Chapter 1 - History and Development of Islamic Banking System

8/11/2019 Chapter 1 - History and Development of Islamic Banking System

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ISLAMIC BANKMANAGEMENT

BWBS3043

Topic 1: History and developmentof Islamic Banking

System


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Objectives:

1. Explain the structure of financial system

in Malaysia2. Explain the definition and type of banks.

3. Explain history and the development ofIslamic banking system.


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The flow of funds in financial system

3

Surplus Units Deficit UnitsFinancial

Market

FinancialIntermediaries

Secondary debt/ indirect debt

Primary debt/ direct debt


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THE FINANCIAL SYSTEM STRUCTURE IN MALAYSIA

Financial System

Financial Institutions Financial Market

BANKING SYSTEM

1.Bank Negara Malaysia

2. Banking Institutions

Commercial Bank (23)

investment banks (15)

International Islamicbanks (4)

Islamic Banks (17)

3. Others

Discount Houses

Representative Offices

of Foreign Banks

NON-BANK FINANCIALINTERMEDIARIES

1. Provident and Pension Funds2. Insurance Companies/Takaful

3. Development Finance

Institutions

4. Savings Institutions

National Savings Bank

Co-operative Societies

5. Others

Unit Trusts

Pilgrims Fund Board

Housing Credit Institutions

Cagamas Berhad

Credit Guarantee Corporation

Leasing Companies

Factoring CompaniesVenture Capital Companies

Money & Foreign ExchangeMarket

1. Money Market

2. Foreign Exchange Market

Capital Market

1. Equity Market

2. Bond Market

Public Debt Securities

Private Debt Securities

Derivatives Market1. Commodity Futures

2. KLSE CI Futures

3. KLIBOR Futures

Offshore Market

1.Labuan InternationalOffshore Financial Center(IOFC )


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1. Bank Negara Malaysia (BNM)

Bank Negara Malaysia (the Central Bank of Malaysia) wasestablished on 26 January 1959, under the Central Bank of MalayaOrdinance 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 BNMs powers for thesupervision and regulation of financial institutions and deposit-taking institutions who are also engaged in the provision of financeand credit.


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2. Commercial Banks

Commercial banks were brought under BNM supervision throughBanking Act, 1973, but this was subsequently replaced by theBAFIA 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 oftrade bills, shipping guarantees, trust receipts and BankersAcceptances;

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 exchangeand are the only financial institutions allowed to provide current

account facilities.


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3. I nvestment 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 theeconomic 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 amore 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 businessopportunities, diversify their source of funding and enhance their market making

capabilities in the capital market.


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5. Islam ic 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 wasestablished.

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.


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7. Representat ive Off ices o f 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 andJapan.

Representative office is merely a liaison office and

does not offer banking products directly to theMalaysian market.


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B. NON-BANK FINANCIAL INTERMEDIARIES

Non Bank Financial Intermediaries mainly comprise

of

1.Provident and Pension Funds

2. Insurance Companies

3.Development Finance Institutions

4.Savings Institutions

5.Others..


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1. Provident and Pens ion Funds

Provident and Pension Funds (PPFs) are a group of

financial schemes designed to provide membersand their dependents with a measure of socialsecurity in the form of retirement, medical, death ordisability benefits.

The major PPFs in Malaysia comprise theEmployees Provident Fund (EPF), the SocialSecurity Organization (SOCSO), the Armed ForcesFund and the Teachers Provident Funds.

The PPFs are the second largest group of financialinstitutions in the country in terms of aggregateassets, next to banking institutions


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2. Insurance Companies

Currently, the total number of licensees under the Insurance

Act 1996 stands at 141, comprising 64 insurers, 36 brokersand 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


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3. Developm ent Financial Ins t i tut ions

Development 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 DFIsin Malaysia:-

i) Bank Pertanian Malaysia

ii) Bank Industri & Technologi Malaysia

iii) Bank Pembangunan & Infrastruktur Malaysia Berhadiv) EXIM Bank

v) Malaysian Industrial Development Finance (MIDF)


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4. Savings Institutions

These institutions play a particularly importantrole in the promotion and mobilization of savingsamong 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 Governments objective todevelop an Islamic banking system in Malaysia.


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5. Others

The group of institutions classified as otherfinancial 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 offinancial markets.


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C. FINANCIAL MARKETThe Financial Market mainly comprises:-

1) Money Market

is an avenue for the channeling of short term funds withmaturities typically not exceeding 12 month.

It provides a ready source of funds for market participantsfacing temporary shortfalls in funding, while at the same

time, providing short term investment outlets for thosewith temporary surplus funds. Operations in the moneymarket comprise 2 broad categories:

i) The placement of deposits

ii) The purchase and sale of short term securities (bankersacceptances (BA), negotiable instruments of deposit (NID),treasury bills (T-bill), Cagamas notes, etc.


