Shariah Governance of Islamic Banking in Malaysia

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Shariah Governance of Islamic Banking in Malaysia Sherin Kunhibava*

Abstract This research explores and evaluates how Shariah governance is ensured in Malaysia. Since Malaysia is not an Islamic state subjected to Shariah, it will be interesting to note how Shariah law is governed in the practice of Islamic banking in Malaysia. To evaluate how compliance with Shariah governance is achieved this paper divides its application into two distinct levels, one at a micro and the other at a macro level. The organs ensuring compliance with Shariah governance at a micro level are the Shariah Advisory Boards of Islamic banks, and the adoption of the Shariah Governance Framework by Islamic financial institutions. At a macro level there is the National Shariah Advisory Council of the Central bank, the Shariah Advisory Council of the Securities Commission, and legal redress through the civil courts and arbitration. The role of each organ will be explained and evaluated. I. Background In Malaysia Islamic banking assets have reached USD65.6 billion, with an average growth rate of 18–20% annually.1 Recently the Prime Minister of Malaysia commented that Malaysia has been maintaining its leadership in Islamic banking and finance for over three decades.2 Malaysia’s position at the forefront of Islamic banking and finance can be attributed to a number of reasons, which include inter alia a comprehensive legal and Shariah governance infrastructure for Islamic banking and finance.3 Islamic banking is the conduct of banking in accordance with the principles of Shariah. Shariah is often simply defined as Islamic law, but a better and far more accurate definition is as follows: Shariah refers to a “code of law or divine

* Sherin Kunhibava PhD is a Senior Lecturer at the Law Faculty in University Malaya and can be contacted at [email protected] or [email protected]. 1 BNM, “Islamic Banking Industry”: www.bnm.gov.my/microsites/financial/0204_ib_takaful. htm#ib (accessed August 3, 2011). 2 Islamic finance is the conduct of banking and finance in accordance to the principles of Shariah. 3 Mohd Razif bin Abd Kadir, Opening Remarks by Deputy Governor at the 2nd Foundations of Islamic Finance Series Conference: “Islamic Banking Products: Theory, Practice & Issues”, Bank Negara Malaysia www.bnm.gov.my/index.php?ch=9&pg=15&ac=398 (accessed November 23, 2011).

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injunctions that regulate the conduct of human beings in their individual and collective lives”.4 This research critically analyses the regulatory approach of Malaysia on how it ensures adherence to Shariah law and governance in the application and practice of Islamic banking and finance. Malaysia is chosen because of its advanced position in Islamic banking and finance and because of its comprehensive legal and regulatory dual system, that is, where conventional banking functions parallel to Islamic banking. Shariah governance is a new term in the Islamic banking world. Its definition can be gathered from the Shariah Governance Framework5 (SGF) and the Islamic Financial Services Board’s (IFSB’s)6 principles. The SGF states that the Central Bank of Malaysia “places great importance in ensuring that the overall Islamic financial system operates in accordance with Shariah principles”. This is to be achieved through the two-tier Shariah governance infrastructure comprising two vital components, which are:

• a centralised Shariah advisory body at the Central Bank and,



• an internal Shariah Committee formed in each respective Islamic financial institution (IFI).7

Principle 3.1 of the IFSB Guiding Principles on Corporate Governance8 states that an appropriate mechanism must be created to ensure the compliance with Shariah principles. 4 Muhammad Ayub, Understanding Islamic Finance (West Sussex: John Wiley & Sons Ltd, 2007), p 21. 5 The Central Bank of Malaysia or Bank Negara developed the Shariah governance framework effective January 1, 2011 for Islamic Financial Institutions with the primary objective of enhancing the role of the Board of Directors, the Shariah Committee, and the management in relation to Shariah matters, “including enhancing relevant key organs having the responsibility to execute the Shariah compliance and research functions aimed at the attainment of a Shariah based operating environment”: see BNM, “Shariah Governance Framework” (2011): www.bnm.gov.my/guidelines/05_shariah/02_Shariah_Governance_ Framework_20101026.pdf (accessed August 5, 2011). 6 IFSB is an international standard-setting body of regulators and supervisory agencies that have interest in the soundness and stability of the Islamic financial services industry. The work of the IFSB complements that of the Basel Committee on Banking Supervision, International Organisation of Securities Commission, and International Association of Insurance Supervisors. One of the objectives of the IFSB is to promote the development of a prudent and transparent Islamic financial services industry. 7 BNM, “Shariah Governance Framework”: supra, n 5. 8 IFSB, “Guiding Principles on Corporate Governance for Institutions Offering Only Islamic Financial Services (Excluding Islamic Insurance (Takaful) Institutions and Islamic Mutual Funds)”: www.ifsb.org/standard/ifsb3.pdf (accessed November 2, 2011).

