Chapter 1

DEVELOPMENT OF THE MALAYSIAN

ISLAMIC FINANCIAL SYSTEM
Prepared for : Sir Wan Yusrol Rizal Bin Hj. W.Yusof
Mohamad Nasstain Nal Arzihi Bin Muhd Fauzi
Muhamad Fazly Bin Hasan
Muhammad Fahmi Bin Zulkifli

CONTENT
MALAYSIAN ISLAMIC FINANCIAL SYSTEM
HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING
NSC REPORT ON BANK ISLAM MALAYSIA
1ST PHASE OF DEVELOPMENT
2ND PHASE OF DEVELOPMENT
3RD PHASE OF DEVELOPMENT
CONCLUSION

MALAYSIAN ISLAMIC FINANCIAL SYSTEM

Comprehensive Islamic financial system covering all financial sectors

operating in parallel with conventional financial system

Diversities of players

Twelve full-fledged Islamic banking institutions

2 domestic Islamic banks

3 full-fledged foreign owned Islamic banks
7 Islamic banking subsidiaries

9 takaful operators

Sound and robust Islamic financial institutions governed by

international best practices

Rapid growth with wide range of product and services

Retail, corporate & investment banking

Internationally integrated with international Islamic financial system

HISTORICAL LANDMARKS IN ISLAMIC FINANCE

DEVELOPMENT
1963

Mit Ghamr, Egypt

1969

Pilgrims Fund Board (Lembaga Tabung Haji), Malaysia

1970

Oil boom

1975
1977

Islamic Development Bank, Saudi Arabia

Dubai Islamic Bank, UAE
Fatwa issued by the Fiqh Council of Muslim World League in favour of Islamic insurance
(takaful)

1978

Luxembourg Islamic Bank (1st attempt in the West )

1979

Sudanese Islamic Insurance Company is established as the worlds 1st Takaful company by
Faisal Islamic Bank of Sudan

1983

Malaysia passes comprehensive legislation on Islamic finance (Islamic Banking Act)

1988

OIC Islamic Fiqh Academy legitimizes Sukuk which paves the way to the development of
Islamic debt securities

1990

World 1st sukuk issued in Malaysia (Based on BBA) by Shell MDS worth USD 30 million

1991

AAOIFI , Bahrain

2002

IFSB, Malaysia

2011

International Islamic Liquidity Management (IILM), Malaysia

NSC REPORT ON BANK ISLAM MALAYSIA

An Islamic bank, which operates according to the rules of Shariah,

should be established; provide services and operating profitably.

Only one Islamic bank should be established.
The proposed Islamic bank should be incorporated as a limited
company under the Companies Act 1965.
The Islamic Banking Act needs to be legislated in order to provide
for the licensing and supervision of the Islamic bank
The Central Bank should administer the Islamic Banking Act.
The proposed Islamic bank should set up a Religious Supervisory
Council to supervise the compliance of its operations with Shariah
principles.
The proposed Islamic bank should be named Bank Islam Malaysia.

1st PHASE OF DEVELOPMENT

All recommendations of the NSC Report were

accepted by the Government.

The Islamic Banking Bill was passed and the IBA
came into force on 7th April 1983.
Consequently, the Islamic bank was incorporated
and officially launched on July 1, 1983.
The establishment of BIMB marked a new milestone
for the development of the Islamic financial system
in Malaysia.

LEGISLATION OF THE ISLAMIC BANKING ACT (IBA) 1983

To enable an Islamic bank to be established and operated in

Malaysia, a suitable legal framework according to the Shariah

principles should be provided.
The existing Banking Act 1973 (now replaced by BAFIA 1989), did
not conform with the principles of Islamic banking because :

It required all banks to operate on the basis of interest

Prohibited all types of trading

The Islamic Banking Act (IBA) 1983 was legislated in March 1983

provided BNM with the power to supervise and regulate Islamic

banks.
IBA was the first act to provide the necessary amendments to
allow Islamic banks to operate without interest as well as to
engage in trade and commerce.