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2) Foreign exchange marketis 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 andswap market.

3) Capital marketis 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 issuingstocks, while secondary market trading in stocks is conducted throughstockbrokers on the Bursa Malaysia as well as the Malaysian Exchange ofSecurities Dealing and Automated Quotation (MESDAQ)


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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 markettrading 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 claimson underlying assets, and whose values depend on the

price of the underlying assets or securities. The main use ofderivatives is to hedge against volatility in the price of theunderlying assets. Examples of derivatives are forwards,

futures, options and swaps.


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6. Offshore market

is a new addition to the financial landscape of Malaysia withthe establishment of the Labuan International OffshoreFinancial Centre (Labuan IOFC) in October 1990.

Labuan IOFC is aimed enhancing the attractiveness of

Malaysia as a regional financial centre as well as to promotethe economic development of Labuan and its vicinity.

It provides a wide range of offshore products includingbanking, insurance, trust business, fund management,

investment holding, Islamic financing and companymanagement services.


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SECURITIES COMMISSION1. The Securities Commission (SC) is a statutory body entrusted with the

responsibility of regulating and systematically developing Malaysias capital

markets.2. It has direct responsibility in supervising and monitoring the activities of

market institutions and regulating all persons licensed under the SecuritiesIndustry Act, 1983 and Futures Industry Act, 1993.

3. 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.


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FINANCIAL REGULATION

Among the main regulations and guidelines issuedby the authorities to govern the financial system inMalaysia are:-

1. Banking and Financial Institutions Act, 1989

(BAFIA)

2. Insurance Act 1996

3. Anti-Money Laundering Act 2001


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1. Banking and Financial Institutions Act, 1989

(BAFIA)

1. The Banking and Financial Institutions Act, 1989 (BAFIA) was passedin Parliament and came into force on October 1, 1989.

2. BAFIA has effectively replaced the Banking Act 1973 and the Finance

Companies Act 1969.

3. The Islamic Banking Act 1983, however, is not affected.

4. 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 moneybrokers) and also regulate scheduled and non-scheduled institutions.


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5. BAFIA 1989 is divided into 16 parts and covers a widespectrum of subject matters related to the bankingindustry in Malaysia. The Act provides a framework that

enables BNM to supervise and regulate three broad groupsof financial institutions:

Scheduled institutions comprising non-bank sources ofcredit and finance, which include issuers of charge/creditcards and travellers cheques, operations of cashdispensing machines, development finance institutions,building societies and housing credit institutions, factoring

companies, leasing companies, representative offices offoreign banks or foreign institutions which carry out thebusiness or activities similar to the scheduled institutions;


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Licensed institutions comprising the commercial banks,merchant banks, finance companies, discount houses, moneybrokers and foreign exchange brokers;

Non-scheduled institutions comprising all other statutorybodies and institutions involved in the provision of finance andcredit.

The Act also provides BNM the regulatory power to regulate thefollowing:

Control of establishment or acquisition of subsidiaries oropening of offices in Malaysia by a local or foreign licensed

institutionsMaintenance of reserve fund, capital, net working funds, liquidassets by the financial institutions

Appointment of auditors, submission of financial statement,exhibition of financial statements, submission of statistics toBNM.


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2. Insurance Act 1996

Under 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. Amongthe areas subject to BNMs 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.


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The Insurance Act 1996 which became effective on 1January 1997, has incorporated amendments made to theInsurance Act 1963.The subsidiary legislation, theInsurance Regulations 1996 (Regulations) saw severalchanges in 1999 in respect of minimum capital requirementas follows:-

1.The minimum paid-up capital prescribed for a licensedlocal insurer underwriting direct insurance business, orsurplus of assets over liabilities in the case of a licensedforeign insurer is set at RM50 million from 31 December2000; and

2.The absolute minimum margin of solvency (before taking

into account insurance fund liabilities) for each class ofinsurance business of direct and local professionalreinsurers is set at RM50 million from 1 January 2001.


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3. Anti-Money Laundering Act 2001

The Anti-Money Laundering Act 2001 (AMLA) was gazette on 5July 2001. AMLA provides comprehensive new laws for the

prevention, detection and prosecution of money laundering, theforfeiture of property derived from, or involvement in moneylaundering and the requirements for record keeping andreporting 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 seizurePowers of freezing, seizure and forfeiture of property


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History and Development of Islamic Banking

Banking Under The Influence of Islamic Culture

1.Prophet Muhammad (peace be upon him) noted as trustworthy;deposits remained in his custody until a short while before he emigratedfrom Mekka to Medina, when he assigned Ali to return the deposits to theirowners

2.Az-Zubair bin Awwam was one of those who entrusted with thesafekeeping of money; he was a man of sagacity and intelligence whorefused to take money on deposit preferring to take it as a loan, thusrealizing two objectives:

i. He reserved his right to dispose of the money considering it a loan not adeposit; and

ii. It represent a secure guarantee to the owner because where moneyremains a deposit without use, it would constitute a loss to the owner; butwhen deposit becomes a loan it would be secure as the borrower liable forit.


