I LEGISLATIVE AND REGULATORY FRAMEWORK
The Philippines officially recognised Islamic banking and finance some 40 years ago, when a legislative charter was granted to Al-Amanah Bank,2 the first Islamic bank established in the country to cater to the banking requirements of the Muslim population. In 1990, that bank was reorganised and replaced with the Al-Amanah Islamic Investment Bank of the Philippines (AIIBP).3
Although Islamic banks are recognised as a distinct category of banking institutions under the General Banking Law of 2000,4 the AIIBP remains to date the only bank of its kind in the country. Also, within conventional banks, there are no Islamic windows or units. However, under the General Banking Law of 2000, the Bangko Sentral ng Pilipinas (BSP), if minded to act accordingly, can already authorise the establishment of Islamic banks other than the AIIBP, as well as Islamic units within conventional banks. This is so because Subsection 3.2 of that Law empowers the BSP to make 'other classifications of banks', specifically mentioning 'Islamic banks as defined in Republic Act No. 6848, otherwise known as the Charter of AIIBP'. As the reference in Subsection 3.2 is to 'Islamic banks' in the plural (not singular), there is a legislative intent for the BSP to enable the formation of more Islamic banks (and, for that matter, Islamic units within conventional banks), in addition to the AIIBP. In fact, the BSP is well aware of this, considering that Section X101(b)(6) of the BSP's Manual of Regulations for Banks contains an enumeration of the services that Islamic banks can provide to their customers.
Nevertheless, the recent passage of Republic Act No. 11054, the Organic Law for the Bangsamoro Autonomous Region in Muslim Mindanao (Bangsamoro Organic Law), should boost Islamic banking and finance, considering that the BSP, the Department of Finance and the National Commission on Muslim Filipinos are mandated therein to 'jointly promote the development of an Islamic banking and finance system, to include, among others, the establishment of a Shariah Supervisory Board and the promotion and development of shariah-compliant financial institutions'.5 Further, there will be a review of 'existing market environment policies' and the adoption of 'measures to enhance the competitiveness of Islamic finance products', so that 'Islamic financial players are not inhibited from introducing Islamic finance products'.6
i Legislative and regulatory regime
At present, there is no general legislative framework for Islamic banking and finance in the Philippines. However, the Bangsamoro Organic Law authorises 'the crafting of the Bangsamoro Islamic banking and finance framework by the Bangsamoro Parliament applicable within the Bangsamoro Autonomous Region'.7 Moreover, in the Philippine Senate, there is a pending bill8 that seeks to 'provide for the regulation and organisation of an expanded Islamic banking system in the Philippines'. If this bill is enacted, it will be known as the Philippine Islamic Financing Act. As the operation of Islamic banks and financial institutions within the Bangsamoro Autonomous Region is also to be supervised by the BSP, the uniformity of regulations on Islamic banking and finance outside of, as well as within, the Bangsamoro Autonomous Region is expected.
The BSP had already issued the regulations implementing the Charter of the AIIBP.9 Under the proposed Philippine Islamic Financing Act, the BSP is also mandated to promulgate the necessary rules for the effective implementation of the law.10 This new set of implementing rules will govern the operations of entities that will be authorised by the BSP to perform banking, financing and investment operations designed to promote and accelerate the socio-economic development of the country, based on shariah principles.11 The BSP is expressly empowered under the proposed law to authorise the establishment of Islamic banks other than the AIIBP, as well as Islamic units within conventional banks.12 This empowerment is more direct and explicit than Subsection 3.2 of the General Banking Law of 2000 grants to the BSP.
In the absence of a special legislative framework for Islamic banking and finance, existing laws applicable to conventional banking, capital market and insurance would have to be considered. Central to this is Article 1306 of the Civil Code of the Philippines,13 which allows contracting parties to 'establish such stipulations, clauses, terms and conditions as they may deem convenient, provided they are not contrary to law, morals, good customs, public order or public policy'. This freedom in contract-making would allow the adoption of terms and conditions suitable to Islamic banking, capital market and insurance, with the approval of pertinent regulators, namely the BSP for banking, the Securities and Exchange Commission (SEC) for capital market, and the Insurance Commission for insurance.14
Interestingly, the absence of legislation or regulation on Islamic capital markets has not prevented the Philippine Stock Exchange (PSE) from releasing its list of shariah-compliant shares of stock, with a view to diversifying its investment base. The list is updated, from time to time, and published by the PSE on its website (www.pse.com.ph) by the fifth trading day of the month following every quarter.15
ii Regulatory and supervisory authorities
The BSP has sole supervision over the operations of banking institutions in the Philippines, including Islamic banks and financial institutions.16 On the other hand, the Insurance Commission is expected to regulate and supervise entities that will issue Islamic insurance in due time in the country.
