ISB655

INTRODUCTION TO ISLAMIC
FINANCIAL SYSTEM

1.1 History and Development

1.2 Islamic Banking in Some Muslim Countries
1.3 Overview of Islamic Banking in Malaysia
Learning Outcomes

• Understand the Islamic financial/banking

system; its history and development.
• Understand the history and development
of Islamic banking in Malaysia.
• Understand the philosophies and
principles of Islamic banking.

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History & Development

• Generally aims to promote and develop

the application of Islamic principles to the
financial affairs.
• An advantage of Islamic banking – do not
deal with loans.
• Instead introduces the principle of
Musharakah & Mudharabah – investments
will depend on the usefulness and
feasibility of the invested projects.
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• Main principles – prohibition of interest,
the basis of fair and legitimate profit and
the prohibition of monopoly and hoarding.
• BUT STILL…a profitable organizations
that aim to gain profit.
• Islamic banking only emerged as a new
reality since 1970s, but its philosophies
and principles are not new – birth of Islam.

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• The emergence of Islamic banking is
evident of the revival of Islam and the
desire of Muslims to live in accordance
with the teachings of Islam.

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 Islamic Banking In The Early
Days of Islam
• The four revelations of Al-Quran
specifically dealing with riba shaped the
operational aspects of the Islamic banking
system.
• The only known organised Islamic
financial institution during the time of
Prophet (saw) was called ‘Baitul Mal’.
• Objective – manage the financial affairs of
the Islamic state – not generally accept
deposits nor grant loans.
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• Public money and valuables were kept by
trustworthy individuals such as the
Prophet (saw) and Zubair bin al-Awwam.
• The Prophet (saw) was entrusted by the
people of Mecca with safekeeping their
money – this concept, the trustee did not
have the right to use the funds.
• Zubair bin al-Awwam chose to only
receive money as a loan (qard) – had a
right to make use of it & had the obligation
to return it intact.
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• Ibnu Abbas was noted to have transferred
some money to Kufah. So was Abdullah
bin Zubair in Mecca, who sent money to
his brother Hisab bin Zubair, who lived in
Iraq – activities related to remittance and
bills of exchange.
• The use of cheques was widely known
with the growing trade between the cities
of Syam and Yaman – with this cheques
the beneficiaries would be able to collect
from Baitulmal a quantity of wheat
imported from Egypt.
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• There were already a few individuals who
practiced banking functions although not
performing comprehensively.

Banking functions
during To transfer money
To channel financing
the Prophet era

To accept deposits
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 Banking Practices During Bani
Umayyah and Bani Abbasiyah

• In the Prophet (saw) time, banking

functions were undertaken by individuals –
one-man one-function basis.
• In the era of Bani Abbasiyah, these three
banking functions were undertaken
individually – one-man multi-function
banking practice.

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• When various types of currencies were in
circulation, special expertise was required
to distinguish one coin from the others.
• Each coin had its own precious metal
content, hence its own value.
• Special expertise – naqid, sarraf,and
jihbiz. – the impetus of the practice of
money exchange.
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• The role of bankers began to pick
popularity during the reign of Muqtadir –
most wazirs had their own bankers.
• A milestone in the development of banking
practices at the time – wide circulation of
saq (cheques) as an instrument of
payment.
• Money could be transferred across
countries without a need to move the
physical money.
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 Islamic Banking in The
Modern Era
• The last decade has seen a marked decline
in the establishment of new Islamic banks
and the established banks seem to have
failed to live up to the expectations.
• The literature of the period begins with
evaluations and ends with attempts at
finding ways and means of correcting and
overcoming the problems encountered by
the existing banks.
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• The first such work is that of Muhammad Uzair
(1955). Another set of works emerged in the late
sixties and early seventies. Abdullah al-Araby
(1967), Nejatullah Siddiqi (1961, 1969), al-Najjar
(1971) and Baqir al-Sadr (1961, 1974) were the
main contributors.

• The first attempt came in Malaysia mid-1940s. A

plan to invest prospective pilgrim savings in real
estate and plantations in accordance with Syariah
was, however, unsuccessful.

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• The first experimental local Islamic bank was
established in the late 1950s in a rural area of
Pakistan that charged no interest on its lending.

