INTRODUCTION
Islamic banking has emerged as an alternative and competitor to the commonly used conventional banking system. Since its establishment, the system has been slowly adapted into the existing banking system and has proven its effectiveness and sustainability. In fact, it is reported that Islamic banking sector grew 50% faster than the overall banking sector. In 2011, Islamic banking assets with commercial banks grew to US$1.3 trillion and achieved at US$2 trillion by the end of 2014.
Islamic finance will grow with rapid pace in the year 2015, with Islamic banking dominating at 78%, sukuk at 16%, takaful at 1%, Islamic funds at 4% and Islamic microfinance with 1%. It is estimated that Islamic finance will be able to tip US$6.5 trillion by the year 2020 with the current growth rates. The recent World Islamic Banking Competitiveness Report 2014- 2015 estimates that Islamic banking assets in Malaysia, Qatar, Indonesia, Saudi Arabia, UAE and Turkey will reach US$1.8 trillion by 2019.
In line with the consistent growth globally, Islamic banking in Malaysia is also experiencing considerable growth and considered as one of the fast-growing and leading countries in the sector. To date, Malaysia has 16 full-fledged Islamic banks, 12 takaful operators, five international Islamic banks and six development financial institutions offering Islamic financial services and products. With the additional players including foreign Islamic banks, the Islamic banking industry in Malaysia has shown significant progress with market share increased up to approximately 25% of the total banking system. Total Islamic financing continued to grow 16.6% and represented 26.9% of total loans in the banking system with the household sector continuing to account for the bulk of Islamic financing at 65.9%. Not only that, 799 Shari’a-compliant securities were listed on Bursa Malaysia, representing 87.7% of the total listed securities, with a market capitalization of RM995.7 billion or 63.7% of the total market capitalization. The Islamic Finance Country (IFCI) has consistently ranked Malaysia as the most developed and well rounded Islamic finance market amongst the countries following a dual banking system.
IFSA AND REGULATORY REFORM
The legal framework of Malaysia’s Islamic finance system has undergone a tremendous change with the enforcement of the Islamic Financial Services Act 2013 (IFSA). The IFSA grants the BNM with the necessary regulatory and supervisory oversight powers to fulfill its broad mandate within a more complex and interconnected environment including introducing more comprehensive consumer protection regime and providing clear demarcation between conventional and Islamic finance.
The current regulatory framework provides a clearer and more comprehensive set of provisions for IFIs. The BNM also has wide-ranging powers to issue directives and guidelines, which are binding upon every director, officer or Shari’a committee member of the institution. To complement the IFSA, the BNM has issued Shari’a parameters to IFIs as guidance and reference to promote harmonization and standardization of Islamic finance practices. The Standards cover both Islamic banking and takaful industries. More importantly, Section 28(6) of the IFSA provides that a failure to comply with the standards issued is an offence under the Act and carries with a maximum penalty of eight years imprisonment or a fine of RM25 million or both. In other words, this provision potentially exposes board or directors, management, officers and even Shari’a committee members with heavy penalties including imprisonment. Therefore, IFIs are required to be more vigilant and diligent in carrying their business, failure in which may lead to potential jail terms and heavy fine to their personnel.
POST-IFSA: IS THERE ANY REAL IMPLICATION?
Law Revision
As a continuous effort to overcome impediments to efficient conduct of Islamic finance, the Law Harmonization Committee Report formulated several recommendations to resolve issues in Islamic finance. The Committee is also studying the legal implications on the implementation of Islamic Financial Services Act 2013. Process of harmonization here refers to the integration of the existing laws with the Shari’a principles for the purpose of strengthening further legal infrastructure on Islamic finance.
With the findings from several consultations and studies, the Committee proposed a few recommendations to improve the Islamic finance regulatory framework by providing legal certainty of Shari’a contracts enforcement, being responsive and sensitive to implement legislative changes, developing human capital through producing highly qualified legal talent and commercially experienced judiciary and finally to create a supportive and reputable dispute resolution environment for adjudication and dispute settlement at the national and international levels. The Committee also introduced several new legal provisions in court such as rules on imposition of late payment charges on judgment debts, to allow better access to Islamic financing for consumers through recommended amendments to reserve land legislations at all states, to facilitate Islamic financing involving landed property through recognition of Islamic finance in the National Land Code 1965 and to amend the Companies Act 1965 in order to facilitate the effort to offer globally accepted Shari’a compliant product structures for the Islamic money market.
