(Charren 2: nstTunIs Axo Mares risk of default on securities such as commercial paper. The capital market, on the other hand, is the market in which longer term debt (one year or more) and equity instruments are traded. CLASSIFICATION OF FINANCIAL MARKETS In today’s financial world, one of the renowned classifications of financial markets is the money market and capital market. As mentioned in the previous section, this classification is based on the maturity of the securities traded in a financial market. The Islamic Money Market The money market is an approach for channelling short-term funds with maturities typically varying from overnight to those not exceeding 12 months. It provides a ready source of funds for market participants facing temporary shortfalls in funds. At the same time, it also provides short-term investment opportunities and outlets for those with temporary surplus funds. An efficient money market is an intermediary not only for financial institutions but also for firms and non-bank investors to invest their surplus funds. Because the transaction does not take place in a building, it is being settled through phone call and electronically so the money market usually has an active secondary market. The instruments differ in terms of their rates and liquidity. Money market operations comprise two broad categories: placement of short-term funds, and purchase and sale of short-term money market instruments (such as banker’s acceptances, negotiable instruments of deposit, Treasury bills, Cagamas notes, etc.). The interbank players in the money market are the commercial banks and investment banks. Banks as financial institutions are regulated by the Central Bank to put aside deposits in the form of reserves. Theoretically banks should not have any problems to provide the sufficient reserve, but in practical due to their lending activities, the banks may have deficits in their deposits. Therefore, to fulfil the policy they need to borrow from businesses or any financial institutions (lenders) that have surplus cash money. Lenders in the money market usually do not aim for high returns on theit money market funds. They actually do not want to hold the idle surplus cash because cash Scanned with CamScanner‘suas Faunce: Privoptes avo Pracnces Money alone can earn no income; idle cash is the opportunity cost in terms of lost interest income (dividend). However, they do not want to invest in the capital market either because perhaps in the short time they need to use the funds and it will be difficult if they liquidate in the capital market, ‘The persons involved in the money market can be either the lender or the borrower. They can be the government, businesses, banks, investment companies (brokerage firms), finance companies (commercial leasing companies), insurance companies (property and casualty insurance companies), or pension funds provider. Because of the high amount of funds needed during the transactions in the money market, the individual investors are difficult to interfere. Money Market Participants The main participants in the money markets are banks, non-bank financial institutions such as takafil and insurance companies, business corporations, the government treasury, and the Central Bank. Banks use the money market for liquidity purposes, especially to adjust the mismatch of assets and liability in their balance sheet. They will use the money market to obtain liquidity or to place their surplus funds for a limited period, They could also buy money market instruments such as Malaysian Islamic Treasury bills and NIDCs to invest surplus funds, or sell their holdings of these instruments to raise funds. | Business corporations as well as government agencies also use the money market for short term investments, Likewise, large business corporations, by virtue of their high credit ratings, source short term funds | by issuing commercial papers. The Central Bank, being the regulator and | whose role is to promote market stability, uses the money market to transmit its monetary policy. One such example is the use of open-market operations as a means of influencing the liquidity level and short term interest rates in the domestic financial system. Changes to the liquidity and shot term interest rates will affect long term rates in the financial system. Finally, the government, another important player in the money market, uses the market 8 a source of short term funding via the issuance of securities, | 34 Scanned with CamScannerCurren 2; usrmmons Avo MarwTS ‘The ultimate objective of Islamic financial system in Malaysia is to operate in parallel with the conventional financial system, This system is pound to specific legal frameworks, such as the Islamic Banking Act, Takaful Acts, and rules governing the Islamic Interbank Money Market (IIMM), The Islamic financial system comprises of Islamic banking Institutions, Islamic money and capital markets, the Takafidl industry, and non-banking ' institutions. Components of the Malaysian Islamic Money Market The