Islamic Banking in Italy:Regulatory issues

Mohamad Bakkar

17 MARCH 2008PALAZZO MEZZANOTTE – BORSA ITALIANA

MILAN

Content of Presentation

• Introduction

• Regulatory Challenges

• Conclusions

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Introduction

An effective legal infrastructure is essential for the development of any type of sector in any country, especially in the Islamic finance sector which is currently enjoying a renaissance

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Notable Facts and Figures

• Islamic funds in global financial institutions are approximated to a total of US$1.3 trillion

• Islamic banking assets worldwide are ranging between US$200 billion and $400 billion

• Annual growth: 10%-20%

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Current Situation in Italy

• Banking regulation does not allow banks to offer Islamic banking services

• Tax regulation does not permit competitiveness of Islamic banking services

• Project of opening first Islamic bank in Italy: a 100 million Euros institution Shareholders: Middle Eastern banks

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Challenges in Italy

CHALLENGESArabic Terminology

Trained and skilled Islamic Bankers

Exchange of surplus liquidity/funds between

conventional and Islamic Banks

Islamic Banking understanding by

clients

Islamic Banking Control by regulators : Shariah

Governance

Competition with conventional banks

Regulatory and

tax issues

Clear basic understanding of Islamic contracts

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Islamic Banking Framework

• EU Regulation

• Islamic Banking Law

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EU Regulation

• Does EU Regulation on Financial Services allow Islamic Finance?

• Definition of deposit/Contradiction with principle of Profit & Loss Sharing

• European “passport”

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EU Regulation

• Do we need a new EU Regulation on Islamic Finance?

• Harmonization

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Islamic Banking Law

If ITALY does not have the tax and regulatory framework to deal with the basic products,

… than ITALY will not be in a position to fully participate in any emerging market of associated securities or derivatives equivalents (SUKUK Market).

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Islamic banking law

• Definition of Islamic Bank:Islamic bank is the bank whose Article of Association comprises the undertaking not to breach, in the operations it carries out, the provisions of Islamic Law (Shariah), and not to pay or receive interest.

• Definition of Deposit: Profit & Loss sharing principle

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Islamic banking law

• Definition of products: Murabaha, Musharaka, Mudaraba, Ijara, Istisna…

• The application of Islamic modes of financing requires Islamic banks to assume at some stage the ownership of the underlying asset before transferring it to the client.

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Islamic banking law

• Shariah Advisory Board:

A Shariah Advisory Board must be established by each and every Islamic bank, Islamic window & Takaful operator

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Shariah Advisory Board

Reviews and certifies the permissibility of products offered by Islamic Bank

Ascertains that investments and projects in which the Islamic Bank has participated are Shariah compliant

Observes that the Islamic Bank is managed in accordance with Islamic principles

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Tax barriers

• Double stamp duty or registration tax

• VAT on Murabaha mark-up

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Double stamp duty or registration tax

VAT=20% = 20.000€

Islamic Islamic Bank Bank

Islamic Islamic Bank Bank

ClientClientClientClient

Office price =1.000.000 €

2

7 %7 %

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Murabaha = Extra VAT ?

SPSP ==

Cost price + VAT+ VAT==

120.000120.000 € €

SPSP ==

Cost price + VAT+ VAT==

120.000120.000 € €

SellerSellerSellerSeller

VAT=20% = 20.000€

20% VAT on mark up= 2.000 €

Item PB + mark-up = 120.000 + 10.000

=130.000 €

Islamic Islamic Bank Bank

Islamic Islamic Bank Bank

ClientClientClientClient

PC = PC = (SP +mark-up) + VAT on markup(SP +mark-up) + VAT on markup

== 131322 .000€ .000€

PC = PC = (SP +mark-up) + VAT on markup(SP +mark-up) + VAT on markup

== 131322 .000€ .000€

1

4

Cost price =100.000 €2

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Central Bank

• Authorization of Islamic Banks

• No authorization for Islamic Windows

• If Central Bank is a financial regulator and not a religious one, than who will control?

• Shariah Supervisory Board at Central Bank

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Shariah Supervisory Board

• an independent body of specialized jurists (scholars) in Islamic commercial jurisprudence.

• the Board may include a member other than scholars, who should be an expert in the field of Islamic financial institutions

• the duties of the SSB are: directing, reviewing and supervising the activities of the Islamic financial institution in order to ensure that they are in compliance with Islamic Shariah rules and principles.

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Shariah Supervisory Board

• Sole authoritative body to advise Central Bank on Islamic Banking and Takaful

• “a priori & “a posteriori” control:“a priori”: accept Shariah Advisory Board“a posteriori”: co-ordinate the activity of

Shariah Advisory Boards

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Dispute Resolution

• Jurisdiction

• Applicable law

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Jurisdiction

The SSB of Central Bank will be referred to by the court or arbitrator in disputes involving Shariah issues in Islamic banking & finance

In the case of the arbitrator, the SSB’s resolution “shall be binding” upon the arbitrator (obligatory)

In the case of the court, the SSB’s resolution “shall be taken into consideration” by the court (advisory)

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Applicable law

• Clauses of contracts: reference to Shariah principles & choice of law of the land

• Validity of clause (English experience):Rome conventionNational lawShariah rules are not identified

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Conclusions

European Strategy to introduce Islamic Finance to European customers

Enacting Islamic banking law and amendments to tax law

Ensure optimal Shariah governance of Islamic Financial Institutions

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Conclusions

European Islamic Center for Reconciliation and Arbitration for the Islamic finance industry

A specialized branch to deal with Islamic financial transactions at the Chamber of National & International Arbitration of Milan

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Italian Passport ?I hope soon

GRAZIE MILLE !

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For further information kindly contact:

Mohamad Bakkar

PETRUCCI & ASSOCIATI STUDIO LEGALE E TRIBUTARIO

Via Lanzone 31, Milano

Tel : +39.02.88891711Fax : +39.02.88891777

www.petrucciassociati.it

mbakkar@petrucciassociati.it