The document discusses the critical roles of monetary policy and payment systems in banking, focusing on their definitions, tools, and objectives. It emphasizes the alignment of these elements with Islamic principles, which prohibit interest and promote ethical financial practices. Furthermore, the document reviews various payment systems, including conventional and shariah-compliant methods, and highlights challenges and opportunities in modern banking environments.

1. 1
CHAPTER 6: MONETARY POLICY
AND PAYMENT SYSTEM IN
BANKING
By: Major Dr. Mohd Adib Abd Muin, IFP, CQIF (Wealth Management)
Senior Lecturer
Islamic Business School (IBS)
Universiti Utara Malaysia
BIBCJ2013 - ISLAMIC BANKING

2. BIBCJ2013 - ISLAMIC BANKING
OUTLINE
1. INTRODUCTION
2. THE DEFINITION AND OBJECTIVES OF MONETARY POLICY
3. MONETARY POLICY TOOLS
4. PAYMENT SYSTEM IN BANKING
5. WHOLESALE PAYMENT SYSTEM (EFPOST, CHIPS & ACH)
6. CREDIT SYSTEM – CCRIS & CTOS
7. CONCLUSION
2

3. BIBCJ2013 - ISLAMIC BANKING 3
INTRODUCTION
 Monetary policy and payment systems play a crucial role in the stability and functionality of the banking sector
and the broader economy. Monetary policy, primarily executed by central banks, involves the regulation of
money supply and interest rates to achieve macroeconomic objectives such as inflation control, economic
growth, and employment stability. Through tools such as open market operations, reserve requirements, and
discount rates, central banks influence liquidity in the financial system and guide economic activities.
 Payment systems, on the other hand, are the mechanisms through which financial transactions are conducted
and settled. These systems facilitate the transfer of money between individuals, businesses, and financial
institutions, ensuring efficiency, security, and reliability in economic exchanges. Advanced payment systems are
critical for modern banking as they support seamless transactions, reduce settlement risks, and enable digital
and cross-border payments.
 In the context of Islamic banking, monetary policy and payment systems must align with Shariah principles,
which prohibit interest (riba) and encourage risk-sharing and ethical financial practices. This unique dimension
adds complexity to how monetary tools and payment mechanisms are developed and implemented. For
instance, Islamic financial institutions often rely on profit-sharing contracts and non-interest-based instruments
in their operations.
 This introduction sets the stage for an exploration of how monetary policy and payment systems intersect in
banking, their implications for financial stability, and how Islamic principles influence these processes.

4. BIBCJ2013 - ISLAMIC BANKING 4
DEFINITION OF MONETARY POLICY
 Monetary policy refers to the strategic actions undertaken by a central bank or
monetary authority to control the money supply, influence interest rates, and
regulate credit availability in an economy.
 Its primary goal is to manage economic stability by influencing inflation,
employment, and overall economic growth.
 Central banks, such as the Federal Reserve (U.S.), Bank Negara Malaysia, or the
European Central Bank, use monetary policy as a key tool to achieve
macroeconomic goals.
 Monetary policy can be broadly categorized into two types:
 Expansionary Monetary Policy: Designed to increase the money supply and lower interest rates to
stimulate economic growth, particularly during periods of economic recession or low inflation.
 Contractionary Monetary Policy: Aimed at reducing the money supply and increasing interest rates to
curb inflation and prevent overheating in the economy.

5. BIBCJ2013 - ISLAMIC BANKING 5
OBJECTIVES OF MONETARY POLICY
The main objectives of monetary policy vary by country and economic context, but generally include the following:
1. Price Stability
1. Ensuring stable inflation rates to maintain the purchasing power of money and foster confidence in the economy.
2. Economic Growth
1. Promoting sustainable economic expansion by creating a favorable environment for investment and production.
3. Full Employment
1. Achieving a high level of employment by ensuring that monetary conditions support job creation and economic activity.
4. Exchange Rate Stability
1. Maintaining stable exchange rates to facilitate international trade and investment, as well as to prevent excessive currency volatility.
5. Control of Inflation and Deflation
1. Managing the money supply to prevent extreme inflation (rapid increase in prices) or deflation (rapid decrease in prices), both of which can
destabilize the economy.
6. Balance of Payments Stability
1. Ensuring that the country’s external financial transactions (exports, imports, and capital flows) are in equilibrium to avoid excessive foreign
debt or reserve depletion.
7. Credit Availability and Financial Stability
1. Facilitating smooth functioning of the financial markets and ensuring that sufficient credit is available to support productive sectors of the
economy.

