Legal and Regulatory Framework of Islamic Banking and Finance in Malaysia

The main statute that sets out the jurisdiction of the courts in Malaysia is the Federal Constitution 1957 (FC). Article 121 of the FC establishes the jurisdictions of courts in Malaysia, and dictates that the civil court has no jurisdiction over matters within the jurisdiction of the Shariah Court.

The jurisdiction of the civil courts covers all matters conferred by federal and state law, except for the personal law of Muslims.

The civil court’s jurisdiction is specifically laid down in List I — Federal List, Ninth Schedule of the FC. This includes matters on civil and criminal procedure and the administration of justice, contracts, mercantile laws, arbitration and so on. This will obviously include banking and financial laws.

On the other hand, the Shariah court’s jurisdiction is laid down in Para 1 of List II — State List of the Ninth Schedule. However, the jurisdiction of the Shariah court is limited to matters in Para 1 only, and it has no jurisdiction over any criminal offenses, except as provided by federal law.

In essence, Para 1 includes matters pertaining to Islamic law, and personal and family law of persons professing the religion of Islam, including divorce, wakaf, succession, and offenses against the religion of Islam (except which is in the federal law).

Based on the above provisions in the FC, it can be concluded that the jurisdiction over Islamic banking and finance matters rests with the civil court, as it is within List I of the Ninth Schedule on mercantile law.

Although the term “Islamic law” in Para 1 of List II is wide, its application is limited to persons professing the religion of Islam. Thus, it has no general application to other persons and legal persons, such as banks and financial institutions, which cannot be construed to be professing the religion of Islam.

Furthermore, the legislations on Islamic banking and finance are all federal legislations that are subject to the civil courts’ jurisdiction. There has not been any state legislation on Islamic banking and finance matters.

This conclusion is further supported by the decided cases in Malaysia, where the civil courts have heard and decided on Islamic banking and finance matters.

Examples are Tinta Press v Bank Islam Malaysia Berhad [1986] 1 MLJ 474; Bank Islam Malaysia Berhad v Adnan bin Omar [1994] 3 CLJ 735; and Dato Hi Nik Mahmud bin Daud v BIMB [1996] 1 CLJ 576 (High Court); [1998] 3 MLJ 396 (Supreme Court).

In all these cases, the civil courts had used the civil law and procedures in reaching their decisions. Apparently, the civil courts did not consider whether the application of the existing law and would have contradicted the Shariah or affect the validity of the documents.

The reported cases also indicate that the courts had always based their decisions on the current banking laws regime without making any reference to the underlying Shariah principles that apply to the Islamic banking and finance (IBF) facility in dispute.

The full extent and impact of the courts’ decisions on Islamic banking and finance transactions will be considered later.

However, it is proposed that the Malaysian courts take into consideration the attitude of the English Court of Appeal in the recent case of Shamil Bank of Bahrain v Beximco Pharmaceuticals Ltd and Others [2004] EWCA CIV 19, [2004] All ER (D) 280 (Jan), where it indicated its willingness to consider Shariah principles and obtained evidence from the Shariah experts before making its decision.

Legal infrastructure in Malaysia

•Islamic Banking Act 1983 (IBA)
Introduced to govern the operations of Malaysian Islamic bank(s), it was the first legal infrastructure to facilitate Islamic banking in Malaysia. There was also an amendment to the Government Investment Act 1983 to facilitate both (Islamic) statutory reserves and liquidity reserve requirements, which were to be interest-free.

This was followed by the enactment of the Takaful Act 1984 (TA) to allow for the licensing and operation of Islamic insurance (Takaful) companies in Malaysia.

Then, there was the amendment in 1996 to section 124 of the Banking and Financial Institutions Act 1989 (BAFIA) to allow banks licensed under the Act to introduce Islamic banking business.

The IBA mainly provides for the licensing and regulation of Islamic banks and Islamic banking business in Malaysia. Subsequently, the IBA was amended in 2003, and became the Islamic Banking (Amendment) Act 2003.

