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(IUU I) 9 IIUML.1 I

ISLAMIC BANKING IN MALAYSIA: LEGAL

HICCUPS AND SUGGESTED REMEDIES
Norhashimah Mohd. Yasin*

ABSTRACT

Malaysia is at the forefront of Islamic banking and

finance. The support from the government, corporate
bodies and the society at large are instrumental to
its major success. In addition, the strict supervisory
role of the Central Bank ensures good corporate
governance of the Islamic banks and conventional
bank's Islamic Banking Divisions (IBDs).
Nevertheless, in spite all this, the legal framework
has not been too supportive and conducive to
facilitate the smooth running of the Islamic banking
industry. On the one hand, the infrastructure within
which Islamic banking is operating is very
sophisticated and ahead of other countries around
the globe but on the other hand, the legal framework
seems to suggest the exact opposite. The legal system
of the country is lagging behind the rapid
development that taken place within the Islamic
banking system. While all the steps have taken to
ensure .the strict compliance with the Islamic
principles of doing business by the establishment of
the Sharfah Supervisory Council (SSC) at the
Central Bank, upon dispute, the court which has
jurisdiction is still vested with the Civil Court.

*Assistant Professor, Alunad Ibrahim. Kulliyyab. of Laws, International Islamic

University Malaysia.
 2 IIUM LAW JOURNAL VOL. 9 NO. 1, 2001

The Civil Court will not hesitate to apply the

rules of law that they are familiar with. The case
law has proven that the Islamic principles of
Muck nalat are not applied. Similarly, the regulating
law under which Islamic banking is operating (IBA
1983) is not meant to be exhaustive, free of loopholes
and lacuna which gives room for interpretation. The
existing statutes dealing with substantive laws and
procedures, which wee enacted prior to the
establishment of Islamic banking, have circumscribed
the smooth running and operations of Islamic
banking.
It is against this backdrop that the article
seeks to disclose the reality of the Islamic banking
system in Malaysia vis-a-vis the legal framework.
The article will also suggest some reforms necessary
to be urgently attended to in order to materialise" the
genuine success and progress of the Islamic banking
system in Malaysia. It is high time that Malaysia
should have her own version of Common law, which
gives due respect and an active role to Islamic law
to be applied and practised by the Civil court. It
would be illogical to imagine that in any dispute
involving Islamic banking, which has its roots in
SharIah principles and spirit, the non-Islamic
principles are referred to and applied.

INTRODUCTION

In Malaysia, currently, there are two Islamic banks called Bank

Islam Malaysia Berhad (BIMB) which commenced operation in July 1983
and Bank Muamalat Malaysia Berhad (BBMB), a newly formed bank
as a result of a merger and take over exercise.' They were established

1
At the end of 1999, Bank Muamalat was established following the merger of
Bank Bumiputra Malaysia Berhad (BBMB) and Bank of Commerce (M) Berhad
(BOCB). Under the arrangement, all conventional banking assets and liabilities
of BIMB would be transferred to BOCB while the Islamic banking assets and
liabilities of BOCB and BBMB Kewangan Berhad would be moved to Bank
Muamalat Malaysia Berhad. See The Star 9 February 1999, New Straits Times 13
August 1999.
Islamic Banking in Malaysia: Legal Hiccups and Suggested Remedies .3

by virtue of an act of Parliament; the Islamic Banking Act (IBA) 1983

which is considered as the beginning of the effort to assimilate Islam into
the Malaysian economic system. Thereafter, more statutes were enacted
to govern and regulate the financial sector in Malaysia. For instance the
Government Investment Act (GIA) 1983' and the Takaful Act (TA) 1984.3
The full monopoly of BIMB in Islamic Banking lasted for ten
years until 1993, when three commercial banks, i.e. Maybank, Bank
Bumiputra and United Malayan Banking Corporation were given the
opportunity under the pilot project of the Interest-free Banking Scheme
(1138)4 probably to test the market as to the profitability and viability of
Islamic banking offered by conventional banks.' Certainly, the project
has been shown to be a remarkable success with many more commercial
banks participating in the IBS. Now almost every commercial bank offers
Islamic banking.
As part of the effort to promote the development of Islamic
banking in Malaysia, Bank Negara Malaysia (CBM) has implemented
the following measures:
i) Effective 1 December 1998 the term 'Perbankan Tanpa Faedah'
or 'Interest-free Banking' was replaced by the term Terbankan Islam'
or Islamic Banking;
GIA 1983 is an Act which confers on the Minister the pow6r to receive
investments for a fixed period and to pay dividends thereon. The Act was
enacted to enable the Government to receive moneysrom an Islamic bank for a
fixed period. The Act empowers the Government to issue Malaysian Government
Investment Certificates (MGIC) with no fixed return (to replace interest) but in
the form of a gift (Hibah). The Islamic bank is acting as creditor to the Government
(Bank Negara) based on the principle ofAl-Qara 'Hasan (interest-free loan).
TA 1984 provides for the regulation of Islamic insurance (Takaful) business. It
allowed for the establishment of the first Takaful company, Syarikat Takaful
Malaysia Berhad (STMB), now better known as Takaful Malaysia, which operates
along SharTah principles. Only in 1993 was a second Takaful company
incorporated with the name of MNI Takaful, later renamed as Takaful Nasional.
In addition, an Islamic Hire Purchase Bill to deal with Islamic leasing (1j e-rah) is
now on the way and is waiting to be tabled in Parliament.
4
It was known as Skim Perbankan Tanpa Faedah (SPTF) which was also known
as Islamic Windows or Islamic Counters. It means that interest-free products are
offered to the customers along with conventional products under the same roof.
BIMB is still monopolising Islamic banking in Malaysia as it is still the only
commercialbank licensedunder the IBA to offer exclusive Islamic banldng products
and services, thus free from BAFIA's restrictions and constraints. Bank Muamalat
for technical reason has to be operated within BAFIA as it has yet to get a
license under the IBA.
 4 IIUM LAW JOURNAL VOL. 9 NO, 1, 2001