Islamic Money Market is known in Malaysia as the Islamic Interbank Money Market (IIMM). Prior to the establishment of IIMM in January 1994, the Government Investment Certificate (GIC) was the only available Shariah-compliant short term instrument available to Islamic banks for liquidity management. The problem experienced using this instrument was that the secondary market for the instrument was not available, as the instrument was issued under the principle of gard al-Hasan (benevolent Joan), which made it non-tradable. Today, the Malaysian Islamic money market comprises two components: Islamic interbank market, and trading of Islamic money market instruments. Islamic Interbank Market Generally, the Islamic interbank market is considered the largest component of any Islamic money market, particularly the overnight sub- component. An active interbank market is essential to provide signals to the Central Bank to determine the volume of open market operations. The overnight market is where Islamic financial institutions (IFIs) trade. among themselves their reserve balances to meet their day-to-day liquidity requirements. For instance, banks with surplus liquidity can place their excess funds at other banks overnight. The overnight rate adjusts to balance the supply of and demand for bank reserves, A short market rate, in particular, the interbank overnight rate may be used to serve as an operational guide for monetary operations of the Central Bank. In 2009, the overnight market comprises 83 percent of the total interbank market. 35 Scanned with CamScannerava Feunce: Pravcetss avo Pracnces The Shariah contracts currently used in the Malaysian Islamic interbank market are Mudharabah, murabahah and wakalah, Mudharabah interbank investment ‘The first Islamic interbank investment started in Malaysia in early 1994 with the establishment of Mudharabah Interbank Investment (MII). In this arrangement, a surplus bank as rabbul mal or fund provider will place its excess funds for a limited period with a deficit bank or mudarib (manager of fund) on a pre-agreed profit sharing ratio. In line with mudharabah principles, any losses will be borne by the surplus bank. Under the current BNM rules, the minimum amount of investment is, RM 50,000, while the tenor can be anywhere from overnight to 12 months, When MII was first introduced, the rate of return paid by the deficit bank was based on its gross profit rate on a one year investment. However, this method was not transparent, as some banks underdeclared their return by excluding certain types of income. Following this, in 1995, BNM came up with a new rule by introducing a benchmark rate that is equivalent to the prevailing rate of the Government Investment Issue (GI) plus a spread of 0.5 percent. Hence, the minimum rate of return payable to the surplus bank is the prevailing rate of return from GI plus 0.5 percent. This rate of return computation methodology was used until 2004 when BNM replaced it with a more comprehensive framework, where it sets out the calculation of distributable profits and the derivation of rates of return to depositors, Commodity murabahah ‘Also known as Tawarrug, this is a liquidity management programme originally introduced by BNM in March 2007, as an avenue for Islamic banks to invest their excess funds with the Central Bank. Now it is being used as interbank investment among the Islamic money market participants, In Malaysia, Bursa Suq Al-Sila’ has been established to provide a platform for commodity murabahah transactions. The underlying asset used in this exchange is Crude Palm Oil (CPO) although other assets such as aluminium have also been used in the GCC countries. Under this arrangement, an investing bank purchases an underlying asset, say CPO, from a broker and sells it to the investee bank at cost plus with an agreement that it pays the investing bank on a deferred payment basis. The investee bank may then appoint the investing bank as its agent to sell the commodity to another 36 Scanned with CamScanner(Chueren 2: esmrunins Ax0 MARWETS broker on a spot basis or may sell the commodity on its own to another broker. The reverse of this transaction is also known as reverse fawarrug, and can be done ifa bank is in need of short term funds. In contrast to MII where the rate of return is determined upon the maturity of the investment, the rate of return of commodity murabahah is fixed upfront and known to the investing bank. Wakalah investment Wakalah investment is an agency concept whereby the muwakkil Cinvestins bank) appoints the investee bank (wakil) as its agent to invest ir caAconplan Tasco RESTO nak wl no tiinvetng baieor te pone upon placement offins. Any pafisoceoinE Te oa will be retained as an incentive to the investee bank. The investee bank is also entitled to draw an agency fee from the incentive obtained. The investing bank as principal will bear all risks associated with the transactions except for those risks resulting from the investee bank's willful act or gross negligence. The formula to calculate