• The establishment of Mit Ghamr Local Savings

Bank marked a new milestone in the revolution
of the modern Islamic banking system. The bank
was considered to be the most innovative and
successful experiment with interest-free banking.
But then closed down for various reasons.

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• 1963
• In Malaysia the Pilgrims Saving Corporation was
incorporated, and it was launched on September 30, 1963. It
changed its name to Pilgrims’ Administration and Fund
(Tabung Hajji), and it took its final shape as a government
sponsored and supervised financial insititution that collects
savings and invests them in accordance with Shari’ah.

• 1971
• The Nasir Social Bank, established in Egypt in 1971, was
declared an interest-free commercial bank, although its charter
made no reference to Islam or Shari’ah

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• 1973
• The Islamic Development Bank was established. The purpose of the
Islamic Development Bank is to foster the economic development and social
progress of member countries and Muslim communities in non-member
countries individually as well as jointly in accordance with the principles of
Shari’a. It certainly is one of the pioneering Islamic banks having been
opened for operations on October 20, 1975.

• 1975
• Established in 1975, Dubai Islamic Bank is the first Islamic bank to have
successfully implemented the Islamic system of banking in all its shades.
Bank’s headquarter is in Dubai. Help and encouragement came in from
everywhere such as the government, people and the central bank of UAE.

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• 1976
• The beginning of the new alliance between Shari’ah scholars and
bankers had to wait until 1976 when the Faisal Islamic Bank of Egypt
was established. The Bank was the first to have a formal Shari’ah board
consisting of selected Ulama from Egypt.

• 1977
• The Faisal Islamic Bank, whose principal patron was the Saudi prince,
Muhammad ibn Faisal Al Saud, was officially established in Sudan in
1977. The Faisal Islamic Bank enjoyed privileges denied other
commercial banks (full tax exemption on assets, profits, wages, and
pensions), as well as guarantees against confiscation or nationalization.

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• 1977
• Kuwait Finance House (KFH) was established in Kuwait in 1977 as Kuwait's
first Islamic Bank with an aim to develop and promote Islamic Banking
worldwide. KFH was listed on the Kuwaiti Stock Exchange (KSE) in
September 1984. Kuwait Finance House is the Gulf region's second-largest
Shariah-compliant lender by market value.

• 1978
• Jordan Islamic Bank was established in 1978 as the first Islamic bank in
Jordan, and is one of the first banking units of the Group. The Bank is one of
the most important Islamic banks in Jordan and ranks as the 3rd biggest bank
in Jordan in terms of total assets and deposits, which is a big success
considering the very tough competition from the traditional banks in the
Jordanian market.

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• 1978
• Al Rajhi Banking and Investment Company (Al Rajhi) from Saudi
Arabia was established in 1978 with the merger of a group of companies
into Al Rajhi Trading and Exchange Corporation. Rajhi later converted
into a joint stock company under the name of Al Rajhi Banking and
Investment Corporation. Al Rajhi is the world’s biggest Islamic bank by
assets, which stand at more than $28 billion.

• 1979
• Bahrain Islamic Bank was established in 1979 as the first Islamic
commercial bank in the Kingdom of Bahrain. The Bank has grown
consistently and steadily since then to become a leading Islamic
institution, to be publicly listed on the Bahrain Stock Exchange.

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• 1982
• The Qatar Islamic Bank is established as the first Islamic bank in Qatar in 1982,
and it developed into one of the top ten listed companies in the country.

• 1983
• Bank Islam was established in July 1983 as Malaysia’s first financial institution to
be Shariah compliant. Today, the bank has a strong presence in the domestic
arena catering for the personal and commercial needs of Muslims and non-
Muslims alike.

• 1985
• The very start of Islamic Banking in Turkey is in 1985 with Albaraka Türk, the
Turkish participation banks (before called Special Finance Houses) were poised
to aim at the Turkish market as a whole

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Name Country Date of Establishment
Nasser Social Bank Egypt 1972
Islamic Development Saudi Arabia 1975
Bank
Dubai Islamic Bank UAE 1975
Faisal Islamic Bank of Egypt 1977
Egypt
Faisal Islamic Bank of Sudan 1977
Sudan
Islamic Banking System Luxembourg 1978
International Holding

Jordan Islam Bank Jordan 1978

Bahrain Islamic Bank Bahrain 1979
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Cont..

