The Islamic Financial Services
Industry, comprising Islamic Banking, Islamic
Insurance (Takaful) and the Islamic Capital Market
are areas that have become an important segment
within the global financial markets. Malaysia's
objectives are to develop a viable Islamic Financial
As globalisation and liberalisation
of financial markets accelerates, it becomes more
imperative to have a financial market with diverse
and innovative products. The challenge is to therefore
evolve strategies that will promote a competitive,
dynamic and sustainable Islamic Financial Services
Industry. Central to this common vision is the
creation of a comprehensive Islamic Financial
System that will be able to respond to the requirements
of the domestic economy and also to become an
integral component of the International Financial
The principles of Islamic
financial instruments in Malaysia
The Islamic Financial System broadly refers to
financial market transactions, operations and
services that comply with Islamic rules, principles
and codes of practices. These laws and rules require
certain types of activities, risks or rewards
to be either prohibited or promoted.
Islamic laws and rules are known
as Shariah or Islamic jurisprudence.
Shariah governs all aspects of Islamic
matters including worship, economic, social, political
and cultural aspects of Islamic societies.
The Shariah is derived from three
important sources, namely the Holy Quran (the
holy book of the religion of Islam), Sunnah (the
practices of the Prophet Muhammad) and Ijtihad
(the reasoning of a group of qualified scholars).
There are two different approaches
to developing modern Islamic financial products
and services. The first approach identifies existing
conventional products and services that are generally
acceptable to Islam, and modifies as well, as
removes any prohibited elements so that they comply
with Shariah principles. The second approach involves
the application of various Shariah principles
to facilitate the origination and innovation of
new products and services.
Prohibited elements of a commercial
transaction must first be removed for it to be
Shariah compliant. Among the major elements prohibited
under Shariah, in summary, are:
- riba (interest);
- gharar (uncertainty);
- maisir (gambling) ; and
- non-halal (prohibited food and drinks and
With the fundamental prohibitions
identified, products were then developed in Malaysia
using a combination of approaches and have evolved
over time to meet the needs of the local population.
The Islamic principles underlying
the products available in Malaysia are:
These principles are used as a basis for financial
instruments used in both Islamic banking and Capital
- Mudharabah (profit-sharing) -
loss borne by capital provider
Mudharabah offers the owner of capital the opportunity
to invest his capital in a certain project without
becoming involved in managing that capital,
and limits his liabilities to the capital committed.
The salient features of Mudharabah is that the
capital provider cannot claim a fixed amount
of profit and an assured return on his capital
if the project is profitable, as the profit
will be distributed based on a pre-agreed ratio
between the capital provider and the entrepreneur,
in this case, who solely manages the projects.
In the event the project is making losses, it
shall be borne solely by the capital provider
and none on the part of the entrepreneur, unless
the loss is due to negligence of the entrepreneur.
- Musharakah (profit and loss sharing)
Musharakah, which is analogous to a joint venture,
where both the entrepreneur and investor contribute
to the capital of the operations (assets, technical
and managerial expertise, etc) in varying degrees
and agree to share the returns, as well as risks,
in proportions agreed in advance.
- Murabahah (trade with mark-up
or cost-plus sale)
Murabahah is widely used for instruments for
short-term financing which is similar to more
conventional purchase finance. Under Murabahah,
the seller purchases the asset at cost and sells
it back to the customer at marked-up price agreed
by both parties.
Essentially, it is an agreement that refers
to the sale and purchase transaction for the
financing of an asset or project, whereby the
costs and profit margin are made known and agreed
to by all parties involved.
- Bai Bithamam Ajil (BBA) (deferred-payment
BBA has similar features as Murabahah
whereby the sale of goods is made on a deferred
payment basis at a price, which includes a profit
margin agreed by both parties. However, the
difference is that BBA is generally used for
- Bai al-Salam (advance purchase)
This is a sale and purchase transaction whereby
the payment is made in cash at the point of
the contract but the delivery of the asset purchased,
as specified in the agreement, is deferred to
a pre-determined date.
- Istisna (purchase order)
A sale and purchase agreement whereby the seller
undertakes to manufacture or construct according
to the specifications given in the agreement.
It is rather similar to Bai al-Salam, with the
main distinction being the nature of the asset
and method of payment.
Istisna generally covers those things which
are made to order; an advance payment is not
always necessary. The method of payment is flexible
according to the terms agreed to by the contracting
- Ijarah (lease financing)
Ijarah, which is similar to leasing
in conventional financing, is a popular instrument
designed for financing an asset or equipment.
It is a manfaah or benefit or the right to use
the asset or equipment.
Under Ijarah, the lessor leases out an asset
to the client at an agreed rental fee for a
pre-determined period pursuant to the contract.