6. BIBCJ2013 - ISLAMIC BANKING 6
MONETARY POLICY TOOLS
Monetary Policy Tools
 Monetary policy tools are instruments used by central banks or
monetary authorities to achieve macroeconomic objectives
such as price stability, economic growth, and employment.
These tools can be categorized into conventional and, in the
context of Islamic finance, Shariah-compliant methods.
1. Conventional Monetary Policy Tools
2. Shariah-Compliant Monetary Policy Tools

7. BIBCJ2013 - ISLAMIC BANKING 7
1. Conventional Monetary Policy Tools
These tools are commonly used by central banks in traditional financial systems.
a. Open Market Operations (OMO)
The central bank buys or sells government securities in the open market to regulate liquidity.
 Expansionary OMO: Buying securities injects liquidity into the banking system, lowering
interest rates and encouraging borrowing.
 Contractionary OMO: Selling securities withdraws liquidity, raising interest rates and
reducing borrowing.
b. Reserve Requirement Ratio (RRR)
The percentage of deposits that commercial banks are required to hold as reserves at the
central bank.
 Lowering RRR: Increases the money supply by allowing banks to lend more.
 Raising RRR: Reduces the money supply by restricting the amount banks can lend.

8. BIBCJ2013 - ISLAMIC BANKING 8
Cont..
c. Discount Rate
The interest rate at which commercial banks borrow from the central bank.
 Lower Discount Rate: Encourages borrowing by banks, leading to increased money supply.
 Higher Discount Rate: Discourages borrowing, reducing money supply.
d. Interest Rate Policy
Adjusting the benchmark interest rate (e.g., Federal Funds Rate) influences borrowing and lending activities.
 Lower Interest Rates: Stimulates spending and investment.
 Higher Interest Rates: Reduces spending and controls inflation.
e. Quantitative Easing (QE)
• A non-traditional tool where the central bank purchases long-term securities to inject liquidity and
stimulate the economy.
• Used during periods when traditional tools are insufficient, such as during recessions.

9. BIBCJ2013 - ISLAMIC BANKING 9
2. Shariah-Compliant Monetary Policy Tools
Islamic financial systems adapt conventional tools to align with Islamic principles, which prohibit interest (riba) and speculative activities.
a. Open Market Operations with Sukuk
 Instead of interest-based securities, central banks issue and trade Shariah-compliant instruments like Sukuk (Islamic bonds) to
regulate liquidity.
 For example, purchasing Sukuk injects liquidity into the economy while adhering to Islamic rules.
b. Islamic Reserve Requirements
 Similar to RRR but structured to ensure compliance with Shariah, often based on risk-sharing and ethical principles.
c. Profit-Sharing Ratios
 Instead of using interest rates, Islamic banks adjust the profit-sharing ratio in partnership contracts (e.g., Mudarabah or
Musharakah) to influence investment and savings behavior.
d. Liquidity Management Instruments
 Islamic financial institutions use tools like Commodity Murabahah or Wakalah agreements to manage liquidity while avoiding
interest.
e. Zakat and Waqf
 Unique to Islamic finance, Zakat (mandatory charity) and Waqf (endowment) mechanisms can indirectly influence monetary policy by
redistributing wealth and promoting social welfare.
f. Islamic Interbank Money Market (IIMM)
 A platform for short-term borrowing and lending between Islamic banks using Shariah-compliant contracts, facilitating liquidity
management.

