Name : Muhammad Haykal Ariabrastama

DEFINITION OF ISLAMIC BANK :

• An insightful definition is provided in the Islamic Banking Act, 1983 which defines
“Islamic banking business as banking business whose aims and operations do not
involve any elements which is not approved by the religion of Islam.

• Islamic banking is a form of modern banking based on Islamic legal concepts

developed in the first centuries of Islam, using risk-sharing as its main method, and
excluding financing based on a fixed, pre-determined return.

OVERVIEW OF ISLAMIC BANK OPERATION

The origin of Islamic banking is shariah ie. Islamic law or sometimes referred to as Islamic
jurisprudence. The teaching of Islam encompasses the essence of economic well-being and
development of the Muslims at the individual, family, society, state and ummah levels. 2
main sources of reference of IB operation. Banking and financial activities- part and parcel
of Islamic Muamalat- therefore subject to the Shariah Laws on Muamalat. In application, the
use of Fiqh as a tool to interpret the main sources which in turn applies certain methodology-
where the scholars play a role.

FUNCTIONS OF ISLAMIC BANKS

(1) Fund based

Primary functions i.e.. acceptance of deposits from savers and lend money to deficit
individual/institutions. Accepts deposits against savings and current account- to generate
income under specific investment account or general investment account. May receive from
people under current account. IBs lend money to borrowers for short-term, medium-term and
long- term investment. Depositors, bank and borrower share risk of loss according to sales
contract.

(2) Non-Fund based

Agency services or general utility services. As an agent to provide different types of services.
Eg: Collection of cheques, purchase/sale of securities, execution of standing orders etc.
General utility services. Eg.: Collection of utility bills, foreign exchange remittances, ATM
services etc.

CHALLENGES FACED BY ISLAMIC BANKS

Apart from the potential for growth in Islamic banking, there are several challenges facing
Islamic Financial Institutions.

- Lack of experts in Islamic banking: The supply of trained or experienced bankers has
lagged behind the expansion of Islamic banking. Training needs not only affect Arab
domestic banks, both Islamic and non-Islamic banks, but also foreign banks.
- Absence of accounting standards (and audits) related to Islamic banks: Uncertainty in
accounting principles involves realization of income, disclosure of accounting information,
basis of accounting, valuation, income and matching of costs, among others. Thus, the results
of the sharia banking scheme may not be adequately defined, especially the profits and losses
associated with depositors.

- Lack of uniform standards of credit analysis: Islamic banks do not have appropriate credit
analysis standards. Likewise, there is a broad training need that involves related aspects such
as financial feasibility studies, business monitoring, and portfolio evaluations.

- Potential conflict with the central bank: Islamic banks have been established as separate
legal entities; therefore, their relationship with the central bank and / or other commercial
banks is uncertain. Problems can be further aggravated when an Islamic bank is established in
a non-Muslim country, and is subject to the country's rules and requirements.

- Instruments that meet the demand for specific investment requirements: One of the biggest
challenges facing institutions is the provision of short-term investment instruments. Some
institutions have tried to develop high-quality short-term instruments, but are hampered by
their ability to produce assets, by their credit ratings, and by liquidity.

REGULATORY FRAMEWORK OF ISLAMIC BANKS

As stated above, Malaysia officially introduced Islamic banking to its coast with the adoption
of IBA1983. The main objective is to regulate the operations of Islamic banks, such as
declaring requirements for banks to be licensed as Islamic banks. IBA 1983 defines Islamic
banks as companies that run the Islamic banking business and have valid licenses. And that
defines the Islamic banking business as a banking business whose goals and operations do not
involve any elements that are not approved by Islam. Islam was not defined by IBA 1983.
Instead IBA 1983 abandoned Islam and interpreted it through it. 3. According to s.3 of IBA
1983, every bank wishing to practice Islamic banking must establish a Sharia Advisory body
to advise banks about their banking business operations to ensure that these banks meet with
the Islamic religion. Thus the Shariah Advisory body ensures that Sharia is fulfilled by
Islamic banks.

Another more recent development by the Central Bank of Malaysia is to increase the Islamic
government financial institutions (IFI) Sharia in Malaysia. The Central Bank of Malaysia has
developed a framework known as the Sharia Governance Framework (Framework) which has
officially been in effect since January 1, 2011 (although IFIs were awarded until June 1, 2011
to comply with the new Framework). Under this framework, it is the duty and responsibility
of IFI to establish a sound and strong Sharia governance framework. The main purpose of
this Framework is to enhance the role of the Board of Directors, Sharia Advisory Board and
Management in relation to Sharia issues, including improving the relevant key organs that
have the responsibility to carry out Shariah compliance and research functions.