Role of Islamic Banking in Economic Growth Of Malaysia - Case Study Example

• Introduction

Islamic banking, today, has become a growing trend as it is used not only by Muslims but also by other religions group. One of the aspects of Islamic banking is that Shariah is followed in the Islamic banks that forbid banks from charging interest rates on the capital invested. All over the world, Islamic bank has made their presence and it is predicted that it will grow further (Lewis, Ariff & Mohamad, 2014). Islamic banking is not similar to conventional banking due to more religious aspects associated with the banking. The activities of Islamic banks are governed by Religious Supervisory Board controls. However, Islamic banking system’s implementation to some extent differs among Islamic nations. The major objective of Islamic banks is to promote, develop and foster the application of Islamic tradition, law and principles to the banking affairs or financial transaction. In the current study, role of Islamic banking shall be analysed in context to economic growth of Malaysia. Through this, contribution of Malaysian Islamic banking industry in the country and on global platform would be evaluated

• Discussion

The Islamic financial system covers financial markets, financial instruments and intermediation with the bank. According to Gheeraert and Weill (2015), in any functioning market, two levels are considered that are macro and micro aspects. The macro-economic aspect highlights economy based on the aggregate level. Therefore, Islamic banking takes account of output, income, general price behaviour, employment of resources and interrelationship among the varied economic sectors. On the other hand, under micro-economic aspect, Islamic banking considers behaviour of industries and firms, households, individual consumers, production and distribution of income (Kasmo et al. 2015). It can be pointed that Islamic banking through this aspects largely focuses on providing equal and right banking services to their customers around the globe.

During the period of global recession, unlike many conventional banks, Islamic banks were less affected as the banks were not exposed to fatalities from the investment in toxic assets and the banks were also not reliant on the wholesale funds (Osman, Rosnan & Mat Nor, 2015). It has been discussed by the scholars that Islamic banks are being invited by the non-Muslim countries due to its growing acceptance by the people of different religions. However, in order to understand Islamic banking, its distinguish features need to be discussed. One feature is the abolition of interest charge under Islamic banking system. It allows the customers to pay service charges over the money they deposit, transfer, withdraw or take loan (Abedifar et al., 2015). Due to this, Muslim community primarily prefers Islamic banks for making investment or opening bank account. However, in non-Muslim nations, Islamic banks are not popular in comparison to Muslims nations like Iran, Saudi Arabia, etc.

Islamic banks operate as a means that helps in developing financial expertise in non-financial organisations for development and industrialization. Moreover, financial needs of the customers are taken by the bank for overcoming any liquidity shortage (Lewis, Ariff & Mohamad, 2014). Deposits of individuals are utilised for helping public interest and realizing the Islam’s socio-economic objectives. Therefore, it can be pointed that Islamic banks are more goal-oriented rather than being playing merely a role of profit-maximizing firm. The economic need is fulfilled by Islamic banks by offering products that are compliant with the laws of Shariah. Such products are developed considering the philosophy that no individual should benefit from the loss of other individual. It is stated by Abduh and Alias (2014) that in Islamic banks, profit-sharing works as a curtailed risk transfer as it is believed that bank bears the whole weight of financial risk whilst the entrepreneur is only accountable for the risk of wasted effort and time. Therefore, if a projection of a borrower is unsuccessful, then the bank will single-handedly seize the loss on profit and borrower will not be liable to pay back any loan amount.

The current status of Islamic banking shows that it has moved further from being a novel experiment as now Islamic banks are developing investment and financial instruments that are not only considered as profitable but also as an ethical motivation. Currently, Islamic finance includes Sukuk (securities), banking, investment funds and leasing, insurance (Takaful) and equity markets (Gheeraert & Weill, 2015). As per the report of International Monetary Fund (IMF), Islamic finance’s assets have augmented at double-digit duty. In 2003, the assets were about US$200 billion which increased to around US$1.8 trillion in 2013 (Lo & Leow, 2014). It indicates that financial assets are well traded around the globe and customers are able to convert their financial assets in liquid form more easily. However, Kasmo et al. (2015) pointed that Islamic finance assets are still resolute in Iran, GCC (Gulf Cooperation Council) countries and Malaysia despite of its growing worldwide. On the other hand, it has been recorded that over the last decade, Islamic banking surpassed conventional banking which increased the penetration rate more than 15% in Asia and Middle East. Also, in 2013, the Sukuk issuance also raised twenty fold to reach US$120 billion (Osman, Rosnan & Matnor, 2015). Therefore, it can be mentioned that Islamic banking is growing globally and is successful in generating high income and expanding their market in non-Islamic nations.

