## 1. Resolution Triggers Under Malaysia’s Islamic Financial Services Act of 2013

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---

### Introduction
- Purpose:
  - Discusses the design of legal frameworks for the resolution of Islamic banks.
  - Examines the applicability of international best practices for bank resolution to Islamic banks and whether modifications are needed.
- Context:
  - Islamic banks are gaining global systemic relevance; failure of a large Islamic bank could significantly impact global financial stability.
  - Islamic banks are vulnerable to failure despite risk-sharing and conservative investment characteristics.
- International standard:
  - The prevailing international standard is the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions (the “Key Attributes” or “KAs”).
  - KAs aim to ensure authorities can resolve institutions in an orderly manner without taxpayer exposure to losses, while maintaining continuity of vital economic functions.
  - KAs include designation of a specific resolution authority and a broad range of tools including mandatory recapitalization, forced mergers, debt restructuring, and transfer of assets and liabilities.
- Scope and caveats:
  - “Islamic banks” refers to institutions set up as Islamic banks as well as Islamic banking windows of conventional banks (whether outsourced or in-house).
  - KAs were developed in jurisdictions with predominantly conventional banking and make no special provision for Islamic banks; special characteristics of Islamic banks require assessment of applicability.
  - Malaysia is a notable exception with a specific resolution framework for Islamic banks in its Islamic Financial Services Act (Act 759) enacted in March 2013.
  - Very few countries with Islamic banking systems have experience resolving Islamic financial institutions; many resort to public financial support to preserve financial stability.
  - Assessment of Sharī`ah compliance is constrained by different interpretations of Sharī`ah across schools of jurisprudence (madhahib).
  - Jurisdictions with both conventional and Islamic banking face calibration challenges between regimes, especially where Islamic banking exists as full banks, windows, or subsidiaries.

### Key points on applicability and legal issues
- Need for resolution frameworks:
  - Legal frameworks for resolution are required because Islamic banks have experienced financial distress and may fail, necessitating orderly resolution mechanisms.
- International practice and gaps:
  - Very few specialized bank resolution frameworks distinguish between conventional and Islamic banks.
  - Existing frameworks largely do not expressly accommodate Sharī`ah-specific concerns, except Malaysia’s Act 759 (March 2013).
- Practical implications of Sharī`ah:
  - The sanctity and validity of Islamic finance hinges on Sharī`ah; a resolution regime may need to be Sharī`ah compliant to avoid undermining investor confidence and financial stability.
  - Possible application of Sharī`ah bankruptcy principles (iflās) and Sharī`ah-based market regulation (hisba) should be considered.
  - Under Sharī`ah, mandatory forgiveness of debt appears forbidden; there is no final discharge of indebtedness as the debtor remains obligated until payment in full or voluntary forgiveness by the creditor.
  - Unsecured creditors share pro rata in the unencumbered assets of the debtor.
- Institutional and procedural considerations:
  - Determinations on whether resolution powers, tools, and techniques must be Sharī`ah compliant influence institutional arrangements for resolution and the legal powers available to authorities.
  - The design of a bank resolution framework should address and minimize risks from divergent Sharī`ah interpretations to enable prompt resolutions with assurance of compliance.

### What’s different with Islamic banking and implications for resolution
- Religious considerations and prudential norms:
  - Islamic banks are shaped by Sharī`ah principles affecting governance, assets, liabilities, and operations.
  - Jurisdictions mostly apply international bank supervisory standards to Islamic banks with Sharī`ah-specific adjustments affecting computation of capital adequacy ratios (“CAR”), liquidity management, corporate governance, accounting treatment, and contracting rights and responsibilities.
  - Lack of consistency in prudential norms across jurisdictions affects supervision, including cross-border and consolidated supervision.
  - IFSB and AAOIFI contribute to harmonization but application is not uniform across countries.
- Supervisory approach variation:
  - Some jurisdictions incorporate Sharī`ah into secular law and impose supervisory responsibility for Sharī`ah compliance; others do not.
  - The U.K. does not contain separate prescriptions on Islamic banking or Sharī`ah compliance within the bank regulatory framework, though authorities may consider governance, internal controls, reputational risk, consumer protection.
- Governance—Sharī`ah boards:
  - Most jurisdictions require a Sharī`ah board; some (e.g., Kenya and Tunisia) do not.
  - Sharī`ah boards:
    - Comprised of Sharī`ah scholars and sometimes specialists (economists, accountants, financial experts, lawyers).
    - Review and ensure transactions, contracts, products, and activities comply with Sharī`ah law and principles; can issue fatawa and rulings binding on the institution.
    - Generally conduct ex-ante reviews and approvals; ex-post review occurs in some cases.
    - Responsible for the Sharī`ah governance regime and may have mechanisms allowing direct access to the board of directors if failures occur.
  - Models:
    - Centralized Sharī`ah boards (sometimes within the Central Bank).
    - Decentralized bank-level Sharī`ah boards.
    - Combined models where centralized rulings may be binding alongside bank-level boards.
  - The chosen model can affect institutional arrangements for resolution.

### Stylized balance-sheet differences and contract complexity
- Stylized balance-sheet items (key items listed in source):
  - Islamic financial institutions — Assets: Cash and cash equivalents; Investment in securities; Sales Receivables; Investments in leased assets; Investments in real estate; Equity/Profit-sharing financing; Investment in Subsidiaries; Fixed assets; Other assets.
  - Islamic financial institutions — Liabilities: Current Accounts; Other Liabilities; PSIA (Unrestricted); Profit Equalization Reserve, Investment Risk Reserve.
  - Islamic financial institutions — Owner’s Equity: PSIA (Restricted).
  - Islamic financial institutions — Off-balance sheet: [Letters of Credit, Guarantees].
  - Conventional financial institutions — Assets: Cash and cash equivalents; Investment in securities; Loans and advances; Statutory deposits; Investment in Subsidiaries; Fixed assets; Other assets.
  - Conventional financial institutions — Liabilities: Current Accounts; Saving and Time Deposits; Other Liabilities.
  - Conventional financial institutions — Owner’s Equity: (standard Owner’s Equity entry).
  - Conventional financial institutions — Off-balance sheet: [Letters of Credit, Guarantees, Derivatives].
  - Note: PSIA = profit-sharing investment account. Note: Differences are shown in red.
- Asset-side contract types:
  - Contracts economically equivalent to pure lending (example: vector muḍārabah transactions).
  - Equity-like/partnership financing (mushārakah).
  - Lease-based financing (ijarah).
  - Fee-based activities (wakalah).
  - Non-remunerated lending (qard and wadiah).
  - Sales with mark-up and deferred payments (Murābahah).
  - Salam and istisna’a for deferred delivery.
  - Some transactions entail complex tri-partite bundles of rights in rem and in personam between investor, bank and investee.