Investment Account
Year 2015 will be more interesting to witness the development of the industry, as the 30th June was the deadline for IFIs to clearly separate between the deposits account and investment account. With this statutory requirement, IFIs are expected to introduce a new structure of mudaraba investment, which reflect the actual characteristics of investment. Section 2 of the IFSA defines investment account as an account for the purposes of investment, including for the provision of finance, on terms that there is no express or implied obligation to repay the money in full and with profits-sharing, or both the profits-or- losses-sharing features (b) with or without any return. This provision not only classifies Islamic deposit as principal guaranteed and investment as non-principal guaranteed but also requires IFIs to facilitate proper priority of payments upon liquidation. The deposit insurance cover also will no longer relevant for investment-type of accounts.
The BNM has issued Transition Policy under Islamic Financial Services Act 2013 on 14th February 2014 for the purpose of flexibility and to grant more times to enhance its operational capacity to meet the requirement. This Transition Policy allowed IFIs to continue and accepting Islamic deposits on current account, deposit account, saving account or other similar accounts under any Shari’a contract including investment deposit products until 30th June 2015. By 1st July 2015, all IFIs must separate all of their investment deposits products either into Islamic deposits or investments accounts.
The IFSA requirement on the separation of Islamic deposit and investment account is actually to allow the banks to customise their products according to the customers’ profile and risk appetite. IFIs can now offer higher returns to any investors for their investment account. To facilitate this transition period, the Malaysian government backed the Investment Account Platform with an initial start-up fund for RM150 million. Lembaga Tabung Haji also allocated RM200 million for the establishment of the Shari’a-compliant Restricted Investment Account. By looking at the current development, Bank Islam Malaysia Berhad is the first IFI that introduced new investment account products namely Waheed Investment Account, Special Investment Account and Al Awfar Account products. These investment account products are structured under the principles of mudaraba and wakala. It is expected that more IFIs will introduce their new investment account products this year.
Takaful Business
In term of the takaful funds, the IFSA makes it mandatory for the takaful operator to clearly segregate the takaful participants’ funds and the shareholders’ funds. The nature of Shari’a contracts embedded in the takaful business model will be clearly accounted through this requirement. Another significant requirement refers to single licensed takaful business. The IFSA requires takaful operator to separate its family business with general takaful business within five years grace period. Takaful operators are given five years to split their family business and general takaful business into separate entities.
The new requirements imposed on takaful operators are expected to enable the takaful sector to operate in a solid and specialised business model that would lead to promoting takaful industry growth. Despite this positive expectation, it is observed that these requirements may create difficulties to the takaful operators if there are no proper measures to overcome them. The effects include the demand for separate management, chief executive officers for both the family and general takaful companies as well as possibility for the need to establish separate Shari’a committees. We also can witness the challenges faced by the takaful industry in Malaysia as a result of these statutory requirements. Takaful sector is now experiencing some difficulties particularly in retaining their existing talents including issues of staff pinching and unnatural hikes in salary and remuneration.
Shari’a Non-compliance Report
The IFSA puts strict conditions on IFIs in term of statutory reporting. To complement the IFSA requirement, the BNM has issued Shari’a non-compliance reporting guidelines. IFIs are required to immediately notify the BNM and its Shari’a committee of any non-Shari’a compliant activities and immediately cease from carrying on such business, affair or activity. The IFIs are required, within 30 days, to submit to the regulator a plan on the rectification of the non-compliance as provided in Section 28(3)(c).
The BNM utilises an integrated system known as the Operational Risk Integrated Online Network (ORION) for guidance on treatment of Shari’a non-compliant items. ORION is the BNM regulatory reporting system and processes. This system enables efficient reporting and supervision. Through this system, the BNM can easily monitor and supervise any Shari’a non-compliance cases in IFIs. It is reported that since its effective date, the BNM received more than 100 submissions from IFIs for Shari’a non-compliance reporting and less than 21% are actual Shari’a non-compliance. The amount of actual loss due to this non-compliance is also significant. Generally, any money due to the Shari’a non-compliance sources will be channelled to charity or returned to the rightful customers. This is the framework for the treatment of Shari’a non-compliance income as part of purification processes for any IFIs in Malaysia. The nature of non-compliance factors refers to operational issues, inadequacy of documentation and internal procedure.
Shari’a Research and Scholars Activism
The International Shari’a Research Academy for Islamic Finance (ISRA) and various institutions of higher learning have been at the forefront in improving the Shari’a governance-related matters including research and development. A number of external bodies on an international level acknowledge the ISRA as the top contributor of Shari’a research. The overall performance of Shari’a research in Malaysia is also commendable. Malaysia scored 211 points representing 31% of the total research papers on Islamic finance in the world far ahead of any jurisdictions that offer Islamic financial products and services.
