Zeti Akhtar Aziz: The new Islamic finance landscape
Keynote address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
Islamic Financial Intelligence Summit (IFIS) 2011 "The new Islamic finance landscape",
Kuala Lumpur, 15 November 2011.
* * *
This decade has witnessed dramatic changes in the Islamic financial landscape. As a
dynamic industry, Islamic finance is responding to the forces of change emanating from the
changing requirements of the real economy, the changing pattern and pace of globalisation
and the wide spread financial reforms being undertaken at both the international and national
levels. This transformation of the Islamic financial system is also taking place during the most
challenging of times as the world enters the fifth year of the global financial crisis. A central
aspect of the new Islamic financial landscape is also the increased focus on financial stability
to enhance further its potential as a form of financial intermediation in an increasingly more
challenging environment.
It is my great pleasure to join this Islamic Financial Intelligence Summit organised by "The
Banker" held this year in Kuala Lumpur, in association with Bank Negara Malaysia to speak
on the subject on the "New Islamic Financial Landscape". This event which is being held for
the first time outside London brings together practitioners from the financial community from
different parts of the world. While the focus of this Summit will be on Islamic finance, it is
inevitable that the discussions today will touch on the recent developments in Europe, given
the potential impact it may have on the rest of the world and the need to implement
strategies and policies for coping with the consequences of these developments.
While the financial solutions being implemented in managing the crisis and the measures
being introduced to mitigate the impact of the crisis by the rest of the world is important, it
can only provide temporary relief. It is the structural policies and reforms that are more
challenging to undertake that will ensure fundamental financial stability and a long lasting self
sustaining economic recovery.
My remarks today will focus on the changes in the Islamic financial landscape and its
increased potential to contribute to sustainable growth, increased international connectivity
following the increased pace of internationalisation of Islamic finance and new developments
to achieve financial stability in the Islamic financial system. The changing financial landscape
and the accelerated expansion in Islamic finance have also resulted in changes in the nature
of the supporting ancillary services, including education that is being provided for the
business and financial sectors.
Islamic finance and fostering sustainable growth
As the Islamic financial system evolves to become more diversified and more comprehensive
to meet the changing requirements of the real economy, it is increasing its potential to
fostering sustainable growth. Given that the inherent principle of Islamic finance requires that
financial transactions be accompanied by underlying economic activity, it already ensures the
close link between the expansion in financial assets with the real economy. As the Islamic
financial system transitions from being banking centric to becoming more diversified and
comprehensive, it has been able to provide the spectrum of financial products and services
to the range of activities in the economy, as required by small businesses to conglomerates,
and by households to the high networth individuals.
The development of intermediaries that previously was dominated by banks now comprises
the range of financial institutions that also includes investment banking, specialised banking
institutions, takaful, capital market intermediaries and microfinancial institutions. Financial
markets, including the Islamic money and sukuk markets have been instrumental in
intermediating funds in the Islamic financial system. The Islamic money market not only
facilitates liquidity management but also the implementation of monetary policy. The sukuk
market has facilitated the raising of funds by businesses, while providing investors with a
range of instruments for investment, thereby facilitating the mobilisation and allocation of
funds to productive economic activity.
Accompanied by research and development, innovation has intensified. Islamic finance
however has the governance arrangements which require the approval process by the
Shariah advisories. This ensures avoidance of the creation of financial instruments that have
its origins from other financial instruments. A further principle of profit sharing and hence risk
sharing also ensures a high degree of transparency and disclosure, thereby a greater shared
responsibility on the viability of the products.
The rapid expansion of Islamic finance is reflected in more than 600 Islamic financial
institutions operating in more than 75 countries in centres that are now beyond Muslim
jurisdictions. Indeed, Islamic finance is increasingly becoming part of the growth strategies of
an increasing number of global financial institutions. New horizons are also fast emerging
following legislative and regulatory changes in several non-traditional markets that have now
emerged as the fastest growing segment in the international financial system. In fact, the
Banker's latest 2011 Top 500 Islamic Financial Institutions report being released at this
Summit shows that the global Islamic finance industry continues to experience double digit
growth of 21%, with the Shariah compliant assets now breaching the USD1 trillion mark.
The rapid expansion of Islamic finance essentially reflects its ability to meet the changing
requirements of the global financial community and its competitiveness. The elements of
checks and balances in Islamic finance that promote accountability and transparency
enhances its potential as a stable form of financial intermediation. There is also a growing
recognition that the inherent tenets of Islamic finance are aligned with the sustainable
dimensions of ethical finance and responsible financing.
As the new financial landscape emerges, it has also been accompanied by the development
of ancilliary support services that include legal, accounting, taxation and Shariah advisory. In
addition, there is the development of Islamic indices, information repositories and
consultancy services. In the areas of human capital development there is a proliferation of
programmes and certifications that focus on Islamic finance. Malaysia is committed in this
pursuit and has put in place a comprehensive talent infrastructure in Islamic finance with the
aim of meeting the increased demand for practitioners by the global Islamic finance industry.
Dedicated institutions of learning such as the International Centre for Education in Islamic
Finance (INCEIF) and the Islamic Banking and Finance Institute (IBFIM) have been
established to focus on education in Islamic finance.
Increased international connectivity and Islamic finance
Despite the continued strains experienced in the economy and the international financial
system, it is important to recognise the fundamental long-term global transformation that is
taking place. In this recent decade, the concurrent rise of the emerging economies is
resulting in a fundamental realignment in the global landscape. This transformation is
characterised by the shifting balance of global economic strength to the emerging
economies, with its significant implications on the global economic and financial flows. The
international financial landscape will also be inevitably transformed with the distribution of
financial centres becoming more dispersed. Increasingly, new centres of financial activities
will likely to emerge. In addition, financial system inter-linkages - particularly among the
emerging economies - will deepen, supported by the increased global trade and investment
that is already taking place. With considerable capacity to meet large investment
requirements, opportunities therein lie in the more effective and efficient channelling of the
sizeable surplus funds towards the vast productive investment opportunities within and
across the emerging economies.
