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					                     ISLAMIC BANKING

Scope of business activities
Eligibility criteria
Modes of entry
Islamic banking business in international currencies
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
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
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
An applicant wishing to establish an IIB
shall observe the following general eligibility
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
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
               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;
                           c) risk management plan and the reporting
                        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
                        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).

                       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
                  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
                   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;
                          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
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
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,
Conventional non-mutual insurance is not permitted in Islamic finance for two
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
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
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
 • 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
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
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
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
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
(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
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
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
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

The importance of seeking Shariah expertise can be emphasized by means of an
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
advice on the instruments and services offered by the institutions in their
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
systems is via investment banking activities. Indeed, in an increasing number of
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
sophisticated conventional financial systems—there is a disconnect between the
prospects of the Islamic investment banking and retail banking industries in
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
         1. PWC.COM

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