Islamic Financial System Design: What are the Incentives?

Abstract

This paper examines the Islamic financial system design that is determined by the regulation dictating the structure of the banking industries, the law and accounting incentives. This regulatory framework for financial intermediaries should be tailored to achieve the different levels of economic development. How do these changes take place? Are these changes also aimed towards the changing roles of financial intermediaries and the emergence of new markets and products? Do the development of the legal and accounting standard have influenced on revolutionized roles of the financial intermediaries and market? And finally, how would all these changes affect the firm financing choices and capital structure? Therefore, the aim of this paper is to produce the incentives of regulation, law and accounting that may influence this design.

JEL classification: G21; G23; G28;

Keywords: Islamic financial system design; regulation; law; finance; accounting;

Islamic Financial System Design: What are the Incentives?

by

Abd. Ghafar b. Ismaila

Ismail b. Ahmad

Islamic Economics and Finance Research Group

Centre for Economic Studies

Universiti Kebangsaan Malaysia

Bangi, 43600 Selangor D.E.

Malaysia

e-mail: drismaileco740@gmail.com

Third Draft April 2004

Paper to be presented at the Universitas Riau Seminar, Pekanbaru, Indonesia 16 April 2004

Abstract

This paper examines the Islamic financial system design that is determined by the regulation dictating the structure of the banking industries, the law and accounting incentives. This regulatory framework for financial intermediaries should be tailored to achieve the different levels of economic development. How do these changes take place? Are these changes also aimed towards the changing roles of financial intermediaries and the emergence of new markets and products? Do the development of the legal and accounting standard have influenced on revolutionized roles of the financial intermediaries and market? And finally, how would all these changes affect the firm financing choices and capital structure? Therefore, the aim of this paper is to produce the incentives of regulation, law and accounting that may influence this design.

JEL classification: G21; G23; G28;

Keywords: Islamic financial system design; regulation; law; finance; accounting;

1. Introduction

Recently, there has been a rise of academic interest in the design of financial systems. Economists have centered their discussions on the theoretical insights into comparative advantage of bank-base or market-base systems in promoting economic growth. Advocates of the bank-base systems emphasize the systems are better at mobilizing savings, identifying good investments and exerting sound corporate control, particularly during the early stages of economic development and in weak institutional environments (Stienherr and Huveneers 1994; and Titman and Wessels 1988). Others, however, emphasize the advantages of markets in allocating capital, providing risk management tools, and mitigating the problems associated with excessively powerful banks (Levine and Zervos, 1998 and Bartholdy et. al 1997). Reflecting these schisms, policymakers continue to struggle with the relative merits of bank-base versus market-base financial system in making policy decisions.

On the other hand, the Islamic financial design that has gaining ground is without exception. Nonetheless, the areas of research on this matter are very limited. It only focuses on the permissible scope of activities for Islamic banks and other Islamic depository financial intermediaries. These activities are mainly determined by the regulations dictating the abolishment of interest rate in the financial system (such as, Kurshid Ahmad (2000), Chapra (1985), and Siddiqi (1982)) The abolishment of interest rate seems to suggest that money should play its original role, as medium of exchange or commodity-money-commodity (C-M-C) as discussed by Al Ghazali in his Ihya, and not to be money for money (M-M-M).

In addition, to dictate the design of Islamic financial system, the prudent and sound regulatory frameworks are also needed. Hence, the regulatory framework for financial intermediaries should be tailored to achieve the different levels of economic development. How do these changes take place? Are these changes also aimed towards the changing roles of financial intermediaries and the emergence of new markets and products? Do the development of the legal and accounting standard have influenced on revolutionized roles of the financial intermediaries and market? And finally, how would all these changes affect the firm financing choices and capital structure? Therefore, the aim of this paper is to produce the incentives of regulation, law and accounting that may influence this design.

The remainder of this paper is organized as follows. Section 2 presents the role of money that becomes crucial in the design of financial system. Section 3 presents the current financial system design in Malaysia. What are the incentives that create the current design of Islamic financial system? Do the current regulations, legal and accounting play as incentive towards financial development? The answer for these questions will be discussed in section 4. Section 5 produces the conclusions.

