Legal Issues in Islamic Banking and Finance

Commentary on Shariah Parameters (SPR by BNM)

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Legal Issues in Islamic Banking and Finance The recent move of Bank Negara Malaysia in the issuance of parameters on Islamic commercial banking products is but a great effort to laid down guidance and settle the arguments and disputes on relevant Islamic banking products in the county

I strongly agree with the effort to harmonize the Shariah interpretations and guidelines of the Islamic banking practice by the Bank Negara Malaysia. The issuance of these Shariah parameters will surely benefited both the practitioners and Shariah scholars with regards to Shariah risk management and Shariah compliance of Islamic products and services. Feedbacks and comments from the industrys perspectives should always be taken into consideration in drafting and publishing these parameters.

The general aims of these parameters are to provide: i. Standard guidance on applying respective Shariah contracts in Islamic finance ii. iii. Promote harmonization of Islamic finance practices in Malaysia Any innovation are within risk management capacities and does not compromise long term sustainability of the business

After going through the five (5) parameters, the author is quite convince, that these parameters shall do wonders in the market with some modifications. Not being in the market (lack of market practice exposure), shall be the biggest limitation to the author in providing insightful and meaningful arguments, the author will try the best to discuss and give suggestions for further improvement. Among the five (5) reviewed, Shariah Paramaters 2: Ijarah contract found to be in the draft form up till today. Even after almost all the Shariah parameters draft papers are in their final form, SPR 2 is still in its draft form. The analysis will discuss more on the elements that are found to be missing in the draft form of SPR 2.

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Industry players have been persuasive in recent years promoting Shariah harmonization across jurisdictions. While Shariah risk is seen to be the single most influential and fatal risk in Islamic banking and finance sector, the work towards harmonization seems to be little. Cases in the past have shown how differences in Shariah interpretation lead to uncertainty in the Islamic banking industry. Acting as a source of reference, these Shariah parameters are most welcomed. Industry players and Shariah scholar lauded the idea of convergence in the Shariah ruling, instead of going toward convergence with the conventional product orientation.

The commentary of the Shariah Parameters will be structured according to the well-known issues in the industry and cross check with the parameters to investigate whether or not the pertinent issues are highlighted in the parameters provided by BNM: Shariah Parameter 1: Murabahah Among the big issues aside from the Shariah issues of the usage of bay al inah, are: 1. Rebate 2. Floating/variable rate 3. Default Satisfactorily, all the issues were highlighted and given proper justifications and guidance. Some mistakes if the author may comments shall be on the usage of certain term which would tarnished the image of Islamic banking would be, the usage of Base Lending Rate (BLR) in the document as the reference rate for the profit rate. Settlement issues cross jurisdiction are well-explained, with detail explanation and guide given on page 18. Since SAC of BNM has mentioned that waad is binding thus the entire Islamic contract which include the term waad in their contract shall have the promise binding by the law. From the authors point of view, the relevant issues with regard to ibra is not extensively discussed in these parameters. The discussion on the permissibility of rebate, and the rebate calculation in the event of default was found to be missing. Moreover, the mechanism of ibra in the variable rate financing, in which the options to settles early and extend the payment has not been highlighted specifically. Started in

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2003, the breakthrough from the starting of variable rate financing makes BBA or Murabahah with bay al inah as the underlying contract has gain attention again. While the academics are pushing for more equity based financing to be done in the banking arena, bankers seem to be complacent with the usage of BBA in almost every transactions. Found missing in this parameter is the explanation on how banks securitise their debt based financing and resells the securitized asset to third party. Among issues arise would be the guarantee provided by the bank in the event of default, and Shariah ruling on that particular banking activities. 94% of the total financing in the Islamic banking sector is the proof that BBA is still the most favorable contract by the industry players. While almost 90% of the court cases involving BBA financing, the parameters shown less effort in highlighting the essential remedies for to cater the high rate of default in the BBA contract.

Shariah Parameters 2: Ijarah

Since inception, ijarah has been controversial, thanks to the dual banking system that this country practiced; a lot of issues arises from the difference of the act (law) of the country that governs banks. Some pertinent issues which I believe the SPR 2 fails to resolve would be: 1. Ownership 2. Tax 3. Delivery 4. Maintenance 5. Takaful

The ownership issue would be the biggest stumbling block for the accomplishment of ijarah in the banking market. Dependent solely on being the financial intermediary, banks does not plays the role of owning the assets in practice. In ijarah, banks must own the assets then only, it can sell the right to enjoy the usufruct of the assets to the customers (Abdullah & Tag El-Din, 2007). The SPR 2 fails to recognize the taxation issue which also arises from the ownership issue. Who should pay the tax in this case?

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SPR 2 did not provide clear guideline on this matter. Tax issue will be prominent in the property lease because it involves the payments of property tax. The ownership issue will also bring to another problem which is in the event of accident (total lost) and stolen property. In normal banking and car industry practice, the value of the car depreciates by time. Thus making lease asset sometime does not match the real value of the car since the depreciations goes down faster than the contractual lease time. Since, in the SPR 2, the lessor will eventually pay the takaful fees for the asset but the lessee will pay on their behalf and later one there will be reimbursement. What if the car, in particular had a crash and the accident cost the car total loss. Will the lessee be responsible in making up the sum of difference between the takaful valuation and the value of the lease (since lease had become debt-based contract as well today)?

