LAW 551 – BANKING LAW AND PRACTICE II:

TEST

PREPARED BY:

JEEVA RACHELUSUN PRAGAS

2020470902

LAWB06A

PREPARED FOR:

DR. SYUHAEDA AENI BINTI MAT ALI

FACULTY OF LAW UITM SHAH ALAM

20 JULY 2023
Examine the legal reform brought by Islamic Financial Services Act 2013 (IFSA). (20 m)

The Islamic Financial Services Act 2013 also known as the IFSA is a Malaysian statute
enacted to provide to supervise and regulate Islamic financial institutions, payment systems
and other relevant entities. Additionally, its creation was to supervise the Islamic money market
and Islamic foreign exchange market, with the primary objectives of promoting financial
stability, ensuring compliance with Shariah principles, and addressing any associated matters
that may arise as a result. It consists of 18 Parts containing 291 sections and 16 schedules,
including no amendment. Prior to the formation of the IFSA 2013, Islamic Banking was
governed by the Islamic Banking Act 1983 and the Takaful Act 1984. The Central Bank of
Malaysia (BNM) also issued several guidelines for Islamic Financial Institutions (IFIs) such as
the Guidelines on the Disclosure of Reports and Financial Statements of Islamic Banks and the
Shari’ah Governance Framework. However, in 2013, the IFSA came into force together with
The Financial Services Act (FSA) on the 30th of June 2013, to replace the repealed Payment
System Act 2003 (PSA), in hopes to promote safe, efficient, and reliable payment systems and
instruments and consolidates the previous Islamic Banking Act 1983 and the Takaful Act 1984
as well as repeals both Acts. The IFSA also grants Bank Negara Malaysia the essential authority
and supervision capabilities to carry out its extensive mandate in an increasingly intricate and
interconnected financial landscape, influenced by regional and international developments.
This encompasses a heightened emphasis on proactive measures to tackle potential problems
within financial institutions that could impact depositors and policyholders' interests, as well
as ensuring the smooth and effective operation of financial intermediation 1. The IFSA stands
out for its distinct emphasis on Shariah compliance and governance within the Islamic financial
sector. It offers a comprehensive legal framework that strictly aligns with Shariah principles
throughout all aspects of regulation and supervision, encompassing licensing to the winding-
up of institutions according to Shariah law2. Its goal was to further boost the development of
Islamic finance in Malaysia via laying the foundation for a comprehensive regulatory
framework to promote a resilient and stable Islamic financial system in Malaysia.

This paper will discuss the legal reform brought by the IFSA in our current legal landscape.

1
Financial Services Act 2013 and Islamic Financial Services Act 2013 Come Into Force - Bank Negara Malaysia.
(n.d.). Www.bnm.gov.my. https://www.bnm.gov.my/-/financial-services-act-2013-and-islamic-financial-
services-act-2013-come-into-force
2
Ibid

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 As aforementioned, the IFSA, replaced the existing Banking and Financial Institutions
Act 1989 (BAFIA), Islamic Banking Act 1983 and Takaful Act 1984. The newly introduced
IFSA grants BNM the essential authority and supervision capacity to effectively carry out its
extensive mission within an intricate and interconnected financial landscape, considering the
regional and global aspects of financial advancements. Essentially, the main purpose of the
IFSA is to promote financial stability, enhance the Shari’ah compliance framework, and elevate
the Islamic finance industry in Malaysia to a globally competitive standard. Converse to the
previous repealed statutes on Islamic finance, the IFSA the governs all IFIs including Islamic
banks, takaful operators, international Islamic banks, international takaful operators as well as
operators of payment systems which the transfer of funds between Islamic bank accounts or
which enables payments to be made by means of Islamic payment instruments, issuers of
Islamic payment instruments, takaful brokers and Islamic financial advisors. At heart, it
streamlines the Islamic financial provisions for IFIs under a single legislation.

