Islamic Banking in Malaysia by topman1984

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Executive Summary

The market for Islamic banking has grown rapidly over the past few years, and this robust growth is expected to continue for the foreseeable future. In many markets, Islamic banking has evolved from being a niche offering into being part of the mainstream financial services landscape.

At the same time, the competitive landscape is being redrawn, with more Islamic financial services institutions in the marketplace than ever before. Current banks and new market entrants are facing vastly different market conditions and need to develop new sources of differentiation beyond compliance with Shariah (Islamic law) to compete or remain successful in the future as conventional banks also open window for Islamic Banking Scheme (IBS).

This paper seeks to determine the overview of Islamic Banking industry in Malaysia, to identify the roles of stakeholders in Islamic Banking industry and to analyze the factors of growth behind Islamic banking, the challenges that Islamic Banking industry face and the future of Islamic Banking industry in Malaysia as well as recommendation for the industry.



Historical Background of the Industry

With the concept of Islam, Ad-deen is a way of life in this world. Thus, every ibadah commanded by Allah S.W.T is a benefit to this and next world. To fulfil this desire in performing the Hajj pilgrimage, Muslims have to find enough money for the journey to the Holy Land. Muslims use various traditional methods of saving in order to avoid riba' (usury) which forbidden in Islam. Thus, the concept of Islamic Banking arises for Muslims to perform the Hajj pilgrimage.

The earliest form of Islamic banking in Malaysia started since September 1963 when Perbadanan Wang Simpanan-Bakal Haji (PWSBH) was set up. PWSBH was set up as an institution for Muslims to save for their Hajj expense. In 1969, PWSBH merged with Pejabat Urusan Haji to form Lembaga Urusan dan Tabung Haji. The first Islamic Bank in Malaysia was established in 1983. In 1993, commercial banks, merchant banks and finance companies were allowed to offer Islamic banking products and services under the Islamic Banking Scheme (IBS). These institutions however, are required to separate the funds and activities of Islamic Banking Transactions from the conventional banking business to ensure that there would not be any co-mingling of funds.


Islamic Banking Concept

Islamic banking has the same purpose as conventional banking except that it claims to operate in accordance with the rules of Shariah. Shariah are known as Fiqh al-Muamalat which has the Islamic rules on transactions. The basic principle of Islamic Banking is the sharing of profit and loss and the prohibition of riba‟ or interest.

Among the common Islamic concepts used in Islamic banking are:1. Mudharabah (profit sharing) 2. Wadiah (Safekeeping) 3. Musharakah (joint venture) 4. Murabahah (cost plus) 5. Bai‟ Bithaman Ajil (Deferred Payment Sale) 6. Ijarah Thumma Al Bai‟(Hire Purchase) 7. Bai‟ al-Inah (Sell and Buy Back Agreement) 8. Takaful (Islamic Insurance) 2

Among the governing principles of an Islamic bank are: 1. 2. 3. 4. 5. The absence of interest-based (riba) transactions The avoidance of economic activities involving oppression (zulm) The avoidance of economic activities involving speculation (gharar) The introduction of an Islamic tax (zakat) The discouragement of the production of goods and services which contradict the Islamic value


Growth of Islamic banking Industry

The Islamic financial system in Malaysia has evolved as a viable and competitive component of the overall financial system. In 1983, Malaysia started the establishment of one Islamic bank (Bank Islamic Malaysia Berhad) to spearhead the introduction of Islamic banking products and services. Since then BIMB introduced and offered various interest free products such as Wadiah ad Dhamana account, Mudharabah, Musharakah and others. The business has expanded over the years. Its assets and deposits have increased from RM 325 mil to RM 4,440 mil in 1997. The financing of loans and services increased to RM 991 mil in 1997. The number of branches increased to 75 in 1998.

The growth of Islamic Banking industry continues to grow by the establishment of Takaful operator (Syarikat Takaful Malaysia Berhad) in 1984. In 1994, Islamic money market was established to provide strong support to Islamic banking system and Takaful industry.

Today, Islamic financial system in Malaysia has emerged as important components that contribute to the growth and development of Malaysian economy with the creation diversity of players encompasses the domestic as well as the foreign banking players.



Difference between Islamic Banking and conventional banking

Characteristics Functions Operating modes Investors return rates

Conventional Banks

Islamic Banks

& Based on fully manmade Based on the principles of principles. Islamic Shariah. risk sharing

The investor is assured of a Promotes predetermined interest. rate

of between provider of capital (investor) and the user of funds (entrepreneur).

