Malaysian Authorities & Islamic Banking

Having painted broadly the overview of Islamic financial landscape in Malaysia, it is useful to discuss the approaches undertaken by Bank Negara Malaysia (BNM) in the development of the Islamic banking system in Malaysia. These include:

1. Dual banking system
2. Gradual implementation
3. Providing adequate infrastructure
4. Optimizing available opportunities
5. Openness.

Dual Banking System: Malaysian-Islamic banking system is operating side-by-side with the conventional banking system. Most of the other countries, particularly Muslim countries, have either tried a full-fledged Islamic banking system or conventional system with a few Islamic banks or a totally conventional banking system. Primarily it is because of the existing religious and ethnic divide in Malaysia; such an approach provides Malaysian Muslims a choice to bank in a system that is in line with their religious belief, while non-Muslims can continue with the conventional system. Thus, it provided an alternative to Muslims who had restrained themselves from using the conventional riba-based banking system.

Secondly, a dual banking system provides a complete and comprehensive banking alternative to Malaysians. This means that a wider and diversified range of Islamic banking products and services will be made available in banking institutions that offer Islamic banking. This is possible because there is not only an Islamic bank, but also other supporting banking institutions such as commercial banks, finance companies, merchants banks, Takaful companies, securities firms, savings institutions and rural co-operative banks. Islamic financial services are also available in the financial markets such as Islamic Money Market and the Islamic Capital Market.

Thirdly, the menu of Islamic financial products in a dual banking system tends to be more comprehensive and wider. In a competitive environment, where conventional banking tends to be a competitor, Islamic banking operators have to be innovative and creative to ensure that their products are superior to or at least at par with the conventional products. Therefore, the elements of efficiency and innovation are vital to ensure Islamic banking will remain relevant and able to capture a fair share of the banking system. The operators certainly cannot afford to remain complacent.

Finally, it is a fact that the conventional banking system is in a sophisticated and advanced environment. Hence, Islamic banking has no choice but to keep up with the sophistication and advancement of the banking system. This element has been the plus factors on why Islamic banking products available in Malaysia are at a relatively advanced stage. Islamic banking operators have to be dynamic and pro-active in their pursuit to position Islamic banking in the mainstream banking.

Gradual Implementation: The first Islamic bank was established in Malaysia in 1983. Since then, the establishment of an Islamic financial system has undergone radical transformation particularly in the last five years. Fundamentally, the timeline of the Islamic financial landscape may be characterized by three stages of development:

1. 1983-90 :              monopolistic years
2. 1990-94 :              developing years
3. 1994-onwards :                       take-off years

The first stage of Islamic banking may be dubbed as monopolistic years, but with a cause. The rationale to confine Islamic banking within the structure of a single Islamic bank was to allow the Islamic bank to operate in a smooth manner without undue competition which may hinder the progress of Islamic banking. There was an understanding that the Islamic bank would be given a grace period of 10 years before the government decides to establish another Islamic bank.

The second stage was the developing years beginning 1990 when BNM embarked on the project to disseminate Islamic banking on a nation-wide basis, with as many players as possible and able to reach all Malaysians. Towards this end, BNM considered three options:

1. Allow the setting up of new Islamic banks.
2. Allow the existing financial institutions to set up subsidiaries to offer Islamic banking services.
3. Allow existing financial institutions to offer Islamic banking services using their existing infrastructure and branches.

After a careful consideration of various factors, BNM decided on the third option as the best approach to disseminate Islamic banking throughout the country and as a medium for the development of an Islamic banking system. This option was seen as the most effective and efficient mode of increasing the number of institutions offering Islamic banking services at the lowest cost and within the shortest time frame. It also allowed the existing infrastructure of the banking system including the existing branches and staff to be tapped in offering Islamic banking services.

However, before making a final decision, BNM consulted a number of prominent Islamic jurists whether such approach is in line with the Shari‘ah. The feedback received was overwhelming. BNM received full support from the jurists who applauded the move as a positive step. The reasoning: “if you cannot implement it all together, do not ignore it all together,” was the strongest point to back-up the policy.

Following the above in March 1993, BNM introduced the Skim Perbankan Islam or SPI (previously known as Skim Perbankan Tanpa Faedah). The scheme allows conventional financial institutions to offer Islamic banking services alongside their conventional banking services. Three commercial banks were selected for the pilot test and by end of 1993, 18 banking institutions participated in the scheme. The number of products about 22 was considered adequate while the infrastructure of the Islamic Money Market was already in place by end 1993.

The third stage was the take-off period where various measures were implemented to strengthen the Islamic banking system. This includes the introduction of the Islamic Money Market in January 1994, separate disclosure for SPI banking operations in October 1996, opening of full-fledged SPI banking branches beginning 1996 and the harmonization of Shari‘ah issues via the formation of the central Shari‘ah Advisory Council at BNM in May 1997.

