This document provides an overview of the Malaysian Islamic financial system. It discusses the key players and markets in the Malaysian financial system as well as the basic principles of Islamic finance. The history and development of Islamic banking in Malaysia is then outlined, including the establishment of the first Islamic bank in 1983 and the adoption of a dual banking system. Current statistics on Islamic banking and takaful in Malaysia are also presented.

1. Management of Banking and Takaful Institutions Lecturer: Mr. Abdullaah Jalil 06/02/09 2006 (C) Abdullaah MBA4013 Semester I, Session 2006/2007 Lecture 1: Introduction of the Malaysian Islamic Financial System

2. Lecture Outlines Malaysian Financial System Islamic Financial System Malaysian Islamic Financial System History and Development of the (Malaysian) Islamic Banking System Flows of Funds (A Perspective) 06/02/09 2006 (C) Abdullaah

3. Malaysian Financial System 06/02/09 2006 (C) Abdullaah Players Instruments Markets Regulators

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5. Malaysian Financial System 06/02/09 2006 (C) Abdullaah Money & Forex Markets Capital Markets Derivatives Markets Offshore Markets Money Market Interbank Money Market Forex Equity Market Bond Market -Public DS -Private DS Commodity Futures KLSE CI Futures KLIBOR Futures Labuan International Offshore Financial Centre (IOFC) MARKETS BNM SC MCC Commodities Trading Commission

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7. Islamic Financial System The basic principles of Islamic financial system (Zamir Iqbal, n.d.): Prohibition of riba Risk sharing Money as a “potential” capital Prohibition of speculative behavior Sanctity of contracts Shariah-approved activities 06/02/09 2006 (C) Abdullaah

8. Islamic Financial System Banking is the most developed part of the Islamic financial system. Banking systems to be fully compatible with Islamic law. i.e. Iran, Pakistan & Sudan. Islamic banking exists alongside conventional banking. E.g. Malaysia, Gulf Countris Islamic banking is a part of the system. 06/02/09 2006 (C) Abdullaah

9. Islamic Financial System 06/02/09 2006 (C) Abdullaah Conventional-plus Dual-financial system Totally Islamic

10. Islamic Financial System Issues and challenges: Islamic banking by itself cannot take root in the absence of the other necessary components of an Islamic financial system. A uniform regulatory and legal framework is needed. Establishing a single, sizable, and organized financial center that functions in accordance with Islamic principles. The pace of innovation is slow. needs sound accounting procedures and standards. There is lack of uniformity in the religious principles applied in Islamic countries. 06/02/09 2006 (C) Abdullaah

11. Malaysian Islamic Financial System Overview of Islamic Banking in Malaysia Islamic Banking Concepts List of Financial Institutions Offering Islamic Banking Services Range of Islamic Banking Products and Services in Malaysia The National Syari'ah Advisory Council Government Investment Issues Islamic Inter-bank Money Market Islamic Banking Statistics TAKAFUL Overview of Takaful in Malaysia Registered Takaful Operators Takaful Key Statistics 06/02/09 2006 (C) Abdullaah Go to: www.bnm.gov.my

12. Definition Islamic Bank: The Organisation of Islamic Conference (OIC): A financial institution whose statutes, rules and procedures expressly state its commitment to the principles of Islamic Shari’ah and to the banning of the receipt and payment of interest on any of its operations. Islamic Banking Act / 1983 of Malaysia: A company which carries on Islamic banking business. Islamic banking means "banking business whose aims and operations don't involve any element which is not approved by the religion Islam.” M. Aslam Saleemi: A financial institution which operates with the objective of implementation of the economic and financial principles of Islamic Shariah in the arena of banking. 06/02/09 2006 (C) Abdullaah

13. Definition Islamic Windows: Islamic windows are special facilities offered by conventional banks to provide services to Muslims who wish to engage in Islamic banking. (Zamir Iqbal) In Malaysia: Islamic Banking Scheme (IBS) banks can be defined as a conventional bank that participates in Islamic banking operations. (Saiful Azhar Rosly) The conventional banks than have divisions dedicated to Islamic financial services. (www.econresearch.com) 06/02/09 2006 (C) Abdullaah

14. History and Development of the (Malaysian) Islamic Banking System 06/02/09 2006 (C) Abdullaah

15. 06/02/09 2006 (C) Abdullaah The Development of Malaysian Islamic Banking 1983 Enactment of: (1) Islamic Banking Act 1983 (2) Government Investment Act 1983 (now replaced with Government Investment Issues - GIIs) July 1983 The establishment of Bank Islam Malaysia Berhad (BIMB) as the first Islamic bank in Malaysia Jan 1992 BIMB was listed on the main board of the Kuala Lumpur Stock Exchange with 80 branches and 1,200 employees throughout the country.

16. Dual Banking System 06/02/09 2006 (C) Abdullaah Dual Banking System VISION STATEMENT IN 1990 To create a comprehensive Islamic financial system side-by-side with the conventional financial system. 1990 BNM Governor outlined BNM’s vision to create a comprehensive financial system side-by-side with conventional financial system – was further refined to reflect profound changes in the banking system

17. Dual Banking System 06/02/09 2006 (C) Abdullaah BNM decided to allow the existing banking institutions to offer Islamic banking services using their existing infrastructure and branches. 4 March 1993 BNM introduced a scheme known as "Skim Perbankan Tanpa Faedah“/ SPTF on a pilot basis involving 3 banks. July 1993 Following the successful implementation of the pilot-run, BNM opened the scheme to the commercial banks, finance companies, and merchant banks subject to specific guidelines.