THE ESTABLISHMENT AND DEVELOPMENT OF BIMB

BIMB was incorporated as a public limited company to enable the

Bank to conduct its activitics freely without being constrained by

regulations imposed on statutory bodies.
Even though BIMB was a private company, the largest portion of its
shares should be held by the Government to generate the publics
confidence in the bank.
BIMB was established with the initial paid-up capital of RM80
million consist of :

Malaysian Government RM30 million

LUTH RM10 million
Muslim Welfare Organization of Malaysia RM5 million
State Religious Councils RM20 million
State Religious Agencies RM3 million
Federal Agencies RM12 million

LEGISLATION OF GOVERNMENT INVESTMENT ACT 1983

BIMB was required to undertake short-term investments, as well as a

fund management measure to meet its liquidity requirements prescribed

by BNM.
The existing avenue for short-term investments was by way of purchases
of Government papers in the form of Malaysian Government Treasury
Bills (MGTB) and Malaysian Government Securities (MGS) that bore
interests and BIMB could not invest in them.
The NSC proposed that the Government Investment Act (GIA) be
legislated to enable the Government to issue Government Investment
Certificates on the basis of Islamic principles.
GIA provided the solution to the problem of acquiring interestfree
short-term investments which acted as an instrument to absorb surplus
funds in the short run, a common problem faced by the Islamic Bank in
the absence of an Islamic money market.

ESTABLISHMENT OF SYARIKAT TAKAFUL MALAYSIA BERHAD

The NSC was of the view that the Islamic bank was responsible in

ensuring the safety and security of its own assets and securities against
loss, damage and destruction and recommended that an Islamic
Insurance company should be established
Takaful Act were enacted in 1984 based on the Insurance Act 1973, with
such modifications and amendments to conform with the Shariah and
takaful business practices.
The first Islamic insurance operator Syarikat I Takaful Malaysia Sdn.
Bhd. (STMB) was incorporated in November 1984 as a subsidiary of
BIMB
With the establishment of STMB, other subsidiaries like Syarikat
Wakalah Sdn Bhd (providing nominee and investment fund services for
the bank) and Al-Ijarah Sdn. Bhd.(providing leasing finance) were also
set up.

2nd PHASE OF DEVELOPMENT

The government decided that for the first 10 years there should be

only one Islamic bank before establishing other Islamic banks.

This decision was to enable BIMB to focus on the growth of
Islamic banking and to develop as many Islamic banking
products and services as possible without any competition
By the mid of December 1993, BIMB had developed 21 Islamic
banking products and instruments covering a wide area of
banking activities.
The second phase of the development of Islamic banking started
in early 1990s when BNM outlined objective to develop a
comprehensive and vibrant Islamic banking system operating
side by side with the conventional banking system.

SKIM PERBANKAN TANPA FAEDAH (SPTF)

BNM introduced a scheme named Interest-Free Banking Scheme

(Skim Perbankan Tanpa Faedah) (SPTF) in March 1993 to allow the

existing conventional banking system to offer Islamic banking services
Through SPTF, conventional banks were allowed to introduce and offer
Islamic banking services and facilities at their counters using their
existing infrastructure, including staff and branches.
By the end of end of June 1999, the number of participating banking
institutions increased significantly to 54, comprising 24 commercial
banks, 18 finance companies, 5 merchant banks and 7 discount houses
Although the participation of the banking institutions was voluntary,
they had to comply with the requirements of the guidelines issued by
BNM.

BNM has introduced various measures and policies to meet up the

requirements:

To establish an Islamic Banking Unit (IBU) to be headed by a senior Muslim banker

To create an Islamic Banking Fund (IBF) with the minimum allocation of RM1
million
To open separate current/clearing accounts for Islamic banking operations with
BNM
To register as Indirect Members under the wholesale payments system, SPEEDS
(Sistem Pcmindahan Elektronik untuk Dana dan Sekuriti) (now RENTAS)
To observe a separate cheque clearing system for Islamic banking.
To maintain separate ledgers for their Islamic banking operations.
To appoint at least one Shariah consultant to advise on operations of their Islamic
banking division.

These requirements would ensure that the banks did not co-mingle

the funds freely without proper internal controls.

SKIM PERBANKAN ISLAM (SPI)

In 1998, BNM replaced the SPTF with Islamic Banking Scheme (IBS) or

known as Skim Perbankan Islam (SPI) effective from 1st December 1998.
All banking institutions participating in the SPI were required to upgrade
their Islamic Banking Unit (IBU) to Islamic Banking Division (IBD) and
headed by a Muslim senior management officer of the bank and reports to
the Chief Executive Officer (CEO)
The minimum funds of Islamic banking were raised from RM 1 million to:

RM5 million for commercial banks, gradually increased to RM20 million by 31 December
2000
RM5 million for finance companies, gradually increased to RMI0 million by 31 December
2000
RM3 million for merchant banks, gradually increased to RM6 million by 31 December
2000.

