islamic_banking

ISLAMIC BANKING



Scope of business activities

Eligibility criteria

Modes of entry

Islamic banking business in international currencies

include:

commercial banking business; •

investment banking business [subject to laws, •

guidelines and regulations enforced by the

Securities Commission of Malaysia]; and

other banking businesses in Malaysia, as may •

be specified by the central bank, Bank Negara

Malaysia.

These businesses include dealing in international

currencies, deposit-taking, provision of finance,

investment banking services, and investment in

securities and properties.

An IIB may also carry out the following businesses:

In transacting with a resident, the IIB is allowed to: •

a) maintain a foreign currency account for the

resident to retain any foreign currency receipts

other than export proceeds; and

b) extend foreign currency credit facility to the

resident other than trade financing facility

involving exports.

In respect of Ringgit Malaysia transactions, an •

IIB is allowed to:

a) hold Ringgit Malaysia instruments for investment

purposes;

b) maintain a Ringgit Malaysia account with any

onshore Islamic bank licensed under the Islamic

Banking Act 1983 (IBA); and

c) maintain an external account in any onshore

Islamic bank licensed under the IBA to facilitate

Ringgit Malaysia investments by its non-resident

customer.

An applicant wishing to establish an IIB

shall observe the following general eligibility

criteria:

a well capitalised and reputable licensed •

financial institution;

adopts international banking practices •

formulated by the Bank for International

Settlements, the Islamic Financial Services

Board (IFSB) or any other international

standard-setting body(ies) of equal

standing;

regulated and supervised by a competent •

home regulatory authority; and

possesses a sound track record. •

All IIBs are governed and licensed under

the IBA and may be established either as a

subsidiary or as a branch in Malaysia.



**100% foreign equity ownership

allowed**

Application

requirements

Capital requirements

& licensing fee

An application to establish an IIB must be made

in the prescribed Form IIB to MIFC Secretariat

that includes, among others, the following:

Audited financial statements of the applicant •

for the last two years;

A business plan of the proposed IIB that •

outlines, among others:

a) objectives and types of banking business to

be carried out;

b) target markets and business operations;

and

c) risk management plan and the reporting

control.

A memorandum of association and articles of •

association or other instrument under which

the applicant is incorporated, duly verified by a

statutory declaration by a senior officer of the

applicant;

Letter of awareness from the home regulatory •

authority that supervises the applicant;

Letter of undertaking from the parent •

company; and

Letter of application to the Controller of •

Foreign Exchange Bank Negara Malaysia to

allow the IIB to deal in international currencies.

Upon obtaining approval for an IIB licence,

the bank must then be incorporated under

the Companies Act 1965 via the Companies

Commission of Malaysia.

The minimum paid-up capital and net

working funds for IIB set-up as subsidiary or

branch is RM10 million (US$2.9 million) or its

equivalent in other currencies.

The annual licence fees for either set-up isRM50,000 (US$14,500).









Government

incentives

10-year income tax exemption for IIBs up to •

year of assessment (YA) 2016;Withholding tax exemption on: •

a) profits received by resident and nonresidentdepositors; and

b) income received by non-resident experts inIslamic finance.

10-year stamp duty exemption up to YA 2016 •

on instruments executed pertaining to Islamic

banking businesses conducted in foreigncurrencies;Fast and easy immigration approval for

expatriates in Islamic finance and their familymembers; and

Tax neutrality has been accorded to Islamic •

finance instruments and transactions executed

to fulfill Shariah requirements. Malaysia’s

tax neutrality framework promotes a level

playing field between conventional and Islamic

financial products, hence reducing the cost of

doing business in Islamic finance.



Regulatory requirements

IIBs established as subsidiaries are required to

observe capital adequacy as provided under the

Capital Adequacy Standard issued by the IFSB.

Where the home regulatory authority of the IIB has

adopted a more advanced approach specified

in the International Convergence of Capital

Measurement and Capital Standards (Basel II)

issued by the Bank for International Settlements,

the IIB is allowed to adopt the more advanced

approach.

