Islamic

Banking and
Finance Law
[UIB2612]
Introduction
 Learning Outcome
Students should be able to:
 Understand the underlying concept of Islamic
banking ad finance;
 Describe the development of Islamic banking
and finance system particularly in Malaysia.
Introduction

Islamic finance = financial activities that is in consonance

with the principles of Shari’ah (Islamic rules & values).

Islamic financial institutions (IFIs) carry out business & offers

the same facilities as conventional financial institutions
(CFIs). Its application is also not limited to Muslims alone.

EXCEPT that IFIs strictly follows the rules of Shari’ah in

uphold social justice & prohibits usury (riba’), unlike CFIs
which is based on capitalism and practice riba’.

The development of Islamic financial system is for the sake of

the Muslims community to enable them to invest savings and
raise finance in a way which does not compromise their
religious beliefs.
It is also a reflection of the comprehensiveness of Islam.
Islam is not just a religion but a way of life.

There are 3 main components of Islamic finance:

Islamic Finance

Islamic Islamic
Islamic Banking Insurance Financial
(Takaful) Market
Historical Development

Islamic finance has its roots in the past as well as the

present.

Itslinks to the past relate to the fact that it is based on

principles & features which were established more than
1,400 years ago. (Prophet’s Era)

Itslinks to the present relate to the fact that these ancient

features are now being presented to contemporary society in
a form which is both modern and innovative.

The development can be divided into 3 eras:

 Modern Era
Middle Era
The era of modern
Early Era Islamic banking
The era of the Caliphates
until the fall of the
The Prophet era until the Uthmaniyah Empire
era of the 4 Caliphates
Early Era
Pre-Islamic period: Mecca was a city of trade. Trade
activities have long been conducted in the Arabian
peninsular even before the era of Prophet Muhammad.

The communities followed certain customary commercial

practices. Some of these activities are not in conflict with the
principles of Shariah .

It was reported that Prophet Muhammad used the

mudarabah contract to trade with Khadijah’s capital. The
Prophet also had practice musharakah (partnership) with
Sayfi bin A’idh before his prophet hood.

Prophet period: With the arrival of Islam, those activities

which are not in conflict with Shariah continues to be
practice such as bay’ al–salam (deferred delivery).
Practices which were in direct conflict with Shariah were re-
evaluated and ratifies so as to be consistent with it. E.g. the
practice of riba’ was no longer permitted.

The doctrine of financial operations was derived directly

from the Quran & Sunnah.

Islamicmethods of finance often drew upon examples from

the Prophet’s experiences. There are many hadith (saying)
about the Prophet buying on credit, taking financing and
sometimes giving personal property as a security.

The spread of Islam began shortly after the demise of the

Prophet. The Muslims brought with them their religion,
culture, trade and commence to other Arabic states and to
non-Arab world.
Middle era
Began with the end of the reign of Caliph Uthman in the
year 661 A.C. It witnessed the continuation of banking
activities which were practiced in the early era of Islam.

With the fall of Islamic empire and followed by the fall of the
Roman empire, there were significant adverse impact on the
economic activities of Muslim countries. Islamic banking
system failed to expand on this era.

During the period of the European colonial empires, most

countries adopted Western banking systems and abandoned
Islamic commercial practices.
Modern Era
3 factors attributes to the growth of modern Islamic
banking:

(i) Revenue: Rise of national revenue in the Arab & Muslim

countries due to the rise of oil prices.
(ii) Faith: Increasing number of Muslims have sought to invest
their wealth in institutions which is consistent with the values
of the Islamic faith.
(iii) Freedom from colonisation.

These factors lead the Muslims to rediscover Islamic values

and tradition and find alternatives to the conventional system.

Started in 1963 with the establishment of Mit Ghamr

Savings Bank in Egypt. It used the Shariah principles of
Musharakah which well received by the local community and
the farmers.
 However, in Mid-1967, due to political unrest in Egypt, the
operations were taken over by the National Bank of Egypt and
interest-free operations were reverted to interest-based system.

 The need to establish an Islamic Banking System reach its

peak around 1970’s.

 However, there are problems in establishing Islamic Banking

System due to
-the scarcity & unavailability of proper guidelines concerning
principles & practices of the interest-free banking.
-it was a daunting task finding Muslim Economists who were
also well versed in the knowledge of Shariah laws.

