Research Journal of Business and Management – (RJBM) ISSN: 2148-6689, http://www.pressacademia.

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Research Journal of Business and Management- RJBM (2017), Vol.4(3),p.276-286 Abdullah

Year: 2017 Volume: 4 Issue: 3

A COMPARISON BETWEEN MALAYSIA AND INDONESIA IN ISLAMIC BANKING INDUSTRY

DOI: 10.17261/Pressacademia.2017.705
RJBM- V.4-ISS.3-2017(4)-p.276-286

Atikullah Abdullah
Universiti Sains Malaysia, School of Humanities,11800 Penang, Malaysia. atik@usm.my

To cite this document

Abdullah, A., (2017). A comparison between Malaysia and Indonesia in Islamic banking industry. Research Journal of Business and
Management (RJBM), V.4, Iss.3, p.276-286.
Permemant link to this document: http://doi.org/10.17261/Pressacademia.2017.705
Copyright: Published by PressAcademia and limited licenced re-use rights only.

ABSTRACT
Purpose- This paper aims to compare Malaysia and Indonesia in terms of current circumstances in the Islamic banking industry. This is very
interesting because of several factors. Firstly these two countries are neighbors. Secondly, both countries have expressed their aspiration
to be the center for the Islamic banking industry not only in the region but also in the world. Thirdly, both countries have significant
differences in demographics and economic conditions. It is therefore very interesting to see which country is in a better position than other
in the Islamic banking industry at present. This will help researchers to predict which country will achieve the target first if it occurs.
Methodology- The comparison will focus on five selected items in Islamic banking institutions ie legal framework, court jurisdiction, capital
growth, products offered and shariah governance. For legal frameworks, court jurisdiction and shariah governance analysis will be made on
the basis of provisions in legislations and statutes in both countries. Comparison of the products offered will be analyzed based on the list
of products and the amount involved. However, since profit sharing activities are regarded as a key feature of an Islamic banking system as
argued by many authoritative scholars in this area, the involvement of Islamic banking institutions in profit sharing based products in both
countries will be the main focus in the analysis. Capital growth is chosen because according to Sula (2011) the development of a bank,
should be seen from the market share because the market share reflects the portion from the sale of industrial goods or servi ces
carried out by an industry. Prior to that, Shaffer (1993) reported that market share is important, because it reflects the performance
associated with bank's competitive position in the banking industry.
Findings- The study shows that although both countries are making good progress in the Islamic banking industry, no country is far ahead
of another. While Malaysia is ahead of Indonesia in some items, Indonesia is ahead of Malaysia in some other items.
Conclusion- This paper concludes that both countries have advantages and disadvantages of others in the Islamic banking industry. Hence
both should overcome their weaknesses and continue to build from their strengths to make their aspirations a hub in the Islamic banking
industry as a reality

Keywords: Islamic banking, shariah compliance, Indonesia, Malaysia, banking industry.

JEL Codes: K00, K19, K20

1. INTRODUCTION
Islamic bank in Malaysia was commenced in 1983 with a single fully fledged Islamic banking institution namely Bank Islam
Malaysia. Since then Islamic banking industry in Malaysia has been growing tremendously well through four different
phases and at this moment there are 16 fully fledged Islamic banking institutions in operation in Malaysia (Md Nor, M.Z.
et.al., 2016, p.601-604). With the strong growth in the number of banks, capitals and products, it is no surprise that
Malaysia aspires towards becoming the main player in Islamic banking in this region. Lately though, the position of Malaysia
as the main Islamic banking market in South East Asia has been challenged by Indonesia. Considered as a late comer,
Indonesia started it Islamic banking industry in 1992, almost a decade behind Malaysia through the establishment of Bank
Muamalat Indonesia (BMI). The growth has not been too bad since then and in 2015 the Islamic banking industry of
Indonesia comprised of 12 general sharia banks, 22 shariah business units of conventional banks and 161 sharia people's
credit banks (rural Islamic banks) with significance growth in capital as well (Sobol, I.,2016, p.171-173). Nevertheless, the
product and the capital growth are somewhat slow moving when compared to Malaysian Islamic banking industry. At the

