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CONTENTS
Introduction History and Development Laws and Regulations Accounting Policies Products and Services Performance of the Islamic Banking System Public Acceptance Towards Islamic Banking System Future Directions
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1. INTRODUCTION
The Islamic banking system in Malaysia is regarded as more progressive and robust as opposed to similar banking system in other Muslim countries. Malaysia is now recognised as the pioneer and at the forefront in Islamic banking and finance. At present, Malaysia surpasses other Muslim countries in terms of market infrastructure owing to the unwavering support by the government in providing the impetus for growth of the local Islamic financial services industry. The system has transformed from a humble beginning in 1983 to a vibrant and dynamic system that is able to fulfil the banking needs of Muslims and non-Muslims. The well-planned and coordinated effort between the Malaysian government and the industry players is the most important ingredient to the success story of the Islamic banking system in Malaysia. Today, the Islamic banking in Malaysia runs parallel to the conventional banking and provides depositors with an alternative banking philosophy that is rapidly gaining acceptance from both Muslims and non-Muslims. The Islamic banking sector in Malaysia has been growing at a healthy pace even before the influx of foreign investment. Under the Financial Sector Masterplan of 2001, he industrys assets have been increasing at a rate of 19% over tha past five years. The islamic banking sector has now assets of about RM122 billion. This accounts for about 12% of the total assets in the overall banking system.
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First formal request was made during the Bumiputera Economic Congress in 1980.
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Islamic Banking Act of 1983 was gazetted in March 1983 and came into effect in April, 1983. This paved the way for the establishment of an Islamic banking system in Malaysia. Subsequently, the first Islamic bank, Bank Islamic Malaysia Berhad (BIMB) was incorporated on March 1, 1983 and commenced operations on July 1, of the same year. This marked the beginning of the governments commitment towards the development of a comprehensive Islamic financial system in Malaysia.
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had and Commerce Asset-Holding Berhad in February 1999. Under the merger arrangement, the Islamic banking assets and liabilities of Bumiputra-Commerce Bank Berhad (BCBB), Bank Bumiputra Malaysia Berhad (BBMB) and BBMB Kewangan Berhad were transferred to BMMB. At the same time the conventional operations of BBMB, BCBB and BBMB Kewangan Berhad were transferred to BCBB accordingly. The BMMB had an initial shareholders fund of RM300 million, assets of RM2.5 billion and a network of 40 branches.
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Bank, RUSD Investment Bank Inc., and Global Investment House. Kuwait Finance House started its operations in August 2005. The second foreign Islamic bank was the Al-Rajhi Bank which was established in January 2007 and the third Islamic foreign bank to set up in Malaysia in March 2007 was the Asian Finance Bank (AFB). The AFB bank is a joint venture between Qatar Islamic Bank, RUSD Investment Bank Inc. of Saudi Arabia and Kuwaits Global Investment House. In concurrent with the progressive liberalisation of the Islamic banking industry, several strategic initiatives were undertaken to further strengthen both the institutional capacity as well as the financial resilience of the domestic Islamic banking institutions. In this regard, the government approved that the seven domestic banking groups transform their current Islamic window institutional structure into an Islamic Subsidiary (IS) within their respective banking groups. This strategic move is in line with the recommendations of the Financial Sector Masterplan (FSMP) to further strengthen the institutional structure of the banking institutions participating in the IBS. Under this new structure, Islamic banking subsidiaries are now governed under the Islamic Banking Act 1983 instead of BAFIA 1992; and thus, removing most of the impediments that had prevented Islamic windows in participating in non-traditional banking business such as wholesale and retail trading, purchase of assets and landed properties as well as purchases of equities via joint-venture and portfolio investments. Nonetheless, this transformation of Islamic banking windows into Islamic banking subsidiaries is not made mandatory by Bank Negara Malaysia. In addition, the new IS structure provides the opportunity to potential domestic and international investors to participate in the Islamic financial activities through direct equity participation. A more liberalised policy under the IS structure currently allows foreign participation in Islamic subsidiaries of up to 49% of total equity. The transformation from Islamic windows to Islamic subsidiaries is seen as a positive step in creating greater potential to tap regional as well as international business opportunities and further enhance the global integration of the domestic Islamic banking industry. Consequently, help boost Malaysia to the forefront of Islamic banking and finance. Presently, there are a total of 11 Islamic banks comprising six Islamic subsidiaries, two domestic Islamic banks and three new foreign Islamic banks.