Profit objectives

It aims at maximizing profit It aims at maximizing profit without any restriction. but subject to Shariah

restrictions. Zakat It does not deal with Zakat. In the modern system, Islamic it has


become one of the serviceoriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat. Penalty It can charge additional The Islamic banks have no money (penalty interest) and provision to charge any extra in money from the defaulters. Only small amount and of these


case of defaulters.


proceeds is given to charity. Rebates are giving for early settlement discretion. Ensure growth with Very often it results in the It gives due importance to equity bank's becoming own interest the public interest. Its at the Bank's


It ultimate aim is to ensure

makes no effort to ensure growth with equity. growth with equity.


Loan requirement

Borrowing from the money Must be based on a Shariah market is relatively easier. approved transaction. underlying


of Since income from the Since it shares profit and

developing expertise advances is fixed, it gives loss, the Islamic banks pay in project appraisal little and evaluations importance expertise appraisal to greater attention to

developing project

in developing project appraisal and and evaluations.

evaluations. Greater emphasis on Credit-worthiness clients. Relationship of the The capability of the


The status of a conventional The status of Islamic bank in

between bank and bank, in relation to its relation to its clients is that customers clients, is that of creditor of partners, investors and and debtors. Guarantee deposits trader, buyer and seller. bank can only for

A conventional bank has to Islamic guarantee all its deposits. guarantee


deposit account, which is based on the principle of alwadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the mudharabah concept, client have to share in a loss position.



Stakeholders Analysis

Stakeholders play important role in the Islamic Banking industry for the industry to grow. Every stakeholder has inter-relationship between one and another. Those stakeholders of Islamic Banking industry are government agents, Ministry of Finance, players of the industry (such as Bank Islam Malaysia Berhad) and also the customers of Islamic Banking industry.


Government Agent


Lembaga Tabung Haji (Pilgrims Management and Fund Board)

Every industry needs to get approval from government in order to start an industry. Thus, government support is important. The root of Islamic banking begins in the year 1963 when the government established Lembaga Tabung Haji (or also known as Pilgrims Management and Fund Board). Lembaga Tabung Haji is the government agent of Islamic Banking industry in Malaysia. Lembaga Tabung Haji plays important role in Malaysia‟s Islamic Banking industry. In order to help Muslims to invest their savings without involving in usury activities Lembaga Tabung Haji was established. The institution was established to provide interest free places for the local Muslims to invest their savings who intend to perform Hajj. The institution objectives are to enable Muslims gradually save money to meet the cost of performing the Hajj or other expenses, enable Muslims to take active part in capital investment and provide protection, supervision and welfare to Hajj pilgrims.


Central Bank

The first call for separate Islamic bank was made in 1980, in a seminar held in the National University of Malaysia. The participants passed a resolution requesting the government to pass a special law to setup an Islamic bank in the country. In responding to the request, the government set up a National Steering Committee in 1981 to study legal, religious and operational aspects of setting up an Islamic bank. The committee established the blue print of a modern Islamic banking system in 1983, which later 6

enabled the government to establish an Islamic bank and to issue non-interest bearing investment certificates.

The role of the Central Bank of Malaysia was to create an Islamic banking system operate parallel to the conventional banking system. A single Islamic bank (BIMB) did not represent the whole financial system. It required large number of pro-active players, wide range of products and innovative instruments, and a vibrant Islamic money market. Realizing the situation, the Central Bank introduced Interest Free Banking Scheme (now replaced with Islamic banking scheme (IBS) in March 1993). The scheme allowed conventional banking institutions to offer Islamic banking products and services using their existing infrastructure, including staffs and branches.


Players in the industry

The objective to establish a comprehensive Islamic financial system has created an overflow effect to the non-bank Islamic financial intermediaries also started to offer Islamic financial products and services under Islamic banking scheme. Such institutions include the Takaful Companies, the savings institutions (such as Bank Simpanan Nasional & Bank Rakyat) and the developmental financial institutions (such as Bank Pembangunan dan Infrastruktur Malaysia and Bank Pertanian).


Bank Islam Malaysia Berhad (BIMB)

The establishment of Bank Islam Malaysia Berhad (BIMB) in July 1983 was a start up of the milestone for the development of the Islamic financial system in Malaysia. BIMB carries out banking business concept similar to other commercial banks, but with the implication of the principles of Islamic laws (Shariah). BIMB has grown remarkably since its establishment. It was listed on the Main Board of the Kuala Lumpur Stock Exchange on 17 January 1992. BIMB has total shareholders‟ fund of RM1.3billion as being the leading local Islamic bank.



