This document discusses the legal framework of Islamic finance in Malaysia. It begins by outlining the primary sources of Islamic law - the Quran, Sunnah, Ijma, and Qiyas. It then examines how Islamic legal rulings and principles related to financial transactions have been derived through various methods of interpretation and jurisprudence. Finally, it provides an overview of the key Malaysian laws governing Islamic banking - the Islamic Banking Act of 1983 and Government Investment Act of 1983 - which established the regulatory framework for Islamic financial institutions.

1. Mahyuddin Khalid
emkay@salam.uitm.edu.my
ISLAMIC FINANCIAL
LEGAL FRAMEWORK
LEGAL FRAMEWORK OF THE MALAYSIAN
FINANCIAL SYSTEM

2. CONTENT
2
 ISLAMIC LAW
 SOURCES AND PRINCIPLES OF LAWS IN
ISLAMIC BANKING AND FINANCE
 PRIMARY SOURCES
 SECONDARY SOURCES
 MALAYSIAN LAWS

3. INTRODUCTION
3
 Proof of Shariah consists of the four sources
which agreed by all jurists are the Qur‟an, the
Sunnah, Ijma‟ and Qiyas.
 All of them work consecutively which means
when the jurists have to derive any hukm, the
first reference is the Qur‟an.
 If the hukm is stated in the Qur‟an, then it binds
all Muslims.
 If the hukm cannot be found in the Qur‟an then
the second source is the Sunnah.
 If the hukm cannot be found in both the Qur‟an
and the Sunnah, then, the next in order that shall
be referred is Ijma‟ and then Qiyas.

4. METHODS OF INTERPRETATION OF
THE LAWS
4
 Majority of branch cases (furu‟) are derived
through interpretation of the legal text using legal
reasoning.
 Legal reasoning is certainly needed in issues and
cases where textual evidence is absent.
 Written text is limited while cases that happen
are unlimited
 The process of interpretation through legal
reasoning that relies on ra‟y (a considered
opinion), is known as ijtihd.
 Such interpretation must be consistent with the
spirit and general principles of the Shariah such
as wisdom and justice.

5. SOURCES AND PRINCIPLES OF LAWS
IN IBF
5
 Islamic law is a Divine Law as it is based on the
totality of Allah‟s command revealed to the Prophet
Muhammad SAW.
 The law contained in both sources is the revealed
law and is technically called the Shariah.
 When Muslims seek to understand the Shariah and
apply their understanding of the Shariah to any
particular matter, it will becomes human
interpretations of Shariah namely fiqh.
 The Shariah is the textual law, while fiqh is the
derivative law.
 Hence there is no disagreement in the
Shariah, whereas there might be disagreement in
fiqh, since it has been derived by jurist.

6. AL-QUR‟AN
6
 The Quran is the fundamental and main source of
Islamic jursiprudence.
 The Quran is a text of Islamic law and it contains a
code of conduct for every Muslim.
 According to al-Suyuti, there are 500 verses of
injuction or commandment of legal text (ayat al-
ahkam) in the Quran.
 Abdul Wahab al-Khallaf further classified into:
 70 verses on civil law
 30 verses on penal law
 13 verses on jurisdiction and procedures
 10 verses on constitutional law
 25 verses on international law
 20 verses on economic and finacial law
 50 verses on sources of law

7. PRICIPLES OF MUAMALAH IN AL-
7
QUR‟AN
 Establishing justice and eliminating
exploitation in business transaction
 Prohibition of riba/ interest
 Leniency to debtors who have difficulties with
repayment
 Debt and loan contract in written documents
 Condemnation of hoarding of wealth

8. SUNNAH
8
 The Sunnah has been accepted as second source of
the Shariah.
 The status of the sunah has remain unchanged and
undisputed throughout the centuries.
 The authority of the sunah as a source of Islamic law
is recognised by the Holy Quran and the ijma‟
(consensus) of the companions.
 The hadis literature is very extensive and covers a
much wider range of topics than the legal verses of
the Quran.
 It has supplied the Islamic rationale for a major part
of the shariah.
 Numbers of a hadis pertaining to the commercial and
financial dealings which support and elaborate the
general principles and rules laid down by the Quran.

9. PRICIPLES OF MUAMALAH IN AL-
SUNNAH
9
 The rules governing transactions of ribawi
(usurious) commodities
 Encouraging trustwothiness or truthfulness in
business transactions
 Generosity and modesty in bargaining.
 Giving sufficient time to a poor debtor to
enable them to pay debt.