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outset, the fact that Malaysia with more or less 30 million people and only 60% are Muslims make it look like a miniature
compared to Indonesia as a giant with over 270 million people and over 90% are muslims. Some observers aptly put it
‘Islamic banking in Indonesia is a giant waking up’ (Global Business Guide:2015) or a ‘sleeping giant stirring’ (New
Horizon:2012).
This paper discusses comparisons between Malaysia and Indonesia about the current situation in the Islamic banking
industry with a focus on five key items, namely legal framework, court jurisdiction, capital growth, product offerings and
shariah governance. For this purpose, initially this paper will present the true reality of these five items in Malaysia and
Indonesia based on the available facts and figures separately. Next is followed by comparative discussion and analysis
between the Islamic banking industry in both countries on the five items. In the end, a conclusion will be made to show the
position of both countries in the Islamic banking industry.
2. THE CURRENT STATE OF ISLAMIC BANKING INDUSTRY IN MALAYSIA AND INDONESIA
2.1.Legal Framework
By legal framework it is meant a broad system of rules that governs and regulates decision making, agreements, laws etc.
The development of Islamic Financial Industry in Malaysia is based on top-down approach or “government-driven”
approach where both regulators and the players were initiated and backed by strong political will.(Yussof, S.A., 2013, p.391)
There were at least ten pieces of legislations which form the legal framework for the establishment and operation of Islamic
banking system in Malaysia. These were Islamic Banking Act 1983 (IBA), Banking and Financial Institution Act (BAFIA 1989),
Takaful Act 1984, Central Bank of Malaysia Act (CBMA 1958), National Land Code 1965, Hire Purchase Act 1967, Stamp Duty
Act 1949, Property Gains Tax Act 1979 and Islamic Financial Services Act (IFSA 2013). The earliest legal foundation for the
Islamic banking industry in Malaysia was Islamic Banking Act 1983(IBA). This act paved the way for the establishment of the
first Islamic banking institution in Malaysia and it also authorised the central bank or Bank Negara Malaysia (BNM) to
supervise and regulate Islamic banks, similar to the existing licensed banks. Although the IBA is considered as too general
and non-comprehensive consist of 60 sections, it is acknowledged though that it creates healthy flexibility to Islamic
financial institutions (Hasan, Z., 2006, p. 4). Six years later in 1989 Section 124(7) of the existing Banking and Financial
Instutitution Act 1989 (BAFIA) was then introduced. The introduction of this section allows conventional banks to open
Islamic counter to offer Islamic banking products (Hassan, R., 2006, p.2). This section also required them to establish the
Shariah Committee in order to advise them any matter related to Islamic banking business or Islamic financial business.
Initially this scheme is known as Interest Free Scheme Banks or Skim Perbankan Tanpa Faedah (SPTF) and later on changed
to the Islamic Scheme Banks or Skim Perbankan Islam(SPI) until now. Arguably the introduction of section 124(7) of BAFIA
promotes healthy competition amongst Islamic banking players(Hasan,Z., 2006, p.5). Apart from the IBA and the BAFIA, the
Central Banks Act 1958 (CBA) also plays a crucial role in term of regulating the aspects of supervision and monitoring of the
implementation and operation of Islamic banking. This can be seen in the case of the amendment of section 16B of the CBA
in 2003. This amendment was made in order to enhance the role of the Shariah Advisory Council of BNM in supervising the
operations of every individual Islamic banking institution in this country (Hassan,R., 2006, p.5).
To ensure the smooth and safe operation of financial institutions and to promote stability in financial and payment systems,
the BNM conducts a yearly assessment of risks and challenges faced by the financial system.(Yusuff, S.A., 2013, p.393) This
assessment also enable the BNM to evaluate the strength of its regulatory and supervisory measures. This assessment
exercise produced the Financial Stability and Payment Systems Report in 2012. This report has prompted the government
to enact the brand new “Islamic Financial Services Act (IFSA) 2013 and its conventional counterpart the Financial Services
Act (FSA) 2013 in order to reinforce the BNM’s mandate to safeguard financial stability and strengthen the foundations for
a regulatory and supervisory framework that is effective, transparent and contributive towards an efficient and resilient
financial system. The new laws also strengthen the oversight on the market conduct of financial service providers, promote
effective oversight of payment systems and payment instruments, and support preconditions for the development of the
financial sector. The IFSA is considered as the most comprehensive piece of legislation in the realm of Islamic banking sector
(The Star, 6 February 2013). This is due for several reasons. First, its introduction in 2013 means that a number of existing
Islamic banking related legislations are repealed and replaced. Second, this new legislation also provides a comprehensive
regulatory framework of the various Islamic financial contracts and their application in the offering of Islamic financial
products and services by Islamic financial institutions. Third, the contract-based regulatory framework provided in IFSA also
gives regulators greater oversight and powers to further scrutinize financial holding companies and non-regulated entities if
they pose a risk to financial stability. Fourth, the IFSA governs all IFIs including Islamic banks, takaful operators,
international Islamic banks, international takaful operators as well as operators of payment systems which enable the
transfer of funds between Islamic bank accounts or which enable payments to be made by means of Islamic payment
instruments, issuers of Islamic payment instruments, takaful brokers and Islamic financial advisors. In short, this act which
is destined to ensure end-to-end shariah compliance covers whole range of shariah governance right from shariah standard,
operational standard, oversight functions and regulation. In addition to IFSA, Islamic banking institutions in Malaysia are