ii) Effective from 2 January 1999, the Islamic Banking Unit (IBU)
of banking institutions participating in Skim Perbankan Islam were up
graded to an Islamic Banking Division- (IBD) headed by a senior
management officer of the bank, preferably at the level of Assistant
'General Manager; and
iii) The minimum amount of Islamic Banking Fund (IBF) currently
set as RM1 million for all financial sectors was revised. For commercial
banks, IBF is increased to RM5 million. For finance companies, it is
increased to RM5 million and for merchant banks, increased to RM3
million.'
Interestingly, in Malaysia there are two laws governing Islamic
banking. One is the IBA 1983 which exclusively governs BIMB and the
other is the Banking and Financial Institutions Act (BAFIA) 1989 which
regulates conventional banks and Islamic Banking Divisions (IBDs). The
nature of these laws are somewhat different as the IBA was enacted
with Islamic banking in mind while BAFIA was enacted to govern
conventional banking.' Section 124 (6) of BAFIA specifically provides
that "the Act shall not apply to Islamic banks." As such, one can loosely
say that the IBA, as the name implies, is an Islamic statute while BAFIA
is a conventional or civil statute to govern their respective banks. The
nature of the dual banking system; a full-fledged Islamic banking system
operating on a parallel basis with a sophisticated conventional banking
system is unique. So far, Malaysia is the only Muslim country to implement
such a model to work hand-in-hand or side-by-side utilising essentially
the same banking infrastructure.
Malaysians can be proud that it is the leading country for Islamic
banking with allthe support and backing from the government.' Malaysia
,

is the only country which has its own Islamic Inter-bank Money Market
(WM) to link all the Islamic banking players so they can undertake
Islamic banking business to the fullest.' Malaysia is also the first country
6
Taken from CBM's Homepage entitled "Press Release: Measures to Strengthen
-

the Islamic Banking Sector.

BAFIA is actually a combination of the former Banking Act 1973 and Finance
Act 1969 and is meant to provide a new law for the licensing and regulation of
banking institutions, finance companies, discount houses, money-broking
business and other institutions carrying on certain other financial business and
matters connected to business (Preamble of the Act).
See the article written by the advisor to CBM, En. Nor Mohamed Yakub entitled
"Globalisation of Islamic Financial System: The Malaysian Experience," presented
at the seminar organised by IIUM, 12 April 1995. The article rated various
countries in the Middle East and Asia in terms of government backing for Islamic
Banking. The writer rated Malaysia as excellent in terms of government support
while others are either good, fair or even poor.
It is submitted that in order for Islamic banking to achieve its fully fledged level
9

of sophistication, four aspects need to be established (i) the individual players

(financial institutions) (ii) the instruments/products (iii) Islamic inter-bank money
market (iv) Islamic business ethics. The first three are said to have been fulfilled.
Islamic Banking in Malaysia: Legal Hiccups and Suggested Remedies 5

to introduce Islamic bonds, albeit not totally devoid of controversy.

Unfortunately, despite all the social and political support, it seems that our
legal infrastructure has not been equally supportive and conducive to
facilitate the smooth running of Islamic banking in its holistic sense.
Therefore, this article seeks to uncover some of the constraints with a
view to reform so that the Islamic banking movement in Malaysia will
reach its maximum height, free from any legal impediments whatsoever.
ISLAMIC BANKING BUT CIVIL COURT JURISDICTION
Islamic law in Malaysia is only applicable in a very limited sphere:
family law and "religious offences."10 Islamic law is provided for under
the State list and therefore is under the administration of each state."
There was an amendment to Article 121 of the Federal Constitution 1957
in 1988 which restrains Civil Courts from haying jurisdiction to hear cases
where Islamic law is applicable and such jurisdiction is now vested in the
Shariah Courts '2 Previously, the Shariah Courts and Civil Courts
exercised concurrent jurisdiction on certain matters involving Islamiolaw.
With the inclusion of Clause (1A) in Article 121, it was argued that the
jurisdiction of the Civil Courts on matters involving Islamic law had been
taken away. '3
It includes offences by Muslims against precepts of the Islamic religion except
11)

