REGULATRORY FRAMEWORK

OF ISLAMIC FINANCIAL
INSTITUTIONS
TOPIC 4
ASSOC. PROF. DR. NORAIZA CHE AWANG
LEARNING OUTCOME;
TO DISCUSS THE REGULATORY AND GOVERNANCE FRAMEWORK OF ISLAMIC FINANCIAL
INSTITUTIONS
 Regulatory Framework of Islamic Financial
Institutions (IFI) (Local and International)
Local
Malaysian Accounting Standards Board (MASB)
Bank Negara Malaysia (BNM)
Securities Commission (SC)

International
Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)
Islamic Financial Services Board (IFSB)
International Accounting Standards Board (IASB)
INTRODUCTION

 Shari’ah principles are the foundation for the practice

of Islamic finance.
 Full compliance of Shari’ah principles will lead to public
confidence on the financial markets and on the
credibility of Islamic finance operations.
 The Islamic finance industry in Malaysia are divided into
two sectors:
 The Islamic banking system
 The Islamic capital market system
 INTRODUCTION
 Each sector has a regulatory body that governs the operations of the
respective industry players:

Sector Regulatory body

Islamic banking system Bank Negara Malaysia
(BNM)
Islamic capital market Securities Commission (SC)
system
Relevant Local Acts governing the
Islamic Financial Services industry:

 Insurance Act 1966

 Islamic Banking Act 1983
 Takaful Act 1984
 Banking and Financial Institution Act 1989
 Capital Markets and Services Act 2007
 Central Bank of Malaysia Act 2009
Federal level

 National Council for fatwa

MASB
 Established under the Financial Reporting Act 1997 (the Act) as an
independent authority to develop and issue accounting and financial
reporting standards in Malaysia.
 The MASB together with the Financial Reporting Foundation (FRF) make up
the new framework for financial reporting in Malaysia.
This new framework comprises an independent
standard-setting structure with representation
from all relevant parties in the standard-setting
process, including preparers,users,regulators and
the accountancy profession.
Bank Negara Malaysia (BNM)
Established on 26 Jan 1959, governed by Central Bank of M’sia Act 2009

Role of BNM:
 To promote monetary stability and sound financial structure.
 To act as banker and financial adviser to the government.
 To issue currency and keep reserves, safeguarding the value of the
currency.
 To influence the credit situation to the advantage of the country
Bank Negara Malaysia (BNM)

2-tier Shari’ah governance infrastructure:

 A centralised Shari’ah Advisory Council (SAC) at the BNM
 An internal Shari’ah Supervisory Board in each IFI.
 Advise BNM & IFI on Islamic
1 SAC @ BNM banking & Takaful operations
(Central
Authority Body) Issue fatwa that is binding on
all IFIs

Responsible & accountable

for decisions, views &
IFI opinion on Shari’ah matters
Shari’ah review

Perform oversight
role
Shari’ah Shari’ah audit
Committee /
Shari’ah
Supervisory
Disclosure in annual report state of compliance
Board

Source: Abdul Rahman (2007), BNM ( 2011)

 Reference body to
BNM
Validates all Islamic
BNM-SAC banking and takaful
products
Advisor to BNM

 Established May 1997 as the highest Shari’ah authority

in Islamic finance in Malaysia.
 Has the authority to issue resolutions for the purposes
of Islamic banking business, takaful business, Islamic
financial business, Islamic development financial
business, or any other business which is based on
Shari’ah principles and is supervised and regulated by
BNM.
 Every institution offering Islamic products and services
are required to elect its own Shari’ah Committee (ShC)
to advise on the operations of business in accordance
with Islamic principles.
 Reference body to
BNM
Validates all Islamic
BNM-SAC banking and takaful
products
Advisor to BNM

 As per the Central Bank of Malaysia Act 2009, SAC is the

sole authoritative body on Shari’ah matters pertaining
to Islamic banking, takaful and Islamic finance. SAC
rulings will apply to the court and arbitrator for any
proceedings relating to Islamic financial business and
such rules will be binding.
 Consists of prominent Shari’ah scholars, jurists and
market practitioners.
 Provide the ShC with sufficient resources, such as
budget allocation, independent expert consultation,
reference materials, and familiarise the ShC with the
operations of the bank.
IFIs level-IFI responsibilities

The responsibilities of the IFI are:

 To refer to the ShC on all Shari’ah issues.
 Adopt and take necessary measures for the
implementation of the ShC’s advice.
 Obtain the ShC’s validation on all Shari’ah issues and
documentation.
 Provide the ShC with access to relevant records,
transactions, manual and other relevant information.
IFIs level-ShC

The duties and responsibilities of the ShC are:

 Advise the Islamic bank.
 Endorse documentation.
 Assist the SAC of SC to distribute information.
 Ensure compliance.
BNM Guidelines

 Resolutions of SAC of BNM.

