HL Markets

Background of 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 Mudarabah 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 Islamic accepted bills, Islamic mortgage bonds and Islamic private debt securities.

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.