Islamic Banking in Malaysia and Lessons for Other States

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Page count 5
Word count 1408
Read time 5 min
Subject Economics
Type Essay
Language 🇺🇸 US


Islamic banking has nowadays become a viable alternative to conventional banking system for believers and non-believers of Islamic faith. Islamic banking system was initially developed to cater for the needs of Muslims. However, it has expanded to provide services beyond the scope it was originally developed for (Venados, 2006, p. 145). Islamic banking can be defined as banking that is based and operates on Islamic law or Shariah Law. For Islamic banking to succeed, it must follow the Islamic rules of transaction referred to as fight muamalat in shariah law. The rules described above are formulated directly from Quran teachings Quran and the Sunnah and other modifications that were derived from opinions and scholarly activities of prominent Muslim businesspersons and scholars (ijma) (Venados, 2006, p. 148). Venados adds that they must meet the Muslim reasoning and analogies for them to effectively help govern Islamic banking.

Islamic banking in Malaysia


Islamic banking in Malaysia started in 1983 when the first Islamic bank, Bank Islam Malaysia Berhad (BIMB) commenced operations. Initially the bank was set up by the government to enable Muslims to save for Hajj expenses. It was the only Islamic bank in the country for the next ten years until 1993 when the government allowed the set up of other Islamic banks in the country. Finance companies, banks, and merchant companies began in 1993 to offer Islamic banking and other financial services through Islamic Banking Scheme (IBS banks). The government in that year allowed conventional banks to offer Islamic banking services by using thee existing infrastructure. According to Ahmed et al (2011, p. 22) the reasoning behind the relaxation of rules was the desire by the government to increase the number of institutions offering Islamic banking at affordable costs within a limited timeline. The existing conventional banks offered the best option since they already had established branch networks and the necessary infrastructure. The government then referred to them as Islamic Windows

Another compelling reason for the introduction of large scale Islamic Banking was the need to make the Islamic banking industry competitive through improved performance and enhanced efficiency in this particular sector (Musa, 2003, p. 90).

Modification of Norms and Rules

In Malaysia there are parallel legislations governing the two banking systems that exists in the country. The Islamic banking system was established by the Islamic Banking Act (IBA), which was enacted in 1983 and came to effect in the same year. The act has mandated the Negara Bank Malaysia to oversee and regulate operations of Islamic banking alongside those of the conventional system. The Islamic banking system in Malaysia operates largely as any other Islamic banking system in the world. For an Islamic banking system to succeed, it must have a large number of players in the industry, must possess a wide variety of instruments of trade and there must be an Islamic money market. All these conditions are present in Malaysia. The authorities in Malaysia went a further to ensure that the system reflected the socio-economic values of Islam besides ensuring that the operations were Islamic in both substance and form (Lewis & Hassan, 2007, p. 135).

There are no explicit modifications to the shariah law that governs Islamic banking in Malaysia. Rather, the government in collaboration with the banks has introduced a series of products that are thought to comply within the wider shariah law context. These products include the government Investiments issues and the Islamic inter-bank money market.

Government Investment Issues (GII)

Under Islamic banking, banks don’t charge interest. Therefore, they are likely to met with financial constraints due to diminished revenue steams. The Malaysian government introduced the issuance of Government Investment Issues (GII) that were basically securities issued in accordance with shariah law. Banks would therefore invest in these GII’s to meet their liquidity requirements and for the invention of their surplus funds. Based on the shariah law requirement contract of Qardh Hasan was signed between the banks and the government. Under the arrangement and in accordance to the Qardh Hasan principle of Shariah law, the purchase of the GII from the government by the bank was considered a benevolent loan issued to the government that will initiate projects that will benefit the country (Mirakhor,& Iqbal, 1987, p.69). Though the government was obliged to return the principle of the loan at maturity, returning of the loan was at the sole discretion of the government. However, there was a slight modification to this shariah principle in 2001. The modification was necessary so as to accommodate the secondary activities that characterized the Islamic money market. In the new arrangement, the government was obliged to sell its assets to an Islamic bank at a cash price agreed by both parties and buy back the same assets at a future date at an agreed purchase price. This new arrangement proved to meet both the shariah requirements that govern the Islamic banking system as well as the needs of the Islamic banks in the Islamic money market.

