Issues and challenges for Islamic financial institutions in legal perspective after Islamic Financial Services Act (IFSA) 2013

Prepared for: Madam Khalimah binti Shahidan

NAME MATRIX NO.NURHANIS BINTI MOHD RASHID 221576NUR NADIRAH BINTI NORIZAN 221736NAZIFA AQILAH BINTI MOHD ADAM 221991MIMI ASMIDA BINTI AWANG@NGAH 222021NOOR AIN BINTI MAT ZALI 225983

Objectives

i. To understand the purpose of Islamic Financial Services Act (IFSA) 2013

ii. To examine the key aspects of IFSA 2013

iii. To identify the issues and challenges arises from the establishment of IFSA 2013 to the Islamic financial institutions

iv. To find out the implications of IFSA 2013 to the Islamic financial institutions

Introduction

• Came into effect on 30 June 2013• IFSA 2013 are repealed the various laws:

Islamic Banking Act 1983Takaful Act 1984Banking and Financial Institutions Act 1989Insurance Act 1996Payment Systems Act 2003Exchange Control Act 1953

• To provide a stronger legal foundation to spur the growth of Islamic finance sector

Key aspects of IFSA 2013

• IFSA 2013, consists of 291 sections, 187 pages, divided to eighteen parts. • Our discussion will focus on only specific

parts & sections:Shariah requirementsBusiness conduct & consumer

protection

Shariah Reqiurements

i. Shariah compliance Section 29 allows BNM to set standards on shariah

matter with advise from shariah advisory committee Every director, officer or a member of a Shariah

committee of an institution shall at all times comply with with Shariah standards

If failed to comply with Shariah, Islamic bank be liable to imprisonment for a term not exceeding 8 years or to a fine not exceeding RM 25 million or to both

ii. Shariah Governance Section 30 states that licensed Islamic financial

institutions shall establish a Shariah committee for purposes of advising the institutions to ensure its business, affairs and activities comply with Shariah.

Section 35 states that banks must provide accurate & complete information to shariah advisors in order to perform their duties.

iii. Audit on Shariah compliance Section 37 states that with approval from BNM,

institution can appoint Shariah auditor to carry out an audit on Shariah compliance by the institution

BNM specifies the duties & responsibilities of auditor & auditor shall submit a report to BNM

Section 38 mentions that BNM will appoint shariah auditor when Islamic bank fail to appoint one, and BNM suspects non-shariah compliant activities

Business conduct & consumer protection

i. Business Conduct• Ensuring that a financial service provider is

fair, responsible and professional when dealing with financial consumers ( section 135).

• Islamic financial institutions must be transparent and disclose accurate & clear information to financial consumers

• Section 137, BNM shall approve takaful brokers, financial advisors & issuer of Islamic payment instruments

ii. Consumer Protection Section 149, no person shall accept Islamic deposits

except a license Islamic banks Section 151, no person shall use the word “Islamic

bank” unless such person is licensed under this Act to carry on Islamic banking business

Any person who contravenes these sections, be liable to imprisonment for a term not exceeding 10 years or to a fine not exceeding RM 50 million or to both

PURPOSE OF IFSA 2013

i. Promote financial stability and compliance with Shariah The new Act strengthens regulation of financial institution, Islamic

money market and the Islamic foreign exchange market as well as Islamic instruments

Consumers of Islamic financial services are also required to be protected under the Law

The industry players generally support the introduction of IFSA as it would help create greater transparency, governance and accountability

IFSA intends to strengthen the foundations for end-to-end Shariah governance and compliance

IFSA statutorily enforces management of Shariah non-compliance risk and requires Islamic financial institutions to ensure that their aims, operations, business, affairs and activities are in compliance with Shariah principles at all times

ii. To strengthen regulation of financial institutions IFSA is the culmination of efforts to modernise the laws that

govern the conduct and supervision of financial institutions in Malaysia

The laws also provide Bank Negara Malaysia with the necessary regulatory and supervisory oversight powers

It is important that Malaysia's regulatory and supervisory system is adequately equipped to respond effectively to new and emerging risks

IFSA amalgamate several separate laws to govern the financial sector under a single legislative framework for the conventional and Islamic financial sectors

iii. To implement recommendations under FSAP The objectives of the assessment were to review

developments in the financial sector, assess and formulate recommendations related to financial stability, financial development and the financial sector oversight framework

One of the issues highlighted in the FSAP is that the current regime does not extend appropriately to the supervision and regulation of Financial Holding Companies (FHC)

During the last financial crisis, Bank Negara Malaysia was not able to hold the directors and management of holding companies accountable for wrongdoing because the companies were not financial institutions

Under the IFSA, as long as the FHC deal in banking or financing activities, they fall under Bank Negara’s jurisdiction

Issues in IFSA 2013

i. Final authority on Shariah related matters in IFI: the Board or SC?

