Part one of an abridged and amended version of a paper presented by the writer at the 11th Malaysian Law Conference held in Kuala Lumpur, Malaysia in November 2001. The paper looks at Islamic banking as it is practised in Malaysia and discusses some of the deficiencies in the law applicable to Islamic banking. As disputes in Islamic banking are referred to the civil courts (modelled on the English system) for adjudication, the issue of conflicts between the civil laws and Islamic law that might arise are also considered. The writer makes various proposals for amendments to the existing laws in their application to Islamic banking

Islamic Banking in Malaysia

Islamic banking, introduced into the Malaysian banking system in 1983, was made possible by the passing of the Islamic Banking Act 1983 (Act 276) (IBA), which came into force on 10 March 1983 and applies through out Malaysia.

The IBA is a unique piece of legislation providing for the setting up and licensing of “Islamic banks”. It is unique in the sense that probably for the first time an Act of Parliament has been enacted to deal specifically with Islamic banking. The writer is not aware of any similar legislation in any other jurisdiction following the common law system.

Another aspect of Islamic banking in Malaysia worthy of mention is that the dispute resolution in Islamic banking cases comes within the jurisdiction of the civil courts (and not under the Shariah court system, as some might expect, which apply the civil court procedures to such cases.

Scope of the Paper

This paper discusses the development of Islamic banking in Malaysia since its introduction from a legal viewpoint. It seeks to highlight some shortcomings, problems and issues in the legal framework in a constructive way and makes some proposals to overcome them.

ISLAMIC BANKING BY ISLAMIC BANKS

Islamic Banks

As of now, only one bank has been licensed under the IBA and that is Bank Islam Malaysia Berhad (Bank Islam). It is expected that another bank will soon get its Islamic banking license.

Section 2 defines “Islamic Bank” as “any company which carries on Islamic banking business and holds a valid licence and “Islamic banking business" as “banking business whose aims and operations do not involve any element which is not approved by the Religion of Islam”. The term “banking business” itself is not defined and the IBA does not stipulate how that term is to be understood in the context of Islamic banking.

The definition of “Islamic banking business” in the IBA appears to be simple; but, in the writer’s view, it is not so. What meaning is to be given, for example, to the expression “any element which is not approved by the Religion of Islam”?

Seen from this point of view the tax is not free from problems either, where Islamic banking transactions are concerned. Whilst certain amendments have been made to the Real Property Gains Tax Act 1976, these are considered not comprehensive enough to deal with problems that arise from time to time.

Rules of the Court

The Rules of the High Court 1980 and the Subordinate Courts Rules 1980 were drafted in the year shown in their titles. This was before Islamic banking was introduced into this country and, naturally, the peculiarities of claims made and actions filed under Islamic financing were not taken into account. But the rules have not been amended since to provide for these peculiarities­­­⁴

This became clearly evident in the case of Bank Islam Malaysia Berhad v Adnan Bin Omar⁵, another ABBA financing matter.

Dangerous Living

Lawyers at Risk

The foregoing instances illustrate the type of dangerous living that lawyers practising Islamic law in this country have to undergo in arguing cases in the civil courts. But their luck may not always hold and the danger may become real that an Islamic banking transaction (perfectly valid under the Shariah) may be held to be unenforceable or void because the civil law has not been equipped to handle it. That would be a legal tragedy.

Judges’ Dilemma (or Trilemma)

Another danger zone may be considered — uncertainty in the law and a lack of specification as to the law applicable. The Shariah imposes certain requirements for a contract to be valid under it. But these requirements may not all be the same under all the schools of jurisprudence of Islam or under the civil law. So it is possible for a contract to be valid under the tenets of one madhab of the Shariah and not under another madhab or the civil law. If the validity of such a contract falls to be determined by a civil court, how should the court decide it?

To what sources would a judge deciding the case refer? And if there are conflicting opinions in the Shariah, which one should he adopt? If there is a conflict between Islamic law and the civil laws applicable to the matter, which should take precedence? These are all questions to which there are no ready answers.

A situation such as that described above would be a real legal dilemma for a judge or, more appropriately, a trilemma!

It cannot be over-emphasised that there must be answers in the law to the types of questions raised above. These can only be provided by legislation and that must be done in all hast they are long overdue.

The Way Forward

The Law is Not in Step With Practice

Islamic banking is well entrenched in the banking system of the country and is growing at a healthy rate. It is the writer’s view, as demonstrated in the discussion above, that the same cannot be said of the law relating to Islamic banking. There are many grey areas and uncertainties in the law. If left unattended they could pose grave problems to Islamic banking. This inadequate state of affairs in the law relating to Islamic banking must be given immediate attention.