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1) Exchange of money

Ibn Omar said:I used to sell camels in Baqi (a place in Al Medina), I sellby dinars and take darahim (kind of money) and sell bydarahim and take the dinars, which thing had an effecton me, so I came to the Prophet (peace be upon him)while he was in Hafsas house- or, he said when he leftHafsas house- and said: Oh Gods Prophet, take iteasy, I wish to ask you: I sell the camels in Baqi, I sellby dinars and take darahim and sell by darahim and

take dinars. The Prophet said: It would beunobjectionable if you take them at the price of their dayunless you depart and leave something between you.


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2) Transfer Operation

It is narrated that Ibn Al Abbas used to take the warik (i.e. silverminted 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 Aleppoabout the middle of 4th. Century A.H, visited Baghdad and wanted to seeit without being recognised; he went disguised to the houses of Bani

Khaqan to listen and drink; they served, but did not know him. When hewas about to leave he asked for an inkpot and wrote on a slip of paperand left in the pot; when they unfolded the paper they found it wasaddressed to some money changers in the sum of one thousand dinars.When they presented the slip of paper to the money changer, whohonored the paper and paid the sum of dinars therein stated

immediately and in time'. When they asked the money changer who wasthe man who wrote the paper, he replied that he was Saif au-Dawla Al-hamadani.


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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 duringhis travel between the years 437-444 A.H. reported in oneplace how the work was being carried out in the city ofBasra as he witnessed it himself:

A market is set up in three locations in Basra every day: in themorning, exchange is carried out in Khaza market, at noon, inOthman Market and at sunset in Qaddahin market; the work in amarket is as follows: every person who has money gives it to the

money changer and take in return a cheque and then buy all needsand pays for them by money changers cheque; a purchaser uses noother than the cheque of the money changers so long as he isresident in the city


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Islamic Banking in The Modern Era

The 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 andplantations in accordance with Syariah was, however,unsuccessful.

B.The first experimental local Islamic bank was established inthe late 1950s in a rural area of Pakistan that charged nointerest on its lending.

C.The establishment of Mit Ghamr Local Savings Bankmarked a new milestone in the revolution of the modernIslamic banking system. The bank was considered to be the

most innovative and successful experiment with interest-freebanking.


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List of Islamic BanksName Country Date of

Establishment

Nasser Social Bank Egypt 1972

Islamic Development

Bank

Saudi Arabia 1975

Dubai Islamic Bank UAE 1975

Faisal Islamic Bank of

Egypt

Egypt 1977

Faisal Islamic Bank of

Sudan

Sudan 1977

Islamic Banking System

International Holding

Luxembourg 1978

Jordan Islam Bank Jordan 1978

Bahrain Islamic Bank Bahrain 1979


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List of Islamic Banks

Islamic International Bankfor Inv. & Development

Egypt 1981

Islamic Investment House Jordan 1981

Al-Baraka Investment &

Development Company

Saudi Arabia 1982

Saudi-Philippine Islamic

Development Bank.

Saudi Arabia 1982

Faisal Islamic Bank

Kibris

Turkey 1982

BIMB Malaysia 1983


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Development of Islamic Banking system in Malaysia

Year Remark

1980 Formal request to set-up Islamic Bank was made during theBumiputera 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 whoseoperations 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 licenseand supervise the Islamic bank.

iv. The Islamic bank is to establish its own ShariahSupervisory Board ; to ensure that the operations of

Islamic bank are in accordance to the Shariah.


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March 4,

1993

Central Bank has introduced a scheme known as

Skim Perbankan Tanpa Faedah or Interest-freeBanking 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 andservices. 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.


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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 BerhadEONCAP Islamic Bank Berhad

Hong Leong Islamic Bank Berhad

Kuwait Finance House (Malaysia) Berhad

RHB Islamic Bank Berhad
http://www.bnm.gov.my/index.php?ch=37&pg=600&ac=80&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=603&ac=81&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=95&ac=26&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=96&ac=27&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=583&ac=76&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=599&ac=79&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=588&ac=77&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=592&ac=78&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=577&ac=75&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=577&ac=75&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=592&ac=78&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=588&ac=77&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=599&ac=79&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=583&ac=76&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=96&ac=27&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=95&ac=26&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=603&ac=81&cat=banking&type=IBhttp://www.bnm.gov.my/index.php?ch=37&pg=600&ac=80&cat=banking&type=IB


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hank you

Documents

Chapter 1 - History and Development of Islamic Banking System