There are several main requirements for an Islamic banking system including a broad variety of instruments; a large number of players; an Islamic Inter-bank money market; effective and comprehensive regulation and planning; and strong dispute resolution mechanisms.
In Malaysia, for example, after developing a large number of Islamic financial instruments, the government developed a scheme to allow existing conventional financial institutions to offer Islamic banking services in 1993. All commercial, finance, and merchant banks and eventually discount houses (1999) were allowed to participate in this scheme (Skim perbankan Tanpah Faedah or SPTF later changed to the name Perbankan Islam or IBS). From 1999 onwards, all banking institutions participating in the IBS scheme were required to upgrade their Islamic Banking Unit to an Islamic Banking Division. According to the authors, ‘the IBD was required to carry out all aspects of Islamic banking such as banking services and full-fledged Islamic banking branch supervision and administration including product development, training, etc.”
Furthermore, an Islamic Inter-bank money market (IIMM) was introduced in the Malaysian financial system in January of 1994, which linked all institutions and instruments together. The IIMM covers Inter-bank trading in Islamic financial instruments, Al-Mudharabah Inter-bank investment, and an Islamic Inter-bank Cheque Clearing System. Islamic banks and banks under the IBS are allowed to trade in Islamic financial instruments. Al Mudharabah Inter-bank investment refers to a mechanism whereby a surplus IBS bank can invest in another IBS bank, which has a deficit on the basis of Al Mudharabah (profit-sharing). A new cheque clearing system was introduced, which separated Islamic and conventional cheques for clearing purposes and is also based on the principle of Al Mudharabah.
Therefore, the Malaysian Islamic Banking System has met several of the criteria for establishing an effective Islamic Banking System. It has developed a wide variety of products, has a large number of players, and has an Inter-bank money market. It is regulated by the Central Bank and other relevant institutions to a certain degree. However, Malaysia and the rest of the world still lacks an effective dispute resolution system for Islamic finance disputes, which would preserve the industry and ensure its survival into the future.
*Information taken from the Law and Practice of Islamic Banking and Finance by Dr. Nik Norzrul Thani; Mohamed Ridza Mohamed Abdullah; and Megat Hizaini Hassan. (2003)