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Similarly, Principle 7.1 of the IFSB Guiding Principles on Risk Management9 states that an IFI shall have in place adequate systems and controls, including a Shariah Board or adviser to ensure compliance with the Shariah principles. Hence, it can be understood from these two sources that “Shariah governance” is ensuring Shariah is properly administered within an IFI through adequate systems and in particular through the Shariah advisory body within an IFI and a centralised Shariah Advisory Council. Shariah compliance is what differentiates Islamic banking and finance from conventional banking. The existence of non-Shariah compliant elements would not just affect the confidence of the public in Islamic banking and finance but would also expose an IFI to risks such as fiduciary and reputational risks. The Malaysian legal system is actually one of common law, the country being a former colony of the British Empire. According to Article 3(1) of Malaysia’s Federal Constitution Islam is the religion of the Federation; however, Malaysia’s laws are secular. According to Malaysia’s Federal Constitution Article 160(2)(b), “Law” includes: written law, the common law in so far as it is in operation in the Federation or any part thereof and any custom usage having the force of law in the Federation or any part thereof.

As can be seen from the definition of “law” there is no mention of Islamic law in the Federal Constitution. In fact, Shariah is governed by State enactments in Malaysia which are introduced by State legislature with the approval of the Sultan; every State has its own jurisdiction on the matter.10 Application of Shariah may, thus, not be uniform in the various States and it is limited to family matters. Legal redress of Islamic family law matters takes place in the Shariah courts. Thus Islamic law in Malaysia is confined to Islamic family law. Islamic banking and finance on the other hand is governed by both Shariah and also the law of the land. Islamic banking business must be in accordance to Shariah: this means that the banking must be Shariah compliant and have no elements of inter alia, riba (interest), excessive risk or uncertainty (gharar), gambling (maisir and qimar), or information asymmetry and ignorance (jahala) in Islamic banking transactions. Business and trade activities should take place on the basis of fair and legitimate (halal) profit, there should be giving of zakah (alms tax), and monopoly is prohibited.11

9 IFSB, “Guiding Principles of Risk Management for Institutions (Other Than Insurance Institutions) Offering Only Islamic Financial Services”: www.ifsb.org/standard/ifsb1.pdf (accessed December 2, 2011). 10 See Malaysia’s Federal Constitution 9th Schedule, List II para 1 of the State List. 11 See Muhammad Ayub, supra, n 4.

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Islamic banking is also governed by laws of the land or conventional laws.12 In Malaysia these conventional laws are: the Islamic Banking Act 1983 which covers Islamic banks, the Takaful Act 1984 which governs the Islamic insurance industry, the Banking and Financial Institutions Act 1989 (BAFIA) which governs conventional banks offering Islamic banking products and services, and the Central Bank Act 2009 (CBMA) which has provisions on the establishment, appointment and authority of the National Shariah Advisory Council (NSAC).13 The question is how does Malaysia ensure Shariah governance? In other words, since Islamic banking and finance has to be conducted in accordance with Islamic law how is this Islamic law enforced in Malaysia where the laws are secular in nature? After all Islamic law in Malaysia is confined in its application to Islamic family matters, so how does Malaysia ensure that its Islamic banking and finance industry is adequately administered and governed by Shariah? These are the issues that will be critically assessed in this paper. II. Shariah governance in Islamic banking and finance To answer the questions posed, a bird’s eye view of Shariah governance has to be made. Shariah governance in Malaysia is carried out at a micro level and also at a macro level. Micro level means governance at the level of the IFI, whereas macro level means governance from a national level. The methods through which Malaysia ensures Shariah governance are illustrated below: Table 1: Shariah governance in Malaysia At a Micro Level

At a Macro Level

Shariah Advisory Boards of Islamic banks

National Shariah Advisory Council (NSAC) of the central bank of Malaysia

Shariah Governance Framework for Islamic financial institutions

Shariah Advisory Council of the Securities Commission Legal redress through a dedicated division in the civil courts and through arbitration

The above table is explained in greater detail below.