King Faisal bin Abdul Aziz al-Saud (the late Saudi King)
established the Organization of Islamic Countries (OIC) and
urged Muslim countries to set up their own Islamic Banking
System.
 1960s 1970s 1980s 1990s

1963 1975 1983 1991

• Mit Ghamr, • Islamic • Bank Islam • Accounting
Egypt Development Malaysia and Auditing
• Lembaga Bank (IDB), Berhad Organisation
Tabung Haji, Jeddah • Islamic Bank, for Islamic
Malaysia • Dubai Islamic Bangladesh Financial
Bank Institutions,
Bahrain
1977 1984 1993
• Faisal Islamic • Dar al Maal • Islamic Bank of
Bank, Sudan Islamic Trust, Brunei
Geneva

1979 1989 1999

• Bahrain Islamic • ANZ Global • Bank
Bank, Bahrain Islamic Muamalat
Finance, UK Malaysia
Berhad
Development in Malaysia

Islamic banking can be traced back to its root in 1963, with

the establishment of the Perbadanan Wang Simpanan Bakal-
Bakal Haji (PWSBH), which was the 1st Islamic savings
institution for the special purpose of performing hajj
(pilgrimage to Mecca).

In 1969, PWSBH merged with Pejabat Urusan Haji to form

Lembaga Urusan dan Tabung Haji (now known as Lembaga
Tabung Haji (LTH)). LTH use Shariah principles in its fund
management. Instead of paying interest, it pays dividend
earned out of its investments in equities and securities.

However, since LTH is mainly a savings institution, move

towards establishing an Islamic bank in Malaysia was
initiated.
1st PHASE OF DEVELOPMENT (1980s)
Islamic Banking

 A suitable legal framework according to the Shariah

principles should be provided to enable an Islamic bank to be
established and operated in Malaysia.

The existing Banking Act 1973 (later replaced by BAFIA 1989

and now FSA 2013), 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 (sale)

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

1983. IBA allow Islamic banks to operate without interest as
well as to engage in trade & commerce. It also provides BNM
with the power to supervise and regulate Islamic banks.
Consequently, Bank Islam Malaysia Berhad (BIMB) was
incorporated and officially launched on 1 July 1983.

BIMB was incorporated as a public limited company to enable

the Bank to conduct its activities freely without being
constrained by regulations imposed on statutory bodies.

Even though BIMB was a private company, the largest

portion of its shares was held by the Government to generate
the public’s confidence in the bank.

The corporate objective of BIMB was to provide banking

facilities and services in accordance with Islamic commercial
law.

In order to supervise its operations to ensure its compliance

with the principles of Shariah, BIMB had set up a Shariah
Supervisory Council.
Islamic Insurance (Takaful)

After the establishment of Islamic bank, there was a move to

establish an Islamic insurance company to complement
Islamic banking operations.

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 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 (1990s)
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.
1. Islamic Banking Services – Islamic Window Concept

There is a pressing need to further develop & expand Islamic

bank as BIMB unable to serve the entire needs of the
population, due to several constrained of the limited number of
branches and resources.

For this purpose, 3 alternatives were considered by the

authority:
- establish new Islamic banks
- allow the conventional banks to set up Islamic banking
subsidiaries
- allow the existing conventional banking system to offer
Islamic banking services

After careful consideration, the 3rd alternative (Islamic

banking services) was chosen as it was considered the most
efficient and effective way of expanding Islamic banking
BNM introduced a scheme known as Interest-Free Banking
Scheme or 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 (Islamic window) using their existing infrastructure,
including staff and branches.

Malaysia became the 1st country to practice dual banking

system whereby Islamic and conventional system co-exist &
run concurrently.

Although the participation of the banking institutions was

voluntary, they had to comply with the requirements of the
guidelines issued by BNM to ensure it is Shariah compliant.
Among 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 min.
allocation of RM1 million
-To open separate current/clearing accounts for Islamic
banking operations with BNM
-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.

BNM replaced the SPTF with Islamic Banking Scheme or

known as Skim Perbankan Islam (SPI) effective from 1st
December 1998.
2. Islamic Banking Subsidiary

In 1999, BNM introduced the concept of Islamic banking

subsidiary which allowed financial institutions with Islamic
window operation to convert and set-up as full-fledged Islamic
banks.
3. Islamic Money Market (IMM)

IMM (short-term borrowing & lending e.g. certificate of

deposit, bills of exchange) was established on 3 January 1994.
With this establishment, Islamic banking can now function as
a full-fledged financial system.