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also bound by some guidelines issued by BNM in 2013 as a measure to consolidate Islamic finance industry namely, capital
adequacy framework for Islamic banks, capital adequacy framework for Islamic Banks (capital components), financial
reporting for Islamic banking and Islamic financial institutions and guidelines on ibra (Rebate) for sale-based financing.
Furthermore, to boost up the operation of Islamic banking, the Law Harmonization Committee Report 2013 formulated four
recommendations namely, to introduce provisions in court rules on imposition of late payment charges on judgment debts,
to allow better access to Islamic financing for consumers through recommended amendments to reserve land legislations in
all states, to facilitate Islamic financing involving landed property through recognition of Islamic finance in the National Land
Code 1965 and to amend the Companies Act 1965 in order to facilitate the effort to offer globally accepted Shariah
compliant product structures for the Islamic money market.(Hassan, Z., 2014)
In 1992, to open the door for the establishment of Islamic banking institutions, the government of Indonesia through
parliament has enacted and passed the Banking Act No.7 which recognizes the existence of two banking systems namely
the conventional banking system and the Islamic banking system together to serve the economy. By virtue of this act, the
first Islamic bank in Indonesia, Bank Muamalat Indonesia was established in 1992 (Sobol, I., 2016, p.171). During its early
years, Bank Muamalat, as the only Islamic bank in Indonesia, faced some difficulties as the existing financial environment in
the country then was not conducive enough for the operation and development of a new banking system. For example,
there was no supporting network in the industry like market instrument, alternative for liquidity management and central
bank facilities that comply with Islamic principles. In 1998, to overcome this problems and to encourage network expansion,
the government amended the existing Banking Act no. 7 with a new act, called Act No. 10, to provide a wider opportunity
and a stronger legal foundation for Islamic banking. Act No. 10 can be considered as the legal foundation for Islamic banks,
as it provides assurance to investors, bankers, and the general public. This act does not only provide networking assistance
to the existing Islamic banking institution but it also open the door for conventional banks to establish Islamic banking units
within the conventional banking institutions (Siregar M.E. and Ilyas N., 2011, p.2). A few years after that, in 2004 the
parliament amended Central Bank Act 1999(Act No.23)that resulted in the birth of Act No.3. Through this amendment, the
central bank allowed monetary control with instruments based on Islamic principles. Since then the industry has steadily
progressed and expanded. The Act No.3 also strengthens the legal foundations for Islamic banking industry further.
Furthermore in 2008 the Islamic banking Act (Act No.21) was passed. In the beginning, this act mentions some of the
reasons for its existence such as to achieve justice and virtue in society based on economic democracy, to develop an
economic system based on values of justice, equality and well-being in accordance with the principles of shariah, to meet
the needs of Indonesian society to Islamic banking services, to comply the rules of the Islamic banking system and to have a
more specific legislation relating to Islamic banking than what has been provided in Act No 7 of 1992 and Act Number 10 of
1998. However according to Lindsey (2012), the main aim of this legislation was to gather all the previous regulations in one
act and to eliminate any existing inconsistencies. It has also provided a more adequate legal base to the development of
Islamic banking in Indonesia and consequently accelerate the growth of the industry. Since than, there is no further
development in the legal foundation of Islamic banking in Indonesia despite of the numerous changes and dynamism of the
Islamic banking industry locally and internationally.
2.2.Court Jurisdiction
In Malaysia, like in most of the Muslim countries around the world, Islamic finance cases fall under the jurisdiction of civil
courts and legislations. Since the civil courts hear Islamic banking matters, those matters will, without doubt, be governed
by principles of English common law or civil law. Many cases have been decided that deny shariah court the power to hear
Islamic finance cases. For example, in the case of Bank Islam Malaysia Berhad (BIMB) v Adnan bin Omar (1994), there was a
preliminary objection raised by the Adnan (defendant) who argued that since BIMB (plaintiff) is an Islamic bank, the Civil
1
Court has no jurisdiction to hear the case in view of Article 121 (1A) of the Federal Constitution 1957. The judge overruled
that objection and submitted that the matter was rightly brought before the Civil Court (Hassan,H., 2016, p.34). Among the
arguments was that since BIMB is a corporate body, it does not have a religion and therefore is not within the jurisdiction of
the Shariah Court. To create a more comprehensive and constructive environment for the development of the Islamic
financial system in this country, BNM in the Malaysian Financial Master Plan 2001-2010 has made a recomandation for the
establishment of a specialized shariah court to resolve cases involving Islamic banking institutions. Consequently on
February 2003, the Chief Judge of Malaya has issued a Practice Direction No. 1 of 2003 whereby a Muamalat Court called
Dagang 4 was set up under the Commercial Division of the Kuala Lumpur High Court to hear Islamic banking cases(Hassan,
Z., 2007, p.11; Hassan, H., 2016, p.40). Subsequently, the said Practice Direction was replaced by Practice Direction No. 4, 6
and 7 of 2013. It is stipulated in these Practice Directions that this special high court or also known as Muamalat Bench of
high court will only hear cases involving Islamic banking institutions. Prior to that, in 2009 the Central Bank of Malaysia Act
1958 was amended, which require the court or the arbitrator to take into consideration any published rulings of the Shariah

1
Article 121(1A) of the Federal Constitution of Malaysia 1957 mentions that “the courts referred to in Clause (1) shall have no jurisdiction
in respect of any matter within the jurisdiction of the Syariah courts”.

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Advisory Council(SAC) of BNM or refer the matter to the SAC for its ruling if a question concerning a shariah matter arises in
any proceedings relating to Islamic financial business. This is very reasonable since the background of the judges are from
English law and not from shariah law aspects.
Not different from the situation in Malaysia, in Indonesia business and finance are not under the jurisdiction of Islamic
court. Even the Religious Court Act, Act No 7 1989 clearly mentioned that religious court only enjoy the jurisdiction over
matters related to Muslim family affairs namely marriage, divorce,repudiation, inheritance, bequest, gift (Hasnul Arifin
Melayu, 2012, p.69). However, with the amendment made to the Law No. 7 of 1989 of the Religious Court and replaced by
the Law No. 3 of 2006, the jurisdiction of the religious court has been extended to cover all aspects of Islamic economic
matters, including Islamic banking(Melayu, H.A., 2012, p.69; Dewi,G., and Wirdyaningsih, 2014, p.41) . Later on in 2008, the
jurisdiction of Religious Court to settle Islamic banking disputes was further consolidated in section 55 (1) of Law No. 21 of
2008 concerning sharia (Islamic) banking. This new law clearly mentioned in section 55 that dispute settlement of Islamic
banking is carried out by a commercial court in the Religious Court structure. In the case that the parties have already
agreed to the settlement of disputes through other than Religious Court structure, the settlement of dispute shall be
carried out according to the proper akad (contract) content. In this case, the settlement of disputes may not be contrary to
the shariah principle. Besides the religious court, the act also provides an alternative institution which has the authority to
resolve Islamic banking and finance disputes namely the National Shariah Arbitration Body or Badan Arbitrase Shariah
Nasional (BASYARNAS). This Islamic arbitration body in Indonesia was established in 1993 by the initiative of the influential
Indonesian Ulama Council (MUI) with the objective of resolving muamalat disputes (Dewi,G., and Wirdyaningsih, 2014,
p.41). This means that there are two authoritative institutions that enjoy the legal authority in financial dispute settlement
in Islamic banking in Indonesia, one is the shariah court and two, is BASYARNAS as the mediation institution out side the
formal judicial system hirachy.