It is reasonable to assume, too, that the SEC will be the regulator and supervisor of the Islamic capital market in the Philippines, once the rules for this have been promulgated. In fact, the SEC has already asserted its supervisory authority in this regard, by not interdicting the periodic issuance by the PSE (a stock exchange under the supervision of the SEC) of the list of shariah-compliant shares of stock. It is also expected that the SEC will regulate the issuance of sukuk in the domestic market, pursuant to its authority under the Securities Regulation Code17 to register securities issued and offered to the public in the Philippines.18
To date, there is no central authority in the Philippines responsible for ensuring that transactions or products are shariah-compliant. However, within the AIIBP, there is a five-member advisory council whose function is 'to offer advice and undertake reviews pertaining to the application of the principles and rulings of the Islamic shariah to the Islamic bank's transactions'.19 Under the proposed Philippine Islamic Financing Act, each Islamic bank is required to constitute its shariah advisory council.20 The challenge here is the current scarcity in the Philippines of experts or scholars on Islamic banking and finance.
II COMMON STRUCTURES
Islamic banks (including the AIIBP) have flexibility in structuring their shariah-compliant products and services, considering that they can 'undertake various investments in all transactions allowed by the Islamic shariah in such a way that shall not permit the haram (forbidden), nor forbid the halal (permissible)'.21
i Consumer finance
In consumer finance, for instance, the AIIBP is authorised to 'provide financing with or without collateral by way of al-ijarah (leasing), al-bai ul takjiri (sale and leaseback) or al-murabahah (cost-plus-profit sales arrangement)'.22 Other Islamic banks23 can provide similar consumer finance.
In al-ijarah, the fund owner (such as a bank) purchases the asset required by the fund user (the consumer), who then acquires the right to use the asset through a lease for a fixed period, subject to the payment of rentals to the fund owner.24 Al-bai ul takjiri is similar to al-ijarah except that the fund user will, at a point in time, purchase the leased asset at an agreed price with all the previously paid lease rentals considered as part of the purchase price.25 In al-murabahah, the fund owner purchases the asset required by the fund user and then sells the same at an agreed mark-up to the fund user. In this arrangement, the fund user may be required to place a margin deposit, which will be used to pay part of the purchase price.26
Even under existing law, the prohibition against charging or collection of interest (riba)27 from consumers is not a problem, because Article 1956 of the Civil Code of the Philippines provides that: 'No interest shall be due unless it has been expressly stipulated in writing.' Thus, to comply with shariah principles, all that the contracting parties must do is not to stipulate any interest in their agreement.28
ii Home finance
Al-murabahah can be used in home finance. Here, a bank can buy a house and resell the same in instalments to a buyer for profit. Given the strict avoidance of interest in shariah, the bank must take at least constructive possession of the house before reselling it to the buyer that the transaction can be characterised as an authentic asset-based trade rather than a conventional financing arrangement.29
There is as yet no takaful market in the Philippines. Further, there are no conventional insurance companies that can be adapted to be shariah-compliant.30 It remains to be seen how the Insurance Commission will address or react to the introduction of the takaful concept in the local insurance market.