The IIB shall at all times, also observe the following:

have in place a comprehensive risk management •

infrastructure to identify, measure, monitor, and

control risks arising from the IIB’s business

activities;

maintain sufficient liquidity to meet its obligations •

at all times as it becomes due and ensure

sufficient funds to finance increases in asset;

effective corporate governance practices; •

ensure that its banking and financial activities •

are conducted in conformity with the Anti-Money

Laundering and Anti-Terrorism Financing Act

2001 and other relevant laws and regulations;

and

appoint Shariah advisors to review the •

institution’s operations and activities to ensure

compliance with Shariah requirements, be it

by way of appointment of the Shariah advisors

in the form of establishing its own Shariah

committee, or leveraging on it’s parent’s or

group’s Shariah committee, or appointing

external Shariah advisors.

The IIB is not allowed to source funds from the

domestic Islamic money market operations.

Reporting Requirements

All financial accounts and statements must •

be prepared and maintained in accordance

with the Financial Reporting Standards issued

by the Malaysian Accounting Standards

Board. Where necessary, further guidance

may be sought from International Financial

Reporting Standards or standards issued by

the Accounting and Auditing Organisation for

Islamic Financial Institutions.

Where an IIB is established as a subsidiary, it •

is required to appoint an external auditor to

provide an independent view of the financial

statement’s reliability.

Interim financial statements and the audited •

financial statements are to be submitted to

the Banking Supervision Department of Bank

Negara Malaysia within specified timelines.

In addition, the IIB is a resident for the purpose of

foreign exchange administration rules and subject

to the relevant foreign exchange administration

rules for transaction(s) involving foreign

currencies.

What is Islamic banking?

Islamic banking is banking based on Islamic law ( Shariah)). It f follows the Shariah,

called fiqh muamalat (Islamic rules transactions. The rules and practices of actices

fiqh muamalat came from the Quran an and the Sunnah, another secondary

sources of Islamic law such as opinions collectively agreed among Shariah

scholars (ijma’),analogy (qiyas) and per personal reasoning sonal (ijtihad).



Accounting and Auditing Standards

The rapid expansion of the Islamic financial industry that started in the 1970s

was not

initially accompanied by the creation of a set of internationally recognized

accounting rules. In consequence, Islamic institutions around the globe had to

resort to developing their own accounting solutions for their new products,

rendering comparisons across institutions difficult, and sometimes even giving

the impression of lack of transparency.

Awareness Campaigns

The speed and degree of success with which Islamic banking will emerge in

conventional

systems will largely depend on whether potential depositors and investors are

well informed about the opportunities and risks at hand, and on whether Islamic

banking is perceived as a transparent and well-regulated activity.







Introducing Non-Bank Islamic Financial Institutions and Instruments

As full-fledged Islamic banks increase their operations, and it is clear that there is

a segment of the population interested in these products, other financial

institutions and products may appear in the market. Since the menu of Islamic

financial institutions and products is continuously growing,

Takaful

Conventional non-mutual insurance is not permitted in Islamic finance for two

primary

reasons. First, the insurer-insured relationship does not comply with Shariah

teachings as it involves the trading of uncertainty. This trading is similar to

gambling (qimar), and thus forbidden. The second reason stems from the

investment practices of insurance companies, which often hold interest-bearing

assets. On the other hand, takaful is based on the concept of mutuality among

insured parties, as in conventional mutual insurance.







Islamic banking is steadily moving into an increasing number of conventional

financial

systems. It is expanding not only in nations with majority Muslim populations, but

also in

other countries where Muslims are a minority, such as the United Kingdom or

Japan.

Similarly, countries like India, the Kyrgyz Republic, and Syria have recently

granted, or are considering granting, licenses for Islamic banking activities. In

fact, there are currently more than 300 Islamic financial institutions spread over

51 countries, plus well over 250 mutual funds that comply with Islamic principles.

Over the last decade, this industry has experienced growth rates of 10-15

percent per annum—a trend that is expected to continue.



Islamic Banking Concepts and Paradigm

In Islam, there is no separation between mosque and state. Business, similarly,

cannot be separated from the Islamic religion. The Shariah (Islamic law) governs

every aspect of a Muslim’s religious practices, everyday life, and economic activities.

Muslims, for example, aren’t allowed to invest in businesses considered non-halal or

prohibited by Islam, such as the sale of alcohol, pork, and tobacco; gambling; and

prostitution. 5 In Islamic contracting, gharar(uncertainty and risk) is not permitted, i.e.,

the terms of the contract should be well defined and without ambiguity. For example,

the sale of fish from the ocean that has not yet been caught is

prohibited.

