Malaysia: Prudential Guidelines and Circulars (both conventional and Islamic finance) are now available at its website

MALAYSIA: Performance of Islamic banking sector 2006

Source: Bank Negara Malaysia - Financial Stability and Payment Systems Report 2006 (www.bnm.gov.my)

Operating parallel to conventional banking, Islamic banking has also grown in size, diversity and importance in the Malaysian financial landscape. The number of players in the Islamic banking sector has increased with the commencement of operations of four institutions during the year. Assets of the Islamic banking system expanded by 20.5% in 2006 to constitute 12.2% of banking system assets. This development has been underscored by growth in financing activities (+12.3%) which now accounts for 13.2% of banking system lending. Deposits mobilised by the Islamic banking system had also grown at a robust rate of 18.2% in 2006 to account for 12.2% of banking system deposits.

The Islamic banking sector remained well capitalised, supported by higher pre-tax profit and the injection of capital by new entrants and players. The RWCR recorded a strong level of 16.6% whilst the core capital ratio stood at 12.6%. Preliminary unaudited profit before tax for the Islamic banking system amounted to RM1.7 billion, posting a growth of 9.6%. The higher profit was contributed largely by growth in financing income (13%), income from funds placement (75.1%) and recoveries from nonperforming assets (22.8%). Consequently, return on assets and return on equity for the Islamic banking sector was 1.3% and 16.4% respectively.

The Islamic banking sector continues to support various economic activities that contribute to the nation’s economic growth. Total financing extended by the Islamic banking sector was RM78.5 billion as at end-2006. Similar to the trends observed for conventional banking, of the 12.3% increase in financing, 57.6% was channeled to the household sector. The level of non-performing financing continued to decline steadily as net non-performing assets as at end-2006 declined almost 25% to RM3.4 billion to account for 4.5% of net financing.

Investment deposits (general and specific) rose by 10.3% to account for 49.6% of Islamic banking deposits, the bulk of which was concentrated in the short-term maturity profile of below one year (95.2%). Meanwhile, savings and demand deposits expanded by 16.7% and 38.8% respectively, mainly attributed to the expanding retail customer base in Islamic banking.

The ratio of staff-related expenses and overheads to gross operating income rose to 42.6%. The increase in staff costs was attributed mainly to higher remuneration packages offered to retain and attract expertise amidst competition from the new entrants, as well as additional resources required to support the expansion of the industry. Meanwhile, higher overheads were due mainly to establishment and administrative expenses incurred in the setting up of new branches by Islamic banking institutions, in particular, by the new market entrants.

MALAYSIA: Background of Islamic banking industry

Source: Bank Negara Malaysia's (Central Bank of Malaysia) website

The History of Islamic Banking
Before the re-emergence of the Islamic financial system, the Muslims throughout the world has only conventional financial system to fulfill their financial needs. The Islamic resurgence in the late 1960's and 1970's has initiated the call for a financial system that allows Muslim to transact in a system that is in line with their religious beliefs. The Islamic banking system involves a social implication which is necessarily connected with the Islamic order itself, and represents a special characteristic that distinguished Islamic banks from other banks based on other philosophies. In exercising all its banking or developmental activities, the Islamic bank takes into prime consideration the social implications that may be brought by any decision or action taken by the bank. Profitability, despite its importance and priority, is not the sole criterion or the prime element in evaluating the performance of Islamic bank, since they have to match both the material and social objectives that would serve the interests of the community as a whole and help achieve their role in the sphere of social mutual guarantee. Social goals are understood to form an inseparable element of the Islamic financial system that cannot be dispensed with or neglected.

As the need to have an Islamic financial system was vital and immediate, Muslim scholars had taken the effort to embark on the development of Islamic financial system. This had led to the establishment of Islamic Development Bank in 1974 followed by the Islamic Bank of Dubai, the first Islamic commercial bank in 1975. In the following years, a number of Islamic banks were established, concentrated mainly in the Middle East such as the Islamic Bank of Faisal in Egypt (1977), the Islamic Bank of Faisal in Jordan (1978), Bank of Islamic Finance and Investment in Jordan (1978), Islamic Investment Company Ltd.in UAE (1979) and others.

