Functioning of Islamic Banks in Lebanon

685 / Text/Section/1 Vol./94 Date/2017-6-30 Basic Circular for Banks No. 94

We enclose herewith a copy of the Basic Decision No. 8828 dated 26/8/2004 concerning the operation of Islamic banks in Lebanon.

Beirut, 26 August 2004 Governor of the Central Bank of Lebanon Riad T. Salamé

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Basic Decision No. 8828 Operation of Islamic Banks in Lebanon

The Governor of the Central Bank of Lebanon, Based on the Monetary and Banking Law, And based on Law No. 575 dated 11/2/2004 concerning the establishment of Islamic banks in Lebanon, particularly Articles 3 and 4 thereof, And based on the decision of the Central Council of the Central Bank of Lebanon adopted in its meeting held on 25/8/2004, Decrees as follows:

Article One Based on the provisions of the second paragraph of Article 3 of Law No. 575 dated 11/2/2004 concerning the establishment of Islamic banks in Lebanon, the following principles are adopted for establishing deposit contracts and determining returns on deposits that Islamic banks may receive, which are linked to the bank's annual results or operational results:

First: Types of Deposits:

1. Current accounts and deposits received in accordance with the provisions of the first and second paragraphs of Article 307 of the Commercial Code, to which all applicable laws and regulations apply.
2. Deposits received under a Mudarabah (profit-sharing) contract.
3. Deposits received under a Wakalah (agency) contract.

(Amended by Article 1 of Interim Decision No. 12497 dated 10/4/2017 (Interim Circular No. 455).)

Second: Establishment of the Deposit Contract: -1 The deposit contract received in accordance with the provisions of clauses (2) and (3) under "First" above must explicitly include, at a minimum, the following:

• a The deposit amount delivered to the concerned bank and the terms for its management, along with its maturity date.
• b Each party's share of the profit, which must be a common percentage rather than a fixed amount in Mudarabah contracts.
• c All expenses borne by the capital provider (Rab al-Mal).
• d The possibility or impossibility of the depositor withdrawing part or all of the deposit before maturity, along with the conditions for such withdrawal. 2 In addition to the conditions mentioned in clause (1) under "Second" here, the deposit contract received in accordance with the provisions of clause (2) under "First" of this Article must include an explicit clause stating that the percentage deducted to establish both the "Investment Risk Reserve" and the "Profit Rate Reserve" is given as a gift (tabarru).

Third: Returns on Deposit Accounts: -1 Regarding returns linked to the bank's annual results: The deposit result is linked to the bank's annual results if the deposit contract agrees that the Islamic bank has absolute authority to invest the depositor's funds (current accounts or deposits received in accordance with the first and second paragraphs of Article 307 of the Commercial Code). -2 Regarding returns linked to operational results: The results of deposits received in accordance with the provisions of a Mudarabah or Wakalah contract are linked to the operational results attributable to them. Deposits received in accordance with a Mudarabah contract are recorded within the bank's balance sheet if the Islamic bank has wide discretionary authority (Significant Influence) in investing these funds. Deposits received in accordance with a Wakalah or Mudarabah contract are recorded outside the bank's balance sheet when the Islamic bank does not have wide discretionary authority in investing these funds. -3 Regarding the application of return rates: The rate applicable to deposit holders at the end of the agreed financial period is applied periodically or annually, based on the book value (balance recorded in the bank's books).

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Article Two The value of fixed assets designated for the use of an Islamic bank must not exceed 30% of its net basic own funds. Furthermore, the percentage of its investments in fixed assets, including the aforementioned percentage, must not exceed 50% of the total value of its entire investment portfolio.

Article Three The net basic own funds of any Islamic bank must not, at any time, fall below 5% of the total value of its investment portfolio recorded outside its balance sheet.

