ISLAMIC BANKING

AND FINANCE
OVERVIEW OF FINANCIAL SYSTEM

CONTENT

OVERVIEW OF FINANCIAL SYSTEM

FINANCIAL SYSTEM STRUCTURE IN MALAYSIA

BANKS AS FINANCIAL INTERMEDIARIES

ISLAMIC BANKING

GOALS AND OBJECTIVES OF ISLAMIC BANKING

DIFFERENCES BETWEEN ISLAMIC BANKING AND

CONVENTIONAL BANKING SYSTEM

ADVANTAGES OF ISLAMIC BANKING

CHALLENGES OF ISLAMIC BANKS

FINANCIAL SYSTEM

Concept of Financial System

The collection of accounting processes and procedures

that allow a business to keep accurate financial
records, monitor accounts, prevent fraud and mistakes,
and catch any discrepancies.

A financial system allows a company to maintain

accountability for expenditures and revenues, and to
control their finances to minimize waste and loss.

A financial system is concerned about money, credit

and finance.

FINANCIAL SYSTEM

Concept of Money

Money is anything generally accepted as a means of paying for goods

and services and a measure of value.

Functions of Money :
Medium of exchange
Measure of value
Temporary store of value

Concept of Credit/Loan

An arrangement in which a lender gives money or property to a

borrower, and the borrower agrees to return the property or repay the
money, usually along with interest, at some future point(s) in time.

There is a predetermined time for repaying a loan, and generally the

lender has to bear the risk that the borrower may not repay a loan
(though modern capital markets have developed many ways of
managing this risk).

FINANCIAL SYSTEM

Concept of Finance

Finance is the procurement (to get, obtain) of funds

and effective (properly planned) utilization of funds.

It also deals with profits that adequately compensate

for the cost and risks borne by the business.

Finance deals with matters related to money and the

markets.

FINANCIAL SYSTEM
STRUCTURE IN MALAYSIA

Financial Institutions

Financial Markets

a) Banking System
BNM
Banking Institutions :
- Commercial banks include Islamic
banks
- Finance Companies
- Merchant Banks
Others:
- Discount Houses
- Representatives Offices of Foreign
Banks
- Offshore Banks in Labuan IOFC

a) Money & Foreign Exchange Markets :

Money Market

Foreign Exchange Market

b)
)
)
)
)

Non-Bank Financial Intermediaries :

Provident & Pension Funds
Insurance companies include Takaful
Saving institutions
Others:
- Unit Trusts Pilgrims Fund Board
Housing Credit Institutions Cagamas
Berhad Credit Guarantee Corporation
Leasing Companies Factoring
Companies Venture Capital
Companies.

b) Capital Markets:
Equity markets

Bond Markets Public Debt Securities

Private Debt Securities
c)

Derivatives Markets:
Commodity Futures
KLSE CI Futures
KLIBOR Futures

d) Offshore Markets:
Labuan International Offshore

Financial Centre (IOFC)

BANKS AS FINANCIAL
INTERMEDIARIES

Financial intermediaries is an entity that acts as the

middleman between two parties in a financial transaction.

Financial intermediaries encompass a wide range of entities

in terms of size and scale of operation ranging from a
banks, broker-dealers, investment advisers and financial
planners.

Roles of banks as financial intermediaries:

1.

Promote savings and capital accumulation to finance projects

using various modes of financing.

2.

Finance international trade.

3.

Mobilize resources for investments for the benefit of society.

4.

Contribute
social
welfare
through
Responsibilities (CSR) and zakat.

Corporate

Social

PRINCIPLES GOVERNING OF
ISLAMIC BANKING
Islam

Aqidah
(Faith and Belief)

Shariah
(Practices and
Activities)

Akhlak
(Moralities and
Ethics)

Ibadat

Muamalat

Political
Activities

Economic
Activities

Banking &
Financial
Activities

Social Activities

ISLAMIC BANKING

Islamic banking is defined as banking system which is in

consonance with the spirit, ethos and value system of Islam
and governed by the principles laid down by Islamic Shariah.

