The Malaysian Reserve

Regulatory environment for Islamic finance in Asia

BNM is currently developing several standards for key islamic contracts that set out the Shariah and operational requirements of a particular contract (Pic: TMRpic)


An international Monetary Fund survey on the legal, regulatory and supervisory frameworks for Islamic banking and finance shows that some Asian countries, like Kazakhstan, apply a single integrated regulatory framework to all banks with references identifying provisions applying only to Islamic banks.

Some other Asian countries, like Indonesia and Malaysia, follow a mixed approach; that is, they adopt a similar regulatory framework for areas that are applicable to Islamic and conventional banks, but they issue separate guidelines and regulations for areas that are specific to Islamic Banks (Kammer et al 2015).

Specialised standard-setting bodies in different Asian countries have developed specific Shariah-based standards. Here we present some of the regulatory frameworks from the selective Asian economies.

The Islamic Financial Services Act 2013 (IFSA) is a Malaysian law that has been in effect since June 30, 2014.

The IFSA lays out 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 Shariah and of related, consequential, or incidental matters.

In supporting the aspirations of the Act, Malaysia’s central bank, Bank Negara Malaysia (BNM), is currently developing several standards for key Islamic contracts that set out the Shariah and operational requirements of a particular contract.

Among other things, the Act distinguishes investment accounts from Islamic deposits and prohibits principle and profit guarantees on investment accounts (Islamic Financial Services Board [IFSB] 2015).

The IFSA offers a new dimension to the regulatory framework for Islamic finance, as it accords greater prominence to the Shariah contracts in Islamic finance transactions.

The statutory foundation for a contract-based regulatory frame- work in the IFSA has enabled the issuance of Shariah standards that define the underlying Shariah principles that Islamic financial institutions have adopted and support the effective application of Shariah contracts in offering Islamic financial products and services.

This represents a significant step forward in aligning legal and regulatory principles with Shariah precepts and can serve as a useful benchmark for evolving more comprehensive regulatory frameworks globally that promote greater legal and operational certainty in Islamic finance.

More importantly, it develops the contract-based regulatory framework in a manner that facilitates the next level of Islamic banking business, transcending financial intermediation to include real economic sector participation.

Such a distinctive regulatory approach seeks to realise further the value proposition of Islamic finance as the industry advances towards a new level of maturity and sophistication (IFSB 2015).

In India, the world’s second-most populated country, the Reserve Bank of India (RBI), the country’s central bank, has begun a review of regulations on Islamic banking.

The RBI has established an internal committee consisting of senior central bank officials amid calls for the re-evaluation of Islamic banking regulations in the country (Asian Development Bank [ADB]-IFSB 2015).

Hong Kong, China’s Legislative Council passed the Loans (Amendment) Bill 2014 in March 2014, enabling the government to raise money through alternative bonds, such as sukuk (ADB-IFSB 2015).

The Philippines is expected to enter the global takaful industry in the near future, as the Insurance Commission of the Philippines is formulating takaful regulations to enable takaful services in the country (IFSB 2015).

In January 2014, the State Bank of Pakistan (SBP) prepared its Strategic Plan for the Islamic Banking Industry of Pakistan 2014-2018.

The plan focuses on the initiatives necessary for improving the public perception of Islamic banking and promoting it as a distinct and viable system to address the financial service needs of the public in general and the business community in particular.

Acting to this plan, the SBP, in collaboration with stakeholders, will keep its focus on the following key areas/objectives to facilitate and catalyse stable and distinct growth of Islamic banking in Pakistan: i) Enabling policy environment, ii) Shariah governance and compliance; iii) awareness and capacity building; and iv) market development.

The functional strategies and action plan for achieving objectives in each area have undergone development in consultation with the Islamic banking institutions and their Shariah advisors, SBP Shariah Board members, academics, internal SBP departments, the Securities and Exchange Commission of Pakistan, and the Institute of Chartered Accountants of Pakistan.

People expect that, with the implementation of this strategic plan, Pakistan’s Islamic banking industry will grow prudently and distinctly with the enhanced acceptance and confidence of the general masses contributing to the economic development of the country (SBP 2014).

Although the Islamic banking and finance regulatory framework is well-developed in some Asian countries, the regulatory and supervisory frameworks in many jurisdictions do not yet cater to the unique risks of the industry.

Although Islamic banks appear to be well capitalised, the implementation of the Basel III Accord will involve challenges. For example, further clarification will be necessary from national regulators regarding the instruments that are eligible for treatment as additional Tier 1 and Tier 2 capital.

Furthermore, the scarcity of Shariah-compliant high-quality liquid assets (HQLA) will make it difficult for Islamic banks to satisfy the Basel III liquidity coverage ratio requirement.

Therefore, it is important that national authorities use the leeway that the Basel standards give to grant highly rated and tradable sukuk HQLA status, and take steps to deepen local sukuk and money markets.

Safety nets and resolution frameworks remain underdeveloped. Very few countries with Islamic banking have a full-fledged Islamic deposit insurance scheme with pre miums invested in Shariah-compliant assets.