ISLAMIC FINANCIAL

LEGAL SYSTEM
DEVELOPMENT OF THE MALAYSIAN ISLAMIC FINANCIAL
SYSTEM

CONTENT

MALAYSIAN ISLAMIC FINANCIAL SYSTEM

HISTORICAL DEVELOPMENT OF ISLAMIC BANKING

NSC REPORT ON BANK ISLAM MALAYSIA

1ST PHASE OF DEVELOPMENT

2ND PHASE OF DEVELOPMENT

3RD PHASE OF DEVELOPMENT

CONCLUSION

MALAYSIAN ISLAMIC
FINANCIAL SYSTEM

Comprehensive Islamic financial system covering all financial sectors

operating in parallel with conventional financial system

Diversities of players

Twelve full-fledged Islamic banking institutions

2 domestic Islamic banks

3 full-fledged foreign owned Islamic banks

7 Islamic banking subsidiaries

9 takaful operators

Sound and robust Islamic financial institutions governed by

international best practices

Rapid growth with wide range of product and services

Retail, corporate & investment banking

Internationally integrated with international Islamic financial system

3

HISTORICAL LANDMARKS IN ISLAMIC FINANCE

DEVELOPMENT

1963

Mit Ghamr, Egypt

1969

Pilgrims Fund Board (Lembaga Tabung Haji), Malaysia

1970

Oil boom

1975
1977

Islamic Development Bank, Saudi Arabia

Dubai Islamic Bank, UAE
Fatwa issued by the Fiqh Council of Muslim World League in favour of Islamic insurance
(takaful)

1978

Luxembourg Islamic Bank (1st attempt in the West )

1979

Sudanese Islamic Insurance Company is established as the worlds 1st Takaful company by
Faisal Islamic Bank of Sudan

1983

Malaysia passes comprehensive legislation on Islamic finance (Islamic Banking Act)

1988

OIC Islamic Fiqh Academy legitimizes Sukuk which paves the way to the development of
Islamic debt securities

1990

World 1st sukuk issued in Malaysia (Based on BBA) by Shell MDS worth USD 30 million

1991

AAOIFI , Bahrain

2002

IFSB, Malaysia

2011

International Islamic Liquidity Management (IILM), Malaysia

HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING

Traditional Malay Muslim society is very cautious in

involving themselves in riba transactions

In order to avoid interest-based transactions in getting

cash or liquidity, they practice a local customary
transaction known as jual janji (conditional sale).

The Courts recognize jual janji as a Malay customary

transaction arising out of religious consideration

According to Ungku A. Aziz, the main purpose of savings

for Malay Muslims was to meet the expenses for the
journey to perform haj, thus they preferred to use
traditional ways of savings.
5

HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING

In Malaysia, Islamic banking can be traced back to its

root in 1963, with the establishment of the Lembaga
Urusan dan Tabung Haji (LUTH), which was the first
Islamic savings institution for the special purpose of
performing hajj.

Islamic resurgence in the Middle Eastern countries had

initiated the call for the establishment of an Islamic
financial system that would allow Muslims to practice
their banking and finance according to Shariah
principles.

This can be seen with the establishment of Islamic

Development Bank in Jeddah in 1974 and Dubai Islamic
Bank in 1975, being the first Islamic commercial bank.
6

HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING

Move towards establishing an Islamic bank in Malaysia was initiated

by various private parties

e.g during the Kongres Ekonomi Bumiputera (The Bumiputera Economic

Congress) in 1980 and at the National Seminar on Konsep Pembangunan
Dalain Islam (the Concept of Development in Islam).

A resolution was passed calling off the Government to allow LUTH

to establish an Islamic hank in Malaysia in order to mobilise and
invest the funds of the Malays and the Muslims.

Main factors contributing to the successful growth of Islamic

banking in this country:

Support and encouragement from the government

Commitment and dcdicat ion of the regulatory authority

Favourable economic environment

Creativity of the financial engineers in designing new products.

7

HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING

LUTH undertook a study on the establishment of an Islamic bank

in Malaysia.

The government accepted the proposal by LUTH and appointed a

National Steering Committee on Islamic Bank (NSC) to study
various proposals for the establishment of an Islamic bank.

