Malaysia has embarked on the pioneering effort to develop a comprehensive Islamic financial system for over 20 years now.  It was one of the earliest to recognise the potential to create a financial system compatible with Islamic principles that provides an alternative to the conventional system. 
In the area of institutional development, the first Islamic financial institution established was the Pilgrim Fund Board or Lembaga Tabung Haji, founded in 1969. Its objective is to mobilise savings of Muslims intending to perform the Haj, with the pool of savings being invested in Shariah permissible instruments.
The Tabung Haji model has been adopted elsewhere around the world. The institutionalising of Tabung Haji as a Shariah-compliant organisation paved the way for a more structured institutional development in Islamic banking and finance.  In 1983, Malaysia enacted the Islamic Banking Act and established Malaysia's first full-fledged Islamic bank. For Islamic insurance, the Takaful Act of 1984 was legislated.
The Islamic financial system was further complemented with the inception of the Islamic inter-bank money market in 1994 followed by the availability of short and long-term financial instruments. These Shariah-compliant investments and instruments have been providing the Islamic banking institutions with funding and liquidity requirements, fully supported by the state-of-the-art technology  services including settlement and custodian systems, funds transfer and script-less Islamic securities and commercial papers.
Presently, there are a total of 12 Islamic banks and 7 conventional banks with 7 Islamic windows in Malaysia, offering Islamic banking services that are governed by Bank Negara Malaysia. In addition, there are 9 takaful operators including the 4 new takaful operators that will commence business later this year.

In the area of regulatory development, the Islamic Financial Services Board (IFSB) was established in Kuala Lumpur in the year 2002 to develop international prudential regulatory standards globally to enhance soundness and stability of Islamic financial system. Bank Negara Malaysia is the founding member of IFSB together with 15 other full members that comprises central banks, monetary and supervisory authorities.
Thus far, two standards have been issued, namely the standards for Capital Adequacy and the Guiding Principles for Risk Management for Islamic financial institutions. Bank Negara Malaysia will be implementing these IFSB standards for adoption by Malaysian Islamic banking institutions with effect from year 2007.  
For the orderly development of an Islamic Capital Market (ICM), the Securities Commission has initiated various measures.  Over the past decade, Malaysia ICM has witnessed the proliferation of products and services ranging from equities, unit trust funds, structured products, derivatives, index, fund management and stock broking services.  At present, there are 89 Islamic unit trusts, about 85percent of the listed stocks are Shariah-compliant and 46percent of the corporate bond markets are Islamic bonds.  It is fair to say that Malaysia now has the most comprehensive Islamic capital market in the world.
Having built up knowledge of the underpinning Shariah principles and in line with the growth of demand in Islamic banking products, private institutions now realise the potential of Shariah-compliant products as a viable driver of profitability, market differentiation and enhancer of shareholder value. The next stage was the assimilation of Shariah principles for wholesale banking and finance products and services. This has been done successfully and the industry will continue to do so, moving up the value chain, developing increasingly sophisticated structured products applicable to the needs of an increasingly demanding domestic and international markets.
From a policy-driven industry, Islamic finance has since developed to a more market-driven initiative. In 2005, the Malaysian Islamic banking system grew at an impressive pace, with higher profitability and positive trends in all key indicators. The aggregated Islamic banking assets amounted to RM117 billion, takaful assets at RM6.2 billion and Islamic private debt securities amounted to RM125 billion. In the first half of 2006 alone, a total of 26 new corporate sukuk issues with a total value of RM23 billion were announced.
The contribution of Islamic issues in the development of depth and breadth in the domestic bond market is critical.  As of June last year, sukuk issues made up of 70 percent of the total Malaysian bond market. The aggregate value of Malaysia's sukuk issues places it as the largest Islamic bond market in the world. Malaysia's leading position is further demonstrated by the fact that of the global market capitalisation of Islamic banks, 11percent was from Malaysian Islamic banking institutions.
As for offshore issues, Labuan IOFC was the jurisdiction for the issuance of the world's first global sovereign sukuk that is the US$600 million Malaysian Government sukuk in 2001. The issuance of the global sovereign sukuk signified a new era in international Islamic finance. Numerous institutions including those from Asia, Middle East, Europe, North America and Indian sub-continent subscribed to the groundbreaking issue. It was the catalyst and precursor to the development of the international sukuk market.
The Malaysian sovereign sukuk was listed on the Labuan International Financial Exchange (LFX), making a milestone in Islamic finance. Since then, many issues have been listed at the LFX both domestically and internationally.  The total issuance of Islamic papers listed at LFX now totaled US$2.1 billion.