Thoughts on Economics 1
Thoughts on Economics
Vol. 26, No. 01
The Legal Framework of Islamic Banking and Finance around the WorldMd. Abdul Awwal Sarker*
The paper is a compilation of some internet resources on legal framework on Islamic banking and finance currently practiced by the central banks, Islamic banks and Islamic financial institutions around the world. Some countries have been following the detailed rules and regulations for guiding controlling and supervising the Islamic financial services industry while some of the jurisdictions are a very nascent stage for providing with the conducive Islamic financial architecture. But the trend is very much positive. unlike the Islamic countries the new non-Muslim countries have also been giving level plying field for the Islamic financial services industry. Moreover, the recognition of this challenging paradigm also got serious attention of the multinational bodies like IMF, World Bank, ADB etc. The reader will be able to grasp a first-hand idea about the Islamic financial legal infrastructure throughout the globe.
Introduction
The development of Islamic banking and financial system has started in Asia after the collapse of the British regime immediate after the second world war. Independence of the Muslim countries gave the opportunity to understand and exercise the Islamic finance on their own way. The pioneering theoretical works done by the Islamic revivalists, ulema and economists played the torch-bearing role to actualize the neo-economic system based on Islamic Sharia'h. The first important thing which had attracted attention of the Muslim jurists and economists is to develop legal framework of banking and finance on the basis of Islamic Sharia'h. Several models have been developed and rules and regulations of different Sharia'h-approved modes of financing have also been developed alongside the common and civil laws and regulations. Though the Sharia'h laws and regulations have not been codified as its counterpart, there are several attempts to give a space to think over the issue. The tradition of the Islamic norms regarding banking and finance have been collected in a manner that gave birth of a new discipline called legal framework on Islamic banking and finance. Starting from the Middle eastern countries these attempts have extended over all continents. The regulators of finance and banking jurisdictions of different countries promulgated as guidelines or enacted as laws and acts on Islamic banking and finance.
2. The Islamic financial services industry has come a long way over the last three decades. Today, it is an established industry with a broad array of services and products, operating in nearly 75 countries, managing a global portfolio estimated at more than US$ 250 billion, and still expanding into new geographic areas. As an example of this outstanding growth, the Islamic financial services industry in Kuwait has witnessed swift growth. At the end of the year 2000, there were 10 investment companies operating according to Sharia'h principles, with about US$ 1.4 billion in total assets. Currently, the number of these companies has reached 14 and their total assets have more than tripled to over US$ 5 billion, all in a short four-year period.[1]
3. In general, the presence of an appropriate legal and regulatory structure is vital for an “enabling environment” which provides for healthy development and growth of financial markets. This is especially relevant to the Islamic financial services industry, where the complex nature of Sharia'h-compliant investments and continual innovation of financial products imply varied types and degrees of risk. Moreover, the availability of an appropriate legal and regulatory framework for Islamic banks and financial institutions can contribute to improving their soundness, and accordingly, provide better support to the regulator's role in the regulation and supervision of these institutions. Also, monetary authorities can more effectively execute and manage their monetary and credit policies. Therefore, it could be said that an appropriate legal and regulatory framework for the Islamic financial services industry can nurture an environment that supports its growth, fosters its stability, and safeguards the gains it has realized so far.[2]
4. Perhaps one of the most important challenges facing this Islamic finance industry today is that only a limited number of countries have issued specific laws or regulations governing Islamic banking and finance. The need is therefore pressing for countries which have introduced “Islamic banking” to issue such laws. Having established the need for, and benefits of, a legal and regulatory framework for Islamic banking and finance, one must address its desired features. A key aspect of the needed legal and regulatory framework for Islamic banking and financial institutions is that it should correspond to their particular nature, while at the same time addressing the broad issues common to all financial intermediation, such as the management of contracts, bankruptcy, collateral, and asset recovery. In particular, in regulating the Islamic financial market, the needed legal and regulatory framework must provide a clear definition of an Islamic financial services institution, along with specifying the licensing requirements, particularly with regard to capitalization, scope of activities, prudential dispositions and relationship with the regulatory authorities. Additionally, this legal and regulatory framework needs to allow for both the dynamic nature of Islamic financial services, and the broad objectives and responsibilities inherent in the supervision and oversight of the banking and financialsystem as a whole.[3]
Objectives of the Study
5. The main objective of the study is to survey and review the regulations, rules and acts declared or enacted throughout the world irrespective of Muslim or non-Muslim jurisdictions. Therefore, due to the non-availability of the resources of this kind because of the low information dissemination especially in the OIC countries, an attempt is made to search in the internet. The internet resources available have been used throughout the paper. The subsequent sections are designed to give detailed picture on the stages of development of Islamic legal infrastructure on banking and finance around the globe.