2.3.Capital Growth
The capital growth here refers to the appreciation in the value of an asset over a period of time. The Islamic banking asset
growth in Malaysia has been phenomenal. In 2004, twenty years after its inception the Islamic Banking assets in Malaysia
amounted to RM89 billion, accounting for 9.9 per cent of total banking asset in this country. The Islamic banking industry,
that consists of both full fledged Islamic banks and Islamic banking schemes in the conventional banks, has shown a good
performance with profitability and assets surpassing for the first time the threshold of RM1 billion and RM100 billion
respectively at the end of 2005. This figure continues to increase to RM495 billion in 2012, RM685 billion in 2015 and
RM742 billion in 2016. In term of market share of the total financing of the banking sector, in 2016 Islamic financing
accounted for a third of all bank financing at RM550 billion — some RM55 billion up from the previous year(NST, April 3,
2017). The same is true for the market share of Islamic deposits and investment accounts, which stood at RM602 billion, or
31.8 per cent. From the overall economic impact to the country as a whole the Islamic banking sector has become a major
contributor to the overall economic growth, with assets equivalent to nearly 25% of the country's gross national product.
According to Bank Negara in 2016, with 27 players offering more than 100 financial products , Islamic banking assets in
Malaysia now stand at more than a quarter, or 27 per cent, of the total banking system, surpassing the targeted 20 per cent
under Bank Negara Malaysia’s financial sector master plan. Therefore, it is not surprising that Malaysia, has become one of
the global leaders of the Islamic finance industry. According to a research conducted by Kuwait Finance House Research,
in 2013 Malaysia was ranked second just after Saudi Arabia of the nine Muslim majority countries in term of the volume
of Islamic market. BNM aspires for Islamic banking to achieve 40% of market share in term of total banking asset by
2020. Presently, Malaysia's Islamic banking assets reached USD173.9 billion with an average growth rate of 18-20%
annually. Islamic banking in Malaysia contributes 22% of total shares of Islamic banking in the six main Muslim countries
that provide Islamic banking system namely Qatar, Indonesia, Saudi Arabia, Malaysia, United Arab Emirates and Turkey
(QISMUT) and in term of global share, Islamic Banking Assets in Malaysia constitutes 8% of global share of the Islamic
banking system(NST, April 3, 2017).
According to statistics published by the Indonesia’s Financial Service Authority or Otoritas Jasa Keuangan (OJK), as of 2015
the Islamic banking industry of Indonesia comprised of 12 general Islamic banks, 22 Islamic business units of conventional
banks and 163 Islamic people's credit banks (rural Islamic banks). For three consecutive years, the market share of the
sharia banks in Indonesia stood still at less than 5 percent. Despite of having the largest Muslim population in the world
Indonesia has less than 4% shares Islamic banking assets in the QISMUT and less than 2% of global Islamic finance assets.
Domestically, only about USD21 492M or 4.8% of its total domestic banking assets are Shariah compliant. According to the
Global Advisors’ Islamic Finance Outlook Report for 2016, no Indonesian Islamic banks were ranked in the top five largest
banks based on assets in Southeast Asia. The performance of the Islamic banking industry in Indonesia has yet to satisfy the
public’s expectations. Although with a market of more than 200 million Muslims, Islamic banks in Indonesia still face
difficulties luring more customers and increasing their assets. Islamic banks in Indonesia was ranked as eighth out of the
nine Muslim-majority countries evaluated in 2011-2012. The country ranked first was Saudi Arabia, followed by

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Malaysia(Kuwait Finance House Research, 2013). The market shares of Islamic banks in Indonesia is 20% lower than
Islamic bank market shares of Malaysia (Jakarta Post, July15, 2016).
In order to spur Indonesia aspiration to become global hub for Islamic finance, OKJ developed and launched a five-year
roadmap in early 2015. The government also launched a program called “I Love Shariah Finance Program”(ILSFP) in Jun
2015. The ILSFP aims to increase the Islamic finance industry’s current 4.88% share of Indonesia’s total banking and finance
market to 15% by 2023. On of the steps that has been taken place to achieve the target is the merger of the existing Islamic
units of state-controlled banks Bank Rakyat Indonesia (BRI), Bank Mandiri and Bank Negara Indonesia (BNI). This merger
resulted in a huge USD8B sharia bank asset. According to OJK this mega Islamic bank would also quadruple Islamic banks’
market share in Indonesia to 20 percent by 2018. The three aforementioned banks together currently account for about 40
percent of Indonesia’s Islamic banking assets. While some see this goal as overly optimistic, Indonesia’s Islamic banking
assets grew at a compounded annual growth rate of 29.2% between 2010 and 2014, giving credence to the possibility of
achieving a 15% market share by 2023. Thus the New Horizon Global Perspective on Islamic Banking and Insurance (2012)
referred to Islamic banks in Indonesia as "the sleeping giant stirring".
2.4.Products Offered
Islamic banking in Malaysia has been accused of using many controversial debt-based financing. In Malaysia, debt based
financing is widely used since the first Islamic bank was introduced in 1983. This debt based financing is called variety of
names using different kinds of Islamic business contracts such using either al-bay’ bi thaman ajil (BBA) or murabahah or al-
ijarah thumm al-bay’ (AITAB) or al-ijarah al-muntahiyah bi al-tamlik (IMBT), bay al-dayn and bay al-innah, bay’ al-tawarruq
contracts (Jusoh, M. and Khalid, N., 2013, p.33) which the amount of financing facility could be paid by the customers to the
banks on a deferred payment basis agreed upon by both parties throughout the tenure of the financing and it is normally
on the fixed payment monthly instalment. On the other hand, the equity-based financing especially musharakah
mutanaqisah or diminishing partnership is rather new when it was introduced by foreign bank such as Kuwait Finance
House (Subky K.H.M. et. al. 2017, p.18) after the liberalisation of Islamic financial sector that allow the entry of foreign
players in Malaysia. According to Bank Negara Malaysia’s (BNM) Feb 2014 monthly statistics, the total aggregate financing
of Islamic banking system in Malaysia through musharakah and mudharabah contributed only less then 6 per cent of the
total aggregate financing despite of their noble concepts and philosophy in helping the community to achieve fair and
equitable distribution of profit and reduce the gap between the rich and the poor.
Indonesia, unlike its neighbor, only use some contract that are non controversial, in their perspective such as mudaraba and
musharaka (equity-based products), murabaha, salam and istisna'a (debt-based products). In Indonesia, although the debt
based financing also form the lion shares in Islamic banking total business portfolio, due to the relatively early stages and
lack of supportive infrastructure, the percentage of Islamic equity based financing is much bigger if compared to the
percentage in Islamic banking in Malaysia. The involvement of Indonesia’s Islamic banking institutions in profit-and-loss
sharing contracts namely mudarabah and musgharakah forming 22.2% with musharaka 2.6% and mudaraba 19.6%. while
debt financing (i.e., murabaha), formed 69.3% of all Islamic banks financing portfolios at the end of 2001 (Siregar,M.E., and
Ilyas,N., 2011, p.) By 2013, the financing volume released in the form of murabahah financing amounted to IDR 106,779
billion or 60.2 percent compared to the financing volume released in the form mudarabah and musharakah which slightly
increase from the amount in 2001 to IDR 50 079 billion or 28.23 percent.

