5.5 Phase Eight: Interest-Free Islamic Banking (1970s–Present)
5.5.3 Evolution of Islamic Banking in South East Asia,
As South East Asia, and in particular Malaysia, is currently a financial centre for Islamic finance, it is important to provide an insight on the evolution of Islamic banking there.
5.5.3.1 Malaysia
Malaysia, and other South East Asian countries, had its first introduction to Islam via Arab and traders in the thirteenth century, dealing with Muslim traders and experiencing their honest dealings has attracted the Malaysians to know more about the religion of Muslims. This contributed towards bringing to an end the age of Hinduism and Buddhism there. Islam arrived in the region gradually, and then became the religion of the elite before it spread to the rest of the Malaysian population (Devahuti 1965: 3).
Malaysia is believed to have a liberal approach towards the application of Shariah into banking. The reason for that, according to Wilson is due to the predominance of the Shafi’i school of jurisprudence in Malaysia as well as in Indonesia. This school is regarded as being the most liberal of the other three main schools of jurisprudence including matters of finance. This, therefore, explains the different approach to Islamic finance in the Gulf Countries where the Hanbali school is followed. This contrast arises as the Hanbali school is regarded as the strictest because it limits the scope of judicial interpretation of the Qur’an and Hadith (2012: 31).
The earliest form of Islamic banking in Malaysia can be traced back to September 1963 when Perbadanan Wang Simpanan Bakal-Bakal Haji (PWSBH) was established as an institution for Muslims to save for the cost of doing hajj (pilgrimage to Mecca). In 1969, PWSBH merged with Pejabat Urusan Haji to form Lembaga Urusan dan Tabung Haji (known as Lembaga Tabung Haji), (Bank Negara Malaysia 2005). This was the beginning of introducing religious based savings product in Malaysia for doing a religious duty and the first introduction to the concept of Islamic banking.
Hence, the first Islamic bank, Bank Islam Malaysia Berhad, was set up under the Islamic Banking Act 1983. On 4th March 1993, Bank Negara Malaysia (BNM), the Central Bank of Malaysia, introduced a scheme known as ‘interest-free banking scheme’. Under this scheme, commercial conventional banks and finance compa- nies were also allowed Islamic banking products and services. These institutions 5.5 Phase Eight: Interest-Free Islamic Banking (1970s–Present) 81
were required to ensure complete separation of their Islamic banking operations from the conventional side (Adam and Thomas 2004: 48).
The National Sharia Advisory Council in Malaysia was established by Bank Negara Malaysia (BNM) to advise on all aspects of Sharia and its application in Islamic banking. This enabled the existence of a dual banking system conventional banking and stand-alone Islamic banking system. There are currently in Malaysia ten fully-fledged Islamic banks (Bank Negara Malaysia 2005).
5.5.3.2 Indonesia
As the world’s largest population of Muslims, Indonesia entered the realm of Islamic banking fairly late in comparison with other Muslim majority countries.
This is probably due to Suharto’s policies at that time. The development of Islamic banking in Indonesia started before any legal or regulatory structure exists. There have been many non-banking financial institutions such as Bait Maal Wat Tamwil (Islamic Savings and Loan Cooperatives) offering Islamic finance to the rural sector. The government allowed the operation of Islamic banking in the Act No. 7 of 1992 under the Government Decree No. 72 of 1992, in order to meet the demand for Islamic banking financial products (Haron 1995).
Bank Muamalat was the first Islamic bank established in Indonesia and com- menced its operation in 1992. In 1998, the Act No. 10 that amended the Act No. 7 of 1992 concerning banking regulations came into force to provide a stronger legal ground for the existence of Islamic banking system. Bank Indonesia (the central bank) took a major step in September 2002 for the development of Islamic banking when it issued a blueprint for Islamic banking and set the regulation of 4/1/2002 in relation to the establishment and operations of commercial banks and bank offices based on the principles of Sharia (Khir et al. 2008: 198).
Later on, in January 2006 Bank Indonesia allowed conventional banks to have branches with Sharia compliant units and offer Sharia compliant financial products and services, setting up a dual banking system like Malaysia (Adam and Thomas 2004: 49). As of December 2005, there were three Islamic general banks, 19 Islamic commercial bank business units and 92 small banks limited to financing and lending in certain areas (Khir et al. 2008: 199).