An analysis of the provisions in the IBA shows that the Act is regulatory in nature and does not provide for the substantive law for Islamic banking. There have not been specific thoughts of meeting the requirements and expectation of the Shariah since the clauses used are mainly derived from the conventional banking practices and the existing banking laws.

Moreover, the main legislative framework for Islamic banking in Malaysia is actually based on civil laws and falls within the jurisdiction of the civil courts.

There are also ambiguities in the Islamic Banking Act 1983. For example, there is no definition of banking business in the IBA. By way of comparison, BAFIA provides a definition of banking business in section 2(1), which provides:

(a) the business of —
(i) receiving deposits...;
(ii) paying or collecting cheques;
(iii) provision of finance...

In addition, the term “Religion of Islam” has not been defined. This may give rise to ambiguity as to the position of the Islamic legal schools (madhhab) in the interpretation of the catch-all phrase “approved by the Religion of Islam” used in IBA.

This difficulty is somewhat mitigated by the existence of a Shariah advisory body (SAB) for the Islamic bank as required by the IBA, essentially to safeguard and ensure Shariah ompliance. The general rule to be observed in IBF is ensuring that there is no contravention of any Shariah principles in the transactions; for example, all transactions must be free from the elements of usury, dubiousness and gambling.

A new section was also added to the IBA in the 2003 amendment.
Section 13A provides:

(1) An Islamic bank may seek the advice of the Syariah Advisory Council on Syariah matters relating to its
banking business and the Islamic bank shall comply with the advice of the Syariah Advisory Council.

(2) In this section, “Syariah Advisory Council” means the Syariah Advisory Council established under subsection 16B(1) of the Central Bank of Malaysia Act 1958.

This amendment enables Islamic banks to seek the advice of the Shariah Advisory Council (SAC) of Bank Negara Malaysia (BNM); and it is mandatory for the Islamic banks to comply with the advice given by the SAC pursuant to such request. This indicates that the SAC has advisory powers over the Islamic banks,  where liaison and common understanding between the SAB and SAC are expected. This will also ensure that Shariah compliance is always strictly observed and adhered to by the Islamic bank with the advice of the SAC.

The liaison with the SAC can also facilitate a shorter time frame in endorsing any new products in IBF. Nonetheless, nothing in the IBA provides for a minimum qualification of lawyers who are involved in IBF documentation and litigation. There is no specific requirement that lawyers dealing with Islamic banking transactions should have the relevant qualifications in drafting the documents.

Generally, this lack of necessary knowledge of the Shariah and Islamic law could lead to mistakes in drafting and also risks on the legality of the documents, especially for non-compliance with the Shariah principles.

•Banking and Financial Institutions Act 1989 (BAFIA)
Conventional banks licensed under BAFIA are allowed to carry out IBF business in addition to their conventional banking business, provided that they consult BNM.

According to section 124 of BAFIA, a licensed institution may carry on Islamic banking business or Islamic financial business, provided that BNM is consulted before Islamic banking and financial business is carried out.

Under BAFIA, Islamic banking business has the same meaning as that in the IBA, while Islamic financial business is defined in section 124(7)(c) as:

“... any financial business, the aims and operations of which do not involve any element which is not approved by the Religion of Islam”.

Section 124(3) and (4) of BAFIA further provide that any licensed institution carrying on Islamic banking business or Islamic financial business may refer to BNM’s SAC and shall comply with the directions on Islamic  banking business or Islamic financial business issued by BNM in consultation with the SAC.

However, it should be noted that under section 124(5) of BAFIA, the licensed institutions under the Act are not Islamic banks but conventional banks offering IBF services. Previously, these IBF services were known as “Skim Perbankan Tanpa Faedah” (SPTF) windows. Now, they are known as Islamic banking divisions.

Other significant amendments

•Central Bank of Malaysia Act 1958
The Central Bank of Malaysia Act 1958 (CBA) provides for the establishment of the National Shariah Advisory Council (SAC) at BNM. An amendment was made to the CBA in 2003 to enhance the power and integrity of the SAC.