in regard to matters included in the Federal list of the 1956 Constitution. Such
offences include eating inpublic places during day time in the month of Ramadan,
close proximity (Khalwat) and adultery (Zin4.
11
Look at Schedule 9, list 2, Federal Constitution 1957.
12
See Ahmad Ibrahim "The Amendment to Article 121 of the Federal Constitution:
Its Effect onAdministration of Islamic Law" [1989] 2 MU.
13
The point contended by the defence counsel in the preliminary round in the
case of BIMB v Adnan Omar (infra) which is discussed later. In addition, the
Supreme Court in the case of Mohamed Habibullah bin Mahmood v Faridah
bte. Dato Talib [1992] 2 MU 793, reaffirmed that the effect of the amendment to
Article 121 was that matters within the jurisdiction of the Shariah Court were
outside the jurisdiction of the Civil Court, Harun Hashim SCJ (as he then was)
stated at p. 800 "(I)t is obvious that the intention of Parliament by Article 121
(IA) is to take away the jurisdiction of the High Court in respect of any matter
within the jurisdiction of the Shariah Court I am therefore of opinion that when
there is a challenge to jurisdiction of the Shariah Court has jurisdiction and not
whether the Sharicah Court has jurisdiction and not whether the State Legislature
has power to enact the law conferring jurisdiction on the Shariah Court." However,
The Federal Court in the case of Sukma Darmawan Sasmitaat Madja v Ketua
Pengarah Penjara Malaysia [1999] 1 Mil 266 has overturned the above effect
of the amendment and decided that when there are conflicting jurisdictions
between the Shariah Court and the Civil Court, it will depend on the authority
concerned to choose the relevant forum for the case to be tried. For commentary
on this recent state of affairs, see article written by Salleh Buang in his weekly
column "Peguam Menulis", Utusan Malaysia, 4 May 1999. Refer also Salleh
Buang, "Historic Judgment on Article 121 (IA) of the Federal Constitution",
Malaysian Law News, February 1993 at 11-16.
6 HUM LAW JOURNAL VOL 9 NO. 1, 2001

Nevertheless, in cases involving a banking transaction based on

Islamic principles, the High Court ruled that the said clause has not taken
away the Civil courts' jurisdiction and that they do have jurisdiction to
hear the case.14 Thus, the law relating to commerce and business including
Islamic banking and commerce (Mu'Imalat) is still either the Malaysian
statutes law or the English law.
In a nutshell, Shariah Courts only have jurisdiction over matters
falling under the State list. The Civil Court has jurisdiction to hear all
cases falling under the Federal list. Thus, banking and its related matters
fall within the ambit of the Federal list, ie. the Civil Court. Besides, the
State List expressly states that Shariah Courts "shall have jurisdiction
only over persons professing the religion of Islam." Nevertheless, it
does not mean that if both parties to an Islamic banking transaction are
Muslim, the matter can fall under the SharFah jurisdiction." The
judgement of the Supreme Court in Mohamed Habibullah bin Mahmood
v Faridah Dato'Talibi5 has ruled that the Shariah Court can only decide
matters falling under its jurisdiction, as such the amendment to Article
121 of the Constitution does not take away the jurisdiction of the High
Court in matters when they fall under the Federal list. Such matters include
banking and finance.
Two leading Islamic banking cases relating to Bay' Bithaman
Afil (BBA) were decided by the Civil Court (High Court). The discussion
and commentary on these cases have already been discussed
elsewhere.16 In the case of BIMB v Adnan bin Omar,'7 there was a
preliminary objection raised byAdnan (defendant) which was not reported
and no written judgement was supplied. The issue was about the courts'
jurisdiction." The defendant argued that since BIMB (plaintiff) is an
Islamic bank, the Civil Court had no jurisdiction to hear the case in view
of Article 121 (1A) of the Federal Constitution 1957. The judge, N.H.
Chan, overruled that objection and submitted that the matter was rightly
brought before the Civil Court. It was submitted that List 1 of the Ninth
'4 It was held by the judge in Adnan's case which was unreported.
15
Ibid.
16
See Norhashixnah Mohd. Yasin, "Islamic Banking: Case Commentaries Involving
Al-Bay' Bithaman 410 [1997] 3 MU excii-cciv.
17
[1994] 3 CLJ 735.
's BIMB v Adrian bin Omar & Others (KL High Court Civil Suit No S3-22-101-9)
also reported by Al-Marhum Prof. Alunad Ibrahim, "Legal Solution: Toward a
Smoother Implementation of Islamic Banking and Finance," paper presented at
the National Congress on Islamic Banking and Finance, Kuala Lumpur,
December 1996.
Islamic Banking in Malaysia: Legal Hiccups and Suggested Remedies 7

Schedule enumerates the various matters in which Parliament can enact

laws. The scope is very comprehensive which includes banking and the
constitution, organisation, jurisdiction and powers of all courts other than
Shariah Courts and native customary courts. List 11 in the State list
provides for the constitution, organisation and procedure of Shariah Courts,
which shall have jurisdiction only over persons professing the religion of
Islam and only in respect of any of the matters included which exclude
banking. It was further held that since BIMB is a corporate body, it does
not have a religion and therefore is not within the jurisdiction of the Shariah
Court.
Perhaps the time has come to set up an Islamic division under
the High Court structure whereby all Islamic banking cases and any other
Islam related cases can be dealt with. Besides, it could encourage the
specialisation of judges and lawyers in this area of law as has been done
with the four existing other divisions (commercial, civil, criminal, appeals
and special powers). This effort will not lead to duplication of the Shariah
court's jurisdiction as ithas limited jurisdiction, as discussed earlier. This
Islamic Division would be a good solution to this problem and should be
regarded as complying with Article 3 of the Federal Constitution that
upholds Islam as the religion of the Federation. The old rule that Islamic
law means matrimonial matters per se is no longer relevant.
The establishment of an Islamic Division at the High Court should
not be seen as a revolutionary movement to change the country into an
Islamic state. It is a relatively non-drastic change as compared to other
possible solutions that require some changes to the very basis of the 1957
Constitution. It merely puts Islamic law on an equal footing with civil law
so that Muslims are not discriminated against when it comes to commercial
matters. One may wonder what is the point of setting up an Islamic bank
and Islamic instruments, if upon dispute, they may be interpreted by non-
Islamic principles which might cause injustice and inequitable results to
the parties involved.

