STRENGTHS AND WEAKNESSES OF THE ISLAMIC FINANCE SYSTEM, THE

ROLE OF DR MAHATHIR MOHAMAD IN ITS DEVELOPMENT, AND THE

LESSONS LEARNT FROM HIS EXPERIENCES

INTRODUCTION
Islamic finance can be defined as a system of finance whose rules of practice are
derived from the tenets and principles of Islamic law known as the Sharia 1. Islamic
finance is therefore a system of finance that is complementary with the beliefs and
practices of the muslim faithful across the world. Its basis is the Sharia, which as
mentioned a derivative of the Holy Quran which, as Muslims believe is the last book
that was revealed to the Prophet or Pubh, containing a set of guidelines for the
required standard for life as a muslim. The Holy Quran is believed to be free of
blemish or corruption, and the respect of its dictates are meant to be kept in the hope
of attaining the promises of the hereafter as declared by the Creator to the prophet
Muhammad.
Islamic finance has nowadays come into contention with the system of conventional
finance that is practiced by most of the world today, that was carved out through a
study of the forces of demand and supply and which in practice, contains several
aspects that are considered forbidden by the Muslim. It is along these lines that
Islamic finance came to being.
There are three main principles that govern Islamic finance 2 aimed at guiding the
nature and role of finance institutions and their services. These include
-

The prohibition of the Riba or usury.

The prohibition of the Gharar or games of chance (gambling)
The quest for justice.

The constructioin of the principles of Islamic finance along these lines have led to the
creation of a system of finance that is not only rigid, but is also making immense
1 The Sharia a set of rules governing the life and actions of a Muslim derived
from the Holy Quran.
2 Divanna A. J.,Understanding Islamic Banking. The Value Proposition that
Trancends Cultue. Pg 4

success in the world today. With a total of over 65 Islamic finance bodies and
institutions around the world controlling and making approximately 200Billion dollars
per annum, the success of practicing Islamic finance nations speaks for themselves.
Little wonder why the Gulf Community of Countries (GCC) have enjoyed so much
success and become a destination of choice for many people nowadays.
To have come this far, Islamic finance must have traversed a lot of hurdles and seen
immense contribution to its growth and development. One can hardly talk about the
development of Islamic finance without mentioning the name Malaysia. Malaysias
success story is a bitter-sweet expression of the hard road traversed by Islamic
finance to achieve its current success. By implication, mentioning Malaysia warrants
the respect for Dr. Mahathir Muhamad who was one of the major contributors to the
development of Islamic finance in Malaysia. It will be long these lines that the
paragraphs below shall seek to explain the Development of the Malaysian Islamic
Finance system, the strengths and weaknesses of this system, the role played by Dr.
Mahathir Muhamad in its development and the lessons we learnt from his
experiences.
1.1 THE MALAYSIAN EXPERIENCE IN ISLAMIC FINANCE THE ROAD
TOWARDS A SHARIA-COMPLIANT SYSTEM OF FINANCE
To discuss the development of Malaysian Islamic finance, it is necessary to discuss
the history of Islamic Finance in Malaysia and the development of Islamic finance in
Malaysia after the creation of the BIMB
1.1.1

ORIGINS

OF

ISLAMIC

FINANCE

IN

MALAYSIA

(HISTORICAL

DEVELOPMENT OF ISLAMIC FINANCE IN MALAYSIA)

The origins of Islamic finance can be traced as far back as the Quranic era. The
Prophet Muhmmad is said to have entered into a Mudaraba with his wife, a system
of investment where one party provides the capital for a business and the other runs
the business, just like a partnership in conventional business. However the first
formal steps towards the creation of a specific streamline for Islamic finance came
when Barclays Bank PLC made the decision to open a branch of hers in Egypt so as
to facilitate the raising of funds for the construction of the Suez Canal in the 1960s.
this move was heavily criticised, mainly due to the fact that Barclays was an interest-