2. Money and the Financial System

The activities of channeling funds (money) from the surplus unit (savers) to the deficit units (entrepreneur) in both Islamic financial system and conventional financial system are almost the same. However, Islamic economist such as Al Ghazali, in his Ihya (4:91-93) stresses the important of money in the economic affairs. He believes that the role of money a means towards production, through creative entrepreneurial efforts. It remains an intermediary and an instrument for real productive effort, for asset creation, for value added and for the expansion of the physical economic activity in a manner that benefits all sectors and which participates in the economy as a whole.

Further, Al Ghazali argues that charging interest on the borrowing and lending of money deflects money from its key function. The creation of riba or usury is viewed as economic exploitation and of injustice to transaction (aside from sinful). Money, he argues, not created to earn money, and doing so is a transgression. If a person is permitted to sell (or exchange) money with money (for gain), then such transaction becomes her goal, and thus money will be imprisoned and horded. Imprisonment in this form is also a transgression because it denies money to perform its function.

Then, Kurshid Ahmad (2000) asserts that money in the Islamic financial system is primarily and exclusively a measure of value, a mean of exchange and a standard for deferred payment. He also concludes that money in the conventional system is not being regarded as a commodity in itself, to be bought, sold and used to beget money. As a logical consequence of this, in an Islamic framework, money has to be operating through some real economic activity or service. It is a means (intermediary) and not self-contained agent in itself.

Therefore, with this concept and role, money becomes a crucial to any financial system. The Islamic financial system will have to offer their financial services in the form of risky open-ended “mutual fund” type packages for sale to the investor’s depositors. Thus, there will be a greater interdependence and closer relationship between investment and deposit yield since financial institutions can primarily accept investment deposits on the basis of profit loss sharing and can provide funds to the enterprises on the same basis

3. The Current Islamic Financial System Design in Malaysia

In this section, our task is to survey the landscape and identify the institutional players. By describing what financial institutions look like today, it is also revealing to see how financial institutions have evolved over the last four decades and where is the Islamic financial system currently placed?

The banking system in Malaysia, which is the major component of the financial sector, consists of Bank Negara Malaysia, 32 commercial banks, two Islamic bank, 19 finance companies, 12 merchant banks, seven discount houses and eight money and foreign exchange brokers. All of components are regulated and supervised by Bank Negara Malaysia. 

The other non-bank institutions are supervised by other government agencies. These institutions can be divided into four major groups, consisting of the development finance institutions, the saving institutions, the provident and pension funds, and a group of other financial intermediaries, comprising of building societies, unit trusts and property trusts, leasing companies, factoring companies, credit token companies, venture capital companies, special investment agencies and several financial institutions such as the National Mortgage Corporation (Cagamas) and Credit Guarantee Corporation.

The traditional banking system role has been to make long-term loans and fund them by issuing short-term deposits. But banking systems are prohibited from engaging in direct placement activities such as share ownership. While, the non-bank financial institutions such as insurance companies and pension funds; they receive investment funds from their customers; both of these institutions place their money in a variety of money-earning investments. Leasing companies; they purchase equipment/asset and then lease to businesses for a set number of years. Factoring companies; provide specialized forms of credit to businesses by making loans and purchasing accounts receivable at a discount, usually assumes responsibility for collecting the debt, specialize in bill processing and collections and to take advantage of economies of scale. Market makers; as an agent that offer to buy or sell security (trading in securities), storage the securities and insured the securities against loss, provide margin credit, cash management account services. 

The trust funds companies; pool the funds of many small investors and purchase large quantities of securities, offer a wide variety of funds designed to appeal to most investment strategies, allow the small investors to obtain the benefits of lower transaction costs in purchasing securities and reduce the risk by diversifying the portfolio. The National Mortgage Corporation; is to promote the secondary mortgage market in Malaysia, with the issuance of secondary mortgage securities, Cagamas Berhad performs the function of an intermediary to bring together the primary lenders of housing loans and investors of long-term funds. 

The evolution of financial intermediation in Malaysia is reflected in Table 1. This table shows the major financial intermediaries by assets and also by percentage share (in parentheses) from 1980 to 2002. To the extent that we can view the pace of financial intermediation as a horse race, there seem to be a clear winners and losers. For example, in terms of relative importance the winners are unit trust, Cagamas Berhad, leasing companies, factoring companies and venture capital companies. Commercial banks and finance companies are losers.

