Islamic banking in Malaysia – A review

Background

Islamic banking is a subset of Islamic economics which emphasis among others on hard work to obtain income, universal brotherhood in establishing social order, and satujustice in all dealings. Thus begging is basically abhorred, the giving of alms or zakat is institutionalised in the religion and appropriate wages should be given by employers to their employees for the labour done.

One aspect of Islamic economics that engulfs Islamic banking almost exclusively compared to conventional banking is the prohibition of the payment and acceptance of interest, or riba. Depositors into Islamic banks become partners of the banks’ investment decision, sharing the profits and losses instead of just mere capital owners who must get paid with interest on their money. Instead of interest paid to depositors, dividends are paid to the depositors for their money used as investment by the banks. Instead of interest, profit margin is charged on money borrowed which has a finite amount instead of the ever growing compounding effect that interest-based loans are notorious for.

Apart from the prohibition of riba, the investments that the banks involve in must also be in accordance to the principles of shariah. Any dealings with alcohol and pork business are to be avoided. On top of that, any morally unacceptable business such as prostitution and gambling should also be shunned.

The Islamic Banking Industry

The Islamic banking industry is not unlike conventional banking industry as it offers almost the same service to the customers. The difference is it follows the Islamic principles of shariah in its transactions,  the most significant difference being the giving and accepting of interest or riba which are strictly prohibited. It is not a stranger to the financial industry of the world as it is present at all four corners of the globe. As of 2005, a quarter of Islamic banking or financial institutions actually operate in non-majority muslim countries (Taap et al, 2011). This presence is not merely small banks by individual muslim immigrants in the non-muslim countries. The Islamic banking industry is growing so fast, even large banks in developed countries have already begun to show interest in Islamic banking (Sufian, 2007).

The products and services by Islamic banks usually complement the conventional counterparts, except that they are devoid of the riba element and most notably named using Arabic terms. Some of the Islamic products offered by Islamic banks are Wadiah Yad Dhamanah (savings with guarantee), Mudharabah (profit sharing), Murabahah (cost plus),  Ijarah (leasing), Musyarakah (partnership), Bai’ Bithaman Ajil (deferred payment sale), and Qardhul Hasan (benevolent loan) (Yahya et al, 2012). The first product is equivalent to savings account in conventional banks, the second two products are equivalent to investment deposits while the last four are loans either commercial, mortgage or personal.

The Growth of Islamic Banking and Service in Malaysia

Financial services based on Islamic principles started in Malaysia in the early 1960’s by the introduction of Pilgrims Fund Board (Tabung Haji) although it is not a full fledge banking system yet (Sufian, 2007). The main reason for the set up of Tabung Haji was for the people to put their money for the pilgrim to Mecca purpose. Even if people during those days did keep their money at conventional banks, for this particular holy reason, it would be very odd to save the money in non-islamic financial institutions, thus this idea was mooted out. The first true fully functional Islamic bank in Malaysia is Bank Islam Malaysia Berhad (BIMB) which is set up in 1983 (Echchabi and Olaniyi, 2012). Upon introduction in the early 1980’s, BIMB and other Islamic banking institutions immediately offer competition to the conventional banking system as it can cater to the need of the muslim population that sought shariah compliance banking service (Haron et al, 1994).

Despite being constrained by Islamic principles that limit the products it could offer, Islamic banks in Malaysia prove to be able to achieve the same level of efficiency with conventional banks since its inception in the 1980’s (Yahya et al, 2012). This is true for the consumer products like deposits and loans since the Islamic money market that allows for inter-bank investment was only introduced in the mid-1990’s (Yahya et al, 2012). In terms of assets, Islamic banking sector in Malaysia recorded a mere amount of about RM18 billion to a staggering amount of RM77 billion, between the period of 1997 to 2003 (Mokhtar et al, 2008). In terms of growth, Islamic banking sector in Malaysia reached 18% annually within the period of 2000 to 2005 (Dusuki and Abdullah, 2006). As of October 2005, there are two full fledge Islamic banks including the first bank BIMB, three full fledge foreign Islamic banks, three Islamic bank subsidiaries, 11 banks operating the Islamic window, four Islamic merchant banks and eight Islamic financial institutions (finance companies and discout houses) (Laldin, 2008).

