Muhammad Bin Ibrahim: Convergence and sustainable growth of Islamic
finance in a dynamic environment
Keynote address by Mr Mohammad Bin Ibrahim, Deputy Governor of the Bank of Malaysia,
at the Asia Islamic Banking Conference: "Convergence and sustainable growth of Islamic
finance in a dynamic environment", Kuala Lumpur, 5 July 2010.
* * *
I would like to thank the organisers for inviting me here today to give the opening address at
this inaugural Asia Islamic Banking Conference themed "Convergence and sustainable
growth of Islamic finance in a dynamic environment". This event is timely as the Islamic
finance industry continues to grow and expand in several financial centres around the world.
Since the first Islamic financial institution was established over four decades ago, Islamic
finance has evolved into an industry that has now gained global recognition, transforming its
role from an enabler to a driver of economic growth, offering consumers with diversity of
financial solutions to meet not only the Shariah requirements but also financial needs. This
evolution has been evidenced in many parts of the globe, originating in Asia and the Gulf
Corporation Council (GCC) countries, and spreading to the centers in Europe and Africa.
In Malaysia when Islamic finance started three decades ago, the initiative offered simple
banking solutions that encourage savings and financing. The products were structured in a
manner that is in line with Shariah principles and easily understood by the public at large.
Today, Islamic finance in Malaysia is a dynamic industry that is widely regarded as a
competitive alternative to conventional financing solutions. There are now diverse local and
foreign players in the market, showcasing their dynamism with a wide array of innovative
financial products and services on offer. Islamic banking now comprises 20% of the total
banking sector, complemented by a vibrant Islamic capital market, where 55% of outstanding
domestic private debt papers are sukuk, representing the largest volume of sukuk issuances
globally.
Dynamism is most evident in the Islamic capital market where now there are many varieties
of sukuk being structured and issued, including exchangeable, convertible and hybrid sukuk.
Recent developments have also seen Shariah compliant hedging instruments such as the
Islamic profit rate swap being introduced in the market. These products are able to compete
with conventional bonds by offering superior value proposition to their issuers and investors.
At the international level, we are also seeing significant progress being made in the
development of Islamic finance. There are more and more institutions offering Shariah-based
financial services being established today to tap on the opportunities in this fast-growing
industry. This includes the participation from global conventional banking giants. The
participation of established financial centers such as London and Hong Kong has further
reinforced the trend of internationalisation in Islamic finance. Similarly, emerging new
markets, from both Muslim and non-Muslim countries, have also identified Islamic finance as
a key growth sector with the potential to contribute significantly to their respective
economies, with some positioning to become established as new financial centres of the
industry in their own right. All these developments are creating a dynamic environment for
the global Islamic finance industry.
Despite the fact that there are now greater appreciation of Islamic finance leading to the
heightening of global interest in the industry, owing to the strength of its embedded value
proposition as demonstrated by the relatively resilient performance of Islamic financial
institutions during the recent financial crisis, we must continue to take steps to reinforce the
prospects for sustainability of the industry in this new development phase of global
expansion and cross-border inter-linkages. Today, I would like to touch upon two key
imperatives, firstly in promoting convergence and harmonisation, and secondly, the transition
to a more industry-led development, and how these can be major drivers pushing the
industry towards greater internationalisation and achieving sustainable growth and continued
development of Islamic finance.
In offering Islamic financial services, institutions are bound by a common thread in Islamic
finance, where all transactions must be in congruence with Shariah. However, differences in
opinion on the application of Shariah in financial products across markets have often been
pointed out to be a major issue which could hinder a more robust expansion of Islamic
finance internationally. Notwithstanding the desire for more standardisation, we should be
mindful not to suppress the generation of alternative point of views which could be the seeds
to innovation and breakthroughs in the marketplace. We need to transform the differences of
Shariah views into competitive strengths for the industry. History had shown that diversity in
opinion had led to the great Islamic civilisation. We should take recognition of this lesson in
history. I therefore would like to suggest that the international Islamic financial community to
subscribe to the fundamental principle of unity in diversity. Healthy debate and dialogues
amongst Shariah scholars must continue and prosper. However, we must always make a
conscious effort to keep an open mind, a tradition that was even espoused and practised by
the Prophet (s.a.w.), so that generation of good ideas would emerge from vigorous, even at
times heated intellectual debates. Over and above this requirement for openness and
dialogue, we should not lose sight of the greater themes that will unite rather than divide. We
should be open enough to amplify agreements rather than divergences.