Further Progress
The Islamic banking industry in Malaysia has experienced rapid transformations predominantly in the past ten years. The Malaysian Islamic banking system has continued to register strong performance with higher profitability and positive trends in all key indicators. Nonetheless, the global financial landscape has witnessed tremendous changes due to globalisa-
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tion and advancement in ICT. Against this backdrop, the government launched the Malaysia International Islamic Financial Centre or MIFC on 14th August 2006. This recent initiative by the government marked the new era for the future Islamic finance landscape in Malaysia. The MIFC initiative is specifically undertaken by the collective efforts of the countrys financial and market regulators, including Bank Negara Malaysia, Securities Commission, Labuan Offshore Financial Services Authority (LOFSA) and Bursa Malaysia, together with the participation of the industry representing the banking, takaful and capital market in Malaysia. Under the MIFC initiatives, several measure and incentives will be put in place to promote this financial centre in the offering of Islamic financial products and services by a diversified range of financial institutions in international currencies to the international and domestic financial community. Some of the key measure and incentives that were introduced in 2006 include are: Malaysian Islamic banks and takaful operators that are offering Islamic financial services in international currencies have been granted approval under the existing licence to set up an International Currency Business Units (ICBU) within the institutions. These new divisions will have their own accounts separate from the ringgit transactions of the head offices, while at the same time sharing the same infrastructure with the head offices. Incentives that have been granted to the ICBUs are a tax holiday for 10 years under the Income Tax Act 1967 starting from the year of assessment 2007 and these International entities will also be able to participate via foreign interest of up to 49 percent in Islamic banks. A new category of licences known as International Islamic Banks (IIB) under the Islamic Banking Act 1983 were issued to qualified foreign and Malaysian financial institutions to conduct business in international currencies. The IIB can either be a branch or a subsidiary of the parent financial institution can enjoy the same tax incentives as those accorded to the ICBU. In term of business operations, the licensed International Islamic bank would be allowed to undertake a wide-range of business of Islamic commercial banking, Islamic investment banking and Islamic leasing in international currency. The Central Bank also issued new registrations under the Takaful Act 1984 to qualified foreign and Malaysian insurance companies to conduct the full range of takaful business in international currencies. Similar tax treatment is also be accorded to these entities as that for the IIBs. Labuan offshore Islamic banks and the Islamic divisions of the offshore banks as well as offshore takaful operators were granted approval to establish operational offices anywhere in Malaysia with no limitation on staffing and to conduct non-ringgit business while maintaining their presence in Labuan. The MIFC Executive Committee was set up in August 2006 as a single
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coordinating committee to efficiently and effectively act collectively in the implementation of the MIFC recommendations. The Committee is chaired by the Governor of Bank Negara Malaysia with members comprising heads of relevant Ministries, Government departments, agencies, financial and market regulators and industry representatives. The Committee is entrusted to provide direction as well as review existing policies for the comprehensive and coordinated promotion of MIFC, and to align the role and responsibilities of the respective parts of Government and the industry to the development of MIFC. These measures and initiatives will serve as a catalyst in the governments effort to promote Malaysia as the centre of origination, issuance and trading of Islamic capital market and treasury instruments, Islamic fund and wealth management, international currency Islamic financial services, and takaful and retakaful business.
