1.1History of Islamic Banking in Malaysia
Islamic banks today exist in all parts of the world and are looked upon as a viable alternative system which has many things to offer. While it was initially developed to fulfill the needs of Muslims, Islamic banking has now gained universal acceptance. In Malaysia, the first Islamic bank is Bank Islam Malaysia Berhad (BIMB). Operated as the only Islamic bank for 10 years since July 1983 before the government allowed other conventional banks to offer Islamic banking services using their existing infrastructure and branches in 1993 (Bank Negara Malaysia (BNM), 1194 and 1999).
The government decided to allow the conventional banking institutions to offer Islamic banking services or “Islamic windows” this was thought to be the most effective and efficient mode of increasing the number of institutions offering Islamic banking services at the lowest cost and within the shortest time frame. By doing so, it would also force the Malaysian banking industry to be more competitive, which would lead to an improved performance and enhance efficiency of the Islamic banking industry.
The history of Islamic banking in Malaysia can be traced back to 1963 when Tabung Haji (the Pilgrims Management and Fund Board) was established by the government. It is a specialized financial institution that provides a systematic mobilization of funds from Muslim to assist them perform pilgrimage in Makkah as well as encourages them to participate in investment opportunities and economic activities. In fact, due to its uniqueness Tabung Haji is considered to be the first of its kind in the world (Mohammed Seidu, 2002).
The long-term objective of BNM is to create an Islamic banking system operating on a parallel basis with the conventional banking system. However, similar to any banking system, an Islamic banking system requires three vital elements to qualify as a viable system, i.e.:
• a large number of players
• a broad variety of instruments
• an Islamic money market
In addition, an Islamic banking system must also reflect the socio-economic values in Islam, and must be Islamic in both substance and form.
1.1.1Background of Study
Banks play an important role in the operation of an economy and it is important to an understanding of determinants of their profitability are essential and crucial to the stability of the economy. Investigating the determinants of profitability has been one of the more popular topics among researchers in banking studies as stated by Vong (2008).
Malaysia is one of the unique countries which operate a dual banking system where the Islamic banking system operates in parallel with the conventional system. The Islamic banking system in Malaysia started in 1983 when the first Islamic bank, Bank Islam Malaysia Berhad (BIMB) commenced its operations. In the process of increasing the number of players in the system, rather than allowing a new Islamic bank to operate, the government introduced a scheme known as the “Interest-Fee Banking Scheme” in 1993. Similar to conventional banks, all banking facilities for example like deposit account, financing and other products and services are available at Islamic banks. Islamic banking is a banking activity based on Islamic principles, which is do not allow the paying and receiving of interest that is riba’ and promotes profit sharing in the conduct of banking business.
The most important different between Islamic and conventional bank is prohibition of interest (riba’). Islamic banking activity must comply with Shariah principles. Beside riba’, gharar is also forbidden by the Qur’an, which explicitly forbids trades that are considered to have excessive risk due to uncertainty.
Islamic banks was established since 1963 and...