 Guidelines on Corporate Governance for Licensed
Islamic Banks (Revised BNM/GP1-i)
 Guidelines on the Governance of Shari’ah Committee for
the Islamic Financial Institutions.
 Shari’ah Governance Framework for Islamic Financial
Institutions.
BNM Guidelines
Resolutions of SAC of BNM.
The main objectives of the guide are to:
 Disseminate Shari’ah resolutions issued by the SAC.
 Facilitate Islamic financial institutions in developing
financial products by providing reference in Shari’ah
matters; and
 Promote harmonisation of Shari’ah interpretation is
Islamic finance industry.
Resolutions of SAC of BNM:
Issues discussed

Topics Issues raised

Mudharabah Floating Islamic Negotiable Instrument of
Deposit
Mudharabah Current Account
Wadiah and Mudharabah Current Account
Indicative Rate in Islamic Banking
Mudharabah Investment Certificate
Administrative Costs in Mudharabah Deposit
Account
Collateral in Mudharabah
Intra-day Transaction
Musharakah Financing based on Musharakah Mutanaqisah
Mutanaqisa Contract
h
Tawarruq Deposit Product and Financing based on
Resolutions of SAC of BNM:
Issues discussed

Topics Issues raised

Bai’ ‘Inah Bai’ ‘Inah Transaction in the Money Market
Islamic Credit Card based on Bai’ ‘Inah
Revisiting the Rulings on Bai’ ‘Inah
Hibah Hibah in the Contract of Al-Ijarah Thumma Al-
Bai’
Hibah in Takaful Industry
Hibah for Loan Contract (Qardh)
Hibah in Inter-Bank Mudharabah Investment
Contract
Kafalah Deposit Insurance Scheme
Credit (Debt) Guarantee
Qardh Qardh Hasan Terminology
Liquidity Management Instrument based on
Qardh
Resolutions of SAC of BNM:
Issues discussed

Topics Issues raised

Ta’widh Imposition of Ta’widh in Islamic Financ
Ta’widh on Debt Judgement
Ibra’ Ibra’ Clause in Financing Agreement
Ibra’ in Variable Rate Bai’ Bithaman Ajil
Product
Wa’d Sale and Buy-back Agreement (Repo)
“When Issue” Transaction
Forward Foreign Currency Transaction
Accepting Customers’ Deposit
of Funds Islamic Financing Insured by Conventional
from Insurance
Unlawful
Sources
BNM Guidelines: Guidelines on
Corporate Governance for Licensed
Islamic Banks (Revised BNM/GP1-i)

The guidelines contains broad principles dealing with:

