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Islamic Bank Is Not Islamic? The Implementation of Islamic Banking and Finance in Malaysia By Mohd Fuad Mohd Salleh1 UNISEL

Abstract Since the introduction of the first full-fledged Islamic Bank in Malaysia in 1983, Islamic Bank and Institutions have grown significantly. All of which are offering what is known as a copy of conventional banking or some called it the Islamization of conventional products. It is good to have many products and services offered to customers especially those who are expecting the practice of Islamic Banking. The most misleading statement in making a distinction between Islamic and conventional banking is the absence of interest in Islamic Banking. Practitioners as well as customers are in the beliefs of without interest, then, the banking system is now following the teaching of Islam. The no interest statement is very misleading since no-interest is just one of the principles in Islamic Financial System. There are other principles that must be observed in order for any financial system to be accepted as a practice according to the Islamic teaching. The other important principles is risk sharing where it is known as profit bear risks (alGhunmu bi al-Ghorm).

Keyword: Islamic Finance, no-interest, profit, risks

Introduction Islamic financial services industry has witnessed a pace of growth since its inception four decades ago. During the last decade Islamic finance is developing at a remarkable frenetic pace. The number of Islamic financial institutions worldwide has risen from one in 1969 with the formation of Tabung Haji (Pilgrimage Fund) in Malaysia followed by first commercial Islamic bank, Dubai Islamic Bank in 1970 then Islamic Development Bank, the Jeddah-based multilateral development institution in 1975, to over 500 in 2009 in more than 75 countries with Bahrain in the Middle East and Malaysia in Southeast Asia as the biggest hubs. Even though they are concentrated in the Middle East and South East Asia, they are also appearing in other countries in Asia-Oceania, Europe, and the United States.

Mohd Fuad is the Dean of Faculty of Business, Universiti Selangor (Unisel).

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Islamic finance has grown tremendously since it first emerged in the 1970's. Current global Islamic banking assets and assets under management have reached USD750 billion and is expected to hit USD1 trillion by 2010. There are over 300 Islamic financial institutions worldwide across 75 countries. According to the Asian Banker Research Group, the world's 100 largest Islamic banks have set an annual asset growth rate of 26.7%2 and the global Islamic finance industry is experiencing average growth of 15-20% annually (Mckinsey, 2008). While estimates about the size of the industry differ, conservative sources put the total Islamic assets worldwide held by Islamic Banks, shari`ah-compliant banks and Islamic banking and financial windows of conventional banks rose by 28.6% in 2009 to $822bn from $639bn in 2008 and are constantly growing at an estimate of 15 percent a year. Islamic banking and finance assets continued double-digit growth in 2009, even as conventional bank growth stagnated, according to The Bankers world-renowned Top 500 Islamic Financial Institutions survey. Rising oil prices and Europe's growing Muslim population are driving an extraordinary surge in financial products compliant with Islamic law and as such. The data seems to be encouraging, but the fact remains that the industry is too small compared to the size of financial markets today. Furthermore it is very small compared to the Muslim wealth which is estimated at about USD3 trillion that are concentrated in the Middle East. The strength that lies in the number of 1.6 billion Muslims and the Muslims wealth around the world is yet to be exploited. One of the key factors that impede the growth of Islamic finance is lack of awareness among Muslims (regardless of who they are) about the Islamic models of banking, finance, insurance, and investments.

Islamic Finance

Islamic finance was practiced predominantly in the Muslim world throughout the Middle Ages, fostering trade and business activities with the development of credit. In Spain and the Mediterranean and Baltic states, Islamic merchants became indispensable middlemen for trading activities. In fact, many concepts, techniques, and instruments of Islamic finance were later adopted by European financiers and businessmen. In contrast, the term "Islamic financial system" is relatively new, appearing only in the mid-1980s. In fact, all the earlier references to commercial or mercantile activities conforming to Islamic principles were made under the umbrella of either "interest-free" or "Islamic" banking. However, describing the Islamic financial system simply as "interest-free" does not provide a true picture of the system as a whole. Undoubtedly, prohibiting the receipt and payment of interest is the nucleus of the system, but it is supported by other principles of Islamic doctrine advocating risk sharing, individuals' rights and duties, property rights, and the sanctity of contracts. Similarly, the Islamic financial system is not limited to banking but covers capital formation, capital markets, and all types of financial intermediation. Interpreting the system as "interest free" tends to create confusion. The philosophical foundation of an Islamic financial system goes beyond the interaction of factors of production and economic behavior. Whereas the conventional financial system focuses primarily on the economic and financial aspects of transactions, the Islamic system places equal emphasis on the ethical, moral, social, and religious dimensions, to enhance equality and fairness for the good of society as a whole. The system can be fully appreciated only in the context of Islam's teachings on the work ethic, wealth distribution, social and economic justice, and the role of the state.