• Musyarakah contracts are similar to joint venture agreements, in which a bank

and an entrepreneur jointly contribute capital and manage a business project. Any

profit and loss from the project is shared in a predetermined manner. The joint

venture is an independent legal entity, and the bank may terminate the joint venture

gradually after a certain period or upon the fulfillment of a certain condition.

• Mudarabah contracts are profit-sharing agreements, in which a bank provides the

entire capital needed to finance a project, and the customer provides the expertise,

management handlebar. The profits from the project are shared by both parties on a

pre-agreed (fixed ratio)basis, but in the cases of losses, the total loss is borne by the

bank. Most theoretical models of Islamic banking are based on the maharajah (profit-

sharing) and/ormusyarakah (joint venture) concepts of PLS (Dar and Presley, 2000).



There are, however, other financing contracts that are permissible in Islam but not

strictly PLS in nature. Such financing contracts, for example, may be based on

murabaha (cost plus), ijarah (leasing), bai’ muajjal(deferred payment sale), bai’

salam (forward sale), and istisna (contract manufacturing) concepts.

• Murabaha financing is based on a mark-up (or cost plus) principle, in which a bank

is authorized to buy goods for a customer and resell them to the customer at a

predetermined price that includes the original cost plus a negotiated profit margin. 8

This contract is typically used in working capital and trade financing.

• Ijarah financing is similar to leasing. A bank buys an asset for a customer and then

leases it to the customer for a certain period at a fixed rental charge. Shariah

(Islamic law) permits rental charges on property services, on the precondition that

the lessor (bank) retain the risk of asset ownership.

• Bai’ muajjal financing, which is a variant of murabaha (cost plus) financing, is

structured on the basis of a deferred payment sale, whereby the delivery of goods is

immediate, and the

repayment of the price is deferred on an installment or lump-sum basis. The price of

the

product is agreed upon at the time of the sale and cannot include any charge for

deferring payments. This contract has been used for house and property financing.

• Bai’ salam is structured based on a forward sale concept. This method allows an

entrepreneur to sell some specified goods to a bank at a price determined and paid

at the time of contract, with delivery of the goods in the future.

• Istisna contracts are based on the concept of commissioned or contract

manufacturing, whereby a party undertakes to produce a specific good for future

delivery at a pre-determined price. It can be used in the financing of manufactured

goods, construction and infrastructureprojects.9The acceptability of the above non-

PLS modes of financing, however, has been widely debated and disputed because

of their close resemblance to conventional methods of interest-based financing.

Many Islamic scholars, including Pakistan’s Council of Islamic Ideology, have

warned

that, although permissible, such non-PLS modes of financing should be restricted or

avoided to prevent them from being misused as a “back door” for interest-based

financing.

PRELIMINARIES BEFORE INTRODUCING ISLAMIC BANKS

Owing to the growing demand by the Muslim population in Western countries and

also to the increasing interest of Islamic investors (mostly from the Gulf region) to

diversify

geographically their portfolios, conventional banks are increasingly becoming

interested in entering the market of Islamic financial products. Unfortunately, it is

often the case that these institutions, as well as the supervisory agencies

overseeing them, are not entirely familiar with the gamut of principles governing

Islamic banking.

Besides the well-known Quran admonishment against riba (interest), gharar and

maisir

(contractual uncertainty and gambling), and haram industries (prohibited

industries such as those related to pork products, pornography, or alcoholic

beverages), there are other

principles that must be observed by practitioners and supervisors in order to

comply with

Islamic jurisprudence.

Practitioners need to understand these principles in order to be able to provide

the services and products demanded by consumers that want to comply with

Islamic principles. At the same time, supervisors need to know the challenges

that these new financial products and institutions will impose on the regulated

entities, as well as the potential implications of the interaction between Islamic

and conventional banks.

This section reviews four areas of paramount importance that practitioners and

supervisors need to appreciate in order for Islamic banking to be successfully

introduced into a conventional system: (i) compliance with the Shariah, (ii)

segregation of Islamic and conventional funds, (iii) accounting standards, and (iv)

awareness campaigns.1

Shariah Compliance

Islamic finance in based on the principles established by the Shariah as well as

other

jurisprudence or rulings, known as fatwa, issued by qualified Muslim scholars.

