fixed return on deposits in
Offeror and offeree with full conventional banking
contractual capacity and legal 2) Riba al-fadl (increased riba)
authority to contract (as owner, agent, o Increase in either subjects or
guardian etc.) articles of exchange
3) Subject matter o Conventional forex
Goods or asset, and price or § Riba al-Dayn (in Loan)
consideration, that is of value, legal o Trade is any fair exchange of goods
and ascertainable. or value
o Must have fair distribution of risk
Prohibited elements in Islamic banking and return
o It is riba if:
There are four prohibited elements:
i. Oppressive or unfair
1) Riba
distribution of risk and return
2) Gharar
ii. Unjustified enrichment at the
3) Maysir
expense of others
4) Prohibited commodities
§ Riba al-Buyu’ (in Exchange)
Prohibition #1: Riba
Profit Riba
§ Definition: Operates based on Operates based on
Predetermined excess or surplus over Shariah principles man-made law
the loan received by the creditor Absence of interest- Practice of interest-
conditionally in relation to a specified based transaction based transaction
period. Avoidance of Only aims at
§ Authority: oppressive activities maximising profit
o Surah al-Imran, verse 130: Payment of zakat & Giving loans on
“O Believers, give up the prohibition of haram compounding
devouring of interest by doubling goods & services interest
& redoubling it, and fear Allah.”
Cleansing of tainted Penalty for defaults
o Surah al-Baqarah, verse 275-279:
amount goes to bait goes into bank’s
“…where Allah has made trade
mal & charities org. profit
lawful and interest unlawful.”
Concerns viability Concerns
o Hadith:
of project when customer’s credit
Gold for gold, silver for silver,
investing based on worthiness when
wheat for wheat, barley for barley,
partnership giving loans
 Prohibition #2: Gharar
§ In general, gharar is uncertainty,
deception, risk, hazard, ignorance etc.
§ Definition:
Any transaction of probable items
whose existence or characteristics are
not certain, due to lack of information,
ignorance of essential elements in
transaction to either party, or
uncertainty of ability of one party to
honor the contract.
§ Authority – surah an-Nisa’, 29
“O Believers, do not devour one
another’s property unjustly; (instead of
this) do business with mutual consent.”
§ Interpretation of authority:
o Unjust is all illegal and defective
elements in contracts, including
gharar and uncertainty.
o Trade by mutual consent requires:
§ Manifested via expression
§ Made by competent person
§ Rationale for prohibition:
1) Cause unequal bargaining power
between parties
2) Unable to make informed decision
due to uncertainties
3) Risk of non-deliverability of object
of the contract
4) Ensure full consent and satisfaction
of parties in a contract
§ Types or classification of gharar:
1) Major gharar
o Prohibited due to uncertainty
of ownership or inadequacy of
information
o Examples: sale of fish in the
sea, sale of birds in the sky or
selling a house without
disclosure of defects to buyer
2) Minor gharar
o Permitted if uncertainty is
slight, and tolerable if contract
is charitable such as a future
inheritance.
o Examples: buying a durian
without knowing the taste,
selling house without
specifying colour of walls
Prohibition #3: Maysir
§ Definition:
Act of wagering money or other
valuable things upon the outcome of an
event or making money upon some
chance.
§ In other words, it is getting profit too
easily without working for it, or
participating in activities which involve
betting whereby winner will take all
bets and loser will lose his debt.
§ Authority – surah an-Maidah: 90-91
“O Believers, …gambling… are all
abominable works of Satan. Therefore
refrain from these so that you may
attain to true success.”
§ Rationale for prohibition:
1) Uncertainty in gambling causes
hidden consequences
2) Prohibit unnecessary risk-taking
leading to disastrous losses
3) Detriment a person’s finances
when they suffer from losses
Prohibition #4: Prohibited commodities
§ Definition:
Commodities that are clearly prohibited
by the shariah and shariah prohibits the
Muslim to own and use them.
§ Prohibited commodities include liquor
and any form of alcoholic drinks and
beverages, carcass, unslaughtered
animals, bloods, pigs, pork, dogs.
Additional notes:
§ Prohibition of fraud and deception:
o Words like khilabah, ghishsh and
tatfif are used in the Quran and
sunnah to convey ‘fraud’ and
‘cheating’
o Refers to maneuver practiced by
one of the parties to induce a
person to a contract without which
he would not enter.
o Refers to concealing defects of an
adulteration in merchandise.