Zeti Akhtar Aziz: Banking on Islamic finance - from legality to economic
value
Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
8th World Islamic Economic Forum (WIEF) "Banking on Islamic finance - from legality to
economic value", Johor Bahru, 6 December 2012.
* * *
Powerful forces of change are transforming the functioning of the international financial
system and the global economy. In the aftermath of the global financial crisis, the quest has
been to build financial systems that will best serve the real economy, that provides financial
intermediation that promotes sustainable growth through productive and responsible
innovation, and that will be resilient to shocks and less prone to crisis. There is tremendous
potential to draw on the economic value that Islamic finance has to offer. In realising this
potential, in a now more challenging environment, will depend on our capacity to build new
capabilities that will unleash the inherent intrinsic value propositions of Islamic finance that
supports and energises the real economy.
It is my honour to participate in this 8th World Islamic Economic Forum in my hometown,
Johor Bahru to speak on the topic "Banking on Islamic Finance: From Legality to Economic
Value". The first part of my remarks will elaborate on the economic value of Islamic finance,
in terms of its emphasis on the close linkage to the real economy, in terms of its merit as a
potent tool for enhancing financial inclusion, and in terms of its emergence as a vehicle in
bridging economies and strengthening economic and financial linkages, in particular between
emerging economies.
The second part of my remarks will touch on three key imperatives that will be important to
the ability of Islamic finance to enhance its value proposition to the global economy. These
include the legal framework, in particular that which supports its internationalisation, the pool
of talent that has the international exposure and orientation and finally the convergence and
harmonisation of Shariah interpretations across jurisdictions. These imperatives will be key to
reinforcing the gains from the increased economic inter-linkages.
There are three core propositions of Islamic finance that can be harnessed as the industry
continues with its rapid growth momentum. The first is to ensure that Islamic finance remains
a form of financial intermediation that serves the real economy and that it will continue to
benefit the society. In staying true to the inherent principles of Islamic finance, financial
transactions will be underpinned by real economic activities. This ensures its close linkage to
the economy as it directs the overall intermediation function towards economic production
and wealth creation. This therefore requires the continuous development of financial
products and services that manifests the value propositions of Islamic finance.
In providing the comprehensive range of the whole spectrum of financial products and
services that are in accordance with these principles, Islamic finance has been able to
provide the total financial solution to consumers and businesses. The recent growth of
Islamic finance has been fuelled by a sustained phase of innovation. The scope of financial
business has also increased in sophistication, particularly in the areas of private equity,
project finance, sukuk origination as well as fund and wealth management. To sustain this
trend, further in-depth applied research is needed to develop more financial products that
create such links with the real economy in terms of the operating models, risk management
and supporting infrastructure.
The second value proposition of Islamic finance lies in its merit as a potent tool for enhancing
financial inclusion and for being beneficial to all members of society. Its immense potential in
advancing social-economic development is mirrored by the continuing efforts to introduce
Islamic finance offerings in emerging economies, particularly in Asia, the Middle East and
African nations in recent years. In bringing unserved communities into the economic
mainstream through the financial intermediation process, it can contribute towards poverty
alleviation, job creation and more equitable economic growth.
A recent study has however revealed that, despite being a promising financial segment, the
availability of microfinance in Muslim-majority economies is either non-existent or still at very
early stages. Islamic financing instruments currently comprise only a small fraction of
microfinance business in the Organisation of Islamic Cooperation (OIC) countries. While
there are success stories on the application of Islamic finance principles in microfinance
programs, there is potential to have better models for Islamic microfinance. In addition, it
should also integrate with other financial products such as microtakaful and other social
welfare tools such as waqf to create a viable and impactful microfinance initiative. There are
also immense opportunities for Islamic finance to leverage on the productive potential of
small medium enterprises (SMEs) through greater application of equity-based structures in
such financing structures. There is seemingly a natural fit between Islamic finance and SMEs
financing in that both strongly promote entrepreneurship and value-creating activities.
The third value proposition of Islamic finance refers to its emergence as new vehicle in
bridging economies and contributing to increasing the financial linkages, in particular, the
emerging markets. Previously Islamic finance was domestic centric. It is now increasingly
providing financial solutions for cross border trade and investment. Progressive liberalisation
has facilitated the internationalisation of Islamic finance. This has been reinforced by the
dynamic pace of innovation in Islamic finance that has widened the range of financial
products and services. This internalization process has thus contributed to the more efficient
allocation of funds across borders from centres with surplus funds to regions with investment
opportunities and to the diversification of risks.
The now more developed Islamic financial markets have been particularly instrumental in
intermediating such funds. Sukuk has been a major driving force behind this development
since its emergence as an important platform for international fund raising and investment
activities that are generating increased cross border flows. The international dimension of the
sukuk market has now evolved on many fronts - It has seen the participation of issuers and
investors across continents with sukuk origination centres transcending the issuers' own
home countries. The total global sukuk outstanding now domiciles in 20 countries and more
recently, there has also been a growing trend for multi-currency sukuk issuances. The sukuk
market continues to solidify its position as a leading segment of growth for Islamic finance. Its
strong performance is driven by its unique value proposition to both issuers and investors.
For investors, it has now become a new asset class with orientation towards real underlying
assets in which the issuer cannot leverage in excess of the asset value and in which, the
financing must be channeled towards productive purposes. For the issuers, sukuk financing
provides a competitive avenue for fund raising and access to a wider investor base of both
Islamic and conventional, including the growing investor base looking for a
sociallyresponsible or ethical investment.