the profit payable to the investing bank tinder Wakalah inverstment is the same as commodity murabahah investment. i Trading of Islamic Money Market Instruments ‘Trading in the Islamic money market instruments represents the second component of the Islamic money market. Itis aimed at facilitating placement among the money market players just like the interbank investment, but through the issuance or purchase of financial instruments. The money market instrument is more flexible compared to the interbank investment in the sense that the instruments can easily be traded in the secondary market. This therefore makes it easy for banks that purchase money market instruments to sell or liquidate them whenever they want without waiting until the maturity of the instruments. An active secondary market is therefore necessary to facilitate the trading of money market instruments before maturity, thereby reducing liquidity risk and enhancing the efficiency in the market. Unlike interbank investment that is mainly restricted to approved interbank institutions, participants in this market constitute both financial and non-financial institutions. The instruments that are offered in the 37 Scanned with CamScannermaine Feutice: PRNcMs Ao Pracnces market are different from one another in terms of risk profile, yield, tenor, marketability and liquidity. It should also be noted that the term money market instruments refers to short term investment papers, including long term instruments, such as government securities that have almost reached their maturity date. Government investment issue (Gil) | Formerly known as Government Investment Certificates (GIC), Glls were first introduced in July 1983 in conjunction with the establishment of Malaysia’s first Islamic Bank, BIMB. BNM, on behalf of the Malaysian government issued for the first time non-interest bearing GIL to meet the special needs of the bank ‘and other corporations which are interested in these securities. The government Investment ‘Act 1983 under which certificates are issued, provides certificates with maturities of one year or more to be issued and for dividends, instead of interest, to be paid on the certificates. The original GIC was issued under the principle of gard a ‘Hasan (bendvolent loan), which restricts its trading inthe secondary market, Financial institutfons needing liquidity will have to surrender or their GICs back to BNM, after which dividends will be paid. The determination of the — dividend is not ex-ante but rather ex post. The above constraints led BNM to replace GIC with GII in 2001. GIL is structured on the contract of bay’al-inah (sale and buyback). For example, BNM will identify a Shariah-compliant asset and then invites tenders from Islamic financial institutions for the asset. The IFI which offers the most competitive price will be selected to be the buyer cum investor and gets to buy the asset on spot sale. The investing bank in turn will resell the asset back to BNM on the principle of bay’ bithaman ajil (deferred sale) if the coupon is to be paid periodically, or murabahah (cost plus) if the GIl is a zero coupon instrument. The debt incurred by BNM through the deferred buyback is securitised in the form of GII. Thus, the spot price paid by the investing bank will be at face value if the GIl is issued on the principle of BBAor discounted value if the GI is issued under murabahah. The investing bank can either hold the GII until maturity or sell it in the secondary market. ‘At maturity, BNM redeems the security by paying the full purchase price of the assets (or face value of Gl) to Gil holders. Scanned with CamScannerChwren 2: srrTens 0 Mawes Malaysian islamic treasury bills (miTB) MITB are short term securities issued by the government as an_ alternative to the conventional Treasury bills. Unlike GI which are issued io finanee the development expenditure of the government, MITB are jsgued to finance the government’s Operating expenditure. The MITB are structured based on the bay’ al-inah principle where BNM an behalf of the government will sell the identified government’ assets on a compaitive tender basis, to form the underlying transaction of the deal, Allotment is based on highest price tendered (or lowest yield). Price is determined after the profit element is imputed (discounting factor). The successful bidders will then pay cash to the government, The bidders will subsequently sell back the assets to the government at par based on credit terms. The government will issue MITB to bidders to represent the debt created. MITB are usually issued weekly with original maturities of one year and are priced on a discounted basis. Both conventional and Islamic institutions can buy and trade on MITB. Bank Negara monetary notes (BNMN) > ‘These are short term money market instruments issued by BNM to replace the Bank Negara Negotiable Notes (BNNN). Th underlying contract used to be bay’ al inah but now has been replaced with murabahah, The issuance of BNMN is based on commodity Murabahah, as explained