THE APPLICATION OF CIVIL LAW ACT 1956

The application of English law in Malaysia is based on the
provisions of Sections 3 and 5 of the Civil Law Act (CLA) 1956. Section
5 expressly states that:

In all questions or issues which arise or which have to be

decided in the States of West Malaysia other than
Malacca and Penang with respect to partnership,
8 IIUM LAW JOURNAL VOL. 9 NO. 1, 2001

corporations, banks and banking (emphasis added),

principles and agents...and with respect to mercantile law
generally, the law to be administered shall be the same
as would be administered in England in like case at the
date of the coming into force...

From the foregoing, in matters relating to mercantile or commerce,

English law is to be applied. As such, the jurisdiction is certainly vested in
the Civil Court. In addition, Section 3 of CLA provides for the application
of English law and rules of equity when there is a lacuna in the provision
of any written law. In Malaysia, although we have the IBA 1983, it is
submitted that the Act is not exhaustive. '9 As such, any ambiguity,
clarification and interpretation will be referred to the Civil Court.
Nevertheless, the application of English law and principles are
not without qualification. The CLA has always qualified its application
when it says that "provided always that the said common law, rules of
equity and statutes of general application shall be applied so far only as
the circumstances of the States of Malaysia and their respective inhabitants
permit subject to such qualifications as local circumstances render
necessary." For those who observe the early history of reception of
English law in the Straits Settlements, one could remember that in most
of the decided cases, the English judges had reminded themselves about
the importance of modification to suit the local inhabitants who had different
habits, usage and religions. The paramount consideration is that when
applying English law, it must not be unjust and oppressive to the local
inhabitants. For instance, in the case of Choa Choon Neo v Spottiswood,
Maxwell C. J. said:

In this Colony, so much of the law of England as was in

existence when it was imported here, and as is of general
(and not merely local) policy, and adapted to the condition
and wants of the inhabitants is the law of the land, and
further, that law is subject in its application to the various
alien races established here, to such modifications
necessary to prevent it from operating unjustly and
oppressively on them. Thus, in questions of marriage
and divorce, it would be impossible to apply our law to
`Mohammedans (sic), Hindus and Buddhists, without the
most absurd and intolerable consequences, and is
therefore held inapplicable to them.
19
This issue will be taken up later, see 4.0.
Islamic Banking in Malaysia: Legal Hiccups and Suggested Remedies 9

As such, Islamic banking principles are different from that of

English principles in the same manner as marriage and divorce. To apply
English law to Muslims who specially chose to use Islamic banking
products as an alternative to conventional ones, will certainly cause
intolerable consequences and oppression to them. Thus, English law
should not be made applicable to them and their personal law should be
applied instead.
A drastic view is to repeal sections 3 and 5 of the CLA so as not
to be legally dependent on English Westminster law. If this is done,
Malaysia will be able to embark on the journey of having our own Common
law which is based on the various religions, customs and usage of its
people. In the area of economy, our leadership has resorted to domestic
aid, so as not to be tied to the IMF, World Bdnk, and other international
agencies so that national interests will not be subdued into foreign
hegemony or neo-colonisation. Surprisingly, in the area of law, the opposite
stance has long been adopted and remains unchanged. As such, it is high
time now that the legal system commensurates with the latest trend, i.e.,
to have our own Common law which has regard to local needs, customs,
religions and different ethnic groups. Furthermore, English judges
themselves had recognised Islamic law as the law of the land in the case
of Ramah v Laton,"
Thus, the time has come to adopt Islamic law and its principles
as the basis of our Common law as Islamic law contains universal values
which are based on divine revelations and guidance. Therefore, its
application and implementation is expected to be free from unjust and
oppressive elements to all involving parties regardless ofbelief, ethnicity
and usage.

IBA IS GENERAL, NON-EXHAUSTIVE AND NON-

COMPREHENSIVE
As indicated earlier, Islamic banking in Malaysia is governed
under the Islamic Banking Act (IBA) 1983. This was the first law in
Malaysia covering Islamic matters dealing with economic activities. It is
a good attempt to enhance the role of Islamic law by not being only
restricted to family and matrimonial matters per se. Nevertheless, this
Act is substantially modelled on the Banking Act 1973 (now repealed and
' (1927) 6 FMSLR 128. This authority was cited with approval in the case of
Fatimah binte Hanis v Haji Ismail bin Tamim {1939] MLJ 134. Much of this will
be discussed in 5.0.
 10 IIUM LAW JOURNAL VOL. 9 NO, 1, 2001

replaced by the Banking and Financial Institutions Act (BAFIA) 1989).

Having a first look at the IBA, one could feel that there is nothing Islamic
about it except where it states "... aims and operation not contrary to the
religion of Islam."" We could say that the IBA is merely a piece of
legislation to permit the establishment and operation of an Islamic bank in
Malaysia. This is probably why the Act is relatively brief and simple as
compared to BAFIA, its civil law counterpart. The Act, for example,
only defines 'Islamic banking business' to mean "banking business whose
aims and operation do not involve any element which is not approved by
the religion of Islam."22 This blanket definition seems to be very ambiguous
and may carry far reaching implications. This definition surely presupposes
the question: What is Islamic banking business? SharFah contracts,
such as al-Muclerabah, al-Mush5rakah, firah, al-MurZatah and
al-Wakgah, are not mentioned in the Act. It is only from BIMB 's official
documents that we know that Islamic banking mechanisms include the
above.23
Much has been written on the generality of the definition of Islamic
banking business which need not be repeated here.24 In the absence of a
statutory definition of 'banking business' in the Act, it seems that the
practice of Islamic banking in Malaysia tends to emulate the conventional
banking practice. This is evidence from the 'Anglo-Saxon' style of banking
by having subsidiaries to undertake various financial functions 25 Although
the IBA 1983 allows an Islamic bank to run Universal Banking,26 BIMB
Holdings Berhad (the parent company) has formed various subsidiaries
to perform various financial activities under the Companies Act 1965.
However, the Bank officials submitted that such a move is for the sake
21
See section 2 of the IBA.
" Ibid.
23
See various pamphlets issued by BIMB and its official book, Islamic Banking
Practice: From the Practitioner s Perspective, BIMB;1994.
24 See for instance Norhashimah Mohd. Yasin, Islarnisation/Malaynisation: The
Role oflslamic Law in the Economic Development of Malaysia (1969-1993), A.S.
Noordeen, 1996, at 268-272. See also article by the same writer, "Universal Banking:
IBA 1983 v BAFIA 1989," Al-Nandah, Vol. 18, No. 3, at 27. Lawyer Mohamed
Ismail Shariff has frequently written on this issue, see "The Development of
Islamic Banking Law in Malaysia" [1998] 1 MU 1998, at cxivii-cxlvii.
Conventional banks under BAFIA are restrained to undertake any other non-
25