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The Islamic financial system is founded on the absolute prohibition of the payment or receipt of any predetermined, guaranteed rate of return. This closes the door to the concept of interest and precludes the use of debt-based instruments. The system encourages risk-sharing, promotes entrepreneurship, discourages speculative behavior, and emphasizes the sanctity of contracts. Islamic finance and Islamic financial products are aimed at investors and depositors who want
to go with a system that comply with the Islamic laws (shari`ah) that governed Muslim's daily life. These laws forbid giving or receiving interest or usury because Islam considered the earning profit from an exchange of money for money is immoral; mandate that all financial transactions be based on real economic activity. Excessive profit and other un-Islamic activities such as investment in tobacco, alcohol, gambling, and armaments industries are totally prohibited. Islamic financial institutions provide an increasingly broad range of many financial services, such as fund mobilization, asset allocation, payment and exchange settlement services, and risk transformation and mitigation. But these specialized financial intermediaries perform transactions using financial instruments compliant with shari`ah principles.

This practice is suitably in accordance with social responsibility from then Islamic perspective as it suited the principles of maslahah (the public good) which as the foundation of Maqasid ai-Syari`ah or Syari`ah objective (Asyraf & Nurdianawati). Another key area of concern relates to lack of human resources adequately trained in the models and tools of Islamic finance and understand the real teaching of Islam as well as the objectives of Islamic Finance. Islamic financial institutions have generally been recruiting from the pool of conventional bankers and financial professionals, who often find it too comfortable to camouflage conventional products and services as Islamic ones. The unsavory outcome of this is there for all to see. Because of the needs many financial institutions have introduced Islamic instruments to satisfy customers need. Today we can find a wide range of products and services, which look Islamic in form but conventional in every other sense. This could be because of lack in knowledge as most of the people involved in Islamic Banking and Finance are only focussing on three elements that must not exist, riba, maisir and gharar, in order for the product to be recognized as shari`ah compliance without understanding the whole Islamic Mu`amalah systems and requirements. A solution to the above perhaps lies not only creating greater awareness among market participants through research, education and training but increase the understanding of what is really mean by Islamic Finance. The depositors, investors, bankers, insurance professionals, financial analysts, regulators and policy makers need to be told the full story - why conventional financial products and services are not acceptable in Islam; what are the specific elements and features that are unacceptable; what are the Islamic alternative products and services that fulfill similar needs and address similar concerns and finally whether the alternatives are efficient as well. But more importantly is whether the products and services really follow the Islamic teaching. Financial System Efficiency Promotion of efficiency is accepted as the primary goal of policy makers and regulators of financial systems. The criteria to measure efficiency of financial systems are well defined in literature. Financial system efficiency is measured in terms of efficiency achieved in mobilizing savings from the savings-surplus units in the economy and in allocating these funds among savings-deficit units in the economy. It is generally believed that an increase in the range of financial assets and instruments would improve efficiency in mobilization of funds. Every saver