earlier. The issuance is normally made through publication in FAST and the tenor for this instrument ranges from | to 12 months, although now it has been extended to three years. The debt created from the commodity Murabahah is tadable in the secondary market under the concept of bay al-dayn, New issuance may be based on discount or coupon bearing. Discount-based BNMN is traded using a convention similar to the existing BNNN and Malaysian Islamic Treasury Bill (MITB), while profit-based BNMN is traded using the market convention of Government Investment Issue, Sukuk Bank Negara Malaysia ijarah (SBNMI) This is an Islamic money market instrument that is issued under the [jarah (lease) principle. To facilitate the issuance of SBNMI, BNM established a special purpose vehicle named as BNM Sukuk Berhad (BNMSB). The first stage of the sukuk issuance involves BNM selling the identified assets to BNMSB and BNMSB paying BNM Tor the assets 39 Scanned with CamScannerfunc Feuice: Pancrues avo Pracnces from the proceeds of the sukuk issuance. The assets will then be leased to BNM for rental payment consideration, which is distributed to investors as a return on a semi-annual basis. Upon maturity of the sukuk ijarah, which will coincide with the end of the lease tenure, BNMSB will then sell the | assets back to BNM ata predetermined price. One advantage of using ijarah principle is that the rental can be set as fixed or variable, thus mimicking a floating rate bond. Islamic negotiable instruments (INI) ‘This is a Shariah-compliant instrument equivalent to the conventional Certificate of Deposits (CDs). INI may be issued based on the BBA or ‘Mudharabah . The instrament based on BBA is called the Negotiable Islamic + Carlificate (NIISC), while the one based on mudharabah is called the Islamic Negotiable Instruments of Deposit (INID). Negotiable islamic debt certificate (NIDC) NIDC isa document issued by an IFI to evidence that a sum of money has been deposited with the issuer fora specific period. The NIDC stipulates that the issuer has the obligation to pai the bearer the amount deposited _ | ogether with profit at a specified future date. This document is issued based on BBA. The issuing bank will first identify an asset whose value is based on the amount to be deposited and sells this asset to the investor at an agreed-on cash price. Subsequently, the investor agrees to resell the same asset back to the issuing bank at the original sale price plus mark up, | which is payable on a deferred basis. To evidence the indebtedness from the | deferred sale, the issuing bank issues NIDC to the investor. Upon maturity, | the investor or bearer presents the NIDC to the issuing bank against payment | for its nominal value plus the profit portion. | NIDC are bearer instruments and are initially issued to the investee bank. They can be resold at discount before maturity. NIDCs are traded on a price basis, which means that the principal value is quoted in terms of price per RM100 nominal value. Islamic negotiable instruments of deposit (INID) INID is a certificate representing a sum of money deposited by an investor with an issuing bank, which is repayable to the bearer on a specified future date at the nominal value of the instrument plus profit. It is issued 40 | Scanned with CamScanner(Churren 2: InsrruTons Avo Mares based on the mudharabah (profit sharing) principle. The investor is the rabbul mal while the mudarib is the issuing bank. Just like NIDC, INIDs are bearer instruments and are traded on the basis of price, which means that the principal value is quoted in terms of price per RM100 nominal value, Islamic accepted bill (IAB) IABis the Shariah equivalent of the conventional Banker’s Ace lance, IABisa bill of exchan; xe drawn on or drawn by a bank, payable ata specific date in the future, to evidence the debt that arises out of a trade transaction, oS So. This bills may be used as part of the trade finance facility by importers to finance their imports or purchases or exporters to finance their ex; rts cor sales. Among the conditions set by BNM for the issuance of IAB are as follows. The financing facility must be for a genuine trade, the good involved must be tangible and Shariah-comy liant, it must not involve the sellin; ol: urchasing of services, and the parties involved must both be a ‘single entity, Under the current BNM tules, the minimum denomination for an IAB is RM 50,000 and in multiples of RM1,000, Import and local purchases In import IAB, the Islamic bank will rst appoint the customer as its agent to purchase the jired asset from the exporter or seller on behalf of basis at a mark-up price with the agreement to repay based on deferred ayment, which can be up to 365 days. Upon maturity, the customer pays to the bank the cost of the goods and the bank’s profit margin. The sale of goods by the bank to its customer on a deferred basis represents debt, which is securitised in the form of a bill of exchange that is drawn by the bank on, and accepted by the customer for, the full amount of