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Conflicts Facing Islamic Banking in Malaysia:

Dual Banking System Versus Dual Legal System

Article · January 2012

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Australian Journal of Basic and Applied Sciences, 6(11): 246-251, 2012
ISSN 1991-8178

Conflicts Facing Islamic Banking in Malaysia: Dual Banking System Versus Dual
Legal System
1
Uzaimah Ibrahim, 2Aishath Muneeza, 3Rusni Hassan
1
Assistant Professor, Ahmad Ibrahim Kulliyyah of Laws, International Islamic University Malaysia,
Malaysia
2
Aishath Muneeza, Head of Islamic Finance, Capital Market Development Authority of Maldives
3
Associate Professor, Ahmad Ibrahim Kulliyyah of Laws, International Islamic University Malaysia,
Malaysia

Abstract: Islamic banking is everywhere in the world today. But Malaysia is still considered as the
leader and cranium of Islamic banking as it has succeeded in creating a full fledge Islamic banking
system parallel to the existing conventional system irrespective of the challenges it faced. Today, the
new Central Bank of Malaysia Act 2009 has openly declared this reality to the world. Section 27 of the
new Central Bank of Malaysia Actstates that Malaysia has dual financial systems that works in parallel
that are conventional and Islamic financial system.The adoption of dual banking system is, however
been perceived as creating the room for possible legal conflicts. The possible legal conflicts may be
due to the fact that the law applicable to Islamic banking is not totally derived from Islamic law and
the judiciary system of the country is complex as the court that hears Islamic banking matters are Civil
Courts. This paper aims to unravel the reasons or cause of obstaclesin Islamic banking in the
Malaysian dual banking structure. This research is novel as few literatures are found on the reason for
the cause of conflicts even after the establishing and sustaining Islamic banking in the country for
nearly three decades.This is a legal exploratory study primarily focused on library research.

Key words: Islamic banking, law, dual banking, legal system.

INTRODUCTION

Malaysia is the first country in the world in which a dual banking system was created and the success of it
became evident. The creation of dual banking system was important for Malaysia as it is a multi religious and a
multi ethnic society with a plural legal structure. Islamic banking was formally incepted to the country in 1983
with the introduction of Islamic Banking Act 1983 and the opening of the first Islamic bank of the country,
Bank Islam Malaysia Berhad. In 2009, with the introduction of the new Central Bank of Malaysia Act 2009, the
country legally recognised the existence of dual financial systems in the country. Furthermore, the creation of
Law Harmonization Committeeat the Central Bank level further proved that there are some legal challenges
facing the development of Islamic banking in Malaysia.
Even from the beginning it was understood that creation of dual banking system was the objective and that
it would not be an easy task under the given circumstance where the conventional legal infrastructure is
applicable to Islamic banking. The prefix “Islamic” attached to banking created an additional flavour to the
banking as for Islamic banking it is a must to apply Islamic law which later coined the application of Islamic
law to the phrase “Shari‘ah compliance” or “Shari‘ah governance”.The banking industry in Malaysia consist
both conventional and Islamic banks and hence the banking atmosphere is very competitive. The banking
customers in Malaysia have a wide range of choice to choose from. This research would identify the reasons for
the obstacles faced by Islamic banking in the dual banking world of Malaysia. This is indeed a topic worth
researching as often observers consider the existence of the dual banking systems as the reason for the conflicts
facing Islamic banking where as in this research it is proved that the existence of dual legal system in the
country is the reason for the conflict in the arena of Islamic banking in Malaysia.

Materials and Discussion:

Development of Islamic Banking:
Islamic banking system has risen as an economical and a feasible proxy for the conventional banking
system during the last three decades. It is particularly for Muslim world where presently Islamic banking exists
at two separate fronts. At one side, efforts are also in progress to clandestine the full financial systems in
accordance to Islamic laws. At the other side, separate Islamic banks are allowed to operate in parallel to
conventional interest based banks.

Corresponding Author: Assistant Professor Dr Uzaimah Ibrahim, Assistant Professor, Ahmad Ibrahim Kulliyyah of Laws,
International Islamic University Malaysia, Malaysia
E-mail:[email protected]
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 Aust. J. Basic & Appl. Sci., 6(11): 246-251, 2012