Genesis of the development of legal infrastructure around the world
6.The beginning of the Islamic banking and finance is based on the model developed by the capitalistic concept of banking. The framework taken was akin to the vision of the capitalistic paradigm. No separate framework was thought or designed to adopt Islamic Sharia'h principles to run a separate model of banking. However, under the conventional banking framework, Islamic banking started its pace alongside the conventional banking practices. On the application side of this framework, it is to be noted that since Islamic financial institutions enter into diverse contractual relationships, each with its own risk profile, the supervision and oversight of Islamic banking and finance needs to address the particular nature of these operations. As we all know, in Islamic banking and finance, which is based on an investor-entrepreneur relationship, supervisory practices regarding risk are more complex than in the conventional debtor-creditor relationship. This calls for a specialized and comprehensive framework for the identification, assessment and management of risks inherent in the activity of Islamic financial institutions. Worth noting here is that the Basel Committee’s latest recommendations on the identification of credit, market and operating risks have provided useful guidance in this regard. Similarly, it should be noted that the establishment of the Islamic Financial Services Board (IFSB) in November 2002 was a prominent landmark on the road to the development of prudential, regulatory and supervisory standards specific to the Islamic financial services industry. Since its establishment, the IFSB has attracted growing participation; its membership currently encompasses 15 full members, represented by the regulatory authorities of countries allowing the licensing of Islamic banking and financial institutions, and the Islamic Development Bank, along with 15 associate members and 40 observers. The laudable efforts that the IFSB deploys in providing regulatory advice for the supervision of Islamic banking and financial institutions, along with its quest to achieve convergence in that area, will further promote the development of a prudent and efficient Islamic financial industry with sound practices, and support its further integration into the global financial market. Quite important in this regard, too, is cooperation and coordination among supervisory authorities in laying down the needed regulatory and supervisory rules and regulations for Islamic banking and financial institutions, along with exchanging relevant experiences.[4]
7. However, we have tried to present in this paper an overview of the legal framework of Islamic banking and finance around the world. The first modern experiment involving Islamic banking activities was initiated in Egypt during the 1960’s. Established as an interest-free banking alternative, the bank mainly focused on providing savings facilities based on the profit and loss sharing concept, often referred to as the PLS scheme. However, in order to avoid being viewed as an experiment conducted by Islamic fundamentalist, the pioneer himself, Ahmad El Nagger, decided not to proclaim the bank Islamic. The experiment continued until 1967, by which time there were nine such banks. A few years later, in 1971, the Nasser Social bank was established in Egypt and declared as an interest-free commercial bank, but still no allusion to Islamic law (Sharia'h) was made.
8. Many Muslim majority countries have not yet enacted specific legislation to authorize Islamic banks while most non-Muslim countries do not have specific laws and legislation for Islamic banking. There are few of the selected countries that have made significant efforts to regulate Islamic banks separately from conventional banks such as Malaysia, Iran, Sudan, Indonesia and Pakistan. Iran has taken steps to move their entire banking system entirely toward Shari’ah-based banking system (Iqbal and Mirakhor, 1987). Pakistan and Sudan while initially attempted to move their entire banking system to Islamic banking, have backed off and have mixed systems that include Islamic and conventional banks. Bangladesh, Bahrain, Saudi Arabia, U.A.E, Kuwait, Turkey, Jordan and some other Muslim countries operate Islamic banking alongside conventional banking.[5]
Overview of Types of Islamic Banking System
9. The legal practice governing Islamic banks varies across the selected countries as shown in Table 1. Islamic bank and financial institutions generally operate under three different regulatory regimes: self-regulation through constitutional limitation (i.e. Al-Baraka International Bank); private regulation through government private legislation (i.e. Jordan Islamic Bank); and public regulation through national legislation (Iran). Under the public regulation, Islamic banks operate mainly in three types of operating environments: a) countries whose constitution requires the banking system to be fully Islamic; b) countries having specific enabling Islamic banking legislation; and c) countries that has no specific enabling legislation but have specific regulation and/or provisions under general financial market regulation for Islamic finance. For example, Indonesia, Iran, Malaysia, Pakistan, Sudan, Turkey, UAE and Yemen have enacted Islamic banking laws to facilitate the infrastructure of Islamic banking. However, these laws may not always fully take into account unique characteristics of Islamic banking; for example, in Malaysia, the Islamic Banking Act, 1983 refers to Islamic banking business as lending business whose aims and operations do not involve any element which is not approved by the religion of Islam. For other Muslim countries, such as Saudi Arabia and Jordan, no laws have been enacted to regulate Islamic banks. They therefore operate under the same laws governing conventional banks.[6]