The NSC was given the following tasks:

To study and identify various critical aspects of Islamic banking such

as the basis of the establishment, areas of operation and business
relationships with the customers and other financial institutions.

To examine the suitability of Islamic banking in the Malaysian context

from various points of view including religious, legal, racial, social
and development; and

To present to the Government recommendations regarding the

establishment of Bank Islam Malaysia
8

NSC REPORT ON BANK ISLAM

MALAYSIA

An Islamic bank, which operates according to the rules of Shariah,

should be established; provide services and operating profitably.

Only one Islamic bank should be established.

The proposed Islamic bank should be incorporated as a limited

company under the Companies Act 1965.

The Islamic Banking Act needs to be legislated in order to provide

for the licensing and supervision of the Islamic bank

The Central Bank should administer the Islamic Banking Act.

The proposed Islamic bank should set up a Religious Supervisory

Council to supervise the compliance of its operations with Shariah
principles.

The proposed Islamic bank should be named Bank Islam Malaysia.

STAGES OF DEVELOPMENT
Gradual and pragmatic
Milestones
1969

1983

1993

2003

Pilgrimage Fund Board

Full-fledged
Islamic banks

Bank Islam
Malaysia Bhd.

Bank Muamalat
Malaysia Bhd.

Foreign Islamic
banks

Conventional banks offer Islamic window

Islamic subsidiary

Islamic money markets

Takaful
Operators

Syarikat Takaful
Malaysia Bhd.

Takaful Nasional, Mayban Takaful, Takaful

Iklhas, Commerce Takaful

10
..achieved significant milestones in building comprehensive
and integrated
Islamic financial system with diversity of players.

DEVELOPMENTAL FOCUS

Institutional & Regulatory

Development

Enhancement of
knowledge and expertise

Product and market

development

Legal and Shariah

framework

11

1st PHASE OF DEVELOPMENT

All recommendations of the NSC Report were accepted

by the Government.

The Islamic Banking Bill was passed and the IBA came
into force on 7th April 1983.

Consequently, the Islamic bank was incorporated and

officially launched on July 1, 1983.

The establishment of BIMB marked a new milestone for

the development of the Islamic financial system in
Malaysia.

12

LEGISLATION OF THE ISLAMIC BANKING ACT

(IBA) 1983

To enable an Islamic bank to be established and operated in

Malaysia, a suitable legal framework according to the Shariah
principles should be provided.

The existing Banking Act 1973 (now replaced by BAFIA 1989),

did not conform with the principles of Islamic banking because :

It required all banks to operate on the basis of interest

Prohibited all types of trading

The Islamic Banking Act (IBA) 1983 was legislated in March 1983
provided BNM with the power to supervise and regulate Islamic
banks.

IBA was the first act to provide the necessary amendments to

allow Islamic banks to operate without interest as well as to
engage in trade and commerce.
13

THE ESTABLISHMENT AND

DEVELOPMENT OF BIMB

BIMB was incorporated as a public limited company to enable the Bank

to conduct its activitics freely without being constrained by
regulations imposed on statutory bodies.

Even though BIMB was a private company, the largest portion of its
shares should be held by the Government to generate the publics
confidence in the bank.

BIMB was established with the initial paid-up capital of RM80 million
consist of :

Malaysian Government RM30 million

LUTH RM10 million

Muslim Welfare Organization of Malaysia RM5 million

State Religious Councils RM20 million

State Religious Agencies RM3 million

Federal Agencies RM12 million

14

THE ESTABLISHMENT AND

DEVELOPMENT OF BIMB

The corporate objective of the Bank was to provide

banking facilities and services in accordance with
Islamic commercial law.

In order to supervise its operations to ensure its

compliance with the principles of Shariah, the Bank had
to set up a Shariah Supervisory Council.

BIMB was listed on the main board of the Kuala Lumpur

Stock Exchange (KLSE) on 17 January 1992

After 23 years in existence, BIMB has proven that

Islamic banking is viable and has demonstrated its
ability and capacity to operate in parallel with
conventional banks with the banking system.
15

LEGISLATION OF GOVERNMENT INVESTMENT

ACT 1983

BIMB was required to undertake short-term investments, as well as

a fund management measure to meet its liquidity requirements
prescribed by BNM.