These findings raise some interesting questions. First, what caused the change in the mix of financial intermediaries? In this section, we will examine this evolutionary process via three factors.

a. Deregulation of Interest Rate

Interest rate deregulation that affects loan pricing takes its earliest form. This deregulation allows more freedom and activity to the banks and other institutions to issue new depository products as well as diversified short and long term credit instruments. Some relaxation to the banks’ portfolio was part of the liberalization that enables bank to diversify investment to private as well as the foreign equity. This made possible with the establishment of the foreign exchange market and the expansion of the underwriting activities of the financial intermediaries. Liberalization in Japan and Germany for instance, brings new paradigm to the roles of the banking institutions. The bank in Germany and Japan is no longer to be a creditor, but can also be the equity holder and in the board of directors and management.

Liberalization of the banking industry, for example in Malaysia and some other countries, take banking institution into a new dimension that is the establishment of Islamic banking. The increasing demand on the interest free banking offer by the Islamic financial institutions leads many conventional banks to offer Islamic counter or rather known as dual banking. This development happens to Muslim and non-Muslim countries.

The results show that the individuals prefer to diversify their investment other than deposits. In particular, they invest in securities such as stocks, bonds and unit trusts. Therefore, new investment in unit trust for the small saver altered permanently the financial landscape.

b. The Institutionalization of Financial Markets

Institutionalization refers to the fact that more and more funds in Malaysia have been flowing indirectly into the financial markets through financial intermediaries, particularly pension funds, trust funds and insurance companies rather than directly from savers. As a result, these “institutional players” have become much more important in the financial markets relative to individual investors.

What caused institutionalization? Quite simply, it was driven by the growth of these financial intermediaries, particularly pension and unit trust. Pension fund growth was encouraged by government policy. Tax laws, for instance, encourage employers to help their employees by substituting pension benefits for wages. This is good for employees because they do not pay taxes on their pension benefits until they are received after retirement.

Unit trusts gained considerably from these changes in pension plan laws. Defined contribution plans were allowed to include unit trust on the menu of assets for which plan members could choose. In addition, the increasing attractiveness of specialized funds such as bond funds and index funds have also fueled unit trust fund growth.

c. The Transformation of Traditional Banking

The fact that banks are exposed to the non-performing loans that stood at 9.1% for the periods of 1997 to 1999 and it seems to us that banking is a declining industry. However, first, the so-called decline of commercial banking is limited to a decline in the relative importance of commercial banking. As shown in Table 1, the decline of commercial banks’ assets as a fraction of total intermediated assets from 43.4% in 1980 to 41.3% in 2001. Table 1 also shows that banking industry assets actually increased between 1980 and 2000. In other words, bank assets have actually increased – just not as fast as the assets of other financial intermediaries. Second, many of the new innovative activities in which banks engage are not reflected on bank balance sheets as assets even though they add significantly to bank revenue. These include, for example, trading in interest rate and currency swaps, selling derivative instruments and issuing credit guarantees.

Third, banks have a strong comparative advantage in lending to individuals and small businesses. Finally, banks have joined forces with a number of other types of financial intermediaries. For example, banks have combined with unit trust funds, merchant banks, insurance companies and finance companies. Bank acquisitions of non-bank financial intermediaries are part of broader consolidation of the entire financial services industry.

With this current financial system development in Malaysia, thus where the Islamic financial system is currently placed? Malaysia has introduced a mix of the two. On the one hand they have established under the country’s legal framework a totally riba free Islamic bank with a distinct law and identity. On the other, they have created a mechanism through which any conventional bank can also have riba-free counters. In this system the two streams of riba free and riba–based banking can somehow co-exist and compete with each other.

The first model of Islamic Financial System is the establishment of Lembaga Tabung Haji (LTH) in 1963, a thrifty institution. Saving and investment activities offered by LTH are not only to those who intends to perform hajj (pilgrimage) but also to the Muslim community to participate in economic activities.

Later, in the year 1983, the Islamic banking Act that came into effect on April 7, 1983, was introduced. This earmarked the establishment of the Islamic Banking and the Islamic banking products. Similarly the government Investment Act was also enacted in 1983 to empower the Government to issue Government Investment Certificates, which are government bonds issued on Islamic basis. This allows Islamic banks investment opportunity as well as meeting their statutory liquidity requirement.