Bank Muamalat Malaysia Berhad

Bank Muamalat begins to operate on 1st October 1999, which is the second full-fledged Islamic financial institution that operates under the Islamic Banking Act (1983). It is headquartered in Kuala Lumpur and is a leading financial institution offering Shariah based financial services and products. It is predicted to play its role in providing Shariah compliant banking products and services to Malaysians, irrespective of race or religious beliefs, thus contributing to the development of modern Malaysia. Bank Muamalat‟s mission is to deliver best value to the stakeholders. Meanwhile, Bank Muamalat vision is to become the preferred Islamic financial service provider regionally.


Maybank Islamic Berhad

Maybank began offering Islamic financing in 1993 as a viable alternative to conventional banking. On 1 July 2002, the Takaful business was launched by Mayban Takaful Berhad. On 1 January 2008, a new phase for Maybank's Islamic banking operations began when a new subsidiary called Maybank Islamic Berhad (MIB) was formed. Currently, Maybank Islamic is the largest Islamic banking player in the Asia Pacific region.


Ministry of Finance

The Ministry of Finance plays an important role to focus on Malaysia's aspiration to evolve its role as an international Islamic Financial Centre and assist Malaysia's Islamic financial services in working together towards achieving this shared vision of expanding the Islamic Banking industry. The Malaysian government has not only provided the necessary support in terms of ensuring tax neutrality for Shariah-compliant products but, in numerous instances, the government has taken a lead role as an issuer as was the case with the Malaysian first global sovereign Sukuk in 2002. Thus, the Ministry of Finance plays a major role in assisting Islamic Banking industry to grow.



Customers are another important element in supporting the growth of Islamic Banking industry as well. In the past, Islamic Banking is only open to the Muslims. Due to the increasing demand in the market, hence Islamic Banking is open to all races of Malaysian. 8

The customers of Islamic Banking are also categorized into two groups of corporate banking customers and personal banking customers same as other conventional banks categorized their customers. Customers also play a major role in contributing the growth Islamic Banking. This is because with the deposit of customers, those players in Islamic Banking will have the fund to grow.


List of Financial Institutions Offering Islamic Banking Services

Islamic Banks 1. Bank Islam Malaysia Berhad 2. Bank Muamalat Malaysia Berhad

Finance Companies 1. Affin-ACF Finance Berhad 2. Alliance Finance Berhad 3. Arab-Malaysian Finance Berhad

Commercial Banks 1. Affin Bank Berhad 2. Alliance Bank Malaysia Berhad 3. Arab-Malaysian Bank Berhad 4. Bank Utama (Malaysia) Berhad 5. Citibank Berhad 6. EON Bank Berhad 7. Hong Leong Bank Berhad 8. HSBC Bank Malaysia Berhad 9. Malayan Banking Berhad 10. OCBC Bank (Malaysia) Berhad 11. Public Bank Berhad 12. RHB Bank Berhad 13. Southern Bank Berhad 14. Standard Chartered Bank Malaysia Berhad

4. EON Finance Berhad

Merchant Banks 1. Affin Merchant Bank Berhad 2. Alliance Merchant Bank Berhad 3. Arab-Malaysian Merchant Bank Berhad 4. Aseambankers Malaysia Berhad 5. Malaysian International Merchant

Bankers Berhad

Discount Houses 1. Abrar Discounts Berhad 2. Affin Discount Berhad 3. Amanah Short Deposits Berhad 4. CIMB Discount House Berhad 5. KAF Discounts Berhad 6. Malaysia Discount Berhad 7. Mayban Discount Berhad



PEST analysis


Political Factor

Islamic Banking refers to a system of banking or activity that is consistent with the principles of islamic law (Shariah). Islamic banking is carried out in accordance with the rules of Shariah as known as fiqh mualamat (Islamic rules on transactions). It prohibits the paying or receiving of riba (interest) for specfic terms as well as investing in businesses that provide goods or services considered contrary to its principles. Also, it does not allow to promote greater degree of fairness and equity in the conduct of banking business.

In the year of 1983 and 1984, the Malaysian government passed the Islamic Banking Act (IBA) and the Takaful Act, the legal basis for establishing Shari‟ah-compliant banks and insurance companies in the country. This legislation has provided the country‟s central bank – Bank Negara Malaysia (BNM), with the authority to supervise and regulate Islamic financial instituitions and takaful operators. This was the take-off point for the development of Islamic banking in the country. Since then, the government has introduced a number of supporting measures and beyond all doubt, this high level of government support has played a significant role in establishing Malaysia as a leading centre for Shari‟ah-compliant finance on a global scale.

