MUZAKARAH PENASIHAT SYARIAH KEWANGAN ISLAM KALI KE-9

SHARIAH COMPLIANCE UNDER

ISLAMIC FINANCIAL SERVICES ACTS
2013 AND ITS CHALLENGES

Prof. Madya Dr. Aznan Hassan

Ahli Majlis Penasihat Syariah
Suruhanjaya Sekuriti

11th Kuala Lumpur Islamic

Finance Forum 2014
10 November 2014 * Hotel Istana Kuala Lumpur CIty Centre

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SHARIAH COMPLIANCE UNDER ISLAMIC FINANCIAL SERVICES ACTS 2013 AND ITS
CHALLENGES.
Assoc. Prof. Dr. Aznan Hasan

Introduction

The Islamic Financial Services Act 2013 (IFSA 2013) received the royal assent and
gazetted in March 2013 and subsequently took effect in June 2013.1 The main objective
of IFSA 2013 aside from encouraging and monitoring financial stability, is to ensure
Shariah compliance of the Islamic financial services and operations by empowering the
Central Bank of Malaysia (CBM) with the right to supervise and enforce the Act on
matters that are connected to Shariah in the ordinary course of business of an Islamic
financial institute (IFI).2 The said objective is concisely recorded in the preamble of
IFSA 2013 which stipulates the purpose of IFSA 2013 as, to provide for the regulation
and supervision of Islamic financial institutions, payment systems and other relevant
entities and the oversight of the Islamic money market and Islamic foreign exchange
market to promote financial stability and compliance with the Shariah and for related,
consequential or incidental matters. (emphasis added).

It must, however, be noted that despite assuming the roles and functions of the main Act
for Islamic banking, IFSA 2013 is nonexhaustive and is to be read together with other
related laws whenever necessary which are the Central Bank Act 2009 (CBA 2009) and
the Shariah Governance Framework of CBM (CBM SGF). This is clearly stipulated in
section 7 (2) of IFSA 2013 which reads; The powers and functions of the Bank under
this Act are in addition to, and not in derogation of, the powers and functions of the Bank
under the Central Bank of Malaysia 2009. Further, section 95 of the CBMA 2009 accords
the power to the Bank3 to issue guidelines, bylaws, circulars, standards or notices in

1 IFSA 2013 repeals the Islamic Banking Act 1983 and Takaful Act 1984 as stipulated in section 282 of

IFSA 2013.
opening speech by Deputy Governor Muhammad bin Ibrahim at the Muzakarah Cendekiawan
Syariah
Nusantara
Kali
Ke7
taken
from
www.bnm.gov.my/index.php?ch=en_speech&pg=en_speech_all&ac=467 on 16 September 2014.
3 It shall be reminded that the term the Bank in these laws refers to CBM at all times and the same shall
be applicable to the provisions referenced throughout this paperwork. Section 2(1) of IFSA 2013 provides
2The

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order to give effect to its objects and carrying out its functions or to any provision of
CBMA 2009 or to better implement the provisions of CBMA 2009 as per section 95 of the
CBMA 2009.

It is irrebuttable that IFSA 2013 is an immense and applaudable effort towards
promoting and advancing Malaysia as the hub of Islamic financing. However, there are
several provisions of the said Act that may benefit from further clarification or
elaboration in the interest of clarity and consequentially the effectiveness of IFSA 2013.
This paperwork, nonetheless, shall focus on the relevant provisions that may contribute
to several selected Shariah challenges that may potentially be encountered by an IFI
from the angle of Islamic banking from the point of view of SC i.e. of attaining complete
Shariah compliance in an IFI. Relevant provisions of the Acts and other related laws
referred to will be herein furnished whenever necessary to ease and assist the readers.

Shariah Challenges of IFSA 2013

In embarking the pursuit to unravel the identified Shariah challenges under IFSA 2013,
it is meritorious to firstly establish the prevalent aim of the Act namely Shariah
compliance via the provisions of IFSA 2013 and other relevant laws as well as other
cardinal principles or regulatory requirements in connected to the Shariah compliancy
which includes the establishment of an internal Shariah Committee (SC) under
separate headings as follows.

i) Shariah compliance as principal regulatory objective

Apart from the emphasis for the above in the preamble of IFSA 2013 as briefly stated in
the Introduction, the same is further elaborated in section 6 of IFSA 20134, detailed out
below:

the definition of Bank as has the same meaning as defined in subsection 2(1) of the Central Bank of
Malaysia Act 2009 and Section 2(1) of the CBMA 2009 defines the Bank as means Bank Negara Malaysia
or in English, the Central Bank of Malaysia.
4 A more detailed elaboration on the imposition of Shariah compliance and governance unto IFIs are
found under Part IV Division 1 and 2 of IFSA 2013 wherein some will be discussed in the later part of this
paperwork.

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6. Regulatory objectives.

The principal regulatory objectives of this Act are to promote financial stability
and compliance with Shariah and in pursuing these objectives, the Bank shall

(a) foster

(i) the safety and soundness of Islamic financial institutions;

(ii) the integrity and orderly functioning of the Islamic money market and
Islamic foreign exchange market;

(iii) safe, efficient and reliable payment systems and Islamic payment
instruments; and

(iv) fair, responsible and professional business conduct of Islamic financial
institutions; and

(b) strive to protect the rights and interests of consumers of Islamic financial
services and products.