Table-1: Overview of Types of Islamic Banking System[7]
Countries whose constitution requires the banking system to be fully Islamic: / Iran, Sudan, Pakistan (1985-2001) / Pure Banking System
Countries having specific enabling Islamic banking legislation: / Malaysia, Brunei, Indonesia / Dual Banking System
Countries that has no specific enabling legislation but have specific regulation and/or provisions under general financial market regulation for Islamic finance: / UAE, Saudi Arabia, Kuwait, Pakistan (since 2001), Jordan, Bahrain, Singapore, UK. / Parallel Banking
Islamic banking system[8]
Islamic Window to Islamic Subsidiary / Badr, Emirates Islamic Bank, First Gulf Bank, RHB Islamic Bank, ABN AMRO, HSBC Amanah, AFFIN Islamic, Arab Banking Corporation
Conventional Banks to Islamic Banks / Bank Aljazira, Sharjah Islamic Bank, Dubai Bank, Kuwait International Bank, Bank Muamalat, Meezan Bank, Kauthar Bank
Islamic Banking Structure around the World
10. The legal requirements influence the variety of structural forms of institutions that offer Islamic financial services. These restrictions range from allowing conventional banks to open an Islamic window within an existing subsidiary or branch, to setup a full Islamic bank from conventional bank subsidiaries or to establish new Islamic banks. However, the most dominant has been to allow mixed banking whereby Islamic banking coexists alongside conventional banking. For an Islamic finance window, the bank operates a window within a conventional bank where customers can access Islamic-finance products. Islamic windows are more prevalent in non-Muslim countries (Muslim minority) and in the developed countries. In the Middle East and large Muslim population countries, Islamic subsidiaries and new Islamic banks are more common. In many cases this may be a more cost efficient way for an existing bank to enter. Conventional banks with considerable customer bases might decide to establish an Islamic subsidiary.[9]
11. This could allow a bank to offer a wider range of Sharia'h-compliant banking products in the Islamic market. A fully Islamic banking system only permits Sharia'h-compliant financial services. It is in countries with a predominantly Muslim population that a tendency towards full Islamisation is more likely to develop. Three notable examples of this trajectory among the countries are Iran, Sudan and Pakistan. Iran's transition towards a fully Islamic financial system started with the enactment of the 1983 Usury Free Banking Law, which abolished interest-based banking operations in Iran. Similarly, Sudan pursued the full Islamization of its financial system with the promulgation of the 1992 Banking Law, which aimed at eliminating interest from banking, as well as from all government transactions. On the other hand, Pakistan has taken the same step for full Islamization of its financial system but has been declared un-Islamic by Pakistan's Islamic court, (the Federal Shari at Court) in 1991.[10]
12. In order to provide the legal foundations for the regulation and supervision of Islamic banks, it is necessary that either the general banking laws or specific laws pertaining to Islamic banks define in detail the nature of these banks and their specific operating relationship with the central bank and other conventional banks if applicable. Such a legal framework should contain provisions relating to licensing, permissible modes of financing and state clearly power to address compliance with laws and regulations. In particular, such provisions should determine which enterprises may call themselves Islamic banks, collect deposits and carry out banking practices on the basis of Islamic principles. Moreover, laws should state clearly that the central bank (or a separate supervisory authority) has the authority and all necessary powers to supervise Islamic banks and conventional banks.[11]
13. To date, although a few of the selected countries have specific legislation for Islamic banks to regulate Islamic banks, while most of the countries have specific provision under general legislation and specific regulation (with the exception of Saudi Arabia and Turkey). For example, Malaysia has specific enabling legislation for Islamic banking (IBA, 1983) with respect to licensing, financial requirements and duties, ownership, supervision and management, restriction of business, and powers of supervision and control over Islamic banks. Similarly, Indonesia has also passed a new Islamic banking law in 2008 that will allow commercial banks to be converted into Shari’ah-compliant ones and for foreign entities to set up Islamic banks in cooperation with Indonesian partners. Bangladesh has also issued Islamic banking guidelines in 2009 to indicate the roles and functions of the Islamic banks, establishment of Islamic subsidiaries or branches by the conventional banks and for conversion of conventional banks into Islamic one. However, in Jordan, Islamic banks are dealt under the common banking law similar to conventional banks with specific provisions with respect to definition of Islamic bank and banking activities, objectives, condition and restrictions to comply in the operation, calculation of investment risk and liquidation, Shari’ah supervisory board, tax, account and financial statement.[12]