Islamic Banking in Malaysia

A Potential Bottleneck for Economic Growth?


Essay, 2011

8 Pages, Grade: 1,0


Excerpt

Malaysia is one of the largest and fastest growing markets for Islamic Finance and Banking worldwide. The current market-share of Islamic banking (IB) accounts for ca. ten 10% of the total banking sector, compared to about 0.1% in 1994.1 The total share of bank assets held by Islamic banks worldwide amounts to 0.5%.2 On the one hand this outstanding growth stems from the initiative of Malaysia’s central bank, Bank Negara Malaysia (BNM). BNM provided for an Islamic Inter-bank money market (IIMM) in January 1994.3 On the other hand the opportunity to invest in Shari’a-compliant financial products is more and more embraced by the Muslim community all around the globe. This consensus is not argued about, but the influence of the Islamic Banking-specific properties on the financial system and the real economy is a field of scientific quarrel. The author tries to analyse the influence of Islamic Banking with regard to Malaysia and its dual financial system. This essay is structured as follows: In the beginning the author will outline a short history of Islamic Banking, followed by a comparison between conventional and Shari’a-compliant financial services. The question, if Islamic Banking could prove as a bottleneck for economic development is answered in the concluding section of this essay.

Contemporary Islamic Banking is supposed to originate from the foundation of the “Mit Ghamr Islamic Bank” in Egypt in 1963.4 The history of the Islam and its influence on banking and finance transaction, however, dates back to the practice of commodity trading using temples as places for financial intermediation around the Mediterranean Sea. Priests and moneylenders accepted deposits in, what is believed to be the first currency, grain. As times changed these bulky deposits were replaced by easier-to-carry precious metals, i.e. gold and silver. In Mesopotamia, today’s Iran, records of transactions and loans were kept in temples. The emergence of stable coinage, namely the “gold bezant” in the 4th century, fostered capital mobility and allowed for larger business ventures.5 It can be concluded from this short outline, that Islamic Banking has a strong religious background. Experts believe that the principle of risk and reward sharing was in practice even prior to the teachings of Prophet Muhammad who died in 632 A.D. Over time the centre of economic gravity moved to the western world, thus institutions adopted the interest-based financial system from the western world. The difference is that today’s western financial system is only subject to restrictions codified in law, not in religion.6 Typical western economic theory defines the human being as a “homo oeconomicus” thereby implying rational behaviour. In contrast, religious definitions of human beings assume them to be fallible, pointing towards potential irrationality in human behaviour. Bringing religion into economic context means bringing moral values into what is supposed to be free of such values. These moral values, which are derived from all major religions, including environmental concerns, protection of the rights of labour and fairness in trade.7

Islamic Banking is seen as a merger of faith and finance, the Shari’a providing the fundamental law for society and economy. The basic principles underlying Islamic Banking (IB) can be summed up as follows: IB should not act against the Shari’a, it must not involve giving or receiving of interest and should avoid risk, uncertainty and speculation. Islam scholars coined the term “homo islamicus”, whose moral values forbid the injustice of charging interest.8 As a practical comment, financing a casino would be prohibited, because gambling is not in line with the Shari’a, while western investors would be free of suchlike constraints.

As already briefly mentioned before, IB promotes the sharing of risk and reward between the contracting parties. Contemporary IB incorporates these principles to meet the growing demand for Shari’a-compliant investment and finance. The Quran permits the accumulation of wealth, as long as it is not harming the society. Profit of a business venture is determined ex-post, depending on the outcome of the venture, contrary to interest, which is determined ex-ante, regardless of the outcome of the venture.9 Prohibition of interest is the core principle of IB, but it also includes more Islamic principles incorporating the promotion of entrepreneurship, sharing of profits, transparency, discouragement of speculation and sanctity of contractual obligations.

The principal objective of Shari’a is economic justice through an equitable distribution of resources. In the Shari’a’s rationale, lending money for interest directs the flow of money to those with a low credit risk (e.g. governments), or to those who can provide collateral (e.g. rich individuals, big companies), even if they may not have the business ideas with the greatest economic potential. This would lead to the concentration of wealth in a few hands, implying wide social repercussions. The major aims of IB constitute of stability in money value, economic and social development and resource optimisation. The Islamic law itself is based on the Quran and the Sunnah, the reported sayings of Prophet Muhammad. The Shari’a is defined as the law of Allah which concerns all aspects of a Muslim’s life. It provides the foundation of modern Shari’a-compliant economic and financial transactions. The Islamic law possesses a certain flexibility that provides for adoption to new socioeconomic situations.

With a brief comparison of conventional versus Islamic Banking with respect to interest charging, restrictions, religious tax (zakat), customer relations and Shari’s supervision the author wants to underline the major differences between the western and the Islamic banking system. As already stated earlier, interest charging is banned in Islamic Finance. In conventional banking, a fixed or variable interest rate is charged for the use of money.10 Islamic banking also prohibits demanding for collateral, thereby rendering Islamic banking hardly reconcilable with western finance theory, which is dominated by the asymmetric information paradigm.11

Whereas conventional banks are allowed to finance any lawful product or service, Islamic banks are restricted by the principles of the Shari’a. Islamic banks cannot finance any business venture that involves selling pork or alcohol, for example. One function unique to Islamic banks is the collection of a religious tax, called “zakat”, which they are supposed to distribute among the Muslim community to fund the alleviation of poverty or donate it to public hospitals, for example. Conventional banks do not charge any sort of religious tax. The customer relationship also differs. While the relationship in Islamic banking is one of partner and investor, conventional banks act as debtors or creditors in relation to their customers.12

Prior to the establishment of the Islamic Inter-bank money market (IIMM) in 1994, the first Malay Islamic bank, Bank Islam Malaysia Berhad (BIMB), had to rely on one single government instrument to manage liquidity. The conventional money market, being interest rate-based, was not Shari’a-compliant. The BIMB could only deal with the government, buying Government Investment Certificates (GIC) with excess liquidity, vice-versa selling GIC when the bank was in need for money. Given the rapid growth of IB in Malaysia, this arrangement was seen as inadequate. Since having no example of how to design a Shari’a-

[...]


1 Bacha (2008): p. 2

2 Karwowski (2009): p. 3

3 Bacha (2008): p. 2

4 Shanmugan et al. (2009): p. 3

5 Ibid.: p. 2

6 Ibid.: pp. 1 et sqq.

7 Shanmugan et al. (2009): pp. 1 et sqq.

8 Karwowski (2008): p. 6

9 Shanmugan et al. (2009): p. 3

10 Shanmugan et al.(2009): pp. 1 et sqq.

11 Karwowski (2009): p. 3

12 Shanmugan et al. (2009): pp. 4 et sqq.

Excerpt out of 8 pages

Details

Title
Islamic Banking in Malaysia
Subtitle
A Potential Bottleneck for Economic Growth?
College
Ruhr-University of Bochum  (Fakultät für Wirtschaftswissenschaft)
Course
Wirtschaft Ostasiens
Grade
1,0
Author
Year
2011
Pages
8
Catalog Number
V177707
ISBN (eBook)
9783640994489
File size
754 KB
Language
English
Tags
Islamic Banking, Malaysia, asset inflation, Islamic Finance
Quote paper
B.A. Georg Körnig (Author), 2011, Islamic Banking in Malaysia, Munich, GRIN Verlag, https://www.grin.com/document/177707

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