emkay@salam.uitm.edu.

my

Mahyuddin Khalid

ISLAMIC FINANCIAL
LEGAL FRAMEWORK
DEVELOPMENT OF THE MALAYSIAN ISLAMIC
FINANCIAL SYSTEM

CONTENT
2

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

3

Comprehensive Islamic financial system covering all

financial sectors

operating in parallel with conventional financial system

Diversities of players

Twelve full-fledged Islamic banking institutions

9 takaful operators

Sound and robust Islamic financial institutions governed

by international best practices
Rapid growth with wide range of product and services

2 domestic Islamic banks

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

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

HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING
5

Traditional Malay Muslim society is very cautious in

involving themselves in riba transactions
In order to avoid interest-based transactions in
getting cash or liquidity, they practice a local
customary transaction known as jual janji
(conditional sale).
The Courts recognize jual janji as a Malay
customary transaction arising out of religious
consideration
According to Ungku A. Aziz, the main purpose of
savings for Malay Muslims was to meet the
expenses for the journey to perform haj, thus they
preferred to use traditional ways of savings.

HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING
6

In Malaysia, Islamic banking can be traced back to its

root in 1963, with the establishment of the Lembaga
Urusan dan Tabung Haji (LUTH), which was the first
Islamic savings institution for the special purpose of
performing hajj.
Islamic resurgence in the Middle Eastern countries
had initiated the call for the establishment of an
Islamic financial system that would allow Muslims to
practice their banking and finance according to
Shariah principles.
This can be seen with the establishment of Islamic
Development Bank in Jeddah in 1974 and Dubai
Islamic Bank in 1975, being the first Islamic
commercial bank.

HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING
7

Move towards establishing an Islamic bank in Malaysia was

initiated by various private parties

e.g during the Kongres Ekonomi Bumiputera (The Bumiputera

Economic Congress) in 1980 and at the National Seminar on
Konsep Pembangunan Dalain Islam (the Concept of Development
in Islam).

A resolution was passed calling off the Government to allow

LUTH to establish an Islamic hank in Malaysia in order to
mobilise and invest the funds of the Malays and the
Muslims.
Main factors contributing to the successful growth of Islamic
banking in this country:

Support and encouragement from the government

Commitment and dcdicat ion of the regulatory authority
Favourable economic environment
Creativity of the financial engineers in designing new products.

HISTORICAL DEVELOPMENT OF ISLAMIC

BANKING
8

LUTH undertook a study on the establishment of an Islamic

bank in Malaysia.
The government accepted the proposal by LUTH and
appointed a National Steering Committee on Islamic Bank
(NSC) to study various proposals for the establishment of
an Islamic bank.
The NSC was given the following tasks:

To study and identify various critical aspects of Islamic banking

such as the basis of the establishment, areas of operation and
business relationships with the customers and other financial
institutions.
To examine the suitability of Islamic banking in the Malaysian
context from various points of view including religious, legal,
racial, social and development; and
To present to the Government recommendations regarding the
establishment of Bank Islam Malaysia

NSC REPORT ON BANK ISLAM

MALAYSIA
9

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.

STAGES OF DEVELOPMENT
10

Gradual and pragmatic

Milestones
1969

1983

1993

200
3

Pilgrimage Fund Board

Full-fledged
Islamic banks

Bank Islam
Malaysia Bhd.

Bank Muamalat
Malaysia Bhd.

Foreign Islamic
banks

Conventional banks offer Islamic window

Islamic subsidiary

Islamic money markets

Takaful
Operators

Syarikat Takaful
Malaysia Bhd.

Takaful Nasional, Mayban Takaful, Takaful

Iklhas, Commerce Takaful

..achieved significant milestones in building comprehensive and

integrated Islamic financial system with diversity of players.

DEVELOPMENTAL FOCUS

Institutional &
Regulatory
Development

Enhancement of
knowledge and
expertise

Product and
market
development

Legal and Shariah

framework

11

1st PHASE OF DEVELOPMENT

12

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
13

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
14

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

THE ESTABLISHMENT AND DEVELOPMENT

OF BIMB
15

The corporate objective of the Bank 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, the Bank
had to set up a Shariah Supervisory Council.
BIMB was listed on the main board of the Kuala
Lumpur Stock Exchange (KLSE) on 17 January 1992
After 23 years in existence, BIMB has proven that
Islamic banking is viable and has demonstrated its
ability and capacity to operate in parallel with
conventional banks with the banking system.

LEGISLATION OF GOVERNMENT INVESTMENT ACT

1983
16

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 interest
free 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
17

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

18

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.

