UNIVERSITI PUTRA MALAYSIA

A STUDY ON CUSTOMERS AWARENESS OF ISLAMIC BANKING SCHEME:

HONG LEONG FINANCE BHD

ROZAIN BIN DAUD

GSM 1999 28

A STUDY ON CUSTOMERS AWARENESS

OF ISLAMIC BANKING SCHEME:

HONG LEONG FINANCE BHD

ROZAIN BIN DAUD

FACULTY OF ECONOMICS Al�D MANAGEMENT

UNIVERSITY PUTRA MALAYSIA

SERDANG, SELANGOR

1999

A STUDY ON CUSTOMERS AWARENESS

OF ISLAMIC BANKING SCHEME:

HONG LEONG FINANCE BHD

ROZAIN BIN DAUD GSO 1394·

Master of Business Administration

A project paper submitted to

The Faculty of Economics and Management in partial fulfillment of the requirement for the

Master of Business Administration

FACULTY OF ECONOMICS AND MANAGEMENT UNIVERSITY PUTRA MALAYSIA

SERDANG, SELANGOR 1999

PENGESAHAN KEASLIAN LAPORAN I

Dengan ini saya Rozain Bin Daud No. matrik GSO 1394, pe1ajar

program MBA, mengaku bahawa kertas projeklkajian untuk kursus ini

adalah hasil usaha asal saya sendiri.

Specia{fy dedicated to my wife) 9rlisali and my

cliiUrens, Pirdaus, Paiz, Palimi,

P arlian, P a tina Ii, Paris

and my motlier and famify mem6ers ...

I would like to express my sincere gratitude and thankful to my supervisor,

Dr. Mohamad Ali bin Abdul Hamidfor his invaluable guidance, comments, suggestions throughout the preparation of this project paper.

I also wish to express thankful to the branch managers who had given cooperation in getting respondents for this survey. Special thanks also goes

to Zulkarnain Muhamad Sari for his guidance during data processing

analysis and materials for the study.

I also wish to express my heartfelt appreciation and inexpressible debt to

my wife, Jvlisah and my childrens, Firdaus, Faiz, Fahmi, Farhan, Fatinah and Faris

for the ir patience and support during the years of my study. It also goes to my dearest mother and family members who had given all the support and

prayers that I needed

Ro::ain Daud September/October 1999

ABSTRACT

A STUDY ON CUSTOMERS

AWARENESS OF ISLAMIC BANKING SCHEME:

HONG LEONG FINANCE BHD

In Malaysia, Bank Islam Malaysia Bhd is the first Islamic bank in this country and it is

still the only one Islamic bank. Realizing the need of the Muslims to transact in an

interest-free environment and allowable under the syari'ah, the government through its

banking system regulatory arm, Bank Negara Malaysia had allowed the conventional

banks to have Islamic banking services parallel to the conventional system. The system

so far has proceeded effectively and have gained tremendous response from the public,

Muslims and non-Muslims.

This study is aimed at identifying the awareness among the customers o f Hong

Leong Finance Bhd as to the factors that encouraged them to have an Islamic banking

account, and also to those that have not opened an Islamic banking facility, the reasons

for them not opening one. The study revealed that the main factors that influence them

are the 1) profit sharing concept 2) It's free of Rib a' or interest 3) It has both loans and

deposits services 4) the profit sharing rate is fair. Besides, it is also available to all and

they are aware that only certain financial institutions offers Islamic banking scheme.

Factors that influence the customers not opening the accounts are 1) the products were

not attractive 2) not much variety of products 3)not much publicity/promotions. The

secondary factor is that they are satisfied with the conventional banking.

11

T ABLE OF CONTENTS

ACKNOWLEDGMENTS

ABSTRACT

TABLE OF CONTENTS

LIST OF TABLES

LIST OF APPENDICES

CHAPTER ONE: INTRODUCTION

1.1 History and Development of Islamic Banking

1.2 The Malaysian Banking System

1.2.1 Commercial Banks

l.2.2 Islamic Banking

1.2.3 Interest-Free Banking Scheme

1.2.4 Characteristics of Interest-Free Banking Scheme

1.2.4.1 Separation of IFBS Management Fund

1.2.4.2 Monitoring of Syari'ah Adviser

1.3 Objectives of Islamic Banking

1.4 Syari'ah's Principles in Islamic Banking

1.4.1 Mudharabah

l.4.2 Musyarakah

1.4.3 Murabahah

1.4.4 Ijara

1.4.5 Qard Hassan

page

ii

iii

ix

1

4

4

4

5

6

6

7

8

9

10

11

11

12

12

!1l

1.4.6 Wadiah

1.5 Definition of Terms

1.5. 1 Muslims

1.5.2 Non-Muslims

1.5.3 Banking

1.6.4 Riba'

1.6 The Prohibition ofInterest or Riba'

1.6. 1 Finance Related Riba'

