Zeti Akhtar Aziz: Islamic finance - promoting the competitive advantage
Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the Islamic
Bankers' Forum 2005: Islamic Finance - Promoting The Competitive Advantage, Putrajaya, 21 June
2005.
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"Islamic finance has become a competitive form of financial intermediation that has been able to meet
the differentiated requirements of our economies. In an environment of rapid change, a key factor that
will influence the future prospects of the Islamic financial services industry will be the investments to
build the foundations on which further progress can be achieved. Investing in the future, in research
and development and in the development of talent and expertise will be the differentiating factor that
will contribute to the effectiveness, resilience and competitiveness of the industry. This undertaking
needs to be the joint responsibility of both the private and public sectors to mutually elevate the
performance of the industry and thus increase its potential to contribute to wealth creation and
prosperity of our nations."
Your Excellencies,
Distinguished Guests,
Ladies and Gentlemen,
It is my honour to be invited to speak at this Islamic Banker's Forum organized by the General Council
for Islamic Banks and Financial Institutions (CIBAFI) on the strategic approach in developing a
progressive Islamic financial system. The occasion of this Forum is indeed an excellent opportunity for
the industry practitioners, regulators and academia to deliberate on the key issues that are important
to the future of the Islamic financial services industry. My remarks today will focus, in particular, on the
issues relating to innovation, which is indeed derived from the investment in research and
development, and from the investment in the workforce in the sector.
Innovation is key to sustaining growth and securing the competitive advantage. Innovation is about
developing new Islamic financial products and services and increasing the range of products and
services to meet the more sophisticated and complex requirements of today's consumers and
businesses. It is also about improving the overall efficiency by which the products and services are
being provided. Innovation will also involve the introduction of new structures that may contribute
towards enhancing convenience for consumers and businesses. Finally, it may also contribute towards
creating new markets or expand the existing markets for Islamic products and services. Industry
practitioners thus have an important role to promote innovation. Financial institutions need to equip
their business strategies with research and development to design new innovative products and
services. Such innovative financial products and services which are credible, competitive and
Shariahcompliant would indeed find a ready market. The introduction of the global sovereign sukuk more than
two years ago was an important innovation that has since gained significant ground.
Innovation can also take the form of the application of technology to improve convenience for
customers and reduce the cost of financial transactions. In embracing new leading-edge technology,
the potential for the Islamic financial industry to provide new products and services will be enhanced. It
also represents the potential to increase access to financial products through a wider range of new
delivery channels. Greater application of IT in the industry can also enhance efficiency by driving down
costs for consumers and businesses. Other areas include leveraging on IT in making strategic
decisions in the alignment of business, in elevating institutional capacity and operational efficiency and
strengthening risk management capabilities. Moving forward, the enhancement of technological
capabilities becomes vital for the financial industry as it competes in an increasingly technology-driven
environment.
The environment and the incentive structure is also important in providing an enabling environment
that promotes innovation. In particular, the regulatory framework and the tax structure are important to
the innovation process. The regulatory framework should not be so onerous as to impose a high cost
and a regulatory burden on businesses. Intrusive regulatory approaches on new products can become
a disincentive to innovation. Tax structures can also be designed to support the innovation process.
Within financial institutions, organisational structures can also create an environment for innovation by
aligning the organization's processes and implementing appropriate performance incentives.
The pace of innovation that has taken place in the Islamic financial services industry has contributed to
the development of a broad and diversified range of Islamic financial products and services that has
been able to effectively mobilize financial resources to meet the investment requirements of the
economy. Notwithstanding this significant progress, the process of innovation in Islamic finance has
generally been structured mainly along the adaptation approach. Although there are Islamic financial
instruments that are distinct from the conventional financial instruments, the numbers are still few. In
most instances, the Islamic financial products are repackaged along the features of the conventional
financial products, while eliminating the elements that are not in compliance with the Shariah.
The Islamic financial services industry is now at the threshold of a new level of development. As we
advance forward, the Islamic financial services industry can expect to have a different set of regulatory
and supervisory standards which is conducive to its unique financial operations. There is also an
increased awareness and understanding amongst the international financial community on the distinct
nature of Islamic banking and financial operations. In addition, a higher degree of Shariah dynamism
is evident in the evolution of sophisticated Islamic financial products that are being structured based
on multiple Shariah concepts. Against these developments, it is timely to move away from "plain
vanilla" innovation and to embrace a new wave of innovation that will evolve Islamic financial
instruments into distinct products that will maximize the potential and wisdom of the Shariah and that
meets the greater sophistication of consumers and the more complex requirements of today's
businesses. This paradigm of innovation in Islamic finance, which by itself shall accord Islamic
financial institutions with the competitive advantage to forge ahead, entails substantial and continuous
investments in research and development (R&D). R&D is indeed an essential aspect of modern
industries and enterprises and is no less the case in the financial world. There are three important
pre-requisites in strengthening research and development capabilities, namely, adequate allocation of
resources for infrastructure development, forging strategic alliances through smart partnerships and
developing the required pool of qualified and skilled talent.
Adequate allocation of resources for infrastructure development
Islamic financial institutions are continually being confronted with new challenges that need to be
addressed. Their institutional capacities and capabilities need to be continuously strengthened. This
includes attention to continually review their strategic orientation and key priorities and the necessary
adjustments that need to be made to position the institutions to effectively respond to the new
developments and challenges that have emerged.