Islamic capital market
The growing need of the Muslim population in Malaysia
for Shariah compliant products as an alternative
to conventional banking and capital markets financial
instruments acted as a catalyst for the development
of an Islamic capital market in Malaysia.
The Malaysian Government issued
the first Islamic Bond, the Government Investment
Certificate (GIC), in 1983. The issuance of the
GIC was based on the Islamic concept of Qardul
Hasan (benevolent loan) non-interest bearing loans.
However, GIC was not a tradable instrument as
Qardul Hasan did not permit secondary trading.
Therefore in order to evolve, the underlying concept
of Qardul Hasan was changed to Bai-al-Inah to
allow it to be traded in the secondary market.
Another aspect of the development
of the Islamic capital market was the need to
establish clear guidance on the types of equities
that comply with Shariah principles. The review
and identification of Shariah-equities stocks
are guided by specific criteria as set out by
In Malaysia, initial efforts were
undertaken by Bank Islam Malaysia Berhad (BIMB)
in 1983. This was followed by the establishment
of Malaysia's first fully-fledged Islamic stockbroking
service which was launched by BIMB Securities
Sdn Bhd (a subsidiary of Bank Islam Malaysia Berhad)
in 1994. There are also a number of conventional
stockbroking companies that offer Islamic stockbroking
services alongside conventional business. The
Securities Commission of Malaysia in June 1997
then introduced a list of Shariah compliant equities
to guide the investing public. Currently some
80% of Bursa Malaysia's counters (Malaysia's stock
market) are Shariah compliant.
With Shariah investment guidance
and infrastructure in place, the establishment
of Islamic funds and asset management activities
Banking Assets 1983 - 2002
Today there are a variety of Islamic
capital market products and services to meet the
needs of those who seek to invest in compliance
with Shariah principles. These include Shariah-compliant
equities, Islamic bonds and Islamic funds. The
Islamic capital market has grown in sophistication
and Islamic forms of product structuring, project
financing, stockbroking, asset management and
venture capital services are becoming increasingly
available in Malaysia.
Islamic funds in Malaysia
Islamic mutual funds or Islamic unit trust funds
are managed in compliance with the Shariah principles.
Islamic mutual funds typically engage a Shariah
board to advise and ensure that its investment
operations and portfolios are managed in compliance
with Shariah principles. There are different categories
of Islamic funds in Malaysia and the typical products
these funds invest in are Shariah-compliant equities,
Islamic bonds and Mudharabah deposits.
In general, Shariah-based equities
are essentially shares of companies meeting Shariah
criteria. However from an Islamic perspective,
corporate stocks can only be classified as Shariah
compliant if the business activities are not related
to any prohibited activities as outlined earlier
as well as meet certain qualitative criteria.
Other than the business criteria,
there is also a cleansing mechanism to purify
income received from investments of the funds
that are tainted by prohibited activities. For
instance, if some part of the income arises from
interest-bearing accounts (prohibited by Shariah)
and has been distributed to the funds, the proportion
of such income will be given to charity and thus
will not be retained by the fund.
The origination of Islamic bonds
typically involves the packaging or structuring
of pools of Shariah-compliant assets with or without
credit enhancement into securities.
The structure is based on a specific
contract of exchange that can be made through
the sale and purchase of an asset based on deferred
payment, leasing of specific assets or participation
in a joint-venture business.
The issuance of Islamic bonds requires
an exchange of a Shariah-compliant underlying
asset for a financial consideration through the
application of various Shariah principles such
as Bai Bitamam Ajil, Murabahah, Istisna, Bai al-Salam
and others. The structure of Islamic bonds has
to be reviewed and approved by Shariah advisers
to ensure that the structures are compliant.
In addition, the structuring process
may also involve the provision of additional protection
for investors against late payment, pre-payments,
potential write-offs and others. Such protection
is often provided in the form of credit and/or
liquidity enhancement schemes.
Malaysia, in its effort to explore
the potential of the Islamic Capital Markets on
a global scale successfully launched the world's
first sovereign Islamic bond in June 2003. The
US$600 million Shariah-compliant papers, known
as Sukuk, were listed on both Labuan International
Financial Exchange as well as the Luxembourg Stock
Exchange. There are currently nine Sukuks worldwide
issued in different jurisdictions.
Bond Market (1997 - 2004)
With today's pace of development in the Islamic
Financial Systems and together with an estimated
1.2 billion Muslims globally, the management of
liquidity is a challenge due to the relative scarcity
of Islamic Capital Markets instruments. The challenge
then for Malaysia and the Islamic Capital Markets
globally is to step up its efforts in term of
product development, harmonisation of Shariah's
views and establishment of a global Islamic Financial
on the Growth in Islamic Equity Fund Assets (1996