Pioneer in the Islamic Banking activities in Malaysia will be the incorporation of Bank Islam Malaysia Berhad (BIMB) which commenced operation in July 1, 1983. By 1993 BIMB has a network of 52 branches and to date it has 83 branches. The bank was listed on the Main Board of The Kuala Lumpur Stock Exchange on 17th January, 1992. Total resources of BIMB increased from RM 171 million at the end of 1983 to nearly RM 2 billion at the end of June 1993 and RM 15 billion by the end of 2001. Financing extended by BIMB increased from RM 41 million to RM 1.1 billion and to RM 8 billion for 1983, 1993 and 2001 respectively. The number of instruments has increased to 21 Islamic banking products by 1993. In 1st October 1999 Bank Muamalat was established making the number of Islamic bank to 2 banks.

In March 4 1993, Skim Pembankan Tanpa Faedah or SPTF (interest free banking) was lunched. The move to achieve a large number of institutions offering Islamic banking services and an Islamic money market to link the institutions with the instruments was gear up by the Central Bank of Malaysia. All commercial banks, merchant banks, and finance companies are eligible to participate in SPTF with specific requirements established by the bank and mainly are the set up an Interest-free Banking Unit and operate under the concept of dual banking. At the end of December 1993, 21 financial institutions were approved to offer SPTF. They consist of BIMB, 10 commercial Banks, 8 finance companies and 2 merchant banks. By then, the number of branches of financial institutions providing Islamic banking services totaled 630, of which BIMB totaled 52 and the branches of the SPTF totaled 578. By the year 2002, the Islamic banking industry in Malaysia has registered rapid annual growth of above 40% in terms of assets. The market share recorded 8.8% in total assets, 10.4% in total deposits and 7.2% in total financing as compared to its conventional counterpart. As at 30th June 2002 they are 37 Islamic banking institutions, 2 Islamic banks and 35 Islamic Banking Scheme. Even though the Islamic Banking Scheme banks comprise of 7 discount houses, 10 domestic commercial banks, 5 merchant banks, 9 finance companies and 4 foreign commercial banks, but there are over 2100 branches of Islamic banking institutions throughout Malaysia.

An Islamic money market was implemented by January 3, 1994. The Islamic inter-bank money market (IIMM) covers: inter-bank trading in Islamic financial instruments; Islamic inter-bank investments; and Islamic inter-bank cheque clearing system. For year 2001, volume of IIMM was RM277 billion (USD73 billion).

Another interesting development in Malaysia is the advent of the Islamic Insurance known as Takaful in 1984. By 30 June 2002, there are three takaful companies with composite license (family and general) with 39 domestic branches throughout Malaysia.

The National Shariah Advisory council (NSAC) was established in 1997 under Bank Negara Malayasia (Central Bank ) supervision. NSAC oversee uniformity in terms of Sharia opinions and instill discipline among banks and takaful operators. In the international arena, International Financial service Board and International Financial Market was established in year 2002. The former serves to enhance the global regulatory framework for Islamic banking and finance and the later serves to enhance liquidity on the global front.

With all these development, however, the concentration of financing is mainly in the form of mark-up (or debt) financing. As shown in Table 2, the average of mark-up financing is 95.3% of the total financing for the periods of 1983-2002. While the profit-loss sharing contribute only 1.5% of the total financing.

4. The Incentives of Regulation, Law and Accounting Standard

The rapid expansions of the financial system are actively promoted through deregulation and legal reforms that may give an incentive to foster the development of financial intermediaries and markets. The following section will further explore these elements.

a. Regulation

Financial development requires liberalization of the financial system. This will be a shift of policies from financial repression. Nevertheless, some economists like McKinnon (1973), Fry (1988), World Bank (1989), and Govannini and De Melo (1993) believe that there are policies that favor financial repression because it increases the demand for money and delivers easy inflationary revenues. He conveys that repression is the source of revenue to the government and this is done by either through high reserve requirements, taxation of financial intermediaries, capital control, interest rate ceilings, and mandatory purchases of government debt and direct credit policies which represent forms of direct and indirect financing for the government sector.

However, these policies undesirably affect economic, because the hosts of laws, regulations, taxes and restrictions that are imposed to the financial system unnecessarily suppress the development and introduction of new financial instruments and markets. In long run, these policies reduce the efficiency of the financial sector, increase the costs of intermediation, reduce the amount of investment and eventually reduce the growth rate of the economy. Therefore, countries that experienced very low growth rates are due to their underdeveloped financial system (financial repression).