banking business except as that provided for under Section 2. In addition, BAFIA
also prohibits the banks to be involved in retail and wholesale trade (Section 32)
26 Universal Banking is similar to the concept of the 'financial supermarket' which
offers all financial needs of the customer under one roof. For details of this, see
Norhashimah Mohd. Yasin, "Universal Banking: IBA 1983 v BAFIA 1989,"Al-
Nandah, Vol. 18, No. 3, at 26-29.
Islamic Banking in Malaysia: Legal Hiccups and Suggested Remedies 11

of specialisation and for effective administration."

Besides being brief and general, the IBA has overlooked a few
important issues that are as follows:

LIMITING LICENSING TO COMPANIES UNDER. THE

COMPANIES ACT 1965

Section 3 of the IBA provides:

Islamic banking business shall not be transacted in

Malaysia except by a company which is in possession
of a licence in writing from the Minister authorising it
to do so.

The above provision limits the licensing of an Islamic bank to a

company only. According to the definition section of the IBA (Section 2),
a 'company' means a company enacted under the Companies Act 1965.
Therefore, only companies enacted under the Companies Act can operate
Islamic banking. As a result, companies enacted under different laws,
such as the Co-operative Societies Act, or statutory bodies, cannot operate
an Islamic bank. Mainly due to this legal constraint, Bank Kerjasama
Rakyat Malaysia (Bank Rakyat) has been unsuccessful in its attempt to
be the second full-fledged Islamic bank, although its operations have been
Islamised. Bank Rakyat is actually de facto an Islamic bank but de jure
it is not, as it is enacted under the Co-operative Societies Act 1948. As
one expert has observed:
The establishment of Bank Muamalat Malaysia
(sic) as the country's second Islamic bank caught
many by surprise since Bank Kerjasama Rakyat
Malaysia had been tipped to be the second of such
banks after Bank Islam Malaysia Bhd. It is surprising
as Bank Rakyat was always having the idea that it
would be the (country's) second Islamic bank...but
most probably the plan was somewhat delayed as
Bank Rakyat was still under the Co-Operative Act."

Senior BIRT official in an interview with the writer.

Statement by Wan Abdul Rahim Kamil, Managing Director ofAbrar Discounts
Berhad when commenting about the establishment of Bank Muamalat as the
country's second Islamic Bank (New Straits Times, 13 February 1999).
12 IIUM LAW JOURNAL VOL. 9 NO. 1, 2001

This limitation should be removed and the same rule applicable in

BAFIA be adopted which is of wider application as BAFIA extends to
"any individual, corporation, statutory body, local authority, society, trade
union, co-operative society, partnership and any other body, organisation,
association or group of persons, whether corporate or unincorporated."
Bank Rakyat has taken on the role of Islamic banking in spite of
the fact that it is not a proper Islamic bank within the definition of the
IBA. So far, Bank Rakyat has managed to attract more Muslim depositors
to put their money in the General Investment Account (GIA) due to
relatively higher dividends, It is said that Bank Rakyat has managed to
do that due to the reason that it is not bound by the stricter laws under the
IBA and BAFIA. The example, is the statutory reserve requirements
and liquidity requirement which require all commercial banks to put aside
some of their money in the Central Bank for monetary purposes. Secondly,
it is due to the safe nature of Bank Rakyat's financing; risk on default of
payment is relatively low since the periodical payment of their customers
will be deducted from the Biro Angkasa and it is on a salary deduction
basis. This is a special position for Bank Rakyat since it is regulated and
licensed under the Co-Operative Societies Act as well as its own statute
i.e. Bank Kerjasama Rakyat Malaysia Berhad (Special Provisions) Act
1978, and therefore not under the supervision and control of the Central
Bank of Malaysia (CBM). It is suggested that there is a need to unify
banking law in Malaysia so that all financial institutions which assume the
function and role of a commercial banks must be subject to CBM, thus
eliminating the advantages accorded to one 'bank' while not to others.

