Legal and Regulatory Frameworks of Islamic Banking and Takaful in Malaysia PDF

LEGAL AND REGULATORY FRAMEWORK OF ISLAMIC BANKING AND TAKAFUL IN MALAYSIA  Outline Legal Framework of Islamic Banking and Takaful Legislations Applicable Central Bank of Malaysia Act 2009 (CBMA) Islamic Financial Services Act 2013 (IFSA)...

LEGAL AND REGULATORY FRAMEWORK OF ISLAMIC BANKING AND TAKAFUL IN MALAYSIA  Outline Legal Framework of Islamic Banking and Takaful Legislations Applicable Central Bank of Malaysia Act 2009 (CBMA) Islamic Financial Services Act 2013 (IFSA) Financial Services Act 2013 (FSA) Development Financial Institution Act 2002 (DFIA) Contracts Act 1950 National Land Code 1965 Stamp Duty Act 1949 Real Property Gains Tax Act 1979 Hire Purchase Act 1967 Anti-Money Laundering and Anti-Terrorism Financing and Proceeds of Unlawful Activities Act 2001Act 2001 (AMLATFPUA) Dispute Resolution for IBT Court Adjudication Alternative Dispute Resolution (Arbitration, Mediation and Ombudsman) Legal Framework on Islamic Banking and Takaful Legal Framework Shariah Advisory Dispute Legislations Council Resolutions Outside Enabling Transaction Court Court Laws Laws System System Legislations Applicable for Islamic Banking and Takaful in Malaysia Applicable Legislations Enabling Laws Transaction Laws Central Bank of Contracts Act 1950 Malaysia Act 2009 Islamic Financial National Land Code Services Act 2013 1965 Financial Services Act Stamp Act 1949 2013 Development Financial Real Property Gains Institution Act 2002 Tax Act 1979 Hire Purchase Act 1976 Anti Money Laundering and Anti Terrorism Financingand Proceeds of Unlawful Activities Act 2001 2001  The Enabling Laws Main statutes which provide for the regulation of IBT in Malaysia Central Bank of Malaysia Act 2009 Islamic Financial Services Act 2013 Financial Services Act 2013 Development Financial Institutions Act 2002 CENTRAL BANK OF MALAYSIA ACT 2009 (CBMA) Repeals CBMA 1958 Act that provides for the functioning of BNM as financial regulator in Malaysia The principal objects of the Bank shall be to promote monetary stability and financial stability conducive to the sustainable growth of the Malaysian economy. The primary functions of the Bank are as follows: (a) to formulate and conduct monetary policy in Malaysia; (b) to issue currency in Malaysia; (c) to regulate and supervise financial institutions which are subject to the laws enforced by the Bank; (d) to provide oversight over money and foreign exchange markets; (e) to exercise oversight over payment systems; (f) to promote a sound, progressive and inclusive financial system; (g) to hold and manage the foreign reserves of Malaysia; (h) to promote an exchange rate regime consistent with the fundamentals of the economy; and (i) to act as financial adviser, banker and financial agent of the Government.  Important Provisions on Islamic Finance “Islamic financial business” means any financial business in ringgit or other currency which is subject to the laws enforced by the Bank and consistent with the Shariah; Sec 2(1) The financial system in Malaysia shall consist of the conventional financial system and the Islamic financial system. Sec 27 Establishment of SAC of BNM as the authority for ascertainment of Islamic law on Sec Islamic financial business 51-58 The power of BNM to issue circulars, guidelines, etc on Shariah matters Sec 59 The Bank shall, in co-operation with the Government or any Government agency, statutory body, supervisory authority or international or supranational organization, Sec develop and promote Malaysia as an international Islamic financial centre. 60(1) ISLAMIC FINANCIAL SERVICES ACT 2013 (IFSA) The Act that provides for: the regulation and supervision of Islamic financial institutions, payment systems and other relevant entities the oversight of the Islamic money market and Islamic foreign exchange market promote financial stability and compliance with Shariah Consolidates the Islamic Banking Act 1983 (IBA) & Takaful Act 1984 (TA) and repeals both Enforced on the 30th June 2013 – except paragraphs 1 to 10 and paragraphs 13 to 19 of Schedule 9 which come into force on 1st January 2015  Important provisions of IFSA Sec 2 Definition Part III, Div. 1 & 2 Licensing and Approval (Sec 8 to 16) Part IV, Div. 1 & 3 Shariah Requirements (Sec 27 to 36) Part VI Prudential Requirements Part IX Business Conduct and Consumer Protection Sec. 83 – 96, 140 – 142, 286 – 287, Schedule 8, 9 & 10 Takaful Provisions Part XVI Enforcement and Penalties What is Licensed Islamic bank? Sec. 2 (1) of IFSA 2013: – Licensed Islamic bank means a person licensed under section 10 to carry on Islamic banking business and includes a licensed international Islamic bank What is Islamic banking business? Sec. 2 (1) of IFSA: Islamic banking business means the business of: (a) accepting Islamic deposits on current account, deposit account, savings account or other similar accounts, with or without the business of paying or collecting cheques drawn by or paid in by customers; or (b) accepting money under an investment account; or (c) provision of finance; and (d) such other business as prescribed under section 3 Note: Sec 3 : any business or activity prescribed by the Minister as an additional to the definition of Islamic banking business.  