2.5.Shariah Governance
Shariah governance framework is a set of organisational arrangements through which Islamic financial institutions ensure
effective oversight, responsibility and accountability of the board of directors, management and shariah committee. The
framework serves as a guide towards ensuring an operating environment that is compliant with shariah principles at all
times. There are two different models of shariah governance supervision framework implemented by Islamic banking
institutions in the world, namely the centralised model as implemented by Malaysia and disentralised model or ‘minimalist
approach’ as implemented by most of the Gulf Countries (Yussof, S.A., 2013, p. 392). In Malaysia, The Islamic Banking Act of
1983 provides for the establishment of the institutional shariah body or shariah comittee at every Islamic banking
institutions. Furthermore, The Central Bank of Malaysia Act 1958 provides for the setting up of the Shariah Advisory Council
operating under the flagship of the Central Bank of Malaysia (BNM) which plays the role of a shariah apex body. This means
that there are two-tiered shariah governance structure has been established, comprising an apex shariah advisory body at
the BNM and a supervisory shariah committee formed at the respective Islamic financial institutions. The supervisory
shariah comittee of the respective Islamic banking institution is however bound by the resolutions issued by the Shariah
Advisory Council of the BNM. In 2011 BNM has introduced the guidelines for Shariah Governance Framework for Islamic
Financial Institutions(IFIs). The guidelines provide road map for IFIs to develop sound shariah governance and to reinforce
the regulators expectation on effective and efficient IFIs governance system. Among other aspects, the emphasis is on the
independence of the Shariah Committee in ensuring sound shariah decision-making and on the role of the board of
directors in recognizing the independence of the Shariah Committee. The ultimate goal of this framework is to ensure

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continuous public confidence on the strength and credibility of Islamic finance industry. Furthermore, the Islamic Financial
Services Act of 2013 was enacted to reinforce the BNM’s mandate to safeguard financial stability as well as to statutorily
monitor and enforce Shariah compliance. IFSA 2013 went as far as given the Central Bank the locus standi to initiate civil
actions in court against financial institutions. In addition to local guidelines and legislation, all Islamic banking institutions in
Malaysia recognize and comply with shariah guidelines and accounting and auditing standards issued by Dubai based the
Accounting and Auditing Organization for Islamic Financial Institutions(AAOIFI) and Malaysian based the Islamic Financial
Services Board(IFSB).
In their recently legislated Shariah Banking Act, Indonesia has molded its shariah governance framework similar to the
Malaysian model, namely the centralised model of Islamic finance supervision . The National Shariah Board of the
Indonesian Council of Ulema is responsible for issuing fatwas in financial matters which are considered binding upon the
shariah boards of each Islamic banking institution. The shariah boards of individual banks have to refer to the National
Shariah Board for the final fatwas. The national board includes the highest authorities in shariah. However, shariah board
members of individual banks have to be highly qualified in order to understand the fatwas, the source of the fatwas and to
produce contracts and agreements in compliance with the fatwas. On 11 November 2014, the OJK signed a memorandum
of understanding with the National Shariah Board of Indonesian Ulema Council (DSN-MUI), laying the groundwork for
cooperation in achieving the stable and sustainable development of the Indonesian shariah financial services sector in
accordance with Shariah principles (Lawrence,J., 2014) Through this MOU the role of DSN-MUI is further enhanced to not
only issue fatwas but also to oversee their implementation. Specific objectives of the MOU include supporting the
strengthening of regulation and supervision of the Islamic financial services industry and enhancing Islamic financial literacy
and protecting consumers in the sector. The MOU’s scope encompasses preparing regulations, supervising the
implementation of fatwas and reciprocal consultation. Like the case in Malaysia, besides the the fatwas and rulings issued
by DSN-MUI, Islamic banking in Indonesia also adopted the rulings and regulations of the AAOIFI and IFSB.
3.DISCUSSION AND CONCLUSION
3.1.Legal Framework
The legal and regulatory framework of Malaysia’s Islamic banking has been praised by many and has been credited for the
smooth and phenomenal development of Islamic banking industry in Malaysia. Right from 1983 with the introduction of
IBA, legal and regulatory framework of Malaysia’s Islamic banking industry consistently evolving and improving in term of
its clarity, scope, and robustness. The introduction of IFSA in 2013 was a testimony of the continuous effort to improve and
strengthen the effectiveness of Islamic banking legal and regulatory framework in Malaysia. IFSA destines to regulates end-
to end shariah compliance activities within the Islamic banking sector as well as overall Islamic financial sector in Malaysia.
Despite of some reservations by industries on some provisions in IFSA, generally though, we can say that IFSA has been the
pride of Malaysia’s Islamic financial system as this legislation makes the Islamic banking activities strictly adhere to the
Shariah rules and principles through a close monitoring and supervision by the regulators. Therefore IFSA arguably marks a
new face in the history of the Islamic banking and financial legislation in Malaysia. Having said that, Indonesia is also not
very far behind in term of implementing a comprehensive and clear cut legislation that provide and monitor the operation
and development of Islamic banking over there. The Islamic Banking Act (Act No. 21) that was introduced in 2008 is a good
step in the right direction in order to stimulate the performance of Islamic Banks in Indonesia. According to some critics
nevertheless, so far, it had not shown the improvement yet. It is argued that the regulator should really prepare other tools
to support the Act No. 21 on Islamic Banking by creating a financial environment that is supportive for the smooth
development of Islamic banking in Indonesia. In this sense, Malaysia is still ahead with a comparatively condusive and
constructive environment for Islamic financial system to flourish.

