ISLAMIC BANK

MANAGEMENT
BWBS3043

Topic 1: History and development
of Islamic Banking
System
Objectives:

1. Explain the structure of financial system
in Malaysia
2. Explain the definition and type of banks.
3. Explain history and the development of
Islamic banking system.

The flow of funds in financial system
3
Surplus Units Deficit Units
Financial
Market
Financial
Intermediaries
Secondary debt/ indirect debt
Primary debt/ direct debt
THE FINANCIAL SYSTEM STRUCTURE IN MALAYSIA
Financial System
Financial Institutions Financial Market
BANKING SYSTEM
1.Bank Negara Malaysia
2. Banking Institutions
Commercial Bank (23)
investment banks (15)
International Islamic
banks (4)
Islamic Banks (17)
3. Others
Discount Houses
Representative Offices
of Foreign Banks
NON-BANK FINANCIAL
INTERMEDIARIES
1. Provident and Pension Funds
2. Insurance Companies/Takaful
3. Development Finance
Institutions
4. Savings Institutions
National Savings Bank
Co-operative Societies
5. Others
Unit Trusts
Pilgrims Fund Board
Housing Credit Institutions
Cagamas Berhad
Credit Guarantee Corporation
Leasing Companies
Factoring Companies
Venture Capital Companies
Money & Foreign Exchange
Market
1. Money Market
2. Foreign Exchange Market
Capital Market
1. Equity Market
2. Bond Market
Public Debt Securities
Private Debt Securities
Derivatives Market
1. Commodity Futures
2. KLSE CI Futures
3. KLIBOR Futures
Offshore Market
1.Labuan International
Offshore Financial Center
(IOFC )
A. BANKING SYSTEM
The banking system consists of:
i.Bank Negara Malaysia (Central Bank of
Malaysia)
ii.Banking institutions (commercial banks,
investment banks, international banks and
Islamic banks)
iii.Miscellaneous group (discount houses and
representative offices of foreign banks).


1. Bank Negara Malaysia (BNM)

Bank Negara Malaysia (the Central Bank of Malaysia) was
established on 26 January 1959, under the Central Bank of Malaya
Ordinance 1958. The objectives of BNM are as follows:
To issue currency and keep reserves to safeguard the value of
currency;
To act as a banker and financial adviser to the government;
To promote monetary stability and a sound financial structure; and
To influence the credit situation to the advantage of Malaysia.
The introduction of the Banking and Financial Institutions Act 1989
(BAFIA) on 1 October 1989 extended BNMs powers for the
supervision and regulation of financial institutions and deposit-
taking institutions who are also engaged in the provision of finance
and credit.
2. Commercial Banks

Commercial banks were brought under BNM supervision through
Banking Act, 1973, but this was subsequently replaced by the
BAFIA in 1989.
The main functions of commercial banks are to provide:
Retail banking services such as the acceptance of deposit,
granting of loans and advances, and financial guarantees;
Trade financing facilities such as letters of credit, discounting of
trade bills, shipping guarantees, trust receipts and Bankers
Acceptances;
Treasury services;
Cross border payment services; and
Custody services such as safe deposits and share custody.
Commercial banks are also authorized to deal in foreign exchange
and are the only financial institutions allowed to provide current
account facilities.
3. I nvestment Banks
The establishment of investment banks, in line with the recommendation of the
financial sector, aims to strengthen the capacity and capabilities of domestic
banking groups through internal rationalization so that they can contribute to the
economic transformation process and better face the challenges of liberalization
and globalization.
The framework on investment banks is now extended to universal brokers.
This move is aimed towards further enhancing the capacity and capabilities of
domestic capital market intermediaries to contribute towards the development of a
more resilient, competitive and dynamic financial system and support economic
transformation.
Universal brokers currently undertake and offer similar range of products and
services as investment banks. The transformation of universal brokers to
investment banks will thus strengthen their potential to capitalize on larger business
opportunities, diversify their source of funding and enhance their market making
capabilities in the capital market.


