Islamic Finance – How Malaysia can stay ahead

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The sukuk market has led to the globalisation of IF with Malaysia accounting for 60.4 per cent of the global sukuk market. Malaysia is currently the world’s second-largest Islamic banking market with assets totalling some US$124 billion (RM397 billion) as at end-May this year (photo credit: Masjid Negara portal)The sukuk market has led to the globalisation of IF with Malaysia accounting for 60.4 per cent of the global sukuk market. Malaysia is currently the world’s second-largest Islamic banking market with assets totalling some US$124 billion (RM397 billion) as at end-May this year (photo credit: Masjid Negara portal)The sukuk market has led to the globalisation of IF with Malaysia accounting for 60.4 per cent of the global sukuk market. Malaysia is currently the world’s second-largest Islamic banking market with assets totalling some US$124 billion (RM397 billion) as at end-May this year (photo credit: Masjid Negara portal)

By Shahjanaz Kamaruddin

Following blistering growth over the past three decades, Malaysia’s Islamic Finance (IF) industry currently faces the inevitable growing pains that occur as the industry matures. This was among many of the issues, challenges and success stories discussed at the 10th Kuala Lumpur Islamic Finance Forum held in late-September.

Given the sophistication of the IF industry today, it is easy to overlook the bold move made by the political masters back in the early 1980s when Malaysia seized the initiative to start developing its own unique brand of IF with little or no support from the IF industry players in the Middle East.

According to Jal Othman, Head of IF Practice Group at the law firm Messrs. Shook Lin & Bok (pic), Malaysia recognises the vast availability of Islamic funds to be tapped worldwide, including the petrodollars, and forged ahead to build from scratch its own Syariah interpretations and approaches as well as the country’s own infrastructure. This eventually led to the introduction of the Islamic Banking Act 30 years ago and the setting up of the first local Islamic bank in 1983.

From the very start, the IF sector proved its credibility by attracting both Muslim and non-Muslim consumers worldwide. Foreigners were attracted by not just its overall competitiveness but also by the moderate Islamic stance adopted by the Malaysian Government. Malaysia’s religious diversity strengthened its moderate Islamic credentials and served as IF’s unique selling proposition. Today more than 50 per cent of demand comes from non-Muslims.

Compared to what it was in its formative years, Malaysia’s IF marketplace today is unrecognisable. As pointed out by an informed source in a leading training institute, it is characterised by a robust regulatory and legal framework, a deep primary and active secondary sukuk market, an efficient price discovery mechanism, and encompasses key components such as Islamic banking, Islamic capital market, Takaful, Islamic money market, professional ancillary services, Islamic fund/wealth management and talent development infrastructure.

The sukuk market has led to the globalisation of IF with Malaysia accounting for 60.4 per cent of the global sukuk market. Malaysia is currently the world’s second-largest Islamic banking market with assets totalling some US$124 billion (RM397 billion) as at end-May this year.

The IF sector is poised to enter another growth phase where there are challenges projected to slow down its growth rate. A number of banks have downsized their IF operations in the West and defaults in the sukuk market are a cause for concern and debate. Experts expect slower growth than in the past as the industry adapts to fresh challenges including rising competition and stricter regulatory regimes.

The Islamic banking industry in Malaysia is in the midst of a major shake-up with the introduction of the Islamic Financial Services Act 2013 (IFSA) which came into effect in July this year. The new Act will likely trigger consolidation and strategic tie-ups within the industry thereby strengthening its ability to remain the frontrunner in IF globally. It is a comprehensive legislation that not only governs IF but also provides how Syariah needs to be governed. This may actually be the first time in modern history where Syariah governance with regard to IF is embedded in the national legislation of a country.

Observers recognize IFSA’s benefits of promoting regulatory transparency and improving governance and accountability. Nevertheless concerns have been expressed over a number of issues; such as, the uncertainty over the higher capital requirements where separate licenses are required for the life and general Takaful businesses; the requirement for providers to operate under a single financial holding company causing it to be the subject of regulatory oversight; and the significant shift of responsibility and accountability of board directors over operations and management.

Notwithstanding Malaysia’s successes, IF players all over Asia and the Middle East are enjoying healthy growth. Whilst international players are looking to make Kuala Lumpur their Islamic banking hub, strategies are needed to keep Malaysia in the forefront and ahead of its competitors in the areas of product innovation and talent management.

Activities such as Islamic Warrants, Islamic IPOs and Islamic REITs have not been pursued due to lack of incentives to promote them. According to the informed source, IF products such as private equity and Istisna’ are uncompetitive. The choice of wealth management products is limited compared to those offered by conventional banks.

Challenges abound. As the IF sector progresses to the next phase of growth within the context of the second Financial Sector Master Plan, it is clear that innovation and skilled talent, together with the laws and incentives to promote them, are the key drivers for the journey ahead. The informed source points out that products offered need to venture out of the usual structures and this is best achieved through enhancing knowledge and expertise.

Jal Othman predicts that the shortage of quality talent will likely continue for the next 5 years. He stresses that skilled IF practitioners must possess a sound grounding in both IF and conventional law/finance as the practical application of IF encroaches into the areas of conventional law/finance. The sought after blend of the two is hard to find. He observes also that students are less attracted to study IF due to perceptions that the discipline is too difficult to master.

Under the Economic Transformation Program, the Performance Management and Delivery Unit (PEMANDU) has set up a consortium headed by the International Islamic University and Bank Negara to develop general and specialized IF courses, and to devise a curriculum that is internationally accredited. It is recognized that a diverse talent base with global capabilities needs to be built up.

Jal Othman fears that complacency may be setting in where industry players are not hungry enough to stay ahead of the game through innovation. Creativity may also be hampered by uncertainties in the interpretation of laws, regulations and standards. He views the competition between the conventional banking and IF sectors as beneficial for the financial industry in Malaysia as a whole, as the success of one would contribute to the success of the other.

Notwithstanding the challenges ahead, the IF sector is in a healthy transitional phase and long term prospects remain good. Jal Othman foresees that, in 10 years’ time, IF would have grown to such a level of acceptance and sophistication that it would no longer be branded as “Islamic” but rebranded as “ethical” or “equitable” financing marketed as a viable alternative to conventional financing. Such a prospect seems well within Malaysia’s reach.

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