GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

1.0 INTRODUCTION
Islamic banking was established in Malaysia since 1983. The products are available at two full pledged Islamic banks and at all commercials and merchant banks in Malaysia. Malaysia is one of the Muslim countries that is dedicated in not only developing Islamic banking system but also a complete Islamic financial system. The Islamic Banking System in Malaysia started in 1983 when the first Islamic bank, Bank Islam Malaysia Berhad (BIMB) originated its actions. It was the objective of the Malaysian government to develop the Islamic banking system parallel to the conventional system. The government also introduced a concept of Islamic Windom which allows the existing conventional banks to introduce Islamic banking products to customers. The Islamic Window concept started in March 1983when the Central Bank of Malaysia introduced the Interest-Free Banking Scheme. There are twenty one Islamic financial products were enlarged to offer for this scheme with only three major banks participated initially. The history of islamic banking can be seen during the Islamic Golden Age. Its the premature form of proto-capitalism and free markets were present in the Caliphate. The early market economy and an early form of merchantilism are developed between the 8th12th century. A dynamic monetary economy was created on the basis of the intensifying levels of circulation of a stable, high-value currency and the combination of monetary areas that were formerly independent. In early Islamic banking, some economic concepts and techniques were applied. It includes the bill of exchange, the first form of partnership (mufawada) such as limited partnership (mudaraba) and the earliest forms of capital (almal), capital accumulation (nama al-mal), cheques, promissory notes, trusts (Waqf), transactional accounts, loaning, ledgers and assignments. Organizational enterprises independent from the state are subsisted in the medieval Islamic world, while the agency institution was introduced during that time. Islamic banking is a system of banking or banking activity that is reliable with the principles of Islamic Law (Sharia). Sharia disallows the payment or acceptance of interest fees for the lending and accepting of money in that order. Riba or usury is a method of investing in businesses that provide goods or services considered opposing to its principles that is Haraam or forbidden. On the other hand, the best way to understand Islamic banking is by gaining an understanding of the products that are considered adequate. The Islamic products are considered acceptable.

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

2.0 THE ISLAMIC BANKING PRODUCTS

BAI MUAJJAL (CREDIT SALE) MUSAWAMAH WADIAH (SAFEKEEPING) MUSHARAKAH (JOINT VENTURE) MUDARABAH (PROFIT LOSS SHARING) WAKALAH (AGENCY) THE ISLAMIC BANKING PRODUCTS QARDUL HASSAN (BENEVOLENT LOAN) SUKUK HIBAH (GIFT) IJARAH THUMMA AL BAI (HIRE PURCHASE) TAKAFUL (ISLAMIC INSURANCE) BAI AL-INAH BAI SALAM (SELL AND BUY BACK AGREEMENT) (ISLAMIC BONDS)

MURABAHAH (COST PLUS) BAI BITHAMAN AJIL (DEFERRED PAYMENT SALE)

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

WADIAH (SAFEKEEPING) In this product, a bank is considered as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit or any part of the outstanding amount, when the depositor demands it. The depositor, at the banks judgment, may be rewarded with a hibah (gift) as a form of appreciation for the use of funds by the bank. The bank pay compensations to depositors for the time-value of their money but refers it as a gift because it does not officially guarantee payment of the gift. MUDARABAH (PROFIT LOSS SHARING) Mudarabah is an arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilise funds for its business activity. The profits that occur will be shared between the capital provider and the entrepreneur according to an agreed ratio, where both parties share in profits and only capital provider tolerates all the losses if occurred. The profit sharing continues until the loan is repaid. The bank is compensated for the time value of its money in the form of a floating interest rate that is attached to the debtors profits. MUSHARAKAH (JOINT VENTURE) This concept is applied for business partnership or joint ventures. The profits made are shared on an agreed ratio, while losses acquired will be divided based on the equity participation ratio. It is different from fixed-income investing. MURABAHAH (COST PLUS) This concept refers to the sale of goods at a price, which includes a profit margin agreed by both parties. The purchase and selling price, other costs and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. This is a fixed-income loan for the purchase of a real asset, with a fixed rate of interest determined by the profit margin. The bank is not compensated for the time value of money outside of the contracted term but the asset remains in the ownership of the bank until the loan is paid in full.