The General Secretariat of the Organization of the Islamic Conference (OIC) defines an Islamic bank as a
financial institution whose statutes, rules and procedures expressly state its commitment to the principle of
Shari’ah, and the banning of the receipt and payment of interest on any of its operations (Hasan, 1999).Islamic
banking was invented to curb the “unislamic "” elements in the banking system. According to Tahir (2004),
Islamic banking started in earnest in the 1970s with the personal initiative of respective Muslims to eliminate
riba. It has been said that the collapse of Uthmanic Khilafah or empire in Turkey created the waves of fear in the
minds of the Islamic world that the teachings of Islam is erasing from the humankind and a preventive measure
is needed to revive it in the so called modern way of life. Ahmad al Naggar, the father of Islamic banking was
residing at Germany during this time. He witnessed how the German Government was applying the Social
Saving bank to sustain the economic growth of the country. And from here, the father of Islamic banking
wanted to implement the same concept in Egypt. This German idea was accepted by the Egyptian government
and eventually, the first Islamic bank in the name of Mit al Ghamr was established to achieve the objective of
exploring possibilities of mobilization of saving and local credits as an essential condition for social and
economic development (Al-Omar, 1996). It is said that in the first three years of the operation of this bank, the
number of depositors increased from 1,000 founding members to 60,000; and by 1967 the number has increased
to 357, 637 (Yacob, 1986). Despite of this ever booming success, Gamal Abdul Nasser closed down the bank.
However, because of Mit al Ghamr, the Arab world was excited to experiment the same in their respective
countries. This was the years in the 1970’s. Due to this growing interest, in 1972, the government of Egypt
presented “a study on the institution of an Islamic bank” and in 1975 the Islamic Development Bank was
established in Jeddah. This was followed by the establishment of Dubai Islamic Bank in UAE in the same year.
And this development encouraged the formation of banks in different regions. Like wildfire Islamic banks
spread throughout the world. In 1977, Faisal Islamic Bank in Egypt and Sudan was created and at the same time
Kuwait Finance House was established in Kuwait. In 1978, Jordan Islamic Bank was created in Jordan; and in
1983 Malaysia created its first full fledged Islamic Bank, Bank Islam. And Citibank is the first conventional
bank in the world which began to provide Islamic shari’ah products. By 1997, there were 177 Islamic Banks in
the world; among these 51 banks is in South Asia, 36 banks in Africa, 31 banks in South East Asia, 37 banks in
Middle East and 12 banks in Europe, Central Asia and Europe (Kahf,n.d). As for the creation of conventional
banks, it has been said that the conventional banks were originated from Vienna in the 16th Century. The first
conventional bank in Malaysia is opened in 1859 in the name of Chartered Mercantile Banks of India, London
and China at Penang. The second bank is the Chartered Bank opened in 1875 followed by the opening of HSBC,
Easter Bank and OCBC in 1959.
Pheng, L. M. et. al. (2007) in her book “Islamic banking and financial law” has briefly and concisely
explained history and development of Islamic banking in general in Chapter 1. This consist of explaining the
Islamic banking in the early days of Islam; Islamic banking in the modern era; and last, but not least the
developments of Islamic banking in some Muslim countries. As for the development of Islamic banking in
Malaysia, she has written that Islamic banking system in Malaysia is the most progressive as separate
legislations and banking regulations existed parallel to the conventional banking system. The first bank
established in Malaysia is the Bank Islam Malaysia Berhad which was established under the Islamic Banking
Act 1983. Under this piece of legislation, like the conventional banks which existed in the society at the time,
Islamic banks are supervised and regulated by the Central bank or Bank Negara (BNM). Subsequently, the
government also passed the Government Investments Act 1983 which gave the power to the government to
issue Government Investment Issues which are government securities issued in accordance with Islamic
principles. It is also mentioned in her book that the long term goal of BNM is to create Islamic banking system
operating parallel to the conventional banking system and in order to make this possible, Islamic banking system
needed a large number of players; a variety of instruments and an Islamic money market. Apart from this, it also
needs to reflect the socio-economic values in Islam in both form and the substance without compromise. BNM
did indeed make all this possible by taking progressive approach (Pheng, 2007).
However, Seidu, A.M. (2002) believes that the initial start of Islamic banking in Malaysia was not from
1983, but it dates back to the 1963 when Tabung Haji (the Pilgrims Management Fund Board) was established
by the government. Tabung Haji is a special financial institution which provides a methodical allocation of
funds from Muslims to assist them perform pilgrimage in Makkah. Not only this, but it also helps them to find
chances to invest and participate in other economic activities. And it should be stated here that Tabung Haji
seems to be the first of its kind in the whole Islamic world.Similarly, Thani N. N, et al (2003) shares the same
view by indicating that the Tabung Haji, a merger of the Pilgrims Affairs Department and the Malaysian
Muslim Pilgrims Savings Corporation, pays its subscribers dividends instead of interests earned out of its
investments in equities and other securities.
Hence it can be said that the Malaysian government moved forward to legislate Islamic Banking Act from
the favourable experience it gained from the Tabung Haji. The first call for separate Islamic bank was made in
1981, in the National Seminar on the Concept of Development in Islam held at the National University of
Malaysia. The participants passed a resolution requesting the government to pass a special law to setup an

