Comment on “Islamic Banking in Malaysia: Unchartered Waters”

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  • Muhammad Chatib BASRI

    Corresponding author
    1. University of Indonesia
      M. Chatib Basri, LPEM-FEUI, Jl. Salemba Raya no. 4, Jakarta 10430, Indonesia. Email: dedebasri@hotmail.com
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M. Chatib Basri, LPEM-FEUI, Jl. Salemba Raya no. 4, Jakarta 10430, Indonesia. Email: dedebasri@hotmail.com

Ariff and Rosly (2011) provide an interesting paper on Islamic banking in Malaysia. Their paper is very informative and allows readers who are not specialists in Islamic banking to follow the essence of Islamic banking. The literature is very rich and explores the achievements of Islamic banking in Malaysia and its challenges. Ariff and Rosly also nicely show the strengths of Islamic banking and argue in a balanced way about what should be done to further develop the industry into a more efficient and competitive business.

There are several important findings in this paper. First, Islamic banking is now a big and truly worldwide industry with many “conventional banks” involved in it. Second, the basic principle of Islamic banking is business risk taking (al-bay) and not financial risk taking. Islam allows trade but prohibits interest or riba. In essence, trade is evidenced by an exchange of money with an underlying asset, whereas an interest bearing loan is based on an exchange of money with money. Third, Ariff and Rosly argue that in order to develop this industry into a more efficient one, there is a need to enhance the current regulatory, legal, and fiscal infrastructure. Fourth, Ariff and Rosly also emphasize that globalization on the one hand can help integrate the segmented markets of Islamic financial products, but on the other hand it also brings a lot of challenges to Islamic banking, for example, the need for innovation and reinvention. The authors then argue that it is important to ensure that riba is not admitted unwittingly through financial innovation, otherwise innovation will undermine the purpose of Islamic banking.

Now I will go into specific comments and questions. First, Sheikh (2007) argues that actually the current Islamic banking type of financing is not different from that of conventional modes. The techniques are to convert the money into assets and then sell the assets for profit. By doing this, it converts the mode of exchange of money for money into an exchange of money with an underlying asset; nevertheless, the principle remains the same. Furthermore, Sheikh points out that the Murabaha does not reflect a “cost+profit” transaction, rather it is more of a “cost+financing” transaction which involves a loan and a deferred sale. Ariff and Rosly's (2011) Section 3.1 explains the Islamic banking mechanism, but it is still not clear to me what fundamentally differs between Islamic banking and conventional banking, because they stated in Section 5.0 that the pricing in Islamic Banking is benchmarked against the interest rate, thus, it essentially assumes that the major risk faced by BBA (bai bithaman ajil) is credit risk which is similar to an interest-bearing loan.

Second, the main difference between Islamic banking and conventional banking lies in the basic principle of doing business; Islamic banking only allows business risk taking, whereas conventional banking allows interest bearing loans. Learning from the global financial crisis in 2008, many argue that the financial sector should limit its “leverage business type” and put more emphasis on the risk taking type (exchanges of money with an underlying asset). It would have been good if Ariff and Rosly had touched on this issue and provided their thoughts on questions such as: Can Islamic banking address the current concerns over leverage business types in the financial sector? Can the Islamic financing system be an alternative? If not, what are the obstacles?

Third, it is worth noting that Islamic banking is flourishing now, and in fact, even conventional banks have given Islamic finance a greater outreach. Why has Islamic finance become so popular? Is it because of religious beliefs (the rules are set by God) or because of other reasons? Unfortunately, Ariff and Rosly are silent on this issue.

Fourth, Ariff and Rosly point out that a rising interest rate environment is not very conducive for Islamic banking. They argue that using floating rate products may help to mitigate the impact of high interest rates. Nevertheless, there is a limit to this. This instrument may not be sufficient when the actual interest rate is higher than the projected rate. This shows that the currently available instruments are still not flexible enough to allow Islamic banking to cope with a tight monetary situation.

Fifth, van Schaik (2001) argues that applying Islamic banking in non-Islamic countries is still very difficult. Ariff and Rosly tend to agree with this argument and suggest the need for some fiscal treatment to allow Islamic banking to grow. This paper offers a lot of potential to draw out policy implications, for instance, the importance of the legal framework, fiscal issues, and infrastructure for the purpose of improving the efficiency of Islamic banking. What is missing in Ariff and Rosly's conclusion is the question of the potential risks because these fiscal treatments may create a distortion in their unequal treatment with other financial institutions, especially now that we are facing a trend of a more regulated banking sector all over the world including in Malaysia. How do we put Islamic banking in this context?

These comments and suggestions do not detract from my overall summary judgment that Ariff and Rosly (2011) is worth reading, and offers an important contribution to the literature on Islamic banking in Malaysia

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