Among the legal reform brought by the IFSA to the current legal landscape lies in its
objective itself. Section 6 of the IFSA provides that the two principal regulatory objectives of
the Act are namely to promote financial stability and IFIs compliance with Shariah law. The
IFSA confers authority to the BNM to act as the governing body responsible for maintaining
stability in the financial sector, with a specific focus on ensuring the safety and stability of
Islamic financial institutions. This includes promoting the smooth functioning of the Islamic
money market and the Islamic foreign exchange market, as well as establishing efficient and
dependable Islamic payment instruments. Moreover, the IFSA emphasizes the importance of
fair, responsible, and professional business practices within Islamic financial institutions.
Additionally, through the IFSA, IFIs are mandated to make efforts to safeguard the rights and
interests of consumers availing Islamic financial services and products.

Besides that, the IFSA confers statutory duty, namely compliance and reporting to
IFIs. Compliance of IFIs is provided for in Section 28(1) of IFSA that requires IFIs to ensure
that at all times their aims, operations, business, affairs and activities are in compliance with
Shariah standards. It also mandates that IFIs are to ensure that their internal policies and
procedures are consistent with the standards specified by BNM, to manage their business,
affairs and activities in a manner which is not contrary to Shariah and to establish a Shariah
Committee for its respective institution. Through the IFSA, the BNM mandate that IFIs must
conduct an audit to verify their adherence to Shariah principles is enforced. The responsibility
for ensuring IFIs' compliance with the standards set by BNM lies with the Board of Directors,

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CEO, Senior Officer, and Shariah Committee. As for the duty to report, by virtue of the IFSA,
IFIs are required to immediately notify the BNM and its Shariah committee of any non-Shariah
compliant activities and immediately cease from carrying on such business, affair or activity.
In the event of non-compliance, as provided in Section 28(3)(c) of IFSA, IFIs are required,
within 30 days, to submit to the regulator a plan on the rectification of the non-compliance.
Besides that, Section 37 of the IFSA requires IFIs to submit Shariah audit compliance reports.

The IFSA has also created an evident demarcation between conventional banking
and Islamic banking. This can be seen in Section 6 (a) (iv) of IFSA that provides that one of
the objectives of the IFSA is to foster fair, responsible and professional business conduct of
Islamic financial institutions, emphasizing that the formation of the IFSA is solely for the
governance of Islamic Banking. For example, prior to the formation of the IFSA, according to
the Islamic Banking Act 1983, the term "deposit" referred to a sum of money or its equivalent
received or paid to any person. The receipt and repayment were governed by an agreement
based on Shari'ah principles, including custody or profit-sharing. However, with the
introduction of the IFSA, Section 148 redefined the term "Islamic deposit" which now refers
to a sum of money accepted or paid in accordance with Shariah principles. The purpose of this
new statutory definition is to create a clear distinction between what constitutes an Islamic
deposit and a conventional deposit. Another reform can be seen in Section 2 of the IFSA,
where the new statute enriches the significance of a depositor by referring to an individual who
is entitled to the reimbursement of an Islamic deposit, regardless of whether the deposit was
made by that individual or by someone else. In contrast to the Islamic Banking Act 1983, the
IFSA clearly demarcates between current account and savings account holders on one hand,
and investment account holders on the other. Meanwhile, the Islamic Banking Act 1983 only
identifies depositors as individuals who have accounts at Islamic banks without any clear
distinction between the types of accounts.