CONFLICT BETWEEN THE IBA AND OTHER LAWS

Section 55 of the IBA reads:

An Islamic bank which is incorporated under the

Companies Act 1965 shall be subject to the provisions
of the Act as well as the provisions of this Act, save
where there is any conflict or inconsistency between
the provisions of that Act and the provisions of this
Act, the provisions of this Act shall prevail.
The above section is quite clear that when there is a conflict
between the IBA and the Companies Act, the former shall prevail. But
what about other laws that an Islamic bank is subject to such as the
Contracts Act, the National Land Code, the Hire Purchase Act and the
Islamic Banking in Malaysia: Legal Hiccups and Suggested Remedies 13

Sale of Goods Act? If there is a conflict between any of these acts and
the IBA, which law shall prevail? Would the court apply the legal maxim
of expressio unius alterius (the express mention of one thing implies the
exclusion of another)? This oversight should be rectified immediately.
Perhaps a lesson could be taken from Pakistan where their Islamic banking
law has been constructed as follows:

The provisions of this ordinance shall have effect

notwithstanding anything contained in the Companies
Act 1913 (VII of 1913), or any other law for the time
being in force.29

The above provision overrides all other laws so that if there is a

conflict between the Islamic banking law and any other laws currently in
force in Pakistan, the provision of the former shall prevail.

CIVIL TRAINED JUDGES AND ISLAMIC LAW AS PART

OF THE LAW OF THE LAND
In the Civil court, the judge will decide the case based on the
submission made by the counsels and the law as he finds it. Normally, if
he is unclear about any part of the law, he will call an expert witness to
assist the court. Islamic law has long been regarded as part of the lex
loci (law of the land) of which the court must take judicial notice. It
means that the judge must propound the law and it would not be competent
for the judge to call for expert evidence related to any issue pertaining to
Islamic law in the court proceedings. The judge is deemed to know the
law or at any rate be able to find it - in statute, case law reports or
academic writings. Whenever necessary, the judge will interpret the law
and apply it before he/she comes to a decision. Being trained in secular
and Common law institutions, one can easily assume that the law that the
judge might find and apply is that of Common law or English law.
The danger of Islamic banking and financial matters falling under
the Civil Court and triable by Civil-trained judges is that it may lead to the
application of laws and concepts that contradict SharFah principles and
spirit. There are cases where these incidents occurred. For instance,
BBA has been referred to as a term loan, whereas is should be termed
Islamic financing facility because BBA is not a loan but is a deferred

Section 42 ofthe Modaraba Companies and Modaraba (Flotation and Control)

29

Ordinance, 1980.
14 IIUM LAW JOURNAL VOL. 9 NO, 1, 2001

payment sale." In another case, the learned judge posed controversy

about the concept of sale in Islam in his judgement. For instance, is the
case of Dato' Haji Nik Mahmud bin Daud v Bank Islam Malaysia
Berhad,3' which was concerned with deferred payment sale under the
contract of BBA. As a matter of fact, the main purpose of sale as far as
Islamic law is concerned is to effect the passing of ownership from one
.party (seller) to another (buyer) against a consideration (price). This is
actually the main purpose of the sale contract. Nevertheless, the judge
upheld that in a BBA contract, particularly in the re-financing arrangement
(where the customer has sold the property to a bank on cash and later
bought it back on deferred payment).32 there was no real intention of the
parties (customer and bank) to effect the transfer of the property. It is
merely a device to facilitate the BBA transaction. Perhaps this judgement,
with due respect, should be reviewed in view of its legitimacy as far as
Islamic law is concerned as the main intention of a sale contract (al-
Bay) is to effect the transfer of ownership from the seller to the buyer.
The solution to this problem is rather easy. Though Islamic law
is part of the law of the land, nevertheless in order to promote justice and
equity which is the ultimate aim of a court of law, expert evidence from
Islamic scholars needs to be called upon to explain the issues involved.
This is particularly true when the presiding judge is totally alien to Islamic
banking and its governing principles. The judge should invite scholars on
Islamic commercial matters (Mu ' amalat) to explain what he/she wishes
to know about the issue under dispute. Section 45 of the Evidence Act
1950 does justify this move.
S 45 (1) When the court has to form an opinion
upon a point of foreign law or of science or art
or as to identity or genuineness of handwriting
or finger impressions, the opinions upon that point
3
See the judgment in BIMB v Adnan Omar (supra).
[1996] 1 CLT737. The case went on appeal and the Supreme Court on 25 February
31

agreed with the findings of the trial judge, see [1998]3 MU 393-403.
32
This is called Bay' al- llah and its acceptability as a valid sale contract has
been under severe criticism. The opponents to al- 'Inah regarded it as a device to
facilitate interest (Ribs) and disguised it as sale whereas it is merely a contract of
loan (see SaifulAzhar Rosly and Malunood M. Sanusi, "The Application of Bai
al-Inah in Malaysian Islamic Bonds: An Islamic Analysis," International Journal
of Islamic Financial Services, Vol. 1, No. 2, July-Sept, 1999, at 13). See also
Norhashimah Mohd Yasin, "BBA: Sale or Loan Contract?'; in Dato' Syed Ahmad
Idid (ed.) Judicial Decisions Affecting Bankers and Financiers, (2nd Ed.),
(Butterworths, la (forthcoming).
Islamic Banking in Malaysia: Legal Hiccups and Suggested Remedies 15

of persons specially skilled in that foreign law,

science or art, or in questions as to identity or
genuineness of handwriting or finger impressions,
are relevant facts.

(2) Such persons are called experts.

From the above, the Section has allowed for expert opinion in 4
categories:

(a) . foreignlaw;
(b) science;
(c) art; and
(d) identity or genuineness of handwriting or finger
impressions

Islamic law is rooted in VW al-Fiqh (science ofjurisprudence).

Vsiil al-.Fiqh"is the science of the sources and methodology of the law.""
Thus, rUsal al-Fiqh refers to the methods that are applied in the deduction
of such rules from their sources. The sources of Islamic law include the
Qur'an, Sunnah, Qiyas and Ijma' ." As such, Islamic law qualifies into
the second category as a kind of science of jurisprudence.

