FIN 4250 BANK MANAGEMENT

SEMESTER 2, 2014/2015
SECTION 1

ARTICLE REVIEW 2:
The Islamic interbank money market and a dual banking system:
the Malaysian experience
by Obiyathulla Ismath Bacha

Lecturer:
Sir Zulkufly Bin Ramly
Group members:
1.
2.

(Leader) Alliya Binti Jaffar

Wan Nor Azni Binti Wan Najmuddin

3. Nazqin Binti Azman

1222398
1227906
1224566

Obiyathulla Ismath Bacha, (2008). The Islamic inter bank money market and a dual banking
system: the Malaysian experience. International Journal of Islamic and Middle Eastern
Finance and Management, Vol. 1 Iss 3 pp.210 - 226.
Introduction
In today's financial world, one of the renowned classifications of financial markets is
the money market and capital market. Since the commencement of Islamic finance in the
1960s, Malaysia is among the countries that have provided a wide range of Islamic financial
products and activities. From Mohd Azmi Omar, Muhamad Abduh and Raditya Sukma
(2013), the Islamic Money Market, known as the Islamic Interbank Money Market in
Malaysia, came into existence 10 years after the establishment of Malaysia's first Islamic
bank in Malaysia on 1st July 1983.
The article describes Malaysias Islamic inter-bank money market (IIMM) and
examines the operation of an IIMM within a dual banking system in Malaysia. Overall, the
article explained about the issues of IIMM in Malaysia and briefly explained the Islamic
money market instrument use. This article review consisted of 5 sections including
introduction. The second section explained the theoretical elements of the article followed by
the third section where we will explained the research methodology that has been used by the
author. In fourth section, the strengths and weaknesses of the article are discussed.
Theoretical elements.
The Islamic Interbank Money Market is considered the largest component of any
Islamic money market and in particular the overnight subcomponent (BNM,2009). The
overnight market is the component of the money market involving the shortest term. Islamic
interbank market is to facilitate placement among them. Banks or any other institutions rely
on the money market to manage their liquidity.
Proceeding to the establishment of IIMM in January 1994, the Government
Investment Certificate (GIC) was the only available Shariah-compliant short-term instrument
available to banks for liquidity management. However, the problem of this instrument was
that the secondary market for the instrument was not available. According to the article, this
is because the instrument was issued under the principle of Qard al-hasan or interest free loan
that made the instrument cannot be traded in secondary market. The banks could only do the
transaction with BNM. They would invest when they have surplus, and sell back to BNM
when they need liquidity.
Next, the article explained the structure of IIMM. It has three components which are
interbank deposits, Islamic money market instruments. As a consequent to Malaysia's dual
banking system, the investors or players of Islamic money market consisted of both Islamic
and conventional players such as Islamic banking, Islamic financial institutions, conventional
banks and financial institutions, and insurance companies. Unlike conventional money
market, Islamic financial institutions cannot access into it.
One of the important components in IIMM which is Islamic inter-bank deposits has
three mechanisms. However, the author only explained one mechanism only that is
Mudharabah Interbank Investment (MII) whereby deficit Islamic banks can borrow from
surplus Islamic banks based on Mudharabah or profit-sharing concept. According to Mohd

Azmi Omar et al. (2013), other mechanisms that are not stated by the author are commodity
murabahah interbank investment and wakalah investment.
Back to MII, Obiyathullas study (as cited in BNM, n.d) found that the BNM rules,
minimum investment amount is RM50,000. Initially, the rate of return is based on the gross
profit rate before distribution for investment on one-year of the investee bank. As there was
an incentive problem because the investee bank or deficit bank had an advantage to enjoy
lower profit rate. Then BNM came up a new rule whereby the benchmark rate is equivalent to
the rate of the GIC add with 0.5 percent.
The second component is the Islamic inter-bank cheque clearing system. This element
is less important between Islamic inter-bank market and Islamic money market instruments.
There are two initiatives to create a separate cheque clearing system for the Islamic bank.
Firstly, all Islamic banks must keep an Al-Wadiah current account with BNM. Secondly, the
same Islamic banks must empower their account to prepare the funding position between
surplus and deficit banks, during the automatic cheque clearing process at midnight.
The last and the most important component in IIMM is Islamic money market
instruments. These instruments can be divided into two categories, one is issue under the
government of Malaysia and another category is issue under corporation. Under the issuance
by the government of Malaysia, the instruments are Malaysian Government Securities (MGS)
and Malaysian Treasury Bills (MTB) which are conventional, but then were 'Islamised' which
change to Government Investment Issues (GII) formerly known as GIC and Malaysian
Islamic Treasury Bills respectively.
Additionally, GII that replaced GIC was introduced in 2001 under a concept of bay'
al-inah. As been explained by the author, GIC was not fitted in secondary market because the
use of the Qard al-Hasan concept given the uncertainty of the redeemable face value.
However, because of the issue of bay al-inah where it said that it has an element of usury or
riba, GII is issue using the concept of Murabahah that is effective from 22 July 2013 (BNM,
n.d.) and the secondary market trading is based on Bay' al-Dayn concept.
There are many new ideas and information that can be founded in this article. The
author explained the concept of IIMM and also the issue of interest risk between Islamic
money market and conventional money market. Besides that, the author also discusses the
issues and challenges happened in IIMM. Above all, still, IIMM plays several important roles
and is needed in dual banking system.

Methodology.
The author use empirical study in collecting the data. In this article, the author does
some observation by comparing the daily quoted yields in Malaysia's IIMM and the
conventional money market. There are four inter bank yields that were been examined.
Furthermore, the author did some day-today observation for the yields and concluded the data
into a table. The researcher collects the data from BNM's website for conventional money
market data and IIMM's website for IIMM data. From the data shown in article it is stated
that the rate between conventional which use interest rate and Islamic which use profit rate
almost match, which means that IIMM would face the same interest rate risk as conventional
does.
Strengths and Weaknesses.
One of the strength of this article is that the explanation by the author regarding IIMM
is good. This is because the author organizes the part accordingly from the basic or concept of
the IIMM to the issues and challenges in IIMM. Therefore, the author gives some ideas to
readers what he wants to explain about. Furthermore, through the table given by the author it
would make readers easily to understand the information that the author wants to deliver.
However, there are also some weaknesses spotted in this article. Firstly, although the
author explained briefly about IIMM instruments in Appendix 2, he should provide what is
the conventional instrument that has been replaced by it. For example, Government
Investment Issues (GII) is an alternative to the conventional Malaysia Government Securities
(MGS).
Other than that, the information given in the Islamic inter-bank market by the author
is an old one. The author informed that the rate is equivalent to the rate of GII plus with 0.5
percent. According to Mohd Azmi Omar et al. (2013), this rule was applied until 2004 when
BNM replaced it with a more comprehensive framework, where it sets out the calculation of
distributable profits and the derivation of rates of return to the depositors.
Conclusion
The Islamic money market enables players to perform similar functions like
conventional markets, but with exception that the instruments used must be based on Shariah.
The Shariah contracts used in IIMM are Mudharabah, Mudharabah Interbank Investment);
Murabahah, Commodity Murabahah Investment; and Wakalah, Wakalah investment. The
trading of IMM instruments is to facilitate placement among money market players through
the issuance of financial instruments. The risks associated with IIMM are the same with the
conventional which are counterparty risk, liquidity risk, interest rate risk and regulatory risk
plus with another two risks only for IIMM which are accounting risk and Shariah risk. From
these risks, it is a challenge for IIMM to be well functioned. So, more research and solution
should be done to develop Islamic money market not only in Malaysia, but also domestically.