Zeti Akhtar Aziz: Potential role of Islamic finance in strengthening the New Silk
Road
Special address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at GIFF Investors &
Issuers Forum: "Islamic Finance: The New Silk Road", Kuala Lumpur, 28 March 2007.
* * *
Up until the 14th century, the Silk Road served as a major global conduit between ancient civilizations
in the East and West. It created mutual prosperity, encouraged knowledge transfer and enhanced
understanding between civilisations through trade, cultural and technological exchange. Now in the
21st century, globalisation and liberalisation, and the emergence of new financial centres and their
increased integration have created an environment of flourishing activity reminiscent of the Old Silk
Road.
Indeed, it suggests that a New Silk Road has emerged. This new route not only carries flows of oil,
manufactured goods, and technological innovation, but also flows of direct investment, portfolio
capital, private equity and human capital. Previously, silk was one of the main commodities traded on
this route. Now, the emergence of Islamic financial products and services has brought together
financial services providers across continents to trade on this new route. The emergence of the New
Silk Road reflects the increasing and evolving economic and financial relationships and inter-linkages,
with Islamic finance well positioned to further facilitate these linkages to offer mutually-reinforcing
benefits to those who participate in it. Indeed, the New Silk Road opens up the prospect of exciting
opportunities for economic progress and prosperity for us all.
I first made reference to the New Silk Road at the 2nd World Islamic Economic Forum (WIEF) on
"Unleashing the Potential of Emerging Markets" in Islamabad, Pakistan in November 2006.
It is my pleasure today to share some thoughts on the potential role of Islamic finance in strengthening
the New Silk Road. My remarks will focus on four areas that is the emergence of the New Silk Road;
how the linkages on the New Silk Road have built on the comparative advantages of Asia and the
Middle East; how Islamic finance is able to foster the linkages along the New Silk Road; and finally,
how we can extend the New Silk Road to the rest of the world to advance global economic stability
and prosperity.
The emergence of a New Silk Road
Today, signs that a New Silk Road is flourishing are abundant. The economic and financial linkages
between Asia and the Middle East are growing. While the world trade has on the average expanded
by 10% over the period 2001-2005, Asia's trade with the Middle East has increased on the average by
24%. More than half of the exports from the Gulf states1 goes to Asia and more than one-fifth of its
imports are from Asia. The Gulf is the major supplier of fuel to Asia, while Asia in turn supplies
manufactured goods and food to the Gulf.
Recent trends in investment activities have been equally significant. Investment projects amounting to
more than USD160 billion to be financed by the Gulf states in Asia have been announced since 20052.
In 2006 alone, mega-deals3 involving corporate acquisitions and real estate purchases from the Gulf
to Asia, are estimated to total more than USD18 billion, including multi-billion dollar IPO purchases in
financial institutions in China, large oil refineries and telecom companies. The value of such
investments are expected to increase to between USD20-30 billion in 2007.
For economic regions with high savings and surpluses such as Asia and the Middle East, the
challenge is to recycle part of these surplus funds to productive investments in the region. The supply
of savings in Asia and the Middle East is by far higher than in any other part of the world. Savings
rates here in Asia are expected to remain in the region of 30-40% of GDP for some years to come.
Similarly, savings in the Middle East economies have been rising in the recent decade and is expected
to average about 30-35% of GDP in the coming years. In 2006, the current account surpluses as
percentage of GDP for Asia and the Middle East were about 5% and 23% respectively4. With Asian
official foreign currency reserves exceeding USD2 trillion, and Middle East oil revenues exceeding
USD1 trillion since 2000, the management of surplus savings and reserves in both regions will offer
significant investment opportunities.
Besides the institutional pool of wealth, the rapidly expanding middle class in both regions is a further
trend sustaining the high savings rate and the increased demand for more sophisticated including
consumer finance and wealth management. In Asia alone, we now have more than 2.4 million high net
worth individuals5, not far behind the US with 2.9 million and Europe with 2.8 million, and these Asian
individuals control an estimated amount of USD7.2 trillion financial assets. The size of this group in
Asia is estimated to be increasing at 7% per year, second only to those in the Middle East, numbering
300,000 and growing at 9% per year. Traditionally, investors in Asia and the Middle East have looked
to the developed Western markets to meet their investment needs, in view of the more developed
financial markets and the range of asset classes. Increasingly however, there is growing interest and
search for improved returns on investment in other parts of the world. This has been a global
phenomenon for some years now, characterised by excess liquidity and low yields in the traditional
markets.
The New Silk Road creates linkages that build on the comparative advantages between Asia
and the Middle East
Ladies and Gentlemen,
Historically, trade and investment in Asia and the Middle East has been linked to the developed
economies. However, it is now increasingly recognised that there are significant complementarities
between our two dynamic regions. These complementarities provide a platform for two-way flows that
enhances income and wealth creation. The different demand patterns of each respective region
reinforces the significance of the complementarities.