“As the only legislation of its kind in the world at this point of time, the IFSA makes Shari’a scholars legally accountable and liable for their duties as any Shari’a committee members may be jailed for up to eight years or fined up to RM25 million, which is equivalent of approximately US$7.6 million, if they fail to comply with the IFSA.”
The establishment of the Association of Shari’a Advisors initiated by Shari’a scholars themselves further stimulates the degree of professionalism and talent development in Islamic finance. With 159 qualified Shari’a scholars in Islamic finance in Malaysia (13% female, 13% non-Malaysian and 12% non-Shari’a background scholars) Malaysia is ready to offer its Shari’a talent and meet the demand of the industry. The level of awareness in the grassroots on Islamic finance is also increasing whereby Shari’a scholars are now actively engaging the communities and civil society entities. To complement this, the mass media also have been very supportive by producing and publishing news, documentaries, talk shows and information on Islamic finance even during prime time hours. Besides, the BNM also makes it compulsory for all Shari’a committee members to attend the Shari’a Leaders Education programme, a specialized and tailored module for Shari’a committee members, organized by the ICLIF Leadership and Governance Centre.
Another interesting development of Shari’a governance in Malaysia refers to professional indemnity Islamic insurance or takaful for Shari’a committee or Shari’a advisory council members. As the only legislation of its kind in the world at this point of time, the IFSA makes Shari’a scholars legally accountable and liable for their duties as any Shari’a committee members may be jailed for up to eight years or fined up to RM25 million, which is equivalent of approximately US$7.6 million, if they fail to comply with the IFSA. This serious legal implication triggers the need of having professional indemnity Islamic insurance for Shari’a scholars as in the case of advocate and solicitor or medical practitioners.
Challenges Ahead
Despite positive development on Islamic finance landscape in Malaysia, there are some valid concerns over its implementation and practices. Vigorous and numerous Shari’a compliance requirements will increase the cost of business and finally will affect the level of efficiency. Since precautions and due diligence have to be exercised to prevent the commission of the offence, any measures to mitigate this legal risk will cost additional expenses. Heavy regulated business environment may negate innovation and influence the market behaviour and the players will opt for products of lesser constrains.
Another legitimate concern to the recent Islamic finance practices in Malaysia refers the trend of Islamic deposit account. All contracts under wakala and mudaraba are deemed as investment account products and hence require additional treatment related with documentation, operation and system. Contrary to the ideal aspiration of promoting true nature of investment as stipulated under the IFSA, most IFIs are now migrating the existing mudaraba deposits into Islamic deposit accounts rather than converting into mudaraba investment accounts.
Majority of mudaraba term deposit accounts in the market are converted into deposit accounts based on the Shari’a concept of tawarruq. As a result, Islamic finance practices in Malaysia remain to concentrate on debt-based deposit account products and consistently neglect the investment account products both from asset and liabilities sides. In fact, the economic role of tawarruq does not offer any real difference with the conventional deposit.
With the rapid and speedy technological globalization, digital banking poses another great challenge to Islamic finance in Malaysia. Since the new generation especially young customers are digitally sophisticated, Islamic finance players in Malaysia must be ready to evolve towards technology-based banking. In order to remain competitive, IFIs must not only able to offer service-driven and value-propositions products and services but also to tender efficient digital banking system that comply with the Shari’a principles in order to meet the customers’ expectation.
CONCLUDING REMARKS
Malaysia, as one the Islamic finance leaders in the world, has proactively and consistently facilitated the implementation of Islamic finance hrough integrated and comprehensive means and initiatives. These formulae seem working well as we can clearly witness considerable development in term of growth in market share, and banking assets, including the increase of domestic and global players. Not only that Malaysia is also leading the global Islamic finance community in various aspects and these include Shari’a research, quantitative development, governance and regulatory framework. Despite all of these, there are some valid and legitimate concerns on the current practices and trends of Islamic finance in Malaysia. Years ahead will evidence another true potential of Islamic finance in Malaysia whereby it can significantly contribute not only to stimulate human capital initiatives, generates more opportunities, to achieve its target of 40% of the country’s total banking sector assets by 2020 but more importantly to link Islamic finance with the real economic development within its own way.
“Islamic finance practices in Malaysia remain to concentrate on debt-based deposit account products and consistently neglect the investment account products both from asset and liabilities sides. In fact, the economic role of tawarruq does not offer any real difference with the conventional deposit.”