What is provision of finance? Sec. 2(1) of IFSA; “provision of finance” means entering into, or making an arrangement for another person to enter into, the businesses or activities which are in accordance with Shariah including: (a) equity or partnership financing, including musyarakah, musyarakah mutanaqisah and mudarabah; (b) lease based financing, including al-ijarah, al-ijarah muntahia bi al tamlik and al-ijarah thumma al-bai’; (c) sale based financing, including istisna’, bai’ bithaman ajil, bai’ salam, murabahah and musawamah; (d) currency exchange contracts; (e) fee based financing including wakalah; (f) purchase of bills of exchange, certificates of Islamic deposit or other negotiable instruments; and (g) the acceptance or guarantee of any liability, obligation or duty of any person Authorised Business under IFSA Licensed business Approved business Islamic banking business Payment system International Islamic Designated Islamic banking business payment instrument Takaful business Takaful broking business International Takaful Islamic financial advisory business business  Financial Institutions governed by IFSA Conventional Financial Institutions Islamic Financial Institutions approved under FSA to carry on Islamic financial business Islamic banks Commercial or investment banks International Islamic banks carrying on Islamic banking business Takaful Operators Insurance brokers carrying on takaful Operators of Islamic payment system broking business Issuers of Islamic payment Operators of a payment system instruments engaged in Islamic financial business Islamic financial advisers Issuers of a designated payment instruments issuing a designated Islamic payment instrument Financial adviser carrying on Islamic financial advisory business  Statutory Requirements for Licensing of an Islamic Bank 1 Must be a public company [sec. 21(1)] Maintain the minimum capital fund or surplus of assets over liabilities as prescribed by the Minister [sec. 12(1)]; 2 and Schedule 1 and 2 of IFS (Minimum Amount of Capital Funds or Surplus of Assets over Liabilities (Licensed Person) Order 2013. Must pay an authorisation fee or annual fee and 3 processing fee as prescribed by BNM [sec. 23(1) and Schedule 1 of Islamic Financial Services Fees Regulation 2014]  Procedure for Licensing Sec 8 Sec 9 Sec 10 No Application to License to be person/institution BNM granted by shall carry on Supporting Minister upon any authorised documents as recommendatio business unless required by n by BNM licensed by BNM Upon the grant Minister upon of licence, the recommendation licensed of BNM person/ institution shall commence business within the prescribed period  Shariah Requirements Shariah Shariah Audit on Shariah Compliance Governance Compliance Sec 27 - 29 Sec 30 - 36 Sec 37-38  Shariah Compliance Institution refers to authorized person or operator of a Sec 27 designated payment system Ensures that its aims and operation, business affairs Sec. 28(1) & (2) and activities are in compliance with Shariah at all times i.e. compliance with the ruling of the SAC Notifies BNM on any non Shariah compliant activity, Sec 28(3) immediately stop from such activity and submit rectification plan to BNM within 30 days Penalties for contravention subsection of 28(1) or 28(3): Sec 28(5) imprisonment for a term not more than 8 years, fine not exceeding 25 million ringgit, or both  Shariah Compliance Sec 29(3) Complies with the Shariah standards specified by BNM Ensures its internal policies are consistent with the Sec 29(4)(a) standards specified by BNM Manages its business, affairs and activities in a manner Sec 29(4)(b) which is not contrary to Shariah Complies with its internal policies and procedures Sec 29(5) adopted by the institution to implement the standards specifiedJ by BNM Penalties for contravention of subsection 29(1): Sec 29(6) imprisonment for a term not more than 8 years, fine not exceeding 25 million ringgit, or both.  