The Legal andRegulatory Aspects ofIslamic BankingA comparative look at theUnited Kingdom and Malaysia

Abdul Karim Aldohni

RoutledgeTaylor & Francis Group

LONDON AND NEW YORK

Contents

Acknowledgements xii

Table of cases xiii

Table of legislation xiv

Table of statutory instruments xvi

Table of European legislation xvii

1 Introduct ion 1

1.1 An ovennew 1

1.1.1 Wliy is the legal aspect important and challenging? 2

1.1.2 Wlial this book aims to do 2

1.2 Structure of the book 3

1.3 A note on terminology and methods 5

2 The h i s tor i ca l a n d i d e o l o g i c a l b a c k g r o u n d o f

I s lamic b a n k s 6

2.1 Introduction 6

Part One: llie history and development of Islamic banking 8

2.2 Islamic banking development: an overview 8

2.3 Islamic banking in Muslim countries: back to the roots 9

2.3.1 llie role oj the religious and political factors 9

2.3.2 llie role oj the economic factor (the oil wealth of the

GulJ countries) 11

2.3.3 llie economic adoption of the. Islamic banking system in

Muslim countries 16

2.4 Trie growth oj Islamic banking in the West: the case of

the United Kingdom 20

2.4.1 The unique financial position oj London 21

2.4.2 The danger oj the informal Islamic financial institutions

(terrorist finance) 23

viii Contents

2.4.3 Vie attraction of oil wealth 24

2.4.4 Investing and saving the growing wealth of

the Muslim minorities 25

2.4.5 Economic globalisation 25

Part Two: Tlie theoretical foundation of Islamic banking — the religious, economic and

