Malaysia lessons on firming up Islamic finance

Islamic banks in Kenya are hugely expected to conform to regulations as stipulated under Central Bank Prudential Guidelines, 2013. Despite its wide application in the banking spectrum; be it conventional or Islamic banking, unique challenges and practices by Islamic banks justify the need to review the prudential guidelines or develop a set that will focus on unique aspects of Islamic banking operations, financing practices and risk management.

To buttress the importance of regulations of Islamic financial institutions, Bank Negara Malaysia introduced few guidelines in 1996, firstly New Financial Disclosure (GP8) to give greater transparency and disclosure of Islamic banking operations. There was also the establishment of Shariah Advisory Council (SAC) as the sole authority to advice BNM on Islamic banking and Takaful operations.

Furthermore, the SAC was to coordinate shariah issues related to Islamic banking and finance. The SAC is responsible to analyse and evaluate shariah aspects on new products proposed by Islamic banking and Takaful companies. Further developments saw the establishment of the International Centre for Education in Islamic Finance (INCEIF) in 2006 to offer professional certification and postgraduate programmes as part of the efforts to build the necessary talents and skills in Islamic finance due to a higher demand for personnel conversant and competent in Islamic finance.

The regulations governing banking in Malaysia give recognition to the need to develop separate set of regulations for Islamic banks. Part of such regulations include capital adequacy framework for Islamic Banks (CAFIB), capital funds for Islamic banks (the minimum capital funds that must be maintained by Islamic banking institution; and components of capital funds), shariah parameters to provide a standard guidance on operationalising and applying the Shariah contracts in Islamic finance, guidelines on Shariah Governance Framework for Islamic Financial Institutions, financial reporting for Islamic banking institutions, guidelines for rebate on sales based financing, shariah resolutions in Islamic finance, among other areas key to Islamic finance.

Islamic banks face unique exposures when there are no regulations that are specific to their business models, operations and contracts.

Likewise, the shariah tenets require that Islamic banks will not engage in activities that are prohibited and not allowed by shariah. To bring it home, consider an Islamic financial institution and their liquidity management practices. Islamic banks in Kenya engage in interbank markets as one avenue for liquidity management. The other aspect is investing in Islamic fixed deposits. Both pose a challenge. There are no money market securities developed in Kenya to allow Islamic banks invest their idle cash.

Currently, the investment activities by Islamic banks and borrowing in the interbank market is subject to scrutiny as it involves lending and borrowing from conventional banks which engage in all businesses not withstanding shariah requirements. In addition, the Islamic product used to facilitate trading in the interbank market is itself a subject of discussion by shariah scholars as to its admissibility as a shariah compliant product. For shariah compliant fixed deposit accounts, the same is offered by a handful of banks that offer shariah compliant services giving rise to the challenge of inadequate investment opportunities in this asset class. The other option is investing offshore in

It is difficult to have a vibrant Islamic banking system without shariah compliant Islamic money markets to help in Islamic banks liquidity management. To overcome this problem, Malaysia introduced a number of Islamic money market products. Bank Negar Malaysia influences Islamic interbank market liquidity through an array of Shariah-compliant instruments, the main instrument being the Qard acceptance (loan). Through the Qard acceptance, the Bank manages liquidity in the context of a surplus liquidity environment by inviting Islamic banking institutions to place their surplus funds with the Bank. The Bank also uses Commodity Murabahah Programme (CMP) to manage liquidity. CMP utilises mainly crude palm oil-based contracts as the underlying commodity transactions to facilitate liquidity management via a commodity trading platform. For longer-term liquidity management, the Bank issues Bank Negara Monetary Notes-i (BNMN-i) which are structured based on Islamic concepts of Murabahah (BNMN-Murabahah), Ijarah (BNMN-Ijarah), Bai Bithaman Ajil (BNMN-BBA) and Istithmar (BNMN-Istithmar). Other financial market instruments are Malaysia Islamic treasury bills, Islamic commercial papers or medium term notes programme and murabahah negotiable certificate of deposits.

Currently, shariah compliant money market instruments hardly exist in the Kenyan market depriving Islamic banks not only avenues to manage liquidity but also investment opportunities to drive their incomes from investment in government securities.

This challenge calls for development of frameworks and regulations to develop Islamic money markets. Whereas there has been debate on issuance of Sukuk, an Islamic capital market instrument, there has not been resounding progress over the development of regulations to enable its issuance and its subsequent trading. Information for public consumption has been that the government through the national treasury and other agencies within the national treasury are working on this. Then the question remains when?

In terms of regulations, there must be a pool of trained and competent human resources at the regulators level to inform the development of guidelines to regulate specific activities and operations of Islamic banks. Malaysia developed the International Centre for Education in Islamic Finance (INCEIF) to ensure there is standardised approach to training of Islamic finance professional and to meet the shortfall in human capacity. Building a competent pool of professionals at all levels from the regulatory agencies such as Central Bank of Kenya, Capital Markets Authority, Insurance Regulatory authority and the Nairobi Securities Exchange and to individual Islamic financial institutions will help speed up the drafting of regulations, establishment and operationalisation of Islamic money and capital markets.