iv Private equity investments
Islamic banks can invest in equities of warehousing companies, leasing companies, storage companies, and companies engaged in the management of mutual funds but not in mutual funds themselves.31 Moreover, they can accept placements from a customer for investment, together with their own funds, in shariah-permissible transactions on a participation basis.32 Here, participation means 'any agreement or arrangement under which the mode of joint investments of specific transactions shall not involve the element of interest charge other than as percentage share in profits and losses of business'.33
v Real estate investments
Financing fixed-asset acquisitions (such as buying real estate) may be effected through al-bai bithaman ajil (deferred payment sale), pursuant to which the ownership of the asset is immediately transferred to the buyer but the purchase price is collected later, usually in instalments.34
Real estate investment trusts (REIT), designed to promote the development of the capital market by broadening the participation of Filipinos in the ownership of real estate in the Philippines, have yet to take off in the Philippines because of problems in implementation, although the REIT Act was passed as early as 2009.35
vi Investment funds
Under BSP rules, Islamic banks can issue investment participation certificates, muquaradah bonds36 and debentures to fund projects that will promote the economic development primarily of the autonomous region in southern Philippines.37 Broadly, they can undertake various investments in all transactions that are halal (permissible) and not haram (forbidden).38
One other arrangement is al-mudarabah (trust financing), wherein the fund owner provides full financing to the fund user, who contributes only his or her entrepreneurship and labour. The profit is shared by them at a pre-agreed rate or ratio, but if the venture fails, the fund owner bears all the losses even if the fund owner is not involved at all in the management of the venture.
vii Other areas
Islamic banks can open savings accounts for safekeeping or custody with no participation in profits or losses, unless the funds are otherwise authorised by the account holders to be invested.39
An Islamic bank can also act as an agent for another for a fee, under an al-wakalah arrangement. Here, the bank may issue a letter of credit for an importing customer, who is required to place a 100 per cent margin deposit on an al-wadiah (safe custody) basis wherein the bank has full discretion to use the deposit to meet its obligations under the letter of credit.40
On the other hand, in an al-kafalah (guarantee) arrangement, an Islamic bank can issue a standby letter of credit in respect of the performance of a task or the settlement of an obligation. Where a security deposit is required, it will be taken on an al-wadiah basis.41
Furthermore, an Islamic bank can take security for an outstanding obligation, based on the al-rahan principle. Although Islamic banks extend financing through partnership and trading assets, security may be taken as a precaution under that principle.42
Under the proposed Philippine Islamic Financing Act, the government is mandated to provide 'neutral tax treatment between Islamic banking transactions and equivalent conventional banking transactions'.43 This is aimed at providing a level playing field in terms of taxation between Islamic banking and conventional banking, so that Islamic banking transactions will not be disadvantaged tax-wise compared with their conventional counterparts.
It is noteworthy that, during its first eight years of operation, the AIIBP was exempted from all taxes under the National Internal Revenue Code.44 This tax exemption has lapsed. There appears to be no plan to have this exemption restored.
There is no separate insolvency regime for Islamic finance participants in the Philippines, and Islamic finance products are not afforded special treatment under local insolvency rules.
The insolvency rules governing conventional banks under the New Central Bank Act45 and the General Banking Law of 2000 are also applicable to Islamic banks. Initially, a conservator will be appointed by the BSP to take charge of the assets, liabilities and management of an Islamic bank that is in a state of continuing inability or unwillingness to maintain a condition of liquidity deemed adequate to protect the interest of bank depositors and creditors.46 If the BSP determines that the bank cannot continue to operate on its own without involving probable loss to its depositors and creditors, then the conservatorship will be terminated and the BSP will appoint a receiver, who will determine whether the bank can still be rehabilitated or otherwise liquidated.47
Similarly, the insolvency rules for conventional insurance companies under the Insurance Code48 could be applied to takaful companies. The rules here also involve conservatorship and receivership prior to liquidation. In a nutshell, if the Insurance Commissioner determines that a company is in a state of continuing inability or unwillingness to maintain a condition of solvency or liquidity deemed adequate to protect the interests of its policyholders and creditors, he or she will appoint a conservator to take charge of the company's assets, liabilities and management.49 If it is determined that the condition of the company is one of insolvency, the Insurance Commissioner will order the company to cease and desist from transacting business and designate a receiver and then a liquidator if the company cannot resume business with safety to its policyholders and creditors.50
For other Islamic finance participants, the Financial Rehabilitation and Insolvency Act of 2010 applies.51 As the name of this law indicates, corporate rehabilitation may be sought in court by or for a debtor company but the rehabilitation proceedings will be converted by the court into one for liquidation if there is no substantial likelihood of the company being successfully rehabilitated.52
V JUDICIAL FRAMEWORK
No special court has exclusive jurisdiction over disputes involving shariah-compliant products and structures. Conventional or regular courts still have jurisdiction over these disputes.