Shariah Governance Establishment of Shariah Committee Sec. 30 Sec 31 Appointment of Shariah Committee Sec 32 Duties of Shariah Committee Sec 33 Cessation as member of Shariah Committee Notice of cessation as member of Shariah Sec 34 Committee Sec 35 Information to be provided to Shariah Committee Sec 36 Qualified privilege and duty of confidentiality Audit on Shariah Compliance BNM may require an institution to appoint any person Sec. 37 (1) to carry out an audit on Shariah compliance. The person appointed shall have such duties and Sec 37 (2) functions as may be specified by the BNM and shall submit a report to BNM The remuneration and expenses of the person Sec 37 (3) appointed shall be borne by the institution. A person appointed shall not be liable for a breach Sec 37 (4) of duty of confidentiality Audit on Shariah Compliance BNM may appoint any person to conduct an audit on Shariah compliance: (a) if the institution fails to appoint such person Sec 38 (1) (b) in addition to the person appointed (c) under any other circumstances as BNM deems appropriate The person appointed shall have such duties and Sec 38 (2) functions as may be specified by the BNM and shall submit a report to BNM A person appointed shall not be liable for a breach of duty of confidentiality Sec 38 (3)  Prudential Requirements [Sec. 57 – 58] BNM may specify Prudential standards At all times, an Islamic standards on include: bank must: prudential matters to promote: the sound financial standards relating to comply with the position of an capital adequacy, standards institution; or liquidity ensure its internal integrity, corporate governance policies and professionalism and risk management procedures are expertise in the related party consistent with the conduct of business, affairs and activities of transactions standards an institution maintenance of manage its business, reserve funds affairs and activities in takaful funds a manner consistent prevention of an with sound risk institution from being management and used for criminal governance practices activities. which are effective, accountable and transparent. Business Conduct and Consumer Protection [Sec. 135 (1)(2)] The standards includes standards relating to: transparency and disclosure requirements including the provision of information to BNM may specify standards financial consumers that is accurate, clear, on business conduct to timely and not misleading; ensure that a financial service provider is fair, responsible fairness of terms in a financial consumer and professional when contract for financial services or products; dealing with financial promotion of financial services or products; consumers. provision of recommendations or advice including assessments of suitability Complaints and dispute resolution mechanisms  Prohibited Business Conduct A financial service provider must not engage Sec. 136 (1) in any prohibited business conduct Penalties for any IFIs that involve in prohibited business - imprisonment for a term not Sec. 136(4)] exceeding 5 years or a fine not exceeding RM10 mil or both  List of Prohibited Business Conduct Schedule 7 IFSA Engaging in conduct that is misleading or deceptive in relation to any financial service or product. Inducing or attempting to induce a financial consumer to do an act or omit to do an act in relation to any financial service or product by Exerting undue pressure, influence or using or threatening to use harassment, coercion, or physical force in relation to a financial consumer. Demanding payments from a financial consumer for unsolicited financial services or products. Exerting undue pressure, or coercing, a financial consumer to acquire any financial service or product as a condition for acquiring another financial service or product. Colluding with any other person to fix or control the features or terms of any financial service or product to the detriment of any financial consumer.  