In October 1996, the Central Bank issued a model financial statement for the IBS banks requiring them to disclose their Islamic banking operations (balance sheet and profit and loss account) as an additional item under the Notes to the Accounts. The Central Bank also setup a National Shariah Advisory Council on Islamic Banking and Takaful (NSAC) on 1st May 1997. The council considers as the highest Shariah authority on Islamic banking and Takaful businesses in Malaysia. On 1st October 1999, the Central Bank issued license for second Islamic bank, Bank Muamalat Malaysia Berhad.

The Islamic Banking Act 1983 (IBA) is an unique legislation which enacted to deal specifically with Islamic banking and it provides for the setting up and licensing of “Islamic banks”. The Act inter alia has provisions on the financial requirements and duties of an Islamic Bank, onwership, control and management of Islamic banks, 10

restrictions on its business, powers of supervision and control over Islamic bank and other general provisions such as penalties. For instant, those cases involving Bank Islam and the Islamic Banking Act fall within the jurisdiction of the civil courts, thus, the Islamic law and Islamic Banking Act generally are to be applied and implemented within the existing common law system of courts and the regime of all other existing laws. All the licensed Islamic banks and Islamic Banking Scheme (IBS) banks are required to display the Islamic banking logo.

While each Islamic bank has its own board which rules on ethical banking principals, the Islamic banking organizations have been establishing standard regulations and policies. The Islamic Development Bank has been working on international standards, policies and procedures and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Islamic Finance Service Board (IFSB), International Islamic Financial Market, Liquidity Management Center and International Islamic Rating Agency are in development to ensure accurate and fair banking practices. In Malaysia, The Bank Islam Malaysia Berhad, Bank Muamalat, Bukhari Capital (Malaysia) and Hong Leong Islamic Bank also associate with the AAOIFI to comply with Islamic Shari‟a precepts and principles in their operations and transactions. Moreover, these members of AAOIFI are representing regulatory and supervisory authorities.

The Malaysia banking system is a highly centralized managed system. They are operating under a same set of regulation, instruction and inspection of the central bank. Individuals do not have credit line and have no credit in the bank, but the mortgage is available. Now as many state-owned enterprises are encountering the recession and the slackened debts have made many financial institutes sink into difficulty, their effect on the contribution to the growth of economy therefore lessened.

Hence, with the standard regulation for Islamic Banking in Malaysia, it helps the players of Islamic Banking industry to have fair competition and attract foreign investors to invest in Malaysia. Thus assist the growth of Islamic Banking industry in Malaysia.



Economic Factor


Overview of Malaysia economy

The Malaysian economy continued its strong growth momentum, expanding by 6.3% in 2007. Private consumption recorded the highest growth rate since 2000; keep up by rising disposable income following high commodity prices, salary increments in both the public and private sectors. Strong investment in the manufacturing, services, construction, and oil and gas industries was further reinforced by large inflows of foreign direct investment.

The services sector led growth in 2007 was supported by domestic demand activities and new growth areas in finance, business services and communications has generated significant economic momentum and the ongoing structural transformation has further strengthened Malaysia‟s macroeconomic fundamentals during the year. Resilient household and corporate sectors, strong banking system place the economy in a better position in global growth. A notable development has been the prominence of new growth areas in the services sector which are mainly knowledge-intensive activities, such as telecommunications, Islamic finance and IT services.

Hence, the strong economic growth of Malaysia assists Islamic Banking industry to growth more effectively. Moreover, with strong economic growth of Malaysia, it attracted foreign investor to invest on Islamic Banking and thus contribute the growth of Islamic Banking industry. 4.2.2 Contribution of Islamic Banking to the Malaysia’s economy

Malaysia plays a major role in developing an international Islamic financial system. The first step taken was realigning Labuan from being an offshore financial centre to an international Islamic financial centre. The first international Islamic financial market established in Labuan at the end of 2001.

As a result of the financial turmoil in 1997 and liberalization of the world banking system, Malaysia has developed a ten-year plan known as „Financial Sector Stability‟. The aim of this plan is to create a more efficient and competitive, innovative, technology-driven, and


strategically more focused financial system. The plan includes Islamic financial system as one of the components that can be further developed to become the key player in Malaysian and international banking sector. Even with the support of the government in introducing various measures to develop the Islamic financial system, its success is very much influenced by the market players. The market share of Islamic banking assets, deposits and financing reflects public acceptance of this system. For example, the Islamic banking total asset in the banking system was 6.9% in 2000, while Islamic banking deposits and financing constituted 7.4% and 5.3% respectively. Malaysia is a country in which Muslims represent half of its population and which is governed by a coalition government led by Muslim-based party.