12 Conventional laws in this paper will be taken to mean laws enacted by a state (e.g. legislation) or judiciary (e.g. case-law) and exclude Shariah law (Islamic law) 13 See Part VII of the Central Bank Act 2009.

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A.  Shariah governance at a micro level Shariah governance is ensured at a micro level, at the level of an Islamic bank through the Islamic Banking Act 1983. The Islamic Banking Act 1983 defines an “Islamic bank” as any company that carries on Islamic banking business and has a valid licence.14 “Islamic banking business” is defined under the same section as “any banking business whose aims and operations do not involve any element which is not approved by the religion of Islam”. The “religion of Islam”, however is not defined by the Islamic banking Act 1983. The question then occurs how it is ascertained, what is approved according to the religion of Islam, and whether the activities of the Islamic bank conform to Islamic teachings? This is answered by s 3(5)(b) of the Islamic Banking Act 1983, whereby every bank that wants to practise Islamic banking must establish a Shariah Advisory body (also known as the Shariah Advisory Committee or Shariah Supervisory Board) to advise the bank on the operations of its banking business to ensure that the bank complies with the “religion of Islam”. Thus this Shariah Advisory body ensures that Shariah is complied with by the Islamic bank. In Malaysia conventional banks licensed under the BAFIA are also allowed to carry out Islamic banking and finance business in addition to their conventional banking business, after consulting the Central Bank of Malaysia, known as the Islamic Banking Scheme (IBS). Under BAFIA, s 126 “Islamic banking business” has the same meaning as in the Islamic Banking Act 1983, whilst “Islamic financial business” is defined as any financial business the aims and operations of which do not involve any element which is not approved by the religion of Islam. These Islamic Banking Scheme banks must also appoint a Shariah Advisory Board just like Islamic banks.15 1. Shariah Advisory Board The Shariah Advisory Board is defined by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)16 as: an independent body of specialised jurists in fiqh mualamat (Islamic jurisprudence). However, the Shariah supervisory board may include a

14 Islamic Banking Act 1983 s 2. Islamic subsidiaries are for all purposes treated as an Islamic Bank governed under the Islamic Banking Act 1983. 15 Para 3.1 Part 1 of the Shariah Governance Framework, supra, n 5. 16 AAOIFI is an Islamic international autonomous non-profit corporate body that prepares accounting, auditing, governance, ethics and Shariah standards for IFIs and the industry: AAOIFI, “Overview” www.aaoifi.com/aaoifi/TheOrganization/Overview/tabid/62/ language/en-US/Default.aspx (accessed November 23, 2011).

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member other than those specialized in fiqh muamalat, but who should be an expert in the field of Islamic financial institutions and with the knowledge of fiqh mualamat. The Shariah supervisory board is entrusted with the duty of directing, reviewing and supervising the activities of the Islamic financial institution in order to ensure that they are in compliance with Islamic Shariah rules and principles. The fatwas and rulings of the Shariah supervisory board shall be binding on the Islamic financial institution.17

According to the OIC Fiqh Academy’s 19th session and decision number 17718 regarding the role of Shariah supervision in regulating the operations of Islamic banks, its importance, stipulations and the way it operates, the Shariah Board must be independent, and in order to achieve that, the following issues must be considered:

• The appointment and removal of Shariah Board members, and the determination of their compensation should be done by a public body.



• The authentication of the aforementioned items will then be done by a central Shariah authority or its representative.



• The members shall not be an executive director in the Islamic financial institution or an employee of the Islamic financial institution or engaged in jobs that are contrary to the role of the Islamic financial institution.

The definition of the Shariah Advisory Board and whether in Malaysia Shariah Advisory Boards are independent will be explored in greater detail below. Appointment and remuneration According to Appendix 2 of the SGF the Board of Directors shall, upon recommendation of its Nomination Committee, nominate the appointment of the members of the Shariah Advisory Board. The appointment and the reappointment of a Shariah Advisory Board member is subject to the prior written approval of the Central Bank and the NSAC. The SGF further provides that in this application the Central Bank may impose necessary conditions it deems fit in addition to the requirements in the SGF. Comparing this to the requirement of the OIC Fiqh Academy’s 177th decision it would seem that since appointment of SAC members must be approved by the Central Bank and the NSAC, this provision on ensuring independence of the Shariah Advisory Board seems to be satisfied.

