Zeti Akhtar Aziz: Globalisation of Islamic finance services -
opportunities and challenges
Speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the Fifth IFSB
Summit: Session 1: Globalisation of Islamic Finance Services - Opportunities and
Challenges, Amman, Jordan, 13 May 2008.
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This decade has seen the financial globalisation of Islamic finance gain significant
momentum. While the early development of Islamic finance was domestic centric, its
internationalisation is now manifested by increased cross border flows, greater participation
in international Islamic financial markets, the increased presence of Islamic financial
institutions in new jurisdictions and more recently, the increased number of Islamic financial
institutions which have shareholders from multiple jurisdictions. This trend has strengthened
the international economic and financial interlinkages between nations bringing with it
mutually reinforcing gains.
Financial globalisation has essentially been facilitated by the more rapid pace of
liberalisation, the advancement in the information and communications technology, and the
significant progress achieved in the development of the international financial infrastructure.
This trend has also been reinforced by the search for higher returns and the need to diversify
risks. In the current international financial environment of increased uncertainties, this trend
has become even more pronounced prompting investors to venture into new asset classes
and markets that provide stability.
The globalisation of Islamic financial services
With the increased significance of the international dimension of Islamic finance, the financial
landscape has been dramatically transformed with more diverse players and a more
competitive environment. This in turn has been a catalyst for increased financial innovation
and resulted in a wider range of Islamic financial products and services. This has ignited
interest from conventional global players from Non-Muslim countries largely in the form of
increased participation in Islamic financial markets and in acquisition of strategic stakes in
domestic Islamic financial institutions. With the opening of borders for banking institutions
and other players, the Islamic financial system has become more diversified and the Islamic
financial markets deepened. These developments have contributed to its rapid expansion
across the globe, and Islamic finance has now emerged as among the fastest segments in
the financial services industry.
The scope of Islamic finance business has thus expanded beyond retail and trade financing,
to more sophisticated financial products in response to the changing global customer base.
Such Shariah-compliant products include private equity, project finance, the origination and
issuance of sukuk, as well as fund, asset and wealth management products. The sukuk
market in particular, has become an important avenue for international fund raising and
investment activities, has expanded by an annual growth rate of 40%. The vast potential in
sukuk market in the international financial system indeed represents the crest of a new wave
of innovation in Islamic finance and is very much part of the globalisation process in Islamic
finance. Sukuk Musyarakah and Ijarah, which command the broader global acceptance,
represents the majority of global sukuk issuances.
As part of the on going internationalisation of Islamic finance has been the development of
the supporting international financial architecture. Of significance, is the establishment of the
Islamic Financial Services Board (IFSB) in 2002 to set the prudential standards for Islamic
finance, and the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI) that was established in 1990. The importance of these international standard
setting institutions has been their role in the harmonisation of prudential and accounting
standards across the different jurisdictions. More importantly is their role in instituting
international best practices in the global development of Islamic finance. It is these concerted
efforts to develop robust international best practices in the prudential and supervisory
framework that will ensure the resilience and long term sustainability of the Islamic financial
industry.
With globalisation also comes enhanced interdependence. While the strengthened
interlinkages can be expected to bring about a more efficient allocation of capital across
borders which in turn would result in lower the cost of capital, it has also resulted in the
potential for the transfer of risks across different jurisdictions. This underscores the need to
ensure the quality of financial globalisation. While the intrinsic nature of Islamic finance
encourages risk management and provides confidence through explicit disclosure and
transparency, the new risks resulting from globalisation needs to be taken into account. This
is to ensure that the Islamic financial institutions have the capacity to manage the risks and
that the regulatory authorities have the necessary instruments at its disposal to respond to
any destablising implications.
Emergence of new set of challenges
The enhanced international dimension of Islamic finance has thus brought about a new set of
challenges. The emergence of more diverse Islamic financial institutions and the expended
development of Islamic financial markets have intensified the development of sophisticated
Islamic banking, takaful and capital market intermediaries. This has also resulted in the
creation of sophisticated and complex structured financial instruments including hybrids of
debt-equity structures. The increased competition has not only intensified the pace of
innovation in products and services, but also of the operational processes and delivery
channels. These developments have contributed to the increasing complexity of the risks
profiles of Islamic financial transactions.
Global strategic initiatives
Recognizing the importance of ensuring financial resilience of the Islamic financial services
industry in this more challenging environment, collaborative international efforts have been
undertaken.
Spearheading the strategic development of the industry is the ten-year Master Plan for the
development of the global Islamic financial industry, a joint initiative by the Islamic
Development Bank (IDB) and the IFSB. This strategic initiative provides a blueprint for the
orderly development of Islamic financial system across jurisdictions to achieve the common
goal of a vibrant, efficient and progressive Islamic financial services industry. This blueprint
also outlines the broad strategies for the development of the key components of the various
parts of the Islamic financial sector, including the guide for determining the best options for
the different stages of development of the Islamic financial system so as to ensure that it
would contribute to the growth and development of the economy and also become an
integral component of the international financial system.
Of importance is that the master plan not only represents a blueprint for the development of a
cohesive and a comprehensive Islamic financial system but also it promotes increased
understanding and appreciation for those that wish to participate in the Islamic financial
system, including providing information on the expected level of achievements that are
required.
