How Malaysia Leads Asia in Islamic Banking
Islamic banking and finance (IBF) has been growing rapidly over the past few years. Though estimates vary, there is little dispute that annual global growth is consistently in the double digits and that Islamic finance assets under management are currently valued at more than US$400bn.
The principles of IBF are embedded in the overall Islamic value system and governed by Islamic (Shariah) law. These principles have the following effects on IBF:
Islamic financial institutions are available in several forms:
Malaysia has established itself as a regional, if not global, hub of Islamic finance through its encouragement of dual banking systems. The country’s pioneering efforts led to the development of many innovative products and also inspired other Islamic markets that have followed the Malaysian example. One of the main reasons Malaysia has been able to take the lead in IBF is that the country maintains a liberal attitude toward IBF practices while remaining grounded in accepted IBF regulatory practices.
Figure 1 shows the growth of Islamic financial assets in Malaysia.
As part of its Financial Sector Masterplan, the Malaysian central bank, Bank Negara Malaysia (BNM), has set a target to have Islamic banking assets equal 20% of total banking assets by 2010.
One of the main reasons Malaysia has been able to establish itself as an Islamic finance hub is its high level of regulatory support in setting Islamic finance standards. Beginning with the introduction of the Islamic Banking Act in 1983, BNM has continued to implement policies that actively promote the growth of Islamic finance. Two examples of this are seen through the government’s issue of non-interest-bearing paper as well as the founding of the Islamic interbank money market.
With the establishment of Bank Islam in 1983, BNM quickly realised that the bank would be unable to hold government securities or T-bills that paid interest. In response, a non-interest-bearing paper was issued that Bank Islam would view as a loan to the government. A dividend committee, with representatives from the major financial and economic government bodies, was formed to regularly declare rates of return. The rate is determined by a variety of economic factors such as macroeconomic conditions, the inflation rate, and the returns of similar instruments. No fixed formula was set in place, and this practice continues today.
In 1994, the interbank money market was established, allowing interbank trading of Islamic financial instruments such as mudarabah (profit sharing) interbank investments (MIIs). The MII program allowed for Islamic banks in need of funds to obtain them from other Islamic banks by issuing profit-sharing certificates for a fixed investment period, from overnight to one year. The profit-sharing ratio is determined in advance, and the principal is repaid at the end of the loan period.
The Malaysian government provides foreign banks with tax breaks on their Islamic operations and limits foreign ownership of local Islamic banks to 49%. However, there is an exception to this rule. Should the Islamic financial institution conduct foreign currency business, then foreign investors can own 100% of the institution.
As a result, Middle Eastern financial institutions have taken active steps to establish operations in Malaysia, as demonstrated in Table 1.
| Financial Institution | Details |
|---|---|
| Dubai Investment Group (DIG) | Acquired a 40% stake in Bank Islam in late 2006 for approximately US$240 million |
| Kuwait Finance House | Established independent operations in February 2006 |
| Al Rajhi Bank | Established independent operations in October 2006 |
| Qatar Islamic Bank (QIB) | Established the Asian Finance Bank (AFB) in early 2007 with a 70% stake valued at US$100 million with partners Rusd Bank and Global Investment, with 20% and 10%, respectively |
Source: Financial Insights, 2007
As Figure 2 demonstrates, Islamic finance as a part of Malaysia’s total financial industry has been steadily growing to ensure its place as a major player in the Malaysian market.
The growth in Islamic banking, in particular, has been so high that the major Malaysian banks are looking to break out of their current Islamic windows operations and establish standalone subsidiaries with a greater scope of services, including investments and private banking.
In terms of Islamic deposit taking and lending, Malaysian banks have also been able to rapidly grow their business. Figure 3 illustrates this growth. Islamic deposits and loans have been increasing due, in part, to the effort banks have put into educating their customer base on their Shariah-compliant products. The majority of banks providing Islamic products have a detailed and easy-to-read overview of Islamic finance as well as a breakdown of each of their Islamic products.
Sukuk is commonly known as a Shariah-compliant bond and was pioneered in Malaysia in 2001. In conventional finance, bond trading is largely about exploiting interest rate developments in order to maximize capital gains; it would seem unlikely that such a product would match Shariah requirements. However, one of the distinguishing features of sukuk products that makes them Shariah compliant is the fact that a real, tangible asset must back them. Thus, a sukuk is more akin to an asset-backed security.
In 2006, the total value of Malaysian sukuk issues was US$11.7bn. With the continued growth of the sukuk market, it is only a matter of time before other Malaysian and foreign financial institutions actively seek to take a bigger piece of the sukuk pie. CIMB is the sukuk market leader but is experiencing rising competition. For example, Bank Islam recently arranged two sukuk issues valued at US$294m in total for a plantation company and a conglomerate.
The Islamic banking industry is still establishing itself, but changes are occurring at a rapid rate. In the coming years one can expect: