The new Islamic Financial Services Act of 2012 (PDF) in Malaysia currently awaiting royal asset after passing Parliament does not on its own make dramatic changes to the Shari’ah governance system within Malaysia. However, there is not much specifically outlined in the law that defines the responsibilities of a Shari’ah board.
However, within the few significant changes from current law (the Islamic Banking Act of 1983) is in the provision of both civil and criminal penalties for Shari’ah-noncompliance by an Islamic financial institution. The law provides a maximum penalty for Shari’ah-noncompliance by an Islamic financial institution of up to 8 years imprisonment and a RM25 million ($8.1 million) fine.
Malaysia is a relatively unique case in the Islamic finance industry because it has two national Shari’ah Advisory Councils (one housed in Bank Negara, the country’s central bank, and the other within the Securities Commission). This provides a baseline of what is compliant and what is not which is lacking in many other countries that have Islamic finance. In those countries, it is left to the free market to determine what constitutes Shari’ah-compliance.
Each company offering Islamic finance has a responsibility (albeit not a legal duty except where regulations specifically mandate it) to have a Shari’ah board of competent scholars. The AAOIFI rules say the Shari’ah board must be composed of at least 3 scholars, but only some countries (e.g. Bahrain) make compliance with AAOIFI rules mandatory for Islamic financial institutions. In general, the bounds of Shari’ah-compliance are determined mostly by what scholars will sign off on and investors/consumers of Islamic finance will accept.
So why the tangent into the differences between different regions? The law as it is described in the law doesn’t specifically link the potential of jail terms to compliance with the Shari’ah Advisory Councils (SACs) rules. Instead, the civil and criminal penalties are laid down for “Any person who contravenes subsection (1) or (3) commits an offence”. Subsection 1 requires that the institution maintain Shari’ah-compliance in its “aims and operations, business, affairs and activities” while subsection 3 requires the Islamic financial institution notify the central bank immediately, cease the non-compliant activity and within 30 days present a plan to the central bank for how it expects to regain compliance.
The differences are not so much apparent within Malaysia, where there has been a relatively long-standing practice of regulating the Shari’ah governance of Islamic finance at the national level. (e.g. see the guidelines that became effective in 2005 [PDF]). The progress in Malaysia to incrementally formalize the regulatory system for Shari’ah-compliance within the overall regulatory system has put it ahead of most other regions on the basis of how much oversight there is over the process of determining Shari’ah-compliance, especially the aspects relating to oversight of the operational details associated with products.
Whether a national Shari’ah board is the best solution or not (opinions vary on that aspect), there is definitely greater scope in countries where there are specific Islamic banking laws for greater formalization of the regulation of Shari’ah boards and Shari’ah audits (both are covered by the new Malaysian law, although the particular standards still have to be determined by Bank Negara). For countries with Islamic banking laws (and those thinking about drafting specific laws for Islamic financial services), the continued evolution of the regulatory structure as it relates to Shari’ah governance are important to consider.
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Presentation by Gopal Sundaram of Abdullah Chan at INCEIF event, The Islamic Financial Services Act of 2012, 5 February (PDF)
Full Text: The Islamic Financial Services Act of 2012 (via CLJ Law [PDF])