1. Board matters;
2. Management oversight;
3. Accountability and audit; and
4. Transparency.
 BNM Guidelines: Guidelines on
the Governance of Shari’ah
Committee for the Islamic
Financial Institutions.
The main objectives of this guideline are to:
 Set out the expectations of BNM on an IFIs Shari’ah governance structures,
processes and arrangements to ensure that all its operations and business
activities are in accordance with Shari’ah;
 Provide a comprehensive guidance to the board, ShC and management of
the IFIs in discharging its duties in matters relating to Shari’ah; and
 Outline the functions relating to Shari’ah review , Shari’ah audit, Shari’ah
risk management and Shari’ah research.
BNM Guidelines: Shari’ah Governance
Framework for Islamic Financial
Institutions.
Primary objective:
 To enhance the role of the board, the ShC or Shari’ah
Supervisory Board (SSB) and the management in relation
to Shari’ah matters.
This includes enhancing the relevant key organisations
having the responsibility to execute the Shari’ah
compliance and research functions to achieve a Shari’ah
based operating environment.
Securities Commission (SC)
 Established on 1 March 1993 under Securities Commission Act 1993
 SC is a statutory body entrusted with the responsibility of regulating and
systematically developing the Malaysia’s capital markets.
Role:
 To protect investor.
 To promote and maintain fair, efficient, secure and transparent securities
& derivative markets and to facilitate the orderly development of an
innovative and competitive capital market
SAC of the Securities
Commission (SC)
 Shari’ah Advisory Council (SAC) of SC established in
1996.
 SAC’s most important function is to endorse the
permissible or permitted counters in its list of Shari’ah
compliant securities.
 The role of the counter is to facilitate Muslim’s
investors’ participation in acquiring Shari’ah compliant
financial assets.
 The counter revises and publishes the Shari’ah
compliant securities list every six months.
SAC of the Securities
Commission (SC)
 The objectives of SAC are to harmonise Shari’ah
interpretations, strengthen the regulatory and
supervisory oversight of the industry and foster a pool of
competent Shari’ah advisor.
 Uses both the qualitative and quantitative approaches
of analysis to decide whether a security is Shari’ah
compliant or otherwise – introduced since 1995.
SAC of the Securities Commission(SC)
 The qualitative approach is used to scrutinise the
business activities of companies. SAC agree that
securities that fall into the categories listed below must
be excluded:
1. Operations based on riba (interest) involving
financial institutions such as commercial and
merchant banks and finance companies.
2. Operations involving gambling activities.
3. Activities involving the manufacturing or sale of
non-permissible (forbidden in Shari’ah’s point of
view) products such as pork, liquor and non-
slaughtered meat and
4. Operations in the presence of gharar (uncertainty),
elements such as conventional insurance
SAC of the Securities
Commission (SC)
If companies are involved in both
permitted and Shari’ah non-compliant
securities, the following criteria
should be used:
1. The core activities must be those
conforming to Shari’ah Guidelines.
Non permissible element must be very
small compared to the non-
permissible activities;
2. The public perception of the company
must be good or accepted as a
SAC of the Securities
Commission (SC)
Benchmark of Shari’ah non-compliant securities
that may be allowed for securities to be granted
Shari’ah adherence status using the quantitative
approach of analysis:
SAC of the Securities Commission (SC)
1. A 5% benchmark of non-permitted activity when non-
permissible elements are inseparable from the
operation of the business: apply to riba from
conventional financial institutions.
2. 10% ‘ulum balwa’ – involve the general public which are
unavoidable: generated from fixed deposits from
conventional banking institutions and income received
from the tobacco business.
3. 20% for the mixed contribution of rental received by the
companies that are not Shari’ah compliant: premises
used for gambling and sale of liquor.
4. 25% - for income generated from unlawful Shari’ah
activities that are regarded as highly important for the
development of society.
 INTERNATIONAL
Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)
Islamic Financial Services Board (IFSB)
International Accounting Standards Board (IASB)
INTERNATIONAL FATWA
ISSUING BODIES
Under the Organisation of the Islamic Conference and Al-
Azhar University:
 Majma’ al-Fiqh al-Islami
 Rabitah al-alam al-Islami
Among the functions:
 To produce fatwa and answer questions posed by
Muslims or non-Muslims.
AAOIFI
Accounting and Auditing Organisation for
Islamic Financial Institutions (AAOIFI)
 Bahrain based.
 It is the main international organisation that formulates
and publishes accounting, auditing, ethics, governance
and Shari’ah standards for the Islamic finance industry.
AAOIFI

The objectives are:

 To develop accounting and auditing thoughts relevant to
Islamic financial institutions;
 To disseminate accounting and auditing thoughts
relevant to IFIs and its applications through training,
seminars, publication of periodical newsletters, carrying
out and commissioning of research and other means;
 To prepare, promulgate and interpret accounting and
auditing standards for IFIs; and
 To review and amend accounting and auditing standards
for IFIs.
 AAOIFI
 The relevant governance standards:

Standard Number Details

Governance Standard for Shariah Supervisory Board: Appointment, Composition
IFIs No. 1 (GSIFI-1) and Report
Governance Standard for Shari’ah Review
IFIs No. 2 (GSIFI-2)
Governance Standard for Internal Shari’ah Review
IFIs No. 3 (GSIFI-3)
Governance Standard for Audit and Governance Committee for Islamic
IFIs No. 4 (GSIFI-4) Financial Institutions
Governance Standard for Independence of Shariah Supervisory Board
IFIs No. 5 (GSIFI-5)
Islamic Financial Services
Board (IFSB)
Objectives:
1. To promote the development of a prudent and
transparent Islamic financial service industry through
introducing new or adapting existing, international
standards consistent with Shari’ah principles and
recommending these for adoption.
Islamic Financial Services
Board (IFSB)
Objectives:
2. To provide guidance on the effective supervision and
regulation of institutions offering Islamic financial products
and to develop for the Islamic financial services industry
the criteria for identifying, measuring, managing and
disclosing risks, taking into account international standards
for valuation, income and expense calculation, and
disclosure.
Islamic Financial Services
Board (IFSB)
Objectives:
3. To liaise and cooperate with relevant organisations
currently setting standards for the stability and the
soundness of the international monetary and financial
systems snd those of the member countries.
4. To enhance and coordinate initiatives to develop
instruments and procedures for efficient operations and
risk management.
Islamic Financial Services
Board (IFSB)
Objectives:
5. To encourage cooperation among member countries in
developing the Islamic financial services industry
6. To facilitate learning and personnel development skills.
7. To undertake research into, and publish studies and
surveys on, the Islamic financial services industry.
8. To establish a database of Islamic banks, financial
institutions and industry experts.
IASB

 Find out about IASB and we will discuss this in the

tutorial!