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of banks). PART V: RESTRICTIONS ON BUSINESS (Sections 24 to 30) (Restrictions on payment of dividends and grant of advances and loans; prohibition of loans to directors, officers and employees; restriction on grant loans, advances or credit facility to directors, officers and employees; restriction of credit to single customer; disclosure of interests by directors, limitation on credit facility for purpose of financing the purchase or holding of shares, and proof of compliance to all restrictions and prohibitions). PART VI: POWERS OF SUPERVISION AND CONTROL OVER ISLAMIC BANKS (Sections 31 to 43) (Investigation of banks, special investigation of production of banks books and documents, banking secrecy, action to be taken if advances are against interests of depositors, bank unable to meet obligations to inform Central Bank, action by Central Bank if bank is unable to meet obligations of conducting business to the detriment of depositors, effect of removal of office of director or appointment of a director of a bank by the Central Bank, control of Islamic bank by Central Bank, Islamic bank under control of Central Bank to cooperate with Central Bank, extension of jurisdiction to subsidiaries of banks, moratorium, and amendment of banks constitution). PART VII: MISCELLANEOUS (Sections 44 to 56) (Indemnity, priority of sight and savings account liabilities; penalties on directors and managers; offences by directors, employees and agents; offences by companies and by servants and agents; prohibition on receipt of commission by staff, general penalty, power of Governor to compound; consent of the Public Prosecutor; regulation; bank holidays; applications of other laws; and exemption). PART VIII: CONSEQUENTIAL AMENDMENTS (Sections 57 to 60) (Amendment of Banking Act 1973, amendment of Companies Act 1965, amendment of Central Bank of Malaysia Ordinance 1958, and amendment of Finance Companies Act 1969).
As for conventional banks operating Islamic windows, these financial institutions are governed under BAFIA. Section 32 of BAFIA 1993 with amendments states that the permissible activities must be conducted based on profit margin and not conducted on interest basis. In addition, Section 124 of BAFIA amended in 1996 further states that any conventional banks wanting to carry out Islamic banking business must obtain approval from the Central Bank. Apart from the IBA, the government also introduced the Government Investment Act 1983. With the passing of this Act, the government was now able to raise funds through the issuance of a non-interest bearing certificates known as the Government Investment Issues (GII). The GII are basically government bonds issued in accordance to Islamic principles and thus, confirm to the liquidity requirements of the Islamic banks.
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The primary reason for the introduction of a Shariah-compliant GII is to enable Islamic bank to hold first class liquid assets instruments to meet its statutory liquidity requirements as well as for investments. In the attempt to further strengthen the legal framework governing Islamic financial institutions, the Government Investment Act 1983 was amended in June 2005 and renamed as the Government Funding Act 1983. This essentially allowed the government to issue a wider range of Islamic securities as the new amended act accorded greater flexibility for the government to source funds from the capital market through the issuance of leased-based and asset-based Islamic financial instruments. However, with the growing significance of the Islamic banking industry requires, a more effective regulatory framework needs to be developed in order to provide the enabling environment to support the development of the industry. Recognising this, BNM had introduced several measures to create an effective and efficient regulatory framework. In 2003, BNM reviewed the Framework of the Rate of Return with the intention to further strengthen the methodology for deriving the rate of return to depositors. The revised framework is to provide a standardised approach in the derivation of the rates of return to depositors and a standard methodology on the calculation of the distributable profits. Previously, Islamic banking institutions adopted various methods in deriving the rates of return which led to large variations in the results and implications. Thus, the introduction of the new framework will effectively address the information asymmetry between Islamic banking institutions and depositors. A guideline on the issuance of credit card based on Shariah principles was issued by BNM in 2004. The guideline known as Credit Card-i Guideline is an extension of the Credit Card Guideline issued to the conventional banks in March 2003. Under this new Guideline, the credit card-i can either apply the Shariah concept of bai inah (sell and buy back arrangement) or bai bithaman ajil (deferred payment sale). Under the bai inah concept, the fund for the cardholders spending limit is created upon the bank buying back the asset from the cardholder for cash on the assets which the bank had previously sold to the cardholder on deferred terms. Under the bai bithaman ajil concept, the fund is created upon the bank buying the asset from the cardholder for cash which will be sold back to them on deferred basis. Islamic banks are also required to observe the Basel Capital Accord in maintaining a minimum risk-weighted capital ratio (RWCR) of 8% and a minimum core capital ratio of 4%. As for the IBS banks, they must observe the compliance to the RWCR framework for the Islamic banking portfolio in addition to the compliance on a consolidated basis.