Islamic Banking Operations in Malaysia

Malaysia has a unique situation whereby it has both the conventional and Islamic banks at the same time. In fact, Malaysia is among the first countries to implement dual banking system of conventional and Islamic operating side by side (Echchabi and Olaniyi, 2012). Apart from the locally set up Islamic banks, the government even gives license to foreign Islamic banks to open branches in Malaysia to increase participants in Islamic banking service in Malaysia, (Laldin, 2008).

Islamic banking service in Malaysia is offered by stand alone full fledge  Islamic banks or conventional banks offering Islamic banking services and products via Islamic windows (Dusuki and Abdullah, 2006). The Islamic window is a concept introduced by the central bank of Malaysia (Bank Negara) whereby conventional banks also offer Islamic products alongside the conventional products within the same setting by the same personnel. Initially, Islamic banks faced stiff competition from the long established conventional banking system (Dusuki and Abdullah, 2006). The introduction of the Islamic window is able to mitigate this since the Islamic products also become a source of profits for the conventional banks. Some of the conventional banks offering Islamic banking service under Islamic window have achieved a significant volume of transactions in its Islamic window that they even set up a full fledge Islamic bank subsidiary (Laldin, 2008).

Within the Malaysian context, it is required by the Bank Negara for the banks to have shariah consultants to ensure they comply with Islamic principles in their dealings (Laldin, 2008). These shariah consultants usually sit in a shariah board of the banks or financial institutions and consist of reputable scholars in the area of Islamic finance and banking.

The Reasons to Choose Islamic Banking in the Malaysian Context

It is noted that many studies indicate that religion is not an overriding factor for customers to opt for banking services but rather quality of service and products (Haron et al, 1994). This means that unlike other Islamic related matters such as choice of food and choice of places of worship, Islamic banking service is considered an alternative and not a must even by the muslim consumers themselves. A study by Amin et al  (2009) for the reason of their choice of banking service to get a house mortgage amongst the all muslims respondents, quality of service trumps both Islamic principles and even price (profit or interest).

A study indicates that understanding of the Islamic banking operations is one of the most important criteria for both muslims and non-muslims to use Islamic banking service (Haron et al, 1994). Therefore, both types of customers would be open to adopt Islamic banking if they understand more of the Islamic products offered in terms of difference with the conventional products as well as the benefits they gain. On top of that, fast and efficient service, friendliness of bank personnel and reference by family members are amongst the strongest factors shared between muslim and non-muslim consumers when choosing banking service in Malaysia (Haron et al, 1994). In this sense, it still boils down to quality in order to attract consumers be it Islamic or conventional banks. Thus, Islamic banks should give excellent services and competitive financial products since first it cannot rely solely on muslim consumers to be their clients and second it can also attract non-muslim consumers by having the quality service in place (Haron et al, 1994).

Nevertheless, there is still a dissenting view on the matter. Despite most questionnaire respondents putting service quality as the reasons to choose Islamic banking products, interviews conducted amongs muslim consumers reveal that shariah principles as the main factor to choose Islamic banking service amongst muslim consumers (Echchabi and Olaniyi, 2012). From this point of view the way the study is conducted becomes a point of difference whereby quantitative method reflect service quality as the main criteria while qualitative method reflect Islamic principles as the main reason to opt for Islamic banking.

Issues in Islamic Banking Service in Malaysia

The employees’ incompetence and lack of courtesy in Islamic banking sectors have been cited as some of the main reasons customers decided not continue to patronize Islamic banks (Dusuki and Abdullah, 2006). This is very disappointing since not only it drives people away from using a shariah based service as wanted by Islam but also reflects Islam in a bad way if the consumer happens to be non-muslim. Since Islamic banks claim to provide ethically superior products due to the Islamic nature, there is a need for them to offer services at a high quality as well since both should come hand in hand (Dusuki and Abdullah, 2006).