Apart from that, Islamic banking is substantially growing in Malaysia. The nation currently has substantial number of full-fledged Islamic banks involving numerous conventional institutions and foreign owned entities that have instituted Islamic subsidiaries. Also, all financial institutions are permitted by the Malaysian government to conduct both non-ringgit and ringgit businesses in Malaysia which contribute in the economic development of the country. Currently, Islamic banking assets of Malaysia have reached to USD65.6 billion. (Gheeraert & Weill, 2015). It is predicted that, it will further increase which would support in more growth of Malaysia’s Islamic banking.

Further, Adeola (2007) discussed that Islamic banks in Malaysia provide better employment opportunities to the people which also adds in the economic development. In the report of Institut Kefahaman Islam Malaysia, it is mentioned that growth of Islamic banking industry has helped in raising the demand for graduates to work in the conventional industry of the economy. For example, Shariah-qualified individuals are highly required as Islamic financial institutions and banks strictly adhere to Shariah rulings. In 2013, the Islamic banks in Malaysia offered employment to about 24.7% out of total population in the country (Abduh & Alias, 2014). Therefore, it helped in curbing the unemployment level to some extent, thereby contributing in increasing GDP and enhancing economic growth. It is expected that Malaysian Islamic banking sector would contribute 5-7% in the country’s GDP by 2020. However, it has been reported that year-on-year growth rate of Malaysian Islamic finance assets (17%) from 2010-14 is less in comparison to other Muslim nations such as Saudi Arabia (20%), UAE (22%), Pakistan (27%), Indonesia (29%), Turkey (25%) and Qatar (22%) (Lo & Leow, 2014). Though, it is believed that assets would grow in future which will support in the growth of banking industry in Malaysia and in other no-Muslim nations.

As per the view of Osman, Rosnan and Matnor (2015), the Islamic banking sector of Malaysia has been developing at an average of 18% per annum since 2000 in terms of assets. It is helping the country to turn into a principal global Islamic banking centre. However, it has been found that market share of Islamic banks of Malaysia is low in relation to conventional banking sector. The Islamic banking sector captures only 18-20% of financing, assets and deposits of the total market shares; whereas, conventional banking sector holds major portion. On the other hand, as per the report of PwC, 2013, Islamic finance system of Malaysia has a competitive benefit in comparison to other Islamic financial centres like Pakistan, Iran, etc. due to their integrated and holistic approach, particularly the potency of their dual banking system (Abedifar et al. 2015). As a result, Malaysian Islamic banking sector is supported by cross-promoting banking products to the confined clients of the conventional banks’.

Further, Abduh and Alias (2014) discussed that the continuous change in international Islamic financial environment has granted Islamic finance of Malaysia to expand in the international banking system. In addition to that, Lewis, Ariff and Mohamad (2014) stated that two factors significantly contribute to the dynamic growth of the Islamic finance sector. First factor is the speed of innovation which offers several ranges of financial solutions to the customers or parties like government and business based on innovative structure. The other factor relates to the flexibility which associates with the Islamic banks’ inherence features of Islamic finance of Malaysia in building the institution for financial stability in the country (Gheeraert & Weill, 2015). These factors help the country to build better financial infrastructure for the people so that they do not fall to any financial liability.

It has been found that the growth of Malaysian Islamic banking sector in domestic regions has attracted the foreign investors to invest in the Islamic banks thereby adding to the economic growth as the country is able to increase foreign currency. Currently, there are six foreign owned Islamic banks in comparison to eleven locally owned in Malaysia (Kasmo et al. 2015). It not only helps in the growth of Islamic financial sector, but also stimulates other countries to make large investment for generating income and increasing customer base globally. As per the opinion of Lo and Leow (2014), Islamic banking in Malaysia largely promotes innovation by taking prime initiative to finance anyone that posses a good idea for starting business or anything that contribute to economic development. For instance, if a medium or small entrepreneur has an effective project then he/she or partners would have a high possibility to receive financial support from Islamic banks and also such parties would not be held back by the risk fear. It is due to the fact that Islamic banking system of Malaysia entails effective risk distribution as risk is disseminated between the entrepreneur and the financier (Adeola, 2007).