10. BIBCJ2013 - ISLAMIC BANKING 10
PAYMENT SYSTEM IN BANKING
 A payment system in banking refers to the set of mechanisms,
technologies, institutions, and rules that facilitate the transfer
of money between entities—individuals, businesses, and
financial institutions—efficiently, securely, and reliably.
 Payment systems are a critical component of the financial
infrastructure, enabling economic activity and trade.

11. BIBCJ2013 - ISLAMIC BANKING 11
Key Components of a Payment System
1. Payment Instruments
1. Tools used to initiate payments, such as cash, cheques, credit/debit cards, electronic transfers, and mobile payments.
2. In Islamic banking, these instruments must comply with Shariah principles, avoiding interest and speculative
elements.
2. Payment Processing
1. The mechanism through which payment instructions are executed, involving clearing and settlement.
2. Clearing: Validating and matching payment information between parties.
3. Settlement: Finalizing the transaction by transferring funds.
3. Clearing and Settlement Systems
1. Centralized systems (e.g., Real-Time Gross Settlement - RTGS) ensure that funds are transferred between financial
institutions in real time.
2. Deferred net settlement systems batch transactions and settle them periodically.
4. Regulatory Framework
1. Rules and standards set by central banks and financial regulators ensure the security, efficiency, and compliance of
payment systems.

12. BIBCJ2013 - ISLAMIC BANKING 12
Types of Payment Systems in Banking
1. Traditional Payment Systems
1. Cash-Based Systems: Physical currency used for direct transactions.
2. Cheque-Based Systems: Written instructions to banks for transferring money.
2. Electronic Payment Systems
1. Automated Clearing House (ACH): Processes batches of electronic payments for salaries, bill payments, and direct deposits.
2. Real-Time Gross Settlement (RTGS): Processes high-value payments instantly, used for interbank transactions.
3. Electronic Funds Transfer (EFT): Transfers money electronically across accounts, often used for retail payments.
3. Card-Based Systems
1. Debit and credit cards linked to banking accounts enable point-of-sale (POS) transactions and online payments.
4. Mobile and Internet-Based Systems
1. Payment platforms like mobile wallets (e.g., Apple Pay, Google Pay) and banking apps facilitate easy money transfers.
2. Islamic banks often offer customized digital wallets with Shariah-compliant features.
5. Cryptocurrency and Blockchain Systems
1. Decentralized digital currencies and blockchain technology offer secure and efficient payment systems.
2. Islamic finance evaluates cryptocurrencies for compliance with Shariah, focusing on transparency and the avoidance of
speculative elements.

13. BIBCJ2013 - ISLAMIC BANKING 13
Payment Systems in Islamic Banking
Islamic banks follow Shariah principles to ensure their payment systems do not involve:
1. Riba (Interest): Payments or receipts involving interest are strictly prohibited.
2. Gharar (Uncertainty): Payment instruments must avoid ambiguity in contractual terms.
3. Haram Activities: Payments must not be associated with prohibited activities.
Features of Shariah-Compliant Payment Systems
 Shariah-Compliant Contracts: Modes like Murabahah, Musharakah, and Mudarabah are
integrated into digital payment solutions.
 Zakat and Waqf Integration: Platforms for collecting and distributing Zakat or
managing Waqf funds.
 Ethical Governance: Ensuring transactions are fair, transparent, and aligned with Islamic
ethics.

14. BIBCJ2013 - ISLAMIC BANKING 14
Challenges in Payment Systems
1. Security Concerns: Cybersecurity threats to electronic
payment platforms.
2. Interoperability: Difficulty in integrating different payment
platforms.
3. Shariah Compliance: Ensuring every aspect of the system
adheres to Islamic law.
4. Accessibility: Ensuring rural and underbanked populations
have access to modern payment systems.

15. BIBCJ2013 - ISLAMIC BANKING 15
Opportunities for Payment Systems in Islamic
Banking
1. Digital Transformation: Islamic banks can leverage fintech to
offer efficient, Shariah-compliant payment systems.
2. Global Trade: Facilitating cross-border payments for Islamic
finance markets.
3. Financial Inclusion: Digital payment systems can help include
underserved Muslim populations in the banking system.
4. Integration with AI: AI-powered platforms can optimize
payment processing while adhering to ethical principles.