The Law

First and foremost the law applicable to Islamic banking has to be made certain. This must include guidelines on the law applicable, the sources (authoritative texts) of Islamic banking law and the basis on which the courts should decide which one of two or more conflicting principles is to be adopted and applied. It must be clearly prescribed that where there is a conflict between Islamic law and the civil laws in relation to Islamic banking transactions, Islamic law shall prevail. The following measures, among others, need to be taken to bring the law to a stage where it can meet the requirements of modern banking:

Amendments to the Islamic Banking Act and the Banking and Financial Institutions Act. There is a real and urgent need to review and revise the IBA and s. 124 of BAFIA to clarify-the position of Islamic law in Islamic banking transactions. Some specific areas have been indicated in the preceding discussion.

Amendments to Existing Laws

There are a host of existing laws (including procedural laws) that need to be amended to make them applicable to Islamic banking. Some of these are: the Contracts Act 1950, the National Land Code 1965, the Stamp Act 1949, the Companies Act 1965, the Malay Reservations Enactment of the various States of Malaysia, The Rules of the High Court 1980 and the Subordinate Courts Rules 1980 and others. A comprehensive study of all such legislation must be made and appropriate amendments passed by Parliament. As an interim measure, a general all-embracing provision may be enacted in the IBA and BAF to deal with situations of conflict among the laws that may be applicable and uncertainty in the law.

 (c) “Islamic financial business” means any financial business, the aims and operations of which do not involve any element which is not approved by the Religion of Islam.”

This section empowers conventional financial institutions to carry on Islamic banking business to the same extent as an Islamic bank, removing in the process the prohibition against the carrying on of Islamic banking business by any person not in possession of a license under the IBA.6 Indeed, the latter can do more since s. 124 (1) also authorises them to do Islamic financial business, although considering the definition of the latter term (which is identical to that of Islamic banking business), it is difficult to see what would come with in that term that is also not within the term Islamic banking business.

Apparently the same laws and rules will apply to Islamic banking business carried on by both Islamic banks and conventional banks (though it is conceivable, that in certain matters the opinions of the Sharia Advisor Councils may differ).

The Shariah Advisory Council Under S. 124

The proliferation of Shariah Advisory Councils could engender certain legal problems. What would be the position if the advice of these bodies on the same issue differ? How would a court be expect ed to resolve such differences in opinion if a matter in respect of which there are differences between these bodies reaches the civil court?

Whilst as an interim measure some inter-consultative machinery may be set up to ensure that the various advisory bodies consult one another and agree on the at to be rendered on any issue of Islamic law, it would be more appropriate if all such advisory bodies were merged into one so that there would be no opportunity for such conflicting advice to be rendered at all.

FROM WHAT SOURCES ARE THE ISLAMIC LAW TO BE DERIVED

Scope of Islamic Law to be Applied

The IBA, having authorised Islamic banks to carry on Islamic business, has not defined the Islamic law that is to be applied to Islamic banking transactions. It has not even indicated the sources7 (e.g. standard texts) from where the law may be derived. The role of the Shariah Advisory Council, important though it is, must as a matter of practicality be restricted. It cannot be expected to provide a ruling or advice on issues that arise in the daily operations of Islamic banking. The lack of guidance in the IBA as to the sources would pose a real problem to both counsel who have to present arguments in court, and to judges who have to decide cases before them.

Whilst the applicable principles for the transaction in question, and to some extent the documentation, might have been approved by the respective Shariah advisory council,8 counsel would b left very much to their own devices in preparing arguments in presenting cases in the courts. Judges, too, would be in a difficult position to decide cases without fully researched arguments by counsel and authoritative reference material to which they could refer in making decisions.

Conversely, the divergence of opinions among Islamic jurists and scholars to which different counsel might have access and which they would each urge the court to adopt might be so complex that deducing a principle of law from them might seem to be as much a deliberate decision after considerable thought as after the toss of a coin.

Civil Laws Applicable to Islamic Banking

A related problem arises from the fact that disputes arising in Islamic banking transactions are brought before the civil courts for adjudication.9 Neither the IBA nor s.124 of BAFIA exclude the application of the civil law to Islamic banking transactions. Alternatively, there is no provision in either Act stipulating that Islamic law shall apply exclusively to such transactions. Thus presumably both Islamic law and the civil laws will apply to Islamic banking transactions.10 And this has to be applied within the existing common law system of courts. This includes substantive as well as procedural laws.

