MPU 3312 – Banking and Finance

Chapter 2 – COMMERCIAL BANKS (CONVENTIONAL and ISLAMIC)

DEVELOPMENT AND FUNCTIONS OF COMMERCIAL BANKS IN MALAYSIA

Barter Trade System

o Buyer and Seller undertook direct exchange of goods.

DISADVANTAGE OF BARTER TRADE SYSTEM

- Unable to strike right exchangeability between two sets of goods or services.
- No incentive to work hard , to save , as surplus goods cannot be stored.
- Not a good medium of exchange.

Money
o Consists of notes and coins.
o Possess the characteristics of good medium of exchange
Surplus units
o Groups who saved their surplus monies.
Deficit units
o Groups who borrowed to finance their deficits.

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With the practice of direct borrowing and lending between surplus units and deficit units the
following problems were encountered:-
a. Meeting
- Where is the surplus & deficit units located?
b) Amount
- Amount sought may not match.
c) Tenure
- Mismatch in tenure.
d) Default risk
- No guarantee of repayment

HISTORY
- 1st commercial bank in the country – The Chartered Mercantile Bank of India,
London and China later renamed Mercantile Bank in Penang in 1859.
- 1st domestic bank in Kuala Lumpur was Kwong Yik Bank(Selangor) Banking
Corporation in July 1913.
- Bank Negara Malaysia set up under Central Bank of Malaya Ordinance 1958
on 26 January 1959.

FINANCIAL INTERMEDIATION
- Financial institutions act as intermediary for savers called surplus units and
borrowers called deficit units.
- A person could be the surplus and deficit unit at the same time or could be either
one if he only deposits or borrows.
COMMERCIAL BANKS
- They are the largest and most significant providers of funds in the banking system.
Functions and business of commercial banks in Malaysia.
- Provide facilities for savings through current, savings and fixed/time deposit accounts
and other financial instruments.
- Provide facilities to effect payments on behalf of its customers.
Dual Licensing of Financial Institutions
- A licensed financial institution is now permitted to apply for and hold 2 licences
namely a licence to carry on banking business and one to carry on finance company
business. An institution which holds these licences is defined as a ‘banking and
finance company’.
- A bank with dual licence is defined as ‘banking and finance company’ which
means it holds a licence to carry on a banking business and a licence to carry on a
finance company business.

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ISLAMIC BANKS
- 1st introduced in Malaysia in 1983.
- Subscribed to Syriah principles.
- Alternative banking system to operate alongside conventional banking system.
- Regulated by Islamic Banking Act 1983 which came into effect 7 April 1983.
- The Act provides the Central Bank (BNM) with powers to supervise and regulate
Islamic Banks
- Not limited to Muslims only.
- Open to both Muslims and Non Muslims.
- Profit sharing in the form of dividends rather than interest charges. (Profit sharing
agreements.)
- Dividends are discretionary payments. If profits are made, a dividend is declared. No
profit, no dividend.
- Losses shared according to predetermined ratio. Removal of uncertainties through
fluctuations and variations.
- Profit sharing rates are fixed, not subject to fluctuations or variations.
Long term objective of the Bank Negara Malaysia is to create an Islamic banking system.
Three ingredients to qualify as a system:-
a. A board variety of instruments.
b. A large number of players
c. An Islamic inter-bank market.
In the process of achieving a full fledged Islamic banking system, Malaysia achieved a first in
the world in the following four areas:-
a. To issue Government bonds on an Islamic basis.
b. To set up an Islamic inter bank money market.
c. To have a full fledged Islamic banking system.
d. To implement a dual banking system, i.e., an Islamic banking system on a parallel
basis with the conventional system.
e. The Islamic bank is to seek advice of the Syariah Advisory Council on Syriah
matters in relation to its banking business and an obligation is imposed on the
Islamic bank concerned to comply with the advice of the Council.
f. One of the criteria to be issued an Islamic Banking licence is that the applicant’s
Articles of Association must provide for the establishment of a Syariah Advisory
Body to advise the applicant to ensure that its banking operations do not involve any
element which is not approved by the religion of Islam. The Syariah advisory body
must now be one that is approved by BNM.
CONCEPT OF COST of FUNDS
The factors that are taken into account in computing cost of funds are as follows:-
a. Interest paid on deposits.
b. Reserve Cost
c. Administration Cost
d. Non Interest Bearing Cost

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DIFFERENCES BETWEEN CONVENTIONAL AND ISLAMIC BANKING SYSTEMS
CONVENTIONAL BANKING SYSTEM
Depositors are paid interest.
The customer has no say where banker
invests the money.
Borrowers are charged interest.
Except for leasing, margin of financing is
less than 100%.
Repayment is not fixed.
Legal relationship – debtor and creditor
Commodity – eg House is the security.
ISLAMIC BANKING SYSTEM
Depositors entitled to profit sharing
Under special investment account,
customer decide where banker invest the
money.
Financing is done through purchase and
resale to the customer, thus earning profit.
100% financing is available.
Repayment price is fixed.
Legal relationship:
a) Seller and Buyer
b) Lessor and Lessee
c) Partner and Partner
Commodity – eg House is the subject
matter and major element.