Zakat and the Performance of Islamic Banks: Empirical Evidence

Introduction

Islamic finance has recorded tremendous growth since it was introduced in 1970s and has gained the attentions of investors, policymakers and researchers alike. Islamic finance is defined as finance governed by the values and the principle of Islamic law (Najwa et al., 2019; Haron et. al, 2020). With assets of USD150 billion in the 1990s, Islamic finance assets have grown to about USD700 billion in 2007. Today, Islamic banks (IBs) are operating around the globe with more than USD160 billion in assets at the 10% to 15% growth rate annually. In addition, the market share of Islamic financial institutions (IFIs) has increased from 2% in 1970s to 15% in 2018 (Nomran and Haron, 2020a). Islamic Finance Development Report (IFDR) (2019) reported that the asset size of Islamic finance industry worldwide grew to USD2.50 trillion in 2018 compared to USD2.40 trillion in 2017. Moreover, the asset size of Islamic finance is projected to reach USD3.472 trillion in 2024.

For the past few decades, IBs have flourished globally and IFIs in the world has totalled to 1,447 in over 72 countries (end 2018). In terms of asset size, Islamic banking constitutes 70% (USD1.76 trillion) of the total assets of IFIs around the world with Malaysia recorded asset size of USD521 billion, ranked number three after Iran and Saudi Arabia. These three countries top the three markets’ share of global Islamic finance assets in 2018 (IFDR, 2019).

In Malaysia, there are two different types of banks in the banking industry, which are Islamic banking and conventional banking, and both of them are governed by the central bank, Bank Negara Malaysia (BNM). The Islamic banks (IBs) in Malaysia have experienced faster growth, supported largely by the creations of Islamic windows, a separate subsidiaries of conventional banks and this development has contributed to the growth of Islamic banking sector in Malaysia (Wasiuzzaman and Gunasegavan, 2013; Haron et al., 2020).

Meanwhile, Malaysia is prepared to become an Islamic finance hub in the world with respect to leadership, institutional establishment, product development, and regulatory changes that allow Islamic banking to work side by side with conventional banking (Nomran and Haron, 2020a). The reason behind the fast growth of Islamic banking in Malaysia is due to the government support. Malaysia is the most developed nation in the area of Islamic finance in the world and the implementation of four strategic plans has helped it to be in the forefront in the area of Islamic finance. These four strategic plans are regulatory framework enhancement, Shari’ah regulatory framework, products and services improvements markets, and enhancement of knowledge and expertise (BNM, 2017).

Malaysia first drafted its Islamic Banking Act to facilitate the regulatory framework of IBs in 1983, in the same year Bank Islam Malaysia Berhad (BIMB) was established. For almost ten years from its inception, BIMB monopolized Malaysia’s Islamic banking industry. However, a change to Islamic banking regulatory framework along the way eventually gives rise to competition in the market for both international and domestic players (Mohammed et al., 2015). After the introduction of Islamic banking in 1983, the industry has recorded promising achievement by taking more than 20% of the market share in 2010 in relation to its total domestic banking sector and controlling about 30% in 2017 (IFSB, 2019). In addition, the Islamic Banking Act 1983 grants the BNM the power to monitor and supervise Islamic banks in the country.

Although different laws were passed by the Malaysian parliament on Islamic finance, including the Central Bank of Malaysia Act 2009 giving special status for the creation of the Shari’ah Advisory Council (SAC), another development in Islamic finance legislations is observed in Malaysia which is the enactment of new Act called Islamic Financial Services Act (IFSA) 2013. This act annulled the previous Act (Bank Negara Malaysia, 2017). The latest enactment is Shari’ah governance framework, which was issued on 20th September, 2019 and came into effect on 1st April, 2020. This Shari’ah governance is to assist the previous Shari’ah governance framework introduced in 2011(BNM, 2019).