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Islamic Banks to decide upon the mechanism for Inter-bank placement amongst

Islamic banks and to move towards the development of an Islamic Inter-bank market.
The statement said that after careful deliberation, standardized agreements namely
Interbank Musharaka and Interbank Wakala Agreements, were finalized and it was
agreed that henceforth only these standard contracts would be used by the Islamic
Banking industry. It said that this achievement is an important milestone towards
development of Inter-bank market for Islamic Banks and would pave the way for the
long awaited Islamic benchmark rate as an alternative to KIBOR

Similar to the London Interbank Offered Rate (LIBOR), EIBOR futures contracts are available for trade
and there are various EIBOR offered rates depending on the life of the loan.
Many Islamic banks use EIBOR rates as benchmarks for determining the rental rates for special leasing
agreements called Ijara.


1. Introduction

A significant development in the Muslim World in the seventies and

eighties was the pan-Islamic movement. This movement aimed to
revive the glory of Islam and began to demand the application of
Shariah in all aspects of life. The effort to establish in Islamic
Banking is one manifestation of this movement. The Muslim
countries began to rediscover Islam and wanted to mould their
economic and financial activities in accordance with Islamic values.

The seventies and eighties of the present century has

witnessed the emergence of a number of Islamic banks and financial
institutions whose modes of operation are distinct from those of
conventional banks. The establishment of these institutions is one
of the several manifestations of the 'back to religion' movement
which is fast gaining strength in present day muslim societies
(quoted in Abulhasan et al. 1991: 155)

The Muslim world has been over-burdened for too long by

western modes of social and economic thought. A large portion of
the Muslim world had been subjugated culturally, economically and
politically by the colonial powers. Even though they have achieved
independence from their colonial masters, the colonial principles
are still deep rooted in the social, economic, political and cultural
life of Muslim communities. Thus, the emergence and expansion of
an Islamic banking system is the starting point of a new path
breaking change in the Muslim world. It is a process of liberating
the Muslims from the yoke of domination by western thought,
values and institutions and remodeling their social and economic
life in accordance with shariah.

The issue of Riba has long been a problem for Muslims. Even
what constituted Riba itself has been a subject under serious
discussion. The existence of Riba has been argued to be a major
factor for the low participation of the Malays in the economic
activities of Malaysia. The establishment of BIMB is a major step
towards an interest-free financial system in Malaysia. This marked
the establishment of more Islamic commercial institutions under the
new mode of the Islamization Policy of Dr. Mahathir Muhammad.

2. The Emergence of Islamic Banks

The elementary concepts of modern Islamic banking date back

to the mid 1940s. Models for Islamic banking appeared in the mid-
1950s, but comprehensive and detailed concepts for interest-free
banking only appeared in the late 1960s. The political environment
during that time almost all Muslim countries was hardly favorable
for a change in the entire system of banking and finance. In fact,
the first experiment in Islamic banking was set up undercover in Mit
Ghamr, Egypt in 1963. The model for the experiment was the
German Savings bank modified to comply with Islamic principles,
i.e. it was barred from charging and paying interest. Nevertheless,
the charter of the Bank did not refer to Shariah.

The second Islamic Conference of Foreign Ministers in 1973

adopted a document on the "Institution of an Islamic Bank,
Economics and Islamic Doctrines". In 1974, the Islamic Development
Bank (IDB) was established as a result of this conference. The
member states of the OIC became members of the IDB. The IDB
helped to establish a number of Islamic banks in various countries.

Beginning in 1974, several Islamic banks have been established

which include: Dubai Islamic Bank in 1975, Faisal Islamic Bank of
Sudan in 1977, Faisal Islamic Egyptian Bank and Islamic Bank of
Jordan in 1978, Islamic Bank of Bahrain in 1979, the International
Islamic Bank of Investment and Development, Luxembourg in 1980
and BIMB in 1983. Today, there are more than a hundred financial
institutions which claim to be operating partially or fully on an
interest-free basis in 34 countries.