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or investor has unique risk-return expectations. The greater the variety of risk return combinations offered by financial assets, the better would be the match between what investors need and what is available in the system. The notion of allocation efficiency implies that funds flow into desirable projects. More funds should flow into projects with higher profitability and lower risk (hence, higher value) and vice versa. This implies that financial instruments issued by such projects should involve a lower cost of funds for the issuer. Prices and rates of financial instruments should reflect the intrinsic worth or value of an instrument. If the instrument or project is more valuable, it should command a higher price. A high price implies low rates or low cost of funds. Pricing efficiency is a prerequisite for allocation efficiency. For example, suppose you receive a qard al-hasan student loan of $10,000 at the beginning of the university semester. But you need only $2,000 of it towards tuition fee and purchase of study materials for the current semester and another $3,000 towards living expenses for the term. You deposit the balance $5,000, needed for the forthcoming term, into a three month mudharabah deposit. You can invest in this rather high-return savings scheme of the local Islamic bank because you are willing to invest your money for a fixed time period. The bank then pools your $5,000 with funds from other students and makes a large Murabahahh financing to the local book-seller to set up an internet browsing section. Given the cost of funds and its profit maximizing goal, the bookseller selects only the most profitable projects and drops other projects whose returns would be below the firm's cost of capital. Other firms with projects that promise low returns will also find money too expensive to finance those projects. If the financial system is working efficiently, the return you receive will be the highest possible rate for your money for a three-month period, the book seller will have borrowed money at the lowest possible cost, and only those projects with the highest rate of return will have been financed. The more efficient our financial system, the more likely this is to happen. Note that prices and rates would reflect the intrinsic value of a financial instrument when all parties are adequately informed about the project its return potential and the risks it involves. Thus, the financial system must ensure costless flow of relevant information. Informational efficiency of the system is therefore, a prerequisite for pricing and hence, allocation efficiency. As we shall see later an Islamic financial system puts great emphasis on all these dimensions of efficiency. Another prerequisite to pricing efficiency is operational efficiency, which implies that transactions should be executed at minimal costs. High transaction costs prevent prices and rates from adjusting to changes. A related notion of efficiency is full-insurance efficiency that deals with availability of methods and avenues of sharing and transferring risk within the system. From the above, it is clear that any move that reduces transaction costs, simplifies transaction system, increases the availability and accuracy of information, improves information processing by participants is a step towards improving the allocation efficiency of the system. Instantaneous and accurate price adjustment also presupposes that intense competitive pressures force all participants to react without any lag and that the system is dominated by rational investors who would not over-react or under-react. An efficient system is also a stable system where violent swings in prices and rates due to irrational behaviour of the participants are ruled out. Financial Products and Services

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Financial institutions that act as intermediaries, are mostly commercial banks. In a more mature financial system the process involves a direct offer of financial products by the savingsdeficit units (SDUs) to savings-surplus units (SSUs). Financial institutions now act as facilitators in the process. They help business firms and governments in various ways in raising the funds from households. They help SDUs design and create securities mostly sukuk, price them, and market the same to SSUs. Financial institutions that act as facilitators, are called investment banks. The first task of mobilizing funds involves offering the SSUs a range of financial products that match with their needs and expectations. These may be in the nature of various deposit products offered by an intermediary (where the process is indirect) and financial securities offered by SDUs (where the process is direct). Every economic unit may have a unique need or expectation (Ayub, 2009). What are the needs of an investor or buyer of a deposit product or financial security? An investor likes returns. The higher the expected returns the more attractive the product is and vice versa. An investor also dislikes risk and uncertainty. Risk refers to the possibility that the actual reward or return would turn out to be less than what is expected. The higher the risk associated with a given product, the less attractive the product is, and vice versa. Risk may itself be defined in various ways. Risk may relate to the volatility of returns. The higher the volatility, the higher is the risk. Risk may also refer to liquidity of the product or the ease with which the same may be sold for a fair price. Every investor may also have a unique time horizon or maturity preference. Given these multiple needs, if a product is less attractive along one dimension (say, more risky) then it must be more attractive with respect to the second dimension (or should promise more returns). Products designed to mobilize funds from SSUs must consider the characteristics and preferences of the household sector in terms of return-risk-maturity and other dimensions. In the Islamic financial system, the SSUs have a unique requirement conformity to Shari`ah. Financial products must not violate norms of Islamic ethics to be acceptable to the Islamic SSU. For instance, as we shall see later, deposit products and fixed-income securities that violate the riba prohibition norm have no place in the Islamic financial system. The second important task is to channel the savings or funds into SDUs. As mentioned above, the needs and requirements of the business firms and governments should now be taken into consideration in designing financial products and services. These needs may relate to cost of funds, maturity, level and pattern of expected cash inflows from the project and the like. The products are in the nature of various financing products offered by intermediaries (where the process is indirect) and financial securities offered by SDUs (where the process is direct). As mentioned above, financial products must not violate norms of Islamic ethics to be acceptable to the Islamic SDU. For example, a business firm would not seek an interest-based loan, nor would offer interest yielding debt securities. Besides the general categorization of financial institutions into intermediaries and facilitators or into commercial and investment banks, a closer examination would reveal many different types of players performing specific tasks that help achieve overall objectives of the financial system. For instance, insurance companies are a kind of contractual savings institutions that obtain funds under long-term contractual arrangements and invest the funds in the capital markets. These institutions are characterized by a relatively steady inflow of funds from contractual commitments with their insurance policyholders. They provide various risk management products to economic units and hence, help achieve full-insurance efficiency of the financial system.