the selling price that will be paid on maturity. The Islamic bank as the drawer of IAB can hold the IAB until maturity, when it will receive the full selling price, or alternatively sell the [AB prior to its maturity at a discount to any investors using the principle of bay’ al-dayn. fi Export/local trade a After an exporter has obtained approval of his bank for export trade finance facility, and fulfilled the export documentations required under the export or sales contract, the documents are sent to the importer’s bank. The a4 Scanned with CamScanner(uuee France: Prnorurs 100 Pracnces exporter later draws on his bank a new bill of exchange as a substitution bill that represents the IAB. The acceptance by the bank indicates a promise that it will pay the full value of the bill to the bearer upon maturity. The bank then purchases the the [AB from the exporter at a discount under the principle of bay’ al-dayn. The bank can hold the [AB until maturity and receive the full selling price or it can sell the bill before maturity to a third party at discount. Sell and buy back agreement (SBBA), iy This is similar to the conventional Repurchase Agreement (Repo) but structured in Shariah-compliant way. Repo in conventional banking is an agreement under which a seller of securities sels the securities to a buyer at an agreed price and repurchases the securities from a buyer at a specified price on a future date. The difference between the repurchase price and the original sale price is the interest earned by the buyer who is also a lender, Under the Sell and Buy Back Agreement (SBBA), the transacting parties enter into two separate agreements. The first agreement is between the seller (owner) of the securities and the buyer (investor) who buys the securities at a specified price agreed upon by both parties. The second agreement is a forward purchase agreement whereby the buyer (investor) promises to sell back the securities to the original owner and the latter promises to buy it back at a specified price on a specified future date. The first contract is an outright sale and thus the securities will cease to be part of the seller’s investment portfolio. BNM requires that at least one of the parties to an SBBA transaction must be an Islamic banking institution, while the tenor for a SBBA transaction must not exceed 1 year and the minimum value must be at least RM50,000. _ Cagamas sukuk ‘Cagamas Berhad, the National Mortgage corporation, was established asa special vehicle ta mobilise low cost funds to support the national home ownership policy and tg spearhead the development of the private debt securities in Malaysia. To that end, Cagamas issued a number of Islamic fixed income securities that are traded in the money market. The securities ‘are Sanadat Mudharabah Cagamas and Sanadat Cagamas. 42 Scanned with CamScanner‘Churren 2: estmunons 100 Marecrs ganadat mudharabah Cagamas (SMC) This is an asset based sukuk issued by Cagamas Berhad under the concept of mudharabah. The main objective of this instrument is to finance the purchase of Islamic housing debts issued under the principle of BBA and the purchase of Islamic hire purchase debts issued undewr the principle of jarah thumma al-bay’. Based on the Mudharabah concept, the sukuk welder Bears any Toss That results in ¢ reduction of the value ofthe sukuk while profit is shared between the sukuk holders and Cagamas according to the agreed-on profit sharing ratio. Coupon i paid semi rede semiannually on coupon. day. the sanadats are redeemable at par on the maturity date unless there principal diminution. The maturity of sanadat can run up to 10 years. Sanadat Cagamas Sanadat Cagamas, also known as Cagamas BAIS, is another type of Islamic security issued by Cagamas to finance the purchase of Islamic housing finance debts and Islamic hire / purchase debts. This sanadat however is issued under the principle of BBA, in which the cost ofthe assets yurchased is equivalent to the par value of the sanadat and the rofit eat a pre med. is equivalentto the coupon of the sanadat. Coupons are paid semiannually while the par value is redeemable upon maturity. The tenor ofthe sanadat can be 10 years. The pricing formula for this snadat is similar tothe fixed rate GIl if the sanadat’s tenor is more than I year, white if the tenor is less than 1 year, the pricing formula will be based on NIDC, which has a tenor of more than a year. Islamic corporate Sukuk These are Shariah-compliant bonds or sukuk first introduced in malaysia in 1990 by Sarawak Shell. They can be structured based on a number of Islamic finance contracts, such as BBA, murabahah, salam, istisna, ijarah, mudharabah, Musharakah and wakalah. These sukuks can be issued on either a discounted basis or profit or rental basis. Hence the pricing formula will also be based on the type of sukuks issued. Functions of the Islamic Money Market ‘The functions of an Islamic Money Market can be divided into three main categories. The first function is liquidity management. The money market serves as an