1.6.2 Trade Related Riba'

1.7 Motives for the Prohibition of Interest

1.8 Problem Statement

1.9 Objectives of the Study

CHAPTER TWO: LITERATURE REVIEW

2. 1 Introduction

2.2 Bank Customers

? .., _ . .J Principles Underlying the Islamic Banking System

2.4 The History ofIslamic Financial Practice

2.5 The Islamic Economist Views on Interest

CHAPTER THREE: BACKGROUND

3. 1 Introduction

3.2 Islamic Banking Division

3.3 Deposits

12

13

13

13

13

14

14

15

16

17

18

20

22

24

26

27

29

30

30

31

IV

3.4 Financing ...,..., .) .)

3.5 Profit Rates on Deposit 34

3.6 Deposits in the Banking System 36

3.6. 1 Conventional Banking 36

3.6.2 Islamic Banking Scheme Deposits 37

3.7 Loans and Advances 38

3.8 Perfonnance of the Islamic Banking Scheme 40

CHAPTER FOUR: METHODOLOGY

4. 1 Introduction 4 1

4.2 Qualitative and Quantitative Methodologies: A Comparison 41

4.2. 1 Qualitative Methodologies 42

4.2.2 Quantitative Methodologies 44

4.2.3 Combination of Qualitative and Quantitative Method 45

4.3 Selection of Method 45

4.3. 1 Data Collection Method 46

4.3.2 Observation 47

4.3.3 Survey Questionnaire 50

4.3.4 Interviewing 52

4.4 Data Collection Procedure 53

4.4. 1 Research Design 53

4.4.2 Questionnaire Design and Testing 54

4.4.3 Sample Design 54

4.5 Data Analysis Techniques 54

v

4.5.1 Factor Analysis 55

4.5.2 Examining The Correlation Matrix 56

4.5.3 Test ofKaiser-Meyer-Olkin (KMO) 56

4.5.4 Factor Extraction 57

4.6 Validity and Reliability 57

4.7 Limitation of the Study 58

CHAPTER FIVE : RESULTS AND ANALYSIS

5.1 Introduction 60

5.2 Response Rate 60

5.3 Frequency Analysis - Respondent's Profile and General

Infonnation 61

5.3.1 Respondent's Profile - Section 1 61

5.3.2 General Infonnation - Section 2 63

5.4 Frequency Analysis - Respondent's Knowledge about Islamic

Banking and Reasons for not trying Islamic Banking 65

5.4.1 Variables 65

5.4.2 Frequency Analysis 66

5.4.3 Descriptive Analysis 67

5.5 Factor Analysis 69

5.5.1 Examination of Data for Reliability 70

5.5.2 Coefficient Correlation Tests 71

5.5.3 Using Factor Analysis 73

5.6 Conclusion to Factor Analysis 75

VI

CHAPTER SIX: CONCLUSIONS AND RECOMMENDATIONS

6.1 Introduction

6.2 Conclusions and Recommendations

BIBLIOGRAPHY

APPE�'l)ICES

76

77

VII

LIST OF TABLES

page

Table 3.1 : HLFB - Islamic Banking Deposit Trend Analysis 32

Table 3.2 : Monthly Loan Disbursement - Conventional and Islamic

Banking 34

Table 3.3 : Profit Rates for AI-Wadiah and AI-Mudharabah accounts

HLFB major competitors 35

Table 3.4 : Savings and Fixed Deposits by Holder: Banking System 37

Table 3.5 : Interest-free Banking Scheme - Deposit by Type

and Holder 38

Table 3.6 : Loans by Type: Banking System 39

Table 5.1 : Summary of Respondent's Profile 62

Table 5.2 : General Infonnation 63

Table 5.3: Frequency (in percentage), Mean and Standard Deviation 67

Table 5.4 : Variables with mean Greater than 4.00 69

VIlI

LIST OF APPENDICES

Appendix A: Questionnaire

Appendices B to K: Specific Results For The Factor Analysis

Apendix L: Initial SPSS Print-out

IX

CHAPTER ONE

INTRODUCTION

1.1 History and Development of Islamic Banking

One of the basic changes envisaged in the wake of the Islamic transfonnation of a

modem economy is the replacement of institution of interest by institutions whose

statutes, rules and procedures expressly state their commitment to the principles of

