Zeti Akhtar Aziz: Building a comprehensive Islamic financial system - new
financial opportunities
Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the Institute of
Islamic Banking and Insurance's International Conference on Islamic Insurance, London,
26 September 2003.
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"Islamic banking and finance initially evolved as a form of financial intermediation for the Islamic
community to conduct financial transactions that conform to Islamic tenets. Today, the Islamic financial
industry has gained wider acceptance and appreciation and has expanded beyond the traditional
borders of the Muslim-based economies into the major industrial economies to become an integral
component of the global financial system. In a global environment that has become increasingly
challenging, an environment that is subject to the powerful forces of change, and that is characterized
by volatile and unstable market conditions, Islamic finance has emerged as a competitive and resilient
form of intermediation. Although Islamic finance is still at the early stage of development, it has
experienced rapid expansion and is fast emerging as a viable and robust form of financial
intermediation with significant potential."
It is indeed an honour for me to be here today before a distinguished gathering of scholars,
researchers and practitioners of the takaful industry. I wish to take this opportunity to congratulate the
Institute of Islamic Banking and Insurance for their efforts in organizing this international conference on
Islamic insurance or takaful. The takaful industry represents an important component in the overall
Islamic financial system given its role in the mobilisation of long-term funds, its role in providing risk
protection, its role in the development of the Islamic capital market and as an important institutional
investor, as well as its role in supporting the overall economic growth and development. Our challenge
is thus to evolve a dynamic and vibrant takaful industry within the Islamic financial system. Of
importance is the development of an Islamic financial system that is dynamic, responsive and
sustainable.
The development of an Islamic financial system needs to include the respective components
comprising the Islamic banking industry, the takaful industry, the Islamic capital and money markets,
given the strong linkages, interdependence and synergies among these components in the system.
The spectrum of participants and the diversity of instruments are among the key attributes in creating
the enabling environment for a dynamic Islamic financial system. This has been the approach adopted
by Malaysia at the very onset of our journey in the development of a comprehensive Islamic financial
system that is progressive and sustainable.
In the initial stage during the early years of the development of the Islamic financial system, our focus
of attention was on the development of the Islamic banking system and to expand the number of
players and volume of activity. Following the introduction of the dual banking system, the pace of
expansion increased significantly. In two decades, the total assets of the Islamic banking industry have
increased from USD97 million at the outset to USD20 billion as at end-June 2003. Similar expansion
also took place in the takaful industry whereby the assets have increased significantly from less than
USD30 million in 1993 to USD1 billion in June 2003. The Islamic capital market in Malaysia also
recorded significant growth whereby the outstanding Islamic private debt securities accounted for
USD17.8 billion, or 65% of the total outstanding private debt market while the new issuance of Islamic
private debt securities in the first eight months of 2003 amounted to USD1.7 billion. What is more
encouraging is that more than one third of the new issuance of Islamic debt securities were issued by
companies owned by non-Muslims, some of which includes multinational companies.
The evolution of an appropriate financial structure would need to take into account the role of the
financial system in the economy and the objectives that need to be achieved. In the context of an
emerging market economy, the financial system is a means to an end. The appropriate financial
structure, particularly in emerging market economies, need to be designed to meet the requirements of
the economy. The financial system needs to be in a position to support the real sector, changing and
evolving with the changing needs of the economy. The strategy adopted in Malaysia is to develop a
comprehensive Islamic financial system that is able to operate in parallel with the conventional
financial system.
The key constituents within the Islamic financial system, which includes the Islamic financial
institutions as well as the capital and money markets need to be firmly reinforced by the legal and
regulatory framework that adequately address the unique characteristics of the industry. These
intradependent key components ultimately form the enabling environment for the Islamic financial services
industry to effectively play its role as an efficient conduit for mobilising resources and channelling them
to productive purposes. The absence of any one of the components could reduce the effectiveness
and efficiency and could affect the viability and sustainability of the system.
While the Islamic banking system plays an important role in mobilizing deposits and providing
financing, the development of the capital market allows the corporate sector to source their long-term
financing needs based on Islamic principles. In addition, it would increase the range of Islamic
financial instruments available to meet the demand of the Islamic investors. In the absence of a
comprehensive Islamic financial system with financial services based on Shariah principles, the
development of Islamic banking and finance would be hindered.
The government would need to assume an important role in the development of the Islamic financial
system. The role of the government is, amongst others to provide the enabling environment and put in
place from the outset, the necessary infrastructure through the formulation of a comprehensive set of
legal and regulatory framework for Islamic banking and finance. In addition, this framework needs to
be reinforced by a Shariah framework to ensure that all financial transactions are Shariah-compliant.
Islamic financial operations would thus need to be based not only on best practices, but also satisfy
the tenets of the Shariah.
For Islamic banking and finance to be sustainable, compliance with Shariah principles alone is not
sufficient. Over the long run, customers and businesses demand for quality in the products and
services that Islamic finance offers. This is the challenge for Islamic banking and finance, to be able to
provide a comprehensive range of Islamic financial products and services that are not only innovative
and competitive but Shariah compliant.