ranting bank at the time. The effect was the creatioin of the Mit Ghamr Bank in 1963.
This bank was built on the German concept of rural living. Circa this same period,
their Malaysian counterparts were also making similar moves with the creation of the
Tabung Haji, a bank aimed at helping the Malaysian Muslims to prepare for the
Hajj3. Before this time however, the courts of Malaysia recognised the jual janji as a
customary tradition in Malaysia. This was one of the first steps by the Malaysian
government to recognise the importance of religiously oriented economic
transaction.
The growth of Middle Eastern states in the 1970s saw an increase in the demand for
Sharia-compliant systems to be set up in the Islamic world, especially since at this
time, the Middle Eastern oil market was witnessing a boom in the demand for their
produce. The enthusiasm of the Middle Eastern states culminated in the opening of
the Dubai Islamic Bank (DIB) in 1975. This was the first full fledged Islamic
commercial bank to provide operations of a Sharia-Compliant nature. Seeing this,
the Malaysian people decided to make a move of their own, and in 1980, the issue of
a Malaysian Islamic bank was put up for discussion at the Bumiputera Economic
Congress and the National Seminar on the Concept of Development in Islam. These
two conferences led to one main decision; they called on the Malaysian Government
to set in motion a process towards the development of a system of finance based on
the Sharia.
In response to this, the National Steering Committee on Islamic banking was set up
to study these proposals. Their task, among other things, was to examine the
suitability of the Islamic Banking in Malaysia and make recommendations for the
establishment of the Bank Islam Malaysia. It also proposed the incorporation of the
Bank Islam Malaysia as a company under the Malaysian Companies Act of 1965 in
order to monitor its operations and ensure its profitability. The resolutions of the NSC
were put to practice and it led the incorporation of the Bank Islam Malaysia Berhad
(BIMB) on the 1st of March, 1983. It commenced operation three months later, with a
total headcount of 30 persons.

3 Hajj- The annual pilgrimage to Mecca required to be done at least once by the
Muslim faithful.

The creation of the BIMB was just the first step towards a robust system of finance
which is and has been the key in the success of Malaysias economy. From this
stage onward, it was now a matter of letting all this work to simmer. The creation of
the BIMB being the first step in the development of Islamic finance in Malaysia, set
the tone for its future development which can be grouped into three main phases as
we shall discuss below.
1.1.2 THE THREE MAIN PHASES OF THE DEVELOPMENT OF ISLAMIC
FINANCE IN MALAYSIA
Once the work of the NSC was done, the focus was now to ensure the success of
their proposed model. To guarantee this, all the arsenal to ensure its success
needed to be developed. To do this, the following issues needed to be addressed;
- The creation of a framework of laws based on the Sharia, guiding the roles and
responsibilities of individuals and institutions under the umbrella of Islamic Finance
- The Enhancement of knowledge and expertise in the field of Islamic finance
through training and development
- The development of necessary institutions and regulations to guarantee the
success and development of financial systems
- The development of the product and the market by raising awareness of Sharia
compliant systems among Malays.
1.1.2.1 STAGE 1 THE CREATION OF THE BIMB
As mentioned above, the work of the steering committee recommended the creation
of a Sharia-based Islamic bank by name the Bank Islam Malaysia, which saw the
light of day following its incorporation. It opened its doors to the public on July 1 st,
1983. Its incorporation was a move to ensure it operated as an independent body,
allowing it to operate with less constraint from the state.
This was a milestone in the development of Islamic finance in Malaysia. However,
the necessary legislation needed to be put in place to ensure its success. Since the
1973 Islamic Banking Act prohibited all forms of trade and functioned on the basis of
interest, it was thus replaced by the Islamic Banking Act (IBA) OF 1983. This law

gave the BIMB the power to supervise and regulate the activities of other banks. The
bank also had to set up a Sharia Supervisory Council to monitor and ensure the
operations it ran were in concordance with the dictates of the Sharia. The BIMB was
also listed on the Kuala Lumpur Stock Exchange in January 1992.
the NSC also recommended the creation of an Islamic Insurance company under the
Islamic Bank to ensure safety and security under in cases of fire and for the
protection of assets inter alia. It was along these lines that the 1984 Takaful Act was
signed, modifying the terms of the 1973 Insurance Act to make the former more
Sharia-compliant. It also led to the creation of the first Insurance operator named
Syarikat I Takaful Malaysia in November 1984.
1.1.2.2 - PHASE 2 THE CONSOLIDATION OF ISLAMIC BANKING IN MALAYSIA
It was the decision of the government of Malaysia to let the BIMB remain the sole
Islamic bank in the country for a ten year period before the creation of any other
banks of similar nature, to ensure BIMB could focus on the development and growth
of Islamic banking. This was in line with the aim of the Malaysian Central banks
(Bank Negara Malaysia) decision to create a vibrant Islamic banking system that
would work side-by-side with the already established conventional banking system
as expressed in the early 1990s. BIMB thus worked hard to satisfy its demanding
clientele, and by 1993 had created a total of 21 instruments and products under
Islamic banking. However being the only Islamic bank in operation meant it began
feeling the pressure of satisfying the needs of the entire country with limited
branches and resources.
To solve this problem, the government after careful consideration chose to allow
conventional banks offer services consistent with the dictates of the Sharia as a
means of ensuring the expansion of Islamic banking. It was along these lines that the
Skim Perbankan Tanpa Faedah (SPTF) was initiated in 1993. This was a scheme
that allowed conventional banks offer Islamic banking operations, and allowed
conventional banks to use their existing structures and staff to open Islamic banking
window operations in their banks. By the end of 1999, 24 commercial banks, 18
finance houses, 5 merchant banks and 7 discount houses were in operation in
Malaysia. To ensure that these banks didnt mingle funds indiscriminately and stay
within the norms of the Sharia, the Bank Negara Malaysia introduced several policies