The Central Bank reviewed the Framework of the Rate of Return in 2003.
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The Market Risk Capital Adequacy Framework for Islamic banks was issued by BNM in September 2004. It sets out the approach in determining the level of capital to be held by the Islamic banks against their market risk, which is defined as the risk of losses in on- and off-balance sheet positions arising from movements in market prices. Another important aspect in the development of the Islamic institutional financial infrastructure is the enhancement of risk management capabilities of the Islamic banking institutions. To this end, several initiatives had been implemented. For example, a variable rate financing product under the concept of bai bithaman ajil (deferred payment sale) was introduced in 2003. This instrument enables Islamic financial institutions to diversify their financing portfolio from over-reliance on fixed-rate financing. Under the fixed-rate regime, Islamic financial institutions faced a funding mismatch because their long-term financing was funded by short-term bank deposits. In the 2005 Budget, tax neutrality policy for Islamic baking and finance was announced. As such, since Islamic banks locked in their profit rates for the financing over a long-period, any upward movement in the market rates would result in the Islamic banking institutions finding it difficult to give a satisfactory return to their depositors. Hence, the variable rate financing was designed to mitigate the risk associated with funding mismatch by allowing Islamic financial institutions to vary the profit rate for the financing in order to raise the deposit rates. So as to complement the bai bithaman ajil (BBA) floating rate financing mechanism, another variable rate financing product based on the concept of ijarah muntahia bittamleek (leasing ending with ownership) is being explored. Additional measures were also introduced by BNM in 2005 to further strengthen the risk management of the conventional banking institutions operating under the IBS. These measures included a separate compliance on the single customer limit for financing facilities based on the capital funds of the Islamic banking portfolio, a separate compliance on the new liquidity framework and statutory reserves requirement for the Islamic banking portfolio and the apportionment of overhead costs and other expenditure incurred in managing the Islamic banking portfolio. In the 2005 Budget, the government announced a tax neutrality policy for Islamic banking and finance with the aim of creating an equitable tax treatment of Islamic banking and financial transactions vis--vis similar conventional banking transactions. Under this tax neutrality framework, exemption is given to additional instruments and transactions executed to fulfil Shariah requirement from additional stamp duty and tax payment. Hence, subsequent amendments were made to the Income Tax Act 1967, Real Property Gains Tax Act 1976 and Stamp Duty Act 1949.
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for validating all Islamic banking and takaful products to ensure their compatibility with the Shariah principles. The Shariah bodies of Islamic banks and IBS bank operate independently of one other and thus, resulted in divergence of Shariah interpretations on similar matters. In order to have an effective Shariah framework that ensures uniformity and harmonisation of Shariah interpretations, BNM issued the Guidelines on the Governance of Shariah Committee for the Islamic Financial Institutions in December 2004 to rationalise and streamline the functions and duties of Shariah bodies of the financial institutions. So as to enhance the role and functions of SAC, the Central Bank of Malaysia Act 1985 was amended by BNM in 2003. With the enactment of the Act, SAC is now the sole authority on all Shariah matter related to Islamic banking and finance. Thus, SAC now serves as the reference point for the court or arbitrator in any dispute resolution which involves Shariah issues on Islamic banking and finance cases. The Guidelines also set out the rules, regulations and procedures in the establishment of a Shariah Committees of Islamic banks and IBS banks. It also spells out the role, scope of duties and responsibilities of the Committee together with the working arrangement between the Committee and the SAC. A significant development with regard to legal infrastructure was the establishment of a dedicated High Court to adjudicate all muamalat cases in the Commercial Division of High Court Kuala Lumpur. In this regard, the Chief Judge Malaya issued a directive (Practice Direction No. 1 of 2003) to all legal practitioners in the country to register Islamic banking and finance cases at both the High Courts and the Lower Courts by means of a special code number. The set up of the dedicated High Court for Islamic banking and finance will aid in expediting the hearing of cases related to Islamic banking and finance and create grater public confidence in Islamic banking system.