Beginning from 4 January 1999, discount houses were permitted to

participate in the SPI

ISLAMIC INTER-BANK MONEY MARKET

The establishment of the Islamic money market on 3 January

1994 was the last element for the Islamic banking system to
function as a full-fledged banking system.
BNM decided to implement the Islamic Money Market based on
the concept of mudharabah or profit- sharing
The development of an Islamic money market was crucial as an
essential avenue to provide a ready source of short-term
investment based on Shariah principles in case of temporary
shortage or surplus of funds faced by Islamic banks.
The Islamic money market comprised 3 components:

Trading of Islamic Financial Instruments

Mudarabah Interbank Investments (MII)
Islamic Cheque Clearing System (ICCS)

ISLAMIC CAPITAL MARKET

Islamic capital market is one of the components in the overall capital

market in the country.

It functions as a parallel market to the conventional capital market for
capital seekers and providers, and plays a complementary role to the
Islamic banking system in broadening and deepening the Islamic
financial markets in Malaysia.
The government established the Securities Commission (SC) as the sole
regulatory body for the regulation and development of capital market on
1 March 1993.
SC has identified the development of ICM as one of its main agenda in
the Capital Market Masterplan (CMMP) of Malaysia, launched on 22
February 2001.
One of the main objectives set by the CMMP was to establish Malaysia
as an International Islamic Capital Market Centre.

The SCs efforts to develop the ICM by setting up of the

necessary infrastructure:

Establishing an Islamic Capital Market Unit (ICMU)

Establishing Islamic Instruments Study Group (IISG)

to carry out research and development of ICM instruments

analyzing the existing securities from Shariah perspectives
to advise the SC on development ICM
to study issues related to the operation of the ICM

Establishing Shariah Advisory Council (SAC) of SC

succeeded the role and function of IISG

to ensure that the operation of the ICM conform to Shariah principles
to advise the SC on all matters related to the development of the Islamic
capital market
as a reference center for issues related to Islamic capital market.

SHARIAH ADVISORY COUNCIL (SAC) OF THE BNM

The primary objectives of NSAC are as follows:

To act as the sole authoritative body to advise BNM on Islamic

banking and takaful operations
To co-ordinate Shariah issues with respect to Islamic banking,
finance and takaful
To analyze and evaluate Shariah aspects of new products/
schemes submitted by the banking institutions and takaful
companies.

ESTABLISHMENT OF THE SECOND ISLAMIC BANK

The second Islamic bank in Malaysia, Bank Muamalat

Malaysia Berhad (BMMB) was established on 1 October 1999.

The establishment of BMMB arose from the merger of Bank
Bumiputra Malaysia Berhad (BBMB)and Bank of Commerce
(M) Berhad (BOC).
Under the merger arrangement, the Islamic banking assets
and liabilities of BBMB, BOC and BBMB Kewangan Berhad
(BBMBK) were transferred in BMMB, while the conventional
operations of BBMB, BOCB and BMBK were transferred to
BOCB.
The establishment of the second Islamic bank has contributed
to the rapid growth of the Islamic banking system.

DEVELOPMENT FINANCIAL INSTITUTIONS (DFIS)

The aspiration of BNM to develop a comprehensive

Islamic banking system had stimulated the nonbanking financial intermediaries to offer Islamic
banking products and services includes:

Bank Simpanan Nasional (BSN)

Bank Kerjasama Rakyat Malaysia (BR)
Development Finance Institutions (DFIs) i.e. Bank
Pembangunan dan Infrastruktur Malaysia (BPIM) and Bank
Pertanian Malaysia (BPM).

3rd PHASE OF DEVELOPMENT

With the rapid development of the Islamic financial industry

on the global front, the Government has promoted Malaysia as

a regional Islamic financial centre.
The government has declared Labuan as an International

Offshore Financial Centre (IOFC) to promote Malaysia as an

international Islamic financial centre.
BNM has participated actively to enhance the development of

Islamic banking and finance such as the formation of an

International Islamic Financial Market (IIFM) and the setting
up of the Islamic Financial Services Board (IFSB).