Another important global initiative in Islamic finance already mentioned is the promulgation of
the international prudential and supervisory standards by the IFSB. The IFSB has fast-
tracked the development of these standards to address the unique and peculiar
characteristic of risks of Islamic financial contracts. Fundamental to the implementation of the
standards is the strengthening of the risk management capabilities of the financial
institutions. In addition, the implementation of these standards needs to be complemented by
the continuous surveillance so as to ensure the early identification of the new emerging risks
and to ensure that the institutions undertake to manage the risks.
Resilience reinforced by the intrinsic features of Islamic finance
The intrinsic features of Islamic finance also contribute to its overall resilience. This is derived
from the Shariah principles, the key pillar of Islamic finance. The Shariah injunctions require
that Islamic financial transactions be accompanied by an underlying productive activity
resulting in a close link between financial and productive flows. Under the risk sharing
concept, there is an explicit risk sharing by the financier and the customer. In this
arrangement, the real activity is expected to generate sufficient wealth to compensate for the
risks. Parties to the transactions would thus be insulated from excessive risks exposure
given that the Shariah prohibits the excess leverage and involvement in speculative financial
activities. The intrinsic principle of profit and risk sharing thus provides an in-built check and
balance to the Islamic financial transactions. A combination of these distinct features
together with the implementation of prudential risk management standards and practices
would contribute to the robustness and resilience of Islamic financial system.
Mutual respect on Shariah matters
This decade has thus been a phase of innovation in the global Islamic financial system with a
number of breakthroughs and major milestones in innovative deals and structures. The
advancement of sukuk, Islamic securitization, Islamic private equity, Islamic real estate
investment fund and other financial instruments in terms of sophistication and product range
has widened the international market reach of Islamic finance, particularly in the cross border
transactions.
At the same time, this phase is also seeing a number of key issues being raised, particularly
in respect of divergence of Shariah views underlying a number of the Islamic financial
transactions. While such a divergence of opinions in Islamic financial transactions is not a
new phenomenon, it has presented a new set of challenges in today's increasingly more
globalized market. To forge closer linkages between the global Islamic financial markets
would require a common understanding and acceptance on the applicable rules and
standards. Indeed, cross border transactions would require the jurisdictions involved to
mutually recognise the validity of respective rules, practices and underlying Shariah
This is key for the orderly development and for advancing the pace of
interpretations.
progress of the international Islamic financial industry.
For this, it is important to have a concerted effort in providing greater clarity on the mutually
acceptable strategy for the development of global Islamic finance. In the current globalised
environment, the role of scholars needs to transcend beyond pure advisory or Shariah
rulemaking, to a more strategic role in charting industry development. This could be in part be
achieved by having global Shariah standards for the Islamic financial industry. A mutually
agreeable position could be achieved with the application of mutually recognized
principles and processes to deduce the Shariah rulings and views.1
In relation to this, Malaysia has taken a three-prong strategic initiative to promote greater
mutual respect of the Shariah views. The first is to recognise the principle of mutual respect
in Shariah opinions issued in other jurisdictions by a recognized Shariah committee for
transactions undertaken in Malaysia. In addition to the key role of a centralized Shariah
Advisory Council as the reference point for all Shariah matters in Islamic finance, Malaysia
welcomes Shariah rulings by other Shariah committees that are deemed to be deduced
through generally accepted rigorous principles, processes and rules.
The second initiative is to have strong resource foundation supported by a pool of qualified
and competent Shariah talent, as well as to accord more emphasis on extensive Shariah
research in Islamic finance. Given the rapid global growth of Islamic finance, there is an
urgent need to meet the talent demand for Shariah scholars with strong interest in the
strategic development of the Islamic finance industry. From the supply side, the International
Centre for Education in Islamic Finance (INCEIF) established in 2006 has made significant
progress with more than 1000 registered students in its professional Islamic finance
certification. It also has 28 PhD students and has recently launched a Masters Programme in
Islamic finance. The Islamic Banking and Finance Institute Malaysia (IBFIM) also offers a
structured, modular training solutions for Shariah advisers focusing on practical and
operational aspects of Islamic banking and takaful.2
Given the importance of the in depth of Shariah research in Islamic finance, the International
Shariah Research Academy (ISRA) was recently established as part of INCEIF to conduct
applied Shariah research on the contemporary Islamic finance issues. The third strategy is to
provide a platform that promotes active engagement and dialogue among the relevant
stakeholders. The annual Shariah dialogue at international and regional levels have
contributed to increased understanding of different views on Islamic finance matters and
enhanced mutual respect of Shariah opinions.
Closing
In conclusion, against a backdrop of an increasingly uncertain global environment, Islamic
financial system is indeed well positioned, as a form of financial intermediation in this more
challenging environment. In the coming years, it is important for adequate focus to be given
on the implementation of international prudential standards and sound risk management
practices in Islamic financial institutions to ensure the financial stability and integrity of the
financial system. According greater mutual respect to global Shariah views for Islamic
finance would also contribute to the orderly global development of Islamic finance, thus
sustaining the overall viability and soundness of the Islamic financial system as it becomes
an integral part of the international financial system.