Last month, Mr. Rustam Idris, Adviser at the Central Bank of Malaysia (Bank Negara) described the government’s moves to establish an alternative - and Islamic - banking system in Malaysia. Here, he discusses the next step in the plan, an Islamic inter-bank market, and explains how it functions. Next month, Idris assesses the popularity of Islamic banking in the South East Asian nation, and talks of the effect Islamic banking has had on Malaysia’s Muslims.

Come 1994, and two of the three requirements for a fully- fledged Islamic banking system in Malaysia (a large number of institutions participating in the system and a broad variety of instruments) had been achieved.

The sole remaining ingredient was the setting up of an Islamic money market. This would link the institutions with the instruments.

The Central Bank introduced the Islamic interbank money market in January 1994. It aimed to provide a comprehensive frame work for interbank trading in Islamic financial instruments along with interbank instruments, and an Islamic interbank cheque clearing system.

In the system, Malaysia’s first Islamic bank, Bank Islam Malaysia (BIM) and all other financial institutions participating in the Interest-free Banking Scheme (IFBS) arc eligible to trade Islamic financial instruments amongst themselves.

This includes Islamic accepted bills, Islamic bankers acceptances and Islamic debt securities. Islamic bookers in Malaysia confidently predict that more Islamic instruments will soon be added to this list. The Islamic interbank money market also introduced Al Mudarabah interbank investment, operating on the basis of Al Mudarabah or profit sharing. What this in effect means is that one IFBS bank with a surplus can invest in another bank which has a deficit, so long as it is part of the scheme. Investments can be for periods ranging from overnight to up to 12 months.

The profit sharing ratios, which are already fixed by the Central Bank, were negotiable from February 2, 1994. The minimum amount of investment for interbank investments is RM 50,000 and the rate of return will be based on the gross profit rate before distribution for a 1 year investment of the receiving bank (i.e., the bank taking up the investments)

Under this scheme, the surplus bank and the deficit bank will negotiate on the investment amount; the period of investment; and the profit sharing ratio, either directly or through a money broker. The surplus bank will not know what the return will be, as the formula will only become concrete figures towards the end of the investment period.

At the end of the investment period, the deficit bank will return the principal amount invested, plus the share of the bank’s profit from the usage of the funds.

The third development is the Islamic interbank cheque clearing system. From January 3, all cheques of the banks participating in the Islamic banking scheme are separated from the conventional cheques. The clearing process will work on the basis of Al Mudharabah.

At 12 midnight, during the automatic cheque clearing at the Central Bank, banks participating in the scheme with a deficit will have their deficits automatically funded from the surplus of other banks in the scheme. If there is still a deficit after this round of funding, the Central Bank will step in and provide funding also on the Mudharabah principle.

The profit sharing ratio for this mechanism is 70:30, giving 70 per cent to the investor bank. The repayment will be made the next morning.

Towards Islamic Banking: The Malaysian’ Experience – III

Last Month Rustam Idris, Adviser at Bank Negara Malaysia described the Bank’s move towards an Islamic interbank market and how it would function. In this final part, Idris analyses the effect Islamic banking has had on Malaysia’s Muslims, and points to new Islamic financial institutions emerging on the border of the banking system.

A number of related developments within and outside the banking system taking place at present should contribute to the early emergence of a viable and vibrant Islamic banking system in Malaysia. More and more Malaysian Muslims now want all aspects of their lives to be on the basis of Islamic values and systems, including the Muamalah aspects of everyday life. They no longer view Islam as a set of personal values and organized rituals. The Government’s declared policy of instilling Islamic values among die population has undoubtedly been very successful.

A number of Islamic institutions are blossoming on the fringes of the banking system. The Pilgrims and Management Fund Board, which has been in existence since the 1960s, is now a large conglomerate with total resources amounting to RM2 billion. An Islamic insurance company Syarikat Takaful Malaysia Berhad was set up under a separate Act, namely the Takaful Act in 1985 as the first Islamic insurance company in Malaysia. The success of the Islamic insurance company has spur the interest of the insurance market, and now another Islamic insurance company, known as MNI-Takaful, has been set up to cater for the incrcasing demand by the Muslims.

Bank Rakyat, the largest cooperative bank in Malaysia, has started offering Islamic financial products, including a network of Islamic pawn-broking Services (Ar-Rahn) throughout the country. The bank is expected to be a full-fledged Islamic cooperative bank in two years nine. Two Islamic unit trusts, namely the Ittikal Fund and the Amanah BAKTI Fund are operating.

An Islamic securities house, known as BIMB Securities began operations in June

1994.

The National Mortgage Corporation (known as Cagamas) has successfully securitised the Islamic housing debts of Bank Islam Malaysia under the concept of Bai’ Al-Dayn and Al-Mudharabah. The purchase of the Islamic housing debts is based on the basis of Bai’ Al-Dayn (debt trading), while the bonds are issued on the basis of Al-Mudharabah (profit-sharing), whereby the bondholders and Cagamas would share the profits based on a specific protit sharing ratio. The profits are generated from the operations of the Cagamas in purchasing the Islamic housing debts and the reinvestment of reflow funds.

The two Islamic principles (Bai’ Al-Dayn and Al-Mudharabah) were combined with the conventional concept of pass-through used in conventional mortgage bonds to create the Islamic mortgage bond. The Rating Agency of Malaysia (RAM) has given a AAA rating for the Bon Mudharabah Bonds, which signifies the attractiveness of the product. The scheme would enable financial institutions, which offer Islamic house financing facility, to obtain a continuous refinancing facility from Cagamas so that they would be able to provide house financing to a large group of people. The existence of the refinancing facility would also enable the financial institutions to grant Islamic house financing facility at reasonable rates.

Among the conventional banks, a core of dedicated and motivated Muslim officers are emerging who are well versed in Islamic economics and finance and who are ready to embark on the next phase of Islamic banking in Malaysia. The Islamic bank and the IFBS banks have recently formed an association known as the Association of Islamic Banking institutions of Malaysia (AIBIM) to serve as an official forum representing Islamic banking issues and agendas.

Malaysia’s approach to the implementation of Islamic banking is to have a clear set of achievable objectives and to work towards the objectives on many fronts but on a step-by-step basis, so as to avoid costly mistakes or the need to back-track. With the introduction of the Islamic interbank money market on January 3, 1994, all the three vital ingredients that arc required for a comprehensive, vigorous and vibrant Islamic banking system are in place to enable the Islamic banking system in Malaysia to take off on a path of sustained growth. In a speech delivered recently, the Governor of the Central Bank made a statement in which he visualised his vision in the implementation of Islamic banking in Malaysia. He said: “I have a dream ... that I  will be able to see in my life time, a fully-fledged Islamic financial system in Malaysia, functioning side-by-side with the conventional system.... Perhaps Malaysia will be the first country to have a dual system of banking and finance, one conventional and the other Islamic, both equally sophisticated and modern.