These findings motivate many countries to deregulate their financial system to allow banks and other financial intermediaries to play a greater role in the economic development. New or revised regulations are, then, implemented. These regulations have a significant effect on activity, solvency and the liquidity of Islamic financial institutions. In the following discussion, we will concentrate on two important regulations, i.e., capital, price and provision.

First, capital regulation. The introduction of risk weighted capital ratio (RCWR) encourages the undercapitalized Islamic banks to reduce their holding on risky assets to lower risks assets. This eventually reduces the total risk weighted asset (TRWA) that enables the capital ratio to increase without changing the basic capital or basic capital remains constant. It shows that Islamic banks use debt-related assets to fulfill the requirement. This regulation also does not provide incentive to invest in subsidiary companies, but it increases the Islamic bank’s exposure in potentially risky off-balance-sheet transactions, such as letters of credit and over-the-counter derivatives.

Second, debt financing provision. Besides that, cosmetic changes in capital requirement can also be done through regulated accounting procedures, which generally records assets at historical costs rather than at their current market value. Eventually, Islamic banks maintain or increase its regulatory capital ratio by not recognizing losses on depreciated assets and accelerate recognition gains on assets that have appreciated in value or Islamic bank can also utilize securities gains or losses to adjust their capital ratios.

Third, price regulation. Interest rate deregulation that has been introduced since in the 1980s allows more freedom and activity to the banks and other financial institutions such as to issue new depository products as well as diversified short and long term credit instruments. In some countries like Malaysia, Pakistan, Iran and Sudan, the liberalization of financial system produces a new dimension, i.e., the establishment of Islamic banking. The increasing demand on the interest free banking offer by the Islamic financial institutions leads many conventional banks to offer Islamic counter or rather known as dual banking. This development happens not only to the Muslim countries but it also happen to the non-Muslim countries. However, the bulk of financing is used to finance the debt-related contract, thus the return on deposit is not parallel with the return on debt financing.

b. Legal Environment

The legal system that rigorously enforce contract (including laws protecting creditors and minority shareholders) tends to produce a better-developed financial system. It asserts that law and finance is a set of contracts. These contracts are defined – and made more or less effective – by legal rights and enforcement mechanisms. From this perspective, a well-functioning legal system (and also its origin) facilitates the operation of both markets and intermediaries. It is the overall level and quality of financial services – as determined by the legal system- that improves the efficient allocation of resources and economic growth.

Comparative legal scholars place countries into four legal families; French, English, German, and Scandinavian (descended from Roman law). As shown by La Porta et al. (1998) which examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules and the quality of their enforcement. The result shows that common-law countries generally have the strongest, French civil-law countries is the weakest, legal protections of investors, and German-and Scandinavian located in the middle.

In Malaysia, firm is established under the Company Act of 1965 (i.e, originally based on the common law), and most of the financial contracts also use the common law (such as hire purchase act), and even the Islamic Banking Act is only amended from the Banking and Financial Institutions Act of 1989 (BAFIA). One of the major constraints facing the Islamic Banking in the pursuance of mudarabah financing is the presence of the BAFIA Act that prohibits the lending bank possessing the borrowing company’s equity more than 5%. Besides that, the profit-loss sharing (PLS) scheme under mudarabah is constrained by the conventional nature of customer-bank relationship. Bank is refrained being in the board of directors and mitigation of the agency problem appears very costly. In addition, the Company Act of 1965 and also the current corporate finance theory believe on the tax benefits of debt-financing. Therefore, the firm’s financing preferences will be mark-up (murabahah) or leasing (ijarah) leaving mudarabah not much unattainable.

Nevertheless, BAFIA with amendments allows dual banking, to enable conventional banks to operate Islamic Banking Windows (under Islamic Banking Scheme). The permissible activities must be conducted based on profit margin and not conducted on the interest basis as stated in Section 32 of BAFIA 1993 with amendments. Furthermore, Section 124 of BAFIA amended in 1996, needed the conventional banks that wanting to carry Islamic Banking business will have approval from the Central Bank. Thus the act do protects the Islamic banking industry.

c. Accounting Environment

The accounting standard that produces the high quality, comprehensive and comparable corporate financial statements tend to produce a better developed financial system. It is the role of information about firms that is critical for exerting corporate governance and identifying the best investment. How do the accounting standards simplify, interpret and compare the information across firms (that utilize the banks’ money). The principle of reporting is comparable across firms if the use of accounting data and accounting rules are similar enough. In addition, financial contracts that use accounting measures to trigger particular actions can only be enforced if accounting measures are sufficiently clear.

