Malaysia Toward an Islamic State

MALAYSIAN ISLAMIC MONEY MARKET

When Bank Negara Malaysia set out to introduce Islamic banking in Malaysia in the early 1980s, it had in mind a two-phased approach. In the first phase, the bank wanted to ensure that the Islamic banking system contained all the three important components of a viable banking system, namely a large number of Islamic financial instruments to meet the various needs of the Muslim business community, a large number of financial institutions providing Islamic financing facilities and an Islamic inter bank money market. The Islamic inter bank money market, by linking the institutions and the instruments, was expected to provide depth to the Islamic financial system.

Malaysia’s first Islamic bank, Bank Islam Malaysia Berhad (BIMB) was set up in 1983, licensed under section 3 (4) of the Islamic Banking Act 1983. The first 10 years were concentrated on developing a large number of Islamic financial instruments. By early 1993, a total of 21 Islamic financial products had successfully been introduced, to meet the needs of the Muslim business community in Malaysia.

The next step was to create a large number of financial instruments offering Islamic products. Bank Negara implemented this in 1993 by allowing existing commercial banks, finance companies and merchant banks to offer Islamic banking services on a parallel basis with their conventional banking services.   The scheme was called Skim Perbankan Tanpa Faedah (IBD OF) or Interest-Free Banking Scheme. By the end of 1993, two of the three components for a viable Islamic banking system were already in place.

What remained missing was the third component, namely and Islamic Inter bank Money Market (IIMM). Bank Negara introduced this on January 3, 1994. The scope of activities of the IIMM included the purchase and sale of Islamic financial instruments among market participants (including the Bank), inter bank investment activities through the Mudaraba Inter bank Investment (MII) Scheme and a cheque clearing and settlement system through an Islamic Inter bank Cheque Clearing System (IICCS).

The Islamic financial instruments that are currently being traded in the IIMM on the basis of Bai al Dayn, are the Green bankers acceptances, Islamic accepted bills, Islamic mortgage bonds and Islamic private debt securities. The total cumulative volume of transactions in the IIMM since January 1994 is about RM2.5 billion ($1 billion).

In addition, financial institutions can sell Government Investment Issues (GIIs) to the Central Bank as and when required to meet their liquidity needs. GIIs are government securities issued on an Islamic basis, which financial institutions can also buy from the Central Bank, depending on availability.

Although there were no major teething problems during the implementation of the IIMM, one drawback the scheme continues to face is the inadequate amount of tradeable Islamic papers. Efforts will have to be expanded to create a critical mass of Islamic financing papers that can be easily traded in the IIMM.
 

Al-Mudaraba Interbank Investment

The Al-Mudaraba Interbank Investment (MII) enable IBD of banks, (defined to include Bank Islam Malaysia), to obtain funds from another IBD of bank on a Mudaraba (profit-sharing) basis. The period of investment is from overnight to 12 months. The minimum amount of investment for the MII is RM50,000. The rate of return is based on the rate of gross profit before distribution for investments of one year of the receiving bank, while the profit-sharing ratio is negotiable.  When an IBD OF bank obtains investment from another IBD of bank for any period, the principal invested is repaid at the end of the period, together with a share of the profit arising from the use of the fund by the receiving bank. All profit calculations are based on above formula.

 

Islamic Inter bank Cheque Clearing System

IBD of commercial banks also participate in the Islamic Interbank Cheque Clearing System (IICCS) at the Kuala Lumpur Automated Clearing House (KLACH). Currently these banks are required to maintain an IBD of clearing account at the Bank Negara on a Al-Wadiah Yad Dhamanah (guaranteed safe-custody) basis. Bank Negara Malaysia allocates and squares the positions of the surplus and the deficit banks at the midnight clearing. Any surplus funds of the IBD of commercial banks at the midnight clearing are automatically invested with the deficit banks, by applying the same formula used in the MII:

    X = Prt (k)  36500

The profit sharing ratio used for the calculation of profit is fixed at 70:30 in favour of the provider of the funds. Surplus funds distributed to the deficit banks are allocated on the following principles:

* Where the total surplus is larger than the total deficit, the total investment of a surplus bank (for example, Bank Bumiputra) is calculated as follows:
 

   Bank Bumiputra’s surplus x Overall deficit Overall surplus

* The funds derived from the formula are first invested with the bank with the largest deficit, and any remaining balance to the next deficit bank and so on;

* Where the total surplus is less than the total deficit, the entire surplus of each bank is invested on the principle that the bank with the largest surplus first invests with the bank with the largest deficit.
 

Government Investment Certificate (GIC)

Government Investment Certificates were introduced in 1983, with the establishment of the Islamic bank. The government issued for the first time non interest bearing Government Investment Certificate to meet the special needs of the bank and other corporations who are interested in these securities. The Islamic bank governed by Shariah law, is not allowed to hold interest bearing government securities. The Government Investment Act 1983 under which certificates are issued, provides certificates with maturities of one year or more to be issued and for dividend instead of interest, to be paid on the certificates.
 

Cagamas Mudharabah Bonds

Cagamas Mudharabah Bonds were introduced in 1 March 1994. Cagamas Mudharabah Bonds involved with the purchase of Islamic housing debts by Cagamas from institutions that provide Islamic housing finance to their clients and staff. The issuance of bonds are based on Al-Mudharabah concept by Cagamas for finance these purchases. The purchase of housing debt on Islamic principles by Cagamas is managed based on the Bai’ Al-Dayn concept whereas the issued of Cagamas Mudharabah bonds is based on the All-Mudharabah concept. Under this concept the bondholder and Cagamas will share profits according to ratios agreed earlier together. The agreements pertaining to the purchase of housing debt based on Islamic principles will be sealed between Cagamas Berhad and Bank Islam Malaysia Berhad. Cagamas will purchase housing debts amounting RM30 billion from Bank Islam. As a result of this agreements, a total of RM30 billion of Cagamas Mudharabah Bonds is created. Government has distribute RM30 billion worth of bonds to financial institution that offer Islamic banking (for pricing of Cagamas Mudharabah Bonds, see Appendix 1).