The existing avenue for short-term investments was by way of

purchases of Government papers in the form of Malaysian
Government Treasury Bills (MGTB) and Malaysian Government
Securities (MGS) that bore interests and BIMB could not invest in
them.

The NSC proposed that the Government Investment Act (GIA) be

legislated to enable the Government to issue Government
Investment Certificates on the basis of Islamic principles.

GIA provided the solution to the problem of acquiring interestfree

short-term investments which acted as an instrument to absorb
surplus funds in the short run, a common problem faced by the
Islamic Bank in the absence of an Islamic money market.
16

ESTABLISHMENT OF SYARIKAT TAKAFUL

MALAYSIA BERHAD

The NSC was of the view that the Islamic bank was responsible in
ensuring the safety and security of its own assets and securities
against loss, damage and destruction and recommended that an
Islamic Insurance company should be established

Takaful Act were enacted in 1984 based on the Insurance Act

1973, with such modifications and amendments to conform with
the Shariah and takaful business practices.

The first Islamic insurance operator Syarikat I Takaful Malaysia

Sdn. Bhd. (STMB) was incorporated in November 1984 as a
subsidiary of BIMB

With the establishment of STMB, other subsidiaries like Syarikat

Wakalah Sdn Bhd (providing nominee and investment fund
services for the bank) and Al-Ijarah Sdn. Bhd.(providing leasing
finance) were also set up.
17

2nd PHASE OF DEVELOPMENT

The government decided that for the first 10 years there

should be only one Islamic bank before establishing other
Islamic banks.

This decision was to enable BIMB to focus on the growth of

Islamic banking and to develop as many Islamic banking
products and services as possible without any competition

By the mid of December 1993, BIMB had developed 21 Islamic

banking products and instruments covering a wide area of
banking activities.

The second phase of the development of Islamic banking

started in early 1990s when BNM outlined objective to
develop a comprehensive and vibrant Islamic banking system
operating side by side with the conventional banking system.
18

2nd PHASE OF DEVELOPMENT

During the first ten years, the development of Islamic bank emphasis on
creating a large number of different types of Islamic financial instruments.

Although BIMB was established in 1983. the Bank was still not able to serve
the entire needs of the population, due to several constrained of the
limited number of branches and resources.

The establishment of a large number of institutions offering Islamic

financial services is necessary to further develop Islamic bank. For this
purpose, three alternatives were considered by the authority:

Establish new Islamic banks

Allow the conventional banks to set up Islamic banking subsidiaries

Allow the existing conventional banking system to offer Islamic banking services

After careful consideration, the third alternative was chosen as it was

considered the most efficient and effective way of expanding Islamic
banking

19

SKIM PERBANKAN TANPA

FAEDAH (SPTF)

BNM introduced a scheme named Interest-Free Banking Scheme

(Skim Perbankan Tanpa Faedah) (SPTF) in March 1993 to allow
the existing conventional banking system to offer Islamic banking
services

Through SPTF, conventional banks were allowed to introduce and

offer Islamic banking services and facilities at their counters
using their existing infrastructure, including staff and branches.

By the end of end of June 1999, the number of participating

banking institutions increased significantly to 54, comprising 24
commercial banks, 18 finance companies, 5 merchant banks and
7 discount houses

Although the participation of the banking institutions was

voluntary, they had to comply with the requirements of the
guidelines issued by BNM.
20

SKIM PERBANKAN TANPA

FAEDAH (SPTF)

BNM has introduced various measures and policies to meet up the

requirements:

To establish an Islamic Banking Unit (IBU) to be headed by a senior Muslim banker

To create an Islamic Banking Fund (IBF) with the minimum allocation of RM1
million

To open separate current/clearing accounts for Islamic banking operations with

BNM

To register as Indirect Members under the wholesale payments system, SPEEDS

(Sistem Pcmindahan Elektronik untuk Dana dan Sekuriti) (now RENTAS)

To observe a separate cheque clearing system for Islamic banking.

To maintain separate ledgers for their Islamic banking operations.

To appoint at least one Shariah consultant to advise on operations of their Islamic

banking division.