Malaysia has established the international centre for education in Islamic banking (INCEIF) in March this year with an objective to produce Islamic finance professionals and expertise. INCEIF was also established to address the human capital needs of a rapidly expanding industry and to be at the forefront in developing innovative Islamic banking product and service.

The world Islamic economic forum would be an appropriate forum to promote Islamic banking and other Islamic financial services which can benefit everybody in particular the ummah. In order to have the capacity to be credible participants in the network of international trade and investment, Malaysia developed their economic infrastructures in order to have adequate physical infrastructure to facilitate economic activity and expedite economic growth. This includes an effective transportation system activity and reliable public utilities such as telecommunication service. Islamic banking can only perform well when these facilities and services are readily available and functioning well.

Furthermore, there must be adequate investment in human capital development. A competent and knowledgeable workforce is needed to operate and manage the systems and maintain cost effectiveness. Education and training system needed to build a talented, skilled and world- class workforce capable of taking on challenging tasks. In this regard, information and communication technologies offer vast possibilities for generating Islamic banking industry growth and providing employment opportunities. Growth would be further enhanced by the development in Islamic finance, with the entry of new Islamic banks and expected strong activity in the Islamic capital markets following the further 13

implementation of initiatives to promote Malaysia as an International Islamic Financial Centre.


Social Factor

According to the CIA fact book website, the total population of Malaysia was 25,274,132 (July 2008.). There are three major race and 35 other ethnic groups in Malaysia. The three major races are Malay 50.4%, Chinese 23.7%, and Indian 7.1% of the total population. Other ethnic groups‟ population are 18.8% of Malaysia‟s total population.

Since Islamic banking was established initially for the Muslims which presents 60.4% of total population of Malaysia, thus Malaysia is a place that has potential for Islamic Banking industry to grow. Yet the non-Muslims found the Islamic banking is an interesting solution especially in the current situation. According to Business Times, Islamic banking is gaining attention from non-Muslims worldwide due to its strict lending principles reflecting industry efforts to exceed religious beliefs to gain market share.

Shariah finance is a blend of Islamic economics and modern lending principles and its products can be sold to Muslims and non-Muslims. While it was previously a small market catering to Muslims who wanted to avoid interest-based conventional banking, Islamic finance has become popular in recent years due to cash-rich Gulf Muslim investors and rising demand for ethical investing. Non-Muslim investors have also been looking for less risky alternatives since the beginning of the global credit crisis spread doubt on many Western risk management practices.

In Islamic banking, there is a lot of other governance to be put in place to enhance the confidence and enhance the risk management through the Shariah governance and framework.



Technological Factor

Technology is growing very fast and it‟s changing on a very high speed, also businesses of Islamic banking are being affected by technology. Banks as well is following the technology in order to improve their performance in offering products and services to the customers more efficiently. In some way the technology will attract customers to invest and the bank will gain profit. Internet is being widely used in the Malaysia, regarding the chart below and its stated that Malaysia internet user has increasing year by year. A good example is the Maybank, whereby it is the first to introduce Internet Banking ( Many customers find it very convenient by visiting this site to do banking transactions. Internet banking helps customers to save some time in avoiding long queues. E-banking is also another technological tool that assists Islamic banking in expanding in the e-market. This is because E-Banking provides a flexible transaction to customers.

Online banking services are one of the convenient ways of doing banking transactions. Other than time saving to online banking customers, online banking is convenient to customers due to customers can view their bank statement globally. YEAR Users 2000 2005 2006 2007 2008 3,700,000 10,040,000 11,016,000 13,528,200 14,904,000 Population 24,645,600 26,500,699 28,294,120 28,294,120 25,274,133 % Pen. 15.0 % 37.9 % 38.9 % 47.8 % 59.0 % Usage Source ITU C.I.Almanac ITU MCMC MCMC

Table 1 Malaysia Internet Users

Table 1 shows the statistics of the number of Internet Users in Malaysia. The statistics below shows that there is huge market in the online user market. Thus, there is a potential opportunity for Islamic banking to target these online users to be their potential customers. Another technological tool that assists Islamic banking to expand its market share is the tele-banking service. Although it‟s not used widely as Internet banking and E-banking, but through this service clients can make a free call to do banking transactions or to get 15

information about the their own accounts. Maybank bank has a good example of a call centre where the clients can dial 1-300 88 6688 or 603-7844 3696 (overseas), which works 24hrs in order to, satisfy the customer‟s needs.