ethical aspects 26

2.5 Tfie ideological background of Islamic banking 26

2.5.1 Islamic theory of the market, money and economy 27

2.5.2 Tlie religious justification of Islamic banking: the

prohibition of interest 29

2.5.3 Trie economic justification of Islamic banking 33

2.5.4 Tlie ethical dimension of Islamic banking 35

3 Legal analysis of the English legal sy s t em incomparison to the Is lamic legal s y s t e m 37

3.1 Introduction 37

3.2 Tlie legal structure of both systems: an overview) 37

3.3 Trie legal sources oj both systems: some basic similarities 39

3.3.1 Tlie customary origins of the legal rules 39

3.3.2 The role of the judges (the judicial precedents) 41

3.3.3 Tlie meaning and role of equity principles in both systems 46

3.3.4 Legal presumption as an integrated division of both systems 48

3.4 'The role of logic in legal reasoning in both systems 50

3.4.1 Deductive logic 51

3.4.2 Legal analogy 52

3.5 A possible legal interaction between both systems 54

4 The legal descript ion and classification of Is lamicbanks under the English law 56

4.1 Introduction 56

Part One: Tlie legal definition of a 'bank' 57

4.2 The meaning oj 'bank' under the UK banking legal framework 57

4.3 Tlie common law definition oj a 'bank' 57

4.3.1 The development of the definition oj 'banking business' 57

4.3.2 Tlie distinctive characteristics oj 'banking business' 58

4.3.3 T he elements imposed by the factual circumstances

of the business 60

4.4 'The statutory definition oj'bank' 61

4.4.1 The UK dimension 61

4.4.2 The EU dimension 63

Contents ix

4.5 The legal status of Islamic banks under the UK banking

legal framework 64 I

4.5.1 Defining Islamic banks in the light of tlie English

case law 64

4.5.2 Tlie description of Islamic banks in view of the statute 70

Part Two: Locating Islamic banks in the main banking categories of the

UK banking sector 71

4.6 Tlie main categories in the banking market 71

4.6.1 Commercial and merchant 'investment' banks: the nature

of the business 72

4.6.2 Tlie impact of economic deregulation on the banking sector 74

4.7 Addressing the position of Islamic banks 76

Islamic banks in practice: the operational aspects

of Islamic banking 78

5.1 Introduction 78

5.2 Hie formation of an Islamic bank 79

5.3 Tlie operations of Islamic banks 85

5.3.1 Islamic law doctrines oj commerce and contracts 85

5.3.2 Tlie contracts used by Islamic banks: an overview 91

5.4 Tlie mam categories of Islamic banking contract 91

5.4.1 Intermediation contiacts 91

5.4.2 I ransaction contracts 94

5.5 Legal concerns arising jrom the finance modes and structure oj

Islamic banking 101

5.5.1 Corporate governance of Islamic banks 102

5.5.2 Tlie lack of an accurate legal frame for Islamic mortgages 108

5.5.3 Tax law and Islamic banking financial products 108

5.5.4 The legal binding power of the promise in the case of

Murabaha agreement 111

5.5.5 Islamic banking cases in the English court:

the applied law 112

The banking regulatory and supervisory s y s t e m inthe United Kingdom: an overview 122

6.1 Introduction 122

6.2 The unique contribution of banks to the economic fabric of society 123

6.3 The need for banking regulation 124

6.4 'The key rationales for banking regulation 125

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6.4.1 Tlie cardinal role of banks in the economy: the social

and ethical aspects 125

6.4.2 Market imperfections 126

6.4.3 Tlie intertwined nature of the banking sector 127

6.4.4 Tlie vulnerable nature of banking business 128

6.4.5 Systemic risk in the banking sector: t/ie deadly results 130

6.5 Tlie regulator of the banking sector in the United Kingdom 131

6.5.1 Tlie transformation to a formalised regulatory system 132

6.5.2 Tlie unified regulatory system 132

6.6 'Tlie regulator's objectives and strategy 136

6.6.1 Tlie regulatory objectives 136

6.6.2 'Tlie techniques of the regulator 139

6.7 Tlie international aspect of banking regulations 149

7 The application of Is lamic banking under theconventional banking regulation o f theUnited Kingdom: fit or conflict? 152

7.1 Introduction 152

7.2 Tlie rationale, for regulation in tlie case oj Islamic banks 153

7.2.1 Islamic banks contribution to the economy 153

7.2.2 Information asymmetry 153

7.2.3 Tlie vulnerable nature of Islamic banking business 154

7.2.4 Islamic banks and systemic risk 156

7.3 The relationship between Islamic banks and thejinancial authorities 157

7.3.1 Tlie Financial Services Authority and Islamic banks 157

7.3.2 Tlie Bank of England and Islamic banks 172

7.4 The applicability of the safety-net schemes in the case

of Islamic banking 173

7.4.1 Deposit insurance scheme 173

7.4.2 Lender of last resort 176

7.5 Tlie applii ability of international banking standards in the context

of Islamic banking 178

7.5.1 Islamic banking and Basel Core Principles for Effective

Banking Supervision 178

7.5.2 Islamic banks and Basel II 179

8 Is lamic banking in Malaysia: the Malays iancase study — a legal analys is 183

8.1 Why is Malaysia an important case study? 183

8.2 Tlie Malaysian economy and ttsjinancial system: an overview 184

8.3 An overview of the Malaysian legal system 186

Contents xi

8.3.1 Tlie evolution of Islam 186

8.3.2 British colonisation 187

8.4 Potential differences between Malaysia and the UK in relation

to Islamic banking 190

8.4.1 Tlie evolution of Islamic banking in the

Malaysian banking system 191

8.4.2 Tlie introduction of the Islamic Banking Act 1983 192

8.5 Some of the lead legal regulatory challenges regarding Islamic

banking: the Malaysian approach 194

8.5.1 Lender of last resort in relation to Islamic banks 194

8.5.2 Deposit insurance scheme 196

8.5.3 Corporate governance in an Islamic banking institution 199

8.5.4 Islamic banking cases in non-Shana courts:

the applied law 203

9 C o n c l u d i n g r e m a r k s 207

9.1 Locating Islamic law in the English legal system 207

9.2 Tlie impact of the UK conventional legal framework

on Islamic banking 209

9.2.1 Tlie laws that govern the structure and contracts of

Islamic banks 210

9.2.2 Prudential banking regulation and international banking

standards 212

9.3 Some reflections on the findings 215

9.3.1 Hie impact on the prosperity of the Islamic banking sector 215

9.3.2 Tlie impact on the Islamic nature of this banking sector 216

9.4 Some reflections on possible future developments 217

Bibliography 221

Index Til