10. IJMA‟
10
 Ijma‟ represents the ultimate sanctioning
authority which guarantees the infallibility of
the positive legal rulings and methodological
principles that are universally agreed upon by
scholars.
 Any law which is not explicitly stated in the
Qur‟an and hadith must he deduced from
these two sources by using analogy.
 The law deduced by ijma‟ is authoritative and
binding.
 Moreover, it guarantees authenticity and
validity and ascertains the veracity of private
judgment.

11. RULINGS OF MUAMALAH BASED ON
IJMA‟
11
 The importance of ijma‟ is that it helps the
jurists to unite the divergences of opinions
and consequently help them settle the
dispute.
 Examples of such ruling based on ijma‟:
 Validity of purchase of goods to be delivered in
the future ( bay‟ al-salam)
 Validity of deferred sale (al-bay‟ bi thaman aajil) .
 Validity of al-qirad or al-mudarabah contract .

12. QIYAS (ANALOGY)
12
 The bulk of the Islamic law has been
developed by individual deductions of jurists
rather than from their collective resolutions.
 A jurist deducing a rule of law by using the
process of analogy (qiyas) only expounds the
law but does not establish it.
 It is an extension of the law established by
the binding authority on a particular case.
 Qiyas is used to extend the rule (hukm)
provided in a text for a specific entity or thing
to a new case not specified in the text.

13. RULINGS OF MUAMALAH BASED ON
QIYAS
13
 The importance of qiyas is more obvious in
commercial issues.
 This has the support of one of the established
maxims that is “the principle in muamalah is
ratiocination and analogy” (al-asl fil muamalah al-
ta‟lil wal qiyas).
 The following application of qiyas in the sphere of
commercial and financial transaction:
 Transactions of sale are forbidden after the call to
Friday prayer.
 Validity of muzara‟ah (share-cropping) on the basis
of mudharabah (partnership) where the sharing of
future profit is not clearly fixed.
 Validity of salam contract as the Prophet SAW
allowed the contract with certain conditions
enunciated by him.

14. ISTIHSAN
14
 Istihsan or juristic preference representing a
more advanced stage of personal opinion (ra‟y).
 Istihsan was resorted to where the jurist had to
make equitable concessions or preferred some
other criteria to analogy.
 Istihsan is a method of exercising personal
opinion in order to avoid rigidity and unfairness
that might result from the literal enforcement of‟
the existing law.
 The departure to an alternative ruling in istihsan
may be from apparent analogy (qiyas jali) to
hidden analogy (qiyas khafi), or to a ruling which
is given in nass i.e. the Qur‟án or the sunnah or
consensus, custom or public interest.”

15. RULINGS OF MUAMALAH BASED ON
ISTIHSAN
15
 Example of istihsan regarding commercial
transactions, which involve the departure
from qiyas jail to qiyas khafi.
 Contract of ijarah (lease).
 According to qiyas jail, ijarah is not valid
because the subject of contract need to be
present at the time of the contract. However, in
this case qiyas has been set aside because
istihsan makes an exceptional validation of ijarah
 Bay‟ bi al-wafa‟
 Bay‟bi al-wafa‟was allowed in view of the
people‟s need for it.

16. MASLAHAH MURSALAH
16
 Mashlahah mursalah is a consideration which
is proper and harmonious with the objectives
of the Lawgiver; it secures benefit or prevents
harm
 Maslahah consists of considerations which
secure benefit or prevent harm while at the
same time, being harmonious with the
objectives (maqasid) of the Shariah.
 Any measure that secures these values falls
within the scope of maslahah, and anything
which violates them is mafsadah (evil), and
preventing the latter is also maslahah.

17. RULINGS OF MUAMALAH BASED ON MASLAHAH
MURSALAH
17
 Examples of public interest as a source of
Islamic law:
A Muslim ruler may impose additional taxes on
wealthy citizens during a period of emergency.
 Imam Malik and Imam Ahmad prohibited the sale
of grapes, which was otherwise legal, to wine
merchants who would use them to ferment wine
which was unlawful.
 The sale of arms during a civil disturbance is
prohibited as it may intensify the struggle.