Islamic Banking according to Islamic Banking Act 1983:

..a company which carries on Islamic banking business means

banking business whose aims and operation do not involve any
element which is not approved by the religion of Islam

Islamic banking, the more general term, is based not only to

avoid interest-based transactions prohibited in Islamic
Shariah but also to avoid unethical and un-social practices.

In practical sense, Islamic Banking is the transformation of

conventional money lending into transactions based on
tangible assets and real services.

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ISLAMIC BANKING IN
MALAYSIA

The first Islamic bank was established in Malaysia in

1983 through Bank Islam Malaysia Berhad.

Later in March 1993, Bank Negara Malaysia (BNM)

introduced Interest Free Banking Scheme (now
replaced with Islamic banking scheme (IBS).

The
scheme
allowed
conventional
banking
institutions to offer Islamic banking products and
services using their existing infrastructure, including
staff and branches

SALIENT FEATURES OF
ISLAMIC BANKING
Ensuring
justice and
equity in
economy

Financial
transaction

Main
concern

Prohibition
of riba

PLS are
major
features

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PHILOSOPHICAL FOUNDATIONS OF
ISLAMIC BANKING

Tawhid
Khilafah
Amanah
Al-adalah
Tazkiyah
Huriyyah

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GOALS AND OBJECTIVES OF

ISLAMIC BANKING
Offer Financial Services
The thrust is towards financing on risk- sharing and strict focus on
halal activities
Focus on offering banking transactions adhering to Shariah
principle and avoiding conventional interest- based banking
transactions.
Economic Development
Established a direct and close relationship between the banks
return on investment and the successful operation of the business
by the entrepreneur.
Optimum Resources Allocation
Considered to be most profitable, religiously permissible and are
beneficial to the economy.

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GOALS AND OBJECTIVES OF

ISLAMIC BANKING
Optimum Approach
Profit- sharing principle encourages banks to go for projects with longterm gains instead of short- term gains.
Banks conduct proper studies before getting into projects. High returns
distributed to shareholder maximize the social benefits and bring
prosperity to the economy.
Equitable Distribution of Resources
Ensures equitable distribution of income and resources among the
participation parties, with its profit- sharing approach which is one of a
kind.
Facilitate Stability in Money Value
Islam recognize money as a means of exchange and not as a
commodity.
Riba- free system leads to stability in the value of money to enable the
medium of exchange.

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PRINCIPLES OF ISLAMIC
BANKING

Islamic banking is the conduct of banking based on

SHARIAH principle, subject to among others:
1.

Prohibition of Riba
Riba is strictly prohibited under Islam and is considered
as haram.
Islam allows only one kind of loan that is Qardhul Hassan.

2.

Equity participation
Islam encourages Muslims invest their money and become
partners in order to share profits and risk in the business
instead of becoming creditors.
In Islam, financing is based on the belief that the financier
and borrower should equally share the risks of the business
venture.

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PRINCIPLES OF ISLAMIC
BANKING
3.

Prohibition of gharar
Gharar means to undertake a venture blindly without sufficient
knowledge or to undertake excessively transactions
An Islamic financial system discourages hoarding and prohibits
transactions featuring extreme gharar.

4.

Contractual relationship
Depends upon the nature of transaction.
It could be a seller and buyer relationship (Murabaha), a lessorlessee relationship (Ijarah), and a partnership (Musyaraka)

5.

Money as Potential Capital

It is way of defining the value of a thing.
Should not be allowed to give rise to more money, via fixed
interest payments, simply by being put in a bank or when lent to
someone.

DIFFERENCES BETWEEN ISLAMIC

BANKING AND CONVENTIONAL BANKING
Islamic Banking
SYSTEM
System
Characteristi Conventional Banking

17

cs

System

Functions and operating

modes are based on
Shariah law.
Banks have to ensure
that all business
activities are in
compliance with Shariah
requirements.

Business
Framework

Functions and operating

modes are based on
secular principles and not
based on any religious law
or guidelines.

Each bank should have

a Shariah Supervisory
Board to ensure that all
business activities are in
line with Shariah
requirements.

Shariah
Supervisory
Board

There is no such
requirement necessary.