Islamic inter-bank money market

The banking institutions in Malaysia are allowed to trade in specific Islamic financial instruments. The instruments include bills and securities accepted under the Islamic banking system. Shariah law forbids the trading of such instruments. However, there is s slight modification that allows exchange of the instruments among players as dictated by the price determined by the BNM.

The BNM also has in place rules and regulations requiring banks to disclose their Islamic banking operations details. This includes the balance sheet and profit and loss accounts. This regulation is meant to curb any illegal trading that may violate the shariah laws that govern that govern Islamic banking in the country.

Challenges Islamic banking faced during the localization process

Islamic banking was a new concept in Malaysia until the formation of the first Islamic bank in the country in 1983. The biggest challenge the localization process in the country faced was lack of established Islamic banking infrastructure (Omar & Haq, 1996, p. 49). The government in 1983 wanted a quick rollout of Islamic banking but the necessary mechanism to rollout the program was severely impaired. The only way they could do it was through the establishment of Islamic windows in conventional commercial banks solely to take advantage of their established network.

Another challenge that newly established Islamic financial institutions faced was the lack of liquid assets that were key to trading in the financial market and critical in the stability of these institutions (Omar & Haq, 1996, p. 53). The government however responded to this challenges by enacting the GII act that allowed the government to sell GII certificates to the newly established Islamic financial institutions.

There was also competition from established conventional banks during the time. This was because the Islamic banks were newly established and had a vague framework to work on and few products that were not clearly defined and understood. With time however, Malaysian warmed up to Islamic banking especially with a second mega Islamic bank being formed in 1999 through a merger.

Lessons from the Malaysian experience to other Asian countries

A number of Asian countries have expressed interest in adopting full-scale Islamic banking system beside the existing conventional systems. Additionally, other countries outside the Asian region have been implements reforms to their banking systems to accommodate new banking techniques including Islamic banking. The Malaysian experience can be used a model for any country that wants to implement the Islamic banking system.

First it’s important that solid legislation exists that clearly lays down the guidelines for operating such a system. From Malaysia’s experience, it’s possible to run the two systems concurrently. The vital lesson here is that the two systems cannot be fused because regular clashes will severely impede the success of an Islamic system.

The countries should also provide a framework for the formation and expansion of infrastructure that supports Islamic banking. It should never be assumed that the conventional banks will automatically jump into Islamic banking even if the law existed. Though they can follow the “Islamic windows” mode initially, the authorities should put imbalance both monetary and non-monetary instruments that will help the take off such institutions.


Despite the progress made by the Islamic banking sector in Malaysia, there is a lot that still need to be done. Of particular importance is the need for modification of more shariah laws to allow for permeation of a little flexibility into the Islamic banking sector for more growth to occur.


Ahmed M.A. et al. (2011). Islamic Banking: How to Manage Risk and Improve Profitability. New York: Springer.

Lewis, M. & Hassan, K. (2007). Handbook of Islamic banking. San Francisco: InfoBase Publishers.

Mirakhor, A. & Iqbal, Z. (1987). Islamic banking. New Delhi: Springer Verlag.

Musa, B.M. (2003). Seeing Malaysia My Way: Collection of Personal Essays. London: Springer Verlag.

Omar, A. F., & Haq, A.M. (1996). Islamic banking: theory, practice, and challenges. Burlington: Cengage Learning.

Venados, A. M. (2006). Islamic banking & finance in South-East Asia: its development & future. New York: Routledge

Cite this paper


EduRaven. (2022, March 31). Islamic Banking in Malaysia and Lessons for Other States. Retrieved from


EduRaven. (2022, March 31). Islamic Banking in Malaysia and Lessons for Other States.

Work Cited

"Islamic Banking in Malaysia and Lessons for Other States." EduRaven, 31 Mar. 2022,


EduRaven. (2022) 'Islamic Banking in Malaysia and Lessons for Other States'. 31 March.


EduRaven. 2022. "Islamic Banking in Malaysia and Lessons for Other States." March 31, 2022.

1. EduRaven. "Islamic Banking in Malaysia and Lessons for Other States." March 31, 2022.


EduRaven. "Islamic Banking in Malaysia and Lessons for Other States." March 31, 2022.


EduRaven. 2022. "Islamic Banking in Malaysia and Lessons for Other States." March 31, 2022.

1. EduRaven. "Islamic Banking in Malaysia and Lessons for Other States." March 31, 2022.


EduRaven. "Islamic Banking in Malaysia and Lessons for Other States." March 31, 2022.