18. ISTISHAB
18
 Istishab is used to denote things whose
existence or non-existence had been proven in
the past should be presumed to have remained
as such for the lack of evidence establishing any
change.
 Many principles are derived from this
maxim, such as “presumption of freedom from
liability” (al-asl baraah al-dhimmah) and
“certainty may not be disproved by doubt” (al-
yaqin la yuzal bi al-shak).
 For example, when someone wastes the
property of another, if they differ on the
amount, what the person who has committed the
waste says is considered to be true, and the
owner of the property needs to provide proof for
his claim.

19. „URF
19
 „Urf is defined as recurring practices which
are acceptable to the people of sound nature.
 Custom must be sound and not in
contradiction with any other rules of Shariah.
 For example, in the act of renting a shop or
house without declaring its purpose or if a
merchant sells a commodity to a purchaser
without agreeing on to the time or mode of
payment. In this case the manner of use or
payment is according to the „urf the place.

20. THE POSITION OF ISLAM AND ISLAMIC
LAW
20
 Islamic law was the law of the land before the
coming of the colonial powers to the Straits
Settlements and the Malay States.
 The position then changed especially after the
coming of the British who introduced English law in
these States.
 The adoption and application of English law in the
Malay states and the Straits Settlements before
independence removed Islamic law from the Malay
Muslim society except for a narrow sphere of
personal law.
 When the Reid Commission was drafting the
Constitution for the Federation of Malaya, it
considered a provision on the position of Islam as a
religion of the state in the Federal Constitution.

21. THE POSITION OF ISLAM AND ISLAMIC
LAW
21
 It was appeared in the Federal Constitution of Malaya and
Malaysia were articles 3 and 11.
 The identification of race with religion and its official status in
Article 160 (2) Federal Constitution have strengthened the
argument in the polemic that Malaysia is an Islamic state.
 The intention in making Islam as the official religion of the
Federation was primarily for ritual and ceremonial purposes
and it was not intended to he the law.
 The Federal Constitution does not consider Islamic Law
within the meaning of the word law.
 Islamic law is not included in the definition of law in article
160(2) of the Federal Constitution, which provides that the
definition of law only includes written law, the common law
and any customs or usage having the force of law in the
country.
 Furthermore, Article 4 declares the supreme law of the
federation to be the Federal Constitution.

22. THE POSITION OF ISLAM AND ISLAMIC
LAW
22
 This does not mean that Islamic law is completely discarded
as the Federal Constitution provides that certain aspects of
Islamic law are applicable to persons professing the religion
of Islam.
 The power to legislate on matters pertaining to Islamic law
lies with the State Legislatures subject to Federal law.
 The jurisdiction given to the states pertaining to the practice
of Islamic law is well defined in the State list of the Ninth
Schedule to the Federal Constitution.
 It appears that the position of Islamic law in the Federal
Constitution does not cover any Islamic commercial
transactions.
 It is merely a state religion with a restrictive purpose
confined to rituals and ceremonies only.
 It was the intention of the drafter to place matters
concerning commerce and trade including banking and
finance under the Federal List and not under State List.

23. ISLAMIC BANKING ACT OF 1983
23
(IBA)
 The prerequisite for the establishment of an Islamic bank in
Malaysia is a legal framework which would enable the bank
to operate on the principles of the Shariah,
 It was argued that the then existing Banking Act of 1973 was
not suitable to cater the needs of Islamic banking because it
required all banks in Malaysia to be interest based and did
not allow the banks to be involved in trading in their
operations.
 Thus, the Islamic Banking Act (IBA) (Act 276) was enacted
on 10 March 1983.
 The Act seeks to provide for the licensing and regulating of
the Islamic banking business.
 The preamble of the IBA states the directive principle of the
Act that is for the licensing and regulation of Islamic banking
business.
 The normal practices of prudent are still retained and it
vests BNM with powers of supervision and regulation over
the Islamic bank as in the case with other commercial
banks.

24. THE GOVERNMENT INVESTMENT ACT OF
1983
24
 Government Investment Act 1983 (Act 275) was enacted to
empower the Government to issue Government Investment
Certificates (GICs)
 This is to comply with the BNM‟s liquidity requirements
where every financial institution is required to have a certain
percentage of liquidity kept (invested) with the Central Bank.
 The Government Investment Act of 1 983 (GIA) was
enacted at the same time as the IBA to allow the
Government through BNM to issue GICs (now replaced by
Government Investment Issues (GIIs) which are based on
Islamic principles.
 The issuance of GlCs under the contract of qard al-hasan
represents benevolent loan to the Government. issued at
par. It is also redeemable at maturity or on demand at BNM
at par.