In fact the only signifant distinction between IFSA 2013 and the Financial Services Act
2013 is the requisite for Shariah compliance.

ii) Regulatory requirement for establishment of SC

Secondly, it is essential to know that it is a regulatory requirement for every IFI to
establish an internal SC as per section 30 (1) of IFSA 2013 who must satisfy the
requirements of fit and proper spelled out in section 29 (2)(ii) of IFSA 2013 that are

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further specified under Appendix 2 of CBM SGF5. This is to ensure close observance and
effective monitoring of the Shariah principles by each IFI that operates Islamic banking
business. Section 30 of IFSA 2013 stipulates:

30. Establishment of Shariah committee.

(1) A licensed person6 shall establish a Shariah committee for purposes of
advising the licensed person in ensuring its business, affairs and activities comply
with Shariah.

In a nutshell, the duty of SC is to perform an oversight function on Shariah matters
related to the IFIs business operations and activities that are ideally achievable via
regular Shariah review and Shariah audit monitoring.7
iii) SCs power and authority subservient to the Shariah Advisory Council of CBM (the
SAC)

It has been long established that the SAC is the authority for the ascertainment of
Islamic law for the purpose of Islamic financial business with the power to determine
its own procedures as stipulated in section 51 of the CBMA 2009. Further, IFSA 2013 by
virtue of section 28 (2) reinforces the same by stating that compliance with any ruling
of the Shariah Advisory Council in respect of any particular aim and operation, business,
affair or activity shall be deemed to be compliance with Shariah in respect of that aim
and operations, business, affair or activity.8 Consequentially, if there is a discrepancy

Appendix
2
of
SGF
(BNM/RH/GL_012_3)
that
is
obtainable
via
www.bnm.gov.my/guidelines/05_Shariah_Governance_Framework_20101026.pdf details out the criteria
of persons to assume the role of SC which includes descriptions on the appointment of SC, application
procedures of SC, resignation and dismissal of SC, qualifications and disqualifications of SC as well as the
negative list.
6 Section 2(1) of IFSA 2013 defines licensed person as means a person licensed under section 10 to carry
on licensed business and section 10 explains that a licensed person is an applicant whom upon passing
the assessment by CBM and thereafter escalated to the Minister with recommendation for a license is
granted the same by the latter to carry on Islamic banking business, takaful business, international Islamic
business or international takaful business, with or without conditions.
7 For a more extensive description, readers may refer to paragraph 2.8 of the CBM SGF.
8 This provision will be revisited at a later part of this paperwork.
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between the ruling or decision of SC and the SAC, the ruling of the SAC will prevail. Such
is clearly spelled out in section 58 of the CBMA 2009 below9:

Shariah Advisory Council ruling prevails

58. Where the ruling given by a Shariah body or committee constituted in
Malaysia by an Islamic financial institution is different from the ruling given by
the Shariah Advisory Council, the ruling of the Shariah Advisory Council shall
prevail.

iv) IFI and SC to conform to the rules and rulings by CBM and the SAC

Hence, it should naturally follow that the SC and IFIs must conform at all times to the
established rules of CBM which shall include any Shariah related circulars, guidelines
and published rulings of the SAC on Islamic banking matters. Such power is prescribed
to CBM by virtue of section 7 (2) of IFSA 2013 which stipulates:

7. Powers and functions of Bank.

(2) The powers and functions of the Bank under this Act are in addition to, and
not in derogation of, the powers and functions of the Bank under the Central
Bank of Malaysia 2009.

A cross reference to section 59 of the CBMA 2009 will further tell us that issuance of
circulars, guidelines or other forms or ruling by CBM in connection to Islamic banking
business has a binding effect on IFIs with a fine of up to RM3,000,000 if breached.
Section 59 of CBMA 2009 stipulates the below:

The Bank to issue circulars, guidelines, etc., on Shariah matters

9 Similar description of the SACs as the highest Shariah authority and functions are found in the website

of CBM at http://www.bnm.gov.my/index.php?ch=en_about&pg=en_thebank@ac=802.

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59. (1) The Bank may issue such written circulars, guidelines or notices on any
Shariah matter relating to the Islamic financial business carried on by any Islamic
financial institution in accordance with the advice or ruling of the Shariah Advisory
Council.

(2) An Islamic financial institution shall comply with any written circulars,
guidelines or notices issued by the Bank under subsection (1) and within such
time as may be set out in the circulars, guidelines or notices.

(3) Any person who fails to comply with any circulars, guidelines or notices issued
by the Bank under subsection (1) commits an offence and shall on conviction be
liable to a fine not exceeding three million ringgit.

Based on the wordings of section 59 (1) of the CBMA 2009 above, it is apparent that
circulars, guidelines or other rules issued by CBM are in accordance or conformity to the
advices by the SAC as the adviser to CBM in matters related to Islamic banking business
in Malaysia and the highest Shariah authority of the same.10


Selected Shariah Issues or Challenges of IFSA 2013

Now that the principal requirements and principles have been laid down above, it is
befitting to proceed with the selected Shariah challenges surrounding the IFSA 2013 and
other relevant laws on Islamic banking. For easy understanding, the issues or challenges
will be dissected under separate subheadings below.