### Liability-side variations and investment accounts
- Liability types and features:
  - Guaranteed safekeeping contracts (qard or wadi’ah).
  - Non-guaranteed investment contracts (muḍārabah and wakalah).
  - Profit sharing investment accounts (restricted and unrestricted).
  - Sukūk (certificates of participation or trust certificates).
- Current accounts:
  - Similar to traditional deposits but tend to be non-interest/return bearing; Islamic banks sometimes provide a “gift” (hiba) equal to competitor conventional banks’ interest financed from the bank’s capital.
- Profit-Sharing Investment Accounts (PSIAs):
  - Structured as muḍārabah, mushārakah, or wakala.
  - Profits shared per predetermined ratio; principal and returns not guaranteed.
  - May not be treated as liabilities of the bank and may be treated as assets of the investment account holder.
  - Two types:
    - Unrestricted investment accounts: bank has full discretion; assets may be comingled and difficult to attribute.
    - Restricted investment accounts: mandate restricted to specific assets; often via SPV; easier to trace and transfer though commingling across similar restricted accounts can occur.
- Profit Equalization Reserves (PERs) and Investment Risk Reserves (IRRs):
  - IRRs: set aside from profits attributable to investment account holders to cushion future investment losses; generally bank does not have a share.
  - PERs: represent liabilities collectively owed to investment account holders and the bank in proportion to respective profit and loss shares; accumulated from general profits to smooth profit payouts and enhance dividends.
  - Key legal issue in resolution: defining rights of account holders versus bank to PERs; contractual arrangements largely determine allocation but lack of legal clarity in some jurisdictions could lead supervisors or courts to redistribute PERs differently than originally agreed.
- Sukūk:
  - Common structure: underlying assets transferred to an SPV by the originating bank in exchange for sukūk issuance proceeds.
  - Sukūk ijarah model: holders receive certificates representing interest in underlying assets; rent/payments flow to SPV then to sukūk holders; maturity involves repayment by SPV after disposal of assets.
  - Legal treatment depends on whether transaction involves a true sale:
    - Asset-backed sukūk: true sale transfers legal title to SPV; general creditors of originating bank have no claim on these assets; sukūk holders have claims against SPV.
    - Asset-based model: no true sale; originating bank retains legal ownership; sukūk holders may have residual unsecured claim against bank for shortfall.

### Prudential regulation and deposit insurance treatment
- IFSB standards:
  - IFSB capital adequacy standards do not classify PSIAs as part of an Islamic bank’s capital because they do not meet criteria of “Core” or “Additional Capital.”
  - IRRs and PERs belong to investment account holders and thus are not part of the Islamic bank’s capital, except to the extent the bank may have a contractual share in PERs.
  - The portion of PERs that is part of the Islamic bank’s reserves should not be treated as part of regulatory capital because PERs are intended to smooth profit payouts, not to cover losses.
- Deposit insurance:
  - More consensus on insurability of wadiah or qard contracts.
  - Jurisdictions are divided on definition and treatment of PSIAs: some provide protection to both unrestricted and restricted PSIA holders; others only to unrestricted PSIA holders; some jurisdictions do not provide any protection to PSIA holders.
  - IFSB has not yet adopted a standard on Sharī`ah-compliant deposit insurance; the Islamic Deposit Insurance Group of the International Association of Deposit Insurers views Sharī`ah compliance as a key challenge.

### Institutional issues: resolution authority and Sharī`ah boards
- Resolution authority requirements:
  - KAs (KA 2) apply broadly: designate and empower a resolution authority with broad mandate, operational independence, robust governance, and adequate resources.
  - Resolution authority must have sufficient expertise, knowledge and human capacity to implement resolution measures; this is even more critical for Islamic banking due to sui generis operations.
- Dual banking systems—options and trade-offs:
  - Jurisdictions may designate same resolution authority for both conventional and Islamic banks, or separate agencies.
  - Separate Islamic resolution authority could be difficult and poses coordination challenges, especially for groups with both bank types.
  - Choice depends on relative sizes of systems and availability of expertise.
  - Single resolution authority is a strong practical argument where same supervisory agencies oversee both bank types.
  - Where separate authorities exist, effective coordination mechanisms and clarity on leadership in resolution are important.
- Sharī`ah boards and certification:
  - If resolution measures must be Sharī`ah compliant, institutional arrangements for certifying compliance should not undermine mandate and autonomy of resolution authority or impede prompt and orderly resolution.
  - Consider roles for Sharī`ah boards (including those of acquiring banks) and whether resolution authority power to suspend or remove boards of directors should extend to Sharī`ah boards.
  - Where Sharī`ah boards are involved in certifying compliance, legal frameworks ought to provide mechanisms for dealing with potential conflicts between a Sharī`ah board and the resolution authority, or between two or more Sharī`ah boards.
  - Centralized or national Sharī`ah boards mitigate conflict risk; in jurisdictions without centralized boards, consider empowering the resolution authority to establish its own Sharī`ah board to advise on resolution measures.

### Triggers and non-viability indicators (including Malaysia Box 1 — section 177)
- Triggers and non-viability indicators:
  - A legal framework should provide clear triggers (quantitative and/or qualitative) for placing a bank in resolution.
  - Conventional quantitative triggers reflect a “borrowing and lending” model: indicators include weak CAR and persistent liquidity problems (e.g., inability to pay debts as they fall due).
  - For Islamic banks, conventional triggers may be problematic given reliance on sales, leasing, and profit/loss arrangements.
  - Challenges in computation of CAR due to balance sheet complexities would need to be addressed to promote transparency and minimize legal risks.
  - Possible Islamic-specific triggers include non-payment or delayed payment of rents or profits, or misuse of underlying assets contrary to agreement terms.
  - Triggers should meet the high threshold in conventional bank resolution: non-viability, likely non-viability, or continuing practices that endanger deposits or other financial contracts and financial stability; triggers should not be set so low as to include simple contractual default unless reflecting institutional problems.
- Protecting broad classes of claimants:
  - Resolution triggers may need to protect claimants who are not depositors but are counterparties under Islamic finance contracts.
  - Example (Malaysia): legal framework empowers the resolution authority to trigger resolution in circumstances which detrimentally affect an Islamic bank’s “depositors, investment account holders, participants, users, creditors or the public generally.”
- Box 1: Resolution Triggers Under Malaysia’s Islamic Financial Services Act of 2013 (section 177)
  - The institution has breached or contravened any provision of this Act, the Central Bank of Malaysia Act 2009 or any written law, regardless that there has been no prosecution or other action in respect of the breach or contravention;
  - The institution has failed to comply with any direction under section 168;
  - The assets of the institution are not sufficient to give adequate protection to its depositors, investment account holders, takaful participants, participants, users or creditors, as the case may be;
  - The capital of the institution has reached a level or is eroding in a manner that may detrimentally affect its depositors, investment account holders, takaful participants, participants, users, creditors or the public generally;
  - The institution has become or is likely to become insolvent or unable to meet all or any of its obligations; or
  - Any other state of affairs exists in respect of the institution that may be materially prejudicial to the interests of the depositors, investment account holders, takaful participants, participants, users or creditors of the institution or the owners of any assets under the licensed person’s administration, including where proceedings under a law relating to bankruptcy or insolvency have been commenced in Malaysia or elsewhere in respect of the holding company of the institution, including its financial holding company.