With regard to the Islamic financial institutions accounting procedures, the Islamic Financial Services Board (IFSB), in agreement with Accounting and Auditing Organizations of Islamic Financial Institutions (AAOIFI) and Malaysian Accounting Standard Board for Islamic financial institutions (MASBi-1) requires all Islamic financial institutions must file financial statements with bank regulators that conform to regulatory accounting principles. The agreement states that, with respect to appropriate reserve the financial institution should have, “prudent, conservative, but not excessive loan-loss allowances that fall within an acceptable range of estimated losses.”

Most bank regulators adhere to the Basle Capital Accord 1988 (amended 1996) for the financial public disclosure and the provision of loan loss accounting. Islamic bank debt portfolios are typically 10 to 15 times larger than bank equity; therefore bank debt portfolio cash flows and default risks are likely to have an important impact on bank stock market values. Hence, high loan-loss allowances are thought to increase banks’ ability to absorb losses without becoming financially distressed or failing if all else is held constant. Thus, the extent of an increase in loan loss reserve on a bank’s capital ratio would however depend on the percentage of loan loss reserve against risk-weighted asset of a bank.

The above issue shows that the role of bank managers with regard to this provision is crucial. The bank managers have private information regarding the default risk inherent in the debt portfolio and can exercise discretion over the timing of provisions for certain loan losses. Hence, the accounting accruals are adjustable at year-end. Thus, the managers can use the loan loss provision as a tool to manage capital, earning (income smoothing) and also as signal to investors.

5. Conclusions

The establishment of the Islamic financial design is a necessity in accordance to the command of Allah. The financial intermediary roles should not only be as the funds provider but at the same time asunder the responsibilities in assessing the viability of the projects and share the risk and return under the PLS. The current development of Islamic financial system in Malaysia is encouraging, but the current design looks like the conventional bank based market. This design is strengthened by the current regulation, law and accounting environments that provide the incentives. Those incentives pose several recommendations for future research. Most importantly, the banking laws and prudential regulations need to be redefined to give a framework that induces banks to operate in a safe and prudent manner, and follow the sharia principle. In addition, the regulatory and supervisory framework can counteract the distortions introduced by public sector guarantees. The effort needs to be formalized by a consistent set of requirements governing accounting, asset valuation, supervisory reporting and public disclosure, risk taking and risk management, and entry and exit. Second, the crucial thing about the liberalization and the deregulation is the question of efficiencies. The economic efficiency of the bank can be evaluated either from the perspective of cost-minimization or revenue-maximization. This ought to be observed prior or after liberalization and deregulation. A re-regulation necessary to remedy the problem accrue if liberalization is adopted to ensure that these efficiencies are achievable.

References

Abd. Ghafar b. Ismail and Ismail b. Ahmad (2003) Does the financial design affect the capital structure? In proceeding of the International Islamic Banking Conference, Prato, Italy, 8-9 September 2003

Abd.Ghafar Ismail and Mohd Saharudin Shakrani (2003) The conditional CAPM and cross-sectional evidence of return and beta for Islamic unit trusts in Malaysia. IIUM Journal of Economics and Management Vol. 11, no.1, 1-30.

Abd. Ghafar b. Ismail and Nur Azura bt. Sanusi (2003) Zakah, tax and financing choices: a discriminant analysis of selected syariah firm in Malaysia. Proceeding of the Malaysian Finance
Association’s Fifth Annual Symposium. Multimedia University, Cyberjaya, pp. 903-915.

Basle Committee. 1999a. Capital requirements and bank behavior: The Impact of Basle Accord, April 1999.

Basle Committee. 1999b. A New Capital Adequacy Framework June 1999.

Fry, M.J. 1988 Money, interest and banking in economic development. (John Hopkins University Press, London).

Ghazanfar, S.M. and Islahi, A.Azim. Economic thought of an Arabic scholastic: Abu Hamid

al-Ghazali (A.H. 450-505/A.D. 1058-1111), History of Political Economy, Vol 22:2, 1990

Govannini, A. and M. de Melo. 1993. Government revenue from financial repression. American

Economic Review VXXXIII: 953-963.