The SAC is now the authority for ascertainment of Islamic law for the purposes of Islamic banking business, Islamic financial business, Takaful business, Islamic development financial business and any other business that is based on Shariah principles and is supervised and regulated by BNM.

The amended CBA also provides that no member of the SAC can be a member of any Shariah body, or act as a Shariah consultant or Shariah adviser with any banking institution or other financial institution.

Further, the CBA provides that any court or arbitration proceedings involving Shariah issues may refer to BNM’s directive or refer to the SAC for ruling. The ruling by the SAC may be considered by the court, and is binding in an arbitrator.

Under the CBA, Islamic banking business has the same meaning as that in the IBA whereas “Islamic financial business” has been defined in section 16B(12) to mean “financial business whose aims and operations do not involve any element which is not approved by Syariah”.

The CBA also deems all advice by the previous SAC as valid.

•Stamping and taxation
An amendment was made in 1989 to section 14A of the Stamp Act 1949 to avoid double stamp duty for Islamic financing documents.

Further orders were issued to give equal status to Islamic financing documents in terms of stamp duties — Stamp Duty (Exemption) Order 1996; the Stamp Duty (Remission) (No 4) Order 1996; the Stamp Duty (Exemption) (No 6) Order 2003; the Stamp Duty (Exemption) (No 2) Order 2004; the Stamp Duty (Exemption) (No 3) Order 2004; and the Stamp Duty (Remission) Order 2004.

An amendment was also made in 1985 to the Real Property Gains Tax Act 1979 to avoid double taxation on IBF transactions. In another recent development, the tax chargeable on all Islamic leasing or Ijarah financing will be at par with conventional leasing.

New developments
Recently, a bill on Islamic hire purchase was drafted in order to provide an Islamic alternative to the existing Hire Purchase Act 1967 to govern Islamic hire purchase transactions. Nevertheless, t is not certain as to when the bill will be passed by the Malaysian Parliament.

There have also been efforts to establish an Islamic tribunal panel to solve disputes pertaining to Islamic banking outside the court, following the procedures of the Code of Arbitration In addition, efforts have been made to solve problems pertaining to some provisions in BAFIA regarding the acquisition of shares and immovable property, towards facilitating Islamic banks or Islamic banking divisions to carry out Islamic banking transactions, especially in offering Musharakah and Mudarabah types of financing.

BNM has also established legal working committees to identify and look into the possibilities of re-moving
other legal impediments to the development of IBF. These include a review of various Acts of Parliament,
such as the Companies Act 1965, the National Land Code 1965 and the Contracts Act 1950.

For example, the central bank is looking into substantial value ransaction under section 132C of the Companies Act, which requires the approval of shareholders for such transactions. This may cause problems to the practice of immediate sale and repurchase of assets under Islamic financing transactions which may amount to substantial value transactions under the Act.

Also, if the Islamic banking transaction involves the use of shares as underlying assets, it may be hindered by the requirements in section 69E to G of the Companies Act for notification of interests to the company in all transfers and retransfers of substantial interest in shares.

There is also a need to remove the “interest” or riba element from some of the sections in the Companies Act. Examples are:

•Section 69,
which provides that where share capital is raised to defray expenses of construction of any works or buildings which cannot be made profitable in the long period, the company may pay interest on such share capital and charge such interest as part of construction cost.

•Section 285(1),
which provides for investment or placing of deposit at interest with any bank of surplus funds of a company in liquidation.

•Section 286(3),
which provides that interest arising from the investments of unclaimed moneys of companies in liquidation be paid into the companies’ liquidation account. While significant advances have been made in the legal and regulatory framework relating to IBF since its introduction in Malaysia in 1983, it is also true that such advances have failed to keep pace with phenomenal development both in Malaysia and elsewhere.

Globalization and the frequent interface and collaboration between conventional bankers and Islamic inanciers have given rise to not only a proliferation of new players but also the rapid introduction of novel and intricate forms of Islamic products and services.

There is, therefore, a need for the legal system of Malaysia to be not just responsive to these challenges but also to be proactive in anticipating and dealing with such issues as may surface from time to time if Malaysia is to realize its ambition of becoming a global leader in the industry.