### Powers to take control and support resolution
- Powers recommended to be explicit in law:
  - Replace senior management.
  - Take official control and place a bank under official administration.
  - Impose moratoriums and stays if necessary.
  - Restructure the bank.
- Replacement of management:
  - Resolution authority should have explicit power to replace senior management; supervisors should be empowered to instruct management and, if non-compliant, to replace management swiftly.
- Official administration:
  - Legal framework should empower authorities to appoint an “official administrator” to take control and manage the failed bank to restore viability under resolution authority guidance.
  - Official administrator typically assumes legal powers of board, managers, and shareholders and displaces their authority.
  - Malaysia’s Islamic Financial Services Act of 2013 explicitly provides to the Central Bank of Malaysia as resolution authority, the power to assume control of an Islamic bank and to manage the whole or part of the business and affairs of such bank.
- Prerequisites for official administration:
  - Clarify scope of official administrator’s mandate, particularly that review and rehabilitation actions comply with relevant Sharī`ah principles and clarify whose interpretation applies.
  - Clarify extent to which official administration displaces the Sharī`ah board and whether placing an Islamic bank under official administration automatically displaces the Sharī`ah board; provide for power to remove Sharī`ah board members who no longer meet “fit and proper” requirements.
  - Official administrators should have expertise in Islamic finance or be authorized to retain people with Sharī`ah and Islamic banking expertise.
- Moratoriums and stays:
  - Provide for power to impose moratoriums and temporary stays on transactions to avoid dissipation of value and ensure equal treatment of creditors in liquidation.
  - Imposing a moratorium on payments or a temporary stay on creditor actions would not appear to raise difficulties in the Islamic banking context.

### Restructuring tools, creditor hierarchy and loss allocation
- Resolution tools (Key Attributes referenced):
  - Merge ailing banks with stronger institutions.
  - Undertake a Purchase and Assumption (“P&A”) transaction by transferring assets and liabilities to a healthy institution or a “bridge bank.”
  - Mandatorily restructure (“bail-in”) debt, equity, and other claims by writing down unsecured debt and/or converting it into equity.
  - Eliminate or dilute existing shareholders’ claims while the institution remains open.
  - These powers should be exercisable without consent of existing shareholders or creditors, subject to safeguards such as the “no creditor worse-off” principle.
- Balance sheet complexity and creditor hierarchy:
  - Creditor hierarchies determine ranking/order for loss allocation: typically shareholders first, then subordinated debt holders and other unsecured creditors, with depositors (at least some, such as small or insured deposits) last.
  - For Islamic banks, clear classification of claims is required because some products (e.g., investment accounts) may not be clearly defined as deposits.
  - Investment accounts are generally not structured as conventional deposits; Islamic banks typically have no liability towards investment account holders except allocation of profits or losses from their investments.
  - Jurisdictional approaches vary: some treat unrestricted investment account holders as “depositors” for deposit insurance purposes (for example, Malaysia and Turkey), while others treat investment account holders akin to equity holders in invested assets.
  - Malaysia treats investment accounts for supervisory and resolution purposes as a separately allocated group of investments; assets of such investment accounts are available in the order: (i) to pay outstanding costs or expenses of the investment accounts; (ii) to pay any profit, fees, gains or other remuneration due to the Islamic bank; and (iii) to meet the liabilities to the investment account holders.
- Preferential treatment and pari passu:
  - Resolution authorities generally must observe pari passu (equal treatment of claims of the same class).
  - The Key Attributes allow flexibility to depart from pari passu if necessary to contain systemic impact or maximize value for all creditors, provided legal framework promotes transparency.
  - From a Sharī`ah perspective, unequal treatment of creditors appears prohibited absent prior agreement by parties; suggests all claims of the same class against an Islamic bank should be treated equally in resolution.

### Mandatory recapitalization, mergers and P&A implementation challenges
- Mandatory recapitalization and forced mergers:
  - Mandatory recapitalization appears applicable to Islamic banks, though some Sharī`ah principles may constrain capital structures (e.g., preferred stock or fixed-income preference arrangements may be perceived inconsistent with prohibition of ribā).
  - Forced mergers feasible provided acquiring institution is Sharī`ah compliant; merger procedures should address cases where acquirer’s Sharī`ah board deems acquired operations non-Sharī`ah compliant and requires disposition or liquidation; temporary financial assistance mechanisms may be needed.
- Purchase and Assumption (P&A) — practical implementation challenges:
  - P&A involves transfer of assets and liabilities to a healthy acquirer or bridge bank without consent of shareholders/creditors.
  - Principal challenge: complex nature of Islamic bank assets/liabilities requires P&A to be structured differently from conventional banks.
  - Specific issues:
    - Current deposits: may be easily transferable.
    - PSIAs and PERs: challenging to transfer under P&A because these claims are typically investments that belong to the investment account holder.
    - Investment accounts: many jurisdictions treat them as client assets not liabilities; need contractual clarity on whether account holders have recourse to bank’s assets in resolution.
    - KAs guidance: client assets held by a financial intermediary should be transferred promptly to another intermediary; resolution authority should have power to transfer contractual rights and obligations among the custodian, the firm in resolution and its clients, to the qualified transferee.
    - PERs: often co-mingled and unclear whether transfer extinguishes claims; recommended legal framework could require contractual clarity on distribution of reserves in resolution.
    - Asset transfers: sales receivables, participation rights in profit-and-loss-sharing arrangements, and leasing receivables may be central to P&A; legal clarity required on transferability.

### Sharī`ah compatibility of P&A and bridge banks
- Sharī`ah concerns for transfers:
  - Prohibition of sale of debt in return for interest (ribā): sale of loan receivables below face value implying a discount could be interpreted as “interest” and barred by Sharī`ah.
  - Hawala (pure transfer of debt): some scholars consider hawala Sharī`ah compliant for transfer of debt from a debtor to a third party willing to pay the debt; unclear how hawala applies where the Islamic bank is creditor.
  - Sharī`ah status of acquirer: purchaser must be qualified and permitted to undertake Islamic operations; concern when acquirer is not Islamic or a conventional institution with an Islamic window.
  - Bridge banks: establishing a bridge bank appears useful and does not appear to pose concerns; a bridge bank could purchase assets and assume liabilities considered non-Sharī`ah compliant by transferee Sharī`ah board and sell them once another buyer is found.