There are shariah courts but they have jurisdiction only over cases relating to Muslim personal law (defined as 'laws on personal status, marriage and divorce, matrimonial and family relations, succession and inheritance, and property relations between spouses').53 These courts are under the administrative supervision of the Supreme Court of the Philippines, which has appellate jurisdiction over cases decided by them.54
In the Philippines, judicial power is vested in the Supreme Court and the lower courts (such as metropolitan or municipal trial courts, regional trial courts, and the Court of Appeals).55 However, only the decisions of the Supreme Court form part of the legal system.56 To date, there are no cases decided by the Supreme Court that affect or interpret Islamic finance products and structures in the Philippines. In fact, there is, as yet, no corpus of jurisprudence on Islamic banking and finance.
Shariah law generally applies only to Muslims in the Philippines and only in respect of Muslim personal law, as defined above. Commercial transactions are governed by the general law on contracts and commerce. This explains why existing Supreme Court decisions on shariah law relate only to Muslim family issues.
Within the AIIBP, disputes between and among shareholders, as well as those between shareholders and the bank itself, are settled by the board of directors, acting as arbitrators. The arbitral award is final and executory.57
The prospects for Islamic banking and finance look promising, with the passage of the Bangsamoro Organic Law. The BSP can already authorise, at the very least, the opening of Islamic units within conventional banks. Indeed, it is high time for the BSP to take bold steps to promote the growth of Islamic banking and finance in the Philippines. In line with the progress of economic integration within the Association of Southeast Asian Nations (ASEAN), the member nations have established the framework for the integration of their financial and banking markets, including the formation of the qualified ASEAN banks (QABs). With the anticipated entry into the Philippine banking system of QABs from the other ASEAN members and with expertise in Islamic banking and finance, the BSP is expected to encourage and enable local banks and financial institutions to enhance their capabilities in Islamic banking and finance to be more competitive with their regional counterparts.
1 Rafael A Morales is the managing partner at Morales & Justiniano.
2 Republic Act No. 6848 is the Charter of the AIIBP.
3 See the chapter on the Philippines in Getting the Deal Through – Islamic Finance & Markets 2016 (Rafael A Morales and Bishr Shiblaq, contributing editors), at 38.
4 Republic Act No. 8791; see Subsection 3.2(f) thereof.
5 Bangsamoro Organic Law, Section 32; see also Rafael A Morales, 'Philippines continues to foster Islamic finance development', Islamic Finance News (4 May 2016).
6 Bangsamoro Organic Law, Section 32.
7 Bangsamoro Organic Law, Section 34.
8 Senate Bill No. 668 (Seventeenth Congress of the Philippines, First Regular Session) introduced by Senator Paolo Benigno A Aquino IV.
9 The implementing rules are contained in Appendix 44 to the Manual of Regulations for Banks.
10 Senate Bill No. 668, Section 35.
11 ibid., Section 7.
12 ibid., Section 5. Under Section 31 of the Bangsamoro Organic Law, the Bangsamoro government 'shall encourage the establishment of: (1) banks and financial institutions and their branches including an Islamic window in domestic and foreign conventional banks; and (2) offshore banking units of foreign banks within the Bangsamoro Autonomous Region, and in accordance with the principles of the Islamic banking system'.
13 Republic Act No. 386, as amended.
14 See footnote 3.
15 The latest list was circulated through the PSE's Memorandum to the 'Investing Public and All Trading Participants' dated 6 July 2018. The PSE has engaged the services of IdealRatings, Inc in screening PSE-listed companies in accordance with the standards set by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). To be included in the list, a company must meet the following PSE criteria: (1) the nature of the company's primary business must not involve any of the prohibited activities in AAOIFI's Shariah Standard No. 21 – Rules for Dealing of Shares (i.e., conventional interest-based lending, financial institutions, conventional insurance, mortgage and lease, derivatives, pork, alcohol, tobacco, arms and weapons, embryonic stem-cell research, hotel, gambling, casinos, music, cinema and adult entertainment) or, if the company derives income from these prohibited activities, the income, on an aggregated basis, must not exceed 5 per cent of its gross revenues; (2) the company's interest-bearing debt, as well as its interest-bearing deposits or investments, must not exceed 30 per cent of its 12-month trailing average market capitalisation; and (3) the company's accounts receivable must not exceed 67 per cent of its 12-month trailing average market capitalisation.