25. BANKING AND FINANCIAL INSTITUTION ACT OF 1989
(BAFIA)
25
 The Banking and Financial Institutions Act, 1989,
(BAFIA) was promulgated in 1989 to replace the
existing Finance Companies Act, 1969 (Act 6)
and Banking Act, 1973 (Act 102).
 With the enactment of the BAFIA, the licensing
and regulating of various institutions carrying
banking, finance, merchant banking, discount
house, and money-broking businesses are now
brought together tinder one Act.
 The introduction of the BAFIA is intended to
provide BNM with sufficient integrated
supervisory and control towers over the banking
and financial institution and to modernize and
streamline the laws relating to banking and
financial system in the country.

26. GUIDELINES FOR ISLAMIC BANKING
OPERATIONS
26
 Bank Negara Malaysia provides certain
guidelines for Islamic banking operations.
 These guidelines explain the
concepts, procedural requirements, the
accounting and technical aspects.
 Among these guidelines are:
 Guidelines on the Islamic Interbank Money
Market
 Guidelines on Islamic Negotiable Instruments
 Guidelines on Interest-free Accepted Bills
 Guidelines on Skim Perbankan Tanpa Faedah
(SPTF).

27. DEVELOPMENT FINANCIAL INSTITUTION ACT
2002
27
 The aspiration of BNM to establish a comprehensive
Islamic banking system has stimulated the non-
banking financial insititutions.
 All of these institutions are governed by the
Development Financial Institution Act 2002 (DFIA)
(ACT 618).
 DFIA states that savings and development
institutions can perform Islamic Banking or financial
businesses as an addition to the existing business,
with the condition that those institutions must have
written approval from BNM.
 In performing Islamic banking or financial
businesses, DFI institutions may acquire advice from
the Shariah Advisory Committee to ensure that the
Islamic banking business and the Islamic financial
operations do not involve activities that are contrary
to Islamic principle.

28. CENTRAL BANK OF MALAYSIA ACT 1958 (AMEND)
2003
28
 One important development in the Islamic
banking and financial system is the amendment
of the Central Bank Act, 2003.
 Among the objectives of this amendment is to
allocate the establishment and appointment of
the SAC.
 Previously, there has been no provision under
the BNM Act regarding the Shariah Advisory
Council.
 This is because the allocations for the
establishment of the Shariah Advisory Council
exist in other acts such as the Islamic Bank Act
of 1983, Islamic Bank and Financial Act of
1989, and the Development Financial Institution

29. COMPANIES ACT 1965 (ACT 125)
29
 The law relating to companies in Malaysia is regulated by
the Companies Act 1965 (revised 1973).
 This Act is based on the English Companies Act 1948 and
the Australian Uniform Companies Act 1961.
 The first Islamic bank in Malaysia, BIMB was incorporated
as a limited company under the Companies Act 1965.
 A company that desires to carry on Islamic banking
business in Malaysia must apply for a license in writing from
the Minister through BNM.
 Islamic bank which is incorporated under the Companies Act
1965 is subject to the provisions of that Act and Islamic
Banking Act 1983.
 If there is a conflict between the provisions of the
Companies Act 1965 and IBA 1983, the provisions of the
latter Act in must prevail.

30. CONTRACTS ACT 1950
30
 Islamic banking transactions would be governed by the
Contracts Act 1950.
 The contract must be valid and comply with all the
requirements of a sale contract under Islamic law as well as
under civil law in order for it to be enforceable in the civil
courts.‟
 For instance, if an immovable asset is being financed, e.g.
land, the legal documentation must satisfy all the
requirements laid down by the National Land Code 1965.
 If it is movable, such as a motor vehicle, the relevant civil
law to be followed is the Hire-Purchase Act 1967, the Sate
of Goods Act 1957 etc.
 The documents to be used in Islamic banking transactions
such as in murabahah, BBA, al-ijarah etc., have to be
structured in such a way to accommodate the English law
principles for them to be enforceable in the civil courts as
long as these principles do not contravene Islamic law.

31. OTHER STATUTES RELEVANT TO ISLAMIC BANKING
AND FINANCE
31
 National Land Code 1965 (Act 56)
 Sale of Goods Act 1957 (Act 382)
 Hire-Purchase Act 1967 (act 212)
 Income Tax Act 1967
 Stamp Act 1949 (Act 378)
 Real Property Gains Tax Act 1976 (Act 169)
 Rules of the Court

32. 32 END OF CHAPTER