### Mandatory debt restructuring (bail-in) — Sharī`ah considerations and practical hurdles
- Bail-in concept:
  - Mandatory write-down or conversion of debt, equity, and other capital instruments of a bank in resolution to stabilize the bank and allocate losses.
- Sharī`ah compatibility uncertainties:
  - Sharī`ah “no debt forgiveness” principle: Sharī`ah law appears not to recognize mandatory debt write-offs; debt may be forgiven only voluntarily by the creditor; mandatory write-downs imply mandatory forgiveness which is forbidden under Sharī`ah.
  - Equity-debt conversions: conversion recognizing debt at par value may be acceptable; conversion at a discount may be problematic under Sharī`ah.
  - Contractual (voluntary) bail-in approach: embedding bail-in in financial contracts (e.g., contingent convertible bonds or “co-cos”) where parties consent in advance may align with voluntary debt forgiveness; uncertainty whether pre-event contractual consent would be deemed binding and equivalent to Sharī`ah-compliant voluntary debt forgiveness.
  - IFSB reference: IFSB’s standards on additional tier 1 and tier 2 structures for Sharī`ah-compliant bail-in capital noted (IFSB 15, section 2 referenced).
- Practical hurdles given Islamic structures:
  - Effective bail-in requires sufficient debt that can be bailed-in; legal nature of claims determines bail-in feasibility.
  - Specific asset/liability types and bail-in feasibility:
    - PSIAs: typically profit-and-loss-sharing with no guaranteed repayment; treated as client assets and may not be recognized as a claim on bank’s balance sheet; bail-in by mandatory write-down or conversion may be a challenge.
    - PERs and IRRs: held on behalf of investment account holders; belong primarily to account holders and may not represent assets or liabilities of the bank in resolution (apart from bank’s pro rata share); generally cannot be bailed-in.
    - Sukūk:
      - If issued directly by the Islamic bank: constitute liabilities and bail-in would seem feasible.
      - If issued by an SPV as “trust certificates”: holders have varying interests in assets held by SPV; if true sale occurred, sukūk holders have ownership interests and no recourse to the bank; if no true sale, sukūk holders may have residual unsecured claims against the bank; bail-in feasibility depends on true sale and whether originating bank retains liabilities.
      - IFSB contemplates structuring sukūk as profit-sharing contracts (mushārakah, muḍārabah, or wakala) for Sharī`ah-compliant bail-in capital, but resolution challenges persist given uncertainties as to true sale concepts under domestic laws.

### Recovery and Resolution Plans (RRPs) and resolvability
- RRPs:
  - RRPs are key to facilitate orderly resolution and preserve systemically important functions (Key Attribute 11 referenced).
  - Mandating detailed RRPs for Islamic banks is justified.
  - RRPs help resolution authorities understand complexities and constraints posed by structure and operations of Islamic banks/groups.
  - Legal framework should empower resolution authority to require changes in structure or operations to enhance resolvability.
  - Consideration: whether RRPs for Islamic banks need pre-clearance by relevant Sharī`ah boards to promote smooth and swift resolution processes.

### Conclusions and policy recommendations
- Findings:
  - International best practices for bank resolution broadly resonate with Sharī`ah principles such as risk taking and loss sharing, but Islamic banks pose specific issues (unique governance structure, complex balance sheets) that require targeted legal and operational adjustments.
  - Resolution tools may broadly apply to all banks, but adjustments are likely required for Islamic banks.
- Policy recommendations and priorities:
  - International guidance is needed to design legal regimes for effective resolution of Islamic banking operations; further analytical work should be undertaken by relevant international bodies in consultation with other standard setters.
  - Harmonization efforts should address Sharī`ah bankruptcy principles, legal and accounting treatment of various assets and liabilities, and institutional arrangements for resolution.
  - Making Islamic banks more resolvable should be a key priority for international and domestic reforms to reduce costs to taxpayers.
  - Strengthen Sharī`ah-compliant deposit insurance schemes and other financial safety nets to promote financial stability.

*Source: _wp15247 - 1. Resolution Triggers Under Malaysia’s Islamic Financial Services Act of 2013 (excerpt) and related sections.*

### 1. Resolution Triggers Under Malaysia’s Islamic Financial Services Act of 2013

### 1. Resolution Triggers Under Malaysia’s Islamic Financial Services Act of 2013 (section 177)

### Introduction
- Purpose:
  - Discusses the design of legal frameworks for the resolution of Islamic banks.
  - Examines the applicability of international best practices for bank resolution to Islamic banks and whether modifications are needed.
- Context:
  - Islamic banks are gaining global systemic relevance; failure of a large Islamic bank could significantly impact global financial stability.
  - Islamic banks are vulnerable to failure despite risk-sharing and conservative investment characteristics.
- International standard:
  - The prevailing international standard is the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions (the “Key Attributes” or “KAs”).
  - KAs aim to ensure authorities can resolve institutions in an orderly manner without taxpayer exposure to losses, while maintaining continuity of vital economic functions.
  - KAs include designation of a specific resolution authority and a broad range of tools including mandatory recapitalization, forced mergers, debt restructuring, and transfer of assets and liabilities.
- Scope and caveats:
  - “Islamic banks” refers to institutions set up as Islamic banks as well as Islamic banking windows of conventional banks (whether outsourced or in-house).
  - KAs were developed in jurisdictions with predominantly conventional banking and make no special provision for Islamic banks; special characteristics of Islamic banks require assessment of applicability.
  - Malaysia is a notable exception with a specific resolution framework for Islamic banks in its Islamic Financial Services Act (Act 759) enacted in March 2013.
  - Very few countries with Islamic banking systems have experience resolving Islamic financial institutions; many resort to public financial support to preserve financial stability.
  - Assessment of Sharī`ah compliance is constrained by different interpretations of Sharī`ah across schools of jurisprudence (madhahib).
  - Jurisdictions with both conventional and Islamic banking face calibration challenges between regimes, especially where Islamic banking exists as full banks, windows, or subsidiaries.

### Key points on applicability and legal issues
- Need for resolution frameworks:
  - Legal frameworks for resolution are required because Islamic banks have experienced financial distress and may fail, necessitating orderly resolution mechanisms.
- International practice and gaps:
  - Very few specialized bank resolution frameworks distinguish between conventional and Islamic banks.
  - Existing frameworks largely do not expressly accommodate Sharī`ah-specific concerns, except Malaysia’s Act 759 (March 2013).
- Practical implications of Sharī`ah:
  - The sanctity and validity of Islamic finance hinges on Sharī`ah; a resolution regime may need to be Sharī`ah compliant to avoid undermining investor confidence and financial stability.
  - Possible application of Sharī`ah bankruptcy principles (iflās) and Sharī`ah-based market regulation (hisba) should be considered.
  - Under Sharī`ah, mandatory forgiveness of debt appears forbidden; there is no final discharge of indebtedness as the debtor remains obligated until payment in full or voluntary forgiveness by the creditor.
  - Unsecured creditors share pro rata in the unencumbered assets of the debtor.
- Institutional and procedural considerations:
  - Determinations on whether resolution powers, tools, and techniques must be Sharī`ah compliant influence institutional arrangements for resolution and the legal powers available to authorities.
  - The design of a bank resolution framework should address and minimize risks from divergent Sharī`ah interpretations to enable prompt resolutions with assurance of compliance.