4. International Islamic Banks

An International Islamic Bank (IIB) is allowed to conduct a wide range of
Islamic banking business in Malaysia under the Islamic Banking Act 1983 (IBA)
with non-residents in international currencies other than Malaysian ringgit. The IIB
is a resident for the purpose of foreign exchange administration policies.
The IIB is eligible for full tax exemption accorded under the Income Tax Act
1967 for ten years from the year of assessment 2007. These Guidelines will be
effective from 15 September 2006.
Eligibility criteria:

1) It is a well capitalized and reputable licensed financial institution;
2)Adopts the international banking practices set by the Bank for International
Settlements or any other international standard-setting body;
3)Regulated and supervised by a competent home regulatory authority;
4) Possesses a sound track record.
5. Islamic Banks
In Malaysia, separate Islamic legislation and banking regulations exist
side-by-side with those for the conventional banking system.
The legal basis for the establishment of Islamic banks was the Islamic
Banking Act (IBA), which came into effect on 7 April 1983.
The IBA provides BNM with powers to supervise and regulate Islamic
banks, similar to the case of other licensed banks.
The banking activities of Islamic banks are based on Syariah principles
(the Islamic principles).
The first Islamic bank established was Bank Islam Malaysia Berhad,
which commenced operations on 1 July 1983. On 1 October 1999, a
second Islamic bank, namely Bank Mualamat Malaysia Berhad was
established.
Apart from Islamic banks, other financial institutions also offer Islamic
banking services through the Islamic Banking Scheme. In terms of
products, all Islamic banking entities are offering banking products based
on the Islamic principles.
6. Discount Houses
Discount houses began operations in Malaysia since 1963.
Generally, the discount houses specialize in short term
money market operations and mobilize deposits from the
financial institutions and corporations in the form of money at
call, overnight money and short term deposits.
The funds mobilized are invested in Malaysian Treasury
bills, Malaysian Government Securities (MGS), banker
acceptances (BAs), negotiable certificates of deposit (NCDs),
Cagamas bonds and Floating Rate Negotiable Certificates of
Deposit (FRNCDs), as well as to provide an active secondary
market for these activities.
7. Representative Offices of Foreign Banks in
Malaysia
There are 32 foreign banks that have establishing
representative offices in Malaysia, with all
concentrated in Kuala Lumpur.
Most of the banks originate from Europe and
Japan.
Representative office is merely a liaison office and
does not offer banking products directly to the
Malaysian market.
B. NON-BANK FINANCIAL INTERMEDIARIES
Non Bank Financial Intermediaries mainly comprise
of
1. Provident and Pension Funds
2. Insurance Companies
3. Development Finance Institutions
4. Savings Institutions
5. Others.
.
1. Provident and Pension Funds
Provident and Pension Funds (PPFs) are a group of
financial schemes designed to provide members
and their dependents with a measure of social
security in the form of retirement, medical, death or
disability benefits.
The major PPFs in Malaysia comprise the
Employees Provident Fund (EPF), the Social
Security Organization (SOCSO), the Armed Forces
Fund and the Teachers Provident Funds.
The PPFs are the second largest group of financial
institutions in the country in terms of aggregate
assets, next to banking institutions
2. Insurance Companies
Currently, the total number of licensees under the Insurance
Act 1996 stands at 141, comprising 64 insurers, 36 brokers
and 41 adjusters. The 64 insurers that were licensed under
the Act is categorized into the following groups:
7 life and general business
9 life business only
24 General business only
1 life and general reinsurance business
1 life reinsurance business
5 general reinsurance business
3. Development Financial Institutions
Development Financial Institutions (DFIs) are established by
the Government to promote the development of certain
identified priority sectors and sub-sectors of the economy,
such as agriculture, infrastructure development and
international trade. DFIs generally specialize in the provision
of medium and long term financing of projects that may carry
higher credit or market risk. The following are the main DFIs
in Malaysia:-
i) Bank Pertanian Malaysia
ii) Bank Industri & Technologi Malaysia
iii) Bank Pembangunan & Infrastruktur Malaysia Berhad
iv) EXIM Bank
v) Malaysian Industrial Development Finance (MIDF)
4. Savings Institutions
These institutions play a particularly important
role in the promotion and mobilization of savings
among the middle and lower-income group.
Among the savings institution in Malaysia are
Bank Simpanan Nasional, Bank Rakyat and co-
Operatives.
Several of them introduced Islamic banking
facilities in tandem with Governments objective to
develop an Islamic banking system in Malaysia.
5. Others
The group of institutions classified as other
financial intermediaries are those which operate on
a much smaller scale than the major financial and
deposit-taking institutions.
These intermediaries were established in
response to government efforts to promote greater
Bumiputera participation in the Malaysian
economy as well as to assist in the development of
financial markets.
C. FINANCIAL MARKET
The Financial Market mainly comprises:-
1) Money Market
is an avenue for the channeling of short term funds with
maturities typically not exceeding 12 month.
It provides a ready source of funds for market participants
facing temporary shortfalls in funding, while at the same
time, providing short term investment outlets for those
with temporary surplus funds. Operations in the money
market comprise 2 broad categories:
i) The placement of deposits
ii) The purchase and sale of short term securities (bankers
acceptances (BA), negotiable instruments of deposit (NID),
treasury bills (T-bill), Cagamas notes, etc.