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

BAI BITHAMAN AJIL (DEFERRED PAYMENT SALE) This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. Its similar to Murabahah, except that the debtor makes only a single installment, on the maturity date of the loan. Through the application of a discount rate, an Islamic bank can collect the market rate of interest. WAKALAH (AGENCY) Wakalah occurs when a person appoints a representative to undertake transactions on their behalf and its similar to a power of attorney. QARDUL HASSAN (BENEVOLENT LOAN) This is a loan extended on a goodwill basis, and the debtor is required to repay the amount borrowed. But the debtor may pay an extra amount on hir or her discretion beyond the principal amount of the loan as a token of appreciation to the creditor. In this case, the debtor does not pay an extra amount to the creditor, this transaction is a true interest-free loan. Some Muslim consider this to be the only type of loan that does not violate the prohibition on riba because it is just a type of loan that truly does not compensate the creditor for the time value of money. IJARAH THUMMA AL BAI (HIRE PURCHASE) These are discrepancys on a theme of purchase and lease back transactions. There are two contracts involved in this concept. The first contract, Ijarah contract (leasing/renting) and the second contract Bai contract (purchase) are undertaken one after the other. In effect, the bank sells the product to the debtor, at an above market-price profit margin. It is in return for agreeing to receive the payment over a period of time. The profit margin on the lease is equivalent to interest earned at a fixed rate of return. This transaction is reminiscent contractum trinius, a complicated legal trick used by European bankers during the Middle Ages. BAI AL-INAH (SELL AND BUY BACK AGREEMENT) The financier sells an asset to the customer on a deferred payment basis and the assets will be purchased immediately by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency.

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

HIBAH (GIFT) This is a token given voluntarily by a debtor to a creditor in return for a loan. Hibah often arises in practice when Islamic banks voluntarily pay their customers interest on savings account balances. TAKAFUL (ISLAMIC INSURANCE) In modern businesses, there is a way to reduce the risk of loss due to misfortunes and it is through insurance. The basic idea behind insurance is the sharing of risk. The concept of insurance where resources are pooled to help the needy does not contradict Shariah. Conventional insurance involves the elements of uncertainty (Al-Gharar) in the contract of insurance, gambling (Al-Maisir) as the consequences of the presence of uncertainty and interest (Al-Riba) in the investment activities of the conventional insurance companies which break the rules of Shariah. It is generally accepted by Muslim Jurists that the operation of conventional insurance does not conform to the rules and requirements of Shariah. Takaful is an alternative form of cover which a Muslim can avail himself against the risk of loss due to misfortunes. The concept of takaful is not a new concept but it had been practised by the Muhajrin in Mecca and the Ansar of Medina following the hijra of the Prophet over 1400 years ago. Takaful is based on the idea that what is uncertain with respect to an individual may end to be uncertain with respect to a great number of comparable individuals. Insurance by combining the risks of many people enables each individual to enjoy the advantage provided by the law of great numbers. SUKUK (ISLAMIC BONDS) A conventional bond is not permitted when they have the prohibition of Riba. A Sukuk bond is a asset-backed and the returns on it are not fixed but they are linked to the return on the assets purchased with the proceeds of the issue. These asset-based bonds of medium-term maturity have been issued internationally by sovereign and corporate entities. Sukuk paper has the advantage of competitve pricing as a risk-mitigation structure. The Islamic Development Bank created the first program for repeat issues of Sukuk.