Guidelines on the Governance of Shariah Committee was introduced to promote uniformity and harmonisation of Shariah interpretations.
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4. ACCOUNTING POLICIES
Financial statements for Islamic financial institutions are prepared in accordance with the provision of the Companies Act, 1965; Bank Negara Malaysia (BNM) Guidelines, applicable Malaysian Accounting Standards Board (MASB) Approved Accounting Standards and Shariah requirements. In August 2003, BNM issued Guidelines on the Specimen Reports and Financial Statements for Licensed Islamic Banks (GP8-i). Its objective is to promote consistency and standardization amongst the Islamic banks in complying with the provisions of the IBA and approved accounting standards of the MASB as well as the Shariah requirements. The Guidelines prescribed the minimum requirements of the financial statements that the Islamic banks need to disclose with the provisions of the Islamic Banking Act 1983, Companies Act 1965, Shariah requirements and other BNM guidelines. Prior to the issuance of the GP8-i, Islamic banks observed the various provisions of the Companies Act 1965, the applicable accounting standards and the Guidelines on the Specimen Financial Statement for the Banking Industry (GP8). The GP8 was formulated to facilitate the conventional banking operations. Amongst the salient features of the GP8-i are: 1. Performance Overview and Statement of Corporate Governance In order to promote good corporate governance, Islamic banks are required to report their performance overview and corporate governance practices. The performance overview requires Islamic banks to disclose their review on performance, measures, business plans and strategies. Meanwhile, the statement of corporate governance compels Islamic banks, among others, to disclose the composition and responsibilities of the Board, internal audit and control activities and risk management strategies and policies. Both the performance overview report and the statement of corporate government provide important additional information to users in evaluating the performance and conduct of Islamic banks. 2. Disclosure of Shariah Advisory Board/Committee and Zakat obligations Islamic banks are required to disclose the functions and duties of their Shariah advisory board or committee in monitoring the activities pertaining to Shariah matters under the Directors Report. With regard to the zakat obligations disclosure, Islamic banks are required to disclose the responsibility towards payment of zakat either on the business or shareholders or on behalf of depositors. 3. Report of the Shariah Advisory Board/Committee Islamic banks are required to report the conformity of their operations with the Shariah principles under the Report of the Shariah Advisory Board/Committee. Similar to the Auditors Report, the Report is expected to enhance the credibility of Islamic banks operation in complying with Shariah principles. 4. Profit Equalisation Reserves (PER) PER is a mechanism introduced in the Framework of the Rate of Re-
GP8-i was issued to promote consistency and standardization amongst Islamic banks in complying with the provisions of the IBA and approved accounting standards of the MASB as well as the Shariah requirements.
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turn. Disclosure of PER would reflect the capability of Islamic banks in managing the level of profit distribution to the mudarabah depositors. Islamic banks are also required to disclose their policy on PER as well as its movement (provision and write-back) during the financial year. 5. Classification of Deposits from Customers and Placements from Banks and Other Financial Institutions Islamic banks are required to disclose their deposits into two categories, i.e. mudarabah and non-mudarabah deposits. Such disclosure provides additional information on the risk profile of Islamic banks deposits portfolio. 6. Presentation of the Income Statement Presentation of the Income Statement of Islamic banks is structured to reflect the nature of the Islamic banking operation, primarily on the application of mudarabah concept concerning deposit-taking activities. The statement discloses the incomes and expenses that are either shared by the bank and depositors or fully belonged to the bank.
Another development in the accounting standards for Islamic financial business, the Malaysian Accounting Standards Board (MASB) has also embarked on the preparation of standards on leasing (ijarah), deferred payment sale (bai bithaman ajil) and cost-plus (murabahah) in relation to the recognition, measurement and disclosure of these Islamic financial transactions.