2) Foreign exchange market
is the market for the trading of foreign currencies against the ringgit of against
other foreign currencies. It can be undertaken in the spot market, forward and
swap market.
3) Capital market
is the market for raising long term funds and comprise the equity and bond
markets.
Equity market : provides the avenue for corporations to raise funds by issuing
stocks, while secondary market trading in stocks is conducted through
stockbrokers on the Bursa Malaysia as well as the Malaysian Exchange of
Securities Dealing and Automated Quotation (MESDAQ)
4) Bond market
is the market through which both the private and public
sectors can raise funds by issuing private debt securities
(PDS) and Government Securities. Secondary market
trading in unlisted bonds is done through the over-the-
counter (OTC) market and for the listed bonds on the Bursa
Malaysia.
5) Derivatives market
is for trading instruments that provide contingent claims
on underlying assets, and whose values depend on the
price of the underlying assets or securities. The main use of
derivatives is to hedge against volatility in the price of the
underlying assets. Examples of derivatives are forwards,
futures, options and swaps.
6. Offshore market
is a new addition to the financial landscape of Malaysia with
the establishment of the Labuan International Offshore
Financial Centre (Labuan IOFC) in October 1990.
Labuan IOFC is aimed enhancing the attractiveness of
Malaysia as a regional financial centre as well as to promote
the economic development of Labuan and its vicinity.
It provides a wide range of offshore products including
banking, insurance, trust business, fund management,
investment holding, Islamic financing and company
management services.
SECURITIES COMMISSION
1. The Securities Commission (SC) is a statutory body entrusted with the
responsibility of regulating and systematically developing Malaysias capital
markets.
2. It has direct responsibility in supervising and monitoring the activities of
market institutions and regulating all persons licensed under the Securities
Industry Act, 1983 and Futures Industry Act, 1993.
3. Its two main roles under the Securities Commission Act 1993 are:
To act as a single regulatory body to promote the development of capital
markets;
To take responsibility for streamlining the regulations of the securities market,
and for speeding up the processing and approval of corporate transactions.
FINANCIAL REGULATION
Among the main regulations and guidelines issued
by the authorities to govern the financial system in
Malaysia are:-
1. Banking and Financial Institutions Act, 1989
(BAFIA)
2. Insurance Act 1996
3. Anti-Money Laundering Act 2001


1. Banking and Financial Institutions Act, 1989
(BAFIA)
1. The Banking and Financial Institutions Act, 1989 (BAFIA) was passed
in Parliament and came into force on October 1, 1989.
2. BAFIA has effectively replaced the Banking Act 1973 and the Finance
Companies Act 1969.
3. The Islamic Banking Act 1983, however, is not affected.
4. The BAFIA is a comprehensive act and extends comprehensive
powers to Bank Negara Malaysia (BNM) to supervise a larger
spectrum of financial institutions, with the direct responsibilities to
regulate and supervise all licensed institutions (commercial banks,
finance companies, merchant banks, discount houses and money
brokers) and also regulate scheduled and non-scheduled institutions.
5. BAFIA 1989 is divided into 16 parts and covers a wide
spectrum of subject matters related to the banking
industry in Malaysia. The Act provides a framework that
enables BNM to supervise and regulate three broad groups
of financial institutions:

Scheduled institutions comprising non-bank sources of
credit and finance, which include issuers of charge/credit
cards and travellers cheques, operations of cash
dispensing machines, development finance institutions,
building societies and housing credit institutions, factoring
companies, leasing companies, representative offices of
foreign banks or foreign institutions which carry out the
business or activities similar to the scheduled institutions;
Licensed institutions comprising the commercial banks,
merchant banks, finance companies, discount houses, money
brokers and foreign exchange brokers;

Non-scheduled institutions comprising all other statutory
bodies and institutions involved in the provision of finance and
credit.