Which Law is to Prevail in Islamic Banking Transactions?

At this juncture s. 55 of the IBA may be considered. It reads as follows:

“55 Application of other laws

An Islamic bank which is incorporated under the Companies Act 1965 shall be sub to the provisions of that Act as well as the provisions of this Act, save that where there is any conflict or inconsistency between the provisions of that Act and the provisions of this Act the provisions of this Act shall prevail.”

The effect of s. 55 could be far- reaching because of the definition of Islamic banking business in S. 2 of IBA. It could in effect displace other wise applicable provisions in the Companies Act in Islamic banking transactions where there is a conflict between that Act and Islamic law. The conflict may extend beyond formal or Shariah matters to other sub dictable. With the passage of time and the benefit of experience over the years in seeing the practical and workings of the Islamic banking system, the way forward has become more clearly defined. The areas  where  new laws an procedures have come into focus. What needs to be done is the refinement and putting in place of the necessary legal infrastructure, both substantive laws and procedures.

 The urgency for this to be done is keenly felt by the Islamic banking industry — the practitioners, bankers, lawyers and customers alike. It is not a situation where the courts and judges can fill the lacuna in the law. Their function, as has often been said, is to interpret and apply the law, not to enact or legislate. Enacting laws is the domain of the Legislature through the Executive. Legislative action is imperative in the areas discussed above and, no doubt, in many others, so that the legal foundation of Islamic banking law that now rests on a somewhat uncertain and tenuous, even tentative, base can be implanted in firmer ground. It is hoped that the relevant authorities will take the necessary action urgently.

1. [1996] 4 MU 295 (HC); [1998] 3MU 393 (CA). The facts of the case have been edited out of the paper for lack of space.

2. At present this is the most prevalent mode of Islamic financing provided by both Islamic and conventional banks in Malaysia and is widely used for financing the purchase of houses and other assets, and also for other purposes.

3. Except for certain purposes as a part of a larger transaction.

4. Amendments have been made since 1980 but they were not made to deal with the matters under discussion.

5. [1994] (3) AMR 44, page 2291 (HC); [1994]3 CU 735 (HC).

6. Infra note 13, page 8.

7. See pars 7.4, below.

8. See pars 7.4, below.

9. See, e.g. Commissioner for Religious Affairs, Trerrgganu Et Ors v Tengku Mariam [1969]1 MU 110 at page 113 (High Court).

ISLAMIC BANKS/FINANCIAL INSTITUTIONS (CAPITAL INTELLIGENCE 11 FEB 2002)

Key S [stable] P [positive] N [negative] all ratings are reviewed on a regular basis Source; Capital Intelligence (CI), Bank Analysis and Rating Service, Limassol, Cyprus

The Development of Islamic Banking Juridical and Practical Issues - Is the Law Equipped?

Part II of an abridged and amended version of a paper presented by the writer at the 11th Malaysian Law Conference held in Kuala Lumpur, Malaysia in November 2001. The paper looks at Islamic banking as it is practised in Malaysia and discusses some of the deficiencies in the law applicable to Islamic banking. As disputes in Islamic banking are referred to the civil courts (modelled on the English system) for adjudication, the issue of conflicts between the civil laws and Islamic law that might arise are also considered. The writer makes various 3roposals for amendments to the existing laws in their application to Islamic banking.

The Present State of the Law The Law is Not Fully Equipped

It is the writer’s opinion that unfortunately the law as it stands today is not fully equipped to deal with Islamic banking law issues that have arisen and that may arise in the future. Many laws need to be amended to make them accommodate Islamic banking principles.

The law relating to Islamic banking is, in the writer’s view, undefined, insufficient and lagging behind the market.

Situations of Conflict

There is also another type of difference: that of conflict-between the Shariah and conventional laws. The “type of conflict that can arise in this situation is illustrated by the case of Dato’ Nik Mahmud Bin Daud v Bank Islam Malaysia Berhad¹. That was a case involving an Al-Bai Bitham Ajil (ABBA) transaction (deferred payment sale)^2.

This case highlighted a stark reality: that there is no provision in the law at present that could be called in aid specifically to protect the validity an Islamic banking transaction.