### Setting the stage: What’s different with Islamic banking and why it matters for resolution
- Religious considerations:
  - Islamic banks are shaped by Sharī`ah principles; governance, assets, liabilities, and operations have religious considerations not typically present for conventional banks.
  - Jurisdictions mostly apply international bank supervisory standards to Islamic banks with Sharī`ah-specific adjustments affecting computation of capital adequacy ratios (“CAR”), liquidity management, corporate governance, accounting treatment, and contracting rights and responsibilities.
  - Lack of consistency in prudential norms across jurisdictions affects supervision, including cross-border and consolidated supervision.
  - IFSB and AAOIFI contribute to harmonization of prudential standards and accounting/governance practices, but application is not uniform across countries.
- Variation in supervisory approach:
  - Extent of Sharī`ah law impact on supervisory standards differs among jurisdictions:
    - Some incorporate Sharī`ah into secular law and impose supervisory responsibility for Sharī`ah compliance.
    - Others do not take a Sharī`ah perspective and do not build capacity to assess Sharī`ah compliance.
    - Jurisdictions like the U.K. do not contain separate prescriptions on Islamic banking or Sharī`ah compliance within the bank regulatory framework, though authorities may consider related issues (governance, internal controls, reputational risk, consumer protection).
- Governance:
  - Islamic banks are typically required to have Sharī`ah governance functions and internal control systems to ensure Sharī`ah compliance.
  - Most jurisdictions require a Sharī`ah board; some jurisdictions (e.g., Kenya and Tunisia) do not.
  - Sharī`ah boards:
    - Comprised of Sharī`ah scholars and sometimes specialists (economists, accountants, financial experts, lawyers).
    - Review and ensure transactions, contracts, products, and activities comply with Sharī`ah law and principles.
    - Can issue fatawa and rulings that are binding on the institution.
    - Generally conduct ex-ante reviews and approvals, though ex-post review occurs in some cases.
    - Are responsible for the Sharī`ah governance regime and may have mechanisms allowing direct access to the board of directors if failures occur.
  - Models of Sharī`ah boards:
    - Centralized Sharī`ah boards (sometimes within the Central Bank) issue binding rulings for all Islamic banks.
    - Decentralized approach: individual Sharī`ah boards exist within each Islamic bank with decisions binding only on the institution.
    - Some jurisdictions combine models: centralized board rulings may be binding alongside required bank-level Sharī`ah boards.
    - The chosen model can affect institutional arrangements for resolution.

### Identified legal and policy issues for resolution frameworks
- Need to examine applicability of conventional resolution tools to Islamic banks and identify legal issues arising from Islamic banking features.
- Important themes for further analysis (as developed in the paper):
  - Institutional frameworks and designation of resolution authority.
  - Applicability and modification of resolution tools (e.g., mandatory recapitalization, transfers, mergers, debt restructuring) to ensure Sharī`ah compatibility.
  - Minimizing delay and legal uncertainty arising from divergent Sharī`ah interpretations.
  - Calibration between conventional and Islamic banking regimes in jurisdictions with both modalities.

*Source: _wp15247 - 1. Resolution Triggers Under Malaysia’s Islamic Financial Services Act of 2013 (excerpt).*

### 17.      The design of a resolution regime for Islamic banks would need to take into

### 17.      The design of a resolution regime for Islamic banks would need to take into

### Stylized balance-sheet differences
- Table 1 depicts stylized features of Islamic banks’ balance sheets versus conventional banks (see Table 1).
- Key balance-sheet items for Islamic financial institutions (as listed):
  - Assets: Cash and cash equivalents; Investment in securities; Sales Receivables; Investments in leased assets; Investments in real estate; Equity/Profit-sharing financing; Investment in Subsidiaries; Fixed assets; Other assets.
  - Liabilities: Current Accounts; Other Liabilities; PSIA (Unrestricted); Profit Equalization Reserve, Investment Risk Reserve.
  - Owner’s Equity: PSIA (Restricted).
  - Off-balance sheet: [Letters of Credit, Guarantees].
- Key balance-sheet items for conventional financial institutions (as listed):
  - Assets: Cash and cash equivalents; Investment in securities; Loans and advances; Statutory deposits; Investment in Subsidiaries; Fixed assets; Other assets.
  - Liabilities: Current Accounts; Saving and Time Deposits; Other Liabilities.
  - Owner’s Equity: (standard Owner’s Equity entry).
  - Off-balance sheet: [Letters of Credit, Guarantees, Derivatives].
- Note: PSIA = profit-sharing investment account. Note: Differences are shown in red.

### Asset-side complexity and contract types
- Islamic banks’ asset portfolios include a mix of contract types:
  - Contracts economically equivalent to pure lending (example: vector muḍārabah transactions involving platinum or palm oil).
  - Equity-like and partnership financing contracts (example: mushārakah).
  - Lease-based financing contracts (example: ijarah).
  - Fee-based activities (example: wakalah).
  - Non-remunerated lending contracts (qard and wadiah).
  - Sales with mark-up and deferred payments (Murābahah).
  - Purchases with deferred delivery of products (salam for basic products; istisna’a for manufactured or constructed products).
- Some transactions entail complex tri-partite bundles of rights in rem and in personam between the investor, the bank and the investee to comply with Sharī`ah principles (see footnote 21).

### Liability-side variations and investment accounts
- Many Islamic liabilities are not conventional deposits; examples include:
  - Guaranteed Sharī`ah safekeeping (“deposit”) contracts (qard or wadi’ah).
  - Non-guaranteed Sharī`ah contracts for investment (muḍārabah and wakalah).
  - Profit sharing investment accounts (restricted and unrestricted).
  - Sukūk.
- Current accounts:
  - Similar to traditional deposits but tend to be non-interest/return bearing.
  - Islamic banks sometimes provide a “gift” (hiba) equal to competitor conventional banks’ interest; this gift amount is financed from the Islamic bank’s capital.
  - Accounting and legal treatment often similar to traditional current deposit accounts.
- Profit-Sharing Investment Accounts (PSIAs):
  - Structured as partnership (muḍārabah or mushārakah) or agency (wakala) contracts.
  - Profits are shared based on a predetermined profit-sharing ratio and are expected rather than guaranteed.
  - Legally, banks do not guarantee principal or returns; may not enjoy legal protections typical for conventional depositors.
  - PSIAs may not be treated as liabilities of the Islamic bank and may be treated as assets of the investment account holder.
  - Two main PSIA types:
    - (i) Unrestricted investment accounts: bank has full discretion to invest in any Sharī`ah-compliant asset; most common; assets may be comingled and difficult to attribute.
    - (ii) Restricted investment accounts: bank’s mandate restricted to specific assets agreed with account holder, sometimes via an SPV; underlying assets usually not comingled and easier to trace and transfer in resolution contexts; however, funds of customers with similar restricted accounts tend to be pooled and commingled.
- Profit Equalization Reserves (PERs) and Investment Risk Reserves (IRRs):
  - IRRs: set aside from profits attributable to investment account holders (after deducting the bank’s mudārib share) to cushion future investment losses on account holders; generally the bank does not have a share in IRRs.
  - PERs: represent liabilities collectively owed to investment account holders and the bank in proportion to respective profit and loss shares; accumulated from general profits to smooth profit payouts to investment account holders and enhance dividends to shareholders.
  - The portion of PERs attributable to investment account holders is typically invested in assets producing pooled returns for investment account holders and potentially the bank if provided by the investment account agreement.
  - In resolution, a key legal issue is clearly defining rights of account holders versus those of the bank to PERs; contractual arrangements largely determine allocation but lack of legal clarity in some jurisdictions could lead supervisors or courts to redistribute PERs differently than originally agreed (see footnote 25).
- Sukūk:
  - Described as certificates of participation or trust certificates issued by an Islamic bank or an SPV set up by the bank.
  - Common structure: underlying assets transferred to an SPV by the originating bank in exchange for sukūk issuance proceeds.
  - Sukūk ijarah model: sukūk holders receive certificates representing interest in underlying assets; rent/payments from segregated assets paid to SPV then to sukūk holders; maturity involves repayment by SPV after disposal of assets.
  - Legal treatment depends on whether transaction involves a true sale:
    - Asset-backed sukūk: true sale transfers legal title to SPV; general creditors of originating bank have no claim on these assets; sukūk holders have claims against SPV.
    - Asset-based model: no true sale; originating bank retains legal ownership; sukūk holders may have residual unsecured claim against bank for any shortfall upon realization of SPV assets.