Other than that, the IFSA empowers BNM as a Financial and Shari’ah Regulator.
The IFSA features a distinctive aspect with the BNM assuming the role of a regulatory
authority for both financial activities and Shari’ah matters. While in regard to Shari’ah
governance, the IFSA incorporates Shariah principles and upholds rulings from the Shari’ah
Advisory Council, it explicitly grants the BNM the authority to establish standards on Shariah
governance and matters concerning Shariah compliance. This includes assessing potential
instances of Shariah non-compliance and overseeing the rectification of such issues by Islamic
Financial Institutions (IFI). Further to that, the BNM is empowered to outline the

3
responsibilities and functions of the Shariah committee. To ensure their independence,
members of the Shariah committee are granted legal protection against actions for breach of
confidentiality, so long as they can prove they have acted in good faith while carrying out their
duties and responsibilities. Additionally, they are protected from defamation actions for any
statements made without malicious intent while fulfilling their duties, as specified in Section
36 (b) of the IFSA.

Further to that, the IFSA also reformed New Requirements for Takaful to safeguard
consumers. Takaful is a co-operative system of reimbursement or repayment in case of loss,
organized as an Islamic or sharia-compliant alternative to conventional insurance, which
contains riba and gharar. With the introduction of the IFSA, came the reform of laws on Takaful
where the IFSA has introduced several new requirements for Takaful. Firstly, the IFSA
introduced a requirement of single licensed takaful business under Section 16 of the IFSA that
requires takaful operators to separate its family business with general takaful business. In order
to meet this stipulation, the BNM grants takaful operators a five-year time frame to separate
their business into distinct entities, comprising of family business and general takaful business.
One of the primary goals of the IFSA is to safeguard consumers, which involves implementing
regulations concerning takaful funds, shareholders' funds, and qard. This can be seen in Section
94 of the IFSA where the IFSA prohibits a licensed takaful operator from withdrawing any
funds from a takaful fund, whether surplus or otherwise, unless all specified conditions are met.
Additionally, Section 91 of the IFSA mandates the separation of takaful funds and
shareholders' funds by takaful operators. Furthermore, as stated in Section 95 the IFSA requires
licensed takaful operators to provide qard or other forms of financial support from shareholders'
funds to the takaful fund, based on terms and conditions specified by BNM, if the value of the
takaful fund's assets falls below the amount defined by BNM. This provision makes it
compulsory for every takaful operator to offer qard or loans in the event of a deficit in the risk
fund. As can be seen by the aforementioned, the introduction of the IFSA has also changed
laws for Takaful with an aim to protect the interests of its consumers, yet another legal reform
brought by the IFSA.

The IFSA also provides a clearer and more comprehensive set of provisions for
corporate governance of IFIs. Section 29 of the IFSA stipulates that all institutions, their
directors, chief executive officers, senior officers, or members of a Shari’ah committee must
always adhere to the standards set by BNM that are applicable to them. The IFSA enforces
strict requirements where in Section 28(6) of the IFSA it states that failing to comply with

4
these standards, including guidelines or standards on corporate governance, is considered an
offense under the Act. The maximum penalty for such non-compliance is either eight years of
imprisonment, a fine of 25 million ringgit, or both. In simpler terms, through the birth of the
IFSA, more responsibility on IFIs, especially on those involved in policy-making decisions and
issuing Shari’ah rulings has existed too. To ensure compliance, the IFSA enforces strict
consequences for board members, directors, management, officers, and Shari’ah committee
members, including severe penalties such as imprisonment. The IFSA can be seen to be much
stricter on IFIs as by virtue of the IFSA, IFIs cannot simply rely on their professional advisors
or experts such as external auditors, lawyers, advisory firms and any other professional entities.
In fact, they must ensure that they have taken reasonable measures to ensure that all business
operations comply with the IFSA and any other related requirements. The IFSA also enhances
and reinforces the Shari’ah governance standards outlined by the BNM in their Shari’ah
Governance Framework, where transparency and good disclosure practices are integral aspects
emphasized in multiple provisions. The IFSA aims to significantly improve transparency
within IFIs. This can be seen in Section 35 of the IFSA, where IFIs must provide accurate,
complete, and non-misleading information to the Shariah committee. Simultaneously, the
Shariah committee is expected to maintain confidentiality regarding relevant information.
Corporate and Shari’ah governance-related provisions demand that IFIs exercise increased
vigilance and diligence in their operations, as failure to do so may result in potential jail terms
and heavy fines for their personnel.