3.2.Court Jurisdiction
While the establishment of The Muamalat Bench in Kuala Lumpur High Court could be praised as a good step to address the
issue of Islamic finance court litigation, it however, raised some pertinent concerns. Firstly, it means that Islamic banking
cases will be adjudicated by the court which operate within the ambit of conventional civil court structure. This means that
there is no designated court being assigned with exclusive jurisdiction under the federal laws to adjudicate Islamic financial
disputes. Instead, Islamic finance cases are filed at all levels of civil courts namely Magistrates’ courts, Sessions courts and
High Courts based on amount of claim involved even though not all the courts have dedicated judges who are well versed in
Islamic law. It also means that there is no dedicated judges trained in Islamic banking and shariah to hear cases involving
shariah matters. Secondly, it has a very limited geographical jurisdiction of hearing Islamic finance cases filed within the
local jurisdiction of Kuala Lumpur High Court only. Hence, this situation suggests that litigants may do ‘forum shopping’ and
elect to file their Islamic finance cases outside the Kuala Lumpur High Court jurisdiction. Thirdly, the function of Muamalat
Bench is also very limited and does not cover all legal proceedings arising from Islamic financial transactions. For example,
after judgment is recorded, the execution proceedings such as winding up proceedings (Code 28) and bankruptcy

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proceedings (Code 29) will be heard by other civil courts in commercial division. These civil courts are not bound to
implement Islamic law of finance in their adjudication process. Fourthly, any appeal from the Muamalat Bench will goes up
all the way to Court of Appeal and Federal Court which, for the time being, do not have specialised panel of judges in the
area of Islamic finance. In this sense, Indonesia can be said as way ahead of Malaysia. Section 55 (1) of Act No. 21 of 2008
concerning shariah (Islamic) banking clearly provides that the Islamic banking cases must be adjudicated by commercial
court under the Religious Court structure. It also provides that any dispute settlement of Islamic banking must by based on
the Islamic law of finance. This is so regardless of the place or mechanism through which the settlement is achieved iether
through the commercial court of the Religious Court structure or through other than Religious Court structure such
BASYARNAS. In any situation, the settlement of disputes may not be contrary to the shariah principle.