Islamic shari'ahl. To confonn with the principles of Islamic law, many Islamic

countries have sought to revive Islamic financial practices in what is becoming known

as 'Islamic banking'. 'Islamic banking' is the conduct of banking operations in

accordance with Islamic teachings (Ahmad, 1994). This banking is essentially based on

principles of profit- and loss-sharing which allows for confonnity to Islamic ethical

principles.

The establishment of Islamic bank and the emergence of interest-free

transactions in the banking system and has created an opportunity for the Muslims to

safely engaged in their banking transactions in a legitimate way. The main principles of

Islamic banking activities comprise of prohibition of interest in all fonns of transaction,

undertaking business and trade activities on the basis of fair and legitimate profit,

lShari'ah is a comprehensive principle of the total way oflife Denny (1985), shari'ah comprises all that might be positively called law and occupies the central place in the Islamic system of final authority

giving zakat (alms tax), prohibition of monopoly, and cooperation for the benefit of

society and development of all 'halal,2 aspects of business that are not prohibited by

Islam (Khan, 1983).

The history of Islamic banking activities can be traced back to the birth of

Islam. Unlike the conventional banks which continued to progress over time, the

Islamic banking concepts which were pioneered in the early years of Islam failed to

expand into a complete banking system. Homoud (1985) suggest that the dark ages of

the European Continent was a cause for the backwardness, not only in the European

but also in Islamic countries, leading to the severance of link with all forms of Islamic

banking practice which had existed in earlier times.

The late 19th and early 20th century is widely known as the beginning of an era

of Islamic resurgence (Sudin Baron & Bala Shanmugam, 1997). As the Islamic banking

concepts awareness took place within many Islamic communities especially at the end

of the 1960s and in the early 1970s, Islamic banks emerged from within. The growth of

Islamic banking during the last two decades has been extremely impressive and there is

little doubt that, with the large customer base, Islamic banking are not merely a passing

phenomenon (Wilson, 1990).

Currently in Arab and Muslim countries, a new banking system on Islamic

economics principle is rapidly developing. Attempts at establishing such banks have

been going on for over 30 years; the first having started in Egypt in the early sixties in

2 Licit as oppose to illicit or 'haram'

2

the village of Mit-Ghamr. It proved quite successful but was then closed down

apparently for political reasons. Nevertheless, the venture laid the seeds of modern

profit-sharing banking system. Soon afterwards, more banks were opened, the first being

the Islamic Development Bank (an intergovernmental bank), set up in 1975.

Some of the Islamic banks are the Dubai Islamic bank (1975), Kuwait Finance

House (1977), Faisal Islamic Bank of Egypt (1977), Faisal Islamic Bank of Sudan

(1973), Jordan Islamic Bank (1978), Bahrain Islamic Bank (1975), Islamic Banking

System, Luxembourg (1980), Islamic Bank of Malaysia (1983) and Islamic Bank of

Mauritania (1983).

Malaysia is the only country with the best government support for Islamic

banking. It means a measured quality support by the finance and banking authorities of

the country using the full force of the various ministries and the central bank and

promoting the profit-and-loss sharing Islamic banking as a viable alternative to the

riba-based conventional banking (Business Times, 7 May 1993).

Islam prohibits riba', which is commonly known as interest in all kinds of loan.

In the conventional banking system where lending is concerned, interest is a fixed

payment in addition to the principal sum that is required to be repaid by the borrower to

the bank. It is nonnally worked out on the basis of fixed rate. The depositors of the

banks also gets interest on their deposits which is normally at a lower rate as compared

to lending.