The Act also provides BNM the regulatory power to regulate the
following:
Control of establishment or acquisition of subsidiaries or
opening of offices in Malaysia by a local or foreign licensed
institutions
Maintenance of reserve fund, capital, net working funds, liquid
assets by the financial institutions
Appointment of auditors, submission of financial statement,
exhibition of financial statements, submission of statistics to
BNM.
2. Insurance Act 1996
Under the Insurance Act 1996, BNM retains a substantial
degree of regulatory control over the management, control of
licensees and the critical aspects of their operations. Among
the areas subject to BNMs approval under the Insurance Act
1996 are:
The appointment of directors and chief executive officers;
The acquisition or disposal of substantial interests in shares of
a licensee;
The establishment of offices and subsidiaries;
Appointment of auditors and actuaries; and
Outsourcing of core insurance activities.
The Insurance Act 1996 which became effective on 1
January 1997, has incorporated amendments made to the
Insurance Act 1963.The subsidiary legislation, the
Insurance Regulations 1996 (Regulations) saw several
changes in 1999 in respect of minimum capital requirement
as follows:-
1.The minimum paid-up capital prescribed for a licensed
local insurer underwriting direct insurance business, or
surplus of assets over liabilities in the case of a licensed
foreign insurer is set at RM50 million from 31 December
2000; and
2.The absolute minimum margin of solvency (before taking
into account insurance fund liabilities) for each class of
insurance business of direct and local professional
reinsurers is set at RM50 million from 1 January 2001.
3. Anti-Money Laundering Act 2001
The Anti-Money Laundering Act 2001 (AMLA) was gazette on 5
July 2001. AMLA provides comprehensive new laws for the
prevention, detection and prosecution of money laundering, the
forfeiture of property derived from, or involvement in money
laundering and the requirements for record keeping and
reporting of suspicious transactions for reporting institutions.
AMLA addresses the following broad issues:-
Money laundering offences
Financial Intelligence Unit
Reporting obligations
Powers of investigation, search and seizure
Powers of freezing, seizure and forfeiture of property
History and Development of Islamic Banking

Banking Under The Influence of Islamic Culture

1.Prophet Muhammad (peace be upon him) noted as trustworthy;
deposits remained in his custody until a short while before he emigrated
from Mekka to Medina, when he assigned Ali to return the deposits to their
owners

2.Az-Zubair bin Awwam was one of those who entrusted with the
safekeeping of money; he was a man of sagacity and intelligence who
refused to take money on deposit preferring to take it as a loan, thus
realizing two objectives:
i. He reserved his right to dispose of the money considering it a loan not a
deposit; and
ii. It represent a secure guarantee to the owner because where money
remains a deposit without use, it would constitute a loss to the owner; but
when deposit becomes a loan it would be secure as the borrower liable for
it.
1) Exchange of money

Ibn Omar said:
I used to sell camels in Baqi (a place in Al Medina), I sell
by dinars and take darahim (kind of money) and sell by
darahim and take the dinars, which thing had an effect
on me, so I came to the Prophet (peace be upon him)
while he was in Hafsas house- or, he said when he left
Hafsas house- and said: Oh Gods Prophet, take it
easy, I wish to ask you: I sell the camels in Baqi, I sell
by dinars and take darahim and sell by darahim and
take dinars. The Prophet said: It would be
unobjectionable if you take them at the price of their day
unless you depart and leave something between you.
2) Transfer Operation

It is narrated that Ibn Al Abbas used to take the warik (i.e. silver
minted into dirhams) in Mekka and write acknowledgement thereof to
El-Kufa, where they used to cash it.

It is related that Saif ed-Daulah al Hamadani who was Amir of Aleppo
about the middle of 4
th
. Century A.H, visited Baghdad and wanted to see
it without being recognised; he went disguised to the houses of Bani
Khaqan to listen and drink; they served, but did not know him. When he
was about to leave he asked for an inkpot and wrote on a slip of paper
and left in the pot; when they unfolded the paper they found it was
addressed to some money changers in the sum of one thousand dinars.
When they presented the slip of paper to the money changer, who
honored the paper and paid the sum of dinars therein stated
immediately and in time'. When they asked the money changer who was
the man who wrote the paper, he replied that he was Saif au-Dawla Al-
hamadani.


The use of cheques for commercial purposes.
The Persian explorer Naser Khasro in his book entitled:
Safarnama in which he recorded what he had seen during
his travel between the years 437-444 A.H. reported in one
place how the work was being carried out in the city of
Basra as he witnessed it himself:

A market is set up in three locations in Basra every day: in the
morning, exchange is carried out in Khaza market, at noon, in
Othman Market and at sunset in Qaddahin market; the work in a
market is as follows: every person who has money gives it to the
money changer and take in return a cheque and then buy all needs
and pays for them by money changers cheque; a purchaser uses no
other than the cheque of the money changers so long as he is
resident in the city

Islamic Banking in The Modern Era
The Attempts to establish an interest-free bank
A.The first attempt came in Malaysia mid-1940s. A plan to
invest prospective pilgrim savings in real estate and
plantations in accordance with Syariah was, however,
unsuccessful.
B.The first experimental local Islamic bank was established in
the late 1950s in a rural area of Pakistan that charged no
interest on its lending.
C.The establishment of Mit Ghamr Local Savings Bank
marked a new milestone in the revolution of the modern
Islamic banking system. The bank was considered to be the
most innovative and successful experiment with interest-free
banking.