Article Four 1: In addition to the reserves mandated by laws and regulations for non-Islamic banks, an Islamic bank must establish an "Investment Risk Reserve" to cover losses resulting from investment operations financed by customers' investment accounts under Mudarabah contracts. Deductions shall be at least 10% of net investment profits annually, after deducting the bank's share as Mudarib, until the accumulated amount reaches 20% of investment accounts. To calculate the "Investment Risk Reserve," or a portion thereof, as part of the provisions required to cover losses, prior approval from the Banking Supervision Committee must be obtained. In other cases, the Banking Supervision Committee retains the right, within its granted powers, to object to any use or disposal of the "Investment Risk Reserve" account. Upon voluntary liquidation of an Islamic bank, the "Investment Risk Reserve" is not considered a right of the bank's shareholders. Disposal of the remaining balance in the account is decided by the liquidator after obtaining approval from the bank's Shariah Board.

(Amended by Article 2 of Interim Decision No. 12497 dated 10/4/2017 (Interim Circular No. 455).)

The Islamic bank must exclusively invest its "Investment Risk Reserve" at the Central Bank of Lebanon, and the returns generated therefrom are added to the balance of this reserve after deducting the Islamic bank's share of the return, which may not exceed 10% at the maximum. -2 Islamic banks may establish a "Profit Rate Reserve" to enhance returns on customers' investment accounts by comparing them with returns on similar operations in the banking market. The reserve is established from operational profits before deducting the bank's share as Mudarib, until the accumulated amount reaches 5% of investment accounts. Upon voluntary liquidation of an Islamic bank, the "Profit Rate Reserve" specific to customers' investment accounts is not considered a right of the bank's shareholders. Disposal of this reserve's balance is decided by the liquidator after obtaining approval from the bank's Shariah Board. The ability to invest the "Profit Rate Reserve" specific to customers' investment accounts is restricted to the Central Bank of Lebanon, and returns generated from deploying funds in the "Profit Rate Reserve" account are added to the reserve's balance after deducting the Islamic bank's share of the return, which may not exceed 10% at the maximum.

Article Five 1: First, an Islamic bank is prohibited from conducting real estate brokerage operations in all their forms, or financing real estate Mudarabah operations, or purchasing properties (built or unbuilt) with the aim of reselling them. Second, an Islamic bank must comply in its financing operations with the following additional obligations: -1 The volume of financing, in cases requiring collateral provided by bank clients, must not exceed 60% of the tangible collateral as estimated by the bank's experts on their personal responsibility. If the value of the collateral decreases for any reason, the bank must immediately require the client to provide additional guarantees to comply with the aforementioned percentage. Financing operations secured by cash deposits or pledged/specified bank guarantees, financing operations granted for purchasing equipment or fixtures, and financing operations granted for consumer (Consumer Loan) or housing purposes (First House Personal Loan) to own a primary residence are exempt from the aforementioned percentage. -2 The bank's financing to its affiliated companies must not exceed 30% of its net basic own funds, and must not exceed 10% in a single company. The aforementioned percentages include financing operations conducted for collective investment entities established and/or managed by the concerned bank under any system.

(Last amendment introduced by Article 1 of Interim Decision No. 9959 dated 21/7/2008 (Interim Circular No. 178).)

Article Six Islamic banks must obtain prior approval from the Central Bank of Lebanon when they wish to adopt any type of operations, mechanisms, structures, or products that are likely to create Islamic investments other than those explicitly regulated or noted in the regulations issued by the Central Bank of Lebanon.

(Added by Article 3 of Interim Decision No. 9898 dated 6/5/2008 (Interim Circular No. 163).)

Article Seven In addition to the provisions contained in this Decision, all laws and regulations concerning non-Islamic banks apply to Islamic banks, unless otherwise specified.

(Numbering amended to "Seventh" instead of "Sixth" by Article 2 of Interim Decision No. 9898 dated 6/5/2008 (Interim Circular No. 163).)

Article Eight This Decision shall be published in the Official Gazette and shall take effect upon its issuance.

Beirut, 26 August 2004 Governor of the Central Bank of Lebanon Riad T. Salamé

(Numbering amended to "Eighth" instead of "Seventh" by Article 2 of Interim Decision No. 9898 dated 6/5/2008 (Interim Circular No. 163).)