In the SPR 2, there no clause mentioning the expectation of late delivery of leased assets. In the beginning, Shariah requires the bank to possess the asset then only can the bank leased it to the customer than it will be absurd to ask the customer to be responsible for the late delivery of the asset. Kamali (2007) said, the Shariah require the lessor to deliver the asset to the lessee.

If all the issues revolving around ijarah are not well-addressed and tackled then what currently practice in the market is ijarah which imitates the conventional hire-purchase product/principle.

Shariah Parameters 4: Musyarakah

The missing of Musyarakah Mutanakisah and Sukuk structuring looks as if these parameters were meant to explain what is a mere musyarakah. Getting to know musyarakah would be suitable purpose of these parameters. The only time sukuk was mentioned in these parameters is on securitization of asset. The issues touch in this segment also implies the depth of the parameters is trying to cover. When there are a lot of pertinent issues regarding the implementation of musyarakah contract, this

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parameter shown little guide in solving the issues such as, guarantee issue, profit sharing ratio determinants, and risk sharing.

To conclude, having these parameters shows tremendous effort from BNM to harmonise the practice of Islamic Banking and Finance in Malaysia, more effort can be put in to ensure sustainability of the Shariah complaint products in the market. According to Rosly (2010), there three more parameters should be imbedded into the existing parameters to avoid costly errors that might lead to litigations and loss of competitiveness in the Islamic financing business: 1. Maqasid As Shariah 2. Financial Reporting 3. Legal documentation of contract

The rare inclusion of specific needed financial products such as sukuk (SPR 5 does not even mention a word on sukuk) clearly indicates the Shariah Parameters produced by BNM have rooms for improvement. It can be seen in the currently published parameters by BNM, there are Shariah rulings on the contracts, flow and implementation of the contract but the maqasid as shariah and financial reporting aspect were left behind. These parameters if it were to serve as guide or reading for materials for those student, newcomer in the industry, and those interested in Islamic banking and finance would be enough. But, to be considered as the almanac for the industry players, it will be far from enough. Normal people should at least understand the basics of Islamic contract if they are to involve in one. If it happens to be that, in everyones mindset that Islamic banking and conventional banking are the same and the only difference is the name and which is haram and halal that would be so wrong and it could hurt the customer themselves. By not knowing what they are signing into, it could leads to cases that attack Islamic banking financial instrument when apparently the defendant does not even understand the core principle in Islamic banking and finance. Educating the people should be the right way to describe the parameters produced by BNM. It is informative but not too technical which allows layman to understand easily the content.

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After few surveys done randomly, the author still hold the perceptions that the society are not well-versed with the Islamic contract. Islamic banks are the banks that provide Islamic loans. Every financing and purchase made not with the intention of purchasing but merely a trick to get the financing. The author strongly feels, the time has come that these parameters to be introduce in the manner that people will learn more and understands the operation and system which might be, Gods willing improve the current chaos in the courtroom with Islamic banking product being accused not Shariah compliant.

The author would suggest that, these parameters being tailored to suit specific segment of people. For instance, the technicalities should be targeted to the industry players, educators, and students. As for the laymans reading and guide, these available parameters should be sufficient. Detail approached in the sense that, one could actually visualize the operational side of the Islamic banking product and services. This would invite controversies as it would involve operating secrets and other activities which the industry wish not to expose, but this kind of parameters would really serve the purpose.

Financial reporting or accounting process would the next most important aspects of the banking sector. Due to the law, some activities cannot be carried out as it should be done, for instance the controversies surrounding the implementation of ijarah contract where bank in Malaysia does not owns assets. One long overdue question would be, when will the Islamic banking and finance industry have their own rate for the purpose of financing? The Islamis benchmark has been a long standing issues in Islamic banking, while the conventional professor argues the impossibilities of setting up Islamic benchmark because of the arbitrage pricing theory, still holds the perceptions, Islamic benchmarking shall the next biggest achievement in the Islamic banking milestone.

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Bibliography
Abdullah, N. I., & Tag El-Din, S. (2007). Issues of Implementing Islamic Hire Purchase in Dual Banking Systems: Malaysias Experience. Thunderbird International Business Review, Vol. 49(2) , 225249. Dusuki, A. W., Abdul Khir, M., & Muhammad, M. (2010). IMPLIMENTASI IBRA DALAM PRODUK BERASASKAN HARGA TANGGUH DALAM SISTEM PERBANKAN ISLAM: ANALISIS DARI PERSPEKTIF OPERASI PERBANKAN DAN MAQASID SYARIAH. Kuala Lumpur: International Shariah Research Academy for Islamic Finance (ISRA). Hasan, Z., & Asutay, M. (2011). AN ANALYSIS OF THE COURTS DECISIONS ON ISLAMIC FINANCE DISPUTES. ISRA International Journal of Islamic Finance, 41-71. Kamali, H. (2007). A Shariah Analysis of Issues in Islamic Leasing. Islamic Econ., Vol. 20 No. 1, 3-22. KHIR, M. F., MUHAMMAD, M., & MD. HASHIM, A. (2011). PARAMETER HIYAL DALAM KEWANGAN ISLAM. Kuala Lumpur: ISRA. Rosly, S. A. (2010). Shariah Parameters Reconsidered. International Journal of Islamic and Middle Eastern Finance and Management, Vol. 3 Iss: 2, 132-146. Yaakob, H. (n.d.). Brief of Islamic Finance Cases 1987-2009.