Challenges and issues in Islamic banking

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1.        Challenges and issues in Islamic banking


1.1    a) Identify and discuss these challenges and issues


1.1.1            Shortage of experts in Islamic banking


Due to a sector-wide shortage of sharia scholars, Brunei-based banks are often forced to fly Islamic financial experts in to the country when they are needed. And because of the industry wide shortage of Islamic financial scholars, some of them site on as many as three or five different banking board according to some industry insiders which will lead to conflict of interest therein and the possibility of leaking sensitive commercial information in the Islamic banking sector. The head of the finance department at the International Islamic University in Malaysia, Dzuljastri Abdul Razzaq, reported recently that Malaysia alone will need over 40,000 qualified experts in the subject in the next few years, while Indonesia will need 17,000. The growth of the Islamic banking industries in both of these countries has been astounding, with a 24 percent increase in Malaysia in 2011 and a 38 percent increase in Indonesia between 2006 and 2011, according to their central banks. However, Malaysian experts warn that growth is slowing due to a lack of experts in the topic ( 2012).


1.1.2            Absence of accounting (and auditing) standards pertinent to Islamic banks


According to the REUTERS report, the lack of a standardized Islamic finance system and mismanagement of bonds because of lack of supervision are obstacles to the future of the industry. Currently, sharia banking systems are open to various interpretations because of the open-ended nature of Islamic law. This makes the standardization of the industry’s practices across jurisdictions – necessary to decrease risk, difficult without closer monitoring. An example of this lack of uniform application is the bai bithaman ajil (deferred payment sale) which are approved by Malaysian regulators but rejected by those in the Middle East ( 2009). And as a result, we can see that because of the specific nature of the Islamic banking, the absence of accounting (and auditing) standards has become a major challenge to the Islamic finance building.


1.1.3            Lack of investment instruments


Although Islamic finance has generated substantial amount of literature coverage in the press and academic journals, there has been little study as yet on how Islamic financial institutions differ in practice from conventional banks. However, a recent study tried to cover this issue based on data from 15 interest-free (Islamic) banks and 15 conventional banks in countries where a dual banking system was in operation. The study tested for differences in liquidity, leverage, credit risk, profitability and efficiency. The study concluded that one of the biggest challenges facing institutions is the provision of short run investment instruments as several studied institutions have tried to develop high quality short-term instruments, but have been hampered by their ability in term of credit rating, liquidity and capability to yield asset ( 2005). Therefore, the lack of investment instruments is generally considered as a major challenge faced by the Islamic finance.


1.1.4            Separation from the rest of finance industry


As known to us Islamic finance can refer to the means by which corporations in the Muslim world, including banks and other lending institutions, raise capital in accordance with Sharia, or Islamic law. It also refers to the types of investments that are permissible under this form of law ( 2011). Therefore the Islamic finance because of its nature has led to the creation of a separate finance industry in the world. And it is still one the major challenges faced by the Islamic finance worldwide.


1.2    b) What is Bank Negara’s view in meeting these challenges?


1.2.1            Background of Bank Negara Malaysia


Bank Negara Malaysia, or National Bank of Malaysia, officially Central Bank of Malaysia, is the Malaysian central bank. Established on January 26, 1959 as the Bank Negara Malaya, its main purpose was to issue currency, act as banker and adviser to the Government of Malaysia and regulate the country’s credit situation. Its headquarters is located in Kuala Lumpur, the federal capital of Malaysia. The Bank is active in developing financial inclusion policy and is a member of the Alliance for Financial Inclusion ( 2012).


1.2.2            Boost the development of financial institutions (DFIs) through Financial Sector Master Plan (FSMP)


In March 2001 Bakn Negara Malaysia launched the Financial Sector Master Plan (FSMP), its ten year road map for the country’s banking and insurance sectors. The objective is to build an efficient, effective and stable financial sector, with strong domestic institutions serving as the core of the financial system. The plan includes specific recommendations to manage the transition (Medalla 2005). Some of the suggestions to promote the development of financial institutions (DFIs) through Financial Sector Master Plan (FSMP) are as following:-


n  Adopt a consultative approach to facilitate coordination and communication among the regulatory and supervisory authority, the Government, the DFIs and industry experts

n  Relevant ministries to clearly specify the role and objectives of DFIs in line with the changing needs of the nation and developments in the economy;

n  Apply annual budgetary allocation processes as tools to determine DFIs’ scope of activities and funding sources;

n  Establish measures to address ad-hoc development and social projects which are not budgeted for in Government allocation to DFIs and incorporate performance review and accountability criteria; and

n  Formulate and agree on the performance plan, targets, benchmarks and measurement criteria for DFIs’ operations. ( 2001)


And through the boosting the development of financial institutions (DFIs) through Financial Sector Master Plan (FSMP), it is expected that the boosted financial institutions (DFIs) will certainly increase the provision of investment instruments.


1.2.3            New financial sector blueprint themed “Strengthening Our Future”


Bank Negara Malaysia’s new Financial Sector Blueprint (FSBP) 2011-2020 themed “Strengthening Our Future – Strong, Stable, and Sustainable” sets an ambitious path for the country’s economic development and entrenches the financial sector not as an enabler of growth. There are nine focus areas under the Blueprint to further advance financial sector development to drive Malaysia’s transition to a high value-added, high-income economy. And one of the focus areas is Internationalization of Islamic finance. The new blueprint will entail developing a more conducive environment for the mobilization of higher volumes of international Islamic financial flows from a diverse range of players to be channeled through innovative Islamic financial instruments. In strengthening the legal and Shariah frameworks and further advancing Malaysia’s thought leadership in Islamic finance, a single legislated body to be the apex authority on Shariah matters in Islamic finance will be established ( 2011).


1.2.4            Financial Sector Talent Enrichment Programme (FSTEP) (2007)


FSTEP, the brainchild of the Governor of Bank Negara Malaysia Tan Sri Dr. Zeti Akhtar Aziz is managed by Institut Bank-Bank Malaysia (funded by Staff Training Fund) in collaboration with Bank Negara Malaysia and driven by the financial services industry. It is a unique training programme with the objective to address the shortage of entry level executives within the financial services. It is also aims to contribute and building the talent pool to serve the present and the future needs of the financial services industry in Malaysia. FSTEP offers an intensive 1-year training programme covering the four banking/insurance streams: Conventional banking, Investment banking, Islamic banking, Insurance/Takaful ( 2010). Therefore the FSTEP is targeting at attracting graduates from diverse academic backgrounds to pursue exciting and successful careers in the financial services industry. In addition, the qualified graduates will be awarded a scholarship with a monthly allowance and stand to acquire and develop essential skills under the one-year training programme ( 2011).


1.2.5            Shariah standards on Mudarabah


Bank Negara Malaysia (BNM) has issued the Shariah standards on Mudarabah to all Islamic financial institutions under its purview. BNM claimed that the issuance of the Shariah standards on Mudarabah was an important milestone and was part of its continuous efforts to strengthen the Shariah and regulatory framework in Malaysia. And it is believed that the standards would serve as guidelines for the Islamic financial institutions in developing Islamic financial products and services based on Mudarabah. And the central bank pointed out the Shariah standards on Mudarabah was to provide a standard on the features of mudarabah contracts applicable in Islamic financial transactions ( 2012).