The IFSA has also created a stronger and stricter rules Shariah compliance. For one,
the IFSA makes Shari’ah scholars accountable and liable for their duties creating potential
exposure of Shari’ah scholars to jail terms for rule breaches as stipulated under the IFSA. Under
this Act, Shari’ah committee members may be jailed for up to eight years or fined up to RM25
million if they fail to comply with the rules provided in the IFSA. The IFSA's Shari’ah
compliance requirement should also be read with the BNM Shariah Governance Framework
(SGF). The SGF explicitly states that the ultimate responsibility for Shari’ah governance and
compliance lies with the board of directors, not the Shari’ah committee. Section 2.1 of the
SGF emphasizes that the board holds the highest accountability and responsibility for the
overall Shari’ah governance framework and compliance of IFIs. The IFSA imposes stringent
conditions and a robust process for Shari’ah compliance where Section 28 (3) mandates that
IFIs must promptly inform the BNM and its Shari’ah committee of any incidents of Shari’ah
Non-Compliance, whether actual or potential and such activities must immediately be halted

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as well as a submission of a plan to rectify the non-compliance within 30 days. In fact, the
BNM Circular on Shariah Non-Compliance Reporting, issued on 15 March 2013 and effective
from 1 May 2013, provides further details on this requirement. Actual reports of Shari’ah non-
compliance must be submitted to the BNM within fourteen (14) days. Additionally, IFIs are
obligated to submit a rectification plan to the Board of Directors and the Shariah Committee
for approval within thirty (30) days. Furthermore, within 14 days of identifying Shari’ah non-
compliance, IFIs must obtain confirmation from the Shari’ah committee. Thus the IFSA has
introduced stricter laws for Shariah compliance that carries heavy penalties to parties that are
involved and subject to it.

But of course, with reform comes its consequences. Among the biggest issues posed by
the formation of the IFSA is the fact that there is no judicial supervision over the BNM. As
aforementioned, the IFSA empowers the BNM not only as a financial authority but also as a
Shari’ah regulator. Unlike the previously retired Islamic Banking Act 1983, the IFSA expands
its reach to encompass both Shari’ah compliance and financial activities. It grants BNM
extensive powers to establish standards, handle prudential matters, and issue binding directives
that apply to Islamic Financial Institutions (IFIs). The IFSA also empowers the BNM to hold
extensive authority to determine what is deemed suitable for an institution and its holding
company. These powers encompass various aspects, such as Capital Requirements, Corporate
Governance, Consumer Protection, Shareholding, Intervention, and adherence to Shari’ah
principles. The IFSA goes beyond just advisory capabilities for the BNM, granting the BNM
the authority to make recommendations that influence Ministerial decisions. In essence, any
exemptions granted by a Minister necessitate the BNM's recommendation. Essentially, the
IFSA can be said to commission the BNM to act on a big part of Islamic Banking procedures
but does not provide anything to govern judicial jurisdiction over the BNM's actions. This
raises the concern of who will assess and evaluate the functions and roles of the BNM. Judicial
oversight plays a crucial role as it allows for a review of the BNM's actions, considering the
significant powers vested in it. To ensure responsible governance and safeguard the stability of
the financial system, there should be appropriate legal mechanisms to limit and regulate the
BNM's authorities and establish a suitable avenue for reviewing and overseeing its actions
when required. This adherence to best governance practices will, in turn, ensure the soundness
of Islamic finance practices. While the IFSA has strengthened safeguards for Islamic Finance
consumers and enforced more responsibility on IFIs, it has failed to provide measures to control
the BNM who it has conferred lots of power to. There is a potential abuse of power by the

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BNM that needs to be seriously deliberated by the IFSA, which may result in the need to
introduce amendments to this Act.