17 AAOIFI, Accounting, Auditing & Governance Standards (for Islamic Financial Institutions) (Bahrain: AAOIFI, 2010), Governance Standard No 1. 18 International Council of Fiqh Academy, “Decision Number 177 (19/3) Regarding the Role of Shariah Supervision in Regulating the Operations of Islamic Banks, Its Importance, Stipulations and the Way It Operates”: www.isra.my/articles/confererence-series/oic-fiqhacademy/19th-session.html (accessed October 26, 2011).

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Further, according to Appendix 2 of the SGF the Shariah Advisory member cannot be an employee of the IFI or any of its related companies for the current or the last financial year. This again would be in line with the OIC Fiqh Academy’s 177th decision that a Shariah Advisory member cannot be the employee of the IFI. However under Principle 2.4 of the SGF the Board of Directors are encouraged to appoint at least one member of the Shariah Advisory Board as a member of the Board of Directors. According to Principle 2.4 “The presence of a director with sound Shariah knowledge would foster greater understanding and appreciation amongst the board members on the decisions made by the Shariah Committee”. This provision is in direct contradiction to the OIC Fiqh Academy’s 177th decision. It is opined that the Shariah Advisory’s independence might be compromised if the Shariah Advisory Board member sits on the Board of Directors. Further, what would be the duty of the Shariah Advisor, would he/she owe a fiduciary duty to the company as directors do? It is opined that there would be a blurring of lines of responsibility, roles and duties if a Shariah Advisor sits on the Board of Directors. A better option would be for a Shariah Advisor to be invited in certain special occasions to the Board meetings in the event there are Shariah matters that are discussed. The Shariah Advisor should not be a permanent member of the Board of Directors; this is to ensure a clear separation of responsibility, role and duty between the Board of Directors and the Shariah Advisory Board. Each Shariah Advisor is only allowed to sit on one Shariah Board in the same industry.19 This means that each Shariah Board member can only sit on the Shariah Board of one Islamic bank and at the same time can sit on the Shariah Advisory Board of a takaful (insurance) company and the Shariah Advisory Board of a non-banking institution. It is opined such a provision prevents incidences of conflict of interest, preserves secrecy and confidentiality and allows for more new talent to enter the market. However at the same time there may be some very experienced Shariah Advisors who will be restricted from serving more than one Islamic bank and this may deprive the market of excellent expertise; there may also be minimum interaction between experienced and inexperienced Shariah Advisors, since Shariah members are to sit on only one Islamic Bank’s Shariah Advisory Board. Thus while one may see this as a provision to ensure proper governance it does have its fallbacks as well. Duration of the appointment of members for the Shariah Advisory Boards is usually for a term of two years and can be renewed by recommendation of the Islamic bank and upon approval of the Central Bank and the NSAC.20 19 See the Shariah Governance Framework 2011, Appendix 2. This is contrary to the position in the GCC and other parts of the world except Pakistan, where there is no restriction on the number of Shariah committees a Shariah Advisor can sit on. 20 This information was from a Shariah Advisor, currently advising an Islamic Bank in Malaysia.