Islamic banking has been adopted at the national level in

Pakistan, Sudan, and Iran, and they have decided to Islamize the
whole banking system. Iran enacted a new banking law in August
1983 requiring complete abolition of interest by March 1985 (M.N.
Siddiqi 1988: 48). Sudan opted for a total change when a
presidential decree was issued in 1984, directing all banks to stop
dealing with interest. The Central Bank of Sudan, on 10 December
1984, directed all commercial banks to stop dealing with interest
with immediate effect, and to negotiate conversion of existing
deposit into investment deposits or any other kind of deposits in
accordance with shariah. All outstanding interest bearing advances
were either to be settled through repayment or they had to be
converted into one of the Islamic modes of financing. Foreign
transactions were to continue on the basis of interest till an
alternative way as available.

3. The Theory of Islamic Banking

3.1 Economic Impact of Interest

At the outset, the most important departure of Islamic banking from

conventional banking is the prohibition of Riba, and promoting
Profit and Loss Sharing (PLS) as an alternative to Riba. The
prohibition of interest is obvious in the Quran as well as in the
Sunnah. Riba originally meant 'increase and growth'. This meaning
is taken from the Quran (22:5). Increase means the increase over
capital or nominal amount, the increase being either large or small.
According to Islamic law, Riba technically refers to the premium that
must be paid by the borrower to the lender along with the principal
amount as a condition for an extension in its maturity. In 1992, the
Pakistan Federal Shariah Court ruled that:
It makes no difference whether the loan is for consumption purpose
or for commercial purposes. It does not matter if the rate of
interest is low or high, simple or compound for short or long times,
between the two Muslims or between a citizen and a state or
between two states. Any excess which is pre-determined over the
principal sum in a loan transaction will constitute Riba in all
circumstances (quoted in K. Zaheed 1994: 83)

This immediately leads us to the essence of Islamic banking; an

Islamic bank is a financial institution that conducts its operations in
accordance with Shariah principles. If we have to contrast the
Islamic bank to an existing conventional bank, we may say that
while the latter earns the major portion of its revenues and
expenses on the basis of interest, the former earns the same on the
profits. In the operation of an Islamic bank, profits therefore
assume the place of interest in a conventional bank. 'Usury', the
original name for modern interest.


BIMB was established after the enacting of the Islamic Banking Act
(IBA) in 1983, the IBA permitted the establishment of the first
Islamic Bank in Malaysia. BIMB with a paid up capital of RM 100
million and an authorised capital of RM 500 million is carrying out
its activities on an interest free basis. Tengku Razaleigh , the then
Finance Minister described the Islamic bank as the:
First step in the government's efforts to instill Islamic values into
the country's economic and financial systems as a replacement for
the current Western-base economic system (NST 6 July 1982)

Takaful Malaysia

Syarikat Takaful Malaysia Berhad was incorporated on 29 November

1984, has an authorised capital of RM 500 million and a paid up
capital of RM 55 million. It has been converted into a public quoted
company with the listing of its shares on the Main Board of the
Kuala Lumpur Stock Exchange since 31 July 1996. As a subsidiary
company of BIMB Holdings Berhad, 65.5% of its equity is held by the

Other major shareholders are the State Islamic Religious Councils /

Baitulmals of Terengganu, Pahang, Negeri Sembilan and Amanah
Saham Bank Islam (ASBI).
The company objectives is to provide takaful services (Islamic
Insurance) at the highest standard of efficiency and professionalism
to all Muslims and the population in Malaysia.

Lembaga Tabung Haji (Pilgrims Fund Board)

In line with the concept of Islam as Ad-deen, a way of life in this

world and the Hereafter, every ibadah commanded by Allah S.W.T.
is of benefit in this and the next world. To fulfill this desire to
perform the Hajj pilgrimage, Muslims have to find enough money for
the journey to the Holy Land. To avoid riba' (usury), which is haram
(forbidden) in Islam, Muslims resort to various traditional methods
of saving. Of course, there are those who dispose their animals or
inherited properties for cash to cover their Hajj expenses, a practice
which ultimately imposes economic burden on themselves and their
families while they are on the pilgrimage or when they return from
the pilgrimage. Such practice also does not augur well for the rural
economy, besides retarding the country’s economic growth.