In Malaysia, Islamic finance traces its root back to 1963, with the establishment of the Pilgrims Fund Board or Lembaga Tabung Haji (LTH). This was a savings mechanism under which devout Malaysian Muslim set aside regular funds to cover the costs of performing the annual pilgrimage. These funds were in turn invested in productive sectors of the economy, aimed at yielding return uncontaminated by riba'.

As a country which population is dominated by Muslims, Malaysia was also affected by the resurgence that had taken place in the Middle East. Many parties were calling for the establishment for an Islamic bank in Malaysia. For example, in 1980, the Bumiputera Economic Congress had proposed to the Malaysian Government to allow the setting up of an Islamic bank in the country. Another effort was the setting up of the National Steering Committee in 1981 to undertake a study and make recommendations to the Government on all aspects of the setting up and operations of Islamic bank in Malaysia, including the legal, religious and operational aspects. The study concluded that the establishment of an Islamic bank in Malaysia would be a viable project from the operation and profits points of view. The conclusion marked the establishment of the first Islamic bank in Malaysia, Bank Islam Malaysia Berhad (BIMB) in July 1983, with an initial paid up capital of RM80 million. The establishment of BIMB also marked a new milestone for the development of the Islamic financial system in Malaysia. BIMB carries out banking business similar to other commercial banks, but along the principles of Syari'ah. The bank offers deposit-taking products such as current and savings deposit under the concept of Al-Wadiah Yad Dhamanah (guaranteed custody) and investment deposits under the concept of Al-Mudharabah (profit-sharing). The bank grants financing facilities such as working capital financing under Al-Murabahah (cost-plus), house financing under Bai' Bithaman Ajil (deferred payment sale), leasing under Al-Ijarah (leasing) and project financing under Al-Musyarakah (profit and loss sharing). BIMB had grown tremendously since its inception. It was listed on the Main Board of the Kuala Lumpur Stock Exchange on 17 January 1992. BIMB's total assets rose from RM325.5 million in 1984 to RM10.12 billion in 2000. Presently, the bank's services can be obtained from its 82 branches throughout the country.

It has been the aspiration of the Government to create a vibrant and comprehensive Islamic banking and finance system operating side-by-side with the conventional system. A single Islamic bank does not fit the definition of a system. An Islamic banking and finance system requires a large number of dynamic and pro-active players, a wide range of products and innovative instruments, and a vibrant Islamic money market. The first step in realizing the vision was to disseminate Islamic banking on a nationwide basis with as many players as possible and within the shortest period possible. This was achieved through the introduction of Skim Perbankan Islam (SPI) in March 1993. SPI allows conventional banking institutions to offer Islamic banking products and services using their existing infrastructure, including staff and branches. The scheme was launched on 4 March 1993 on a pilot basis involving three banks. Following the successful implementation of the pilot-run, Bank Negara Malaysia allowed other commercial banks, finance companies and merchant banks to operate the scheme in July 1993 subject to the specific guidelines issued by the central bank. From only three banks in March 1993, the number of Islamic financial institutions have increased to 36, comprising 14 commercial banks (of which 4 are foreign banks), 10 finance companies, 5 merchant banks and 7 discount houses. On 1 October 1999, the second Islamic bank, Bank Muamalat Malaysia Berhad, was established.

Today, 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. The aspiration to establish a comprehensive Islamic banking and finance system has created a spill-over effect to the non-bank Islamic financial intermediaries which started to offer Islamic financial products and services. Such institutions include the takaful companies, the savings institutions (i.e. Bank Simpanan Nasional & Bank Rakyat) and the developmental financial institutions (i.e. Bank Pembangunan dan Infrastruktur Malaysia and Bank Pertanian).

Overview of Islamic Banking in Malaysia
Since the 1970s, Islamic banking has emerged as a new reality in the international financial scene. Its philosophies and principles are however, not new, having been outlined in the Holy Qur'an and the Sunnah of Prophet Muhammad (p.b.u.h.) more than 1,400 years ago. The emergence of Islamic banking is often related to the revival of Islam and the desire of Muslims to live all aspects of their live in accordance with the teachings of Islam.