In order to meet the increasing demands of a modern and sophisticated market, financial institutions
must continually invest in the supporting infrastructure that promotes research and development. This
will enhance the capacity for innovation. Attention also needs to be given to the applied approach to
Islamic finance and its modern practice. Financial support for advanced research at universities and
research institutes will increase research opportunities. Efforts to utilise and install strong technological
capabilities will also contribute to enhance research and development. In embracing the new
leadingedge technology, the potential for the Islamic financial industry to develop new products and services
will also be enhanced.
Forging strategic alliances through smart partnerships
To further enhance research and development (R&D) activities, the promotion of strategic alliances
through smart partnerships can play an important role. Entering into strategic alliances with other
entities would create greater synergy, which may bring about new approaches, new technologies and
new areas of specialization. Collaborative efforts amongst Islamic financial institutions in particular,
would strengthen the ability to leverage on the industry's expertise. The introduction of innovative
Islamic financial products in a specific jurisdiction can be expanded to other jurisdictions, which in turn,
will contribute to broaden and deepen Islamic financial markets and thus strengthen the overall
development of the Islamic financial industry. In addition, active collaboration between academic
researchers and the practitioners will enable the practical application of research findings. In Malaysia,
an industry-owned research and training institute in Islamic banking and finance, the Islamic Banking
and Finance Institute Malaysia (IBFIM) has been established to spearhead greater collaborative efforts
with universities to undertake research in areas that are key for the progressive development of the
Islamic financial industry.
A highly qualified and skilled pool of talent
The fast pace of innovation in global financial services in general and for the Islamic financial services
sector in particular, will demand a rapid and continuous infusion and upgrading of skills. Developing a
substantial pool of talent and expertise is indispensable for strengthening research capabilities. In this
regard, there has to be a strong focus on human capital development through training and education.
In today's competitive environment, intellectual capital is the major factor in determining the level of
innovation and competitiveness of an institution or corporation. A key challenge for Islamic financial
institutions is to attract a knowledge-based workforce with the skills required to enhance the potential
for innovation, productivity and performance. The Islamic financial services industry needs to
continually promote human capital development and expertise to create a larger pool of experts and
high calibre professionals. This involves attracting and retaining the existing talent, and building a
robust pipeline of skilled individuals for the future. In addition, specialists in Islamic finance would need
to combine knowledge and understanding of the Shariah with the necessary skills in finance. The
provision of training and career development will have a key role in the sector. Learning systems
therefore need to be strengthened to meet the skills and talent requirements of the next decade.
Training is a joint responsibility between the industry, academia and Government. In Malaysia, the
Government plans to establish an international financial training institute on Islamic finance. The
ground work to establish this institute has already commenced. While this may meet some of the
requirements, Islamic banking institutions are also encouraged to explore the feasibility of entering into
collaborative arrangements with universities and other institutions locally and abroad, to identify and
provide specialized training for the financial services industry. These would include training workshops
and courses in new and emerging product lines which require specialised skills and expertise.
Education of graduates and other personnel entering the Islamic financial market is also important.
Undergraduate opportunities to study Islamic finance or Shariah, either as a speciality or a major
component of a business degree, should be readily available at local and foreign universities. The
challenge is to provide programmes which keep pace with changes in financial innovation and
technology. Meeting this need requires rigorous, extended programmes such as the post-graduate
programmes in Islamic Finance and Financial Engineering with emphasis on Islamic banking
principles. At the same time, relevant organizations can support such programmes by creating funds
to sponsor promising students to pursue formal education, ranging from modular courses in Islamic
finance to full post-graduate programmes. There is also a need to increase programmes and initiatives
that provide education and training in Shariah. Islamic research organizations and financial institutions
need to work towards developing a sufficient number of competent Shariah scholars who are
equipped with sound knowledge and expertise in both Islamic jurisprudence and Islamic commercial
laws to deal with innovative and cutting-edge products.
There is also the need for extensive education of the consumer and business community. This would
increase the outreach resulting in increased demand for new and innovative products and
approaches. Malaysia has implemented a 10-year structured consumer education programme to
increase the level of consumer awareness on the unique characteristics of Islamic financial products
and the product choices offered by Islamic financial service providers. Increased awareness will drive
the demand for a broader range of Islamic products and services customized to their requirements at
more competitive prices and through more convenient channels. The outreach has also been targeted
at small and medium sized businesses. This process will also prompt the financial industry to increase
innovation to strengthen their competitive position. This can be reinforced by market research to
enhance the understanding of customers' distinct financial needs and their risk tolerance and therefore
enable the design of Islamic financial instruments that offer tangible benefits and value to customers.
In addition, with increased disclosure and transparency on the manner in which Islamic financial
transactions are being conducted and on how Islamic financial contracts are being executed as well as
on the risk and return profiles of financial products, this will further strengthen the role of competition.
In conclusion, the investment in the future needs to be undertaken by all the relevant entities in the
Islamic financial sector - the industry, the regulators, the market participants, the academia and the
international community. As a co-ordinated and concerted effort it will be mutually reinforcing in
elevating the performance of Islamic finance. While the increasingly more competitive prevailing
environment raises the pressures to produce immediate-term results, it is the investment in human
capital and in research and development that will secure the long-term sustainability of the industry. It
is these investments that will be the defining element of the future development of Islamic finance and
its long-term success.