1. Final authority on Shariah related matters in IFI: the Board or SC?

10 As earlier mentioned, section 28 (2) of IFSA further reinforces the SACs authoritative position by

stating that, For the purpose of this Act, a compliance with any ruling of the Shariah Advisory Council in
respect of any particular aim and operation, business, affair or activity shall be deemed to be compliance
with Shariah in respect of that aim and operations, business, affair or activity.

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We have seen the requirement for the establishment of an internal SC for its functions as
adviser to the Board of the IFI as well as executor of the SACs rulings and other
guidelines or circulars issued by CBM. A simple look at these functions, which are in sync
with the principal aim of IFSA 2013 i.e. Shariah compliance, it is easy for one to form a
presumption that the SC shall have the final authority on strictly Shariah related matter
or issue that may arise in an IFI. However, in actuality, the position is slightly hazy and
not very straightforward. A close observation on the related laws concerning the
authority to make decisions on Shariah matters between the Board and SC will arrive at
diverging findings. Below are the arguments in support of the above proposition:

i) The Board as ultimate decision maker including on Shariah related matters

Paragraph 2.1 of the CBM SGF clearly identifies the Board as the responsible body that
carries the ultimate accountability for the overall Shariah compliance by an IFI as
detailed out in paragraph 2.1 of the SGF in below:

2.1 The board is ultimately accountable and responsible on the overall Shariah
governance framework and Shariah compliance of the IFI, by putting in place
the appropriate mechanism to discharge the aforementioned responsibilities.

Hence, it is the Board with the burden to ensure Shariah compliance by the IFI which
also implies that the Board possesses the ultimate right to decide on matters related to
Shariah, as rights always commensurate with accountabilities. Further, section 65 (2)(f)
of IFSA 2013 acquaints us with the understanding that the Board is only required to take
due regard of the decision or views by the SC. Section 65 (2)(f) of IFSA 2013 stipulates:

65. Functions and duties of board of directors

(2) Without limiting the generality of subsection (1), the board of directors shall

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(f) have due regard to any decision of the Shariah committee on any Shariah
issue relating to the carrying on of business, affairs or activities of the
institution.

Due regard from its plain language11 indicates that the Board is expected to take
appropriate or adequate consideration of the SCs views on Shariah related matters
prior to drawing its own decision, which, in the Boards opinion best suits the IFIs aims
and operations. There is no other provision in IFSA 2013 to suggest that the Board is
bound or expected to adhere to the advices or rulings put forth by the SC although we
might find evidence to support otherwise from SGF of CBM.

ii) SCs decisions, views and opinions bind the IFI

The CBM SGF under paragraph 2.7 not only explicitly states that the Board is expected
to rely on the SC on all Shariah decisions, views and opinions but further states that the
decisions, views and opinions are in fact binding upon the IFI. Paragraph 2.7 of CBM SGF
quoted in verbatim below:

2.7 The Shariah Committee shall be responsible and accountable for all its
decisions, views and opinions related to Shariah matters. While the board
bears the ultimate responsibility and accountability on the overall governance
of the IFI, the board is expected to rely on the Shariah Committee on all Shariah
decisions, views and opinions relating to the business of the IFI. As the Shariah
decisions, views and opinions bind the operations of the IFI, the Shariah
Committee is expected to rigorously deliberate the issues at hand before
arriving at any decisions.

From the above, one may infer that the Board is to adopt the decisions or views
suggested by the SC as they bind the operations of the IFI. In furtherance to above,
paragraph 3.3, Section III: Independence of the CBM SGF states that:

11 The Oxford dictionary defines due as expected or of proper quality or extent and regard as

consider or think of in a specified way or attention to or concern for something. Both definitions are
and
obtainable
from
http://www.oxforddictionaries.com/definition/english/due
http://www.oxforddictionaries.com/definition/english/regard.

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3.3 The Board shall ensure that decisions made by the Shariah Committee are duly
observed and implemented by the IFI. Decisions made by the Shariah
Committee should not be set aside or modified without its consent.

If one chooses to say that the Board is only required to consult the SC for views as mere
guidance, one should have a second look at the above paragraph 3.3 of CBM SGF as
decisions reached by the SC on Shariah matters or issues shall be implemented by the IFI
and not to be belittled or set aside in any way without the SCs consent. It must be
remembered that the SC shall gradually report to the Board of its decisions which means
that the SC, in this context, is the final decision maker on those Shariah matters referred
to by the Management of the IFI for decisions.12 Further, it does not need a reminder
that the Board is to act in accordance with IFSA 2013 and other relevant laws
enforceable at that given time as per section 65 (1) of IFSA 2013 below and thus obliged
to observe the guidelines in the CBM SGF. Section 65 (1) of IFSA 2013 stipulates:

65. Functions and duties of board of directors

(1) The business and affairs of an institution shall be managed under the
direction and oversight of its board of directors, subject to this Act and any other
written law which may be applicable to the institution.

An IFI or the Board must be careful as not to exert any influence on the SC in its
decisions as the SC must be allowed to maintain its independence at all times as stated in
paragraph 3.1 of Section III of CBM SGF below:

3.1 The board shall recognise the independence of the Shariah Committee and
ensure that the committee is free from any undue influence that would hamper

12 Paragraph 1.6 of Part 2, Section I of the CBM SGF states that, The IFI shall establish formal reporting

channel(s) among the key functions to ensure that the reporting on Shariah matters is carried out
effectively and on timely manner. In this regard, the Shariah Committee shall functionally report to the
board of directors. Hence, Shariah related matters that require resolutions will come to the SC prior to the
Board of the IFI.