3

1.2 The Malaysian Banking System

1.2.1 Commercial Banks

Banking in Malaysia is more than 100 years old and the first commercial bank

to be established in the country was a branch of the Chartered Mercantile Bank

of India, London and China in Penang in 1859 (Johnson Pang, 1991). In the

early days, commercial banks were commonly known as "exchange banks" as

their business was predominantly confined to financing of external trade by way

of overdraft, packing credits, various forms of trade bills and foreign exchange

transactions. Since then, the evolution of the banking and financial system has

been profound, especially in the 1970' s with the rapid expansion of the local

banks and their branch network. As of 31st December, 1998 there are 38

commercial banks 10 merchant banks and 39 finance companies.

1.2.2 Islamic Banking

Practically all existing Islamic banks were established and operated where the

system of interest persist. Islamization of the banking system has been phased to

avoid any abrupt changes which might cause unpredictable disarray in the

economy (Zakariya Man, 1988). According to this approach, Islamization of the

banking sector is to be implemented by first establishing a model Islamic bank

side by side with the existing interest-based banks. It is hoped through time, the

superiority of the Islamic banking model will cause the practice of interest­

based banking to be phased out without any adverse effect on the economy.

4

The progress of Islamic banking in Malaysia is not peculiar and it co­

exist with the conventional banks. Islamic banking system in Malaysia is

considered to be more progressive compared to the systems of other Muslim

countries. It's history began when the Bank Islam Malaysia Berhad (BINlB) was

established in 1983 and now it is complemented by the Islamic financial

market, Islamic windows, and the Islamic stock market. It has been the model

for Islamic banks in Indonesia and Brunei. It is to note that the establishment of

BINlB marked the commitment of the Malaysian government to introduce

Islamic banking·in Malaysia, the present government, however, does not have

any intentions of Islamization of the entire financial system. It is the long tenn

objective of the Central Bank of Malaysia to create an Islamic banking system

parallel to the conventional system.

1.2.3 Interest-Free Banking Scheme

In the process of increasing the number of players in the Islamic financial

services, the Central Bank has introduced a scheme known as 'Skim Perbankan

Tanpa Faedah' or the 'Interest-Free Banking Scheme' (IFBS). Under this

scheme often known as the 'Islamic windows' , all commercial banks, merchant

banks and finance companies are given an opportunity to introduce Islamic

banking products and services. It began in 1993 and as at end of 1995, 44

financial institutions participated in the IFBS comprising of 23 commercial

banks, 18 finance companies and 3 merchant banks. Total deposits mobilized

5

under the scheme as at end 1995 amounted to RM2.1 billion while total

financing extended amounted to RMl.4 billion.

1.2.4 Characteristics of the Interest-Free Banking Scheme (IFBS)

There are two main characteristics that must exist before IFBS is allowed to

operate in a financial institution;

1. Separation of IFBS· management fund from the management of fund of the

conventional banking.

2. Monitoring of shari 'a adviser over institution.

1.2.4.1 Separation of IFRS Management Fund

The reason is to detennine IFBS financial stand and profit distribution to

the customers (saverlinvestor) through accumulations of deposits such

as "al-wadiah,,3 current and saving account, and "al-mudharabah,,4

investment account.

The agreement based upon al-wadiah's principle or trust is the

agreement between the owner and the trustee. The wealth must be able

3 Refers to goods or deposits which have been deposited with another person, who is not the owner, for safe keeping.

4 Refers to an agreement made between a party, who provides the capital and another party (entrepreneur), to enable the entrepreneur to carry out business projects, which will be on a profit-sharing basis according to predetermined ratios agreed upon earlier.

6

to be returned to the owner when requested. Both parties cannot name

any payment conditions unless with the willingness and sincerity of both

parties.

In the management of al-wadiah current and saving account, the

customer is the property's owner while the bank is entrusted to care for

the property. In order to maintain it's competitiveness as a commercial

institution, a bank will authoritatively give part of it's profit to the

customer in the form of 'hibah,5 or prize money. However, the bank is

not obligated to allocate a larger portion to the customers' saving.

Based on the mudharabah principle, the parties involved are the

investors and the entrepreneur that agree to do business together.

Investors contribute their wealth while the entrepreneurs make use of

their skills. Profit division from the business will be agreed based on the

contracts fixed. The Mudharabah General Investment Account operates

with it's principle of profit sharing where a customer act as an investor

and the bank as the entrepreneur. Profit gained from the distribution of

minimum ratio agreed between the investor and the bank.