ATM machines are being widely used in the Malaysia to offer instant withdraw from ATM rather than withdrawing from brick-and-mortar bank premise for customers who needs small amount of cash. ATMs are usually available in shopping centres and petrol station. Other than that, M-banking (Mobile Banking) is also being used to do banking transaction. Customers can settle their bills through M-banking.

Hence, with the technological advancement available in Malaysia helps in contributing the growth of Islamic Banking industry. This is because the technological advancement provides a convenient to the consumers in doing banking transactions. It is also a tool to attract foreign investors to invest in Islamic Banking industry and thus lead to economic growth.





Challenges face by Islamic Banking Industry in Malaysia

Both of the theory of Islamic banking and the rapid expansion of Islamic Banks recent years have demonstrated the viability and feasibility of non-interest-based operations. Experience has shown that Islamic banks are powerful means of mobilizing resources. The most important among the challenges is the fact that, while it has been relatively easy to create a system in which deposits do not pay interest, the asset portfolios of Islamic banks do not contain sufficiently strong components that are based on profit sharing.

The main reasons are: a) Lack of a legal and institutional framework to facilitate appropriate contracts as well as mechanisms to enforce them. b) Lack of appropriate menus containing a broad range and a variety of maturity structures of financial instruments.

There is still no major Islamic bank that has been able to develop ways and means of intermediating between Western financial resources and the demand for them in Muslim countries. It also appears that individual Islamic banks face difficulties in fund placement because they have has a major bias toward short-term, secured, low-return but liquid investments.

The most important challenge for Islamic banking is in its systems-wide implementation. At present, many Islamic countries suffer from financial disequilibria that frustrate attempts at wholesale adoption of Islamic banking. Financial imbalances in the fiscal, monetary and external sector of these economies cannot provide fertile ground for efficient operation of Islamic banking with a level playing field.

Additional, adoption of a legal framework of property ownership and Contracts that would clearly specify the domain of private and public property rights as well as stipulation of legally enforceable rights of parties to contract that fully reflect the requirements of the Shari‟ah, are necessary to allow an operational framework favourable to efficient operation of Islamic banking. 17

Another challenge that Islamic Banking industry faces is there is a shortage of liquid instruments and lack of an Islamic inter-bank market. Even though Islamic banks avoided the speculative investments and complex financial instruments that spoilt Western banks, their balance sheets still show a mismatch between assets and liabilities. They depend more on short-term maturity liabilities than conventional banks.

Furthermore, Islamic Banking industry also face challenges of banks are suffering a chronic shortage staffs with knowledge of Islamic finance and regulatory differences in different regions continue to outbreak efforts to build true cross-border Islamic banking. Thus, there is need to have more staffs with knowledge of Islamic finance in the Islamic Banking industry.


Future for Islamic Banking in Malaysia

Bank Negara Malaysia states that the number of new Islamic banking licences is optimal to allow for growth in a competitive environment. Malaysia has the intention of becoming an Islamic banking hub. Thus, Malaysia has given licenses to top international players, such as Saudi-based Al Rajhi Banking and Investment Corp, Kuwait Finance House and Qatar Islamic Bank. Al Rajhi Bank's shareholders' funds consist of RM7.4billion is almost five times more than combination of Bank Muamalat's RM353 million and Bank Islam's RM1.2 billion. According to the „World Islamic Banking Conferences Competitiveness‟ report, the Al Rajhi Bank is also the most profitable Islamic institution, with an average return on equity of 25% between 2000 and 2003.

However, having foreign banks is a plus point as competition should be welcomed. The Islamic banking system is a deep and liquid market. The challenge now is to encourage and innovates new Islamic financial instruments with better pricing.

Therefore, it can be foreseen that the Islamic Banking industry is growing rapidly for the future. With the large group of international players in the Islamic banking industry market, local players may also gain from the exposure to new business models and products those foreign licensees offer.


BNM adds that smart partnerships and synergies may be forged to create investment avenues for local players to gain access to Middle Eastern investors and technical knowhow, and for foreign players to obtain knowledge on the local business environment. This is because with the knowledge that obtained, it can assist Malaysia‟s Islamic banking industry to grow more rapidly.

From a macro view, Malaysia is trying to attract as much investment as possible from huge international funds floating globally, estimated to be worth between US$ 600 billion and US$ 1 trillion. Therefore, it can be forecast that there are potential growth for Islamic Banking industry in Malaysia. 5.3 Recommendation for Islamic Banking in Malaysia

Islamic Banks should be given more attractive tax breaks and further incentives to help them develop into global players in line with the government‟s vision of making Malaysia a global Islamic banking hub. In the Malaysian context, Islamic banking assets make up just 11% of the entire banking system assets. Though, it is difficult for Islamic banks to make an impact globally due to the size, local Islamic capital banks lacked regional networking and distribution. For Malaysia to be a hub, these banks must have the ability to distribute products and services internationally, especially in wealth management and Islamic capital market.