ISLAMIC BANKING DOCUMENTS AND STATUTES

CONNECTED TO ISLAMIC BANKING

As far as Islamic legal documentation is concerned, the practice

seems to suggest the following scenario:

i) the document must be valid according to Islamic law;

ii) that document must also comply with Civil law, i.e. various laws
applicable to it;
iii) to be structured in such a manner that it can be enforced in the
Civil courts.

' Mohammed Hashim Karnali, Principles of Islamic Jurisprudence, (2nd Ed.),

(Ihniah Publishers, 1999), p.1.
34
For details on this aspect, see MohammedHashimKamali, Principles of Islamic
Jurisprudence, see also Ahmad Ibrahim, Islamic Law in Malaysia, Malaysian
Sociological Research Institute, 1975 at 1-2.
16 IIUM LAW JOURNAL VOL. 9 NO. 1, 2001

From the above, it is asserted that the workload for the drafters
of Islamic banking transactions is more as compared to their conventional
counterparts.
Having said that, Islamic documents must satisfy all the
requirements of a sale contract, otherwise it will be rendered null and
void. In addition, it has got to satisfy the requirement of a valid sale
contract as far as Civil law is concerned. For instance, if it is financing
for land, the legal documentation must satisfy all the requirements as laid
down by the National Land Code (NLC) 1965. If it is for a motor vehicle,
the relevant civil laws to be satisfied are the Sale of Goods Act (Malay
States) Ordinance 1957, and the Road Traffic Act. If it is share/stock
financing, attention is to be given to the relevant Securities Acts and
other rules and regulations as set by the Securities Commission.
It is suggested that in order for the rules and principles of Islamic
commercial law to be applied, the lawyers need to provide documents
relating to Islamic transactions for disputes arising thereunder to be
referred to mediation, to be based on the principles and precepts of
SharFah.35 The document should further state that the decision of the
mediator" shall be binding on the parties and it is regarded as full and
final settlement of claims.
" It is in accordance with Al-Que an 4:35, although the verse is more relevant to
cases relating to marriage but the rule of arbitration could be extended to disputes
arising from commercial transactions as well.
36 In Malaysia, there exists a Banking Mediation Bureau which was established
in 1997, aimed at mediating claims with the authority to award up to RM25,000.
The Bureau is headed by the mediator (Dato' Wan Mohammed) and was
established by financial companies which are licensed and regulated under
Companies Act 1965 and BAFIA 1989. The mediator will act as a neutral
intermediary between the disputed parties. His role is to assist the parties on
their own accord to arrive at a mutually agreeable solution. The main aim is to
persuade the parties to settle the commercial resolution based on commercial
principles that will bring justice to disputing parties. Therefore, it is so much
based on the principles of natural justice having disregard to strict rule of evidence
and procedure. So far, the cases decided are mainly on Automated Teller
Machines (ATMs) withdrawals, credit cards and interest charges. It is hereby
presumed that the mediator also has the right and powers to adjudicate the
matters that involve Islamic commercial matters (Mu rknalet) when its rules and
principles are under dispute. The mediator is not bound by earlier decisions and
the main thrust is to mediate the dispute in whatever lawful ways. As such, as
the parties want themselves to be bound by Islamic principles, the mediator is
obliged to fulfil their sacred intention. Although currently, Islamic banks are
excluded fromthe jurisdiction of the Bureau, but Islamic Banking Divisions (IBDs)
attached under conventional banks are not exempted as they are also governed
under BAFIA. Attempts should be made to include other non-BAFIAregulated
financial institutions such as Bank Islam, Bank Rakyat, Bank Pertanian, Bank
SimpananNasional, Bank Industri and etc,
Islamic Banking in Malaysia: Legal Hiccups and Suggested Remedies 17

Furthermore, the Civil court needs to make the necessary

modification to the substantive and procedural law in order to
accommodate Islamic banking. For instance, the old law such as Malay
Reservation Enactments of each state should be amended or made
inapplicable to Islamic banks as it may cause problems as to the status of
an Islamic bank as a Malay or native. The Kelantan Malay Reservation
Enactment 1930 for instance states "(N)o right or interest of any Malay
in reservation land and no right or interest in such land acquired by virtue
of Section 13A by any person not being a Malay shall be transferred to or
transmitted to or vest in any person not being a Malay ..." Likewise, the
Rules of the High Court (RHC) 1990 do not accommodate the operation
of an Islamic bank in the case of an order for the sale of the land. Such
rules require a bank to state the amount ofinterest which is contrary to
the operation of Islamic banking which is interest-free. In the two leading
cases cited earlier, two issues related to the above points were disputed
and it took the Bank's counsel strenuous endeavours to refute the
arguments contended by the other party to win the case. The Courts
were urged to make necessary modifications, as well as being flexible to
the rules in view of greater development of Islamic banking in Malaysia.
The statutes which were enacted before the existence of Islamic banking,
pending amendment, should be interpreted actively in favour of Islamic
banking. The laws are supposed to be organic pieces of legislation that
always need modern application to promote justice and fairness which is
the cardinal principle of the legal system.
DOUBLE TAXATION
Islamic banks and other financial institutions are also subject to
double taxation, corporate tax and Zakat (alms/religious tax). The payment
of Zakat applies to individual Muslims and Muslim owned institutions.
The Income Tak Act (ITA) 1967 allows Zakat by a resident individual to
be set off against the tax payable. Section 6A(3) of the ITA 1967 provides
that "(A) rebate shall be granted for a year of assessment for any Zakat,
Fitrah or any other Islamic religious due payment of which is obligatory
and which are paid in the basis year for a year of assessment to, and
evidenced by a receipt issued by an appropriate religious authority
established under a written law." It simply means that individual Muslims
are given an income tax rebate for Zakat i.e it can be set off against the
tax payable. Where the tax payable is lower than the Zakat payment, the
excess cannot be carried forward into the next year. However, such a
position is not applicable to the Muslim owned company. Muslims, both
individual or corporate, should regard Zakat as part of their obligations
18 IIUM LAW JOURNAL VOL. 9 NO. 1, 2001

