Chapter 7

Sharī`ah Non-Compliance Reporting

7.0. INTRODUCTION

Regarding Sharī`ah non-compliance reporting, a circular was issued by the Central Bank of Malaysia on March 15, 2013. The effective date of the circular was May 1, 2013.1

7.1. OBJECTIVE

Bank Negara Malaysia (the Bank) places great importance on ensuring that the Islamic financial system operates in accordance with Sharī`ah. In meeting this objective, compliance with Sharī`ah has become an integral aspect in the operations and business conduct of the Islamic financial institutions (IFIs).

Paragraph 2.17 of the SGF for IFIs (the framework) stipulates that it is the duty of the IFIs to inform its board of directors (the board), the Sharī`ah committee, and the Bank in the event that the IFIs have become aware that certain operation of the IFIs is found to be Sharī`ah non-compliant:

In the event the management becomes aware that certain operations are found to be carrying out business(es) which is(are) not in compliance with Sharī`ah, or against the advice of its Sharī`ah Committee or the rulings of the Sharī`ah Advisory Council of the Bank (SAC), the management shall:

I. Immediately notify the board and Sharī`ah Committee as well as the Bank of the fact;

II. Immediately cease to take any new business related to the Sharī`ah non-compliant business; and

III. Within thirty (30) days of becoming aware of such non-compliance or such further period as may be permitted by the Bank, furnish a plan to rectify the state of non-compliance with the Sharī`ah, to be duly approved by the board and endorsed by the Sharī`ah Committee.

Pursuant to the preceding requirement, the IFIs are obliged to notify the Bank on any Sharī`ah non-compliance event of the IFIs business operations and activities. Although the IFIs have been notifying the Bank on Sharī`ah non-compliance events from time to time, there is a need to develop a mechanism to streamline the reporting template to enable effective monitoring and surveillance by the Bank. This circular is issued to facilitate the IFIs in meeting the foregoing requirement.

This circular provides a standard reporting mechanism for the IFI to inform the Bank of any Sharī`ah non-compliance of IFI’s business operations and activities as well as to provide guidance to the IFIs in preparing the reports on Sharī`ah non-compliance events for submission to the Bank on a regular basis.

The circular shall be read together with the framework and other regulations, guidelines, or circulars that the Bank may issue from time to time.

7.2. APPLICABILITY

The circular is applicable to:

7.3. LEGAL PROVISIONS

This circular is issued pursuant to section 53A of the IBA, section 69 of the TA, section 126 of the BAFIA, section 126 of the DFIA, and section 59 of the Central Bank of Malaysia Act 2009 (CBA).

7.4. REPORTING REQUIREMENTS

The IFIs are required to submit reports to the bank on the actual and potential Sharī`ah non-compliance events using the attached reporting forms in Attachment 1. The chart on the whole process flow of the Sharī`ah non-compliance reporting is attached in Appendix 1 for reference.

In the event that the IFIs realised that they are engaging or have engaged in Sharī`ah non-compliance activities, the IFIs are required to bring the non-compliance event to the attention of their respective Sharī`ah committee for confirmation about whether the non-compliance event is either actual or potential Sharī`ah non-compliance.

Upon the confirmation by the Sharī`ah committee that the reported event is actual Sharī`ah non-compliance, the IFIs are required to immediately notify the board and subsequently to provide the Bank with sufficient information of the fact, together with the rectification plan that has been approved by the board.

In addition, the IFIs are also required to report to the Bank on potential Sharī`ah non-compliance events specifically to serve as an alerting tool to the Bank of any potential Sharī`ah non-compliances that may lead to other type of risk—for example, legal or reputational risk, especially when it comes to similar issues that occur across the industry. In addition, such reporting is also to ensure a level playing field when it comes to the treatment of Sharī`ah non-compliance events. For example, Bank A may treat an incident as actual Sharī`ah non-compliance that affected its income. However, similar cases might not be reported by other IFIs if it might not appear as an actual Sharī`ah non-compliance event due to differences in Sharī`ah interpretations by the respective Sharī`ah committee.

An example of a potential Sharī`ah non-compliance event (inclusive of financial and/or non-financial implications) is illustrated next:

Bank Z charges annual administrative fees on dormant savings and current accounts from the outstanding balance in these accounts, without obtaining consent from the customers. Bank Z recognised the fees as income to the bank. Following a Sharī`ah audit conducted, the practise was discovered and brought to the attention of the Sharī`ah committee of the bank.