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Islamic finance is not a product to be offered to a niche market. It is a system. It must be promoted and implemented as a system. Where the monetary system is concerned, it cannot be achieved by the private sector alone, Islamic or otherwise. A lead is required from the State since we must redefine the meaning of the words 'legal tender'. We must somehow overturn the monetary system as it is. And that will require us to defeat the monster that faces us. Meanwhile, in many countries, small and medium sized Muslim-owned businesses are offered no Islamic finance facilities at all. When they do finally encounter a financing proposal from an Islamic bank, many of these businessmen quickly become cynical because the financing cost is fixed at the outset of the financing agreement (Tarek El Diwany, 2002). At a very basic level, the disbursement of collateral free loans in some cases constitutes an example of how Islamic banking and microfinance share common aims. Thus Islamic banking and microcredit programs, may complement one another in both ideological and practical terms (Dhumale, Sapcanin, 1999). The basic framework for an Islamic financial system is a set of rules and laws, collectively referred to as shariah, governing economic, social, political, and cultural aspects of Islamic societies. Shariah originates from the rules dictated by the Quran and its practices, and explanations rendered (more commonly known as Sunnah) by the Prophet Muhammad. Further elaboration of the rules is provided by scholars in Islamic jurisprudence within the framework of the Quran and Sunnah. The two most important of the basic principles of an Islamic financial system are prohibition of riba (interest) and risk sharing. Prohibition of interest. Prohibition of riba, a term literally meaning "an excess" and interpreted as "any unjustifiable increase of capital whether in loans or sales" is the central tenet of the system. More precisely, any positive, fixed, predetermined rate tied to the maturity and the amount of principal (i.e., guaranteed regardless of the performance of the investment) is considered riba and is prohibited. The general consensus among Islamic scholars is that riba covers not only usury but also the charging of "interest" as widely practiced. This prohibition is based on arguments of social justice, equality, and property rights. Islam encourages the earning of profits but forbids the charging of interest because profits, determined ex post, symbolize successful entrepreneurship and creation of additional wealth whereas interest, determined ex ante, is a cost that is accrued irrespective of the outcome of business operations and may not create wealth if there are business losses. Social justice demands that borrowers and lenders share rewards as well as losses in an equitable fashion and that the process of wealth accumulation and distribution in the economy be fair and representative of true productivity. Lush (2009) argued that interest became the 'financial screen' from Islamic banking practitioner, is banned because of concern about usury--lending at interest in the Western way is seen as taking advantage of the borrower. Risk Sharing The basic framework for an Islamic financial system is a set of rules and laws, governing economic, social, political, and cultural aspects of Islamic societies. Shariah originates from the rules dictated by the Quran and its practices, and explanations rendered (more commonly known

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as Sunnah) by the Prophet Muhammad. Further elaboration of the rules is provided by scholars in Islamic jurisprudence within the framework of the Quran and Sunnah. The two most important of the basic principles of an Islamic financial system are Because interest is prohibited, suppliers of funds become investors instead of creditors. The provider of financial capital and the entrepreneur share business risks in return for shares of the profits. Conventional banking practices
are concerned with "elimination of risk" where as Islam imposed on the principle of " risk sharing " in any transaction. When conventional banks involve in transaction with consumer they do not take the liability or as far as possible they will transfer the risk to customer and only taking benefit from consumer in form of interest whereas Islamic banks bear all the liabilities and share the risk in all transaction with consumer. Taking benefit and profit without bearing its liability is prohibited in Islam.