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According to Principle 2.6 of the SGF, remuneration of the Shariah Advisory members is determined by the Board of Directors as advised by its Remuneration Committee. The SGF further states that such remuneration shall reflect, and be commensurate with, the accountability, duties and responsibilities of the Shariah Advisory Board. This provision is contrary to the requirement of the OIC Fiqh Academy’s 177th decision, which states that compensation must be determined by a public body. If remuneration is decided by the Board of Directors on advice of the Remuneration Committee, would this thwart the independence of the Shariah Advisory member? It would seem so. There could also be instances where remuneration of the Shariah Advisory member is not standardised, some paid higher than others. There should be greater transparency of the amount of remuneration and other perks, if any, Shariah Advisors are entitled to. This is to ensure that shareholders of the IFIs are aware of the costs to the IFI. Qualification The majority of the Shariah members should at least be qualified in the field of Islamic jurisprudence (usul fiqh) or Islamic transaction/commercial law (fiqh Muamalat), however the minority of Shariah members may comprise experts from other relevant backgrounds such as finance and law.21 This enables advisors to be from diverse backgrounds. It is opined that those with financial and legal background are necessary to help the Shariah Advisory Board to make the best possible informed decision. Minimum number appointed It used to be a necessity that the Shariah Advisory Board consists of a minimum of three members; now with the SGF a minimum of five members is necessary of which the majority must have Shariah background.22 The minimum number of committee members has been increased due to the greater number of individuals in the industry who have the necessary expertise. The larger number of Shariah Advisory members also allows a greater number of those who have diverse backgrounds such as in finance and law to be Shariah Advisory members. Duties, responsibilities and reporting The responsibilities of the Shariah Advisory Board according to the SGF include advising the Board of Directors on Shariah matters on the bank’s business operations to ensure that they comply with Shariah principles at all times, to endorse the Shariah Compliance Manuals, to endorse and validate relevant documents, and to ensure proper records for easy reference. The 21 See the Shariah Governance Framework 2011, Appendix 2. 22 Ibid Principle 2.3.

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Shariah Advisors are also required to provide written Shariah opinions or decisions. In discharging its duties, the Shariah Committee is expected to disclose sufficient information in the IFI’s annual financial report on the state of Shariah compliance in the IFI.23 An example of the report that must be signed by each Shariah Advisory board member is found in Appendix 3 of the SGF. Part of the sample Shariah Advisory Board report is shown below: In our opinion:

1. the contracts, transactions and dealings entered into by the ABC Islamic Financial Institution during the year ended XX/XX/XXXX that we have reviewed are in compliance with the Shariah principles (emphasis added);



2. the allocation of profit and charging of losses relating to investment accounts conform to the basis that had been approved by us in accordance with Shariah principles (emphasis added);

(where appropriate, the opinion paragraph shall also include the following matters:)

3. all earnings that have been realised from sources or by means prohibited by the Shariah principles have been considered for disposal to charitable causes (emphasis added); and



4. the calculation of zakat is in compliance with Shariah principles. We, the members of the Shariah Committee of ABC Islamic Financial Institution, do hereby confirm that the operations of the ABC Islamic Financial Institution for the year ended XX/XX/XXXX have been conducted in conformity with the Shariah principles. (Emphasis added.)

The words highlighted (emphasised) above are to add emphasis on the burden or responsibility of Shariah Advisors. Shariah Advisors are no longer mere advice-giving religious scholars, they must now ensure that the transactions and dealings entered into by the IFI are in compliance with Shariah principles, they are required to attest that the operations of the IFI are in accordance with Shariah principles and that all the earnings of an IFI are halal (legitimate). Prima facie this appears to be a heavy burden on these religious scholars. They owe a high level of duty to ensure Shariah compliance. What occurs if they are negligent? What if a deal is found to be non-Shariah compliant, can the IFI now sue the Shariah Advisory member based on the report? Can shareholders sue the Shariah Advisory members? It would seem that from the SGF according to Principle 2 of the SGF, the Shariah Advisory Board is responsible and accountable for all its decisions, views and opinions related to Shariah matters. While this accountability seems burdensome it is opined that Shariah Advisors will now take more care in arriving at their decisions, fatwa (legal opinions/rulings) and carrying out their other duties. The only 23 Ibid Principle 2.9.