3.3.Capital Growth
It is very clear from the figures above that Malaysia is very far ahead of Indonesia in term of Islamic banking asset
growth. This can be attributed to many factors. According to Moody's Investors Service, this is down to the fact that
Islamic banking in Malaysia has more established franchises, deeper market penetration, and long-standing regulatory
support. Although banks in both countries have been experiencing slower growth in Islamic financing since the last couple
of years, the lowdown in Indonesia was far more manifested. There is also a more diversified portfolio mix in Malaysia. This
situation reflects in turn Malaysia's pioneering role in establishing comprehensive legal, tax and regulatory frameworks to
facilitate Islamic finance development. Compared with other major Islamic finance markets such as Saudi Arabia, the United
Arab Emirates, Qatar and Kuwait, the Malaysian market differs in a crucial way in that it is as comprehensive and holistic as
its conventional counterpart. Indonesia on the other hand, according to some researchers, needs to improve in many ways
in order to raise to a more prominent position in Islamic banking sector in the world, Indonesia’s. Firstly, competitiveness
especially in term of economic benefits such as return on equity, service quality, efficiency and shariah compliance
assurance. Secondly, service quality and products information. Surveys conducted show that customers consider
Indonesia’s Islamic bank’s service quality and product information are inferior to those of conventional banks. Thirdly, given
their current size and legal lending limits, Islamic banks faced difficulties in serving corporations, except through syndication
of financing and fourthly, there is a need to have a proactive approach by Islamic bankers to promote their products and
services to corporate customers.
3.4.Products Offered
In term of the number of Islamic banking products, it is so obvious that Malaysia’s Islamic banking institutions offer greater
number of banking products compared to Indonesia. In this sense, conventional banking products are actually the mirror of
the Islamic banking products, different only in term of their contracts involve and the branding, using more Arabic
terminologies. Therefore, Islamic banking in Malaysia has been accused of using many controversial debt-based financing.
This debt based financing is called variety of names using different kinds of Islamic business contracts such as al-bay’ bi
thaman ajil (BBA), murabahah, al-ijarah thumm al-bay’ (AITAB), al-ijarah al-muntahiyah bi al-tamlik (IMBT), bay’ al-‘inah,
bay’ al-tawarruq, bay’ al-dayn. Besides some fiqhi issues associated with the implementation of these technics of financing,
such as the issues of back door to riba (interest) and complete transfer of ownership, the situation become worse due to
the fact that through debt based financing, Islamic banks tend to choose risk avoidance strategy which prompt many to
accuse the removal of morality from the banking business (Rosly, S.A., and Bakar, M.A., 2003, p.1262). The Islamic banking
market is nevertheless, different in Indonesia because there are far fewer products used. This limited product development
is due to restricting contracts to those that are “all conformed with shariah". Indonesia, does not approve some debatable
contracts such as bay al dayn, bay al innah, tawarruq and bay al arbun and more comfortable with contracts such as
mudaraba and musharaka (equity-based products), murabahah, salam and istisna'a (debt-based products). These limited
products are useful in many aspects of Islamic finance, but restrict the variety of products that can be offered by banks. This
is not necessarily always detrimental because it can check the growth of controversial products from Islamic muamalat
point of view.
It is argued therefore, that Islamic banking in Malaysia in particular needs to improve more in term of equity and profit loss
sharing ventures. It is the point of agreement among scholars that the profit sharing principle is the main feature of Islamic
banking system as it can play critical role in helping the alleviation of the living standard of society through business
activities promoted by Islam (Antonio,M.S., 2001:137; Ahmad, A., 1993, p.19; Errico,L., and Farahbarksh,M., 1998, p.6;
Chapra, M.U.,1985, pp.68-72; Siddiqi,M.N., 1985, Usmani, M.T., 2002 & 2007; Ali, M.A. and Hussain, T, 2016, p.121;
Obaidullah M.,2005, p.57; Siddiqui, S.H., 2002, p.15). It is also argued that lack of equity based or profit and loss sharing
financing phenomena around the world may result in the negative public perception on Islamic banking(Sholikhah,Z., et.al.,
2017, p.30). Several studies highlighted that almost exclusive reliance on debt-based financing is one of the serious
problems facing the Islamic banking industry today(Ahmed,A., 2010, p.308; Beck, T., et al., 2012, p.435). Among others,
many Islamic banks rely on interest rate as a benchmark in deciding the profit rate. Additionally, the heavy reliance on debt-

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based financing is also not advisable as it can lead to issues in getting the instalment paid on time to Islamic banks, which
later lead to charging of penalty for late payment.
It is easy to understand the reason behind the lack on interest among commercial banking sector to get involved heavily in
equity and profit loss sharing based ventures. However as argued by many researchers before, Islamic banks should not
only be profit-oriented, but should also be promoting Islamic values and norms as a whole without undermining
commercial viability. Toward this goal, the regulator such as BNM must take proactive action. It is suggested that the
regulators imposes a maximm amount of murabahah and other debt based financing to certain percentage only and
encourage more profit and loss sharing based financing, such as mudarabah and musyarakah.
3.5.Shariah Governance
The effort of Malaysia in drafting specific and clear cut guidelines and legislations to ensure a systematic structure and
smooth operation of shariah governance framework is a commendable move. The Shariah Governance Framework of 2011
for Islamic Financial Institutions (IFIs) is very important in order to consolidate the Shariah governance framewok in IFIs in
Malaysia. This is because it gives a strong emphasis on two very critical points namely the sound shariah decision-making by
the shariah comittee of every individual IFIs and the role of the board of directors in recognizing the independence of
the shariah committee. The ultimate goal of this framework is to ensure continuous public confidence on the strength and
credibility of Islamic finance industry. Furthermore, the Islamic Financial Services Act of 2013 was enacted to reinforce the
BNM’s mandate to safeguard financial stability as well as to statutorily monitor and enforce shariah compliance. While
critics argue that the new legislation does not make major changes to the shariah governance system in Malaysia as it does
is to reorganize the system and monitoring measures to ensure a comprehensive shariah compliance especially in relation
to the shariah governance processes and product execution, it is a fact though that this legislation has made major
improvements to the Islamic Banking Act 1983 and the Takaful Act 1984. At first glance, the new act provides a
comprehensive regulation and supervision of Islamic financial institutions, payment systems and other relevant entities. In
comparison with Malaysia, the shariah governance model of Bahrain, Kuwait, UAE, Qatar and Oman is based on a
“minimalist approach”, in which the regulatory authorities expect IFIs to have a proper shariah governance system without
specifying the requirements in detail. The more centralised of approach in shariah governance framework as implemented
in Malaysia is no doubt makes the development of Islamic financial system is more systematic and transparent. Therefore it
is not surprising that Indonesia decided to follow the Malaysian approach in the shariah governance of its IFIs. Moreover, it
was reported that Dubai has recently switched over to a centralised shariah board after seeing the benefits of legal and
regulatory clarity offered by centralised governance. However although the Malaysian shariah governance model displaying
some semblance of uniformity, it still in need of some fine tuning, as the general wisdom goes “no system can be perfect”
as Yussof S.A. (2013) has put it. The table below summarize the above discussion.
Table 1: Comparing Malaysia to Indonesia for Islamic Banking Industry

Items
Malaysia Indonesia
Countries

Constructive environment with many related legislations

Need to create more supportive environment by creating
have been put in place to support Islamic banking
other tools and introducing and implementing related
industry. IFSA 2013 regulates end-to end shariah
legislations.The enactment of the Islamic Banking Act
compliance activities within the Islamic banking sector
Legal framework No. 21 of 2008 is a good step to stimulate the
and makes the Islamic banking activities strictly adhere to
performance of Islamic Banks in Indonesia. After almost
the shariah rules and principles through a close
a decade the act needs some improvement.
monitoring and supervision by the regulators.