16. BIBCJ2013 - ISLAMIC BANKING 16
1. WHOLESALE PAYMENT SYSTEM (EFPOST, CHIPS &
ACH)
 Wholesale payment systems are designed to process large-
value and time-critical payments between financial institutions
and other large entities.
 These systems form the backbone of the financial
infrastructure, facilitating transactions that are critical for both
domestic and international economic activities.
1. EFPOST (Electronic Funds Transfer at Point of Sale)
2. CHIPS (Clearing House Interbank Payments System)
3. ACH (Automated Clearing House)

17. BIBCJ2013 - ISLAMIC BANKING 17
EFPOST (Electronic Funds Transfer at Point of Sale)
Definition
 EFPOST refers to systems that process transactions where funds are transferred electronically at the point of sale.
 Though primarily used in retail contexts, EFPOST also supports business-to-business (B2B) transactions, making it
relevant in wholesale contexts.
Key Features
 Real-time processing: Transactions are approved or declined almost instantaneously.
 Secure payment channels: Encrypted communications protect sensitive information.
 Interbank settlements: Final fund transfers are managed through the interbank system.
Applications in Wholesale
 Used by businesses for purchasing inventory or supplies.
 Integrated into corporate expense management systems.
Advantages
 Speed: Payments are processed in real-time or near-real-time.
 Efficiency: Reduces paperwork and delays associated with traditional payment methods.
 Security: Enhances trust through secure and auditable transactions.

18. BIBCJ2013 - ISLAMIC BANKING 18
2. CHIPS (Clearing House Interbank Payments
System)
Definition
 CHIPS is a U.S.-based private sector real-time gross settlement (RTGS) system that processes high-value
payments.
 Operated by the Clearing House Payments Company, CHIPS handles domestic and international dollar payments.
Key Features
 Large-value payments: Primarily used for transactions exceeding $1 million.
 Real-time netting: CHIPS uses a centralized netting process to minimize the settlement amounts.
 Finality: Once settled, payments are irrevocable and final.
Applications in Wholesale
 Settlement of interbank loans and large commercial transactions.
 Used in foreign exchange markets and securities trading.
Advantages
 Cost-efficient: Netting significantly reduces the amount of liquidity required for settlement.
 Reliability: Supports a high volume of transactions with robust infrastructure.
 Integration: Compatible with global financial systems for cross-border transactions.

19. BIBCJ2013 - ISLAMIC BANKING 19
3. ACH (Automated Clearing House)
Definition
 ACH is an electronic network that processes batch payments, primarily for domestic transactions.
 It is used for both debit and credit transfers, enabling bulk payments for businesses and institutions.
Key Features
 Batch processing: Transactions are grouped and processed in scheduled batches.
 Lower cost: ACH transfers are generally more cost-effective than wire transfers.
 Versatility: Supports payroll, direct deposits, vendor payments, and more.
Applications in Wholesale
 Payroll disbursement for large organizations.
 Payment of recurring bills or subscriptions for corporate services.
 Vendor payments in supply chain management.
Advantages
 Scalability: Processes a large volume of transactions efficiently.
 Cost-effectiveness: Lower fees compared to other wholesale systems like wire transfers.
 Reliability: Consistent and widely adopted in banking and business environments.

20. BIBCJ2013 - ISLAMIC BANKING 20
Comparison of EFPOST, CHIPS, and ACH

21. BIBCJ2013 - ISLAMIC BANKING 21
CREDIT SYSTEM: CCRIS & CTOS
 In the context of financial systems, the credit system plays a
pivotal role in assessing and managing the creditworthiness of
individuals and businesses.
 Two critical components of the credit system in Malaysia are
CCRIS and CTOS. These systems support lenders in making
informed credit decisions while promoting financial discipline
among borrowers.

