LONDON: Another sign of the seriousness with which Asian countries are developing their Islamic finance regulatory and legal frameworks is the number of consultations currently taking place in new emerging markets for the facilitation of Islamic financial products, including Sukuk, Murabaha, Ijara and Istisna.
These countries include Japan, South Korea, Hong Kong, Singapore and Thailand. Of course, countries such as Malaysia have multiple consultations on a regular basis covering different aspects of Islamic finance, including Shariah parameters on the various contracts and on other financial and insurance (Takaful) issues, as and when they are discussed and opened up for market consultation before they are debated and adopted in any legislation or policy.
The two latest initiatives that could have important implications not only for the relevant countries but the Islamic finance market in general are the Fiscal Year 2011 Tax Reform Proposals of the Financial Services Agency of Japan which was launched in August 2010 aimed at institutionalizing sukuk taxation and the proposal of the Monetary Authority of Singapore (MAS) to amend the country's Deposit Insurance Act.
Japanese bankers stress that there is definitely a need for tax reform relating to Islamic finance products to create a level playing field as for the treatment of equivalent conventional products. The status quo according to one Japanese banker is that Islamic investors can invest only in equity type of Islamic bonds, since they are prohibited from receiving interest for the religious reason. In major countries, dividends of Islamic bonds (equity type) received by foreign investors are not subject to tax, while they are subject to tax in Japan.
Japanese financial institutions active in the Islamic finance such as Nomura, Daiwa, Japan Bank for International Cooperation, Mitsui and others, would like to see the Financial Services Agency making dividends of quasi-bond beneficial interests (QBIs) of special purpose trusts received by foreign investors tax-exempt.
QBIs, according to one Japanese banker, means a type of beneficial interest to receive a certain predetermined amount. In a legal context, they correspond to an equity in which Islamic investors can invest. Currently, interest of bonds received by foreign investors is not subject to tax.
They stress that the Financial Services Agency's proposal contains three important aspects. It would be the first measure on Islamic finance products in the Japanese legal system; it would be the first measure on taxation of Islamic financial transaction in the Japanese legal system; and the proposal is targeted to make Sukuk issuance possible although it can be used for conventional transactions as well.
In contrast, the consultation on the proposal of the Monetary Authority of Singapore to amend the country's Deposit Insurance Act to allow MAS to prescribe products as insured deposits, and to prescribe Murabaha as an insured deposit was concluded last week.
MAS launched the public consultation on Feb. 25, 2010, as part of its review with the Singapore Deposit Insurance Corporation (SDIC), on whether to amend and enhance various features of the Deposit Insurance Scheme in Singapore.
"None of the respondents objected to the proposal. A respondent expressed support to insure Murabaha deposit as it would enable Islamic products to compete on equal footing with conventional products with similar features, encourage more product innovation and widen consumer choice," stressed MAS, which also confirmed that "we will proceed with prescribing Murabaha as proposed".
On another proposal to enhance depositor protection by raising Deposit Insurance coverage limit from SGD20,000 to SGD50,000 per depositor per institution, saw respondents generally supportive of the proposal to raise the coverage limit although there were some concerns over higher business costs associated with higher premiums. Some respondents proposed a higher level of coverage such as SGD100,000, while a few felt that all deposits should be fully insured as these were hard-earned savings. One respondent thought that full Deposit Insurance coverage would obviate the need for the government to intervene in a distressed situation and could mitigate any potential outflow of deposits from Singapore to other jurisdictions.
In its response, MAS stated that it recognizes the need to provide a basic safety net for small depositors who may be less able to make informed decisions and yet may be most affected by the loss of their deposits in the event of bank failure. "It is with this objective in mind that the Deposit Insurance scheme was put in place to provide an explicit level of protection for depositors. Such explicit coverage is consistent with Deposit Insurance schemes internationally, which do not seek to ensure full protection for all depositors against any bank failure," said MAS.
To do so would undermine market discipline and make the pre-funded scheme unviable as the costs to scheme members would be prohibitive and these could then be passed on to depositors".
Therefore, in proposing Deposit Insurance coverage of SGD50,000 which applies on the basis of per depositor per scheme member, "we considered the need to provide adequate protection to small depositors while limiting the cost to scheme members and depositors. SGD50,000 would fully insure 91 percent of depositors covered under the scheme. This is a reasonably high coverage. Beyond SGD50,000, the incremental benefit is small and may not justify the costs. For instance, doubling the proposed coverage from SGD50,000 to SGD100,000 would only fully insure another 4 percent of depositors at potentially twice the costs. Furthermore, if DI coverage was too generous, depositors may seek high interest rates without due regard to risks undertaken by the bank."
Only two countries -- Malaysia and Turkey -- have Shariah-compliant deposit insurance schemes alongside conventional deposit insurance schemes. The Malaysian one is a parallel one to the official conventional deposit insurance scheme, while the Turkish one is not part of the general deposit insurance scheme of the banking sector, but an interest-free insurance (Takaful) scheme run by the statutory body, the Participation Banks Association of Turkey, and endorsed by the Turkish government.