and the amount is calculated by reference to their wealth and income and
payable annually. As such, Islamic banks are subject to Zakat as part of
their religious obligation as well as to corporate tax under the Income Tax
Act 1965. As a result, Islamic institutions,have to pay double taxes while
conventional institutions pay just one tax. Perhaps a rebate should also
be given to these Islamic institutions as is done with Tabung Haji under its
own law ie. Pilgrimage and Fund Board Act 1969."

ISLAMIC BANKING DIVISIONS (11311)5) AND RELATED

ISSUES

IBDs, which were the product of the Interest-Free Banking

Scheme or Skim Perbankan Tanpa Faedah (SPTF), are a peculiar and
unique creature of the system. The whole operation of IBDs for all intents
and purposes should be as same as Islamic banks as regulated under the
IBA; however the whole structure of IBDs remains conventional as they
are licensed and regulated by the BAFIA 1989. There is no new law
enacted to govern them, rather they are operating within the existing
conventional legal framework. Prior to 1989, they were operating Islamic
banking business using the second limb of Section 2 of BAFIA which is
concerned with "such other business as the Bank (Central Bank), with
the approval of the Minister, may prescribe." Islamic banking business
such as involving in trade (eg. Bay' Bithaman Ajil, Murabaha.h) . and
investment (Mudgrabah and Musharakah) were therefore not covered
under the first limb of the said Section.38
In 1989, there was an amendment to Section 124 of BAFIA by
virtue of the BAFIA (Amendment) Act 199639 which tends to legalise
and formalise the carrying on of Islamic banking and financial businesses
by licensed institutions; as well as establish a SyariahAdvisory Council to
advise the operators. With this amendment, 6 new provisions were
incorporated simply to govern and regulate the IBD's. It is not the intention
of this paper to discuss in detail about each of the provisions as these
issues will be covered in another article. It suffices to point out that the
Act 8.
37

Section 2 of the BAFIA 1989 states "Banking Business means-(a) the business
38

of (1) receiving deposits on Current account, deposit account, savings account

or other similar account; (ii) paying or collecting cheques drawn by or paid in by
customers; and (iii) provision of finance; or (b) such other businesses as the
Bank, with the approval of the Minister, may prescribe."
"ActA954,
Islamic Banking in Malaysia; Legal Hiccups and Suggested Remedies 19

complicated legal issue is the conflict between Islamic banking business

with other provisions of the BAFIA which the IBDs are still subject to;"
as well as a new terminology introduced to go along with Islamic Banking
Business (IBB) namely Islamic Financial Business (IFB). 4' The question
is, what is the difference between IBB and IFB? Does Sharlcah
differentiate between banking and a financial business which justifies
separate and distinct definitions? However, the apparent difference
between the two is only between the words 'banking' and 'finance' while
the rest are all the same: i.e. "the aims and operations do not involve any
element which is not approved by the Religion of Islam."42

CONCLUSION
Legal support and backing is crucial for the promotion and
development of Islamic banking and finance in Malaysia. Despite-the
introduction of Islamic Banking Divisions, Islamic Inter-bank Money
Market and Islamic financial institutions and instruments, if the legal
superstructure is not conducive with loopholes and restrictions, the Islamic
financial system, particularly the Islamic banking sector will never progress
in the real sense of the world. Furthermore, the civil court needs to make
the necessary modification to the governing and procedural law in order
to accommodate Islamic banking. The Civil Court has to make necessary
modifications, as well as being flexible to the rules in view of greater
development of Islamic banking in Malaysia. The statutes which were
enacted before the existence of Islamic banking should be amended, or
else be made exceptional to Islamic banks as there are some provisions
that may be irrelevant or inapplicable to the operation of Islamic banks.
In other words, the law should be interpreted actively in favour of Islamic
banking as laws are supposed to be organic pieces of legislation that
always need modern application in-order to achieve justice and fairness
which is the cardinal principle of the legal system.
Similarly, any lacuna in the MA 1983 and the BAFIA 1989 should
not be left unattended so as to qualify as a good law that is exhaustive,
,comprehensive and devoid of any ambiguity. Last but not least, it is high
time that the CLA 1956 be amended or removed since Malaysia has
4
See Section 124 (2) which states that "For the avoidance of doubt, it is declared
that a licensed institution shall, in respect of the Islamic banking business carried
on by it, be subject to the provisions of this Act"

See Section 124 (7) (b) and (c) of the BAFIA 1989.
42
Ibid.
20 IIUM LAW JOURNAL VOL. 9 NO. 1, 2001

been independent for more than 40 years. Malaysia should have its own
Common law and equitable principles which gives the right position to
Islamic law and the Shariah Court. Islamic law in Malaysia should be
extended to non-matrimonial cases especially in the area of commerce
since Islam has always been used as an instrument to promote economic
development among Muslim Malays.43

" For details on this issue, see Norhashimah Mohd Yasin, Islamisation/
Malayntsation: A Study of the Role of Islamic Law in the Economic Development
ofMalaysia. Kuala Lumpur: A.S Noordeen, 1996.