COMPARISON BETWEEN ISLAMIC

BANKING AND CONVENTIONAL BANKING
IslamicSYSTEM
Banking System Characteristic Conventional Banking
s
Promotes risk sharing
between investor and
the bank & the bank
and the entrepreneur :
pre-agreed proportion

Risk sharing

Predetermined rate of
interest

Under PLS-return only if

there is a profit
-more concern with
soundness of the
project and managerial
competence of the
entrepreneur.

Emphasis to
product

Credit worthiness

All economic agents

have to work within the
Islamic moral value.

Moral
Dimension

Little attention to the

moral implications of
the activities

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COMPARISON BETWEEN ISLAMIC

BANKING AND CONVENTIONAL BANKING
SYSTEM
Islamic Banking
System
Characteristi Conventional Banking
cs

System

Financing is not interest

oriented
Based on the principle of
buying and selling of
assets, whereby the
selling price include a
profit margin
Fixed from the
beginning.

Prohibition
of Riba in
Financing

Financing is interest
oriented
A fixed/floating interest
is charged for the use of
money.

Islamic banks are

restricted to participate in
economic activities,
which are not Shariahcompliant.

Restrictions

There are no such

restrictions.

Pay zakat as a religious

obligation and tax

Zakat
(Religious

Dont pay zakat but

only pay tax as required

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ADVANTAGES OF ISLAMIC
BANKING
Justice and Fairness
The main feature of the Islamic model is that it is based
on a profit-sharing principle, whereby the risk is shared
by the bank and the customer.
This system of financial intermediation will contribute to
a more equitable distribution of income and wealth.
Liquidity
Follow the profit and loss-sharing principle to mobilize
resources and are less likely to face any sudden run on
deposits.
As such, they have a minimum need for maintaining
high liquidity.

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ADVANTAGES OF ISLAMIC
BANKING
Better Customer Relations
Financing and deposits are extended under the profit and
loss sharing arrangement. The banks are likely to know their
fund users better in order to ensure that the funds are used
for productive purpose and vice-versa for investors.
It will develops better relations between the financial
intermediary and the fund providers or consumers.
No Fixed Obligations
Islamic banks do not have fixed obligations such as interest
payments on deposits. Therefore, they are able to allocate
resources to profitable and economically desirable activities.
Also holds good for Islamic financing, as the payment
obligations of the entrepreneur is associated with the
revenue.

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ADVANTAGES OF ISLAMIC
BANKING
Transparency
Transparent to the account holders on the investments made in
different areas and the profits realized from these investments.
The profit is then shared in the pre-agreed ratio.
Ethical and Moral Dimensions
Strong ethical and moral dimensions of doing business and
selecting business activities to be financed, play an important
role in promoting socially desirable investments and better
individual or corporate behavior.
Banking for All
Although based on Shariah principles to meet the financial needs
of Muslims, it is not restricted to Muslim only and is available to
non-Muslims as well.

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CHALLENGES OF ISLAMIC
BANKING

Misconception about Islamic banking

Many still has a wrong understanding or misconception

against Islamic Banking which among the thoughts are:
Islamic Banking is only for Muslims
Islamic Banking is not profitable because no interest is charged
Islamic Bank is a charitable organization

Thus better awareness shall be create among the customers

that Islamic Banking is not only an alternative financial
approach but also in some aspects provides better value
propositions to the consumers.

Divergence of opinions

Shariah interpretation versus business practicability/

financing commercial viability

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CHALLENGES OF ISLAMIC
BANKING

Moving towards equity based financing (Musharakah/ Mudharabah) financing?

Commercial banks requires a new set of technical and risk management capabilities
i.e. industry experts and know-how

Market readiness profit sharing, trade secrets, bank as strategic business partners
(potential conflicting interest).

Balance sheet size, risk appetite and underwriting capabilities

Supervisory and prudential regulatory framework.

Accounting and auditing standards.

War of talents

Global shortage of Islamic finance talents at almost all levels

Inadequate pool of Shariah scholars with the right combination of knowledge in

Shariah and modern finance

Rising Cost for Small Islamic Banks

Ballooning operating costs for Islamic banks as opposed to relative cost stability for
the overall banking system - expenditure on IT infrastructure, expenses for R&D and
product innovation and network expansion and new delivery channels

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END OF CHAPTER