and matrices such as the Islamic Banking Unit ( headed by an Islamic banker) and
the Islamic Banking Fund (IBF with a minimum allocation fund of 1M Malaysian R)
amongst others. The SPTF was replaced in 1998 by the Skim Perbankan Islam
(SPI).
Having had a compendium of rules governing the Islamic finance system and several
banks and financial institutions rendering Sharia-compliant services, there was one
more essential element to complete the job. This came in the form of the creation of
the Islamic inter-bank money market in 1994 by the BNM. Based on the mudaraba,
the Islamic money market was based in 3 components;
-

The trade of Islamic finance instruments

Mudarabah Interbank Investments (MII)
Islamic Cheque Clearing Systems (ICCS)

It functions as a capital market for capital seekers and providers and plays an
important role in complementing the banking system by opening a wide range of
opportunities within the Malaysian Islamic finance market.
The BNM also created the Sharia Advisory Council in 1997. Its role was to ensure
the interpretation of the Sharia by the banks and Takaful was harmonised, and
evaluate the possibility of new Sharia-compliant products and schemes. It also
served as a consultant in matters concerning the Sharia. It contained seasoned
academicians and Sharia experts among its members who had vast knowledge in
the Sharia, Islamic banking and finance.
1.1.2.3 PHASE 3 THE GLOBAL OUTREACH OF MALAYSIAN ISLAMIC FINANCE
Having consolidated the internal growth of Islamic finance in Malaysia, it was time for
the Malaysia to show its model to the world. The first step was taken when the
government of Malaysia declared Labuan as an International Offshore Financial
Centre (IOFC), thus making Malaysia an International centre for offshore banking
and finance of Sharia-compliant nature. This decision was aimed at completing and
complementing domestic financial activities, strengthening the contribution of the
financial services sector to the Gross National Product of Malaysia and to promote
Labuans development. This was also going to boost business in Malaysia as a
whole and provide a wide range of job opportunities for Malays in general.

One of the most important introductions in this phase of Malaysian Islamic Banking
development was the launching of the first Global Islamic Sukuk based on the
principle of the ijarah in the year 2002. This was a demonstration of malaysias
support to the growth of Islamic finance in the world. This was followed up by the
creation of the Islamic Finance Services Board (IFSB) that same year, meant to
prepare the way for the adaptation, harmonisation and development of International
supervisory and regulatory standards and rules of governance for all financial
institutions under the Sharia umbrella to follow. It had nine founding country
members and its secretariat is at Kuala Lumpur, which we should remember is the
only place where the Sukuk is issued.
The completion and consolidation of Malaysian Islamic finance in the international
scene was the icing on the cake on the development of Malaysian Islamic finance.
Malaysia had now become the reference point for other countries to follow. This was
further deepened by the success of the Islamic finance system they had built.
1.1.3 STRENGTHS AND WEAKNESSES OF THE MALAYSIAN ISLAMIC
FINANCE SYSTEM
1.1.3.1 STRENGTHS
The first major strength of the Malaysian Islamic finance system is the heavy reliance
on government during the development phases of the concepts. The fact that the
Malaysian government championed the course of the creation of the Malaysian
system of Islamic finance allows room for the creation of a stable, robust and long
lasting system of finance. The nature of Sharia banking rules provides a solid base
for the continuity of the Islamic finance model in Malaysia, making her a reference
point in the field within and without the Asian sub-continent.
The well very solid structure that the Malaysian Islamic financial system is another
strength. With a solid set of rules and institutions to monitor and evaluate the mode
of practice and evolution of products and services of Sharia-compliant nature, not
only is the respect for the tenets of Islam guaranteed (especially with regards to the
conventional banks that provide Sharia-compatible services), it also has created a
feedback-feed forward information system that allows room for the quick
identification and resolution of problems within the system.

1.1.3.2 - WEAKNESSES