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 Aust. J. Basic & Appl. Sci., 6(11): 246-251, 2012

Islamic bank in the country (Thani et al, 2003). Responding to the request, the government set up a National
Steering Committee in 1981 to study legal, religious and operational aspects of setting up an Islamic bank. The
committee established the blue print of a modern Islamic banking system in 1983, which later enabled the
government to establish an Islamic bank and to issue non-interest bearing investment certificates (Kaleem,
2000).
The systematic approach used by the government is divided into three phases (BNM, 2004). The following
diagram summarised the three stages involved.

Period of familiarization (1983-1992)

Period of creating competitive environment (1993-2003)

Period of further Financial Liberalization (from 2004)

Diagram 1: Stages involved in the Development of Islamic Banking in Malaysia.

The period of familiarization was the period in which the first Islamic bank in Malaysia, that is Bank Islam
Malaysia Berhad (BIMB) was created by enacting Islamic Banking Act 1983. BIMB is the first Shari‘ah
compliant bank operated in Malaysia. The second phase of the development of Islamic banking in Malaysia was
exclusively to educate the public in the new concept of banking and to create an environment which is
competitive. The opportunity was given for the Islamic banks to capture bigger portion of market shares, so that
the Islamic banking can be sustained in the country. The conventional banks were also given the opportunity to
open Islamic banking branches during this period by amending section 119 of the Banking and the Financial
Institutions Act. As a result of this in 1993 “Islamic windows” under the “Islamic banking scheme” was set up.
And this created more players in the market. The objective of the Malaysian government is to develop the
Islamic banking system parallel to the conventional system (Ahmad and Haron, 2002). In addition, those
“Islamic windows” were required to upgrade their Islamic Banking Unit into an Islamic Banking Division which
took effect from January 2 1999. During this phase also,the Central Bank set up the Islamic interbank money
market (IIMM) as well as a new Islamic interbank cheque clearing system that took effect in 1994for Islamic
banks and “Islamic windows”(Thani et al, 2003). In the third phase, further financial liberalisation began by
giving the golden opportunity for the foreign banks to operate in the Malaysian territory.

Conflicts Facing Islamic Banking in Malaysia:

Before the cause of the obstacles facing Islamic banking in Malaysia is explored, it is imperative for one to
understand the conflicts facing Islamic banking in Malaysia. For this purpose, the authors believe that the best
way is to discuss some of the critical conflicts facing Islamic banking in Malaysia that have been discussed by
scholars found in literatures. One of the most comprehensive bunch of conflicts facing Islamic banking is
described by Muneeza et,al. (2011) and their classification of conflicts facing Islamic banking is summarized in
the following table (Table 1).
As discussed above, Malaysian banking arena is dominated by two super powers; that are conventional and
the Islamic banking. Hence, the banking legal framework is set up in a way to give space for both to
autonomously work without overlapping each other. The reality is that this is how this legal framework
theoretically works. From a microscopic view, it would be understood that the Islamic bankers face several
serious conflicts in practise when they operate within the dual banking systems. The following diagrams would
simplify the root of the legal obstacles facing Islamic bankers today:
Diagram 2 (above) shows that before 1983, the Malaysian banking system was dominated by the conventional
banking system which accepts interest as an integral part of the system and, hence, in this system money can
make money. Lending and borrowing activities are the main types of banking activities in which income is
derived. Malaysia has a dual legal system in which Islamic law and the common law exists parallel to each
other. By virtue of List I of the Ninth Schedule of the Federal Constitution, banking is a matter for federal
legislature to deliberate on. Hence, conventional banking is a matter governed by the federation. By virtue of

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 Aust. J. Basic & Appll. Sci., 6(11): 246-251, 2012

List II of the
t Ninth Schedule of the Federal
F Constittution, Islam is a matter for the state goveernment. Hencce,
everythingg related to Islaam and Islamic law would be b determined by the rulers of o the state. Thhis is the reasoon
why the Isslamic laws ap pplied in Malay ysia are not unniform throughhout the federration. The gisst here is that in
Malaysia, all the federal laws like the Contracts Actt 1950, which governs contraactual agreemeents between thhe
parties; Naational Land Code,
C the lawss which indicaate the rights related
r to landd; and all the procedural law ws
related to Civil Courts formed
f by Artticle 121 of the Federal Con nstitution are bbased on Comm mon law. Theese
Federal lawws are not necessarily madee consistent w with the Islamiic law. This m means that the procedural annd
substantivee federal laws of
o the federatioon of Malaysiaa are totally bassed on Commoon law principles of Law.

