UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for January 24, 2011

Bank Negara Malaysia: The Central Bank of Malaysia and the Malaysian Financial System

Bank Negara Malaysia is the sole currency issuing authority and the main regulatory authority of all monetary and non-monetary institutions and Development Finance Institutions (DFI’s) in Malaysia.  DFI’s are enterprises owned largely by the public sector engaged in mobilizing financial resources to supplement the development efforts of the government.  In regards to DFI’s, Bank Negara Malaysia promotes effective and efficient DFI’s with the goal that they will eventually minimize government cost in meeting its policy objectives.

Bank Negara Malaysia is at the core of the Regulatory Framework of the Malaysian Financial System.  Two of the objectives of Bank Negara Malaysia are in fact:

  1. To promote monetary stability and a sound financial structure; and
  2. To influence the credit situation to the advantage of Malaysia.

These objectives give bank Negara Malaysia responsibility over matters affecting monetary and prudential control.  The bank is thus charged with implementing all regulations concerned with these matters as per Malaysian law as well as issuing policies and directives to further implement these regulations.  In addition, Bank Negara Malaysia must formulate new policies and/or correct old policies when needed.  Only one entity stands above Bank Negara Malaysia and that is the Minister of Finance of Malaysia, however, the Minister acts as sort of a puppet of the Bank Negara Malaysia as the Minister only acts after an action is initiated by Bank Negara Malaysia.  Although having the Finance Minister in this role is intended to limit the power of Bank Negara Malaysia, the Bank Negara Malaysia in fact acts as the main regulatory authority of the Malaysian financial system…setting benchmarks and model contracts, which you can find in many of my Islamic finance posts on this website.

Other entities have since been created to regulate various sectors of Malaysia’s financial system.

For example, on the recommendation of Bank Negara Malaysia, the Malaysian government created the Securities Commission, which was established in March 1993 under the Malaysian Securities Commission Act 1993.  The Securities Commission took over the regulation of the securities, options, and financial futures industries and other capital market instruments in Malaysia and complemented Bank Negara Malaysia as the supervisor of the banking industry, the money market, and its participants.

The money market is a market for securities that when originally issued had less than 12 months to maturity.  The money markets comprise the inter-bank market where the lending and borrowing of short term funds take place as well as the market for short- term money market papers.  Short -term money market papers includes negotiable instruments of deposits, bankers’ acceptances, repurchase agreements and bills issued by the Treasury and Bank Negara Malaysia.

The capital market comprises a primary securities market and a secondary securities market and is regulated by the Securities Commission and Companies Act 1965.  In the primary market, new securities are sold, hence its association with initial public offerings while the secondary securities market is where outstanding issues of securities are traded.  The primary market is used to raise new capital for enterprises while the secondary market provides the requisite liquidity for investors to arrange their portfolio to best meet their individual needs.

An Islamic inter-bank money market (IIMM) was introduced in the Malaysian financial system in January of 1994, which linked all institutions and instruments together.  The IIMM covers inter-bank trading in Islamic financial instruments, Al-Mudharabah Inter-bank investment, and an Islamic Inter-bank Cheque Clearing System.    Islamic banks and banks under the IBS are allowed to trade in Islamic financial instruments.  Al Mudharabah Inter-bank investment refers to a mechanism whereby a surplus IBS bank can invest in another IBS bank, which has a deficit on the basis of Al Mudharabah (profit-sharing).  A new cheque clearing system was introduced, which separated Islamic and conventional cheques for clearing purposes and is also based on the principle of Al Mudharabah.

In addition, the Futures Industry Act of 1993 provides for an underlying regulatory framework for trading in options and financial futures.  Self-Regulatory Organizations including the Kuala Lumpur Stock Exchange (KLSE) complement the role of the Securities Commission to ensure the development of a capital market that is in accordance with the commercial aspirations and needs of Malaysia.  (The trading of listed securities in Malaysia takes place mainly on the KLSE and the Malaysian Exchange of Securities and Automated Quotation (MESDAQ)).

Furthermore, Labuan Offshore Financial Services Authority (LOFSA) was set up in 1996 to regulate the Labuan Offshore Jurisdiction and to develop and promote Labuan as an international offshore financial center.  (IOFC)

The Commodity and Monetary Exchange of Malaysia (COMMEX) is a futures and options exchange formed by the merger of the Malaysian Monetary Exchange Berhad and the Kuala Lumpur Commodity Exchange in 1998.  Crude Palm Oil Futures and KL Inter-bank Offered Rate (KLIBOR) interest rate futures contracts are traded on COMMEX.

The Kuala Lumpur Options and Financial Futures Exchange (KLOFFE) is Malaysia’s financial derivatives exchange, which allows the trading of equity-based derivatives contracts such as stock index futures, stock index options, and stock options.  KLOFFE is a wholly owned subsidiary of KLSE.

In June of 2001, the Malaysian Derivatives Exchange Berhad (MDEX) was formed as a subsidiary of KLSE after the merger of KLOFFE and COMMEX.

In addition, to ensure the development of the Islamic Finance industry in Malaysia, the Association of Islamic Banking Institutions Malaysia (AIBIM) was formed to serve as a forum for addressing issues related to Islamic Banking and to chart out future plans for the industry and an Islamic Banking and Finance Institute (IBFIM) was launched to strengthen the industry and its practitioners.  IBFIM was formed in 2001 and  serves as a one-stop shop  for providing education, training and research on Islamic financial services concerning Islamic banking, Takaful and Islamic capital markets at both the domestic and international levels and arenas.