The government should also encourage intermediaries as well as corporate to undertake additional Islamic syndicated facilities. This could be in the form of stamp duty exemption to corporate and tax-exempt revenue for banks operating their syndication team in Malaysia. D-8 Organisation is at highest awareness to this issue, and paying a serious attention on the importance of Islamic finance for supporting the member states cooperation in institutional developments of finance, banking and insurances.


Other than that, Islamic Banking institutions may practice benchmarking programme to facilitate them in evaluating their relative efficiency, identifying the performance gaps and formulating strategies to improve and deliver the best results. The efficiency that Islamic banking institutions practice can assist Islamic Banking industry to grow and attract foreign investors to invest.

In addition, Islamic banking institutions may enhance their staffs knowledge and expertise to support the visualized growth of the industry. This can be done by establishing an institution to train their human capital. Awareness can also be created to the public on the concept and advantages of Islamic banking.

Lastly, strong management teams in the Islamic Banking institutions can be build to have capable and innovative management teams committed to Islamic banking, the employment of experienced and qualified staff, including the expatriates to facilitate transfer of knowledge and expertise will be encourage. The recruitment of expatriates will complement the efforts made to build the skills of the domestic industry players.



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+malaysia&page=1&qsrc=0&zoom=&ab=0& m%2Fmalaysia.html (accessed 6 February 2009) 11. Noordin, S.M. & Lim, P.K. 2008. “An Overview of Malaysian Legal System and Research”, GlobaLex, URL: (accessed 6 February 2009) 12. Kuhan, T. & Celestine, C. 2007. “Malaysia: Summary of Recent Malaysian Legislative and Legal Developments”, Modaq, URL: m%2Farticle.asp%3Farticleid%3D51070 (accessed 6 February 2009)



Appendix 7.1 Appendix (Law of Malaysia)

Law of Malaysia Act 276 Islamic Banking Act 1983
An Act to provide for the licensing and regulation of Islamic banking business. [7th April 1983] PU(B) 182/1983

ARRANGEMENT OF SECTIONS PART I PRELIMINARY 1. 2. Short title, commencement and application. Interpretation. PART II LICENSING OF ISLAMIC BANKS 3. Islamic banking business to be transacted only by a licensed Islamic bank. 4. 5. 6. 7. 8. Minister may vary or revoke condition of licence. Licence not to be granted in certain cases. (Deleted). Opening of new branches. Islamic bank may establish correspondent banking relationship with bank outside Malaysia. 9. 10. 11. 12. Licence fee. Restriction of the use of certain words in an Islamic bank‟s name. Revocation of licence. Effect of revocation of licence.



Publication of list of Islamic banks.

13A. Advice of Syariah Advisory Council. PART III FINANCIAL REQUIREMENTS AND DUTIES OF ISLAMIC BANKS 14. 15. 16. 17. 18. 19. 20. Maintenance of capital funds. Maintenance of reserve funds. Percentage of liquid assets. Auditor and auditor‟s report Audited balance sheet. Statistics to be furnished. Information on foreign branches. PART IV OWNERSHIP, CONTROL AND MANAGEMENT OF ISLAMIC BANKS 21. 22. 23. Information on change in control of Islamic banks. Sanction for reconstruction, etc., of bank required. Disqualification of directors and employees of banks. PART V RESTRICTIONS ON BUSINESS 24. 25. 26. Restrictions on payment of dividends and grant of advances and loans. Prohibition of loans, etc., to directors, officers and employees. Restriction on grant of loan, advance or credit facility under section 25 (4). 27. Restriction of credit to single customer.

27A. Control of credit limits. 28. 29. Disclosure of interests by directors. Limitation on credit facility for purpose of financing the purchase or holding of shares.



Proof of compliance with sections 24, 25, 26, 27 and 29. PART VA INTERNATIONAL ISLAMIC BANKING BUSINESS

30A. Prohibition to carry on international Islamic banking business. 30B. Application for a licence to carry on international Islamic banking business by persons other than a licensed Islamic bank. 30C. Minister may vary or revoke condition of licence granted under this Part. 30D. Licence under this Part not to be granted in certain cases. 30E. Application of the provisions of this Act to international Islamic bank. PART VI POWERS OF SUPERVISION AND CONTROL OVER ISLAMIC BANKS 31. 32. 33. 34. 35. 36. 37. Investigation of banks. Special investigation of banks. Production of bank‟s books and documents. Banking secrecy. Action to be taken if advances are against interests of depositors. Banks unable to meet obligations to inform Central Bank. Action by Central Bank if bank unable to meet obligations or conducting business to the detriment of depositors. 38. Effect of removal of office of director or appointment of a director of a bank by the Central Bank. 39. 40. Control of Islamic bank by Central Bank. Islamic bank under control of Central Bank to co-operate with Central Bank. 41. 42. 43. Extension of jurisdiction to subsidiaries of banks. Moratorium. Amendment of bank‟s constitution.