22. BIBCJ2013 - ISLAMIC BANKING 22
1. CCRIS (Central Credit Reference Information
System)
1Definition
 CCRIS is a centralized system established and operated by Bank Negara Malaysia (BNM).
 It compiles credit information from financial institutions in Malaysia to provide a comprehensive report on borrowers.
How CCRIS Works
 Financial institutions submit credit data to CCRIS on a monthly basis.
 CCRIS generates a Credit Report summarizing a borrower's credit facilities, including loans, credit cards, and payment
histories.
 The information includes outstanding balances, repayment behavior, and overdue accounts.
Key Features of CCRIS
1. Objective and Centralized: Information is factual and unbiased, coming directly from financial institutions.
2. Comprehensive Reports: Covers all active credit accounts, including defaults and delinquencies.
3. Accessible by Borrowers: Individuals can access their CCRIS report via BNM's credit bureau.
Purpose of CCRIS
 Helps lenders evaluate the creditworthiness of potential borrowers.
 Promotes financial transparency and accountability among borrowers.
 Assists in reducing credit risks within the banking sector.

23. BIBCJ2013 - ISLAMIC BANKING 23
2. CTOS (Credit Tip-Off Service)
Definition
 CTOS is a private credit reporting agency in Malaysia.
 It collects and maintains credit-related information from both private and public sources.
How CTOS Works
 Gathers data from legal proceedings, trade references, bankruptcy filings, and financial institutions.
 Compiles a Credit Report that includes personal identification, directorships, legal cases, and repayment
behavior.
Key Features of CTOS
1. Wide Data Sources: Includes information beyond banking institutions, such as court cases and trade credit.
2. Customizable Reports: Reports can be tailored for specific industries or credit assessments.
3. Real-Time Updates: Data is continuously updated for accuracy and relevance.
Purpose of CTOS
 Supports lenders in assessing credit risks with detailed background checks.
 Encourages borrowers to maintain good credit behavior by tracking their public financial records.
 Provides a broader picture of creditworthiness beyond the banking sector.

24. BIBCJ2013 - ISLAMIC BANKING 24
Differences Between CCRIS and CTOS

25. BIBCJ2013 - ISLAMIC BANKING 25
Challenges in Credit Systems
1. Data Privacy Concerns: Protecting sensitive borrower
information while maintaining transparency.
2. Awareness Among Borrowers: Many borrowers may not
understand how CCRIS and CTOS reports impact their
financing applications.
3. Integration with Islamic Principles: Ensuring that the credit
evaluation process aligns with ethical and Shariah standards.

26. BIBCJ2013 - ISLAMIC BANKING 26
CONCLUSION
 The integration of monetary policy and the payment system forms the backbone of a robust and efficient
banking sector. Monetary policy serves as a critical tool for managing a nation’s economic stability by
regulating money supply, controlling inflation, and ensuring sustainable economic growth. The tools of
monetary policy, such as open market operations, reserve requirements, and interest rate adjustments,
provide central banks with mechanisms to influence credit availability and economic activity.
 Simultaneously, the payment system ensures the seamless transfer of funds within the financial system,
enabling transactions across various stakeholders, from individuals to corporations. Advancements in payment
systems, particularly through innovations like EFPOST, CHIPS, ACH, and credit information systems like CCRIS
and CTOS, have enhanced the efficiency, transparency, and security of financial transactions. These systems
promote financial inclusion, reduce transaction risks, and support the broader objectives of economic policy.
 In Islamic banking, both monetary policy and payment systems must align with Shariah principles,
emphasizing fairness, transparency, and the avoidance of riba (interest). The integration of modern
technologies with Islamic financial ethics presents an opportunity to create innovative solutions that address
the unique needs of the Islamic banking ecosystem.
 Ultimately, the synergy between monetary policy and payment systems underpins the stability and resilience
of the banking sector, fostering trust and efficiency while supporting economic development in both
conventional and Islamic frameworks.

27. BIBCJ2013 - ISLAMIC BANKING 27
Q & A