*Information taken from the Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

Bank Islam Malaysia Berhad (BIMB) and Bank Muamalat Malaysia Berhad (BMMB)


Malaysia’s first Islamic bank, Bank Islam Malaysia Berhad (BIMB) was incorporated as a public company under the Malaysian Companies Act 1965 in March of 1983.  Malaysia’s second Islamic bank, Bank Muamalat Malaysia Berhad (BMMB) was established in 1999.

Guiding Principles of Malaysia’s Islamic Banks:

  1. ‘Prohibition of Riba (Interest) and the sharing of profit and losses.  Profit and loss sharing is the basis of all economic activities involving money, wealth, and labor in Islam.  The concept of profit- sharing should replace interest in the Islamic banking system.
  2. Management of Islamic Banks based on Islamic Acts and Practices (Mu’amalah Islamiah). The success of the Islamic bank is based on the understanding of Mu’amalah Islamiah (Islamic Acts and Practices) by the management, followed by the observation of these practices as required by Islam.  In other words, all management activities should not contravene these Islamic principles.
  3. Avoidance of the activities contradictory to the interest of the Muslim ummah.  Any activity which is not in conformity with the interests of the ummah is tantamount to misuse and abuse of the wealth entrusted by God.

The National Steering Committee on Islamic Banking set up by the Government of Malaysia set up by the Government of Malaysia in July of 1981with the following mandate:

To study and identify various critical aspects of Islamic banking such as the basis of establishment, the areas of operations, and the business relationship with the customers and other financial institutions.

  1. To examine the suitability of Islamic Banking in the Malaysian context from various points of view, including the religious, legal, racial, social and development angles;
  2. To present to the government a proposal to establish Bank Islam Malaysia in a complete report encompassing the following aspects:- the fundamental concepts of Islamic banking, the legal framework, the structure of the company, the areas of operation and the organizational structure.

The Islamic Banking Act 1983 of Malaysia incorporates the following recommendations of the National Steering Committee on Islamic Banking set up by the Government of Malaysia in July of 1981:

  1. An Islamic bank, which operates according to the rules of Shari’ah should be established.  The bank should be able to provide services to Muslims as well as operate on a profitable basis.
  2. Considering that the concept of an Islamic bank is new to this country, the Committee was of the view that only one Islamic Bank be established initially.  The establishment of other Islamic banks would be considered only after the proposed initial Islamic Bank is seen to be able to operate smoothly and efficiently.
  3. The proposed Islamic Bank should be incorporated as a limited company under the Companies Act 1965.  The Committee noted that the Islamic Bank could be established either as a statutory body or a company carrying on banking business.  The Committee considered that it was preferable for the Islamic bank to be established as a company so that it could operate as a business concern and not as a government agency, although the Islamic bank had features of social welfare in line with Islamic teachings.  It should be free to operate alongside the other banks, without being constrained by regulations normally imposed on statutory bodies.  Furthermore, the Committee noted that although the Islamic bank was to have a number of corporate objectives pertaining to the social and spiritual well-being of society, it was still a business institution.  In the final analysis, such a business institution would have to depend for its survival on its business viability and performance as a basis for all business dealings.  The incorporation of the Islamic bank under the Companies Act 1965, therefore, would be more in line with the concept and philosophy of an Islamic Bank.
  4. In order to provide for licensing and supervision of the Islamic Bank, an Act styled the Islamic Banking Act would need to be legislated and consequential amendments made to existing related acts.
  5. Bank Negara Malaysia should administer the Islamic Banking Act.
  6. The Islamic Bank should set up a Religious Supervisory Council to ensure that the bank operates according to the rules of Shari’ah.
  7. The proposed Islamic bank should be named “Bank Islam Malaysia Berhad.”’

*Information taken from the Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

The Advent of Islamic Banking

Islam is not only a religion but a complete code of conduct of life covering legal and economic affairs for Muslims.  Islam developed the concept of Bait-al-Mal (Treasury of the Muslim State), which correlates to the modern central banking system long before the modern Western banking system came into existence.

What distinguishes Islamic economics from Western conventional finance is the absence of interest-based transactions as the taking or giving of interest (Riba) violates the Sharia’h Law.  Therefore, financing in Islam is only allowed on an interest free basis.  (Q’uran: Surah Al-Baqarah (2)275/280; Surah An-Nisa (4)/160-16; Surah Al Rum (30/130).  In contrast, the modern Western banking system rests on the principle of the giving and taking of interest.

The first Islamic Banking experiment emerged in Mit Ghamr, Egypt in 1963.  Consequent to this experiment, proposals were submitted to the Second Islamic Conference of Foreign Ministers in 1971 for establishing an Islamic Bank and an Association of Islamic Banks.  This led to the adoption of the Charter of the Islamic Development Bank in 1974 and since then many Islamic Banks have come into existence including the Dubai Islamic Bank in 1975 and the Kuwaiti Finance House in 1977.

*Information taken from the Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan.  (2003)

Interesting Report Related to the Advent of Islamic Banking

Islamic Development Bank

IDB in Brief



IDB Articles of Agreement

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance