It is a truism to say that the financial sector plays a critical role in the socio-economic development of any country. Financial institutions provide for effective mobilisation and allocation of savings and this contributes effectively  towards socio-economic development.

Malaysia, which is, as of now, perhaps the fastest growing country in the third world, is characterised by a well-developed financial system. What, however, is unique about Malaysia is that, as in some other Muslim countries, conventional and Islamic financial institutions exist side by side, interacting with one another. The development of Islamic financial institutions in Malaysia has the potential to playa leading role in serving the Muslim Ummah and contribute towards socio-economic development of the country in conformity with Islamic sensibilities. Yet their market share is rather insignificant in comparison with the conventional financial institutions

As elsewhere, financial institutions in Malaysia provide four distinct types of intermediation in the process of exchanging funds and financial instruments among the surplus units and the deficit units - viz., denomination intermediation, maturity intermediation, risk diversification intermediation, and liquidity intermediation.

FINANCIAL STRUCTURE

The commercial financial institutions in Malaysia, as in any modern country, are supervised by a central monetary authority called Bank Negara Malaysia. It has nine offices. Additionally, there are 38 commercial banks, 47 finance com­panies, 12 merchant banks, 7 discount houses, 7 development institutions, several cooperatives and savings institutions, 5 provident and pension funds, 60 insurance companies, 4 housing credit institutions, 7 unit trust companies, 2 stock exchanges and several other institutions. These institutions channel funds from the surplus units to the deficit units and account for the flexibility of denomination, maturity, risk, and liquidity.

ISLAMIC FINANCIAL INSTITUTIONS

Financial institutions primarily sell demand deposits, savings deposits, time deposits, insurance policies, pension funds, commercial papers, and bonds to the surplus units. They purchase business loans; consumer loans, mortgages, government securities, corporate bonds, corporate stocks, municipal bonds, and money market securities from the deficit units. By providing finances for both consump­tion and investment purposes, financial institutions contribute towards the pros­perity of households and economic growth in the economy. Conventional financial institutions pay interest on funds procured and charge interest on funds loaned out. But Islamic scholars describe interest as riba, which is prohibited in Islam. Hence, the participation of Muslims in interest-based contracts is considered illegal by the Islamic law (1).

Secondly, the Islamic perspective on development is also distinct from the conventional, Western perspective. The conventional development paradigm emphasises development of material factors such as- industrialization, agricultural development, per capita growth, per capita calorie intake, literacy, poverty and health (e.g., mortality, life expectancy, sanitation), and so on.- Islamic scholars wish to supplement material development with spiritual development as well. Indeed, emphasis on spiritual factors dominates the emphasis on the material factors because, in Islam, mundane material progress at the neglect of its consequences in the hereafter does not represent development. Therefore, spiritual and material components of human endeavours should not be separated, but rather be developed concomitantly.

Consequently, the dominance of the interest-based financial system may not remain acceptable for long to the Malaysian Muslims. Hence the need to Islamize some of the conventional financial institutions, upgrade the existing Islamic financial institutions, and permit establishment of new Islamic financial institutions.

Muhammad Anwar is associated with the International Islamic-University, Malaysia.

Author's Note: This is a revised and updated version of the paper originally prepared for the Seventh Annual General Meeting of the Pakistan Society of Development Economists in collaboration with Hj. Jamil Osman of International Islamic University, Malaysia and Rosli Yakop of Bank Negara Malaysia.

1. See M. Umer Chapra Towards a Just Monetary System, Leicester: Islamic Foundation, 1985, pp,,235-246.

2. See Gerald M. Meier Leading Issues in Economic Deuelopmenl. New York: Oxford University Press, 1989. Fifth Edition, pp. 5-10.