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Title: The Reason of Growth of Islamic Bank in Malaysia

Literature Review

1. Introduction

Islamic banking refers to a banking activity or a system of banking that consistent

with the principles of Islamic law (Shariah) and guided by Islamic economics. Islamic
banking known as interest free banking system as the Shariah prohibits acceptance of
interest or fees for loans of money (riba). In Islamic banking system, a business that offers
good interest rates or services is considered unlawful or haraam (Banking, 2009).

The first model of Islamic banking system can be traced back to Egypt in 1963
which the chief founder of this bank was Ahmad Al Najiar (Islamicity.com, 2014). The
main characteristics of Islamic banking are profit sharing on the non-interest based
philosophy of the Islamic Shariah. The first Islamic bank called the Islamic Developme nt
Bank (IDB) was created by the Organization of Islamic Countries (OIC) in 1974. By the
end of 1970, a few number of Islamic banking systems have been created throughout the
Muslim world which were including the first private commercial bank in Dubai (1975),
Faisal Islamic bank of Sudan (1977) and Bahrain Islamic bank (1979) resulted in
unexpectedly high profits, however, the high demand from Muslim customers were still
unfulfilled. The growing of Islamic banking concentrated in two markets included Bahrain
in the Middle East and Malaysia in South East Asia. These countries were the major Islamic
banking hubs of the world until today as the big Islamic investments still coming in from
all over the world (Perry & Rehman, 2011).

Bank Islamic Malaysia Berhad (BIMB) was the first Islamic bank in Malaysia
which was established in 1983 under the Islamic banking Act. Currently, Malaysia is
having a significant number of Islamic banking institutions which was including full-
fledged Islamic banks, Islamic banking window and Islamic banking subsidiaries. A rapid
growth in the Islamic finance industry in Malaysia has created competition among industry
players, ultimately affected the structures of Islamic banking products, services and
activities (Bahari, 2009).

The main purpose of this study is to review the various aspect of Islamic Banking.
For instance, it's important to identify the factor of growth of Islamic Banking within
Malaysia and assess their viability and applicability in respect to individual and corporate
consumers. More specifically, analysis the history and development of Islamic Banking in
the Malaysia. Furthermore, in order to determine the corporate and individual of a
particular consumer towards Islamic Banking. It is crucial to indicate the enthusiastic of
potential clients for a new product.

2. Study of Variables

2.1 Religion Variables

Malaysia is a multicultural ethnic country but Islam is the official religion of

Malaysia. According to The Star (2014) stated that Bumiputras make up 67.4% of the
population, Chinese (24.6%), Indians (7.3%), with other races making up the remaining
0.7%. Therefore, there is an opportunity that religious belief plays an important role in the
banking decision of customers in Malaysia.
 The research regarding the impact of selected economic variables on deposits level
in the Islamic and conventional banking systems in Malaysia conducted by Haron and Wan
Azmi (2008). This study was applying the cointegration and error correction framework.
The results showed that the savings behavior theories are applicable to customers of
conventional system. In contrast, the Islamic banking customers behave in nonconfor mity
with most of these theories. Therefore, it is a possibility that religious belief plays an
important role in the banking decisions of Muslim customers

Study of Radiah, A.K. (1993) examined that there are two types of depositors
among local Muslims in Malaysia. The first type of depositors indicates people who strictly
follow the religion in life and stick with Islamic banking at any cost while the second type
of depositors are those who gives more priority to quality of service and time value of the
savings. The factors that support the use of Islamic banking in Malaysia included profits
and religion. This point was supported by Haron and Planisek (1994) as well. They studied
that 40% of the Muslim customers give preferences to Islamic banking while the remaining
majority including non-Muslim customers believed the time value is more important. They
pay more attention to the efficiency of banking transactions

The studies of Metawa and Almossawi (1998) found that customers of Bahrain
Islamic Bank and Faisal Islamic Bank of Bahrain believed Islamic principle is the main
factor while choosing Islamic banks. The second important factor was the banks extended
reward, the next would be the influence of family, friends and convenient location. This
study also showed that socio-demographic factors were influence the criteria in bank
selection such as gender, age, income and education.

Gerrad and Cunningham (1997) investigated that the main reason for Muslims
holding a relationship with Islamic banking in Singapore which are religion and profits.
Based on the demography survey indicated there are 61.70% of the Muslims customers
would hold their accounts with Islamic banking even if the Islamic banks not succeed to
generate desirable profit in a year. However, non -Muslims customers are more preferences
to higher rate of return in instead of holding the Islamic account.

2.2 Bank Features

 According to Erol and EL-Bdour (1989) and Edris and Almahmeed (1997), their
finding suggest the opposite. They found that the customers dealing with Islamic banks
based on the provision of efficient services, reputation of the banks and bank
confidentiality in Jordan. The religious motive is not a most important consideration among
the customers to support the Islamic banks. In addition, study of Metawa and Almossawi
(1998), Almossawi (2001) also mentioned that the factors which influence preference of
customers selection in Bahrain included image, friendliness of bank's personnel,
availability of parking space near the bank and availability of ATM. Young generation are
more concerned about technology as a factor while selecting a banks. For an example
online banking services (Poon, 2008). Primary source of competition is expected from
commercial banks, with the second level of competition being from Islamic banking
industries. Therefore, the brand planning of Islamic banks should be concerned in their
capability to expand viable gains and institute a strong brand image.