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the Shariah Committee from exercising objective judgment in deliberating

issues brought before them. Correspondingly, the Shariah Committee is
expected to make sound decisions on Shariah matters in an independent and
objective manner.

One may argue that since the expertise of Shariah lies with Shariah Committee, it is
natural that the Board shall always rely on the Shariah Committee in its decision
regarding Shariah compliant. Nevertheless, is it allowed for the Board not to adopt the
opinion of the SC, instead obtaining another partys opinion and adopt it? By provision of
SGF, the answer is explicitly negative. However, if the provision of IFSA 2013 is
considered, one may argue that the Board shall be given the final authority to make
decisions even on Shariah matters as IFSA only says Board to have legal obligation to
take due regard only to the opinion of the SC, even on Shariah matters.


2. Assurance of Shariah compliance: the Boards or SCs main responsibility?

There is no dispute that IFIs must at all times be in compliance with Shariah as spelled
out in section 28 (1) of IFSA 2013 below:

28. Duty of institution to ensure compliance with Shariah.

(1) An institution shall at all times ensure that its aims and operations, business,
affairs and activities are in compliance with Shariah.

Any kind of breach or nonadherence of the above provision i.e. noncompliance with
Shariah would invoke grievous penalty as per section 28 (5) IFSA 2013:13

13 A breach of Shariah compliance under IFSA would tantamount to a harsher punishment as prescribed

under section 28 (5) of IFSA 2013 in comparison to a breach of Shariah related guidelines or rulings by the
SAC or CBM as stipulated in section 58 (3) CBMA 2009 with the additional of (1) imprisonment up to 8
years or (2) higher pecuniary punishment of up to RM25 million instead of RM3 million under CBMA 2009
or (3) both. Section 58 (3) of CBMA 2009 states that, Any person who fails to comply with any circulars,
guidelines or notices issued by the Bank under subsection (1) commits an offence and shall on conviction be
liable to a fine not exceeding three million ringgit.

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(5) Any person who contravenes subsection (1) or (3) commits an offence and
shall, on conviction, be liable to imprisonment for a term not exceeding eight
years or to a fine not exceeding twentyfive million ringgit or to both.14

However, the question to pose is, who in the IFI bears the ultimate responsibility of
ensuring Shariah compliance and consequentially be liable under section 28 (5) of IFSA
2013 following a breach or Shariah noncompliance? Will it be the Board being the top
decision maker in the IFI or SC as adviser to the Board on matters that are related to
Shariah?

Even though this paperwork is confined to the Board and SC, it is worth noting, that the
term any person in section 28 (5) of IFSA 2013 above suggests that anyone who is
involved in the decision making of the matter that leads to the Shariah noncompliance
may potentially be tried and convicted under section 28 of IFSA 2013 i.e. from the Board
down to the frontline officers who may have contributed to the Shariah non
compliance.

i) The Board has ultimate accountability to ensure Shariah compliance

As seen earlier under section 65 (1) of IFSA 2013 and paragraph 2.1 of CBM SGF, the
Board is of the responsibility to ensure Shariah compliance by an IFI. Hence,
undoubtedly, the Board is subjected to the relevant punishments prescribed under each
law. 15

ii) Does SC share same accountability as the Board for Shariah noncompliance?

14 Ultimately, the IFI may lose its license to be in operation as per section 18 (1) of IFSA 2013 which

stipulates that, 18. (1) The Minister may, on the recommendation of the Bank, revoke the licence of a
licensed person, and the Bank may revoke the approval of an approved person, on the grounds that
(a) the person is pursuing aims, or carrying on its operations, business, affairs and activities contrary to
Shariah;

15 IFSA 2013 imposes a heavier legal burden on the Board to take accountabilities in ensuring strict
Shariah compliance of an IFI including implementation of Shariah rulings, effective communications,
sound Shariah compliant business operations, and etc.

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It is well established and accepted that rights always commensurate with liabilities.
Hence, it is fair to say that the SC shall take responsibilities of the views or rulings issued
to an IFI. Such is supported by paragraph 2.7 of the CBM SGF extracted below:

2.7 The Shariah Committee shall be responsible and accountable for all its
decisions, views and opinions related to Shariah matters.