These trends are being reinforced by the rapid expansion of financial institutions in emerging
economies that have ventured beyond national borders. Financial institutions from the
emerging economies have grown significantly in size and strength in this recent decade to
now account for almost half of worldwide financial industry market value. Eight out of the
twenty largest global banks, including the top two, are emerging market financial institutions.
As the emerging market financial institutions continue to regionalise and internationalise,
their role and importance can be expected to further expand. Another key development is the
integration of financial markets amongst emerging economies, driven in part by the increased
economic inter-linkages and the increased liberalisation trend in the financial sector.
The rapid internationalisation of Islamic finance is reinforcing this trend and has enhanced
the economic and financial connectivity between the emerging economies. The high level of
savings and wealth accumulation in several of the emerging economies, including in Asia
and the Middle East, need to be effectively channelled towards productive investments
including for large infrastructure development. In this environment, Islamic finance has
emerged as a viable and attractive form of intermediation including financing of large scale
infrastructure projects. Recent examples include the USD500 million Islamic Infrastructure
Fund established in 2009 by the Asian Development Bank (ADB) and Islamic Development
Bank (IDB) to meet the Shariah-compliant financing needs in the member countries.
In addition, the advancements achieved in the sukuk market also provide evidence on the
ability of Islamic finance in meeting the requirements of the differentiated demands of the
modern economy. The recent issuance of the world's first offshore RMB sukuk by Khazanah
Nasional in Malaysia reflects the growing trend of multi currency sukuk issuances in Asia.
Growing at an average annual rate of 40 percent, the global sukuk market has demonstrated
its ability to effectively intermediate funds across borders, allocating funds efficiently in the
international financial system and fast becoming an important financing and capital raising
option.
Islamic finance and financial stability
An important aspect of the new financial landscape is the increased focus on financial
stability. The more market oriented systems with market-based finance activities, the creation
of new financial instruments and an increasing number of market participants with global
reach, and more interconnected financial systems has expanded the potential for, and
channels through which, financial shocks are transmitted to the economy and across
borders. Indeed, recent experiences with crises have also shed new insights into the
complex web of relationships that exist between sovereign, financial and economic risks, and
underscored the critical importance of strengthening the pillars of financial stability that can
serve to contain the impact of a crisis.
The increased focus on financial stability has several implications for the new financial
landscape. The most significant will be the fundamental changes in the regulatory
environment. These include changes to institutional arrangements for oversight of the
financial system - both at the international level and within national borders in a number of
countries, significantly strengthened prudential standards with a focus on building stronger
capital and liquidity buffers, increased transparency in financial transactions and exposures,
and enhanced options to resolve failed financial institutions.
Much progress has already been made by the Islamic Financial Services Board in
promulgating an extensive set of prudential standards for the Islamic financial services
industry since its establishment in 2002. The IFSB has already introduced standards for
capital adequacy, risk management, corporate governance and Shariah governance. This
important work has been significant in promoting international uniformity of the regulatory
framework and international best practices for the Islamic financial system in different
jurisdictions. The IFSB has also established a facilitative platform to promote overall financial
stability through the Islamic Financial Stability Forum (IFSF) that serves as an avenue for
cross-border engagement amongst regulators.
The important goal of strengthening the foundation of the global Islamic financial system has
also been reinforced further following the recent global financial crisis, through the work of
the IFSB-IDB Task Force of Islamic Finance and Global Financial Stability. In its report that
was released in 2010, eight building blocks were identified to manage potential risks and
vulnerabilities to the Islamic system. These include steps that need to be taken for the
implementation of the prudential standards; the development of a liquidity management
infrastructure; the introduction of strong financial safety nets; the development of an effective
crisis management and resolution framework; the development and implementation of
accounting, auditing and disclosure standards; the formulation of an effective macro
prudential framework; the development of credible credit rating institutions and processes;
and finally, to strengthen efforts for capacity building and talent development for the Islamic
financial services industry.
Following these recommendations, this year, the International Islamic Liquidity Management
Corporation (IILM) was established to strengthen the liquidity management of Islamic
financial institutions. This initiative represented a collaboration between 10 Central Banks
and 2 multilateral development institutions. Its aim is to enhance the availability of liquid
Shariah-based Islamic financial market instruments - a crucial step in promoting more
efficient cross-border liquidity management for Islamic financial institutions to support
increased cross-border flows.
Cumulatively, these efforts will build a solid foundation for the orderly growth and
development of Islamic financial system that will contribute to its continued resilience and the
overall stability of the global financial system in a way that better serves households and
businesses.
Going forward, it is important that the international standard setting process allows and
continues to promote the more effective integration and exchange of perspectives between
Islamic and conventional finance to ensure a coherent global framework that is consistent
across similar risks, promotes a better understanding of risk interactions between
conventional and Islamic finance activities, and accelerates progress towards best practices
based on the sharing of research, experiences and frameworks.
Conclusion
Let me conclude with a statement from this year's Per Jacobsson Lecture given by
Sir Andrew Crockett on what should guide us in our "efforts to devise a new and stronger
financial system". "It should be global, it should be robust, it should be an effective servant of
the real market economy". This is what the new Islamic financial landscape has evolved to
achieve. With its inherent close links to the economy and its trend towards
internationalization and the robust institutional arrangements and regulatory standards being
introduced and implemented, it will indeed enhance the potentials for Islamic finance to not
only serve the economy but to achieve sustainability in this more challenging environment.