avenue for IF ls to source daily funding or to invest 43 Scanned with CamScanner(suaec France: Priors 10 Peacrices short term. Access to the money market enables IFls to maintain optima} liquidity, thereby allowing them to meet the demands of their customers at any time. This therefore allows the IFIs to cope with short term pressures that may arise. It gives flexibility tothe IFIsto face every liquidity situation that might arise due to different timing of cash inflows and outflows. Non. financial institutions use the money market to manage the fluctuations in their working capital needs, by obtaining either short term funding or placement. Consequently, they will be able to enjoy low cost funding or investment returns with low risk. The money market also serves as the avenue for secondary trading of money market instruments. Money market participants, depending on their view of rates of return, will either buy or sell money market instruments in anticipation of obtaining investment returns. The instruments available in the money market provide investors with different levels of risks, returns, and maturity. Z Finally, the money market is used as a channel for the central bank to conduct its monetary policies. ‘The central bank will use open market operations by undertaking repos and reverse repos, purchasing and selling eligible securities, and providing shor term financing directly to banks that are in a deficit sittuation. In this way, the central bank is able to manage liquidity and influence benchmark rates in the money market. Changes in the liquidity and benchmark rates in the money market will thereby influence liquidity and rates of retum in other markets. As such, the effect of amonetary policy change is first reflected in the money market, and that will ultimately lead to adjustments in other: markets such as sukuk and bond, equity, and banking systems. Whether it is conventional money market or Islamic money market, they have the same characteristics, purposes and aims. What make them differ are the instruments allowed in the Islamic money market that are restricted to certain circumstances. The Islamic money market refers to the market where the activities are carried out in ways that do not contradict with the conscience of Muslims and the religion of Islam. The Islamic money market started in Malaysia during the introduction of Islamic banking in the early 1980s. Due to this establishment, the Islamic 44 Scanned with CamScannerCChuoren 2; hesrmumons ato Marware banking system is regulated to have the following three main components: large number of Islamic financial institutions offering Islamic products, large number of Islamic financial institutions providing Islamic facilitries, and the Islamic Interbank Money Market. Malaysia has a strong Islamic banking industry, with a strong Islamic interbank money market at work. The Central Bank of Malaysia established the Islamic money market in 1994 to cater to the needs of the Islamic banks by managing their excess and deficit funds in short term investments. Mudharabah \nterbank Investment (MII) was the first instrument introduced. ‘The number of instruments developed increased from year to year to include a single or multiple Islamic contracts from mudharabah (profit and loss sharing), murabahah (matk up cost), bay bithaman ajil (deferred payment sale), bay al-dayn (sale of debt), and bay al inah. An increase in the number of money market instruments in the Islamic money market increased the Islamic bank’s exposure to a wide range of risks such as credit, operational, profitand liquidity risks. The money market where medium and short term instruments are being traded is different from the debt and capital market, which dealt with long term investments. An attempt will be made to explain the present structure of the Islamic money market system at the national level and the possible Islamic contracts used in the sale and purchase of securities in the primary and secondary interbank money markets. THE ISLAMIC CAPITAL MARKET Since the inception of Islamic finance in the 1960s, Malaysia is among the countries that have provided a wide range of Islamic financial products and activities and therefore has become the main player of Islamic finance in the world today, particularly in the Islamic Capital Market (ICM) area. These achievements cannot be separated from the role of the Malaysian government through its bodies / institutions, such as Bank Negara Malaysia (BNM), Securities Commission (SC), and Bursa Malaysia (BM). The capital markets.in Malaysia consist of conventional and Islamic. markets for medium- and long-term investments. 