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There are more than 40 Islamic products and services offered by financial institutions.
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Demand deposit facility is widely known as current account and is designed for those who need money for transaction purposes, i.e. for convenience or to make payment for daily commitments. Demand deposit facilities may be opened for various types of customers such as individuals, joint individuals, business organisations which include sole proprietorship, partnership and companied and other legal entities such as societies Generally, there are two types of Shariah principles, that is wadiah and qard hassan which are used by Islamic banks in providing this facility. In Malaysia, demand deposits are operated on the Shariah principle of wadiah yad dhamanah or guaranteed custody. The second category of deposits is the savings account. Three Shariah principles are used Islamic banks for savings accounts, namely, qard hassan, wadiah and mudarabah. The principle of wadiah yad dhamanah is used by banks in Malaysia. Under this principle, customers are not entitled for any kind of rewards, but banks do provide rewards to their savings account customers. In Malaysia, the reward for saving account holders is usually in the form of rates of profit announced by the bank on a monthly basis. The third category of deposit facility is for those who keep money for investment motives. Customers who have idle funds usually want better returns. These customers normally prefer to place this money in the fixed deposit facilities. In the Islamic banking system, this facility is known as investment deposit. Investment deposits available at Islamic banks are governed by the principle of mudarabah. Within this context, Islamic banks act as entrepreneurs or managers and depositors become investors. The bank would provide no guarantee or no fixed return on the amount deposited and under the principle of mudarabah, the customers will share the profits or losses made by the bank. The agreement on how the profit or loss will be distributed between the bank and the depositor is made at the beginning of the deposit and cannot be amended during the tenure of the deposits, except by consent of both parties. Total deposits in the Islamic banking systen grew 18.2% in 2006. Table 3 and Figure 1 provide illustrations of the growth rates of each of the Islamic deposit account. Over the years, investment deposits (general and specific) continually capture the largest portion of the Islamic banking deposits. On the investment side, investment deposits accounted for 49.6% of Islamic deposits. Investment deposits only grew by 10.3% in 2006, while savings and demand deposits grew by 16.7% and 38.8% respectively. The bulk of investment deposits are concentrated in the short-term maturity profile of less than one year which constitutes 95.2% of the total investment deposits. As reported by BNM, this is mainly due to the increase in the retail customer base in Islamic banking. There was also ample liquidity in the Islamic banking system throughout 2006. Total deposits recorded a significant growth of 18.2% in 2006 to account for 12.2% of the banking system deposits.
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modes of financing. These principles which are also known as investment modes of financing do not require the users to repay the total amount of financing. While debt creating modes involve a debt burden on the users irrespective of how much they benefits from the loans, those who enjoy the investment modes are without a debt burden. In Malaysia, the methods of financing are issued by Bank Negara Malaysia who will issue guidelines that indicates the methods to be used for various financing activities. In the case of financing acquisition of assets such as houses, buildings, vehicles and other properties; the bai bithaman ajil method is recommended. The principle of ijarah is applicable also to the financing of vehicles. Meanwhile, principle of mudarabah recommended for working capital and project financing. The principle of musyarakah is recommended for project financing only. Table 4 below indicates the Shariah principles employed by Islamic banks in Malaysia and the percentage of usage each of the principle in financing from 2003 to end of June 2006.
Bai bithaman ajil (BBA) financing is the most popular financing contract in Malaysia and has continued to dominate the market. At end of June 2006, BBA financing accounted 42% of total Islamic financing in the industry. This is followed by ijarah (30.6%) and murabahah (7.1%). It is evident that Islamic partnership contracts are the least popular, with both mudarabah and musyarakah only capturing 0.2% of total Islamic financing. Similar trends can also seen since 2003. Figure 2 and 3 illustrate the financing growth trend of the Islamic banking system in Malaysia where Islamic financing expanded by 12.3% or RM78.5 billion as at end-2006. The total financing extended by the Islamic banking sector was a mere RM9.5 billion and 9.2 billion in 2005 and 2004 respectively. Supported by the strong consumer spending, consumer financing continued to account for the largest component of financing extended by the Islamic banking institutions, mainly for the purchase of passenger cars. The second largest component of financing was the broad property sector.