5.5.3.3 Thailand
Although Thailand is predominantly a Buddhist country, A Muslim population is concentrated in certain provinces such as Yala, Pattani, Songkhla, Satun and Narathiwas. Nonetheless, while only 4 per cent of the country is Muslims, they are wealthy and influential. Islamic banking can be traced there back to 1987 when the Pattani Islamic Savings Cooperative was established. The objective was then to create a separate Islamic fund for the benefit of the poor of the Muslim community (Adam and Thomas 2004: 50).
Thereafter, four similar Islamic institutions were established, Ibnu Affan Sav- ings Co-operative, As-Siddiq Savings Co-operative, Saqaffah Islam Savings Co-operative and Al-Islamiah Savings Co-operative. The idea of establishing the first stand-alone Islamic bank in Thailand was initiated in 1994 when the Thai government signed the Indonesia-Malaysia-Thailand Growth Triangle Project (IMT-GT Project) with a view to promote banking services with focus on the needs of Muslim consumers, in particular those in the four southern provinces (Bank Negara Malaysia 2005).
Islamic banking was first provided by a commercial bank in late 1997, but closed down as a result of the financial crisis. The next major step was establishing a full- fledged Islamic branch by state-owned Krung Thai Bank in 2002. Krung Thai Sharia Services is now under the Islamic Bank of Thailand (a major player in the Thai financial system) which was set up in 2002, to meet the demands of Sharia compliant financial products, under the Islamic Bank of Thailand Act B.E 2545 (Khir et al. 2008: 200).
5.5.3.4 Brunei
A dual banking system is also adopted in Brunei whereby Islamic banks operate in parallel to conventional banks. Islamic banking started in 1991 with the establish- ment of Perbadanan Tabung Amanah Islam Brunei (TAIB) by a constitution of Brunei Darussalam (Order under section 83[3]) Emergency Order, 1991. TAIB is government owned with the objective of offering Islamic financial services and raises the socio-economic status of the population (Haron 1995).
Islamic Bank of Brunei (IBB) was the second fully Islamic bank established in 1993; it replaced the International Bank of Brunei. Banks in Brunei are regulated under the Banking and Finance Companies Act through the Ministry of Finance.
There is not a central bank in Brunei. To further strengthen Islamic banking in Brunei, two Islamic banks have merged to become Brunei’s largest Islamic bank, the Islamic Bank of Brunei Ltd and Brunei Islamic Development Bank Ltd (Khir et al. 2008: 201).
5.5.3.5 Pakistan
The process of converting the financial system in Pakistan to be an Islamic system was initiated in 1979. Pakistan took a gradual transition approach to an interest-free banking system. All steps were taken into consideration to ensure that, as a result of new banking rules and regulations, disruption to the existing financial system is kept to the minimum (Anwar 1992). This gradual approach was adopted in order to establish new laws, institutions, concepts and practices on sound intellectual ground, develop a wide agreement and broad acceptance of the new measures and ensure flexibility to accommodate differences on minor issues in the Islamic commercial law (Khan 1984).
5.5 Phase Eight: Interest-Free Islamic Banking (1970s–Present) 83
Then, the specialised institutions in the public sector reoriented their financial activities to be operated on a non-interest bearing basis of profit and loss sharing (PLS). All commercial domestic banks were allowed to accept deposits on the basis of PLS on 1st January 1981. Hence, over the next 3 years measures were taken to develop new financial instruments in which PLS deposits could be invested (Iqbal and Mirakhor 1987: 4).
The Pakistani model aimed to ensure that the new instruments of financing did not upset the basic function and structure of the existing conventional banking system. This and the gradual transition made it easier for the Pakistani banks to adapt the new system (Ariff 1988). This gradual transition also included the government and its agencies, export bills, investment in shares, purchase of partic- ipation term certificates, provision of loans to the credit specialised institutions, partnership lending and hire purchase (Iqbal and Mirakhor 1987: 4). However, this progress has slowed down due to the actions of successive governments that held power thereafter.
5.5.3.6 Iran
Following the Islamic revolution in Iran in 1979 and the overthrow of the Shah, Iran initiated its conversion into an Islamic banking system in August 1983 with a transition period planned over 3 years (Ariff 1988). Banks were allowed to accept current and savings deposits without having to pay any return, but the government permits banks to offer incentives instead such as variable prizes or bonuses in cash or kind to account holders. Term deposits earn a rate of return based on the profit generated and the maturity of the deposit (Ariff 1988).
People were hesitant in the beginning to make investment deposits, but with time the number of term investment deposits substantially increased. The number of deposits increased by 6.3 times in 1991, in contrast with 1985. Iran established and strengthened collaboration and coordination of the credit policies of banks with the economic policies of the government in various spheres (Anwar 1992).