7.5. REPORTED AS POTENTIAL SHARĪ`AH NON-COMPLIANCE EVENT

The Sharī`ah committee of the bank has not made any decision on the issue and needs to conduct further research and investigation. Due to the pending decision by the Sharī`ah committee on the matter, it shall be reported as a potential Sharī`ah non-compliance event to the Bank.

7.6. SUBMISSION OF REPORTS ON ACTUAL SHARĪ`AH NON-COMPLIANCE EVENTS

Report on actual Sharī`ah non-compliance event shall be submitted to the Bank on an “immediate” basis “as and when” necessary. The term “immediate” is defined as within 14 days of realisation that the Sharī`ah non-compliance event has occurred. During this period, the IFIs are required to obtain the confirmation from the Sharī`ah committee. In addition, the IFIs are also required to submit to the Bank the rectification plan, to be approved by the board and the Sharī`ah committee within 30 days. Figure 7.1 illustrates the timeline for actual Sharī`ah non-compliance reporting to the Bank.

FIGURE 7.1 Timeline for Actual Sharī`ah Non-Compliance Reporting

7.7. TIMELINE FOR ACTUAL SHARĪ`AH NON-COMPLIANCE REPORTING

The timeline, shown in Figure 7.1, for Sharī`ah non-compliance reporting, is very crucial and sensitive. Hence, the stakeholder of the Sharī`ah non-compliance in the Islamic financial institution must act in timely manner through efficient coordination and communication with the Sharī`ah board and the board of directors to ensure compliance with the guidelines of the regulator in reporting the Sharī`ah non-compliance matters.

In the event that no board meeting will be held within 30 days from the date of confirmation by the Sharī`ah committee that an actual Sharī`ah non-compliance event has occurred, the IFI is required to exhaust other means to obtain the board’s approval on the rectification plan prior to the submission to the Bank.

7.8. POTENTIAL SHARĪ`AH NON-COMPLIANCE EVENT

Any pending decision by the Sharī`ah committee on the identified issue shall be treated as a potential Sharī`ah non-compliance event.

Report on potential Sharī`ah non-compliance events to the Bank shall be made on a monthly basis based on a calendar year that is not later than two weeks after the end of each monthly period. Figure 7.2 illustrates the timeline for potential Sharī`ah non-compliance reporting to the Bank.

FIGURE 7.2 Timeline for Potential Sharī`ah Non-Compliance Reporting

7.9. TIMELINE FOR POTENTIAL SHARĪ`AH NON-COMPLIANCE REPORTING

The timeline for potential Sharī`ah non-compliance, shown in Figure 7.2, is different from the actual, where there is a flexible time frame for the potential Sharī`ah non-compliance.

7.10. NO SHARĪ`AH NON-COMPLIANCE EVENT IS DETECTED

When there is no Sharī`ah non-compliance event in the IFIs for any particular period, the IFIs are still required to submit the reports on a monthly basis, which serves as a declaration or official attestation on the status of Sharī`ah compliance of the IFIs.

Submission of all the reports shall be made to the Bank within the stipulated deadline as specified in paragraphs 6.6.1, 6.7.2, and 6.8.1. The IFIs shall refer to Attachment 1 (Figure 7.3) for the reporting template forms on Sharī`ah non-compliance event reporting to the Bank.

FIGURE 7.3 Process Flow for Sharī`ah Non-Compliance Risk

Submission of the reports constitutes an official attestation by the IFI based on the business operations and activities conducted. The officer-in-charge of IFI shall be prepared to respond to any query from the Bank about the details of their submission.

The chief risk officer/senior management in charge of statutory reporting of the IFI is responsible and will be held accountable for the quality and accuracy of the information submitted to the Bank.

7.11. PROCESS FLOW FOR AUTHENTICATION OR CONFIRMATION OF SHARĪ`AH NON-COMPLIANCE IN THE IFIS

The process flow shows the line of reporting through the three different levels of screening. (See Figure 7.3.) The first level is the screening process by Sharī`ah compliance function, the second level is the confirmation by Sharī`ah committee to be reported to the central bank, and the third level is the correction measures to be undertaken by the Islamic financial institution. Actually, the Sharī`ah non-compliance risk started by detecting the risk in the business banking operation, then it will be reported to the Sharī`ah committee for decision about whether the risk is to be declared actual or potential. If actual, a possible financial impact may take place; in case of potential, a following decision is to be made, either to be removed from the list of Sharī`ah issues or to be declared actual.

NOTE

1. Sharī`ah non-compliance reporting issued by the Central Bank of Malaysia on March 15, 2013. The effective date of the circular was May 1, 2013.