The Islamic Financial System in Malaysia – Its development and progress

It was back in 1981 that the government of Malaysia first established a National Steering Committee to study the viability of introducing Islamic banking in Malaysia. That study subsequently led to the creation of the first Islamic bank in Malaysia – Bank Islam Malaysia Bhd (Bhd stands for “Berhad,” our “Inc.”)–in 1983.

Ten years later in 1993, a further step was taken and the dual banking system was introduced, whereby the Islamic banking system operates in parallel with the conventional banking system. Under this framework, the conventional banking institutions were able to provide Islamic banking services within their existing conventional banking establishment in an arrangement known as the Islamic Banking Scheme. This was a pioneering effort then, as it had not been contemplated in any other parts of the world. But today, similar systems can be found in a number of other countries.

The development of Islamic banking, or for that matter banking in general in Malaysia, took a major leap forward when in September 2003 the Central Bank of Malaysia announced that it would issue up to three new Islamic banking licenses to qualified foreign players. This was the first time foreign banking institutions were issued banking licenses in Malaysia since the 1950s and also the first time that foreign banking institutions were allowed to own 100 percent of the Malaysian operations.

Following the issuance of these 3 new Islamic banking licenses under the Islamic Banking Act, the first foreign Islamic bank, Kuwait Finance House (Malaysia) Bhd, commenced operations in August 2005 while the two other foreign Islamic banks – Al Rajhi Banking & Investment Corporation and Asian Finance Bank – commenced operations later in 2006. The expertise brought in by the foreign Islamic banks, ranging from retail banking to the more sophisticated investment banking, wealth and fund management, real estate development and venture capital business, further enhanced the competitiveness of the domestic Islamic banking industry, its global linkages and Malaysia’s position as an international Islamic financial centre. Today, there are eleven Islamic banking institutions in Malaysia, of which three are wholly foreign-owned.

Under Malaysia’s Financial Sector Master Plan, The Islamic financial infrastructure has been progressively developed to build the capacity of Islamic banking institutions to capitalize on the universal nature of Islamic banking business. These developments, among others, include the transformation of Islamic windows into dedicated Islamic subsidiaries, the licensing of foreign Islamic banking players with distinct capabilities in Islamic investment banking activities and the divestment of up to 49 percent equity interest in these Islamic banking institutions to strategic institutional domestic and foreign investors. These Islamic banking institutions are thus able to leverage on this progressive liberalization policy to forge strategic alliances as well as tap new expertise and growth opportunities within the domestic environment and abroad to maximize the potential of Islamic banking business.

The Central Bank of Malaysia envisages that the relative significance of the market share of Islamic banking institutions in Malaysia will increase to 20 percent by the year 2010. During the year 2005, the total assets of the Islamic banking sector in Malaysia increased significantly by US$4.9 billion or 17.7 percent to US$32.4 billion with more than half of the increase attributable to a 16.5 percent growth in total financing. As at end-2006, total outstanding financing amounted to US$22.8 billion (2005: US$20.3 billion) or approximately 60 percent of the total Islamic banking assets. [Figures for total assets of the Islamic banking sector as at end-2006 are not available. US$1 = RM3.45].

As can be seen from the above, the development of the Islamic financial system in Malaysia has come a long way, not just in terms of total assets growth but also in the areas of sophistication of products and services, regulatory environment and pace of liberalization. With all these, Malaysia is truly on its way to becoming the international Islamic finance hub.