Starting an Islamic Bank
Requirements to start an Islamic bank often vary greatly from country to country. Many difficulties may arise when establishing an Islamic bank in complying with rules originally conceived for the regulation and supervision of conventional banks. These rules intend to ensure the viability and strength of individual banking institutions to secure the entire banking system in the country; they often include principles such as capital certainty for depositors and certainty as to the rate of return on deposits. Therefore, it is important for sponsors willing to establish an Islamic Bank to be aware for familiar with national banking laws and regulations that would affect Islamic banking operations; they must ensure that the activity has been pre-approved under existing law, or must seek a determination from the regulator to permit the activity of the Islamic bank. Introducing new business practices of an Islamic bank may be an unusual concern to a regulatory body which main activity is to regulate and supervise conventional banks. Most Central Banks require commercial banks to follow a capital adequacy ratio for liquidity purposes by investing a percentage of their liabilities in approved securities which are often interest bearing. In addition, regulators do not generally authorize banks to engage directly in business enterprises using depositors’ funds. Islamic banks also need an interbank money market not using interest bearing transactions or using dual system off-loans their excess liquidity, which may not be available in the country. Therefore, there is a need for some concessions to an Islamic bank in order to meet these legal requirements; government intervention or active support is also necessary to establish Islamic banks working under the PLS scheme by introducing or adapting legislation or by giving Islamic banks special dispensation to conduct their activities.
In addition, it is important for sponsors wishing to establish an Islamic bank to look into the corporate tax and personal tax structures and look for any available exemptions. Tax implications are more imperative for an Islamic bank than for a conventional. In fact, profit paid to Islamic bank’s depositors should be treated as an acceptable charge for the bank, just as interest paid by conventional banks to their depositors is. Besides, there could be an issue of double taxation in the case of Islamic trade financing where goods are transferred twice, which could decrease the profitability of the venture. The rates of personal taxes and other statutory payments will also have an impact on charges on the total employees’ costs and hence on the cost of operations.
The organising group should also study the foreign exchange position of a country, as it may have a direct impact on the bank’s foreign trade transactions and affects their processes and profitability. In fact, in a country that places exchange controls restrictions on the free out flow of foreign currency, most investment will have to be made in the locally in the local currency equivalent; this will also negatively affect the volume of import financing; and in the case where the Islamic bank had surplus liquidity in foreign currency it would not be able invest the money on its own. Regulations for investment of resources in international markets and on the repatriation of the bank’s capital, dividends and profits are other important aspects to be studied.
In addition, it is important for sponsors wishing to establish an Islamic bank to look into the corporate tax and personal tax structures and look for any available exemptions. Tax implications are more imperative for an Islamic bank than for a conventional. In fact, profit paid to Islamic bank’s depositors should be treated as an acceptable charge for the bank, just as interest paid by conventional banks to their depositors is. Besides, there could be an issue of double taxation in the case of Islamic trade financing where goods are transferred twice, which could decrease the profitability of the venture. The rates of personal taxes and other statutory payments will also have an impact on charges on the total employees’ costs and hence on the cost of operations.
The organising group should also study the foreign exchange position of a country, as it may have a direct impact on the bank’s foreign trade transactions and affects their processes and profitability. In fact, in a country that places exchange controls restrictions on the free out flow of foreign currency, most investment will have to be made in the locally in the local currency equivalent; this will also negatively affect the volume of import financing; and in the case where the Islamic bank had surplus liquidity in foreign currency it would not be able invest the money on its own. Regulations for investment of resources in international markets and on the repatriation of the bank’s capital, dividends and profits are other important aspects to be studied.