Realising this as well as to help Muslims to save enough money

without involving in activities deemed haram in Islam, Perbadanan
Wang Simpanan Bakal-Bakal Haji was set up in November 1962, and
began its operation on 30 September 1963. The corporation to
manage the savings of Muslims, intending to perform the Hajj
pilgrimage, was the result of a working paper entitled "Rancangan
Membaiki Ekonomi Bakal-Bakal Haji" presented by Royal Professor
Ungku Aziz in 1959 to improve the economy of intending pilgrims.

Enable Muslims to gradually save enough money to meet the cost of
performing the Hajj or other beneficial expenses; Enable Muslims,
through the use of their savings, to take active part in capital
investment in a way, halal to Islam, and Provide protection,
supervision and welfare to Hajj pilgrims.

Pusat Pungutan Zakat (Zakat Collection Center)

Established by The Federal Territory Islamic Council, Kuala Lumpur

(known as MAIWP). It started its operations in 1991. PPZ uses a
corporate style of management through the setting up by the
Council of a company called Hartasuci Sdn. Bhd. which is placed
under a foundation called Yayasan Taqwa Wilayah Persekutuan
Berhad controlled by the Council. PPZ's basic responsibility is to
collect zakat for the Council. It is not responsible for zakat
distribution which is done by other agencies/sections of the Council.

Organization Structure Externally, PPZ is placed under the

foundation which is responsible to the Council. Internally, PPZ has a
Board of Directors which supervises management headed by a
General Manager. There are two divisions, namely the Operations
Division (headed by a Manager), and the Finance & Administration
Division. Each division in turn has various functional units. Basic
functions of PPZ :

To explain to the public about zakat and the responsibility of paying

zakat. To help payers, both individuals and companies, calculate
their zakat. To collect zakat and to increase the collection, both in
terms of amount and payers.

All Collection is immediately bank-in into the Baitulmal account (of

the Federal Territory Islamic Council). Apart from the above
mentioned responsibilities PPZ is also responsible in producing
daily, monthly, quarterly and yearly reports, both for the
management and Council use.

Style of Operation: The guiding philosophy in doing work at PPZ is

to make the zakat payers feel that zakat payment is an ibadah or
duty that is easy to perform; that helps to purify their wealth and
soul; and can give them a great feeling of satisfaction and relief.
PPZ focuses on reaching out to the Muslim community and
reminding them of their religious duty. Talks, pamphlets, posters,
explanations and reminders through the media or through direct
mailing to prospects are some of the methods being used by PPZ.
PPZ relies more on educating the Muslim public as opposed to using
force or the law. Self awareness is more effective and more
appealing to the educated public.

Payer's Preference: Most of the payers prefer to pay zakat in the

month of Ramadhan so that they can pay both their zakat mal
(zakat on wealth) and zakat fitr (zakat on self); and in the month of
January, since a person could get their rebate from income tax
payment for that particular year. These 2 months constitute 65% of
yearly collections. Normally prayers prefer to come to the zakat
counter to pay zakat because they like the act of akad
(solemnisation) even though it is not a must. Other would pay
through the mail, salary deduction, sending a representative to the
zakat center and paying at selected bank counters where major
banks in the country have been appointed as agents by the Islamic
Islamic Banking Concepts

Al-Wadiah Yad Dhamanah (savings with guarantee)

Al-Mudharabah (profit-sharing)
Al-Musyarakah (joint venture)
Al-Murabahah (cost plus)
Bai’ Bithaman Ajil (deferred payment sale)
Bai’ al-Dayn (debt trading)
Al-Ijarah Thumma al-Bai’ (leasing and subsequently purchase)
Al-Ijarah (leasing)
Al-Qardhul Hassan (benevolent loan)
Bai’ as-Salam (future delivery)
Bai’ Al-Istijrar (supply contract)
Al-Kafalah (guarantee)
Ar-Rahnu (collateralised borrowing)
Al-Wakalah (nominating another person to act)
Al-Hiwalah (remittance)
As-Sarf (foreign exchange)
Al-Ujr (fee)
Al-Hibah (gift)