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issue is whether the Shariah Advisors themselves are aware of this higher status of responsibility? On this point reference should be made to Principle 2.3 of the SGF which provides that the Board of Directors must ensure that the Shariah Advisory members are aware of their fiduciary responsibilities in discharging their duties. In relation to the delineation of the responsibility of the Board of Directors and the Shariah Advisory Board the SGF makes it clear that while the Board of Directors bears the ultimate responsibility and accountability on the overall governance of an IFI, the Board of Directors is expected to rely on the Shariah Advisory Board on all Shariah decisions, views and opinions relating to the business of an IFI. On reporting, Principle 3.2 of the SGF provides that the Shariah Advisory Board shall report directly to the Board of Directors and regularly inform the Board on relevant Shariah matters. Referral of a question to the National Shariah Advisory Council The Islamic Banking Act 1983 provides that an Islamic bank may seek the advice of the NSAC on Shariah matters relating to its banking business, and the Islamic bank shall comply with the advice of the NSAC.24 Like the Islamic Banking Act 1983 the BAFIA provides that IBS banks may also refer a question to the NSAC and shall comply with directions on Islamic banking business and Islamic financial business issued by Bank Negara in consultation with the NSAC.25 It should be noted that by s 58 of the Central Bank Act of Malaysia 2009, where there is conflict in the ruling given by a Shariah body or committee and the NSAC, the ruling given by the NSAC will prevail. This is to ensure that there is certainty of decisions by all IFI’s in relation to Shariah matters in Malaysia. 2. Shariah governance framework In addition to the Shariah Advisory Boards the SGF also provides for Shariah governance at a micro level. The provisions discussed under this section are in addition to those discussed on the Shariah Advisory Board. Under the SGF it is the duty and responsibility of an IFI to establish a sound and robust Shariah governance framework. The SGF is applicable to all IFIs regulated and supervised by the Central Bank, which includes:26 24 Islamic Bank Act 1983 s 13A. 25 Banking and Financial Institutions Act 1989 s 124(3). 26 See the Shariah Governance Framework 2011, Part 1 para 3.

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(i) an Islamic bank licensed under the Islamic Banking Act 1983;

(ii) a takaful and retakaful operator registered under the Takaful Act 1984; iii) a financial institution licensed under the Banking and Financial Institutions Act 1989 (BAFIA) that participates in the Islamic Banking Scheme; (iv) a development financial institution prescribed under the Development Financial Institutions Act 2002 that participates in the Islamic Banking Scheme. Under the SGF certain functions have been prescribed to the following organs. Board of directors’ role in Shariah compliance Under the SGF Principle 2, the Board of Directors is responsible for the overall Shariah oversight of IFIs and the effective functioning of the Shariah governance structure, policies and processes. However, the board must recognise the independence of the Shariah Advisory Board and uphold its decisions on Shariah aspects of an IFI’s business operations. The system of Shariah governance and status of the Board of Directors and the Shariah Advisory Board can be seen in diagram 1 below. Diagram 1: Shariah governance in an IFI

Source: Bank Negara Malaysia. (2010). Shariah Governance Framework, available at www.bnm.gov.my

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Senior management According to the SGF, Principle 2, the senior management of an IFI is responsible to promote a strong culture of Shariah awareness and compliance within an organisation, including implementing best practices in Shariah governance in all aspects of the institution’s operations. Shariah risk management, review and audit Under the SGF IFIs are also expected to establish three functions that provide a system of checks and balances within the IFI, which include the following:

• Shariah risk management control function that is able to identify all possible risk of Shariah non-compliance and, where appropriate, recommend remedial measures to manage the risk;



• Shariah review function that continuously assesses Shariah compliance of all activities and operations of the IFI. Where instances of non-compliance are identified, the IFI is expected to take prompt rectification measures and put in place the necessary mechanisms to avoid recurrences of non-compliance; and,



• Shariah audit function that performs annual audits to provide an independent assessment of the adequacy and compliance of the IFI with established policies and procedures, and the adequacy of the Shariah governance process.

These provisions have defined the role of each organ in an IFI to ensure Shariah compliance at a micro level. Next this paper discusses Shariah governance at a macro level. B. Shariah governance at a macro level Shariah governance at a macro level or at the national level is ensured through the NSAC, the Shariah Advisory Council of the Securities Commission and the Muamalat Division in the civil courts. These organs are discussed next. 1. National Shariah Advisory Council of Bank Negara (NSAC) The NSAC was established under s 16B of the repealed Central Bank of Malaysia Act 1958. The new Central Bank of Malaysia Act 2009 (CBMA) provides for its establishment under s 51, which states that the NSAC shall be the authority for the ascertainment of Islamic law for the purposes of Islamic financial business. The functions of NSAC are found under s 52 which are: (a) to ascertain the Islamic law on any financial matter and issue a ruling upon reference made to it in accordance with Part VII of CBMA;

