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Islamic finance rules show signs of convergence

islamicfinMalaysia’s Securities Commission has tightened rules on bai inah, a popular but divisive Islamic financing contract, in a fresh sign that standards in the world’s two main centres for sharia-compliant banking are slowly converging.

Regulators and scholars in Malaysia and the Gulf have contrasting approaches to Islamic finance; the Gulf tends to be stricter in defining permissible transactions, and banks in the region have therefore shunned bai inah.

But under pressure to develop a cross-border industry, authorities in both centres have shown signs of narrowing their differences in the past few years. For example, some Gulf countries have been moving towards centralising supervision of Islamic banks under a single sharia committee, as Malaysia does.

Treatment of bai inah, which involves the sale and subsequent repurchase of an asset on a deferred-payment basis, may now become another area of convergence.

The structure is commonly used in Malaysia, which follows the Shafi school of Islam, regarded as more flexible in its interpretation of sharia law. But scholars from more conservative schools in the Gulf frown on it, arguing that it is only weakly linked to real economic activity, a key principle in Islamic finance.

New rules published by Malaysia’s Securities Commission this month do not ban bai inah, but they stress that the two legs of the transaction must be executed and completed separately, and that ownership of the asset must actually be transferred.

“This will enhance the application of inah as required by the Shafi school and will avert any legal risk on the application of inah if it is challenged in the courts,” said Mohamad Akram Laldin, executive director at Malaysia’s International Sharia Research Academy for Islamic Finance.

“The main issue is the two legs of the contract must be totally separated, and it has to be evidenced in all the documents.”

By making compliance with the new rules more demanding, the ultimate effect may be to encourage Islamic banks in Malaysia to shift away from bai inah to alternative modes of financing, scholars said. Use of other structures, such as commodity murabaha, which is similar in some ways, or musharaka, which many scholars believe more closely follows the Islamic principle of profit-sharing, could increase.

“Most of the Islamic financial institutions have a problem complying with the new ruling. The rules are too tight – to fulfill them they have a problem,” said Shamsiah Mohamad, a member of the sharia advisory council of Bank Negara, Malaysia’s central bank.

“The interconditionality is hard to meet – first leg and second leg, the two can’t have links.”

The presence of bai inah has been one deterrent to the entry of Gulf-based Islamic banks into the Malaysian market, so if the practice fades, banking ties between the two regions could grow.

Even before the new rules, some Malaysian banks had been reducing their reliance on bai inah, and Mohamad made clear that Malaysia’s central bank was comfortable with this trend.

“Bank Negara does not forbid this, but we don’t encourage it because it’s not a kind of contract that all mazhabs (Islamic schools of thought) agree on,” she said.

“Indirectly, when Islamic banks don’t do it, over time it will phase out. The appeal will disappear.”-Reuters