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As at end 2006, Islamic banking assets accounted for 12.2% of total banking assets.
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Both deposits and financing activities in the Islamic banking system have shown a positive growth from 2003 to 2006 as shown in Table 6. In terms of financing activities, Islamic financing in Malaysia accounted for 13.2 % of total bank lending (12.2% in 2005) and registering a growth of 12.3% in 2006. Islamic banking deposits accounted for 12.2% of total bank deposits (11.7% in 2005) and thus, recording a robust growth of 18.2% in 2006.
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The Islamic banking sector has registered a strong growth of 15% per annum from 2000-2006.
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8. FUTURE DIRECTIONS
Although the Islamic financial services industry is currently experiencing a double digit growth, the industry is still in its infancy compared to the conventional financial system. Nonetheless, the rapid growth and positive performance of achieved by the Islamic banking system signifies one of the major accomplishments over the last three decades in Islamic banking and finance in Malaysia. As Islamic banking in Malaysia journeys towards global integration and international acceptance, there are key areas in the banking industry that needs to be enhanced to progressively support future development. Islamic banking system in Malaysia already has some embedded key values and essence that are needed to move forward. The most significant is the strong alliance among the players within the industry as well as with the relevant institutions including educational, training and research institutions, and other professional bodies in promoting the development of the industry. The introduction of new Islamic banking products and services will continue to be an uphill task if reviews are not made to the existing framework and structures governing the issuance of global Shariah-complaint products. Fervent structural changes as well as judicial consciousness are imperative for the Islamic banking industry to survive the currents of globalisation and change. Even though Malaysia have already in placed a robust regulatory structure, the challenge ahead remains on how to bring convergence on regulatory structures across national borders. The changing financial landscape has also transformed the financial industry, particularly in the past five years. Amongst the most notable trends in the financial services industry include disintermediation and the blurring of traditional boundaries between banking, insurance and the securities sectors. The process of convergence has been along several dimensions, i.e. between financial institutions and between jurisdictions. Hence, one cannot over stress the fact that an effective and efficient regulatory is imperative to promote and encourage the participation of bigger customers and players into the Islamic banking industry. The Islamic banking industry would be highly inefficient if it were to develop as a closed system in which only local or domestic clients participated. A strategy of openness is essential in order to create an international Islamic banking industry that is characterized by both liquidity and effectiveness in serving the needs of both local and international customers. Another issue facing the development of the Islamic banking industry is the lack of convergence of Shariah interpretations. Different Muslim countries have adopted different practices in relation to various Islamic banking product and services which is a result of the varying interpretation on various Shariah issues across jurisdictions due to the different school of thoughts among Shariah scholars. This may have implications for cross border flows in relation to investment and trading of international Islamic instruments. The harmonisation of Shariah interpretations will lead to the creation of more homogeneous Islamic banking products and services that in turn will increase demand and enhance the overall growth of the Islamic
The challenge is to bring convergence on regulatory structures across national borders and convergence of Shariah interpretations.
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banking industry. In the environment of rapid changes, innovative solutions are required to meet the changing and more complex customers needs. Product innovation is crucial in the process of deepening and broadening the Islamic financial industry and thus, a critical factor in the development of the Islamic banking industry. For Islamic banking industry to remain competitive, attractive and innovative; indigenous Islamic financial products must be introduced to meet the risk-reward profiles of investors and issuers, fulfilling all the tenets of the Shariah while remaining sufficiently cost-effective and competitive vis--vis conventional products. By confining product development to mere evaluation and adaptation of products in the conventional markets, the Islamic banking industry will have to play a perpetual catch-up game with the conventional financial system. There will also be a continuous reliance on the expertise within the conventional market to take the Islamic banking system forward.
Product innovation is crucial for the further deepening of the Islamic financial services industry.
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