Other Civil Laws National Land Code

A relatively simple example can be taken from the land code. S.330 of the National Land Code (the Code) relates to the lodgement of a lien holder's caveat. It allows for the lodgement of a lien-holder’s caveat “as security for a loan”. In Islamic banking, no loans are granted as in conventional banking save in the case of a qard al-hasan (a friendly (i.e. interest free) loan)³ Islamic Bankers, of course, would not normally grant interest-free loans. Their financing is done principally by means of trade transactions or what are sometimes termed as asset- based or activity-based transactions. These transactions, not being loan transactions, do not fall within s. 330 on a literal reading. So it would appear that this form of security (a lien-holders’ caveat) could not be entered for an Islamic financing transaction. But some might argue that in the case of an Islamic financing transaction the word “loan” should be read to include such a financing transaction. Whether there is merit in such an argument or not would be a matter of opinion and ultimately for a-court to decide. The point here, however, is that the Code does not, in its original version or by subsequent amendment, accommodate Islamic banking transactions in all cases.

Stamp Duty and Other Tax Provisions

Another area where considerable difficulty is experienced in everyday practice is stamp duty. The Stamp Act 1949 was amended in 1989 to insert a new s. 14A. This section provides that where a principal security secures the repayment of moneys provided under a scheme of financing made according to the Shariah, duty chargeable thereon shall be calculated on the principal amount provided by the financier.

There are many other areas (e.g. refinancing arrangements, addition al facilities granted which are to be secured by the same security, such as a house renovation facility to a customer who already has a house purchase financing facility for the same property) where problems or uncertainties still exist.

The area of real property gains………had been more precise such as providing that in the event of differences between the schools on any point, the law to be applied should be the law in accordance with, say, the Shafi’e madhab.²

On the other hand the general definition in the writers opinion highly significant, at once forward-looking and universal in its sweep. The prescribed formulation would allow for the reception and application of the law from any of the mad-hahib or even from the Shi’a branch on any issue that might be most appropriate in the given circumstances, thus making the resulting proposition of the law more widely acceptable, both within and outside Malaysia.

Who Can Carry on Islamic Banking Business?

Section 3(1) of the IBA states that “Islamic banking business shall not be transacted in Malaysia except by a company which is in possession of a licence in writing from the Minister authorising it to do so”. So, it appears only an Islamic bank can do Islamic banking business. This is, in fact, not so.³

The Law Applicable to Islamic Banking Business

Surprisingly, the foregoing provisions are all that the IBA contains about the law that is to be applied to Islamic banking. It is astonishing that in an Act that paves the way for the establishment of Islamic banks and authorises the carrying on of Islamic banking business there is not a fuller treatment of the law that is to be applied or even broad guide lines on what the law is to be.⁴ This topic is dealt with in greater detail later in this paper.⁵

……IBA in relation to the applicable Shariah law (or the apparent deficiency in the law within the Act) is to provide the input by the establishment of a Shariah advisory council for each Islamic bank. S. 3 of the IBA makes the establishment of a Shariah Advisory body a condition for the grant of a license to an Islamic Bank.

This is an important provision which seems to have been designed to deal with the immensely intricate subject of the Islamic law that is to apply to Islamic banking transactions.

However, its real purport has not been tested in the courts as yet. But it is reasonable to conclude that, since the setting up of a Shariah advisory body is a condition for the granting of a licence, (the Act envisages a central role for that body in the sphere of the law may even be seen as a mini Parliament, entrusted with power to “en laws (by rendering advice to the bank) applicable to Islamic banking.

The statutory function of the Shariah advisory body is “to ensure that (the operations of the bank] do not involve any element which is not approved by the Religion of Islam”. What is the real legal ambit of this subsection?

Are decisions of the Shariah advisory council subject to judicial review by the courts? This is an issue of critical importance since it involves the question of the role and function of the Shariah advisory council. The IBA does not provide an answer.

But the answer that might be given by a civil court to this question could well determine the future evolution of the law of Islamic banking one way or the other.

Banking and Financial Institutions Act 1989 (BAFIA)

Section 124 (in force from 1 August 1996) of BAFIA (which applies to conventional banks) reads as follows:

(1)….Nothing in this Act or the Islamic Banking Act 1983 shall prohibit or restrict any licensed instruction from carrying on Islamic banking business or Islamic financial business, in addition to its existing licensed business, provided that the licensed institution shall consult the Bank before it carries on Islamic banking business or any Islamic financial, business.

(2) For the avoidance of doubt, it is declared that- a licensed institution shall, in respect of the Islamic banking business or Islamic financial business carried on by it, be subject to the provisions of this Act.

(3) Any licensed institution carrying on Islamic banking business, or Islamic financial business, in addition to its existing licensed business may, from time to time seek the advice of the Shariah Advisory Council established under subsection (7), on operations of its business in order to ensu