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

BAI MUAJJAL (CREDIT SALE) Bai muajjal means a credit sale. It is a financing technique adopted by Islamic banks that takes the form of murabahah muajjal. It is a contract in which the bank earns a profit margin on the purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price. MUSAWAMAH This is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. When the seller do not have full knowledge of the cost of the item being negotiated, they will be under no obligation to reveal this costs as part of the negotiation process. Musawamah is the common type of trading negotiation seen in Islamic commerce. BAI SALAM Bai salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver or currencies based on these metals. Bai salam covers everyting that is capable of being described as to quantity, quality and workmanship.

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

3.0 THE ADVANTAGES OF ISLAMIC BANKING PRODUCTS

PRODUCTS
Wadiah Mudharabah

FOR CUSTOMER
To facilitate payment activities and incoming payment. To earn possible bonus or profit sharing.

FOR BANK
Sources of fund both in rupiah or foreign currency. Sources of revenue in the form of fee from further activity customer. of conducted by

and

Musyarakah

Fulfilling

the

need

The form of financing. Earning revenue in the form of profit sharing by referring to the revenues of the business under their management.

business capital through bank partnership system.

Murabahah

One of the alternatives of procurement of certain goods by using bank financing.

Main forms in financing. Earning revenue in the form of margin.

Ability

to

pay

in

installment with a flat amount in the course of agreement period.

Bai Salam

Procurement of funds in advance goods. as working capital in production of

The

framework of of

of certain

procurement the need

goods in compliance with the last customer. Oppurtunity to earn profit if the time of submission to the bank and the market price of the goods is higher than the amount of financing provided by bank.

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

Ijarah

To obtain the rights of benefit on the required goods.

One form of financing. Earning revenue in the form of fee or ujroh.

To have the oppurtunity to obtain the rights of ownership in the case of Ijarah Bittamlik. Muntahiya

As source of financing and service of Islamic banking leased to object have and the to rights of use on the have the oppurtunity to the rights of ownership.

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

4.0 THE DISADVANTAGE OF ISLAMIC BANKING PRODUCT

PRODUCTS
Wadiah and Mudharabah

DISADVANTAGES
Liquidity risk due to the relatively high fluctuation of demand deposit and the bank have responsibility to fulfill its short-term obligation. Market risk due to the movement of exchange rate for demand deposit in foreign currency. Credit risk due to customers default. Market risk due to the movement of exchange rate if financing based on Musyarakah agreement is provided in foreign currency. Operational risk due to internal fraud such as incorrect record of outstanding value, bribery, onconformity of tax reports, errors, manipulation and marking up in accounting and reporting.

Musyarakah

Murabahah

Credit risk due to customer default. Market risk due to the movement of exchange rate if the financing based on Murabahah agreement is provided in foreign currency.

Bai Salam

Credit risk due to customer default. Market risk caused by the movement of exchange rate if the capital of Salam is in foreign currency. Credit risk due to customer default. Market risk caused by the movement of exchange rate if the supply capital of Ijarah asset or if source of Ijarah financing is in foreign currency.

Ijarah

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

5.0 CONCLUSION
Islamic banking effectively explains on the attitudinal differences of Malaysian customer towards Islamic banking products. The competition among the banking service providers rise rapidly because the concern on customers attitude behaviors in the banking market had become the focus of academic and field researches. The Islamic banking authorities will take action plans directed toward spreading the culture of Islamic banking through specialized courses and organized seminars. The products usage need to be known by all the customers. This could help them to choose which product that they need.

10

GT20303 BANK AND FINANCIAL INSTITUTIONS MANAGEMENT

2010

6.0 REFERENCES
FORMAT
REFERENCES Issue 18(2010) European Journal of Economics, Finance and Administrative Sciences. http://www.eurojournals.com Online document with no author identified.

SOURCE

Ahmad, F. (2001), Recommendation of Workshop on Software Development in Ummah, In proceedings of International Conference on Information Systems and Islam Kuala Lumpur, Malaysia.

Online document with no author identified.

www.bankinginfo.com.my

Online document with no author identified and with no publication date.

Frederic S.Mishkin(Graduate School of Business, Columbia University) Sixth edition. Financial Market and Institution.

Book

11