We can agree that complete convergence is neither practicable nor achievable, as Shariah
also recognises differences in customs and cultural practices between various societies.
Also, the use of 'urf, the methodology through which customary practices are recognized,
enables different societies to function smoothly and efficiently, provided they are not
antithetical to the principles of Islamic law of transactions. 'Urf in Islamic law refers to the
general opinion or customs of a community, and forms the basis for rulings issued by a
mujtahid or a group of mujtahids, who has attained the right to exercise ijtihad, which is an
important part of the process of making a Shariah ruling.
Historically, 'urf played a crucial part in business development in Islam during the time of the
Prophet (s.a.w.). I shall briefly summarise the story on salam contract to illustrate this point.
In the Islamic law of transactions, the general rule is that parties are not allowed to contract
with each other where subject matter is non-existent to avoid anything that can lead to
gharar, or uncertainty, which can result in one party benefiting at the expense of the other
unfairly. This rule is based on a sunnah of the Prophet (s.a.w.) that states "Do not sell things
that you do not own."
This was the practice adopted in Mecca, a city of trade where such contracts were not
difficult to construct and physically tangible goods were plentiful in supply. Medina, though,
was a city of agriculture where typically the produce would not always be available at the
time of the contract. The practice called salam, a forward sales contract, was customarily
used so that farmers could sell their produce to be delivered at an agreed later date in
exchange for advanced payment which would be used as capital to cultivate land and grow
crops. The Prophet (s.a.w.) recognised the need for this practice in the economy of Medina,
and allowed the people to continue practising salam transactions. Today, salam, and by
extension istisna', are important contracts in modern Islamic financial transactions and are
now widely used in the structuring of financial products such as sukuk.
'urf
Clearly, there is wisdom in recognising to accept the permissibility of various practices
that may not be commonplace between different societies, but which are required to ensure
that the livelihood of communities is not disrupted. Greater engagement and dialogues
among Shariah scholars are therefore indispensible as platforms through which Shariah
scholars can discuss differences in financial practices, legal frameworks, operational
requirements, taxation, cultural differences and other issues pertinent in other jurisdictions.
Through this process, scholars shall become more appreciative of the many differences in
business and economic environments that might lead to different Shariah interpretations. A
more thorough understanding of such matters will also lead to better co-operation between
the scholars and industry practitioners and preserve the sanctity of the Shariah principles,
resulting in more well-informed opinions and better quality financial products and services.
However, as the market continues to evolve, the need for market harmonisation will continue
to grow. This is understandable as markets desire certainty and simplicity in engaging
business. It is therefore encouraging to see that, based on recent developments, there
appears to be an increasing movements towards combining efforts in establishing
internationally acceptable standards. A commendable example of this concerted effort
towards standardisation is the recent global master agreement on Islamic hedging, also
known as the tahawwut agreement, launched in March 2010 by the International Islamic
Financial Market (IIFM) and the International Swaps and Derivatives Association (ISDA). To
pave the way towards greater standardisation in the marketplace, the Master Wakala
Agreement For Deposit was recently signed by the Malaysian and UK Islamic banks in
November 2009 to provide alternative tool for deposit placements and provide the industry
with an increased choice in risk management instruments. Malaysia had also earlier
launched the first global Islamic derivatives master agreement (IDMA) in 2007 to develop
hedging tools for the Islamic financial markets to manage investment risks. This was followed
by the Interbank Murabahah Master Agreement (IMMA), which was signed in August 2009
by Malaysian Islamic banks, designed to facilitate effective risk and liquidity management
through Shariah-compliant deposit placements using the commodity murabaha concept.