The Middle East investors have a greater need for diversification, both in terms of geographical
allocation and asset classes, beyond the traditional investments in the US and Europe. Asia in turn,
the home to some of the fastest growing economies in the world, offers highly diverse investment
opportunities, ranging from in Vietnam to Japan, and in a broad scope of industries, ranging from
natural resource producers to established high-tech brands. Such investment opportunities continue to
support the growth momentum in the region. At the same time, Middle East domestic infrastructure
requirements are estimated to total USD500 billion for the next five years, and Asian companies have
demonstrated the capacity to provide the technology, expertise and human capital to meet these
infrastructure demands.
Asia's relentless march towards development offers new opportunities for the Middle East. Asia's
continued need for productive capital and uninterrupted energy supply to sustain its high growth
matches the Middle East's resource endowments. It is estimated that Asia needs USD 1 trillion worth
of infrastructure investment over the next five years, and is in search of new partnerships and strategic
investors to co-invest in these undertakings.
In focussing on the respective comparative advantages and connecting via the New Silk Road, it
contributes to expanding the opportunities in both the regions. Essentially, this extends the production
possibility frontiers to create new areas of growth. The participation of a wider pool of investors also
enables better risk sharing and consequently, increases the viability of projects as well as the returns
to the investment. New value is also created is in mutually beneficial collaborations, such as in
downstream energy activities. Products resulting from hybrid ideas are also evident in innovations in
several areas, including in Islamic finance, with the early global sukuks being issued from Asia and the
Middle East economies.
Islamic Finance: strengthening the financial linkages between Asia and the Middle East
Ladies and Gentlemen,
Islamic finance has demonstrated its viability and competitiveness in a more liberalised and globalised
financial environment and has become important in strengthening the linkages between the two
regions. While the sizeable Muslim populations in both regions have been attracted to the unique
features of Islamic finance, it has also attracted interest and participation from non-Muslims within
these regions. At present, there are more than 1006 Islamic banks in both regions, while Islamic
financial transactions involving sovereigns and corporations have amounted to USD 35 billion during
the period 2004 and 20067.
Several factors have supported this trend. The orientation of Islamic finance towards real underlying
assets is aligned to the nature of the investment opportunities in both regions. Infrastructure and
project finance in both regions are particularly suited for Islamic finance.
The emphasis in Islamic finance on risk-sharing and the equity-oriented nature of such financing also
suits the requirements. The Islamic financial structures clearly distinguish the roles and responsibilities
as well as risk and profit-sharing profiles of the parties involved. This clear delineation of the roles also
promotes greater transparency and the appropriate governance. The nature of the structures also
enables the risks to be transferred to those more able to contribute towards value creation.
In addition, the use of Islamic finance promotes stability in the financial markets and the financing
flows, which is important for emerging market economies such as those in Asia and the Middle East.
In Islamic finance, strategies to minimize and manage the risks involve integrating with the risk in the
real activities. The real activities therefore needs to generate sufficient wealth to compensate for such
risks. In contrast, conventional instruments generally separate the risks from the underlying assets. As
a result, risk management and wealth creation may at times move in different or even opposite
directions. Conventional financial instruments also allow for the commoditisation of risks, leading to its
proliferation through multiple layers of leveraging and disproportionate distribution. These could result
in higher systemic risks, increasing the potential for instability and inequitable concentration of wealth.
The adoption of Islamic financial principles encourages financing to be primarily adopted as a means
to facilitate real underlying economic transactions and not for speculative purposes.
There are also clear value propositions in Islamic finance for both investors and issuers from both
regions. For investors, Islamic financial products offer portfolio diversification and new investment
opportunities as they avail themselves to a new asset class. They also encourage risk management
and provides confidence through explicit disclosure and transparency of the roles and responsibilities
defined in the contract. For issuers, Islamic finance allows access to a new source of funds and
liquidity besides providing, new risk management options and new mechanisms for price discovery.
Islamic finance is well positioned to be a vehicle on the New Silk Road, as the enabling supporting
infrastructure is already in place. The required regulatory and legal frameworks for Islamic finance
have been established, not only in a growing number of countries in both regions but also at the
international level through standard-setting bodies such as the International Financial Services Board
and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). Efforts
towards the harmonisation of Shariah interpretations and issues concerning mutual recognition are at
an advanced stage. The platforms for extending regional linkages and cross-border initiatives,
including to the Middle East, are already in place within Asia, where there has been a significant
degree of regional financial and economic integration.
Malaysia as an intermediary destination along the New Silk Road
Malaysia is committed to and extensively engaged in strengthening linkages through Islamic finance.