The study of selection criteria of Muslim and non-Muslim customers in patronizing

a particular bank in Malaysia was conducted by Haron, Ahmad and Planisek (1994). The
study found that there are three most important criteria perceived by Muslims and non-
Muslims in Malaysia were the provision of a fast and efficient service, the speed of
transaction and friendly bank personnel. The analysis from the data collection indicated
there are 80 per cent of Muslims and 53 per cent of non Muslims respondents would
consider establishing a relationship with an Islamic bank if they had a knowledge of this
new system. Therefore, Islamic bank should not over confidence or rely on the religio n
factor as a marketing strategy in its effort to attract more customers. The studies by Karim
and Afiff (2006) and Rohmah (2006) on Indonesia and Dusuki and Abdullah (2007) on
Malaysia, both agreed that religiosity is not the main factor for people to patronize Islamic
banks.

The study of selection criteria factors for Islamic home financing carry out by
Hamid and Masood (2011). The research found that sharia abidance is the most essential
factor for customers. In Pakistan, sharia abidance for choosing an Islamic bank is the top
priority for the people. In the full of competition of bank industries, efficient services is
one of the important factors as customers prefer good quality services as fast as possible in
a least time. The research also found that, the another factor for Islamic home financing is
price which are lower monthly cost and lower service cost. Bank reputation also plays a
significant role in determining customers' choice of preference. By using an independent
sample t-test, the results showed that there was a statistical different in loan amounts and
profit on gender, occupation, age groups and income level when selecting an Islamic bank.

A research in Indonesia during the year 2000 to 2005, Bank Indonesia (BI) and
Department of Statistics of Bogor Agricultural University (IPB) carry out a survey for West,
Central, and East Java respectively as well as West Sumatera and South Kalimantan. The
results indicated quality of service and convenience level of the bank are the main factors
in patronizing Islamic banks instead of religiosity. This implication showed that not most
of Muslims customers would select Islamic banks as their priority (BI and IPB, 2000).

2.3 Interest and Profit Rate

The research about Bank Islam Malaysia over the year 1983-1993 discovered by
Haron and Shanmugam (1995). The study was using the models of simple correlation
coefficient and autoregressive to look into the relationship between the rates of return
offered by Bank Islam Malaysia and the level of deposit in the bank. The result found that
there is a negative relationship between the variables. That means the customers of Islamic
bank did not care about returns from the Islamic deposit as an incentive to maintain funds
with the banks. The further study of Haron and Ahmad (2000) which include all funds
deposited in Islamic banks in Malaysia from 1994-1998. The result showed that the interest
rate have negative relationship with Islamic bank deposits while the rate of profit have
positive relationship with it. This research conclude that customers of Islamic banks in
Malaysia are concerned to higher return and guided by earnings motive. This conclusio n
indicated the same result with researchers of Sukmana and Yusof (2000) as well.

2.4 Risk Level

The study about Bank Islam performance of risk from 1984 to 1997 in Malaysia
published by Samad and Hasan (1999). This research was using the debt-equity ratio
(DER), debt to total asset (DTAR) and earning multiplier (EM). The result reveals that
Bank Islam have lower risk compared with another two conventional banks; Bank
Pertanian and Perwira Affin Bank. The reason for low risk of the Islamic bank is that its
investment in government securities is much larger than the conventional banks as
government securities is considered risk-free. Therefore, investors prefer products from
Islamic banking rather than conventional banks as a safer investment.

How, Karim & Verhoeven (2005) study of comparative credit risk in Islamic and
conventional banks to analysis three important bank risks which are credit risk, interest rate
risk and liquidity risk by using Malaysia data. The research reveals that Islamic banks have
lower credit risk compared to conventional banks. Due to the Shariah principle, Islamic
banks can share their losses with the depositors through the profit-and-loss sharing model,
this model is not exist in conventional bank. Besides, the credit risk is lower as religio us ly
factors involve due to Islamic banks run their business based on Shariah. Default might be
less while religiously motivated involved in Islamic Banking, the investors may take into
account of credit risk as one of the components when they are selecting neither Islamic
banks nor conventional banks.

3. Conclusion

In conclusion, the empirical evidences discussed above suggest that determina nts
of preference towards Islamic bank in Malaysia is not only affected by religion even though
it is a Islam country. Those variables discussed at above will take into account as a criteria
of bank selection. The study discovered by Metawa and Mossawi (1998), Haron and Wan
Azmi (2008) mentioned that religiosity is the most important factor as the criteria of bank
selection. However, few studied such as Erol and EL-Bdour (1989), Edris and Almahmeed
(1997) reveal that religiosity gives affect though in a low level compared to other factors
like profitability and services on individual's decision to patronize Islamic banks.
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