### Prudential regulation and deposit insurance treatment
- IFSB capital adequacy standards do not classify PSIAs as part of an Islamic bank’s capital because they do not meet criteria of “Core” or “Additional Capital.”
- IRRs and PERs belong to investment account holders and thus are not part of the Islamic bank’s capital, except to the extent the bank may have a contractual share in PERs.
- The portion of PERs that is part of the Islamic bank’s reserves should not be treated as part of regulatory capital because PERs are intended to smooth profit payouts, not to cover losses (see footnote 28).
- Deposit insurance classification for Islamic contracts is problematic:
  - More consensus on insurability of wadiah or qard contracts.
  - Jurisdictions are divided on definition and treatment of PSIAs: some provide protection to both unrestricted and restricted PSIA holders; others only to unrestricted PSIA holders; some jurisdictions do not provide any protection to PSIA holders.
  - IFSB has not yet adopted a standard on Sharī`ah-compliant deposit insurance; the Islamic Deposit Insurance Group of the International Association of Deposit Insurers views Sharī`ah compliance as a key challenge (see footnote 29).

### Institutional issues: resolution authority and Sharī`ah boards
- International standards for resolution authorities (KAs, KA 2) apply broadly to both conventional and Islamic banks: designate and empower a resolution authority with broad mandate, operational independence, robust governance, and adequate resources.
- Resolution authority must have sufficient expertise, knowledge and human capacity to implement resolution measures; this is even more critical for Islamic banking due to sui generis operations.
- Dual banking systems: options and trade-offs
  - Jurisdictions may designate same resolution authority for both conventional and Islamic banks, or separate agencies.
  - Separate Islamic resolution authority could be difficult to implement and poses coordination challenges, especially for banking groups with both conventional and Islamic banks.
  - Choice depends on relative sizes of systems and availability of expertise.
  - Single resolution authority is a strong practical argument in jurisdictions where same supervisory agencies oversee both bank types.
  - Where separate authorities exist, effective coordination mechanisms and clarity on which authority leads resolution are important.
- Sharī`ah boards and certification of Sharī`ah compliance:
  - If resolution measures must be Sharī`ah compliant, institutional arrangements for certifying compliance should not undermine mandate and autonomy of resolution authority or impede prompt and orderly resolution.
  - The role of Sharī`ah boards (if any) in ensuring Sharī`ah compliance of resolution measures should be carefully considered.
  - Potential roles for Sharī`ah boards (including those of acquiring banks) must be justified.
  - Consider whether the usual resolution authority power to suspend or remove boards of directors should extend to Sharī`ah boards.
  - Where Sharī`ah boards are involved in certifying compliance, legal frameworks ought to provide mechanisms for dealing with potential conflicts between a Sharī`ah board and the resolution authority, or between two or more Sharī`ah boards (see footnote 31).
  - Centralized or national Sharī`ah boards mitigate conflict risk; in jurisdictions without centralized boards, consider empowering the resolution authority to establish its own Sharī`ah board to advise on resolution measures.

### Resolution powers and authority design
- Effective resolution frameworks should explicitly empower the resolution authority to assume effective control of a bank and to take appropriate restructuring measures.
- Where feasible, resolution authority should have a variety of restructuring powers and tools to stabilize and restructure an institution.

*Source: Excerpt from IMF Staff Discussion Note material within the provided PDF content.*

### 25.      Triggers for activating resolution powers in respect of Islamic banks, should

### Triggers for activating resolution powers in respect of Islamic banks, should reflect their unique business model

### Triggers and non-viability indicators
- A good legal framework should provide for clear triggers (such as quantitative and/or qualitative triggers) for placing a bank in resolution.
- For conventional banks, quantitative triggers largely reflect a “borrowing and lending” business model, with indicators of non-viability that include weak regulatory capital adequacy ratios (CAR), and persistent liquidity problems (e.g., inability to pay debts as they fall due). 32
- For Islamic banks, the application of conventional resolution triggers may be problematic given differences in their business model which relies heavily on sales, leasing, and profit/loss arrangements. 33
- Challenges in the computation of CAR as a result of balance sheet complexities would need to be addressed to promote transparency in resolution and to minimize legal risks for the resolution authority. 34
- Profit and loss arrangements under muḍārabah and mushārakah contracts, lease-based or sale/purchase type arrangements, could require unconventional triggers to determine the likelihood of non-viability of a bank, on a timely basis.
- Possible triggers to explore include non-payment or delayed payment of rents or profits, or misuse of underlying assets contrary to the terms of agreement or in a manner prejudicial to the interests of the clients or account holders.
- Triggers should meet the high threshold applied in conventional bank resolution: non-viability, likely non-viability, or continuing practices that endanger deposits or other financial contracts and financial stability. Triggers should not be set so low as to include a simple contractual default unless it reflects underlying institutional problems threatening viability or financial stability.

### Protecting broad classes of claimants
- Resolution triggers may need to protect claimants who are not depositors but are counterparties under Islamic finance contracts.
- Example (Malaysia): legal framework empowers the resolution authority to trigger resolution in circumstances which detrimentally affect an Islamic bank’s “depositors, investment account holders, participants, users, creditors or the public generally.” (See Box 1)

Box 1: Resolution Triggers Under Malaysia’s Islamic Financial Services Act of 2013 (section 177)
- The institution has breached or contravened any provision of this Act, the Central Bank of Malaysia Act 2009 or any written law, regardless that there has been no prosecution or other action in respect of the breach or contravention;
- The institution has failed to comply with any direction under section 168;
- The assets of the institution are not sufficient to give adequate protection to its depositors, investment account holders, takaful participants, participants, users or creditors, as the case may be;
- The capital of the institution has reached a level or is eroding in a manner that may detrimentally affect its depositors, investment account holders, takaful participants, participants, users, creditors or the public generally;
- The institution has become or is likely to become insolvent or unable to meet all or any of its obligations; or
- Any other state of affairs exists in respect of the institution that may be materially prejudicial to the interests of the depositors, investment account holders, takaful participants, participants, users or creditors of the institution or the owners of any assets under the licensed person’s administration, including where proceedings under a law relating to bankruptcy or insolvency have been commenced in Malaysia or elsewhere in respect of the holding company of the institution, including its financial holding company.