LABUAN AS AN ISLAMIC IOFC

Government has made a decision to promote Labuan as an

International Offshore Financial Centre (IOFC) to position

itself as an international center for offshore Islamic banking
and finance with the objectives:

To complement domestic financial activities in Kuala Lumpur

To strengthen the contribution of the financial services sector in the gross
national product of Malaysia
To promote the economic development of Labuan

Labuan with the status of IOFC has the advantage to attract

international banking business by:

reducing or eliminating the need for full compliance with local capital
requirements
having lower licence fees, corporate taxes and other business levies

INTERNATIONAL ISLAMIC FINANCIAL MARKET (IIFM)

Labuan Offshore Financial Services Authority (LOFSA) was established

and responsible for setting national objectives, policies and priorities for
the development and administration of offshore financial services in
Labuan.
In its efforts to develop Labuan as an Islamic IOFC, LOFSA worked with
Islamic scholars to identify potential offshore activities as well as to
develop viable Islamic financial instruments which would attract Islamic
investors to the Labuan
Following this, Malaysia, Bahrain, Indonesia, Sudan, Iran and the
Islamic Development Bank (IDB) established an IIFM Board April 2002
The IIFM Board was entrusted to develop and supervise the
development of the IIFM and supported by two committees, the Market
and Product Development Committee MPDC and the Shariah
Supervisory Committee (SSC).

FIRST SOVEREIGN GLOBAL ISLAMIC SUKUK

Malaysia successfully launched the first Sovereign

Global Islamic Sukuk, structured on the principle of

ijarah on 25 June 2002.
The launching of the global Islamic bond signified
Malaysias strong commitment in supporting the
development of Islamic banking and finance on the
global front.
The move to access the international Islamic capital
market would give impetus to the development of the
Islamic financial market.

ISLAMIC FINANCIAL SERVICES BOARD (IFSB)

Islamic Financial Services Board (IFSB) was established in 2002.
The establishment of the IFSB will set the stage for the adaptation,

harmonization and development of the international regulatory

and supervisory standards as well as best practices for the
governance of all financial institutions offering Islamic financial
services and products.
The nine founding members are Bahrain, Indonesia, Iran, Kuwait,
Malaysia, Pakistan, Saudi Arabia, Sudan and the Islamic
Development Bank, The IFSB secretariat is located in Kuala
Lumpur. Malaysia.
The Board will also contribute towards ensuring the soundness
and stability of the Islamic financial system, thus paving the way
for Islamic banking to expand globally.

LICENSING OF FOREIGN ISLAMIC BANKS AND ISLAMIC

BANKS SUBSIDIARIES
The financial liberation of the Islamic banking sector was introduced

on 2007 with the issuance of three new Islamic bank licenses under
the Islamic Banking Act 1983 (IBA)
The new entries of the foreign Islamic banks were in line with the
recommendations of the Financial Sector Master plan (FCMP) to
position Malaysia as an international Islamic financial hub.
The presence of foreign players will promote healthy competition
which is necessary to elevate the industry to new levels of dynamism
as well as to accelerate the global integration the domestic Islamic
banking system.
It will also promote greater economic and financial linkages between
Malaysia and the Middle East, and foster greater harmonization in
terms of Shariah interpretation and understanding.

FINANCIAL SECTOR MASTER PELAN FOR ISLAMIC BANKING

Financial Sector Master Pelan was launched on March 2001

incorporates 10 years master plan for Islamic banking a

FSMPs aim is to create an efficient, progressive and
comprehensive Islamic financial system that contributes
significantly to the effectiveness and efficiency of then
Malaysian financial sector.
FSMP provides recommendations which focus on three
main areas:

institutional capacity enhancement

financial infrastructure development
regulatory framework development

CONCLUSION
Islamic banking system has experienced a rapid growth and tremendous

development since its first debut in 1983

Various measures have been adopted by the authorities in implementing

the Islamic banking system with a step by step and open-minded

approach with each step taken after careful consideration of all
implications.
In order to he a viable Islamic banking system, all the basic elements

towards this purpose were being established by the authority.

These include a large number of products, instruments and institutions

and the establishment of an Islamic money and capital market which

would link the institutions and the instruments.