However, the concern raised is in situations where the SC has appropriately and
sufficiently advised the IFI and its Board on a Shariah related matter but is one which is
not considered to be in the best interest of the IFI and thus altered by the Board in
accordance with the power granted to it by virtue of section 65 (2) (f) of IFSA 2013 and
paragraph 2.1, Section II of CBM SGF despite the letters of paragraph 3.3, Section III of
the CBM SGF16, as discussed at length earlier. In such circumstances, will the SC be
considered to have discharged its duties satisfactorily or will it be forced to face the
harsh punishments under IFSA 2013? Is it fair to presume that if the SC does not in
actuality have the authority to make the final decision on matters related to Shariah, the
SC is hence absolved from its responsibility to ensure actual implementation of the
issued Shariah rulings as demanded under section 28 (1) of IFSA 201317 which is thus
passed to the Board? This is another area that could benefit from clarification by the
authority.

iii) Contravention of IFSA 2013 may result to termination of SCs membership

Other than the punishments we have seen under IFSA 2013, there is a specific provision
in the Act that empowers CBM upon consultation with the SAC18 to terminate the SCs

16 Note the paragraph 3.3 of CBM SGF prohibits any form of alteration of the SCs views without the SCs

consent. Paragraph 3.3 of CBM SGF states, The Board shall ensure that decisions made by the Shariah
Committee are duly observed and implemented by the IFI. Decisions made by the Shariah Committee should
not be set aside or modified without its consent.
17 Section 28 (1) of IFSA 2013 requires An institution shall at all times ensure that its aims and
operations, business, affairs and activities are in compliance with Shariah.
18 Paragraph 3.8 of CBM SGF laid down the foundation that the SAC alongside CBM must approve any
decision to remove any SC member. Paragraph 3.8 of the CBM SGF states, All appointments including
reappointment, resignation and removal of the Shariah Committee members shall be made by the Board,
subject to the approval by the Bank and the SAC.

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membership if the SC is found to have breached or not comply with any provision of
IFSA 2013 i.e. section 33 (4) (a) that is general and wide enough to cover both deliberate
or unintentional acts. Section 33 (4) (a) stipulates:

33. Cessation as member of Shariah committee.

(3) An institution shall not terminate the appointment of a member of its
Shariah committee unless the institution has obtained prior written approval
to do so.

(4) Subject to section 273, the Bank may, by order in writing, remove a
member of a Shariah committee if the Bank is of the opinion that

(a)such member has contravened any provision of this Act or failed to
comply with any standards applicable to him.

iv) Shariah matters unresolved by the SC to be escalated to the SAC

With regard to Shariah issues or matters that could not be resolved by the SC, the CBM
SGF, under item 7 of Appendix 4, states that the SC may advice the IFI to consult the SAC
for resolutions or rulings:

7. Advise on matters to be referred to the SAC

The Shariah Committee may advise the IFI to consult the SAC on Shariah matters
that could not be resolved.
However, in light of the provisions of IFSA 2013, it seems that this option provided to
the SC has become an obligation which failure may tantamount to a breach of the Act.
For example, section 29 (4) of IFSA 2013 stipulates:

29. Power of bank to specify standards on Shariah matters
(4) Every institution shall at all times
(a) ensure that its internal policies and procedures on Shariah governance are
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consistent with the standards specified by the Bank under this section; and
(b) whether or not standards have been specified by the Bank under this
section, manage its business, affairs and activities in a manner which is not
contrary to Shariah.

The above provision of IFSA 2013 demonstrates that any deviation from Shariah, which
may potentially result from an unresolved Shariah matter, may implicate the SC. Hence
the SC must take the necessary steps to ensure that its duties are properly and
satisfactorily discharged under the Act.

3. Adequate competencies of the SC

IFSA 2013 does not detail out the expected functions and scope of duties and
responsibilities of the SC. It merely provides that CBM has the power to specify
standards in relation to Shariah which must be adhered to. Hence one must go back to
the CBM SGF to look at the list of duties, rights, functions and accountabilities of the SC.

i) Oversight function via Shariah audit and Shariah review

Paragraph 2.8, Section II of CBM SGF underlines the oversight role of SC via Shariah
review and Shariah audit functions which require the SC to identify issues and propose
appropriate solutions19, as below:
2.8 The Shariah Committee is expected to perform an oversight role on Shariah
matters related to the institutions business operations and activities. This
shall be achieved through the Shariah review and the Shariah audit functions.
Regular Shariah review reports and the Shariah audit observations should
enable the Shariah Committee to identify issues that require its attention and
where appropriate, to propose corrective measures.

19 Item 5 of Appendix 4, CBM SGF states that SC is to, To assess the work carried out by Shariah review

and Shariah audit in order to ensure compliance with Shariah matters which forms part of their duties in
providing their assessment of Shariah compliance and assurance information in the annual report.

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ii) Sufficient knowledge in Islamic finance and general finance

Other than Shariah review and Shariah audit functions, the SC is further expected to hold
sufficient knowledge on not only Islamic finance but also finance in general to ensure its
effectiveness in deliberating issues brought forth by the IFI. Paragraph 4.1, Section IV of
CBM SGF states:

4.1 The board and management are expected to have reasonable understanding
on the principles of the Shariah and its broad application in Islamic finance.
The Shariah Committee is expected to have sufficient knowledge on finance in
general, and Islamic finance in particular, to enable the Shariah Committee to
comprehend Shariah issues brought before them. The Shariah Committee
members are expected to constantly equip themselves with relevant
knowledge on Shariah and finance as well as attend relevant training
programs.

iii) Adequate legal, marketing and sales knowledge

Adequate knowledge in legal, marketing and sales are required for the SC in order to
exhaust its advisory function in determining Shariah compliance of legal documents,
marketing and sales including advertisements as well as campaigns of Islamic products
offered by an IFI all of which must receive endorsements by the SC before they can be
launched or executed. Item 4, Appendix 4 of the CBM SGF states that:

4. Endorse and validate relevant documentations

To ensure that the products of the IFI comply with Shariah principles, the
Shariah Committee must approve:

i) the terms and conditions contained in the forms, contracts, agreements or
other legal documentations used in executing the transactions; and

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ii) the product manual, marketing advertisements, sales illustrations and

brochures used to describe the product.

