UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for January 25, 2011

Further Development of the Malaysian Islamic Financial System

 

 

After establishing the initial structure of its Islamic Financial System, Malaysia instituted several more developments, which has allowed it to emerge as one of the most well-known countries in the world with an established and reputable Islamic Banking Establishment.

In 1984, the Malaysian Parliament passed the Takaful Act to allow the setting up of Takaful companies in Malaysia.

Furthermore, an Islamic Capital Market was developed, which comprises an equity market, government securities, and a corporate bond market (private debt securities).  ‘The Islamic capital market, similar to the conventional capital market, refers to the market in longer term financial assets, comprising all public and private debt instruments with various maturities, corporate stocks, and shares for which there are no fixed maturity periods, and commodity futures, issued, managed and traded based on Islamic principles.’

Malaysia also developed an Islamic equity market.  ‘The Islamic equity market is characterized by the absence of interest based transactions, doubtful transactions, and stocks of companies dealing in unlawful activities and items.  The principles governing the Islamic equity market includes the principle of moderation on the part of the investors not to expose themselves to the risk of fluctuations in the price of shares, either in quoted or unquoted shares.  The investors are prohibited to deal with all unethical and immoral practices, ensuring that the funds are clean and pure according to Sharia’h…(In addition) There must be complete ownership as this ensures that the buyer will get the item contracted for in the Bai’ (trading) contract.’

Furthermore, a government securities market was developed to allow the purchase or trade in Malaysian government securities, Malaysian treasury bills, and other such instruments.  In 1983, Malaysia passed the Government Investment Act to enable the government to issue non-interest bearing investment certificates called government investment certificates (GIC).   The certificates were issued on the basis of Qard al-Hasan (benevolent loan) ‘whereby the purchase of the investment certificates by the public will be considered as a benevolent loan by the public to the government to enable the government to undertake projects or provide services to the benefit of the nation.’  Under the terms of the GIC, the purchaser of the GIC would be entitled to the principal amount paid for the GIC to be returned at maturity.  Even though the GIC holder would not expect a return, the government always provides some type of return to the investors, the amount being at the discretion of the Malaysian government.

In a bid to further strengthen its Islamic Financial System, Malaysia also developed its Islamic private debt securities market.   In 2002, the average size per issue was RM 118.5 million. Islamic PDS and long-term straight bonds were the preferred methods of funding during 2002 and accounted for more than 50% of total issuance in 2002.  In fact, since then Islamic PDS has exceeded the issuance of conventional bonds in Malaysia.  ‘Islamic PDS attracted a wider range of investors, including both Islamic and conventional institutional funds.’   In order to further develop the Islamic private debt securities market, the Malaysian government announced in 2003 that it would give a tax deduction for expenses incurred in using any Islamic PDS that adopts Mudharabah, Musharakah, or Ijarah principles for five years starting from 2003.

In addition, the Malaysian government strengthened Labuan as an International Islamic Offshore Financial Center.

*Information taken from the Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

Developing an Islamic Financial/Banking System in Malaysia

 

There are several main requirements for an Islamic banking system including a broad variety of instruments; a large number of players; an Islamic Inter-bank money market; effective and comprehensive regulation and planning; and strong dispute resolution mechanisms.

In Malaysia, for example, after developing a large number of Islamic financial instruments, the government developed a scheme to allow existing conventional financial institutions to offer Islamic banking services in 1993.  All commercial, finance, and merchant banks and eventually discount houses (1999) were allowed to participate in this scheme (Skim perbankan Tanpah Faedah or SPTF later changed to the name Perbankan Islam or IBS).  From 1999 onwards, all banking institutions participating in the IBS scheme were required to upgrade their Islamic Banking Unit to an Islamic Banking Division.  According to the authors, ‘the IBD was required to carry out all aspects of Islamic banking such as banking services and full-fledged Islamic banking branch supervision and administration including product development, training, etc.”

Furthermore, an Islamic Inter-bank money market (IIMM) was introduced in the Malaysian financial system in January of 1994, which linked all institutions and instruments together.  The IIMM covers Inter-bank trading in Islamic financial instruments, Al-Mudharabah Inter-bank investment, and an Islamic Inter-bank Cheque Clearing System.    Islamic banks and banks under the IBS are allowed to trade in Islamic financial instruments.  Al Mudharabah Inter-bank investment refers to a mechanism whereby a surplus IBS bank can invest in another IBS bank, which has a deficit on the basis of Al Mudharabah (profit-sharing).  A new cheque clearing system was introduced, which separated Islamic and conventional cheques for clearing purposes and is also based on the principle of Al Mudharabah.

Therefore, the Malaysian Islamic Banking System has met several of the criteria for establishing an effective Islamic Banking System.  It has developed a wide variety of products, has a large number of players, and has an Inter-bank money market.  It is regulated by the Central Bank and other relevant institutions to a certain degree.  However, Malaysia and the rest of the world still lacks an effective dispute resolution system for Islamic finance disputes, which would preserve the industry and ensure its survival into the future.

*Information taken from the Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance