ISLAMIC BANKING MANAGEMENTBWBS3043

Topic 1: History and development of Islamic Banking System

History and development of Islamic Banking System

Objectives:1.Explain the structure of financial system in

Malaysia2.Explain the definition and type of banks.3.Explain history and the development of

Islamic banking system.

THE FINANCIAL SYSTEM STRUCTURE IN MALAYSIA

Financial System

Financial Institutions Financial Market

BANKING SYSTEM●Bank Negara Malaysia2. Banking Institutions •Commercial Banks (22) •investment banks (15) •International Islamic banks (2) •Islamic Banks (17)3. Others •Discount Houses •Representative Offices of Foreign Banks

NON-BANK FINANCIAL INTERMEDIARIES1. Provident and Pension Funds2. Insurance Companies/Takaful3. Development Finance Institutions4. Savings Institutions •National Savings Bank •Co-operative Societies5. Others •Unit Trusts •Pilgrims Fund Board •Housing Credit Institutions •Cagamas Berhad •Credit Guarantee Corporation •Leasing Companies •Factoring Companies •Venture Capital Companies

Money & Foreign Exchange Market1. Money Market2. Foreign Exchange Market

Capital Market1. Equity Market2. Bond Market • Public Debt Securities • Private Debt Securities

Derivatives Market1. Commodity Futures2. KLSE CI Futures3. KLIBOR Futures

Offshore Market●Labuan International Offshore Financial Center (IOFC )

A. BANKING SYSTEMThe 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 BNM’s 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 Banker’s 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. Investment 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 INTERMEDIARIESNon Bank Financial Intermediaries mainly comprise of ●Provident and Pension Funds ●Insurance Companies ●Development Finance Institutions ●Savings Institutions ●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 CompaniesCurrently, 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 InstitutionsDevelopment 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 Malaysiaii) Bank Industri & Technologi Malaysiaiii) Bank Pembangunan & Infrastruktur Malaysia Berhadiv) EXIM Bankv) 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 Government’s 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●The Securities Commission (SC) is a statutory body entrusted with the responsibility of regulating and systematically developing Malaysia’s capital markets. ●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. ●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 REGULATIONAmong 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 19963. Anti-Money Laundering Act 2001

1. Banking and Financial Institutions Act, 1989 (BAFIA)●The Banking and Financial Institutions Act, 1989 (BAFIA) was passed in Parliament and came into force on October 1, 1989. ●BAFIA has effectively replaced the Banking Act 1973 and the Finance Companies Act 1969. ●The Islamic Banking Act 1983, however, is not affected. ●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 1996Under 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 BNM’s 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:-●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 ●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 2001The 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 ●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 ●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; andii. 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 Hafsa’s house- or, he said when he left Hafsa’s house- and said: ‘ Oh God’s 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 4th. 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 changer’s 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 EraThe 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 BanksName Country Date of

EstablishmentNasser Social Bank Egypt 1972Islamic Development Bank Saudi Arabia 1975

Dubai Islamic Bank UAE 1975Faisal Islamic Bank of Egypt

Egypt 1977

Faisal Islamic Bank of Sudan

Sudan 1977

Islamic Banking System International Holding

Luxembourg 1978

Jordan Islam Bank Jordan 1978Bahrain Islamic Bank Bahrain 1979

Islamic International Bank for Inv. & Development

Egypt 1981

Islamic Investment House Jordan 1981Al-Baraka Investment & Development Company

Saudi Arabia 1982

Saudi-Philippine Islamic Development Bank.

Saudi Arabia 1982

Faisal Islamic Bank Kibris Turkey 1982

BIMB Malaysia 1983

List of Islamic Banks

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 investmentsiii.Islamic inter-bank cheque clearing system

Oct 1999 The establishment of 2nd 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 BerhadMaybank Islamic BerhadAl Rajhi Banking & Investment Corporation (Malaysia)BerhadAlliance Islamic Bank BerhadAsian Finance Bank BerhadAffin Islamic Bank BerhadAmIslam Bank BerhadBank Islam Malaysia BerhadBank Muamalat Malaysia BerhadCIMB Islamic Bank BerhadEONCAP Islamic Bank BerhadHong Leong Islamic Bank BerhadKuwait Finance House (Malaysia) BerhadOCBC Al-Amin Bank BerhadPublic Islamic Bank BerhadRHB Islamic Bank BerhadStandard Chartered Saadiq Berhad

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