The development of IMM was crucial as an essential avenue

to provide a ready source of short-term investment based on
Shariah principles in case of temporary shortage/surplus of
funds faced by Islamic banks.

BNM decided to implement the IMM based on the concept of

mudharabah (profit-sharing).

IMM comprised 3 components:

- Trading of Islamic Financial Instruments
- Mudarabah Interbank Investments (MII)
- Islamic Cheque Clearing System (ICCS)
4. Islamic Capital Market

Recognising the importance of the capital market, Malaysia

initiated the development of a private Islamic financial
securities market.

Itfunctions 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.

Malaysia also initiated the issuance of Islamic financial

instruments by the government and BNM. These instruments
are utilized in the conduct of open-market operations by BNM
to manage liquidity in the domestic financial system.
5. Shariah Advisory Council (SAC)

Prior to the establishment of SAC, there were some

differences in opinion among Shariah consultants on similar
issues which might obstruct the development of Islamic
banking system.

The Shariah Advisory Council (SAC) of BNM was established

in May 1997 to streamline & harmonise the Shariah
interpretations among banks and takaful companies and to
advice BNM on any Shariah issues relating to financial
business.

The SAC of BNM took over the role of SSC of Bank Islam as
the consultant to the Islamic banks pertaining to Shariah
issues.
The SAC is the highest authority in deciding Shariah
issues pertaining to Islamic banking and takaful operations in
Malaysia.

Members of SAC comprise academicians and Shariah

experts who posses vast knowledge and experience in the
areas of Islamic banking and finance.
6. Second Islamic Bank

The second Islamic bank known as 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).

The establishment of the second Islamic bank has

contributed to the rapid growth of the Islamic banking system.
3rd PHASE OF DEVELOPMENT (2000s)

Integration with Global Financial System

The Islamic finance system has been progressively

liberalized to allow for foreign entry and participation in the
Malaysian financial system.

With the rapid development of the Islamic financial industry

on the global front, the Government has promoted Malaysia
as a regional Islamic financial centre.

Financial Sector Master Plan (FSMP) was launched on

March 2001 incorporates 10 years master plan for Islamic
finance. It’s aim is to create an efficient, progressive and
comprehensive Islamic financial system that contributes
significantly to the effectiveness and efficiency of Malaysian
financial sector.
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).

In 2006, Malaysia launched the Malaysia International

Islamic Financial Centre (MIFC) to enhance the inter-linkages
in the global Islamic financial markets.
1. Labuan as Islamic IOFC

The government has declared Labuan as an International

Offshore Financial Centre (IOFC) to promote Malaysia as an
international Islamic financial centre.

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

In its efforts to develop Labuan as an Islamic IOFC, Labuan

Offshore Financial Services Authority (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
2. International Islamic Financial Market (IIFM)

Malaysia,Bahrain, Indonesia, Sudan, Iran and the Islamic

Development Bank (IDB) established an IIFM Board in 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).
3. Islamic Financial Services Board (IFSB)

IFSB was established in 2002. The establishment 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 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.

The 9 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.
4. First Sovereign Global Islamic Bond (Sukuk)

Malaysia successfully launched the first Sovereign Global

Islamic Sukuk and Guthrie Sukuk, structured on the
principle of ijarah on 25 June 2002.

The launching of the global Islamic bond signified Malaysia’s

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.
5. Licensing of Foreign Islamic Banks

The financial liberation of the Islamic banking sector was

introduced in 2007 with the issuance of 3 new Islamic bank
licenses under the IBA.

The new entries of the foreign Islamic banks were in line with
the recommendations of the FSMP 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.

Itwill also promote greater economic and financial linkages

between Malaysia and the Middle East and foster greater
harmonization in terms of Shariah interpretation and
understanding.
CONCLUSION

In Malaysia, Islamic banking and finance system has

experienced a rapid growth and tremendous development since
its first debut in 1983. Islamic banking and finance has
emerged as important component of the overall financial
system.

Malaysia has succeeded in implementing a dual banking

system and has emerged as the first nation to have a full-
fledged Islamic system operating side-by side with the
conventional banking system.

Main factors contributing to the successful growth of Islamic

banking in Malaysia:
- support and encouragement from the government;
- commitment and dedication of the regulatory authority;
- favourable economic environment; and
- creativity of the financial engineers in designing new
products.