Islamic Accepted Bills (IAB)

Islamic Accepted Bills as an order to a bank by a bank customer to pay a sum of money at a future date. When the bank endorses the order for payment as accepted, it assumes responsibility for ultimate payment to the holder of the acceptances. This bills can be used for import or purchase and export for sales, with one condition, the trade of “halal” goods. The details are as follows:-

1. IAB-Import or Purchase
The customer can approach the bank to provide financing for his working capital requirements to purchase stock and inventories, spares and replacements, or semi finished goods and raw materials. First the bank purchases or appoints the customer as its agent to purchase the required goods on its behalf and settles the purchase price from its own funds. Then, the bank sells the goods to the customer at an agreed price comprising its purchase price and a profit margin and allows the customer to settle this sale price on a deferred term of 30 days, 60 days or 90 days or other period. Lastly, on the due date the customer pays the Bank the agreed sale price on maturity date of the financing. Islamic Accepted Bills can be traded in the secondary market.

2. IAB-Export or Sales
The bank finances exports and sales under the principle of Bai Al-Dayn. Under this bill, an exporter who wishes to avail himself of this facility, prepares export documents as required under the sale of contract or letter of credit. He represents these documents to the Bank to be purchased. As the export documents have to be sent to the buyer overseas, the exporter is requests by the bank to draw another Bill of Exchange drawn on the bank. This bill is known as IAB-Exports. The IAB-Exports can be traded in secondary market.
 

 “Green” Bankers Acceptance
Banks may purchase BA issued by other banks (inclusive of conventional banks) provided that it is a “halal” BA. To be considered as “halal”, the BA must be:-
  a. An export or sales BA
  b. Drawn to finance “halal” goods or commodity.

Repurchase Agreements

Although the application of repo in Islamic banking is not exactly the same as the conventional repo, the conceptual framework is still the same. Thus repo in conventional banking is an agreement under which a seller of securities undertakes to repurchase the securities from a buyer at an agreed price on a specified future date. However in Islamic banking, the agreement to repurchase back the securities is just an agreement and not a condition for the contract to be settled. Thus this means that there are two contracts involved in Islamic repo. The first one is to sell the securities and the second one is to purchase back the securities. The first contract is an outright sale and thus the buyer of the securities is not oblige to sell back the securities to the original buyer if he does not wants to as the title has been fully transferred to the buyer. Thus in the accounting entries of the seller, the transaction is recorded as contingent liability/asset of the bank and not a direct liability. Thus in the first leg of transaction where the securities is sold to the buyer, the transaction is still recorded as contingent liability. However, if the buyer decides not to sell back the securities, the eligible liabilities will cease from the seller’s account.

Sell and Buy Back Agreement (Islamic Repo)

1. Under the Sell and Buy Back Agreement (SBBA), the transacting parties shall enter into two  separate agreements as follows:

1. First agreement – the seller (owner) of INI sells and the buyer (investor) buys the instrument at a specified price agreed by both parties; and  
2. Second agreement – a forward purchase agreement whereby the buyer (investor) promises to sell back the INI to the original owner who shall buy it back at a specified price on a specified future date.

2. Ownership of the INI shall be transferred to the buyer (investor) upon conclusion of the first agreement of the SBBA.
3. An INI may be sold under SBBA, subject to the following conditions:
   (i) An Issuer shall not buy its own INI under SBBA; and
   (ii) The tenor of the SBBA must be within the tenor of the INI used for the transaction. 
4. The INI used for the SBBA is not required to be delivered, unless otherwise agreed by the two transacting parties.
5. Where the SBBA transaction involves an INI that does not pay interim dividends or coupon profits (as in the case of NIDC), the amount of proceeds receivable by the seller under the first agreement of the SBBA shall not exceed the nominal value of the INI.
6. A licensed financial institution may provide on a regular basis a two-way quotation either by quoting rates or profit-sharing
   ratio to indicate its willingness to enter into SBBA.
7. Upon it release, the Guidelines on Sell and Buy Back Agreement shall govern SBBA transactions involving INI.
    

Islamic Private Debt Securities

Islamic Private Debt Securities (IPDS) has been introduced since 1990. At the moment, IDS have been introduced using different types of Syariah concept namely through Bai Bithaman Ajil, al-Musharakah, al-Mudharabah, Qardhu ul Hassan, Murabahah etc. Under the concept of Bai’ Bithaman Ajil the financiers will purchase an asset from the borrower and later resell the assets at a higher price which contain the cost and profile element. The loan which arise from the finance will be securitised through the issuance of two notes that is the primary notes which is equivalent to the asset price that is purchased by the financiers from the borrower and secondary notes which is equivalent to the profit value of the resell price.   Both of these notes will be traded in the secondary market under the concept of Bai’ al Dayn.

Through Qardhu ul Hassan, the issuer of the notes will be able to arrange the repayment of the loan which was given by the parent company. The IDS note is the evidence of debt for the amount which is yet to be repaid. Through the IDS, the loan will be repaid by liquidating the IDS after certain period of time.   The IDS is issued together with the Transferable Subscription Right (TSR). The TSR is the form of a “gift” (hibah) to the holder of the papers. The IDS is an alternative to the issuance of the conventional zero coupon bond.