IRP 114 – Policies, Processes and Procedures for Converting Conventional Banks to Islamic Banks: A Proposed Framework

The conversion of conventional banks into Islamic banks is an increasingly common phenomenon in many jurisdictions. It is part of a pattern accompanying the global expansion of Islamic finance. Nonetheless, the Islamic banking industry is facing a challenge in the lack of a comprehensive and structured framework for the phases and requirements of the conversion process. AAOIFI’s Sharīʿah Standard No. 6 on ‘Conversion of a Conventional Bank to an Islamic Bank’ and some cross-jurisdictional guidelines lack details about the specific processes and procedures, leaving considerable ambiguity and uncertainty about the conversion process. The conversion processes comprise related activities to produce a conversion while procedures are detailed steps to perform an activity within a process. Part of the problem is a lack of sequential steps within a thorough framework. Meanwhile, some jurisdictions have no guidelines for conversion at all.

Bearing this in mind, this research aims at providing a comprehensive conversion framework. It has been derived by examining different regulatory guidelines and relevant guiding principles and Sharīʿah standards from international standard-setting bodies for Islamic financial institutions such as IFSB and AAOIFI. It sets forth the requirements for the conversion procedures and the process flow throughout the conversion process. The framework is designed to provide robust guidelines comprising effective, comprehensive and detailed steps of the conversion process inclusive of the existing policies, guidelines and standards.

This research provides a framework for conversions at the limited level of branches as well as the thoroughgoing conversion of an entire bank. The research adopts a qualitative method of study, utilising multiple qualitative instruments, namely document analysis, content analysis, observation for analysis to identify need, policies, processes and procedures as well as approaches to conversion. Semi-structured interviews were also conducted with staff at some local Malaysian banks that successfully converted into Islamic banks and of others that are currently undergoing conversion. The aim was to get first-hand information about conversion and to highlight prospects and challenges arising throughout the process.

The research finds the following:

1. Conversion from a conventional bank to an Islamic bank is not a matter of choice for Muslim shareholders; it is an obligation based on their capacity. Allah says: (فَٱتَّقُواْ ٱللَّهَ مَا ٱسۡتَطَعۡتُمۡ…) “So, observe taqwā (total obedience to Allah in awe of Him) as far as you can” (Sūrah al-Taghābun, 64:16).
2. There are three factors that form the generative force behind the conversion process. They are creed, along with legal and economic factors.
3. These factors also form components of Sharīʿah, and implementation of them manifests adoption of both the letter and spirit of Sharīʿah.
4. The economic factor has positioned itself in this age as the main source for social needs, and it requires a means to allay the concerns of Muslims across the globe regarding dealing in ribā.
5. One of the practical solutions is conversion of the existing conventional banks to Islamic banks, which can be achieved in different forms, namely: setting up an Islamic window or division within a conventional bank; setting up an Islamic subsidiary alongside a conventional bank; and establishment of full-fledged Islamic banks.
6. The gradual approach (tadarruj), which forms one of the fundamental principles in Sharīʿah, is indispensable in both aggressive and organic approaches to conversion. It can be captured from two dimensions: first, graduality in the formulation of conversion policies, and second, in the execution of conversion processes and procedures. These two approaches are formulated based on the Sharīʿah’s gradual approach in legislation and in implementation of that legislation.
7. The existing regulatory guidelines, guiding principles and Sharīʿah standards from different regulatory authorities and international standard-setting bodies for Islamic financial institutions are stepping stones for conversion. However, the conversion process needs a comprehensive framework that captures the policies, processes and procedures involved.

In view of the above, the research recommends the following:

All the stakeholders need to support the conversion in order for it to be carried out successfully. That is because the implications of conversion include business models, organisational structure and relationship with the central bank. These affect several regulatory authorities such as central banks or monetary authorities, securities and exchange commissions, and others.

As the approaches to conversion vary considerably, the supervisory authorities need to issue guidelines on the different approaches to the conversion process, namely aggressive and organic approaches to conversion.

The guidelines should consider the conversion phenomenon and challenges facing the applicant bank and offer best practices most suited to the attendant challenges or that at least minimise them.

There is a need for collective fatwas/resolutions on the fiqh characterisation of the conversion process by Sharīʿah authorities at different levels: international, regional and national.

The licensing or supervisory authority should benefit from the experience of others in developing the appropriate regulatory and policy requirements.

The converting banks should read through the relevant regulatory and policy requirements that match their existing laws and organisational needs to develop their policies and procedures for conversion.

Regulators, practitioners and converting banks may use the proposed framework, which involves policies, processes and procedures for conversion, as a guide throughout the entire process.

We recommend the use of project management tools like PRINCE2, Critical Chain Project Management (CCPM), Waterfall, and APF as most suitable for the conversion project.

The proposed checklist can be customised and parametrised to measure the performance of the applicant bank against the requirements for conversion and ascertain if the compliance is satisfactory.

Keywords: Full-fledged conversion, branch conversion, organic conversion, complete conversion, conversion processes, micro conversion, macro conversion