Moving forward, there are three key imperatives that will determine the ability of Islamic
finance to further enhance its value proposition for the global economy. First, is the evolution
of the legal framework that is facilitative to the continuing market evolution and the
internationalization of Islamic finance. Whilst the global financial crisis has provided Islamic
finance with a unique opportunity in the international financial system, the future success of
the industry moving forward, will also depend on its continuing ability to innovate more
indigenous shariah-based instruments and evolve business models that strengthen the
nexus of Islamic finance with the real economy. An essential part of the overall infrastructure
therefore is an effective legal framework to provide an enabling environment that will enforce
the legality of contracts according to the Shariah and the regulatory treatment of the new and
innovative Islamic financial solutions.
While Islamic finance practitioners and scholars continue to draw from the source of fiqh
muamalat to create new and innovative instruments, the legal framework needs to be further
strengthened to ensure alignment with new market developments. This is to ensure that it
continues to lend certainty and predictability to the innovative products and financial
transactions. Furthermore, as Islamic financial activities venture beyond national boundaries,
the development of legal frameworks that is facilitative of cross-border transactions is pivotal.
There has to be court recognition and acceptance of the Islamic contracts within the common
and civil law systems, with a common approach of interpreting the rights of the contracting
parties based on Shariah principles, in particular for cross-border transactions.
Malaysia has taken the approach to address this imperative via the Law Harmonisation
Committee which was established in 2010. As part of its mandate, the Committee undertakes
an objective review on the legislation and proposes the necessary amendments on existing
Malaysian laws which are applicable to execute the whole chain of Islamic financial
practices. Since its inception, the Law Harmonisation Committee has reviewed seventeen
(17) laws in Malaysia and identified the areas that require legislative amendments so that
Islamic financial transactions can be conducted in the most legally efficient manner. The
work of the Committee will continue to remain relevant as the Islamic financial markets
continue to expand and develop new products and business models. This mandate of the
Committee will not only ensure that non-Shariah compliant elements in the legal provisions
are harmonised, it will also ensure that our laws are facilitative to Islamic financial
transactions.
Another major milestone in Malaysia, is the new legal framework for Islamic banking and
takaful, which is currently undergoing the legislative process towards its enactment. This new
legal framework, will not only streamline the legal requirements across sectors, but will also
ensure that the law is reflective of the nature and features of Shariah contracts and that the
degree of regulation is commensurate with the level of risks that Islamic financial institutions,
markets and products pose to the overall financial system. The greater clarity on the legal
and prudential requirements underpinned by Shariah principles will enable participants of the
Islamic financial system to align to their practices and expectations accordingly when
undertaking Islamic financial business and transactions.
The second imperative relates to the continuous effort to develop the key resources of the
industry, by expanding and building new capabilities needed to support its growth and
development. There is a critical need to upskill the leadership and technical competency of
talents given the increasing complexity of the industry. With broader scope, scale and
internationalization, the demands on the capability of talents in Islamic finance industry can
only increase. It will require more internationally oriented management teams that have the
necessary international exposure and orientation. In addition to education and research to
build the expertise in Islamic finance, a more structured framework for capacity-building that
includes other key resources including the investment in technology for industry development
is also needed.
Such a coordinated effort in capacity-building has been initiated by the Islamic Development
Bank (IDB) in support of its member countries in the development of Islamic finance. This is
being undertaken through the IDB's Member Country Partnership Strategy (MCPS)
programme. Indeed, in a world of increasing interconnectedness, there is a need for such a
strategic approach to capacity-building through cross-border cooperation for the mutual
benefit of the members so that growth and development of the industry can be collectively
strengthened.
Finally, the third imperative is to accord importance to mutual recognition of Shariah
interpretations across jurisdictions and thus contribute towards greater international financial
integration. A critical factor that will support this process pertains to the need to enhance
awareness in respect of the justifications underlying the Shariah resolutions in the industry.
To achieve this greater awareness will require both openness on the grounds for the rulings
and in-depth research on the basis of such grounds. A recent study conducted by the
International Shariah Research Academy for Islamic Finance (ISRA) on fatwas of Shariah
boards in the Asian region and the GCC countries reveals that, contrary to the popular
perception, there are more similarities than differences in Shariah resolutions between the
two regions. The study by ISRA however further indicates that there is a lack of awareness
on the Shariah justifications to most of the resolutions being reviewed. This awareness is
essential to pave the way towards greater understanding and nurturing of mutual respect.
Whilst there are some initiatives to enhance the greater awareness on the juristic reasoning
in Islamic finance, to facilitate greater mutual recognition, it will require greater transparency
in the Shariah rulings in addition to constructive dialogue on the grounds of such rulings.
With the efforts of the Islamic Development Bank (IDB), the Islamic Financial Services Board
(IFSB) and the Accounting and Auditing Organization for Islamic Financial Institutions
(AAIOFI), it has facilitated greater cross-border engagement among practitioners and
Shariah scholars. In turn this has contributed to a greater understanding on issues and
challenges faced by the industry and the progressive convergence of Shariah views and
rulings. More such international collaborative work and engagement would further facilitate
this harmonization process.
To navigate amidst turbulent seas to arrive at the new frontier of opportunities in Islamic
finance, there is a need for the industry to build on its strengths and achievements thus far, in
the pursuit to realize the distinctive value that Islamic finance brings to the global economy.
Indeed, Islamic finance needs to leverage on its inherent strengths and demonstrate
leadership in the real economic agenda and contribute towards global economic prosperity
and stability.