One of the main issues in Islamic banking institutions is that the Islamic principles adopted in Islamic banks are said to touch only the shariah compliance side but neglect the social welfare side (Dusuki, 2008). Thus, not only there is no difference from any profit making instituitions such as conventional banks, it also does not adhere to the spirit of Islam when conducting business. Social welfare initiatives by Islamic banks actually could also contribute to profits if looked at the point of view of marketing strategy (Dusuki, 2008). People might be inclined to use Islamic banks in order for them to share with the welfare initiatives by the banks. Offering ‘payment holiday’ to customers for certain months is one of the ways one of the Islamic banks in Malaysia help the social need of the people (Amin et al, 2009). This is offered usually at the end of the year because some parents may need the money more to buy new school attires and equipment for the start of the new academic year for their children.

Another issue worth to mention on Islamic banking service in Malaysia is that personnel of conventional banks offering Islamic window do not seem to give equal emphasis to the conventional and Islamic products where they tend to be bias to the former (Taap et al, 2011). It is always the conventional products becoming the default product for house financing for example, while the Islamic products are only offered upon request by the customers.   

Discussion and Conclusion

From the literature there are two views on the reason why Malaysian muslim customers opt for Islamic banking. On one hand, quality service overrides religion, which means they would go for conventional banking service should the quality of service in Islamic banks is not up to standard. On the other hand, religion is the main factor to choose Islamic banking without any doubt, since the need for a shariah compliant service. The divergence occurs via the method of study, whereby the former view is the result of quantitative survey while the later view is from qualitative interview.

There could be several factors leading to this divergent. First, the qualitative interview is more limited in the number of respondents, thus the sampling may be not representative as compared to quantitative survey that covers the wider population. Second, during quantitative survey, respondents may use the opportunity to stress quality as a way to encourage Islamic banks to offer quality service instead of actually saying they choose Islamic banks only if it offers quality service. To conclude, both  religion and quality service are important aspect to bank users and Islamic banks should strive to achieve both compliance and excellence.

Not unlike conventional banks, Islamic banks also are set up for business purposes. However, there is an issue of how it neglects the social welfare aspect of Islam, using the label Islam only by having interest or riba free transactions. The cost of doing business with Islamic banks is not cheaper than their conventional counterparts since the profit rate is somehow tied to the interest rate so there is no contribution to the social need of muslims at least in that aspect. There is one bank giving payment holiday so that the customers need not pay their instalment for some months at times of financial need. Aside from that, there could be found almost none financial products that could help the socio-economy of the muslims. In the end, this issue is very real.

One of the reasons this happen is perhaps most of Islamic banks today are set up to tap the opportunity from the demand of shariah compliant products instead of to cater for the need of shariah compliant products. The former is more of a commercial reason, which precipitates the set up of Islamic windows and Islamic subsidiaries by conventional banks. The later are only represented by the initial islamic financial institutions, Tabung Haji which goes extra mile to help pilgrims with subsidies and service beyond the savings of the depositors, and by BIMB, which offers the payment holiday options. Thus, there is a need to study the matter and to encourage Islamic banks to also go for social welfare aspect of Islam by emphasising at both the Islamic values as well as the strategic gains.

On the issue of conventional banks’ personnel offering conventional products by defaults when it comes to Islamic windows, the reason is perhaps they view that both conventional and Islamic products give the same profit to their organization, and second, there is no significant different of the two types of products except for having extra documentations for the Islamic products. The extra documentations are that of ‘akad’ or Islamic contracts. This is quite disappointing as some of the customers especially the muslim ones perhaps would want Islamic products instead. The personnel should be educated on the differences between conventional and Islamic banking in order for them to better appreciate the difference in concepts and thus would give equal emphasis on both products.

As a conclusion, there is still room for improvement for Islamic banking in Malaysia, in terms of quality of its service, social responsibility aspect of Islam and equal treatment especially in Islamic windows. The institutions should do this in the spirit of Islam, by upholding excellence service, by looking beyond commercial gains, and by understanding the religion and its concepts more.

Lufti Abbas bin Bidin
ISMA Gombak Activist
PETRONAS Reservoir Engineer
Master of Management, IIUM

References

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