PART VII MISCELLANEOUS 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. Indemnity. Priority of Islamic deposits. Penalties on directors and managers. Offences by directors, employees and agents. Offences by companies, etc.,and by servants and agents. Prohibition on receipt of commission by staff. General penalty. Power of Governor to compound. Consent of the Public Prosecutor. Regulations.

53A. Power to issue guidelines, etc. 54. 55. 56. Bank holidays. Application of other laws. Exemption.

PART VIII CONSEQUENTIAL AMENDMENTS 57. 58. 59. 60. Amendment of Banking Act 1973. Amendment of Companies Act 1965. Amendment of Central Bank of Malaysia Ordinance 1958. Amendment of Finance Companies Act 1969.

Sources from Bank Negara Malaysia – Islamic Banking (Amendment) Act 2007


7.2 Appendix (Glossary)

Wadiah (Safekeeping) In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when the depositor demands it. The depositor, at the bank's discretion, may be rewarded with a 'hibah' (gift) as a form of appreciation for the use of funds by the bank.

Mudharabah (Profit Loss Sharing) Mudharabah is an arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilise funds for its business activity. Any profits made will be shared between the capital provider and the entrepreneur according to an agreed ratio, where both parties share in profits and only capital provider bears all the losses if occurred. The profit-sharing continues until the loan is repaid. The bank's profit comes in the form of a floating-point profit rate that is pegged to the debtor's profits.

Musharakah (Joint Venture) This concept is normally applied for business partnerships or joint ventures. The profits made are shared on an agreed ratio, while losses incurred will be divided based on the equity participation ratio. This concept is distinct from fixed-income investing (i.e. issuance of loans).

Murabahah (Cost Plus) This concept refers to the sale of goods at a price, which includes a profit margin agreed by both parties. The purchase and selling price, other costs and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. This is a fixed-income loan for the purchase of assets (such as real estate or a vehicle), with a fixed rate of interest determined by the profit margin. The bank cannot charge additional interest on late payments), however the asset remains in the ownership of the bank until the loan is paid in full. This type of transaction is similar to "rent-to-own" arrangements for furniture or appliances that are very common in North American stores.


Bai' Bithaman Ajil (Deferred Payment Sale) This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. This is similar to Murabahah, except that the debtor makes only a single installment, on the maturity date of the loan.

Ijarah Thumma Al Bai' (Hire Purchase) There are two contracts involved in this concept. The first contract, Ijarah contract (leasing/renting) and the second contract, Bai' contract (purchase) are undertaken one after the other. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed rental over a specific period. When the lease period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed price. In effect, the bank sells the product to the debtor, at an above market-price profit margin, in return for agreeing to receive the payment over a period of time; the profit margin is equivalent to interest earned at a fixed rate of return. This type of transaction is particularly reminiscent of contractum trinius, a complicated legal trick used by European bankers and merchants during the Middle Ages, which involved combining three individually legal contracts in order to produce a transaction of an interest bearing loan (something that the Church made illegal).

Bai' al-Inah (Sell and Buy Back Agreement) The financier sells an asset to the customer on a deferred payment basis and then the asset is immediately repurchased by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency.

Takaful (Islamic Insurance) In modern business, one of the ways to reduce the risk of loss due to misfortunes is through insurance. The basic idea behind insurance is the sharing of risk. The concept of insurance where resources are pooled to help the needy does not contradict Shariah. Conventional insurance involves the elements of uncertainty (Al-gharar) in the contract of insurance, gambling (Al-maisir) as the consequences of the presence of uncertainty and interest (Al-riba) in the investment activities of the conventional insurance companies which contravene the rules of Shariah. Takaful is an alternative form of cover which a 28

Muslim can avail himself against the risk of loss due to misfortunes. Takaful is based on the idea that what is uncertain with respect to an individual may cease to be uncertain with respect to a very large number of similar individuals. „Insurance by combining the risks of many people enables each individual to enjoy the advantage provided by the Law of Large Numbers.


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