Islamic International Bank Egypt 1981

for Inv. & Development

Islamic Investment House Jordan 1981

Al-Baraka Investment & Saudi Arabia 1982

Development Company
Saudi-Philippine Islamic Saudi Arabia 1982
Development Bank.
Faisal Islamic Bank Kibris Turkey 1982

BIMB Malaysia 1983

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 Development of Islamic
Banking in Some Muslim
Countries
 Egypt
• Mit Ghamr Local Savings Bank
- privately-owned
- Received overwhelming support from customers
- Due to the turbulent political situation and changes in Egypt –
been undertaken by the National Bank of Egypt and the Central
Bank – reverted back.
- Reduced the number of depositors drastically.
• Nasser Social Bank
• Faisal Islamic Bank
• Islamic International Bank for Investment & Development
• Egyptian Saudi Finance Bank
• Bank of Egypt – Islamic Transaction branches.

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 Iran
• In Iran, certain administrative steps were taken in
February 1981 to eliminate interest from banking
operations.
• In August 1983 the Usury-free Banking Law was
introduced – required banks to become interest-
free by 21 March 1984.
• The whole system was converted to an interest-
free one in March 1985 – allowed to accept 2 types
of deposits : Qard hassan and investment term
deposits.

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• Current & saving deposits – bank’s resources
• Investment deposits – depositors’ resources.
• Banks mainly channelling their funds towards mark-
up instead of profit-sharing.
• Lending on the basis of fixed rate of return
continues – as fixed rate is not interest according to
Shi’a teaching
• International banking still based on interest.

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 Pakistan
• Islamisation of the banking system took place in end 1970s –
“Superior Task Force” been set up to eliminate interest in the
banking system.
• 1979, 4 financial institutions started offering facilities based on
Shariah.
• June 1980, the State Bank of Pakistan started using ‘profit-
sharing’ and ‘mark-up’ methods.
• January 1981, all banks had a counter for accounts based on
profit-sharing and Shariah based services commenced.
• January 1985, all financial transactions became interest-free.
• 15 July 1985, all deposits placed became interest-free.

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 Sudan
• Islamisation was in 1977 when the Faisal Islamic
Bank of Sudan (FIBS) was established.
• 5 more Islamic banks were set up.
• September 1983, all banks were asked to be
Islamised but when that government was
overthrown in 1985, there was disarray.
• 1994, the existing government re-Islamised the
entire banking system.

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 Turkey
• The only Muslim country which was completely
secular in its banking system.
• December 1983 onwards, laws relating to
Islamic banking were decreed.
• Instead of ‘Islamic Bank’,‘Special Finance
House’ were used, such as Albaraka Turkish
Finance House and Faisal Finance Institution
Incorporation which provide deposits and
financing facilities.

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Overview of Islamic Banking
in Malaysia
• Influenced by both external and internal factors.
• Establishment of the Pilgrims Fund Board in 1963 and the calls from
Malaysian Muslims for the need to establish an Islamic bank have
prompted the government to respond accordingly.
• 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 Government Investment Act 1983 was also enacted at the same
time to empower the Government of Malaysia to issue Government
Investment Issue (GII).

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• The first Islamic bank established in the country was Bank
Islam Malaysia Berhad (BIMB) which commenced operations
on 1 July 1983
• Listed on the Main Board of the Kuala Lumpur Stock
Exchange on 17 January 1992.
• The long-term objective of BNM is to create an efficient,
progressive and comprehensive Islamic financial system that
contributes significantly to the effectiveness and efficiency of
the Malaysian financial sector.
• Requires three vital elements :
1. a large number of global players;
2. a broad variety of instruments; and
3. a comprehensive financial infrastructure.

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• The foundations of an Islamic banking system
must also reflect the socio-economic justice and
values in Islam, as well as must be Islamic in
both substance and form.
• The effort to streamline and harmonise the
Shariah interpretations among the Islamic banks
and takaful companies, BNM established the
Shariah Advisory Council for Islamic Banking
and Takaful (SAC) on 1 May 1997.