Table 1: Sum
mmary of the Confflicts Facing Islamic Banking in Mallaysia as describedd by Muneeza et all., (2011).
Typpe of Conflict Ex xplanation
L
Legislative These aree the conflicts founnd in the legislatioons applicable to Isslamic banking. Foor example, what
will happen whenn National Land Co ode 1965 is appliccable to Islamic baanking?
Shariff (20002)- S.330 of Nattional Land Code 1965 which only allows a the lodging
g of private caveat
as a seccurity for a loan, not
n to an Islamic baanking product
Yasin (20001)- S.55 of Islammic Banking Act 1983 is silent on thhe effect of conflict arsing between
Islamic
I Banking AAct 1983 and otherr legislations exceppt the Contracts Acct 1950.
Monney Laundering These arre the conflicts facced in curbing monney laundering whhen dealing with Isslamic banking.
Juridical These arre the conflicts facced when the dispu utes related to Islam
mic banking is heaard by the Civil
Courts that appply conventional laaws.

In the casse of Bank Islam M Malaysia Bhd v Addnan Omar [1994] it was held that th he Civil courts in
Malaysia have
h the jurisdictioon to hear Islamic banking cases andd Shariff (2002) haave identified that
the appplication of civil llaw to Islamic ban
nking to which Islaamic law is ought to
t be applied.
Doocumentation These arre the conflicts facced by the Islamic banking when thee documents related to the Islamic
banking prooducts are executedd.
Sharii'ah Governance Thhese are the confliccts facing Islamic banking
b when appplying the additional layer of
Shari'ahgovvernance to the existing corporate goovernance structuree.

  Convenntional Bankingg: the Sole Sup

per Power

 
Interest is 
law
wful and 
 
money can 
make money 

Diagram 2:
2 Malaysian banking
b system
mbefore 1983.

Diagram 3:
3 Malaysian banking
b system
m after 1983.

Then, what happeneed was as thee diagram 3 (aabove) indicattes, in 1983, Islamic I law brreathed into thhe
Malaysia. As a result, Islamic Bankingg Act was legislated, merely regulating thee licensing requ uirements of thhe
bank, ratheer than emphassising on the substantial
s mattters relating too the Islamic bbanking. The reality
r is that thhe
laws of thhe federation like
l the Contrracts Act and the proceduraal laws like Rules R of Highh Court are sttill
applicable to Islamic bannking due to thhe fact that Islaamic banking Act
A is a federall law and becaause banking iss a
matter for the federation to decide. Thee point here is that both Islam mic and the coonventional bannks had to shaare
the same legal
l infrastructure which iss totally basedd on Commonn law system. This situation n is exacerbateed

249
 Aust. J. Basic & Appl. Sci., 6(11): 246-251, 2012

because of Section 3 of the Civil Law Act 1953 which says that when ever there is a lacuna in law, the law
applied to fill the gap should be the English Common law and equity. Now the tumult here is that Islamic
banking law is a concept totally based on Islamic ideologies which prohibit riba (interest) and everything related
to it should be consistent with Islamic commercial law. So the probing question here is how would it be possible
to reconcile fundamentally two different ideologies which cannot be harmonised or compromised? Furthermore,
when section 119 of the Banking and the Financial Institutions Act was amended to open the Islamic windows
in the Conventional banks to create more players in the market in the year 1993, the same legal problems arose
as to how Islamic ideologies of Islamic banking can be protected. The root of all legal problems faced by the
Islamic bankers today arises from this.
According to Tahir, (2004), there were no serious efforts undertaken to implement the necessary changes in
banking laws and laws that affect the Islamic banking industry in Malaysia. Hence, this research is an effort to
enhance the legal infrastructure of Islamic banking for a sustainable development of it for the further
generations.

Conclusion:
From the above, it is evident that existence of the dual legal systems is the reason for the creation of
conflicts in Malaysian Islamic dual banking system. There are no conflicts between conventional and Islamic
banking systems; but the conflicts facing Islamic banking arises due to the clashes it has with the civil legal
system of the country which is not made considering the Islamic or Shari‘ah values which is the ground law of
Islamic banking. Hence, it is wrong to blame the existence of the dual banking systems for the conflicts facing
Islamic banking in Malaysia.
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Case
Bank Islam Malaysia Berhad v Adnan Bin Omar [1994] 3 CLJ 735.

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