Let me now turn to the development of the takaful industry. Takaful as a system of Islamic insurance,
is based on co-operation and mutual help for the good of the society at large. Although takaful has
been in the market for more than 20 years, it has yet to make significant inroads. It should however, be
noted that although the conventional insurance market is deeply entrenched in several of the Muslim
countries, the percentage of the Muslim population that are insured is relatively low. The market
penetration level is very low, notably less than 5 per cent in many Muslim countries. In Malaysia, the
level of market penetration in terms of takaful certificates in force over the total population is only 3.8
per cent compared to a market penetration for conventional insurance of 34.7 per cent. It therefore
represents an enormous potential market that remains yet untapped.
Takaful operators assume an important role as economic or financial agents as they essentially
mobilise long-term funds in the form of contributions and invest them in the available Islamic
investment avenues. As custodians of public funds, takaful operators must ensure that the takaful
funds are invested in compliance with Shariah and are soundly managed to instil public confidence.
For the takaful industry to be developed into a viable alternative to the more entrenched conventional
insurance industry, the need for it to be supported by the core components of a comprehensive Islamic
financial system cannot be over-emphasised. As takaful operators are both mobilizers of long-term
funds and fund managers to the policy holders, their ability to generate returns to fulfil the obligation to
the policy holders depends very much on the range of financial instruments available in the market
place.
Without an effective financial system, takaful operators may not be able to perform as effectively and
as efficiently in terms of delivering their promise on the profit sharing basis and to be able to keep
pace with their conventional counterparts in the area of fund performance. In the absence of a viable
Islamic capital market, there would not be an adequate supply of quality financial instruments for which
the takaful funds can invest. It may have to depend on low yielding returns from bank deposits. In
addition, it will not be able to offer innovative products like investment linked products, which can
further diversify their investment portfolio as these products are gaining popularity among conventional
insurance companies. In the absence of an Islamic banking system, takaful operators would not be
able to synergise and utilise the network of the banking system through bancassurance which can not
only be an effective distribution channel but also serve to drive down operating costs.
The development of a comprehensive Islamic financial infrastructure in Malaysia that includes Islamic
banking, the money and capital markets has reinforced the development of the takaful business.
Today, the takaful industry in Malaysia has emerged as a fast growing industry within the insurance
sector since its introduction in 1985, 18 years ago. From total assets amounting to only USD0.5 million
in 1986, it has reached more than USD900 million in 2002, constituting 5.2 per cent of the total assets
of the insurance sector. In the same period, the takaful operators have offerred a wide range of family
and general takaful products.
The Malaysian Financial Sector Master Plan represents the blueprint for the development of the
financial sector over a 10-year period. The plan, which was launched in 2001, places importance on
the development of Islamic banking and takaful sector as an important component in the financial
system. To achieve this objective, emphasis is being given to financial infrastructure and institutional
development, aimed at enhancing efficiency of the system and building the internal resilience and
competitive position of the takaful operators, while meeting the needs of the nation. This includes
providing the foundations for the development of the financial markets and strengthening the
institutional development. As part of this process, the benchmarking exercise is an important tool to
enhance performance and to guide the takaful operators on improvement of their business strategies.
To reinforce this, a service quality index has also been initiated to promote the development of
worldclass products and services. This is also complemented with a comprehensive consumer education
programme so as to promote product transparency and increase accountability. The introduction of
financial advisers is also a further element to facilitate consumer access to a wider range of financial
products.
Amongst the most imminent challenges is the creation of the critical mass in the market to allow for
meaningful cross-border alliances at the regional and global level. The establishment of an adequate
number of takaful operators in the market is also crucial to provide the groundwork for the setting-up of
more retakaful operators, in terms of sustaining business support and providing the economies of
scale in order for the retakaful industry to develop.
Currently there is still a dearth in the number of players providing the retakaful facility, resulting in
takaful operators ceding to conventional reinsurers. While this has become a common practice, ideally
more competitive retakaful operators who provide reinsurance in accordance with Shariah principles
need to be established so that the takaful industry would not be dependent indefinitely on conventional
reinsurance as the conduit to which they can mitigate risk. More importantly, retakaful operators
ultimately serve to strengthen and enhance the financial capacity of the takaful industry, and the
synergistic by-products emanating from the interactive business alliances would contribute towards the
overall betterment and robustness of the Islamic financial system. Indeed, there is much to be gained
by the takaful operators in particular, and the Islamic financial industry in general, by having access to
an adequate and competitive market of the retakaful facility. It is therefore important to increase the
collaborative efforts and examine plausible ways to address this gap in the takaful industry.
Our quest to create a dynamic Islamic financial system is to achieve the ultimate objectives of
developing an Islamic financial system that will be able to contribute significantly to the overall
development of our economy through the intermediation process. Thus, Islamic banking and finance
industry needs to extend its agenda towards the development of a comprehensive Islamic financial
system. The Islamic banking and finance should strive to add value towards enhancing greater
integration to the economy and the financial system. To harness the potential fully, genuine
endeavours to develop and innovate Islamic financial instruments and activities that are able to fulfil
the changing requirements of the economy and the emerging needs of the contemporary global
marketplace need to be continuously pursued. Conferences such as this can contribute invaluable
ideas to foster new initiatives towards the development of the Islamic financial system. With the
acceleration of its global integration, it will provide the synergies and opportunities for the Islamic
financial industry to evolve into an important component of the international financial system that can
contribute to enhance prospects for balanced global growth and an enhanced shared prosperity.
On that note, I wish you a successful Conference. Thank you.