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Regulatory updates on Islamic banking in Lebanon

Regulatory updates on Islamic banking in Lebanon

The Lebanese legal system has developed a pluralistic approach to banking that provides for both Islamic and conventional banks. However, despite a relatively dense regulatory framework and the recent adjustments to it, Islamic banks still operate in an environment dominated by conventional banking.

In this article first published in Islamic Finance News on 11 July 2018, Managing Partner Elias Chedid and Senior Associate Georgette Salamé of Chedid Law Offices in association with Dentons in Lebanon provide insight into the current regulatory environment in relation to Islamic banking in Lebanon.

1. The Lebanese legal system has developed a pluralistic approach to banking. It provides both for conventional and Islamic banks. However, despite a relatively dense regulatory framework and the recent adjustments that were brought to it, Islamic banks still operate in an environment dominated by conventional banking.

2. Law No.575/2004 provided a legal framework for Islamic finance pursuant to which the Central Bank (Banque du Liban, “BdL”) and the Capital Markets’ Authority (the “CMA”) have issued regulations. The BdL has thus provided for such aspects as the establishment of Islamic banks, the practice of Islamic finance (BdL’s Basic Decision No.8828 and 8829/2005), corporate governance (BdL’s Basic Decision No.9725/2007), monetary reserve requirements (BdL’s Basic Decision No.9763/2007) and cash transfers in accordance with the Hawala system (BdL’s Basic Decision No.9708/2007), as well as transactions such as Istisnah (BdL’s Basic Decision No.9208/2005), Bai’salam (BdL’s Basic Decision No.9207/2005), Mudaraba (BdL’s Basic Decision No.9084/2005), Ijarah (BdL’s Basic Decision No.9042/2005), Musharaba (BdL’s Basic Decision No.8954/2005) and Murabaha (BdL’s Basic Decision No.8870/2005).

3. Upon its establishment, the CMA took up the main provisions of the BdL’s Decision on Islamic collective investment schemes (CMAs Decision No.15/2014). A draft regulation on collective investment schemes was published by the CMA in 2016. However, it has not yet been formally issued. Moreover, its provisions are not expected to dramatically transform the mechanics of Islamic collective investment schemes in Lebanon.

4. The most recent regulatory updates in relation to Islamic finance date back to the BdL’s Intermediate Decisions No.12498/2017, No.12499/2017 and No.12497/2017. These decisions have not triggered any major reform, but have provided adjustments to the existing regulatory framework. They are driven by the BdL’s efforts to ensure that Islamic banks can better meet their liabilities as well as by a policy aiming to secure an increased transparency of the sector. These objectives go beyond the Islamic banking sector and reflect the regulator’s concern for the banks’ resilience to financial crisis in general.

5. Under the 2017 reform, the provisions differentiating between restricted and unrestricted investment accounts in the context of a Murabaha or Mudaraba have been repealed. It should be noted that criticism was sometimes directed against unrestricted investment accounts, which according to some commentators lack the required transparency. By promoting transparency, the reforms should render Islamic banks more appealing to the public.

6. Whereas formerly, funds received in the context of a Mudaraba where the bank had unrestricted rights were subject to the bank’s annual results, deposits made in the context of a Mudaraba as well as in that of agency contracts are now subject to the results of specific transactions entered into by the parties, which is a sensible change.

7. The BdL moreover specifies that agency and Mudaraba contracts whereby the bank does not have significant influence over the investments must be registered by the banks as off-balance sheet items. Before this change, funds on which the bank had an unrestricted right of disposal (current accounts, funds received in the context of Mudaraba) as well as deposits made pursuant to contracts that provided that deposits were commingled with the bank’s equity were registered off-balance sheet.

8. Finally, it is a long-standing requirement for Islamic banks to have to meet the reserve thresholds set for all banks in Lebanon and to comply with the BdL’ Basic Decision No.9763/2007 which regulates Islamic banks’ reserves. In an effort to strengthen the public’s trust vis-à-vis Islamic banks, the 2017 reform focuses on the losses incurred by investments financed by customer accounts pursuant to Mudaraba transactions. It repeals the reserve provisions of BdL’s Basic Decision No.8828/2004. Pursuant to the latter decision, Islamic banks were required to constitute an additional result-linked deposit account by withholding at least 12% of the net investment profit of all transactions carried out during the year until the said account reached twice the paid up capital of the bank. Currently, Islamic banks must withhold at least 10% of the annual net investment profits after deduction of their share in any Mudaraba, until the reserve amount reaches 20% of the investment accounts. This method of calculation provides increased protection as it is proportionate to the bank’s investment activities. Calculating such withholding is done after obtaining the Central Banking Commission’s prior approval in order to verify due compliance. Also, under the 2017 reform, Islamic banks have the option to constitute a third profit reserve whose purpose is to improve returns on customer investments that fall below the rate of equivalent transactions on the market. This reserve is to reach 5% of the investment accounts of the bank and is constituted before deduction of the bank’s share in any Mudaraba. The investment of both the risk investment and the profit reserves can be made exclusively with the BdL.

9. These recent reforms should contribute in furthering trust in Islamic banks. Also worthy of note is that the recent BdL decisions have focused on Mudaraba, an equity-based contract that is at the heart of Islamic finance. However, despite these reforms, Islamic finance still faces a number of challenges in Lebanon such as the absence of appropriate tax schemes, which only the Parliament can enact, as well as the lack of proper education of the public by the banks on the concerned products.

Elias R Chedid and Georgette Salamé

Elias R Chedid is the managing partner of Chedid Law Offices in association with Dentons in Beirut, Lebanon. He is admitted to practice in Beirut, Paris and New York.

Dr. Georgette Salamé is a senior associate at Chedid Law Offices in association with Dentons.

They can be contacted at elias.chedid@chedidlaw.com and georgette.salame@chedidlaw.com respectively.