45 Scanned with CamScannerIsunc Faunce: Panos avo Pracnces TAKAFUL INDUSTRY The word takaful is derived from an Arabic word which means joint guarantee, whereby a group of participants agree to jointly guarantee among themselves against a defined loss. Takaful is a Shariah-compliant form of insurance, The fakafi operator is the administrator ofthe fund and manages the fund in trust on behalf of the participants, and the contract between participants and the operator is governed under the contract of Mudharabah or Wakalah. Mudharabah gives the right to the contracting parties to share profit, while liability for loses is borne by the participants; and under the Wakalah model, the takaful operators eam a fee for services rendered while liability for losses is borne by participants. The fee may vary based on the performance of the takafull operator. It can be a fixed amount or based on an agreed ratio of investments profit or surplus of the takaful funds. Mudharabah Model Under the mudharabah contract, the takaful operator acts as the ‘mudarib (entrepreneur) and the participants as rabbul mal (capital providers). The contract specifies how the surplus from the takafuul operations is to be shared between the fakaful operator and the participants. Losses are borne by the participants or capital providers. Wakalah Model The wakalah concept is essentially an agent-principal relationship, where the sakaful operator acts as an agent on behalf of the participants and eamsa fee for services rendered. The fee can be a fixed amount or based on an agreed ratio of investment profit or surplus of the takafiul funds. There are a number of significant differences between takafil and conventional insurance companies. Takaful companies not only follow the principles of Shariah, but also have distinctive features compared to conventional companies. The following is a comparison between fakaful and conventional insurance companies: 64 Scanned with CamScanner(Charter 2: besrmmons avo MARETS Table 2.3: Takaful vs Conventional Insurance ‘Takaful Companies eae ae Conventional Insurance Companies ag ese SWORE Te RIED Sag ear “Takafulis based on mutual cooperation. ‘akaful is free from interest (riba), gambling (maysir) and uncertainty (gharar) ‘Allorpart of the contribution paid by the participant is a donation to the Takaful Fund, which helps other participants by providing protection against potential risks. ‘Takaful companies are subject to the governing law as well as a Shariah Supervisory Board, ‘There is a full segregation between the participants Takaful Fund account and the shareholders’ accounts. ‘Any surplus in the Takaful Fund is shared among participants only, and the investment profits are distributed ‘among participants and shareholders ‘onthe basis of Mudharabah or Wakalah models. In case of the deficit of a participants’ Takaful Fund, the takaful operator (wakeel) provides free interest loan (gard hasan) to the participants. The plan owners’ and shareholders’ capital is invested in investment funds that are Shariah-compliant. Takaful companies have re-insurance with Re-Takaful companies or with conventional re-insurance companies that adhere to certain conditions of Shariah. Conventional insurance is based solely ‘on commercial factors. Conventional insurance includes elements of interest, gambling and uncertainty. The premium is paid to conventional insurance companies and is owned by them in exchange for bearing all expected risks. Conventional companies are only subject to the governing laws. Premium paid by the policyholder is Considered as income to the company, belonging tothe shareholders. Al surpluses and profits belong to the shareholders only. In case of deficit, the conventional insurance company covers the risks. The capital ofthe premium is invested in funds and investment channels that are not necessarily Shariah-compliant, Conventional insurance companies do not necessarily have re-insurance with re-insurance companies that abide by Shariah principles. 65 Scanned with CamScanner‘suunc Faunce: Prncrues avo Pracrices OTHER ISLAMIC FINANCIAL INSTITUTIONS Other than the Islamic banking institutions presently available in Malays there are other non-bank Islamic financial institutions which contribute * the development of the Islamic Financial System in Malaysia, Islamic Development Bank (IDB) IDB is an international financial institution established in pursuance of the Declaration of intent issued by the Conference of Finance Ministers ‘of Muslim Countries held in Jeddah in Dhul Q’adah 1393H, corresponding to December 1973. The Inaugural Meeting of the Board of Govemors took place in Rajab 1395H, ‘corresponding to July 1975, and the Bank was formally opened on 15 Shawwal 1395H corresponding to October 1975, “The functions ofthe Bank are to participate in equity capital and grant loans for productive projects and enterprise besides providing financial assistance to member countries in other forms for economic and social development. The Bank is also required to establish and operate special funds for specific purposes including a fund for assistance to Muslim ‘communities in non-member countries, in addition to setting up trust funds, The Bank is authorized to accept deposits and to mobilise financial resources through Shariah compatible modes, It is also charged with the responsibility of assisting in the promotion of foreign trade especially in capital