Cases involving Islamic finance are under the jurisdiction

Act No 21 of 2008 clearly provides the jurisdiction for the
of conventional civil courts. The introduction of
Religious Court to adjudicate all cases involving Islamic
Muamalat Bench in Kuala Lumpur High Court should have
Court jurisdiction finance. Settlement through arbitration must adhere to
been a first step not the end of the road. Unfortunately
the Islamic principles
no significant improvement afterward.

In 2013 Malaysia was ranked second just after Saudi The market share of the shariah banks in Indonesia stood
Arabia of the nine Muslim majority countries in term of still at less than 5 percent. Indonesia has less than 4%
Capital growth
the volume of Islamic market. In 2016, Islamic banking shares Islamic banking assets in the QISMUT and less
assets in Malaysia stand at 27 per cent, of the total than 2% of global Islamic finance assets. According to the
banking system. Presently, Malaysia's Islamic banking Global Advisors’ Islamic Finance Outlook Report for
assets reached USD173.9 billion with an average growth 2016, no Indonesian Islamic banks were ranked in the
rate of 18-20% annually. Islamic banking in Malaysia top five largest banks based on assets in Southeast
contributes 22% of total shares of Islamic banking in the Asia. Islamic banks in Indonesia was ranked as eighth

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six main Muslim countries namely Qatar, Indonesia, out of the nine Muslim-majority countries evaluated in
Saudi Arabia, Malaysia, United Arab Emirates and Turkey 2011-2012. The market shares of Islamic banks in
(QISMUT) and in term of global share, Islamic Banking Indonesia is 20% lower than Islamic bank market shares
Assets in Malaysia constitutes 8% of global share of the of Malaysia
Islamic banking system
Debt based financing is widely used since the first Islamic Indonesia only use some contract that are non
bank was introduced in 1983. On the other hand, the controversial, in their perspective such as mudaraba and
equity-based financing especially musharakah musharaka (equity-based products), murabaha, salam
mutanaqisah or diminishing partnership is rather new and istisna'a (debt-based products). The involvement of
when it was introduced by foreign bank such as Kuwait Indonesia’s Islamic banking institutions in profit-and-loss
Product offered
Finance House. According to Bank Negara Malaysia’s sharing contracts forming 22.2% of all Islamic banks
(BNM) in 2014, the total aggregate financing of Islamic financing portfolios at the end of 2001 with musharaka
banking system in Malaysia through equity based 2.6% and mudaraba 19.6%. By 2013, the financing
musharakah and mudharabah contributed only less then volume released in the form of mudarabah and
6 per cent of the total aggregate financing. musharakah increase from the amount in 2001 to IDR 50
079 billion or 28.23 percent.
There are two-tiered shariah governance structure have
The National Shariah Board of the Indonesian Council of
been established, comprising an apex shariah advisory
Ulema(DSN-MUI) is responsible for issuing fatwas in
body at the BNM and a supervisory shariah committee at
financial matters which are considered binding upon the
the respective Islamic financial institutions. The
shariah boards of each Islamic banking institution.
supervisory shariah comittee of the respective Islamic
Shariah Shariah board members of individual banks have to be
banking institution is however bound by the resolutions
governance highly qualified in order to understand the fatwas, the
issued by the Shariah Advisory Council of the BNM. In
source of the fatwas and to produce contracts and
2011 BNM has introduced the guidelines for
agreements in compliance with the fatwas. In 2014 with
Shariah Governance Framework for Islamic Financial
the MOU between DSN-MUI and OJK the role of DSN-
Institutions which emphasis on the independence of the
MUI is further enhanced to not only issue fatwas but also
Shariah Committee. Islamic Financial Services Act of 2013
to oversee their implementation, supporting the
was enacted to reinforce the BNM’s mandate to
strengthening of regulation and supervision of the
statutorily enforce shariah compliance to the extent
Islamic financial services industry and enhancing Islamic
initiating civil actions in court against errant financial
financial literacy and protecting consumers in the sector.
institutions.

4. CONCLUSION
In conclusion Malaysia probably ahead of Indonesia in three aspects, namely legal framework, asset growth and shariah
government while Indonesia has took over Malaysia in term of court jurisdiction and products offered. It is acknowledged
that Malaysia imposes more authoritative regime in term of legal framework and shariah government to ensure smooth
and systematic development of Islamic banking sector and to avoid any factor that could destabilise financial eco-system in
this country. This is probably a lesson learnt from past experience where many financial researchers argues for a more
dicipline and well-regulated banking and financial system. In this sense the U.S subprime mortgage criss in 2008 can always
be referred to. In term of asset growth, the area that Malaysia is claimed to perform extremely well it appears however,
there are many corners are cut with its heavy involvement in many debatable muamalat business contracts. Indonesia’s
approach in this respect is rather more cautious by limiting its products only on sound contracts from muamalat
perspective. Thus slow growth is understood. As far as the court jurisdiction is concerned, Indonesia is seen to have a more
consistent and coherent court structure to deal with cases involving Islamic banking system disputes. In short, although
Malaysia is a decade ahead of Indonesia in term of the first to have the Islamic banking system, but it is not running away
too far as Indonesia is slowly but surely closing the gap.

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