Kurshid Ahmad. 2000. Islamic finance and banking: The challenge and Prospects. Review of Islamic Economics 9: 57-82.

La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R.W. 1998. Law and Finance. Journal of Political Economy 106: 1113-1150.

Leightner, J.E. and Lovell, C.A.K.1998. The impact of financial liberalization on the performance of Thai Banks. Journal of Economics and Business 50: 115-131.

McKinnon, R.I., (1973). Money and Capital in Economic Development. Brooking Institution, Washington DC.

World Bank. 1989. World Development Report 1989. Oxford University Press, New York.

Yusuf ‘Ali, A. 1991. The Meaning of the Holy Qura’an. Brentwood, MD: Amana Corporation.

Table 1: Malaysia: Assets of the Financial System

As at end of

1980 1990 2002

RM

million % RM

million % RM

Million %

Banking system 54 336 73.3 226 954 68.9 924 600

Monetary Institutions 45 180 60.9 171 584 52.1 199 400

Central Bank 12 994 40 914 162 200

Commercial Banks1 32 186 130 670 563 000

Non-monetary Institutions 9 156 12.4 55 370 16.8

Finance Companies 5 635 39 448 130 700

Merchant banks 2 229 11 063 41 300

Discount houses 1 292 4 859 27 400

Non-bank Financial Intermediaries 19 817 26.7 102 359 31.1 477 200

Provident, pension and Insurance funds 13 846 18.7 61 607 18.7 322 600

Employers Provident Fund 9 481 207 500

Other statutory and private provide and pension funds2

1 889

5 375

44 800

Life insurance funds 1 657 7 097 54 300

General Insurance funds 819 2 401 15 900

Development finance Institutions 2 193 2.9 6 142 1.9 71 100

Malaysian Industrial Development Finance

354

691

Agriculture Bank 813 2 073

Borneo Development Corporation 53 77

Sabah Development Bank 590 1 141

Sabah Credit Corporation 97 302

Development Bank of Malaysia 154 1 312

Industrial Bank of Malaysia 132 546

Savings institutions 2 463 3.3 8 489 2.6

National Saving bank 1 279 3 223

Co-operative Societies3 1 184 5 266

Other financial intermediaries 1 315 1.8 26 121 7.9

Unit Trust 109 13 470

Building societies4 999 1 876

Pilgrims Management and Fund Board 197 1 227

Cagarmas Berhad 0 3 238

Credit Guarantee Corporation 10 712

Leasing companies n.a. 5 285

Factoring Companies n.a. 220

Venture capital companies n.a. 93

Total 74 153 100 329 313 100 1 401 800

1. Include Bank Islam

2. Include Teachers Provident Fund, Armed Forces Fund, Social Security Organization, Pension Trust fund and other provident funds.

3. Include Bank Rakyat, Co-operative Central Bank and other co-operatives Societies

4. Bornoe Housing Mortgage Finance and Malaysia Building Society Berhad.

Source: Money and Banking in Malaysia, published by Bank Negara Malaysia

Table 2: The Structure of Financing Operations of

Bank Islam Malaysia, 1983-2001

Year Mark-up Financing Profit and Loss Sharing Other Financing

1983 95.5% 4.2% 0.3%

1984 92.7% 1.7% 5.6%

1985 99.9% 0.1% 0.0%

1986 99.7% 0.3% 0.0%

1987 98.4% -0.4% 2.0%

1988 98.1% -0.3% 2.2%

1989 83.9% 0.4% 15.7%

1990 96.3% 0.4% 3.3%

1991 93.3% 0.9% 5.8%

1992 96.9% 0.3% 2.8%

1993 88.3% 11.6% 1.0%

1994 100.6% -0.6% 0.3%

1995 99.6% 0.3% 0.1%

1996 99.1% 0.8% 0.01%

1997 99.0% 1.0% 0.0%

1998 99.4% 0.6% 0.0%

1999 99.5% 0.5% 0.0%

2000 99.7% 0.3% 0.0%

2001 99.7% 0.3% 0.0%

2002 99.0% 0.7% 0.3%

Mean 95.3% 1.5% 3.2%

Std Dev 4.8% 3.2% 4.2%

Notes:

1. Data represents flow of financing. 2. The various instruments used were aggregated to conform to

the profit-loss sharing and markup definitions. Other financing includes social loans and direct investments.

Source: Bank Negara Malaysia, Annual Reports, 1983-2001