Ahmad Lutfi Abdull Mutalip, Partner, Azmi & Associates, on reforms to Islamic banking legislation: Viewpoint

Since the passing of the Islamic Banking Act (IBA) 1983 (repealed 2013), and the establishment of the first Islamic bank, Bank Islam Malaysia Berhad, in the same year, Malaysia has become a market leader in modern Islamic finance. Its success is the culmination of efforts by various stakeholders: government, regulators, industry players, service providers, universities and the public.

However, continuous reform is required to keep up with rapidly changing times. It was with this in mind that in June 2013, the Islamic Financial Services Act 2013 (IFSA) was implemented.

Similar to the repealed IBA, it is hoped that the IFSA will bring Malaysia’s Islamic finance sector to a new level. Reforms cannot happen overnight, however: continuous engagement between the stakeholders will be necessary in order to ensure the objectives are achieved. History has shown how introducing Islamic finance through a comprehensive model has brought outstanding results.

The new legislation sets out a clear framework on governance, encompassing not only management and operations but also sharia governance, which is equally important and has been further strengthened by the IFSA compared to the repealed IBA. It is of paramount importance that the entire operation of an Islamic financial institution be in compliance with sharia. The requirement of having a minimum number of Sharia Committee members is a step in this direction.

In relation to management and operations governance, the IFSA also provides rulings to ensure compliance with the regulations set by the Bank Negara Malaysia (BNM), the central bank. Non-compliance with the IFSA will attract substantial penalties. For example, in November 2015 AmBank paid a RM53.7m ($13.3m) penalty to BNM for failing to comply with section 245 of the IFSA. AmBank reported that the penalty was a result of weaknesses in its reporting systems and processes. This illustrates that the IFSA has tightened the rules on corporate governance.

An interesting point to note regarding the IFSA is the clear separation of deposit and investment accounts, which have completely different features and risk/reward considerations. In an effort to bring Islamic finance into real economic activities, where financing and funding are given for actual participation in business rather than for pure lending, the investment account portfolio will eventually become a huge asset class of its own.

An ecosystem to support this initiative will be required to ensure success and sustainability. A strong governance framework, project monitoring, risk/reward consideration and awareness, and an education process, will all be necessary elements.

One of the positive impacts of the distinction between investment and deposit accounts is that it creates a new sharia product, namely the investment account, which has real features of investment. The initiative has brought together four Islamic banks in Malaysia – Affin Islamic Bank, Bank Islam Malaysia, Bank Muamalat Malaysia and Maybank Islamic – to establish a multibank platform for marketing investment account products.

To achieve economies of scale and deeper penetration of the market, mergers and acquisitions (M&A) among Islamic financial institutions are inevitable. With regional market liberalisation through the ASEAN Economic Community, financial products and services could be offered across borders with less restraint. Exercising M&A will widen the reach to customers, with more products and services and efficiency improved. Undoubtedly, Islamic finance in Malaysia has grown extensively over the years. Nevertheless, continuous reform and commitment from all the stakeholders are crucial to ensure its sustainability in times to come.