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 IBA provides BNM with powers to supervise and regulate Islamic banks, similar to the case of other licensed banks. The Government Investment Act 1983 was also enacted at the same time to empower the Government of Malaysia to issue Government Investment Issue (GII), which are government securities issued based on Syariah principles. As the GII are regarded as liquid assets, the Islamic banks could invest in the GII to meet the prescribed liquidity requirements as well as to invent their surplus funds.

The first Islamic bank established in the country was Bank Islam Malaysia Berhad (BIMB) which commenced operations on 1 July 1983. In line with its objectives, the banking activities of the bank are based on Syariah principles. After more than a decade in operations, BIMB has proved to be a viable banking institution with its activity expanding rapidly throughout the country with a network of 80 branches and 1,200 employees. The bank was 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 Islamic banking system operating on a parallel basis with the conventional banking system. However, similar to any banking system, an Islamic banking system requires three vital elements to qualify as a viable system, i.e.:-

• a large number of players;
• a broad variety of instruments; and
• an Islamic money market.

In addition, an Islamic banking system must also reflect the socio-economic values in Islam, and must be Islamic in both substance and form.

Recognising the above, BNM adopted a step-by-step approach to achieve the above objective. The first step to spread the virtues of Islamic banking was to disseminate Islamic banking on a nation-wide basis, with as many players as possible and to be able to reach all Malaysians. After a careful consideration of various factors, BNM decided to allow the existing banking institutions to offer Islamic banking services using their existing infrastructure and branches. The option was seen as the most effective and efficient mode of increasing the number of institutions offering Islamic banking services at the lowest cost and within the shortest time frame. Following from the above, on 4 March 1993 BNM introduced a scheme known as "Skim Perbankan Tanpa Faedah" (Interest-free Banking Scheme) or SPTF in short.

In terms of products and services, there are more than 40 Islamic financial products and services that may be offered by the banks using various Islamic concepts such as Mudharabah, Musyarakah, Murabahah, Bai’ Bithaman Ajil (Bai’ Muajjal), Ijarah, Qardhul Hasan, Istisna’ and Ijarah Thumma Al-Bai’.To link the institutions and the instruments, the Islamic Interbank Money Market (IIMM) was introduced on 4 January 1994.

In October 1996, BNM issued a model financial statement for the banking institutions participating in the SPI requiring the banks to disclose the Islamic banking operations (balance sheet and profit and loss account) as an additional item under the Notes to the Accounts.

As part of the effort to streamline and harmonise the Syariah interpretations among banks and takaful companies, BNM established the National Syariah Advisory Council on Islamic Banking and Takaful (NSAC) on 1 May 1997 as the highest Syariah authority on Islamic banking and takaful in Malaysia.

On 1 October 1999, a second Islamic bank, namely Bank Muamalat Malaysia Berhad (BMMB) commenced operations. The establishment BMMB was the effect of the spin-off following the merger between Bank Bumiputra Malaysia Berhad (BBMB) and Bank of Commerce (Malaysia) Berhad (BOCB). Under the merger arrangement, the Islamic banking assets and liabilities of BBMB, BOCB and BBMB Kewangan Berhad (BBMBK) were transferred to BBMB, while the conventional operations of BBMB, BOCB and BBMBK were transferred to BOCB accordingly. In addition, BMMB was given 40 branches of BBMB and BBMBK in various locations throughout Malaysia and a staff workforce of 1,000, migrated from BBMB, BOCB and BBMBK.

MALAYSIA: List of Islamic banks

Source: Bank Negara Malaysia

1. Affin Islamic Bank Berhad
2. Al Rajhi Banking & Investment Corporation (Malaysia) Berhad
3. AmIslamic Bank Berhad
4. Asian Finance Bank Berhad
5. Bank Islam Malaysia Berhad
6. Bank Muamalat Malaysia Berhad
7. CIMB Islamic Bank Berhad
8. EONCAP Islamic Bank Berhad
9. Hong Leong Islamic Bank Berhad
10. Kuwait Finance House (Malaysia) Berhad
11. RHB Islamic Bank Berhad