From the above, it is clear that the expected skills and knowledge of the SC is high as the
SC is required to possess adequate or sufficient knowledge in Shariah review, Shariah
audit, Islamic finance, finance, law, marketing and sales.

iv) Active participation required of SC

Recognising the heavy responsibilities placed in the SC, the law requires that all
information submitted to the SC is accurate and complete. To illustrate this, section 35 of
IFSA 2013 stipulates:

35. (1) An institution and any director, officer or controller of such institution
shall

(a) provide any document or information within its or his knowledge, or capable of
being obtained by it or him, which the Shariah committee may require; and

(b) ensure that such document or information provided under paragraph (a) is
accurate, complete, not false or misleading in any material particular,

to enable the Shariah committee to carry out its duties or perform its functions
under this Act.

Similarly, paragraph 2.12, Section II of CBM SGF states:

2.12 Given that the accountability of Shariah decisions rests with the Shariah
Committee, the management is expected to provide information and disclosure
which are complete and accurate to the Shariah Committee in a timely manner,
and shall be transparent on any areas that need clarification by the Shariah
Committee to enable the Shariah Committee to discharge its duties effectively

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However, having said the above, the SC must understand its roles and hence shall have
the right to request for additional information required in order to arrive at the accurate
decisions or resolutions. To this effect, paragraph 3.4, Section III of the CBM SGF states
that:

3.4 The Shariah Committee shall have access to accurate, timely and complete
information from the management. If the information provided is insufficient,
the Shariah Committee may request for additional information which shall be
duly provided by the management.

In furtherance to this, the SC should also be conscious of its right to acquire professional
assistance from lawyers, accountants and economists for guidance which must be
fulfilled by the IFI. Paragraph 4.3, Section IV of CBM SGF states:

4.3 The IFI shall engage other professionals such as lawyers, accountants and
economists to provide appropriate assistance and advice to the Shariah
Committee, especially regarding issues on law and finance.


4. Rectification of Shariah noncompliant events: reporting to CBM and the SAC

Upon the identification of a breach of Shariah or Shariah noncompliant incident, the
same must be immediately remedied by the IFI. All necessary measures and steps must
be satisfactorily taken by the IFI toward rectifying the Shariah noncompliant event by
firstly notifying its SC and subsequently cease the operation of such event with
immediate effects.


i) Notification of the Shariah noncompliant events to the SC, the Board and CBM

IFSA 2013 under section 28 (3) & (4) specifies the actions required of an IFI in
addressing a Shariah noncompliant event as follows:
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28. Duty of institution to ensure compliance with Shariah.

(3) Where an institution becomes aware that it is carrying on any of its
business, affair or activity in a manner which is not in compliance with Shariah
or the advice of its Shariah committee or the advice of or ruling of the Shariah
Advisory Council, the institution shall

(i) immediately notify the Bank and its Shariah committee of the fact;

(ii) immediately cease from carrying on such business, affair or activity and
from taking on any other similar business, affair or activity; and

(iii) within thirty days of becoming aware of such noncompliance or such
further period as may be specified by the Bank a plan on the rectification
of the noncompliance.

(4) The Bank may carry out an assessment as it thinks necessary to determine
whether the institution has rectified the noncompliance referred to in
subsection (3).

To sum up the above provision in a simpler manner, the IFI is required to (1)
concurrently notify CBM and its SC of the identified Shariah noncompliant event; (2)
cease such Shariah noncompliant business or activity; (3) submit a rectification plan to
address the Shariah noncompliant event to CBM within 30 days. (4) An assessment may
be conducted post rectification by CBM to satisfy the effectiveness of the rectification
plan.

Similarly, the CBM SGF provides in paragraph 2.17, Section II at a slightly greater detail,
the reporting process below:

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2.17 In the event the management becomes aware that certain operations are
found to be carrying out business(es) which is(are) not in compliance with
Shariah, or against the advice of its Shariah committee, or the rulings of the
SAC, the management shall:

(i) immediately notify the board and Shariah Committee as well as the Bank
of the fact;

(ii) immediately cease on to take any new business related to the Shariah
noncompliant business; and

(iii) within thirty (30) days of becoming aware of such noncompliance or

such further period as may be permitted by the Bank, furnish a plan to rectify
the state of noncompliance with the Shariah, to be duly approved by the
board and endorsed by the Shariah Committee.

The slight deference in the 2 provisions above lie in steps (1) and (3) wherein the CBM
SGF includes the Board as a party to be notified alongside CBM and the SC in (1) and that
the submitted rectification plan to CBM in (3) must be one that is approved by the Board
and endorsed by the SC. Having section 7 (2) of IFSA 201320 in mind, we can conclude
that these 2 provisions complement each other thus allowing the adoption of a stricter
reporting process i.e. under CBM SGF. Although the processes depicted in both CBM SGF
and IFSA 2013 are clear, the actual execution of the process may be burdensome on the
IFIs, especially the ones with a big operation size.