These requirements would ensure that the banks did not co-mingle the funds
freely without proper internal controls.
21

SKIM PERBANKAN ISLAM (SPI)

In 1998, BNM replaced the SPTF with Islamic Banking Scheme (IBS) or
known as Skim Perbankan Islam (SPI) effective from 1st December 1998.

All banking institutions participating in the SPI were required to upgrade

their Islamic Banking Unit (IBU) to Islamic Banking Division (IBD) and
headed by a Muslim senior management officer of the bank and reports
to the Chief Executive Officer (CEO)

The minimum funds of Islamic banking were raised from RM 1 million to:

RM5 million for commercial banks, gradually increased to RM20 million by 31

December 2000

RM5 million for finance companies, gradually increased to RMI0 million by 31

December 2000

RM3 million for merchant banks, gradually increased to RM6 million by 31

December 2000.

Beginning from 4 January 1999, discount houses were permitted to

participate in the SPI.
22

ISLAMIC INTER-BANK MONEY

MARKET

The establishment of the Islamic money market on 3 January

1994 was the last element for the Islamic banking system to
function as a full-fledged banking system.

BNM decided to implement the Islamic Money Market based on

the concept of mudharabah or profit- sharing

The development of an Islamic money market was crucial as an

essential avenue to provide a ready source of short-term
investment based on Shariah principles in case of temporary
shortage or surplus of funds faced by Islamic banks.

The Islamic money market comprised 3 components:

Trading of Islamic Financial Instruments

Mudarabah Interbank Investments (MII)

Islamic Cheque Clearing System (ICCS)

23

ISLAMIC CAPITAL MARKET

Islamic capital market is one of the components in the overall

capital market in the country.

It functions as a parallel market to the conventional capital

market for capital seekers and providers, and plays a
complementary role to the Islamic banking system in broadening
and deepening the Islamic financial markets in Malaysia.

The government established the Securities Commission (SC) as

the sole regulatory body for the regulation and development of
capital market on 1 March 1993.

SC has identified the development of ICM as one of its main

agenda in the Capital Market Masterplan (CMMP) of Malaysia,
launched on 22 February 2001.

One of the main objectives set by the CMMP was to establish

Malaysia as an International Islamic Capital Market Centre.
24

ISLAMIC CAPITAL MARKET

The SCs efforts to develop the ICM by setting up of the necessary

infrastructure:

Establishing an Islamic Capital Market Unit (ICMU)

to carry out research and development of ICM instruments

analyzing the existing securities from Shariah perspectives

Establishing Islamic Instruments Study Group (IISG)

to advise the SC on development ICM

to study issues related to the operation of the ICM

Establishing Shariah Advisory Council (SAC) of SC

succeeded the role and function of IISG

to ensure that the operation of the ICM conform to Shariah principles

to advise the SC on all matters related to the development of the Islamic

capital market

as a reference center for issues related to Islamic capital market.

25

ISLAMIC CAPITAL MARKET

The SCs efforts to develop the ICM by broadening and strengthen the
market such as:

Analyzing existing conventional capital market instruments to determine

its validity from the Shariah perspective,

Formulating and developing new financial instruments based on Shariah

principles

Reviewing and identifying the activities companies listed on the KLSE for
the issuing of the Shariah approved counter list.

The ICM comprises :

Primary market

New issues of Islamic Government securities and the Islamic Corporate

securities are offered to the public

Secondary market,

Existing Islamic Government securities and Islamic Corporate securities are

traded; the equity market and the unit trust.
26

SHARIAH ADVISORY COUNCIL (SAC) OF

THE BNM

BNM established its Shariah Advisory Council (SAC) on Islamic

Banking and Takaful on 1 May 1997 to streamline and harmonise
the Shariah interpretations among banks and takaful companies.

The SAC took over the role of SAC of Bank Islam as the
consultant to the IBS banks pertaining to Shariah issues.

Prior to the establishment of SAC, there were some differences

in opinion among Shariah consultants on similar issues which
might obstruct the development of IBS.

The SAC is the highest authority in deciding Shariah issues

pertaining to Islamic banking and takaful operations in Malaysia.