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Development of Islamic Banking in Malaysia
Year Remark
1980 Formal request to set-up Islamic Bank was made during the Bumiputera
Economic Congress
July 30, The Government appointed National Steering Committee on Islamic
1981 Banking. The secretarial functions were given to the Pilgrimage Board of
Malaysia. This committee studied both operations of the Faisal Islamic Bank
of Egypt and The Faisal Islamic Bank of Sudan.
July 5, Among the recommendations made by the committee in its report:
1982 i. The Government should establish an Islamic bank whose operations
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 license and
supervise the Islamic bank.
iv. The Islamic bank is to establish its own Shariah Supervisory Board
whose function is to ensure that the operations of Islamic bank are in
accordance to the Shariah.

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Cont..
Mac 1, 1983 BIMB was incorporated and commenced operations on July 1,
1983.

March 10, 1983 The Islamic Banking Act was gazetted.

April 7, 1983 The Islamic Banking Act came into effect.

July 1, 1983 BIMB commenced operations.

1983 The Government introduced The Government Investment Act in

1983 to enable the government to issue Government Investment
Certificates, which are government bonds issued in accordance to
Islamic principles.

March 4, 1993 Central Bank has introduced a scheme known as ‘Skim Perbankan
Tanpa Faedah’ or ‘Interest-free Banking 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 and services. The pilot phase of
the scheme involved the three largest commercial banks in
Malaysia.

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August 21, The second phase started with 10 more finance institutions joining the
1993 scheme.

January, 1994 The establishment of the Islamic Money market which consists of
three elements namely,
i. Trading in financial instruments,
ii. Mudharabah inter-bank investments (MII)
iii. Islamic cheque clearing system

1998 BNM replaced term SPTF (Interest-free scheme) with the SPI (Islamic
Banking Scheme)

October 1999 Bank Muamalat Malaysia Berhad commenced operations on 1

October 1999 as the second Islamic Bank in Malaysia.

2004 BNM approved three new licenses to foreign financial institutions to

set up new Islamic banks.

2005 Three new local Islamic banks commence operations i.e. BBCB Tijari,
RHB Islamic Bank & Hong Leong Islamic Bank

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List of Financial Institutions Offering
Islamic Banking Services
• Full-fledge Islamic Banks
• Affin Islamic Bank Berhad
• Al Rajhi Banking & Investment Corporation Berhad
• AmIslamic Bank Berhad
• Asian Finance Bank Berhad
• Bank Islam Malaysia Berhad
• Bank Muamalat Malaysia Berhad
• CIMB Islamic Bank Berhad
• EONCAP Islamic Bank Berhad
• Hong Leong Islamic Bank Berhad
• Kuwait Finance House Berhad
• Maybank Islamic Berhad
• RHB ISLAMIC Bank Berhad

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• Participating banks in the Islamic Banking Scheme
Commercial Banks
• ABN Amro Bank Berhad
• Alliance Bank Malaysia Berhad
• Citibank Berhad
• HSBC Bank Malaysia Berhad
• Malayan Banking Berhad
• OCBC Bank (Malaysia) Berhad
• Public Bank Berhad
• Standard Chartered Bank Malaysia Berhad

• Investment Banks
• Affin Investment Bank Berhad
• Alliance Investment Bank Berhad
• AmInvestment Bank Berhad CIMB Investment Bank Berhad
• CIMB Investment Bank Berhad

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• Development Financial Institutions Offering Islamic Banking
Services
• Bank Kerjasama Rakyat Malaysia Berhad
• Bank Pertanian Malaysia
• Bank Perusahaan Kecil dan Sederhana Malaysia Berhad
• Bank Simpanan Nasional Berhad
• Export-Import Bank of Malaysia Berhad

• Range of Islamic Banking Products and Services in Malaysia

Deposits www.bnm.gov.my
Investments
Financings
Trade Finances
Card Services

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Conclusion
• The development of philosophies and objectives in Islamic
banking are in line with the principles of Islamic business as
highlighted in the al-Quran and Sunnah.
• As institutions whose foundations are based on Islamic
doctrines, Islamic banks must conforms to Islamic rules and
regulations.
• Islamic business entities are required to engage themselves
in legitimate and lawful business, and to fulfill all obligations
and responsibilities.
• Islamic bank have to uphold both profit and moral principles.

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