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(b) to advise the Central Bank on any Shariah issue relating to Islamic financial business, the activities or transactions of the Central Bank; (c) to provide advice to any Islamic financial institution or any other person as may be provided under any written law; and (d) such other functions as may be determined by the Central Bank. Appointment of members to the NSAC According to s 53 of CBMA the current King of Malaysia may, on the advice of the Minister of Finance after consultation with the Central Bank, appoint persons who are qualified in Shariah or who have knowledge or experience in Shariah and in banking, finance, law or other related disciplines, as members of the Shariah Advisory Council. Duration of the appointment of the NSAC members will be according to their respective letters of appointment. Members of the NSAC are eligible for reappointment. Section 55 provides that the Central Bank may consult NSAC on any matter relating to Islamic financial business; and any IFI may refer for a ruling, or seek the advice, of the NSAC on the operations of its business in order to ascertain that it does not involve any element which is inconsistent with the Shariah. Section 56 provides for the reference to the NSAC for ruling from a court or arbitrator on any question arising concerning a Shariah matter. This provision provides that the court or the arbitrator, as the case may be, shall take into consideration any published rulings of the NSAC; or refer such question to the NSAC for its ruling. According to s 57 the effect of such Shariah rulings by the NSAC shall be binding on the IFI under s 55 and the court or arbitrator making a reference under s 56. It should be noted that the repealed Central Bank Act 1958 had set out that in any proceedings involving Shariah issues the court or arbitrator may refer the issue to the NSAC for a ruling. The decision of the NSAC was binding on an arbitrator but not on a court. However this discretion given to the court was revoked in 2009 with the coming into force of the CBMA. It is opined that the main reason for this amendment was mainly due to the courts’ reluctance to refer Shariah issues to the NSAC. For example in the case of Affin Bank Berhad v Zulkifli Abdullah27 High Court Judge Abdul Wahab Patail refused to refer a question on the validity of the Bai Bithamin Ajil (BBA) a home financing transaction of an Islamic Bank to the NSAC. He stated that: reference of this case to another forum for a decision would be an indefensible abdication by this court of its function and duty to apply established 27 [2006] 3 MLJ 67.

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principles to the question before it. It is not a question of Syariah law. It is the conclusion of this court, therefore, that there is no necessity to refer the question to another forum.28

This was the same stand the learned judge took in the case of Arab Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors (Koperasi Seri Kota Bukit Cheraka Bhd, third party)29 (“Taman Ihsan Jaya”): The starting point of consideration by the court is therefore that these purportedly Islamic financing schemes, approved by the Syariah Advisory Council under the Central Bank of Malaysia Act 1958 (Revised 1994) Act 519, in principle do not involve any element not approved by the Religion of Islam. There is neither necessity nor reason to refer these concepts to the Syariah Advisory Council for any ruling, which in any case, while they are to be taken into consideration, are not binding upon the court.30

A second possible reason why the amendment in the CBMA changed from discretionary to mandatory is because of the ruling in the above case of Taman Ihsan Jaya. Judge Abdul Wahab Patail held that certain BBA Islamic home financing transactions were contrary to the religion of Islam. This was decided without referring any Shariah matter to the NSAC. This decision sent shockwaves in the Islamic financial industry because the vast majority of home financing in Islamic Banks in Malaysia used BBA transactions.31 The Appeal of the Taman Ihsan Jaya case saw the Court of Appeal in Bank Islam Malaysia Bhd v Lim Kok Hoe & Anor and Other Appeals32 overturning the decision of the High Court and adding: … we already have the legal infrastructure to ensure that the Islamic banking undertaken by the banks in this country does not involve any element which is not approved by the Religion of Islam. The court, will have to assume that the Syariah advisory body of the individual bank and now the Syariah Advisory Council under the aegis of Bank Negara Malaysia, would have discharged their statutory duty to ensure that the operation of the Islamic banks are within the ambit of the Religion of Islam.33 Thus the “may” in the Central Bank Act 1958 was changed to “shall” in the CBMA.

Shariah Governance Framework 2011, para 22. [2008] 5 MLJ 631. Shariah Governance Framework 2011, para 30. Habhajan Singh, “Bai Inah Not Contrary to Islamic Finance”, Malaysian Reserve (2009): http:// islamicfinanceasia.blogspot.com/2009/04/bai-inah-not-contrary-to-islamic.html (accessed November 23, 2011). 32 [2009] 6 CLJ 22. 33 Shariah Governance Framework 2011, para 35.