Members of SAC comprise academicians and Shariah experts who

posses vast knowledge and experience in the areas of Islamic
banking and finance.
27

SHARIAH ADVISORY COUNCIL (SAC) OF

THE BNM

The primary objectives of NSAC are as follows:

To act as the sole authoritative body to advise BNM on

Islamic banking and takaful operations

To co-ordinate Shariah issues with respect to Islamic

banking, finance and takaful

To analyze and evaluate Shariah aspects of new products/

schemes submitted by the banking institutions and takaful
companies.

28

ESTABLISHMENT OF THE SECOND

ISLAMIC BANK

The second Islamic bank in Malaysia, Bank Muamalat

Malaysia Berhad (BMMB) was established on 1 October 1999.

The establishment of BMMB arose from the merger of Bank

Bumiputra Malaysia Berhad (BBMB)and Bank of Commerce
(M) Berhad (BOC).

Under the merger arrangement, the Islamic banking assets

and liabilities of BBMB, BOC and BBMB Kewangan Berhad
(BBMBK) were transferred in BMMB, while the conventional
operations of BBMB, BOCB and BMBK were transferred to
BOCB.

The establishment of the second Islamic bank has

contributed to the rapid growth of the Islamic banking
system.
29

DEVELOPMENT FINANCIAL
INSTITUTIONS (DFIS)

The aspiration of BNM to develop a comprehensive

Islamic banking system had stimulated the non-banking
financial intermediaries to offer Islamic banking
products and services includes:

Bank Simpanan Nasional (BSN)

Bank Kerjasama Rakyat Malaysia (BR)

Development Finance Institutions (DFIs) i.e. Bank

Pembangunan dan Infrastruktur Malaysia (BPIM) and Bank
Pertanian Malaysia (BPM).

30

3rd PHASE OF DEVELOPMENT

With the rapid development of the Islamic financial

industry on the global front, the Government has
promoted Malaysia as a regional Islamic financial centre.

The government has declared Labuan as an International

Offshore Financial Centre (IOFC) to promote Malaysia as
an international Islamic financial centre.

BNM has participated actively to enhance the

development of Islamic banking and finance such as the
formation of an International Islamic Financial Market
(IIFM) and the setting up of the Islamic Financial
Services Board (IFSB).

31

LABUAN AS AN ISLAMIC IOFC

Government has made a decision to promote Labuan as an

International Offshore Financial Centre (IOFC) to position itself
as an international center for offshore Islamic banking and
finance with the objectives:

To complement domestic financial activities in Kuala Lumpur

To strengthen the contribution of the financial services sector in

the gross national product of Malaysia

To promote the economic development of Labuan

Labuan with the status of IOFC has the advantage to attract

international banking business by:

reducing or eliminating the need for full compliance with local

capital requirements

having lower licence fees, corporate taxes and other business levies
32

INTERNATIONAHSLAMIC FINANCIAL
MARKET (IIFM)

Labuan Offshore Financial Services Authority (LOFSA) was

established and responsible for setting national objectives, policies
and priorities for the development and administration of offshore
financial services in Labuan.

In its efforts to develop Labuan as an Islamic IOFC, LOFSA worked

with Islamic scholars to identify potential offshore activities as well
as to develop viable Islamic financial instruments which would
attract Islamic investors to the Labuan

Following this, Malaysia, Bahrain, Indonesia, Sudan, Iran and the

Islamic Development Bank (IDB) established an IIFM Board April 2002

The IIFM Board was entrusted to develop and supervise the

development of the IIFM and supported by two committees, the
Market and Product Development Committee MPDC and the Shariah
Supervisory Committee (SSC).
33

INTERNATIONAHSLAMIC FINANCIAL
MARKET (IIFM)

LOFSA initiated the establishment of a global network of

Islamic financial markets known as International Islamic
Financial Market (IIFM) with the objectives:

To establish a structured global financial market that is

based on Shariah principles

To enhance the cooperative framework among Islamic

countries and financial institutions

To generate the liquidity, creation and trading of financial

instruments, thus enhancing investment opportunities and
spins-off of other related services and activities such as
custodial, brokerage and treasury.