Normally, a potential Shariah noncompliant event is escalated to the SC by the
Management of an IFI. The SC will then assess and deliberate on whether the potential
Shariah noncompliant event is in fact actual Shariah noncompliant event, which will
then be reported to the Board for the Boards cognizance. Subsequent to that, the

20 Section 7(2) of IFSA 2013 stipulates, (2) The powers and functions of the Bank under this Act are in

addition to, and not in derogation of, the powers and functions of the Bank under the Central Bank of
Malaysia 2009.

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Management will propose a rectification plan to the SC for endorsement and to the
Board for approval prior to submission of the same to CBM. All these will take place
within 30 days from the confirmation of the actual Shariah noncompliant event by the
SC. Now, if we look at the process drawn in CBM SGF as well as IFSA 2013, the IFI is
required to concurrently notify not just its Board and SC but also CBM of the Shariah
noncompliant event which at this juncture is a mere potential breach pending the
confirmation by its SC. Therefore, the biggest concern by the IFI on this prescribed
process is on the unnecessary complication arising from the premature notification to
CBM if the suspected Shariah noncompliant event is found to be Shariah compliant by
the SC of the IFI. This will surely involve a series of internal processes in the IFI that will
be sure to be time consuming and cost ineffective. The next question to ask is if CBM is
indeed to be notified concurrently, will this mean that the 30 days period for the
submission of the duly approved rectification plan run from the date of the notification
to CBM? If such is the case, then the larger IFIs are at risk of breaching the 30 days
period requirement.

ii) SC to inform CBM of ineffective or inadequate rectification measures

The SC of an IFI carries an extra responsibility related to the reporting of a Shariah non
compliant activity i.e. the SC is required to inform the Board of the same together with
the proposed corrective measures for the Boards consideration and approval.
Paragraph 3.6 of the CBM SGF states:

3.6

Where the Shariah Committee has reason to believe that the IFI has been
carrying on Shariah noncompliant activities, the Shariah Committee shall
inform the board and to recommend suitable measures to rectify the situation.

The said responsibility of the SC does not end with the notification to the Board. The SC
is further required to escalate the Shariah noncompliant activity to CBM in the event
that the same is not effectively addressed or not rectified as per paragraph 3.7 of the
CBM SGF below:

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3.7 In cases where Shariah noncompliant activities are not effectively or

adequately addressed or no rectification measures are made by the IFI, the
Shariah Committee shall inform the Bank of the fact.

Although the above rightfully signifies the SCs independence, its execution may be
challenging for the SC as in reality the SC reports to the Board and the SCs remuneration
as well as continuation of term is subjected to the Boards approval.


5. Protection of the Board against penalties under IFSA 2013: Is SC accorded the same?

IFSA 2013 may offer some degree of comfort to the Board of an IFI particularly from the
words of section 66 (1) (b) & (c) that may save the Board from being tried for a breach
of Shariah compliance if the Board can prove that it has acted in good faith and exercised
reasonable amount of care, skill and diligence in arriving at any decision related to
Shariah. Section 66 (1) (b) & (c) of IFSA 2013 stipulates:

66. Duties of directors.

(1) A director of an institution shall at all times

(b) act in good faith in the best interests of the institution;

(c) exercise reasonable care, skill and diligence with
(iv) the knowledge, skill and experience which may reasonably be
expected of a director having the same responsibilities, and;
(ii) any additional knowledge, skill and experience which the director
has.

However, there is no equivalent provision under IFSA 2013 to accord the same to the SC.
Does this mean that the Act is of the intention to place a heavier burden to the SC due to
the higher skills set expected of SC in regards to the Shariah? The only exemption
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enjoyable by the SC is the immunity against any defamation suit in respect of statements
made without malice in the course of discharging its duties. Section 36 of IFSA 2013
stipulates:

36. Qualified privilege and duty of confidentiality.

A member of a Shariah committee shall not be liable

(b) to be sued in any court for defamation in respect of any statement made
by the member without malice in the discharge of his duties under this
Act.
Outside the Act, protection to the Board may be available in the form of insurance
provided by respective IFIs against any pecuniary punishment under IFSA 2013. As this
is a voluntary initiative undertaken by the IFIs i.e. not prescribed by the law, it is the
prerogative of the IFIs to whether or not extend the same protection to their SC
members. Given the importance and contribution of the SC toward the business of the
IFIs, it is strongly suggested that the SC be accorded with the same protection as the
Board of the IFIs.


6. Public interest as ground of revocation of IFIs license

The voice of Islamic banking consumers has always been heard and plays a part in
helping shape the operations of Islamic banking as we see today. Building public
confidence is an important key towards establishing a strong foundation of Islamic
banking which aim is to ideally bring back good to the public. It is recognised that public
confidence may be established by displaying a close observance of the tenets, conditions
and principles of Shariah in the ordinary operations of Islamic banking as may be seen in
paragraph 1.1 of Part I: Overview of the SGF CBM below:

1.1 Shariah principles are the foundation for the practice of Islamic finance
through the observance of the tenets, conditions and principles espoused by
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Shariah. Comprehensive compliance with Shariah principles would bring

confidence to the general public and the financial markets on the credibility of
Islamic finance operations.