Besides that, despite the multiple benefits to existing law brought by the reform of
introducing the IFSA, the Act itself raises a concern of a probable conflict of interest
between shareholders and other stakeholders. While the IFSA is explicit on the duty to act
in the best interest of shareholders and other stakeholders, contrary to its preceding statute, by
virtue of Section 65 of the IFSA that states that the board of directors of a financial institution
must consider the interests of depositors, investment account holders, and takaful participants,
as applicable; the IFSA encourages a stakeholder-oriented approach in Islamic financial
institutions, which might have a tendency to neglect shareholders. The statutory requirement
to act in the best interest of various stakeholders may lead to potential conflicts of interest
between majority shareholders and depositors or policyholder as at status quo, the
shareholders’ value model remains dominant over the stakeholder value orientation in practical
applications. IFIs will also encounter significant challenges in balancing the interests of
shareholders and consumers, particularly investment account holders or depositors. As a result,
while such provision was created to benefit parties, it may give rise to conflict as it is highly
impractical to apply.

Other than that, the rigidity of the IFSA may result in less in a stunt in innovation of
Islamic Financial Products. The strictness of the IFSA may result in parties turning to other
products such as conventional banking that is not as complicated. For example, under the new
provisions of the IFSA, all contracts under wakalah and mudharabah will be treated as
investment products, necessitating additional attention to documentation, operation, and
systems. This will prompt IFIs to replace their existing non-principal guaranteed Shari’ah
contracts. As a result, IFIs will likely increase their portfolio by offering fixed profit returns,
such as tawarruq and wakalah, which share some characteristics with conventional deposit
products based on commodity murabahah. Due to the flourishing market for tawarruq-based
products, mudharabah and musharakah-based products may be neglected. If IFIs start turning
to products that are easier due to less restrictions by the IFSA, the consequence is that Islamic
financial products may lose their unique identities and characteristics and gradually resemble
conventional banking, thus begging the question what is the need of Islamic banking if it is
nearly identical to conventional banking?

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 The introduction of the IFSA may also cause an increase in cost but a drop in
efficiency. The IFSA’s imposition of strict liability on Directors, Controllers, Officers,
Partners, or any individuals involved in the management of IFIs will undoubtedly lead to
increased costs and expenses for IFIs. Furthermore, the stringent requirements for Shari’ah
compliance will further raise the cost of doing business, ultimately affecting their overall
efficiency. The fact that through the new provisions of the IFSA, Shari’ah committee members
are at risk and subject to similar liabilities, IFIs will then have to take extensive precautions
and exercise due diligence to prevent any offenses from occurring, which will incur additional
expenses. As a result of these legal risks, some IFIs are contemplating subscribing to
professional indemnity insurance for their Shari’ah committee members and increasing
coverage for their board of directors. However, these measures will unavoidably impact the
pricing of Islamic financial products and services in the market. With an increased price of
Islamic Financial Products due to increased cost Islamic financial products and services offered
may become less competitive compared to their conventional counterparts and people may start
turning to conventional banking instead.

In conclusion, the IFSA has significantly changed and reformed the pre-existing law on
Islamic Financial Services by providing more safeguards and being more explicit on certain
matters. Through this reform, many benefits have been birthed creating a more efficient
guideline for Islamic Finance. That being said, due to its rigidity, it has also posed many
concerns mostly on part of the unregulated strong authority of the BNM and the
complicatedness that IFIs would have to endure which poses a concern that less institutions
will provide Islamic Financial Products due to its complexity. Nevertheless, the Islamic
Financial Services Act has brought multiple advantages to the current legal framework. Being
the only legislation of its kind in the world at this point of time, it sets a standard and example
for other countries on the governance of Islamic Finance. As no law is perfect, the potential
consequences of the way the Act is drafted should be further studied so that a more improved
legislation can be created to govern Islamic Finance in Malaysia that is suitable to all parties
and more practical in nature.