Why is it that Islamic banking and finance products cannot be introduced in a jurisdiction straight away, similar to conventional banking products? What takes a country to ‘prepare the ground’ for providing Shariah finance solutions to its people? Do the regulatory bodies of a country need different skill sets in order to monitor Islamic banks and financial institutions? SOHAIL ZUBAIRI tries to find out.
The legal systems of countries around the world are based on either one or a mix of civil law, common law, statutory law and religious law in light of the country’s socioeconomic environment and historical background. Then there are other supplementary laws, such as taxation law, banking law, insurance law, mortgage law and others.
The taxation law deals with numerous types of levies including value-added tax (VAT), goods and services tax (GST), customs duties, stamp duties, land registration, mortgage fees and such. These are applied on transactions related to trade (sale and purchase of goods, assets and services) and investments. Contrary to conventional banking and finance products which originate from interest-based lending and borrowing, the Islamic banking and finance products use trade and investment contracts since lending or borrowing on interest is forbidden in Islam.
While no tax is applied on interest-based conventional banking products (in fact, most of the jurisdictions provide tax relief/rebate on the amount of interest paid by an individual or entity), Islamic banking and finance products by nature invite taxation since these are developed as a means of trade and investment activities and do not have any element of interest payment or receipt.
As such, if a country wants to introduce Islamic banking and finance, it becomes essential for it to first amend the relevant laws in order to provide a level playing field to Islamic banks and financial institutions whereby the trade and investment transactions undertaken by them shall be exempted from VAT, GST, double stamp duty on property financing in addition to the other charges.
More and more countries (including Islamic countries) are now eager to amend the regulations in order to welcome Islamic banking and finance transactions.
The Islamic banking and finance industry works under a three-pronged regulatory environment that focuses on the following:
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The very nature of Islamic financial institutions, which require them to be self-regulated to a great extent
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The country’s neutral regulations based on local and international laws and standards being applied on the banking and finance industry, irrespective of the nature of the financial institution being Islamic or conventional, and
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The country’s own Islamic banking and finance regulations mostly based on AAOIFI and IFSB standards and guidelines.
Review of 2016
The global financial crisis of 2008 amply demonstrated that the regulators’ inattentiveness to remain ahead of the game turned out to be extremely disastrous and a costly affair for the world.
Pursuant to the crisis, the Financial Stability Board (the erstwhile Financial Stability Forum) based at the Bank for International Settlements in Switzerland took it upon itself to guard the global financial stability through the coordination for development of new regulatory and supervisory policies for the financial sector.
In addition to applying the local and global regulatory standards meant for the financial services sector, not many are aware that Islamic financial institutions have two additional corporate governance layers which have kept them at bay from the harm suffered by their conventional counterparts. These are the Shariah supervisory board and the Shariah audit.
2016 saw regulators taking notable steps to ensure the desired outcome from the Shariah supervisory board and the Shariah audit functions. In March 2016, the UAE cabinet approved setting up a new higher Shariah authority — a national regulator — to set standards for Islamic finance products and services in the UAE. The Central Bank of Bahrain also proposed a mandatory external Shariah audit and Oman and Pakistan sought stricter requirements for Islamic financial institutions.
Preview of 2017
I expect to see a combination of global and national regulators further tightening up the financial services sector regulations toward enhanced disclosure and best practices.
In the coming years, the pressure shall also grow on Islamic banks from customers to demonstrate in practical terms what they claim to be – for example, to show that they are different from conventional banks by applying transparency and fair play in their products and services.
Conclusion
Islamic finance has evolved enough during last four decades to now take the centre stage in the mainstream financial system of the world. A lot has been done by national regulators and standard-setting bodies such as AAOIFI and the IFSB to discipline the industry toward claiming its due role in the global financial scene.
I saw a rainbow during my visit to Beijing to attend the first Islamic finance conference in May 2016. My Chinese colleagues attending the event termed it as the good omen for Islamic finance in China. To them, the colors of the rainbow demonstrated the different strings of Islamic finance such as banking, insurance, Sukuk, funds, trust, microfinance and charity. I could not agree with them more, having started to see rising interest from China for Islamic finance.
Sohail Zubairi is CEO of Dar Al Sharia. He can be contacted at [email protected].