The amplified voice of the public is well reflected in IFSA 2013 under section 6 (b)21
apart from one whole part dedicated to the same i.e. Part IX Business Conduct and
Consumer Protection with a much more significant legal impact to IFIs. However, this
paperwork would like to highlight a provision under Part III Authorisation, Division 4 of
IFSA 2013, in particular section 18 (1)(i) which indicates the power of public confidence
as it clearly stipulates that the Minister may revoke the license of an IFI following the
recommendation of CBM on the ground of the interest of consumers:

18. (1) The Minister may, on the recommendation of the Bank, revoke the licence of
a licensed person, and the Bank may revoke the approval of an approved person, on
the grounds that

(i) it is in the interest of consumers of financial services and products to do so.
Potential Ways to Resolve Shariah Challenges of IFSA 2013

1. Applicability of the law

It is hard to foresee any rejection or nonacceptance of the fact that IFSA 2013 and the
CBM SGF complement each other22. However, it may help to clear doubts and
conflictions between the 2 authorities if the following initiatives are taken.

i) IFSA 2013 or SGF to take prevalence?

It is clear from section 7 (2) of IFSA 201323 that IFSA 2013 is to accord additional power
to CBM thus indicating that the existing rulings or guidelines issued by CBM are still in

21 Section 6 (b) of IFSA 2013 stipulates that the principal regulatory objectives of this Act are to promote

financial stability and compliance with Shariah and in pursuing these objectives, the Bank shall
(b) strive to protect the rights and interests of consumers of Islamic financial services and products.
22 For example, refer to section 28 of IFSA 2013 and paragraph 2.17 of CBM SGF.

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force unless otherwise mentioned. Therefore, CBM has the power to state the law or
rules to take prevalence, especially when there is a conflicting or varied rule on a similar
item. For example, section 65 (2)(f) of IFSA 2013 requires the Board to only take due
regard of the SCs decision on Shariah related matters. However, paragraph 3.3 of the
CBM SGF clearly states that the Board is to ensure that the SCs decisions are duly
implemented by the IFI without any alteration24. Both authorities are provided below:

65. Functions and duties of board of directors (of IFSA 2013)

(2) Without limiting the generality of subsection (1), the board of directors shall

(f) have due regard to any decision of the Shariah committee on any Shariah
issue relating to the carrying on of business, affairs or activities of the
institution.

visvis:

Paragraph 3.3, Section III: Independence of the CBM SGF:

3.3 The Board shall ensure that decisions made by the Shariah Committee are duly
observed and implemented by the IFI. Decisions made by the Shariah
Committee should not be set aside or modified without its consent.

ii) Updating the relevant guidelines

Another suggestion is for the relevant guidelines, in this context, the CBM SGF to be duly
updated to be in line with the changes or updates made to similar items that are covered
under IFSA 2013. To state the obvious, CBM SGF still has its scope of application limited
to an Islamic bank licensed under Islamic Banking Act 1983 (IBA), a takaful and

23 Refer to footnote no. 20.

24 An in depth discussion may be found under Item 1 of the selected Shariah challenges of IFSA 2013 of
this paperwork.

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retakaful operator registered under the Takaful Act 1984 (TA), a financial institution
licensed under the Banking and Financial Institutions Act 1989 (BAFIA) that participates
in the Islamic Banking Scheme; and a development financial institution prescribed under
the Development Financial Institutions Act 2002 (DFIA) that participates in the Islamic
Banking Scheme.25


2. Bridging the gap between the Board and SC

An effective way to address the discrepancies in the decisions made by the Board and
the SC on Shariah related matters that may give rise to the issue of the ultimate decision
maker discussed at length earlier is by adopting the suggestion under CBM SGF,
paragraph 2.4 which states:

2.4 The board may consider appointing at least one (1) member of the Shariah
Committee as a member of the board that could serve as a bridge between the
board and the Shariah Committee. 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.

As precisely stated above, the presence of a director of the Board with sound Shariah
knowledge would foster greater understanding and appreciation amongst the Board
members on the decisions made by the SC thus avoiding differing views between the
Board and the SC.

Conclusion

IFSA 2013 is the landmark of a robust development and establishment of the Islamic
banking business and operations in Malaysia. However it must be realised that IFSA
2013 is not a standalone Act but rather complemented by the existing law such as the
CBMA 2009 and CBM SGF. There are several challenges related to an effective

25 As per paragraph 3.1 of the Introduction of CBM SGF

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compliance to Shariah under IFSA 2013, viewed from the perspective of an SC member
such as conflicting authority between the Board and SC on Shariah related matters,
superiority of the SCs decisions on Shariah matters in the IFI, shared accountabilities of
Shariah noncompliant events or breach of the Act as well as the implications of such
breach on the SC. Other than these, concerns are also raised on issues connected to the
adequacy of the SCs competencies in discharging its duties under the Act, rectification of
Shariah noncompliant events and the protections available to the SC against the
provisions of IFSA 2013.

Several suggestions that may be considered in overcoming the identified Shariah
challenges above include determination of the prevailing law by the authority, gradual
updates of the existing guidelines to be in line with IFSA 2013 as well as the
appointment of an SC member as a director to close the gap between the Board and the
SC by enhancing the appreciation of Shariah by the earlier with the presence of the
latter.

The selected Shariah challenges discussed at length throughout this paperwork shall not
be viewed as flaws but rather taken as a challenge to tighten the existing laws and
regulations of Islamic banking in Malaysia to insure a brighter future of the industry.

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