The government of Malaysia also take major initiative for growing and developing the Islamic banking and finance in the country. The government has to liberalise the banking industry in order to tap new growth opportunities and be competitive from the international point of view (Gheeraert & Weill, 2015). Therefore, the government supports this by allowing the full fledged Islamic bank licence to the Middle East’s foreign banks. On the other hand, Central bank focuses to reinforce the institutional infrastructure through strengthening and enhancing the regulatory framework that is legal infrastructure and Shariah along with consumer education and capital development. It supports in ensuring the stability of Islamic finance sector in Malaysia. The government of Malaysia has taken sincere efforts in strengthening the global talent pool, enhancing the capabilities and expertise in Islamic finance as it connects towards innovation of product and allied to the market development process (Abedifar et al. 2015). Therefore, INCEIF (International Centre for Education in Islamic Finance) has been instituted for providing professional certification programs in order to develop human capital for Islamic banks around the globe. Also, Central bank invested RM500 million endowment funds for globally making Malaysia a prominent centre for pursuing Islamic finance education and building human capital for Islamic banks (Osman, Rosnan & Matnor, 2015). All these efforts by the government substantially support the Malaysian Islamic banks to grow nationally and internationally along with conventional or commercial banks of Malaysia.

Lo and Leow (2014) argued that despite the growth of Malaysian Islamic banking industry and contribution in economic growth, the Islamic banks faces some challenges that can negatively influence the growth of finance sector. Malaysian banking institutions is focusing more on receiving assistance from the institutional framework that abides conventional banking. However, Islamic banks suffer from deficiency of institutional support. Therefore, setting up a proper institutional is a challenge for Malaysian Islamic banking. This issue can be overcome by adopting functional approach and attempts shall be made to alter the existing institutions for providing better support (Kasmo et al. 2015). The other issue is related with the investment in the long gestation projects. It has been found that Malaysian Islamic banks mostly invest in those projects that ensure quick returns as the banks are required to disburse a sizeable profit on the deposit each year. Also, if they are rivalling with the interest-based banks then they would to be left with no profit for some period. As a result, it would not only affect the growth in Malaysia, but it may also reduce the long run efficiency of the banks. Such issue can be mitigated by developing an effective institutional framework as it would embrace Islamic banks to offer sufficient financing for infrastructural and long gestation projects (Abduh & Alias, 2014).

An intensive and extensive research has been done by Islamic banks in formulating non-usurious practices for employing their funds. However, very limited research done by banks in developing tools for attracting the deposits. The reason could be that the Islamic banks have not yet encountered the deposits shortage (Lewis, Ariff & Mohamad, 2014). It can be pointed that if the Islamic banks ignore to develop the non-usurious practices for competing with interest-bearing tools for heaving deposits, then those banks may bear dilemma in their growth. Therefore, in order to tackle such issue, the Malaysian Islamic banking industry would have to give an effort in a large scale for devising banking non-usurious tools as it can be effective in raising the deposits for number of Malaysian Islamic banks. Moreover, the existing Islamic banks of Malaysia would have to do the investigation or research not only for their own gain but also in the wide interest of the other Islamic nations (Osman, Rosnan & Matnor, 2015). It can be effective for Malaysia to increase the market for Islamic banks and would also enhance the economy of the country on global scenario.

• Conclusion

The study has largely focused on the significance of Islamic Banking and its impact on the economy development of Malaysia. From the findings and discussion presented in the research, it can be concluded that scenario of Islamic banking industry in Malaysia is good in comparison to other Muslim developing nations. The banks are highly involved in developing the society socially and economically by providing better financial services for the people. It has been studied that Islamic banks have substantial contribution in the Malaysian economy. They contribute in GDP, employment and other important areas which supports in the development of banking industry. Over the years, investment from foreign enterprises in Islamic banking has increased and it would grow further which will add in the economy growth of Malaysia. The study shows that still Islamic banks are not accepted in non-Muslim nations due to its adherence to Shariah laws as its demand is increasing in the Muslim society. On the other hand, it has been evaluated that the Malaysian government provides extensive support to Islamic banks to attract more number of investors and make Malaysia a leading international hub in Islamic banking. The strong support from the government entails a clear picture that Malaysian Islamic banks would strongly compete with the conventional banks in the near future. Some issues that are associated with the Islamic banking in Malaysia can be alleviated if both the government and Islamic banking industry establish a firm institutional framework for better exposure of Islamic banks in international markets.