goods, among member countries; providing technical assistance to member countries; and extending training facilities for personnel engaged ~ in development activities in Muslim countries to conform to the Shariah, Example of its responsibilities are to participate in equity and grant loans forproductve projects, to provide financial assistance to member countries for economic and social development also to provide technical assistance to member countries. Venture Capital Companies ‘Venture capital is a type of private equity capital typically provided to immature, high-potential and growth companies. Venture capital investments are generally madeas cash in exchange for shares inthe invested company, VC typically comes from institutional investors and high net worth 66 Scanned with CamScanner(Chapter 2: hesrmunons a0 Maret individuals and is pooled together by dedicated investment firms. In the Islamic Financial Industry, the investment made by the VC companies must be limited to business activities that are Shariah-complaint. Some examples of VC companies are BIMB Venture Capital Sdn. Bhd, FIRSTFLOOR Capital Sdn. Bhd, MIDF AMANAH Venture Sdn. Bhd and others. Development Financial Institutions and Cooperatives Banks Development financial institutions (DFls) are specialised financial institutions established by the Government as part of an overall strategy to develop and promote specific strategic sectors, such as agriculture, small and medium enterprise (SMEs), infrastructure development, shipping and tc. Development Financial Institutions Act 2002 (DFIA) came effective on 15* February 2002. The DFIA aims to ensure effective and dynamic supervision of DFls, and provides the appointment of Bank Negara Malaysia as the central regulatory and supervisory body for the DFls. Examples of DFis are Bank Pembangunan Malaysia Berhad, Export-Import Bank Of Malaysia Berhad, Bank Simpanan Nasional, Lembaga Tabung Haji, Bank Pertanian Malaysia Berhad (Agrobank) and etc. NEW DIRECTIONS FOR ISLAMIC FINANCIAL SYSTEM So far, the Islamic financial system has been concentrated on debt financing, neglecting equity financing which is more appealing for the development of the Islamic financial system as the conventional banks may be unwilling or unable to undertake this type of financing. Equity financing is best represented by both mudharabah and Musharakah contracts of partnership. The reluctance of the modem Islamic financial system is likely caused by a few reasons which are interrelated and subsequently render the Islamic financing based on equity financing less popular. The first reason undoubtedly is due to the high risk which both mudharabah and Musharakah are exposed to. Although both the conventional and Islamic financial system runs alongside each other, serving the needs of their customers, their concept in the financial world is transparently different as most of the conventional menthods in the financial world goes against the Islamic teachings such as Scanned with CamScannerJsuanc France: PRNCILES AND PRACTICES the practising of Riba, and the involvement of gharar, while the Islamic financial system serves to follow the Shariah law and thus, using the Islamic teachings, does not practise Riba or gharar. This difference between the two financial systems would act as a guid for customers to pick the financial system which will be best for them, in practicality and spirituality ‘Though both financial systems are universal, making them available for everyone regardless of their religion, the Muslims would surely opt for the Islamic financial system in the hope to follow the Shariah law as best as they can while the Non-Muslims may choose either depending on the rate of return they may get from either the two financial systems or which industry they'd like to invest in. Undeniably, the Islamic Financial Services Board (IFSB) has helped create awareness amongst consumers in the significance of Islamic Finance and the issues that may have an impact on the Islamic financial services industry. This has helped to encourage more investments in the Islamic financial system by investors and build consumers’ trust in the system. The role of the Islamic Banking and Finance Institutions situated in Malaysia, abbreviated as IBFIM, should also be noted as its continous effort in producing well-trained, high competent personnel and executives with the required talent in the Islamic finance industry has helped shaped the development ofthe Islamic Financial System and also its future, QUESTIONS TO CHECK YOUR UNDERSTANDING OF THIS CHAPTER: 1. Is ICM in Malaysia complete in terms of realising the Magasid aspect? Relate your answer to the two elements that Islamic financial institutions must have in its implementation. 2. Ifyou look at the Islamic institutions (financial and non-financial) in the financial system of Malaysia, with regards to their mushrooming, have quantity downplay quality? Relate your answer to supporting mechanisms like government intervention, legislation and so on. aa Scanned with CamScanner