To promote greater awareness of Islamic banking and

finance, and facilitate cross border transactions.
34

FIRST SOVEREIGN GLOBAL

ISLAMIC SUKUK

Malaysia successfully launched the first Sovereign Global

Islamic Sukuk, structured on the principle of ijarah on
25 June 2002.

The launching of the global Islamic bond signified

Malaysias strong commitment in supporting the
development of Islamic banking and finance on the
global front.

The move to access the international Islamic capital

market would give impetus to the development of the
Islamic financial market.

35

ISLAMIC FINANCIAL SERVICES

BOARD (IFSB)

Islamic Financial Services Board (IFSB) was established in 2002.

The establishment of the IFSB will set the stage for the
adaptation, harmonization and development of the
international regulatory and supervisory standards as well as
best practices for the governance of all financial institutions
offering Islamic financial services and products.

The nine founding members are Bahrain, Indonesia, Iran,

Kuwait, Malaysia, Pakistan, Saudi Arabia, Sudan and the Islamic
Development Bank, The IFSB secretariat is located in Kuala
Lumpur. Malaysia.

The Board will also contribute towards ensuring the soundness

and stability of the Islamic financial system, thus paving the
way for Islamic banking to expand globally.
36

LICENSING OF FOREIGN ISLAMIC BANKS AND

ISLAMIC BANKS SUBSIDIARIES

The financial liberation of the Islamic banking sector was

introduced on 2007 with the issuance of three new Islamic bank
licenses under the Islamic Banking Act 1983 (IBA)

The new entries of the foreign Islamic banks were in line with
the recommendations of the Financial Sector Master plan (FCMP)
to position Malaysia as an international Islamic financial hub.

The presence of foreign players will promote healthy

competition which is necessary to elevate the industry to new
levels of dynamism as well as to accelerate the global
integration the domestic Islamic banking system.

It will also promote greater economic and financial linkages

between Malaysia and the Middle East, and foster greater
harmonization in terms of Shariah interpretation and
understanding.
37

LICENSING OF FOREIGN ISLAMIC BANKS AND

ISLAMIC BANKS SUBSIDIARIES

In 2004, BNM also continued to further strengthen the

overall infrastructure development of the Islamic
banking system as the Islamic banking industry entered
a more advanced stage of development.

The window-based institutional structure was reviewed

to further strengthen and elevate the development of
domestic Islamic banking industry through a new
enabling institutional structure.

The domestic banking groups and foreign Islamic

Banking Scheme (IBS) banks were encouraged to set up
Islamic subsidiaries (IS) as full-fledged Islamic banks
which would be licensed under the IBA.
38

FINANCIAL SECTOR MASTER PELAN FOR

ISLAMIC BANKING

Financial Sector Master Pelan was launched on March

2001 incorporates 10 years master plan for Islamic
banking a

FSMPs aim is to create an efficient, progressive and

comprehensive Islamic financial system that contributes
significantly to the effectiveness and efficiency of then
Malaysian financial sector.

FSMP provides recommendations which focus on three

main areas:

institutional capacity enhancement

financial infrastructure development

regulatory framework development

39

VISION OF ISLAMIC BANKING AND

TAKAFUL

Constitute 20% of the banking and insurance market share with an

effective contribution to the financial sector of the Malaysian
economy

Represented by a number of strong and highly capitalized IBIs and

takaful operators offering a comprehensive and complete range of
Islamic financial products and services

Underpinned by a comprehensive and conducive Shariah and

regulatory framework;

Supported by a dedicated institution (Shariah commercial court) in

the judiciary system that addresses legal issues related to Islamic
banking and takaful

Supported by a sufficient number of well-trained, high caliber

individuals and management teams with the required expertise;

Malaysia as a regional Islamic financial center.

40

CONCLUSION

Islamic banking system has experienced a rapid growth and

tremendous development since its first debut in 1983

Various measures have been adopted by the authorities in

implementing the Islamic banking system with a step by
step and open-minded approach with each step taken after
careful consideration of all implications.

In order to he a viable Islamic banking system, all the basic

elements towards this purpose were being established by
the authority.

These include a large number of products, instruments and

institutions and the establishment of an Islamic money and
capital market which would link the institutions and the
instruments.
41

END OF CHAPTER

42