The Malaysian Practice It is clear that all products offered by the banking institutions have been scrutinize by the Shari`ah Committee. But implementation and administering of the products lies in the hand of the management team. Based on the research conducted, a large number of staffs at the institutions offering Islamic products has a very limited knowledge on shari`ah compliance guidelines (Fuad, S. and Normilia, 2009, Fuad, S. And Maisalmah, 2008). This is the main hindrance or obstacle in the implementation of Islamic financial products and services. Without proper knowledge of Islam and Islamic Shari`ah, the implementation can go astray. One of the examples is the use of wa`ad. According to Islamic law Al-Wa`ad means promise which connotes an expression of willingness of a person or a group of persons on a particular subject matter. In a commercial transaction, a promise has a dual meaning. This is because, in a unilateral contract, the offer of the offeror is known as promise, while in a bilateral contract, the acceptance of the offeree is known as promise as well. The application of promise can be seen in several Islamic transaction concepts for example in sale and purchase, murabahah, syirkah mutanaqisah, ijarah, takaful etc. (Siti Salwani, 2008). Waad requires a customer to make a unilateral promise to buy the commodity from the bank, before the bank actually makes the purchase from the supplier. Initially the application of wad was limited to the Murabahah sale to purchase orderer facility. Later, its application was extended to other financing and investment facilities which are structured based on sale (bay), leasing (ijarah) and partnership (shirkah) contracts. The use of wad in such facilities is necessary as a risk mitigation tool to show the parties commitment to perform their contracts as mutually intended completely. Most importantly, its ultimate purpose is to ensure continuous Shariah-compliancy in every stage of the transaction, particularly to avoid the formation of two contracts in one or pre-conditioned contract (conditional contract). The Malaysian Accounting Standards Boards in its amendment to the Financial Reporting Standard i-1 2004 had mentioned about al- waad when defining Ijarah Muntahia Bittamleek. It read: Ijarah Muntahia Bittamleek is an Ijarah contract with an undertaking by the lessor to sell the Ijarah asset to the lessee and/or an undertaking by the lessee to purchase the Ijarah asset from the lessor by, or at, the end of the Ijarah period. The sale and purchase is effected by a separate contract. 'Undertaking' is translated from the Arabic word wa'ad". Promise or Waad has been featured so prominently and has been given more importance than Islamic contract itself. Even though it is considered as an effort aimed at helping Islamic finance to grow and be competitive in the world of finance, waad has been employed in structuring many Islamic financial instruments including Murabahah sale, swap and option. The

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major question in the implementation of waad is why in most cases it is the customer who is made to be legally bound by any promise that the customer may be asked to make in favour of Islamic financial institutions. The concept invoked in this connection is what is known as the notion of binding promise premised on views as adopted by some school of thought or Islamic schools of Jurisprudence. Although a great majority of Muslim jurists right from the earliest period of Islamic law have held the view that a promise is undeniably morally binding upon the promisor, but they accepted the view that in a law or judicial term it is not binding in the sense that if the promisor should break his promise he could not be sued in any Shariah court for such a breach. Conclusion Based on the above discussion, in order for a banking and financial system being accepted as Islamic, it cannot break away from what I called Islamic Based and not only Islamic Compliance. There are some critical principles where the implementation of Islamic financial product must follow the basis of Islamic teaching and upheld the Shari`ah objectives (Maqasid As-Shari`ah). Because of the importance in introduction of Islamic Banking and Financial system stems in the need to bring the Muslim closer to Allah every product introduced must follow strictly the teaching of Islam. If the preceding practice has not yet being changed, then the banking system in Malaysia has to be revamped in order to save the people from continuously involved in a questionable activities. Again, the Islamic Banking practice should bring Muslim closer to Allah and not the opposite.

References: 1. 2. 3. 4. 5. 6. 7. 8. 9. Asyraf, W. D. and Nurdianawati, I,A. Maqasid al-Syari`ah, Masalah and Corporate Social Respomnsibility. The merican journalof Islamic Social Sciences 24:1. Bank Negara Malaysia: Annual Banking Statistics 2007 Dhumale R., Sapcanin A. An Application of Islamic Banking Principles to Microfinace Technical Note, A study by the Regional Bureau for Arab States, UNDP, in cooperation with the Middle East and North Africa Region, World Bank. Fuad, S. and Maisalmah, A. (2009). Marketability of Islamic Banking and Finance Towards Muslims in Kuala Lumpur. Unpublished Master Thesis. Fuad, S. and Normilia, A. (2010). Customer Preferences Towards Islamic Home Financing in Klang Valley. Unpublished Master Thesis. Lush, E. (2009). Islamic finance stakes its claim: banking governed by Koranic principles is a rare growth market in a shaken financial world, says Edie Lush--but is it really more stable than its Anglo-Saxon equivalent? The Spectator, October 17, 2009. Malaysian Accounting Standards Boards (2004). Financial Reporting Standard i-1 2004. Mckinsey, (2008). The World Islamic Banking Competitiveness Report 2007-08, "Capturing The Trillion Dollar Opportunity" Muhammad Ayub, (2009). Understanding Islamic Finance. West Sussex: John Wiley & Sons.

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10. Segrado, C. (2005). Islamic microfinance and socially responsible investments. Microfinance at the University of Torino. . Surf on 10th. Nov 2012. 11. Siti Salwani, R. (2008). The Concept Of Waad In Islamic Financial Contract. Islamic Banking, Accounting and Finance Conference (iBAF 2008), The Legend Hotel, Kuala Lumpur. 12. Tarek El Diwany (2002). Islamic Bank Isnt Islamic. Banker Middle East, November 2002.