Financial Ombudsman Scheme Sec 138 : Establishment of Financial Ombudsman Scheme (FOS) Regulations may be made to require a financial service provider to be a member of FOS to ensure effective and fair handling of complaints and to enable the resolution of disputes Where a dispute has been referred to a financial ombudsman scheme, the eligible complainant is not entitled to lodge a claim on such dispute with the Tribunal for Consumer Claims established under the Consumer Protection Act 1999  Enforcement and Penalties – Part XVI ▪ Powers of BNM: to investigate to take administrative action to impose monetary penalty to take civil action in court to compound to publish information in relation to any enforcement action taken under the Act & the outcome of the actions  FINANCIAL SERVICES ACT 2013 (FSA) FSA repeals the following Acts: Banking and Financial Institutions Act 1989 (BAFIA), Exchange Control Act 1953, Insurance Act 1996 Payment System Act 2003 (sec. 271) Provides for the regulation and supervision of the conventional financial institutions and related matters Before FSA, conventional banks participating in Islamic banking business were governed by BAFIA – sec. 124 Sec 14(1)(a) of IFSA allows licensed bank and licensed investment bank under FSA to carry on Islamic financial business subject to approval by BNM  Conventional bank operating Islamic banking business (Islamic banking window) ▪ Sec. 15(1) of FSA: provides for approval for a conventional bank (a licensed bank or licensed investment bank) to carry on Islamic banking business ▪ Sec. 15(2) of FSA: The bank shall be subject to: the provisions of IFSA relating to Islamic banking business any standards, notices, directions, conditions, specifications or requirements specified or made under IFSA relating to Islamic banking business In addition to its duties relating to Islamic banking business under IFSA, the bank must observe prudential requirements prescribed by BNM ▪ Sec. 15(3) of FSA: The bank shall: Establish and maintain at all times an Islamic banking fund with a minimum amount as specified by BNM Keep all assets and liabilities of its Islamic banking business separate from its other assets and liabilities in a manner specified by BNM ▪ Sec. 15(4) of FSA: The Islamic banking fund shall: be funded from the capital funds of the bank and other sources of funds specified by BNM be segregated from the capital funds of the bank for the operation of its conventional banking business ▪ Sec. 15(5) of FSA: The assets of the Islamic banking fund shall not be: used for the operation of bank’s conventional banking business subject to the debts or other obligations of the bank in relation to its conventional banking business ▪ Sec. 15(7) of FSA: The board of director of the bank must respect the advice of its Shariah Committee in relation to its Islamic banking business ▪ Sec. 15(9) of FSA: Penalties for operating Islamic banking business without obtaining approval – imprisonment for a term not exceeding 10 years or a fine not exceeding RM50 mil or both.  DEVELOPMENT FINANCIAL INSTITUTIONS ACT 2002 (DFIA) The Act that is applicable for development financial institutions (DFIs) which is referred to as the “prescribed institutions” DFIs have special mandate prescribed by the government related to country’s development such as infrastructures, agriculture, import export etc DFIA 2002 was amended in 2015 incorporating new provisions including specific provisions on Islamic financial business (eg: sec 33A – 33N) DFIs that carrying on Islamic financial business No Name 1 Bank Pembangunan Malaysia Berhad 2 Bank Perusahaan Kecil & Sederhana Malaysia Berhad (SME Bank) 3 Export-Import Bank of Malaysia Berhad (EXIM Bank) 4 Bank Kerjasama Rakyat Malaysia Berhad 5 Bank Simpanan Nasional 6 Bank Pertanian Malaysia Berhad (Agrobank) Important Provisions on Islamic Finance Sec 33A(1) Definition of Islamic financial business Sec 33B(1) A prescribed institution may carry on Islamic financial business upon approval of BNM. Sec 33C(1) A prescribed institution shall establish and maintain at all times a fund for the operation of its Islamic financial business All assets and liabilities of its Islamic financial business shall be kept separated from its other liabilities Sec 33C(2) The fund established shall be funded from the capital funds of the prescribed institutions and other sources of funds The fund shall be segregated from the capital funds of the prescribed institution for the operations of its business or activity other than the Islamic financial business Important Provisions on Islamic Finance Sec 33C(3) The assets of a prescribed institution relating to its Islamic financial business shall not be used to fund the operation of its conventional business. The assets shall not be subject to the debts or other obligations of the prescribed institution in relation to its conventional business. Sec 33D Duty to ensure compliance with Shariah. Failure to comply with Shariah is subject to penalty of 8 years imprisonment or fine of RM25 million or both. Sec 33E Power of BNM to specify standards on Shariah matters and duties of a prescribed institution to comply with the standards Sec 33F – 33L Matters relating to Shariah Committee Sec 33M & 33N Audit on Shariah Compliance  Transaction Laws The application