18. 06/02/09 2006 (C) Abdullaah Dual Banking System 4 Jan 1994 To link the institutions and the instruments, the Islamic Interbank Money Market (IIMM) was introduced. Oct 1996 BNM issued a model financial statement for the banking institutions participating in the SPI requiring the banks to disclose the Islamic banking operations (balance sheet and profit and loss account) as an additional item under the Notes to the Accounts. 1998 As part of the overall review on Islamic banking, the usage of the term SPTF was revisited and it was found that the term did not portray the right appearance with respect to the Islamic banking operations undertaken by the banks.

19. Dual Banking System 06/02/09 2006 (C) Abdullaah 1 Dec 1998 Thus, BNM replaced the SPTF with SPI/IBS (Skim Perbankan Islam/Islamic Banking Scheme). 1998 BNM also observed that the IB operations of the SPI was regarded as low hierarchy business, being manned by middle-level management, while the IBU was given limited functions to perform its duties and responsibilities effectively. The existing organisation structure, scope, and responsibilities of the IBU was reviewed and enhanced further by introducing a new framework as follows: IBU was up-graded to an Islamic Banking Division (IBD): one-stop centre for all IB operations such as retail, commercial, corporate, and trade/international bankings, treasury operations, corporate planning, product development, and etc.

20. Dual Banking System 06/02/09 2006 (C) Abdullaah 2 Jan 1999 IBD is required to prepare a strategic plan. IBD is expected to have a constructive relationship with other departments/division and should be provided with the necessary support from the departments/divisions in ensuring smooth implementation of IB operations. IBD should be proficient in applying accounting standards (including IB accounting standards), legal and regulatory requirements, directives and guidelines issued by BNM or other relevant banking associations. IBD as a division operates like “a bank within a bank”. IBD shall be headed by a Muslim senior management officer… of the bank, at least the level of the Assistant General Manager (AGM). The position of the AGM should be equivalent to the status of other key functional heads to enable him to deal effectively with his peers and superiors. Importantly, the AGM should be functionally responsible to the Chief Executive Officer

21. Dual Banking System 06/02/09 2006 (C) Abdullaah 1 Jan 2001 (CEO). Initially, the AGM is allowed to carry out banking duties and responsibilities other than Islamic banking during an interim period of 2 years (1999-2000). Beginning 1 January 2001, the AGM shall perform his duties and responsibilities with regard to Islamic banking on full-time basis. May 2003 Islamic Banking System: Total assets: RM73.4 billion; Deposits: RM55.2 billion; Financing: RM41.3 billion. Institutions offering IB: 2 Islamic banks, 13 commercial banks, 9 finance companies, 4 merchant banks, and 7 discount houses. 2,065 Islamic banking counters and 138 banking outlets.

22. Dual Banking System 06/02/09 2006 (C) Abdullaah 2005 BNM approved the transformation of “Islamic windows” institutional structure of seven domestic banking groups into Islamic subsidiaries (IS) August 2005 The first foreign Islamic bank commenced operations in August 2005 while the other two foreign Islamic banks would commence operations later in 2006. Feb 2006 The IFSB issued two standards: CAS and Guiding Principles 2006 The launch of INCEIF (International Centre for Education in Islamic Finance)

23. Dual Banking System 06/02/09 2006 (C) Abdullaah

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25. Current Situation 06/02/09 2006 (C) Abdullaah c i i c i 1. Full-fledged 2. Islamic windows 3. Full-fledged Islamic subsidiary (IS) BIMB, Bank Muamalat

26. Flows of Funds (A Perspective) 06/02/09 2006 (C) Abdullaah Islamic Financial Institutions Sources of Funds Uses of Funds Shareholders Depositors Islamic Bonds (Investors) Riba-free Loan Islamic Funds Retained Earning Islamic Capital Markets Islamic Money Markets Islamic Derivatives Shariah-Compliant Financing Zakat/Sadaqah/Waqf Others – Compulsory Deposits Islamic Instruments Islamic Instruments DOMESTIC MARKETS INTERNATIONAL MARKETS

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28. Topics for Discussions in the Tutorial Classes What are the impact of financial liberalization on Malaysian Islamic banking system? (Group) Find out: What are the current issues in the Malaysian Islamic Financial System? (Group) What are the sources of information for you to keep up-dated with the current issues of Islamic banking industry? (Group) 06/02/09 2006 (C) Abdullaah

29. Suggested Additional References www.bnm.gov.my BNM Annual Report 2005 Zamir Iqbal – Islamic Financial Systems (worldbank) 06/02/09 2006 (C) Abdullaah

30. 06/02/09 2006 (C) Abdullaah شكرا جزيلا على حضوركم وحسن استماعكم إلى هذه المحاضرة المتواضعة Q & A Session These slides only cover the main issues of the topic. The students are required to refer to the recommended references for more details.