The board as ultimate decision maker including on Shariah related matters

SC’s decisions, views and opinions bind the IFI

ii. Assurance of Shariah compliance: the Board’s or SC’s main responsibility?

The Board has ultimate accountability to ensure Shariah compliance

Does SC share the same accountability as the Board for Shariah non-compliance?

Contravention of IFSA 2013 may result to termination of SC’s membership

Shariah matters unresolved by the SC to be escalated to the SAC

iii. Adequate competencies of the SC Oversight function via Shariah audit and Shariah

review Sufficient knowledge in Islamic finance and general

finance Adequate legal, marketing and sales knowledge Active participation required of SC

iv. Rectification of Shariah non-compliance events: reporting to CBM and the SAC

Notification of the Shariah non-compliant events to the SC, the Board and CBM

SC to inform CBM of ineffective or inadequate rectification measures

v. Protection of the Board against penalties under IFSA 2013: is SC recorded as the same?

iv. Public interest as ground of revocation of IFI’s liscense

The challenges arises in IFSA 2013

1. Judicial oversight over the Bank Negara Malaysia (BNM).

2. Potential conflict of interest between shareholders and other stakeholders.

3. Cost and efficiency.

4. Innovation of product and services.

Judicial Oversight over the Bank Negara Malaysia (BNM)

The BNM has more power to determine the Islamic Financial Institution (IFI) and its holding company

Power not only to advise but also to recommend the decision made by the Minister

There must be certain legal mechanism to limit and restrict such authorities and to find the best avenue to review and oversee the BNM’s action

Potential conflict of interest between shareholders and other stakeholders

The Board of Director of an institution shall have regard to the interests of depositors and takaful participants

The IFSA seems to promote stakeholders value based approach in Islamic financial institutions rather than the shareholders value model

Cost and efficiency

The element of strict liability in the IFSA will expose IFIs with further cost and expenses

Since precautions and due diligence have to be exercised to prevent the commission of the offence, any measures to mitigate this legal risk will cost additional expenses

Innovation of product and services

Heavy regulated business environment- may denied innovation or lack of innovation or influence the market behavior and the players will choose for products of lesser constrains

The effect is concentrating on debt-based products and consistently neglecting the equity-based products both from asset and liabilities sides

The Implications of IFSA 2013 to Islamic Financial Institutions (IFI)

Introducing new requirements Shariah compliance

Section 52(1) of the Central Bank of Act 2009 mentioned that, The Shariah Advisory Council shall have the following functions: To determine the Islamic law on any financial matter Is sue a ruling upon reference made to it To advise the Central Bank on any Shariah issue

relating to Islamic financial business To provide advice to any Islamic financial institutions

IFSA 2013 restates the matter by introducing new requirements Shariah compliance

According to section 28, the institution must ensure at all times that their goals and operations, business, and affairs are Shariah compliant

The institution must required to inform the Shariah Advisory Council if there is any fraud or non Shariah compliance happened, so that the necessary procedures can be taken

A rule that will be announced is quite different penalty clause whereby the institution's failure to follow the rules, will be liable to imprisonment not exceeding eight years or pay the fine which is not exceeding RM 250 million or both.

Compare with the provisions under section 46 Islamic Banking Act 1983 which is the penalty will be determined to the director and manager of an Islamic bank who did not take all reasonable steps to compliance with the requirements of the act

Section 50 which provides a fine not more than RM 50,000

Required the Takaful operator with composite business licenses

In Takaful industry, the IFSA required the Takaful operator with composite business licenses to separate the Family takaful and General takaful

The IFSA gives 5 years to the Takaful operate to separate their business of Family takaful and General takaful to became different entities

The intention is to expand the regulator the General Takaful business growth

Consumer impact in transition of deposits

Takaful operator needs to charge the higher price for their products and services to their customers compared to the conventional insurance

For the consumer impact in transition of deposits, customers whose Islamic deposit account are structured based on Shariah contract with the principal guaranteed they will be notified about with alternative products and supplied with enough information or transparency in making the right decision

The customer will have their choice whether to maintain their Islamic deposit funds with or changes to the product investment account depending on the risk appetite of customers

Conclusion

Compliance to Shariah is essential to enhance the confidence of the stakeholders of Islamic financial institutions

Provide greater certainty and predictability to the Islamic financial institutions in order to build public confidence in the system