of Islamic banking and takaful involves various aspects of transactions The court in Bank Kerjasama Rakyat Malaysia Bhd v Emcee Corporation Sdn Bhd stated that: “The BBA Facility is an Islamic banking facility. But that does not mean that the law applicable in this application is different from the law that is applicable if the facility were given under conventional banking. The charge is a charge under the National Land Code. The remedy available and sought is a remedy provided by the NLC. The court adjudicating it is the High Court. So, it is the same law that is applicable, the same order that would be, if made, and the same principles that should be applied in deciding the application” The transaction laws that significantly applicable in IB include: Contracts Act 1950 National Land Code 1965 Real Property Gains Tax Act 1976 Stamp Act 1949 Hire-Purchase Act 1967 Anti-Money Laundering and Anti-Terrorism Financing and Proceeds of Unlawful Activities Act 2001 (AMLATFPUA)  CONTRACTS ACT 1950 All Islamic banking and takaful contracts must follow the requirement of a good and valid contract as per the Contracts Act 1950 The elements of contract such as offer and acceptance; the conditions; performance of contracts; remedies etc must be properly observed otherwise the contract cannot be legally enforced The provisions of the Contracts Act that comply with the Shariah principles of ‘aqd are to be applied in IBT agreements  NATIONAL LAND CODE 1965 The Act that provides the law relating to land and land tenure as well as the registration of title to land and land dealings. Islamic banking transactions may involve dealings with land and thus the relevant provisions in NLC are applicable. The provisions that are relevant to Islamic banking transactions include the registration of title of the land and charge. The NLC is relevant due to the fact that the registration of title of the asset/land acquired is one of the important factor to be considered by the bank in granting the Islamic banking facility to the customer; and the entry of charge as one form of security for the indebtedness created by the Islamic banking facility.  REAL PROPERTY GAINS TAX ACT 1979 RPGTA provides for imposition, assessment and collection of tax on gains/profits derived from disposal or acquisition of real property/shares in real property companies IBT transactions may involve purchase and sale of real property between bank and customer that is subject to payment of tax IBT transactions normally involve multiple layers of transactions and thus subject to multiple payment of tax Amendment was made to RPGTA to avoid double taxation on IBT transactions All IBT transactions are subject to single tax similar with conventional banking transactions STAMP ACT 1949 (AMD 1989) The Act that regulates the liability of instruments to stamp duty including IBT documents There are two types of IBT documents that are subject to stamp duty i.e. the principle documents and subsidiary documents Principle documents are subject to ad valorem stamp duty and subsidiary documents are subject to minimum stamp duty (RM10) Example of ad valorem stamp duty Amount of financing Ad valorem tax RM250,000 RM0.50 for every RM1,000 Additional RM1,000 not exceeding RM2.50 for every RM1,000 RM1,000,000 Additional RM1,000 or part thereof RM5.00  HIRE-PURCHASE ACT 1967 This is an Act that regulates the form and contents of hire- purchase agreements, the rights and duties of parties to such agreements. It protects the hirers and guarantors against unscrupulous dealers who directly handle the transaction. Promote justice and avoid oppression while engaging in a commercial transaction. HPA is not specifically meant for Islamic hire purchase facility agreement but its provisions may be applicable. ANTI-MONEY LAUNDERING AND ANTI-TERRORISM FINANCING ACT 2001 (AMLATFPUA) The Act that provides for the offence of money laundering, the measures to be taken for the prevention of money laundering and terrorism financing offences and to provide for the forfeiture of property involved in or derived from money laundering and terrorism financing offences, as well as terrorist property, proceeds of an unlawful activity and instrumentalities of an offence, and for matters incidental thereto and connected therewith. BNM is the competent authority under the (AMLATFPUA) to regulate and enforce the law against financial institutions and/or Islamic financial institutions under its supervision.  