Moving forward, recognising the need to introduce standards which are acceptable and
applicable to the Islamic finance industry, Bank Negara Malaysia is committed to undertake
research to develop Shariah Parameter References, which are aimed at achieving
convergence and harmonisation of Islamic financial practices. These references are being
developed together with local and international Shariah boards, industry practitioners,
academicians and other relevant parties to ensure the completeness in the documentation.
The first Shariah Parameter Reference on Murabahah contract was released in 2009, while
several concept papers have been issued on Mudharabah, Ijarah and Musharakah before
the final release of these references in the foreseeable future.
Such important efforts to generate greater harmonisation in Islamic finance will enhance
market efficiency particularly in terms of accelerating the product development cycle and
improving time to market, as well as to produce acceptable benchmarks of quality in terms of
products, services, processes and practices against which Islamic financial institutions must
aim to match or exceed. With this objective in mind, the overall Islamic finance industry
stands to benefit from commonality of practices leading to lower operating costs and the
potential set up of shared industry wide platforms, all of which are important considerations
for Islamic financial institutions to achieve economies of scale and interoperabilities across
institutions and national economies.
This brings me to my next point.
Ladies and gentlemen, the development of Islamic finance industry in many jurisdictions has
thus far been largely led by governments and regulators. Whilst this is expected in the earlier
phases of Islamic finance development, a pragmatic transition into the next phase of
development in an increasingly globalised environment would require more corporate or
private-led efforts amongst industry players, particularly in leading initiatives of promoting
convergence and harmonisation of Islamic financial practices. In the case of Malaysia,
initiatives by the government and regulators through more than three decades of
development have already provided a comprehensive enabling environment for the Islamic
financial institutions to now take the lead. In this time of globalization and greater
liberalisation, Islamic financial institutions must be forward-thinking and leverage on their
extensive experience to secure first-mover advantage in tapping into opportunities across
borders, particularly in new markets seeking to develop Islamic finance. I believe that the
future holds better prospects for Islamic finance with greater internationalisation of business
beyond domestic centric operation.
Going forward, we can expect for more leadership from the Islamic financial institutions in
making the paradigm shift to promote industry development initiatives and to become less
government led and more market driven. This calls for more efforts among industry players
to increase cooperation, establish more strategic alliances and build closer relationships
across borders in various fields. For instance, Islamic financial institutions must come
together and drive the initiative to develop the industry's own internationally acceptable code
of conduct and standards of Islamic financial practices that should work to complement
efforts by Bank Negara Malaysia in developing the Shariah Parameters References.
As Malaysia's Islamic finance industry continues to grow and expand beyond domestic
boundaries, our Islamic financial institutions are well positioned to initiate and lead efforts in
converging different organizations' financial practices to establish uniform standards or
instruments that may be applied across borders. These areas span from accounting, legal
and operational practices. Cross-border alliances by Islamic financial institutions in setting-up
new business ventures would also facilitate knowledge sharing and the globalisation of
Islamic business products and services. In this aspect financial market instruments that
enable better allocation of resources in the international Islamic financial system need to be
further enhanced and developed. This certainly needs to be supported by more international
collaborative efforts in the area of research and development to provide the impetus for more
innovation to take place and address global and contemporary issues of market and risk
management practices. These initiatives are important for the industry to develop as it
becomes more internationally integrated.
Conclusion
On that note, let me now conclude. Moving forward, converging Shariah views, where
appropriate, and building greater linkages between industry players that are collectively
driven by the private institutions are important to build on the momentum of industry
development achieved thus far. The involvement of the private sector to drive development
will lead to enhance the efficiency of Islamic finance and greater cross-border transactions.
This would serve the aim to enhance international financial interlinkages and market
participation between institutions and nations practising Islamic finance. In this endeavour,
there is no doubt that it takes nothing less than steadfast commitment and collective will of all
industry stakeholders. The time is now for us to take the leap to the next level of
development. I hope that this conference will focus on specific initiatives that could lead to
inter-market activities. Only when the various jurisdictions are linked as one, could we propel
ourselves to the next phase of accelerated level of growth.