At present, Malaysia is riding on the take-off stage and the growth of Islamic banking is being monitored closely to make it more resilient and robust. The assets of Islamic banking have grown from only RM2.4 billion (US$0.6 billion) in 1993 to RM29.9 billion (US$7.9 billion) as at end-May 1999. Deposits increased significantly from only RM2.3 billion (US$0.6 billion) in 1993 to RM22.9 billion (US$6 billion) while financing increased from only RM1 billion (US$0.3 billion) in 1993 to RM11.7 billion (US$3.1 billion) during the same period. The number of institutions participating in the SPI has also increased from only three players at launching stage to 54 players, comprising 24 commercial banks, 18 finance companies, 5 merchant banks and 7 discount houses. Islamic Money Market also recorded a sharp increase from only a humble RM2.1 billion (US$0.6 billion) in 1994 to RM18.3 billion (US$4.8 billion) as at end 1998. Islamic debt securities which has become a popular feature in the domestic private debt market has managed to capture 20.04% of the total PDS markets, with an outstanding amount of RM17.1 billion (US$4.5 billion) as at end-April 1999.

The gradual implementation has been instrumental in bringing Islamic banking to where it is today. It has not been the intention, particularly in the Malaysian context, to call for a total replacement of the conventional banking system since the move may not only be unwise, but also may not meet the requirements of the economy. Thus, keeping in view the success level, Malaysia, in all probability, will continue with the current approach to develop Islamic banking.

Providing Adequate Infrastructure: The genesis of the present Islamic financial structure began with the institutional building undertaken since 1983. However, since there was only one Islamic bank, the structure was not complete as a banking system must have a large number of players, a broad variety of instruments, an inter-bank market to provide the matching mechanism between the deficit and surplus units. Some important components of the present infrastructure of the Islamic banking system in Malaysia may be summarized as follows:

1. Legal set-up, legal provisions: This is carried out through the Islamic Banking Act 1983 for the Islamic bank and the banking and financial institutions 1989 for the SPI banking institutions.
2. Regulatory framework: BNM provided the necessary framework such as the statutory requirements, liquidity requirement, prudential guidelines (such as the guidelines on SPI and on the Islamic Money Market) and constant monitoring of the Islamic bank and SPI banks operations through off-site on-site supervision. Bnm has also established a special unit in the bank to carry out strategic planning and formulate policies for Islamic banking.
3. Financial disclosure: This is carried out via the gp8 (Garispanduan or ‘Guidelines’ issued to banks to aid them in adhering to bnm Regulatory Requirements). A model financial statement requires spi banks to disclose their Islamic banking operations as part of the principal financial statements. The disclosure, as part of the notes to the accounts entails the balance sheet and the p&l of the Islamic banking operations during the financial year. Bnm is also working closely with the Malaysian Accounting Standard Board to study the various accounting standards developed by the Accounting and Auditing Organization for Islamic Financial Institutions based in Bahrain.
4. Payment systems: The country already has sound and reliable payment, clearing and settlement system to ensure the process of settling monetary transactions are completed in a timely manner. The crucial issue in Islamic banking is the segregation of funds to avoid co-mingling between Islamic and conventional funds. To facilitate such arrangement, bnm has required the spi banks to open and maintain separate current and clearing accounts with the Central Bank. This has resulted in each spi bank maintaining two account numbers with the Central Bank, i.e. conventional account and Islamic account. In addition, the spi banks are also required to maintain separate member accounts for funds transfer and payments. The separate payment system devised for Islamic banking has avoided possible abuse in terms of wrongful accounting entries by the spi banks with respect to Islamic banking operations.
5. Central Shari‘ah Board: Realizing that differences in interpretations in Shari‘ah might not be healthy for a relatively young Islamic banking system, bnm established the National Shari‘ah Advisory Council in 1997, empowered as the sole authority to issue opinions and decisions in Islamic banking and Takaful. Although the Islamic bank and the spi banks appointed Shari‘ah advisers to advise them on day-to-day operations, they are required to refer to bnm on policy-related Shari‘ah issues.

Optimizing available opportunities: bnm is of the view that the most appropriate strategy is to optimize opportunities, particularly on the wide array of instruments already available in the market. While the pure Islamic instruments, like mudharaba investment account and musharaka financing, which are universally accepted and recognized, Malaysia also has the conventional financial instruments which bnm feels could be Islamized. What Malaysia has done is to first identify the Islamic and un-Islamic elements in the instrument. Later, the un-Islamic features in the instrument were replaced with Islamic elements. Islamic accepted bills and negotiable instruments are such examples. Through this approach, Malaysia has managed to increase the number of instruments in the shortest time possible. Given the abundance of banking products available in the market, it is only realistic to capitalize and optimize the opportunities. Notwithstanding that encouragement to innovations remain there, because innovations are still the key factor to differentiate Islamic banking products from conventional products.

Openness: Malaysia has also been successful in that the various Islamic schools of thoughts have adopted an open approach with regard to differences in interpretations in the field of Islamic banking. Malaysia’s stance is quite simple. It is to respect all the recognized schools of thoughts (mazhabs) on differences in opinions. The rule of thumb is to treat all products, minus the riba as permissible. As long as even only one mazhab recognizes a concept as acceptable from the Shari‘ah point of view, the product will be classified as permissible. If there is any ambiguity and the solution is not available directly from the Qur’an, Sunnah, ijma’ and qias, the Central Shari‘ah Board may carry out ijtihad. So far, the process has been smooth barring a very few occasions when the Malaysian interpretations on some Shari‘ah issues have raised questions by others

Source: Towards Islamic Banking: Experience and Challenges, Institute of Policy Studies. Republished with permission.