Dispute Resolution for IBT Alternative Dispute Court Adjudication Resolutions Court adjudication must be ADR provides for the carried out by a court of amicable resolution of competent jurisdiction disputes outside the formal court procedure IBT matters do not fall under the jurisdiction of the Shariah Includes arbitration, court but the civil court mediation and ombudsman  Jurisdiction of Courts Courts jurisdiction is governed by Federal Constitutions of Malaysia Art 121(1A) : Civil courts have no jurisdiction over matters within the jurisdiction of Shariah courts Jurisdiction of Civil Court Jurisdiction of Shariah Court Civil & criminal procedures Organisation and procedure of Shariah Administration of justice Courts Contracts & mercantile laws Islamic law includes divorce, wakaf, Arbitration Personal law succession, offences Family law against religion of Islam Obviously include banking and finance Jurisdiction only over persons professing Islam (Reference: List I (Federal List) of (Reference: Para I of List II (State List) of 9th 9th Schedule) Schedule)  Jurisdiction of Courts on IBT Jurisdiction of courts on IBT lies in the Civil Court IB comes under contract and mercantile matters provided in Federal List (List I of 9th Schedule) Islamic law (as provided in Para I, List II of 9th Schedule) is limited only to persons professing religion of Islam thus exclude persons of other religion and “legal persons” such as banks and financial institutions who do not profess any religion Case: BIMB v Adnan bin Omar (1994)  Muamalat Court Practice Direction 1/2003 (Haidar CJ) for the establishment of special commercial division in High Court of KL to hear cases on Islamic banking and finance. No special division in High Court in other states. In any proceedings relating to Islamic financial business the court is required to refer to the rulings of the Shariah Advisory Council of BNM. Any ruling made by the Shariah Advisory Council pursuant to the above referral from the court is binding on the court.  Decided Cases on IB Bank Islam Malaysia Berhad v Adnan bin Omar 3 CLJ 735 Bank Kerjasama Rakyat (M) Bhd v Emcee Corp 1 CLJ 625 Tahan Steel Corp Sdn Bhd v Bank Islam Malaysia Bhd 2 MLJ 314 Affin Bank Bhd v Zulkifli Abdullah 1 CLJ 438 BIMB v Lim Kok Hoe 6 CLJ 22 Arab-Malaysian Finance Bhd v Taman Ihsan Jaya 1 CLJ 419 Tan Sri Khalid bin Ibrahim v Bank Islam Malaysia Bhd 7 MLJ 597 Mohd Alias bin Ibrahim v RHB Bank Bhd & Anor 3 MLJ 26 Public Bank Bhd v. Mohd Isa Mohd Nafidah 1 CLJ 274 MK Associates Sdn Bhd v Bank Islam Malaysia Berhad 6 CLJ 95 JRI Resources Sdn Bhd v Kuwait Finance House (M) Bhd (President of Association of Islamic Banking Institutions Malaysia & Anor, interveners) 3 MLJ 561  Arbitration in IBT The Kuala Lumpur Regional Centre for Arbitration (KLRCA) was established in 1978. It was renamed to Asian International Arbitration Centre (AIAC) in 2018 AIAC i-Arbitration Rules 2018 exclusively for handling Islamic financial cases In the event of any dispute for the ascertainment of Shariah issues in Islamic finance, the arbitrator is required to refer to the ruling made by the Shariah Advisory Council. AIAC i-Arbitration Rules is enforceable in all countries that are signatories to the New York Convention.  Mediation for IBT Mediation is a voluntary process in which a mediator facilitates communication and negotiation between parties to assist the parties in reaching an agreement regarding a dispute Mediation in Malaysia is governed by Mediation Act 2012. Islamic finance disputes in Malaysia can be resolved through the mediation process such as: ▪ Court-annexed mediation i.e. the mediation programme using judges as mediators to help disputing parties in litigation to resolve disputes. ▪ Malaysian Mediation Centre i.e. the mediation centre established under the Malaysian Bar Council which provides mediation as an alternative dispute resolution for parties that voluntarily seeking mediation as a means to resolve their disputes.  Financial Ombudsman Scheme Financial ombudsman scheme is a scheme for the resolution of disputes between an eligible complainant and a financial service provider in respect of financial services or products. IFSA 2013 allows for the introduction of the Islamic Financial Ombudsman scheme for the purposes of ensuring effective and fair handling of complaints and for the resolution of such disputes. Pursuant to the above, the BNM set up the Ombudsman for Financial Services (OFS) as an alternative dispute resolution to resolve disputes between Islamic financial institutions licensed or approved by the Central Bank and their customers. OFS is regulated by the Islamic Financial Services (Financial Ombudsman Scheme) Regulation 2015 https://www.ofs.org.my/en/dispute_resolution_process