28 29 30 31

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However another issue has arisen as a result of this amendment. In the recent case of Mohd Alias Ibrahim v RHB Bank Bhd & Anor34 the issue was raised as to the constitutionality of the provisions of ss 56 and 57 of CBMA: that is, whether the provisions usurped the court’s judicial power. The High Court held on this issue that the sole purpose of establishing the NSAC was to create a specialised committee in the field of Islamic banking to: ascertain speedily the Islamic law on financial matters so as to command the confidence of all in terms of the sanctity, quality and consistency of the interpretation and application of Shariah principles pertaining to Islamic finance transactions before the court.35 (Emphasis added.)

The High Court concluded that the NSAC was not performing a judicial or quasi-judicial function as ascertainment was not the same as judicial decision of the law. Naturally the next question that will be asked is whether judicial review will be possible of the decisions of the NSAC; this question has yet to be answered by the courts. 2. Shariah Advisory Council of the Securities Commission In addition to the National Shariah Advisory Council of the Central Bank, there also exists a Shariah Advisory Council of the Securities Commission, whose role is to advise the Securities Commission on Shariah related matters and to provide Shariah guidance on Islamic Capital Market transactions and activities. The Capital Markets and Services Act 2007 applicable to the Shariah Advisory Council of the Securities Commission has ss 316E and 316F, which are provisions similar to ss 56 and 57 of the CBMA.36

34 [2011] 4 CLJ 654. 35 Shariah Governance Framework 2011, paras 102, 105 and 106. 36 Capital Markets and Services Act 2007, s 316E. Advice or ruling of Shariah Advisory Council. Any licensed person, stock exchange, futures exchange, clearing house, central depository, listed corporation or any other person may: (a) seek the advice; or (b) refer for a ruling, of the Shariah Advisory Council on any matter relating to its Islamic capital market business or transaction to ascertain whether such Islamic capital market business or transaction involves any element which is inconsistent with the Shariah. Section 316F. Reference to Shariah Advisory Council for ruling from court or arbitrator. (1) Where in any proceedings before any court or arbitrator concerning a Shariah matter in relation to Islamic capital market business or transaction, the court or the arbitrator, as the case may be, shall: (a) take into consideration any ruling of the Shariah Advisory Council; or (b) refer such matter to the Shariah Advisory Council for its ruling. (2) Any request for advice or a ruling of the Shariah Advisory Council under this Act or any other law shall be submitted to the secretariat.

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3. Legal redress There is a dedicated division in the civil courts known as the Muamalat division and a designated judge at the High Court to preside over Islamic finance cases, thus ensuring certainty in the decisions of Islamic banking and finance cases and uniformity in decisions. As for arbitration there are dedicated arbitration rules for Islamic finance under the Kuala Lumpur Regional Centre for Arbitration of Malaysia. Issues pertaining to enforceability of Shariahbased contracts, investor protection and legal redress for Islamic financial institutions are addressed within this legal framework. III. Latest development: the Law Harmonisation Committee A Law Harmonisation Committee was established on July 27, 2010 to review the existing and new laws in Malaysia with the objective of harmonising the laws to be Shariah compatible. The objective of this committee is to achieve certainty and enforceability in the Malaysian laws in regard to Islamic finance contracts; to position Malaysia as the reference law for international Islamic finance transactions; and for Malaysian law to be the law of choice and the forum for settlement of disputes for cross border Islamic financial transactions. The research and progress of the Law Harmonisation Committee is ongoing and the results will, it is opined, positively position Islamic banking transactions on par with conventional banking transactions. IV. Conclusion Ensuring Shariah governance is critical for the forward progress of Islamic banking; it is critical not only to ensure confidence of investors and the public in the authenticity of the conduct and practise of Islamic banking, but also to minimise fiduciary and reputational risks to IFIs. In Malaysia Shariah governance is ensured at both a micro and at a macro level. While much thought and effort has been made in ensuring compliance through the Shariah governance framework there are still some areas that need to be improved, such as the appointment and remuneration aspects of the Shariah Advisory Board members and the possible extension of their duties and responsibility towards an Islamic bank. It will also be interesting to witness the development of NSAC’s role with regard to Shariah issues that crop up in the civil courts. Another interesting development that the banking and legal fraternity will be waiting for would be the outcome of the Law Harmonisation Committee’s efforts in harmonising the laws of Malaysia with Shariah.