### Powers to take control and support resolution
- The legal framework should explicitly provide a broad range of powers to facilitate effective resolution, including powers:
  - to replace senior management;
  - to take official control and place a bank under official administration;
  - to impose moratoriums and stays if necessary;
  - to restructure the bank.
- Powers to take official control, replace management, and impose moratoriums and stays are typically employed at the onset of resolution to support restructuring powers and techniques.

Replacement of management
- Resolution authority should have power to replace senior management; supervisory authorities should be empowered to instruct management and, if non-compliant, to replace management swiftly.
- This power should be explicit in the legal framework for Islamic banks.

Official administration
- Resolution framework should empower authorities to place an ailing Islamic bank under official administration and to appoint an “official administrator” to take control and manage the failed bank, ideally to restore viability under strategic guidance of the resolution authority.
- The official administrator typically assumes the legal powers of the failed bank’s board of directors, managers, and shareholders and displaces their authority.
- Malaysia’s Islamic Financial Services Act of 2013 explicitly provides to the Central Bank of Malaysia as resolution authority, the power to assume control of an Islamic bank and to manage the whole or part of the business and affairs of such bank. 35

Prerequisites for official administration
- Clarify the scope of the official administrator’s mandate, particularly that review and rehabilitation actions comply with relevant Sharī`ah principles and clarify whose interpretation of Sharī`ah principles applies.
- Clarify the extent to which official administration displaces the Sharī`ah board, and whether placing an Islamic bank under official administration automatically displaces the Sharī`ah board; provide for the power to remove Sharī`ah board members who no longer meet “fit and proper” requirements. 36
- Official administrators should have expertise in Islamic finance or the legal framework should authorize them to retain people with Sharī`ah and Islamic banking expertise where such expertise is difficult to source domestically.

Moratoriums and stays
- Provide for power to impose moratoriums and temporary stays on transactions of a bank in resolution to avoid dissipation of value and ensure equal treatment of creditors in liquidation.
- Imposing a moratorium on payments or a temporary stay on creditor actions would not appear to raise difficulties in the Islamic banking context.

### Restructuring tools and loss allocation
- The Key Attributes set out resolution powers and tools for allocating losses to private creditors and shareholders, including:
  - merge ailing banks with stronger institutions;
  - undertake a Purchase and Assumption (“P&A”) transaction by transferring assets and liabilities to a healthy institution or a “bridge bank”;
  - mandatorily restructure (“bail-in”) debt, equity, and other claims by writing down unsecured debt and/or converting it into equity;
  - eliminate or dilute existing shareholders’ claims while the institution remains open.
- These powers should be exercisable without the consent of existing shareholders or creditors, subject to safeguards such as the “no creditor worse-off” principle.
- Clarity in the legal framework is required to ensure prompt exercise of these powers with legal certainty.

Balance sheet complexity and creditor hierarchy
- Islamic banks’ balance sheets reflect a complex mix of Sharī`ah contracts, requiring careful analysis of applicable restructuring tools and creditor hierarchies.
- Creditor hierarchies determine ranking/order in which losses will be allocated: typically shareholders first, then subordinated debt holders and other unsecured creditors, with depositors (at least some, such as small or insured deposits) last.
- Depositor preference can mitigate contagion by increasing depositors’ probability of recovering claims.
- For Islamic banks, clear classification of claims is required to determine ranking for loss allocation because some products (e.g., investment accounts) may not be clearly defined as deposits.
- Investment accounts are generally not structured as conventional deposits; Islamic banks typically have no liability towards investment account holders except to the extent of allocating profits or losses from their investments.
- Jurisdictional approaches vary: some treat unrestricted investment account holders as “depositors” for deposit insurance purposes (for example, Malaysia and Turkey), while others treat investment account holders akin to equity holders in invested assets.
- Malaysia treats investment accounts for supervisory and resolution purposes as a separately allocated group of investments; assets of such investment accounts are available in the order: (i) to pay outstanding costs or expenses of the investment accounts; (ii) to pay any profit, fees, gains or other remuneration due to the Islamic bank; and (iii) to meet the liabilities to the investment account holders. 38

Preferential treatment and pari passu
- Resolution authorities generally must observe pari passu (equal treatment of claims of the same class).
- The Key Attributes allow flexibility to depart from pari passu if necessary to contain systemic impact or maximize value for all creditors, provided legal framework promotes transparency. 39
- From a Sharī`ah perspective, unequal treatment of creditors appears prohibited absent prior agreement by parties; this suggests all claims of the same class against an Islamic bank should be treated equally in resolution.
- This religious/legal principle may complicate orderly resolution where assets are insufficient to cover liabilities and makes it imperative that the legal framework clearly distinguish liabilities and clarify statutory powers (if any) to depart from pari passu treatment where necessary to preserve financial stability.

### Mandatory recapitalization and mergers
- Mandatory recapitalization (issuance of new shares to investors who inject fresh capital, typically diluting existing owners without their consent) appears applicable to Islamic banks.
- Some Sharī`ah principles may constrain capital structures (e.g., preferred stock or fixed-income preference arrangements may be perceived inconsistent with prohibition of ribā).
- Forced mergers of a troubled Islamic bank with a healthier Islamic financial institution appear feasible, subject to addressing Islamic-specific issues:
  - The acquiring institution will need to be a Sharī`ah compliant institution or Sharī`ah compliant window of a conventional bank; the purchasing institution may need an expedited licensing process in the context of resolution.
  - Merger procedures should address cases where the acquirer’s Sharī`ah board deems some acquired operations non-Sharī`ah compliant and requires their disposition or liquidation. Disposition could cause losses to the purchaser and potentially threaten stability; in such circumstances, the resolution framework might provide temporary financial assistance (e.g., a resolution fund) under strict pre-set conditions and mechanisms to address Sharī`ah non-compliant issues in a timely fashion.

### Purchase and Assumption (P&A) transactions
- (Section title present; substantive description of P&A transactions appears in subsequent text not included in this excerpt.)

*Source: _wp15247 - 25.      Triggers for activating resolution powers in respect of Islamic banks, should*

### 40.      While there would appear to be no reason why a resolution authority should

### _wp15247 - 40.      While there would appear to be no reason why a resolution authority should

### Transfer of assets and liabilities (P&A) — practical implementation challenges
- P&A defined: the resolution authority transfers the assets and liabilities of a troubled Islamic financial institution to a healthy acquirer (or bridge bank) without the consent of existing shareholders or creditors of the troubled bank.
- Principal challenge: complex nature of key assets and liabilities on Islamic bank balance sheets requires P&A transactions to be structured differently from conventional banks (paragraph 41).
- Specific issues:
  - Current deposits: may be easily transferable.
  - PSIAs and PERs: may be challenging to transfer under a P&A because these claims are typically investments that belong to the investment account holder, even though the profit participation of the PSIA may be an asset of the Islamic bank.
  - Investment accounts: many jurisdictions treat them as client assets and not liabilities of the banks; jurisdictions need to clarify the contractual relationship and whether account holders have recourse to the bank’s assets in resolution.
  - Key Attributes (KAs) guidance: client assets held by a financial intermediary should be transferred promptly to another intermediary; resolution authority should have power to transfer contractual rights and obligations among the custodian, the firm in resolution and its clients, to the qualified transferee (Key Attributes Annex 3 referenced).
  - PERs: held on behalf of clients as buffers for payment of investment returns; often co-mingled with other liabilities; unclear whether transfer extinguishes claims; recommended legal framework could require contractual clarity on distribution of reserves in resolution.
  - Asset transfers: Islamic bank assets that might be central to P&A include sales receivables, participation rights in profit-and-loss-sharing arrangements, and leasing receivables; legal clarity required on transferability under P&A.