Admittedly, some of the issues covered by these rulings can be quite complex,

forcing the institutions involved to often seek the assistance of experts in

interpreting them.

As a result, it has become a common practice for Islamic banks to appoint their

own board ofShariah scholars. Nevertheless, since expertise in these matters is

still relatively scarce in some countries, different Islamic banks often share the

same scholars. This phenomenon has the beneficial side-effect that it promotes

consistency across the services and products offered by these institutions.

Therefore, the first measure that an institution wishing to offer Islamic products

must

undertake, is to appoint a Shariah board or, at a very minimum, a Shariah

counselor. This

initial step is essential for the future operations of the institution, as it will help

minimize

Shariah risk, which is the risk that the terms agreed in a contract do not

effectively comply with Islamic jurisprudence and thus are not valid under Islamic

law. In consequence, the contract could be declared (partially) void in a Shariah

court.



The importance of seeking Shariah expertise can be emphasized by means of an

example,

drawn from Wilson (1999). Kleinwort Benson was a pioneering investment bank

which setup an Islamic investment fund in London in 1986. The fund aimed at

drawing funds from the Gulf region. Initially, the fund experienced difficulties in

attracting investors, as it lacked Shariah board, and thus it was viewed with

reticence by Gulf investors. After some time, Shariah board was appointed and

the fund took off successfully.

Financial regulators should also appoint their own Shariah experts, which would

provide

advice on the instruments and services offered by the institutions in their

jurisdiction.

Consultation with these experts would be crucial to ascertain whether the

regulations issued by the supervisor with regard to Islamic institutions, as well as

the licensing of different activities, are compatible with Islamic principles. An

additional important aspect for the regulator is that its rulings and decisions are

consistent with those of the Shariah boards of foreign supervisory agencies. An

important effort towards

achieving international consistency was the creation of two multilateral

institutions: (i) the Accounting and Auditing Organization for Islamic Financial

Institutions (AAOIFI), which issues internationally recognized Shariah standards

on accounting, auditing, and governance issues; and (ii) the Islamic Financial

Services Board (IFSB), which issues standards for the effective supervision and

regulation of Islamic financial institutions. The roles of the two institutions are

discussed in more detail below.

Finally, the Islamic Fiqh Academy, inaugurated in 1988 in Jeddah under the

auspices of the Organization of the Islamic Conference, has earned the respect

of Muslim scholars around the world. Although not officially binding, its rulings

and opinions on economic and financial matters are certainly taken into

consideration by Islamic finance practitioners and policy-makers.

Islamic Investment Banking

An additional channel through which Islamic finance is swiftly penetrating

conventional

systems is via investment banking activities. Indeed, in an increasing number of

Western

countries, conventional banks are offering products specifically designed to

attract Shariahcompliantinvestors.

In the last few years, the proliferation of Islamic instruments has been

spectacular, and has encompassed a vast range of modalities: from sovereign

sukuks (such as the €100 millionsukuk issuance by the German state of Saxony-

Anhalt in 2004), to corporate sukuks (like thefirst-ever US sukuk, issued by the

Texas-based oil group East Cameron Partners for an amount of US$166 million),

and to more sophisticated investment vehicles (such as SociétéGénérale’s

pioneering Shariah-compatible hedge fund5). These deals often arise from the

interest by borrowers to tap the large pool of resources available in the Gulf

Cooperation Council (GCC) and some Asian countries, as well as from the

lenders’ desire to avail themselves of investment opportunities in Western

countries while complying with Islamic jurisprudence.

Although these types of products are likely to flourish—particularly in countries

with

sophisticated conventional financial systems—there is a disconnect between the

growth

prospects of the Islamic investment banking and retail banking industries in

Western

countries. The advancement of the latter is tied to the geographical and

demographical trends of the Muslim population in these nations, whereas Islamic

investment banking benefits from today’s high cross-border capital mobility.

(To be continued………….)









Muhammed ali palassery ithikkal

Ref:

1. PWC.COM

2. www.rhbislamicbank.com.my