List of Islamic Banks
Name Country Date of
Establishment
Nasser Social Bank Egypt 1972
Islamic Development
Bank
Saudi Arabia 1975
Dubai Islamic Bank UAE 1975
Faisal Islamic Bank of
Egypt
Egypt 1977
Faisal Islamic Bank of
Sudan
Sudan 1977
Islamic Banking System
International Holding
Luxembourg 1978
Jordan Islam Bank Jordan 1978
Bahrain Islamic Bank Bahrain 1979
List of Islamic Banks
Islamic International Bank
for Inv. & Development
Egypt 1981
Islamic Investment House Jordan 1981
Al-Baraka Investment &
Development Company
Saudi Arabia 1982
Saudi-Philippine Islamic
Development Bank.
Saudi Arabia 1982
Faisal Islamic Bank
Kibris
Turkey 1982
BIMB Malaysia 1983
Development of Islamic Banking system in Malaysia
Year Remark
1980 Formal request to set-up Islamic Bank was made during the
Bumiputera Economic Congress The Government appointed
National Steering Committee on Islamic Banking.This
committee studied both operations of the Faisal Islamic Bank
of Egypt and The Faisal Islamic Bank of Sudan.
1982
Among the recommendations made by the committee :
i. The Government should establish an Islamic bank whose
operations are in accordance to the principles of Syariah.
ii. The proposed bank is to be incorporated as a company
under the auspices of the Companies Act, 1965.
iii. A new Islamic banking act must be introduced to license
and supervise the Islamic bank.
iv. The Islamic bank is to establish its own Shariah
Supervisory Board ; to ensure that the operations of
Islamic bank are in accordance to the Shariah.
Mac 1,
1983
BIMB was incorporated and commenced operations on
July 1, 1983.
March 10,
1983
The Islamic Banking Act was gazetted.
April 7,
1983
The Islamic Banking Act came into effect.

July 1,
1983
BIMB commenced operations.
1983 The Government introduced The Government
Investment Act in 1983 to enable the government to
issue Government Investment Certificates, which are
government bonds issued in accordance to Islamic
principles.
March 4,
1993
Central Bank has introduced a scheme known as
Skim Perbankan Tanpa Faedah or Interest-free
Banking Scheme (Often known as Islamic
windows). Under this scheme, all commercial banks,
merchant banks and finance companies are given an
opportunity to introduce Islamic banking products and
services. The pilot phase of the scheme involved the
three largest commercial banks in Malaysia.
August 21,
1993
The second phase started with 10 more finance
institutions joining the scheme.
January,
1994
The Islamic inter-bank market was introduced in
Malaysian financial system, which consists of three
elements namely,
i.Interbank trading in financial instruments,
ii.Islamic inter-bank investments
iii.Islamic inter-bank cheque clearing system
Oct 1999 The establishment of 2
nd
Islamic bank ; Bank
Muamalah Malaysia Bhd.
2006 Until 2006 we have 9 Islamic Banks
Affin Islamic Bank Berhad
AmIslamic Bank Berhad
Bank Islam Malaysia Berhad
Bank Muamalat Malaysia Berhad
Commerce TIJARI Bank Berhad
EONCAP Islamic Bank Berhad
Hong Leong Islamic Bank Berhad
Kuwait Finance House (Malaysia) Berhad
RHB Islamic Bank Berhad

2009 Until 2009 we have 17 Islamic Banks
HSBC Amanah Malaysia Berhad
Maybank Islamic Berhad
Al Rajhi Banking & Investment Corporation (Malaysia)Berhad
Alliance Islamic Bank Berhad
Asian Finance Bank Berhad
Affin Islamic Bank Berhad
AmIslam Bank Berhad
Bank Islam Malaysia Berhad
Bank Muamalat Malaysia Berhad
CIMB Islamic Bank Berhad
EONCAP Islamic Bank Berhad
Hong Leong Islamic Bank Berhad
Kuwait Finance House (Malaysia) Berhad
OCBC Al-Amin Bank Berhad
Public Islamic Bank Berhad
RHB Islamic Bank Berhad
Standard Chartered Saadiq Berhad