1.2.4.2 Monitoring of Shari'ah Adviser

Negotiations with expert shari'ah advisers is one of the key that holds

the IFBS operation. They are individuals with credentials and capable of

5 A gift from the bank as a token of appreciation for patronizing the bank. 7

monitoring the dynamic operations of Islamic banking. Among the roles

played by the Shari'a adviser are to provide consultation services,

assuring purity of fund and fair profit partitions among bank clients.

1.3 Objectives of Islamic Banking

The existence of Islamic banks is to promote, foster and develop the banking services

and products based on the Islamic principles. Thus, Islamic banking was primarily

designed to cater for the banking and financial requirements of Muslims in the country

who perceive the conventional banking system as being inadequate or inappropriate to

their needs (Investor Digest, 1993). In the Islamic countries, the aims of the Islamic

bank are at realizing the following�

1. Attracting and collecting funds and mobilizing resources available in

the Islamic nation together with consolidating such resources

through the development if individuals' saving awareness,

2. Directing funds to the investment activities that serve the objectives

of the economic and social development in the Islamic nation, and,

3. Carrying out banking activities and services in accordance with

Islamic jurisprudence free from usury and exploitation, and in such a

way as to solve the problem of shot-term financing.

In Malaysia, the objective of Islamic bank is to establish and operate a

banking institution that adheres in its practices to the principles, rules and

8

regulations laid down by the religion (Halim, 1983). The central pillar of the

Islamic banking system is that financing can only be on an interest-free basis.

Therefore, IBS operations and investment policies are based on non-interest

related techniques which take into consideration the underlying transactions;

1. Islamic bank must not receive or pay interest in any form,

2. Islam considers money as a means to satisfy needs,

3. Money cannot be rented for the sake of making more money, and,

4. Financial commitments are determined by the underlying

transactions (Khan, 1986)

However, the shari'ah supervisory council of Bank Negara Malaysia (the

Central Bank) has ruled that Islam does not bar out shares from being held by

non-Muslims (Investor Digest, 1993) and is available to everyone, Muslims and

non-Muslims.

1.4 Shari'ah principles in Islamic Banking

The shari'ah principles are adopted in Islamic banking or interest-free banking, and the

widely used principles can be generally classified into four categories as below:

1. Profit and loss sharing,

a. Mudharabah

b. Musharakah

11. Fees or charges based,

9

a. Murabahah

b.ljara

lll. Free service,

a. Qard Hassan

IV. Ancillary principles,

a. Wadiah

A brief explanation of the principles are as follows:

1.4.1 Mudharabah

Mudharabah means 'Profit and Loss sharing (PLS),

or 'trust finance'. This is

basically an agreement between at least two parties, one being a lender or

sometimes known as an investor and an entrepreneur also known as an agent­

manager. In the agreement, the investor agrees to finance or entrust money to

the entrepreneur who is to trade in an agreed manner and then return to the

investor the principal and pre-agreed proportion of profits and keep for himself

the remainder. The distribution of profit between the two parties must

necessarily be on a proportional basis and cannot be on a lump sum or a

guaranteed amount. In the case of loss as a result of circumstances beyond the

control of the entrepreneur, the investor will bear all the financial risks and the

entrepreneur loses the time and his efforts only. In banking practice, this is a

case of lOO-percent financing. It is a prerequisite that such a contract must

categorically spell out the proportions of profit that will accrue to both the

10

provider of capital and the entrepreneur. It is also contractual in such a contract

that the provider of capital shall not interfere in the management of the venture

(Chapra, 1992).

The main function of the mudharabah bank is to invest funds on the

principle of mudharabah i.e. by advancing money to enterprises for investment

in industry, commerce and agriculture with the object of profit-sharing

(Rahman, 1979).

1.4.2 Musyarakab

This concept is more or less the equivalent of partnership in western concept In

Islamic banking, musyarakah means "participating financing". Under

musyarakah, both the provider of capital and the entrepreneur contribute to the

capital of the joint venture. Both could participate in the management of the

project. The ratio of the distribution of profit should be clearly spelt out; but the

distribution need not necessarily coincide with the proportionate shares of the

project. This is also a concept of profit and loss sharing (Banker's Journal

Malaysia, 1983).

1.4.3 Murabahah

This concept transforms lending activity into a sale-and-purchase transaction. It

thus defines the process as a cost-plus or mark-up sale agreement. The provider

of capital basically buys the goods that the borrower wishes to acquire and

II