16 General Banking Law of 2000, Section 4; Bangsamoro Organic Law, Section 32.
17 Republic Act No. 8799.
18 It was reported that the National Home Mortgage Finance Corporation was planning to issue sukuk. See Rafael A Morales, 'Philippines continues to foster Islamic finance development', Islamic Finance News (4 May 2016).
19 Charter of the AIIBP, Section 5.
20 Senate Bill No. 668, Section 22.
21 Section X101(b)(6)(k) of the Manual of Regulations for Banks; Section 6(7)(l) of the Charter of the AIIBP.
22 Section 7(i) of Appendix 44 to the Manual of Regulations for Banks.
23 General Banking Law of 2000, Subsection 3.2(f).
24 Section 44(3) of Appendix 44 to the Manual of Regulations for Banks.
25 Section 44(2) of Appendix 44 to the Manual of Regulations for Banks.
26 Section 44(6) of Appendix 44 to the Manual of Regulations for Banks.
27 As defined in Section 43(3) of Appendix 44 to the Manual of Regulations for Banks, the term 'riba' includes 'the receipt and payment of interest in the various types of lending and borrowing and in the exchange of currencies on forward basis'.
28 Footnote 3, at 39.
31 Section X101(b)(6)(o) of the Manual of Regulations for Banks.
32 Section X101(b)(6)(b) of the Manual of Regulations for Banks.
33 Section 43(10) of Appendix 44 to the Manual of Regulations for Banks.
34 Section 44(1) of Appendix 44 to the Manual of Regulations for Banks.
35 Republic Act No. 98501. The problems lie in the requirement for a REIT to have a minimum public ownership initially of 40 per cent and eventually 67 per cent, as well as the imposition of value added tax on the initial asset transfer.
36 As defined in Section 43(12) of Appendix 44 to the Manual of Regulations for Banks, muquaradah bonds are 'long-term non-interest-bearing bonds of definite denomination issued and floated by the bank on the basis of participation under the mudarabah principle to be used in financing projects for economic development'.
37 Section X101(b)(6)(m) of the Manual of Regulations for Banks.
38 Section X101(b)(6)(k) of the Manual of Regulations for Banks.
39 Section X101(b)(6)(a) of the Manual of Regulations for Banks.
40 Section 44(11) of Appendix 44 to the Manual of Regulations for Banks.
41 Section 44(4) of Appendix 44 to the Manual of Regulations for Banks.
42 Section 44(9) of Appendix 44 to the Manual of Regulations for Banks.
43 Senate Bill No. 668, Section 31; under Section 32 of the Bangsamoro Organic Law, the Bangsamoro parliament 'shall enact laws that promote the growth of Islamic finance such as those that promote tax incentives and ensure tax neutrality of Islamic finance transactions in the Bangsamoro Autonomous Region'.
44 Charter of the AIIBP, Section 37. The National Internal Revenue Code is set out in Republic Act No. 8424, as amended.
45 Republic Act No. 7653.
46 Section 29 of the New Central Bank Act; Section 67 of the General Banking Law of 2000. As defined in Section 43(5) of Appendix 44 to the Manual of Regulations for Banks, the term 'depositor' refers to 'a person or entity who has an account at an Islamic bank, whether the account is a current account, a savings account or any other deposit account; unless the context requires another meaning, a depositor corresponds to an investor in joint investment of the Islamic bank'.
47 Section 30 of the New Central Bank Act; Section 69 of the General Banking Law of 2000.
48 Presidential Decree No. 612, as amended by Republic Act No. 10607.
49 Section 255 of the Insurance Code.
50 Section 256 of the Insurance Code.
51 Republic Act No. 10142.
52 Section 12 et seq. of the Financial Rehabilitation and Insolvency Act of 2010.
53 Presidential Decree No. 1083, Section 7(i).
54 ibid., Section 145.
55 Section 1, Article VIII, 1987 Constitution of the Philippines.
56 Article 8, Civil Code of the Philippines.
57 Charter of the AIIBP, Section 9.