### Sharī`ah compatibility of P&A transactions
- Fundamental uncertainty whether P&A transfers would be consistent with Sharī`ah principles (paragraph 42).
- Key Sharī`ah concerns:
  - Prohibition of sale of debt in return for interest (ribā): sale of loan receivables below face value implies a discount that could be interpreted as “interest” and possibly barred by Sharī`ah.
  - Possible authoritative clarifications: objective of transfers (preserving financial stability in the public interest) might be argued, but remains to be clarified authoritatively.
  - Hawala (pure transfer of debt): some scholars consider hawala Sharī`ah compliant for transfer of debt from a debtor to a third party willing to pay the debt; unclear how hawala applies where the Islamic bank is creditor (transfer of receivables).
  - Sharī`ah status of acquirer: purchaser must be qualified and permitted to undertake Islamic operations; particular concern when acquirer is not an Islamic financial institution or conventional institution with an Islamic window.
  - Bridge banks: establishment of bridge bank by resolution authority appears useful and does not appear to pose concerns; a bridge bank could purchase assets and assume liabilities considered non-Sharī`ah compliant by transferee Sharī`ah board and sell them once another buyer is found.

### Mandatory debt restructuring (bail-in) — Sharī`ah considerations and legal hurdles
- Bail-in defined: mandatory write-down or conversion of debt, equity, and other capital instruments of a bank in resolution to stabilize the bank and allocate losses (Key Attribute 3.5 referenced).
- Compatibility uncertainties (paragraphs 43–45):
  - Sharī`ah “no debt forgiveness” principle: Sharī`ah law appears not to recognize mandatory debt write-offs; debt may be forgiven only voluntarily by the creditor; mandatory write-downs imply mandatory forgiveness which is forbidden under Sharī`ah.
  - Equity-debt conversions: conversion recognizing debt at par value may be acceptable; conversion at a discount may be problematic under Sharī`ah.
  - Contractual (voluntary) bail-in approach: embedding bail-in in financial contracts (e.g., contingent convertible bonds or “co-cos”) where parties consent in advance may align with voluntary debt forgiveness; uncertainty whether pre-event contractual consent would be deemed binding and equivalent to Sharī`ah-compliant voluntary debt forgiveness.
  - IFSB reference: IFSB’s standards on additional tier 1 and tier 2 structures for Sharī`ah-compliant bail-in capital noted (IFSB 15, section 2 referenced).

### Practical hurdles for bail-in given Islamic banking structures
- Effective bail-in requires sufficient debt that can be bailed-in; legal nature of claims determines bail-in feasibility (paragraph 45).
- Specific asset/liability types and bail-in feasibility:
  - PSIAs: typically profit-and-loss-sharing with no guaranteed repayment; treated as client assets and may not be recognized as a claim on the bank’s balance sheet; bail-in by mandatory write-down or conversion may be a challenge. Note: unrestricted PSIAs are treated by some jurisdictions (e.g., Turkey) as deposits for deposit insurance purposes; treatment for resolution remains unclear.
  - PERs and IRRs: held on behalf of investment account holders; belong primarily to account holders and may not represent assets or liabilities of the bank in resolution (apart from bank’s pro rata share); generally cannot be bailed-in.
  - Sukūk:
    - If issued directly by the Islamic bank: constitute liabilities and bail-in would seem feasible.
    - If issued by an SPV as “trust certificates”: holders have varying interests in assets held by SPV; if true sale occurred, sukūk holders have ownership interests and no recourse to the bank; if no true sale, sukūk holders may have residual unsecured claims against the bank; bail-in feasibility depends on whether there was a true sale and whether the originating bank retains liabilities. Legal framework should clarify treatment of sukūk for bail-in purposes.
    - IFSB contemplates structuring sukūk as profit-sharing contracts (mushārakah, muḍārabah, or wakala) for Sharī`ah-compliant bail-in capital, but resolution challenges persist given uncertainties as to true sale concepts under domestic laws.

### Summary table highlights (Table 2)
- Current accounts and qard/wadi’ah safekeeping:
  - Resemble conventional deposits; mostly treated as deposits; generally eligible for P&A; may be eligible for bail-in except where covered by deposit insurance; Sharī`ah prohibition of forced debt forgiveness implies current account holders must voluntarily forgive bailed-in portion for Shari`ah-compliant bail-in.
- PSIAs:
  - Not generally considered deposits; except for bank’s profit share, PSIAs likely may not be subject to P&A and may need transfer as client assets; bail-in is a challenge as they are not liabilities or equity of bank and account holders bear loss risk; some jurisdictions treat unrestricted PSIAs as deposits for deposit insurance purposes.
- PERs/Investment Risk Reserves:
  - Not treated as part of Islamic bank’s capital except bank’s own share; likely not eligible for P&A except bank’s residual share; likely not eligible for bail-in and may be treated as client assets, though traceability is a concern due to co-mingling.
- Sukūk:
  - If issued directly by bank, bail-in seems feasible; if issued by SPV, eligibility for bail-in depends on whether there was a true sale of assets transferred to SPV.

### Recovery and Resolution Plans (RRPs) and resolvability improvements
- RRPs recommended: RRPs are key to facilitate orderly resolution and preserve systemically important functions (Key Attribute 11 referenced).
- Mandating detailed RRPs for Islamic banks is justified (paragraphs 46–47):
  - RRPs help resolution authorities understand complexities and constraints posed by structure and operations of Islamic banks/groups.
  - Legal framework should empower resolution authority to require changes in structure or operations to enhance resolvability.
  - Consideration: whether RRPs for Islamic banks need pre-clearance by relevant Sharī`ah boards to promote smooth and swift resolution processes.

### Conclusions and policy recommendations
- Findings (paragraphs 48–50):
  - International best practices for bank resolution broadly resonate with Sharī`ah principles such as risk taking and loss sharing, but Islamic banks pose specific issues (unique governance structure, complex balance sheets) that require targeted legal and operational adjustments.
  - Resolution tools may broadly apply to all banks, but adjustments are likely required for Islamic banks.
- Policy recommendations and priorities:
  - International guidance is needed to design legal regimes for effective resolution of Islamic banking operations; further analytical work should be undertaken by relevant international bodies in consultation with other standard setters.
  - Harmonization efforts should address Sharī`ah bankruptcy principles, legal and accounting treatment of various assets and liabilities, and institutional arrangements for resolution.
  - Making Islamic banks more resolvable should be a key priority for international and domestic reforms to reduce costs to taxpayers.
  - Strengthen Sharī`ah-compliant deposit insurance schemes and other financial safety nets to promote financial stability.

*Source: Excerpt from IMF staff paper _wp15247 (paragraphs 40–50, Table 2, and related sections).*

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