In collaboration with the participation of the industry representing the banking, takaful and capital
markets in Malaysia, the regulators have worked towards enhancing the inter-linkages with the global
Islamic financial markets, not only by the further development of the Islamic financial infrastructure but
also through increased liberalisation and through the implementation of measures to increase
competitiveness of the financial services sector. This has included further liberalisation of the capital
account of the balance of payments and the implementation of tax neutrality measures. Just as
historical Malacca was a key port along the ancient trade routes between Asia and the Middle East, it
is envisaged that Malaysia would serve as a key destination along the New Silk Road.
Today, as part of Malaysia's efforts to further spur the infrastructure development of the Islamic
financial system, it is my pleasure to announce that Bank Negara Malaysia, the Securities
Commission, Bursa Malaysia and industry players have worked collaboratively towards establishing a
mechanism referred to as the Commodity Murabahah House. This mechanism which uses crude palm
oil as the underlying commodity will facilitate Islamic financing applying the concept of murabahah or
tawarruq.
BNM commodity murabahah acceptance
As part of these efforts to promote development of products to meet the diversified requirements of
investors, Bank Negara Malaysia is pleased to announce the introduction of a new Islamic monetary
instrument, Commodity Murabahah Programme (CMP) as part of its diverse range of policy
instruments in managing the short-term liquidity in the Malaysian Islamic inter-bank money market.
Unique to Malaysia is that the CMP is designed to be the first ever commodity-based transaction that
utilises the Crude Palm Oil based contracts as its underlying asset. The Bank has executed CMP
master agreements with the eight Islamic banking institutions including the three foreign owned
banking institutions to promote the use of the instrument for liquidity management. Several CMP
transactions have now been conducted between the Central Bank and the respective Islamic Banks.
As commodity murabahah is widely used in other Islamic centres, it is envisaged that this CMP will
promote increased linkages between Malaysia and these centres.
BNM Sukuk Murabahah/tawaruq short-term securities
The Central Bank also intends to diversify the issuance concept of the existing Islamic monetary notes
from being based on Bai Inah and Ijarah into murabahah. Currently, the outstanding amount of the
respective notes is RM 8 billion. This initiative is the continuation from the commodity murabahah
acceptance initiative as the issuance involves the securitisation of the acceptance facility. There are
several key benefits of issuing the Islamic Monetary Notes under this structure. It provides Islamic
financial institutions an additional instrument to manage liquidity risk on a short-term basis. It is also a
financial instrument whose structure has been widely used for retail banking and syndication products
in the Middle East. Finally, it provides an opportunity for new investors to invest in Islamic financial
papers in the Malaysian market, thus diversifying the investor base.
As part of the initiative to be linked to the global Islamic financial markets, this instrument will be
promoted to the international financial market.
Islamic Derivative Master Agreement (IDMA)
Recognising the importance to develop Islamic hedging products for Islamic financial market to
mitigate investment risks, Malaysia has introduced the first global Islamic Derivative master agreement
to document Islamic derivative transactions. The effort is initiated by Bank Negara Malaysia and driven
by the financial industry via the Persatuan Pasaran Kewangan Malaysia. The implementation of the
agreement is expected to improve the risk management practices, balance sheet management,
increase fund mobilisation efficiency and enhance their investment banking capability of the Islamic
banking institutions. With the introduction of IDMA, the rights and obligations of contracting parties are
clearly stated, thus creating an environment that is more transparent. As IDMA also incorporates best
practices in market conduct, this document serves as an important catalyst for the future linkages
between financial markets that offer Islamic financial market instruments.
Extending the New Silk Road to the world
Ladies and Gentlemen,
While the New Silk Road is enhancing linkages between Asia and the Middle East, both regions have
always extended the Silk Road to the rest of the world to participate in the these exciting
developments on this route. Indeed, global investors and the international financial community are
already drawing the benefits from the increased diversification of asset classes while riding on the
dynamism of the two regions. As Islamic finance expands further, reinforced by the activities on the
New Silk Road, there will be greater convergence towards ethical or socially responsible-type of
investments (SRI) in the global financial community. Islamic investment guidelines share significant
similarities with the SRI principles. The focus of Islamic investment not only involves the avoidance of
riba-free activities but also extends to include issues related to ethical values, such as fair trade and
environmental protection. Furthermore, the prospects of increased stability for financing flows and the
focus on the role of real sector economic activities have ignited interest in utilising Islamic finance for
sustainable development.
This overwhelming gathering of so many issuers and investors here today provides some indication of
the growing interest in Islamic finance, reinforcing the potential increased activity on the New Silk
Road. We all have a part in the making of the New Silk Road into a vibrant source of wealth and
prosperity in the global economy.
In closing, Malaysia is committed to be part of the New Silk Road to facilitate greater cross border
economic and financial flows for increased inter-regional trade and investment transactions.
InsyaAllah, the greater inter-regional economic and financial linkages would bring greater benefits which will
be mutually reinforcing and contribute towards raising the prospects for greater global shared
prosperity.