2nd PHASE OF DEVELOPMENT

19

During the first ten years, the development of Islamic bank

emphasis on creating a large number of different types of Islamic
financial instruments.
Although BIMB was established in 1983. the Bank was still not
able to serve the entire needs of the population, due to several
constrained of the limited number of branches and resources.
The establishment of a large number of institutions offering
Islamic financial services is necessary to further develop Islamic
bank. For this purpose, three 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 third alternative was chosen as it

was considered the most efficient and effective way of expanding
Islamic banking

SKIM PERBANKAN TANPA FAEDAH (SPTF)

20

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.

SKIM PERBANKAN TANPA FAEDAH (SPTF)

21

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 comingle the funds freely without proper internal controls.

SKIM PERBANKAN ISLAM (SPI)

22

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

23

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 shortterm 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

24

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.

ISLAMIC CAPITAL MARKET

25

The SCs efforts to develop the ICM by setting up of

the necessary infrastructure:

Establishing an Islamic Capital Market Unit (ICMU)

to

carry out research and development of ICM instruments

analyzing the existing securities from Shariah perspectives

Establishing Islamic Instruments Study Group (IISG)

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.

ISLAMIC CAPITAL MARKET

26

The SCs efforts to develop the ICM by broadening and

strengthen the market such as:

Analyzing existing conventional capital market instruments

to determine its validity from the Shariah perspective,
Formulating and developing new financial instruments based
on Shariah principles
Reviewing and identifying the activities companies listed on
the KLSE for the issuing of the Shariah approved counter list.

The ICM comprises :

Primary market
New

issues of Islamic Government securities and the Islamic

Corporate securities are offered to the public

Secondary market,
Existing

Islamic Government securities and Islamic Corporate

securities are traded; the equity market and the unit trust.

SHARIAH ADVISORY COUNCIL (SAC) OF

THE BNM
27

BNM established its Shariah Advisory Council (SAC) on

Islamic Banking and Takaful on 1 May 1997 to streamline
and harmonise the Shariah interpretations among banks
and takaful companies.
The SAC took over the role of SAC of Bank Islam as the
consultant to the IBS banks pertaining to Shariah issues.
Prior to the establishment of SAC, there were some
differences in opinion among Shariah consultants on similar
issues which might obstruct the development of IBS.
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.

SHARIAH ADVISORY COUNCIL (SAC) OF

THE BNM
28

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
29

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)
30

The aspiration of BNM to develop a

comprehensive Islamic banking system
had stimulated the non-banking
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

31

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

32

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

INTERNATIONAHSLAMIC FINANCIAL
MARKET (IIFM)
33

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).

INTERNATIONAHSLAMIC FINANCIAL
MARKET (IIFM)
34

LOFSA initiated the establishment of a global

network of Islamic financial markets known as
International Islamic Financial Market (IIFM) with the
objectives:

To establish a structured global financial market that is

based on Shariah principles
To enhance the cooperative framework among Islamic
countries and financial institutions
To generate the liquidity, creation and trading of
financial instruments, thus enhancing investment
opportunities and spins-off of other related services and
activities such as custodial, brokerage and treasury.
To promote greater awareness of Islamic banking and
finance, and facilitate cross border transactions.

FIRST SOVEREIGN GLOBAL ISLAMIC

SUKUK
35

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 SERVICES BOARD

(IFSB)
36

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
37

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.

LICENSING OF FOREIGN ISLAMIC BANKS AND

ISLAMIC BANKS SUBSIDIARIES
38

In 2004, BNM also continued to further strengthen

the overall infrastructure development of the Islamic
banking system as the Islamic banking industry
entered a more advanced stage of development.
The window-based institutional structure was
reviewed to further strengthen and elevate the
development of domestic Islamic banking industry
through a new enabling institutional structure.
The domestic banking groups and foreign Islamic
Banking Scheme (IBS) banks were encouraged to
set up Islamic subsidiaries (IS) as full-fledged Islamic
banks which would be licensed under the IBA.

FINANCIAL SECTOR MASTER PELAN FOR ISLAMIC

BANKING
39

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

VISION OF ISLAMIC BANKING AND

TAKAFUL
40

Constitute 20% of the banking and insurance market share

with an effective contribution to the financial sector of the
Malaysian economy
Represented by a number of strong and highly capitalized
IBIs and takaful operators offering a comprehensive and
complete range of Islamic financial products and services
Underpinned by a comprehensive and conducive Shariah
and regulatory framework;
Supported by a dedicated institution (Shariah commercial
court) in the judiciary system that addresses legal issues
related to Islamic banking and takaful
Supported by a sufficient number of well-trained, high
caliber individuals and management teams with the required
expertise;
Malaysia as a regional Islamic financial center.

CONCLUSION
41

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.

42

END OF CHAPTER