Zeti Akhtar Aziz: Islamic finance and financial stability
Opening remarks by Mrs Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
BNM High Level Conference on Financial Stability, Bank Negara Malaysia, Kuala Lumpur,
24 November 2009.
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It is my great pleasure to welcome you to Bank Negara Malaysia Conference on Financial
Stability that is being held in conjunction with 15th IFSB Council Meeting and the 3rd IFSB
Public Lecture on Financial Policy and Stability. This conference takes place at a time when
there has been intense discussion by the international community on the necessary financial
reforms at both the national and international level so that we will avoid such global crisis of
such a scale in the future. This conference today provide us with an opportunity to reflect on
the new challenges that are emerging from this global financial and economic crisis and
discuss Islamic finance and the need to ensure not only its resilience but how it might
contribute to global financial stability.
Indeed, Islamic finance has a potential role in contributing not only to global financial stability
but also towards a more balanced global growth. While Islamic finance by its very nature and
its direct link to economic activity contributes to this process, the recognition of the new
financial challenges ahead require further steps to be taken to strengthen its resilience and
robustness.
In recent months, there have been increasing evidence of strong gains, a rebound in the
financial markets with renewed interest in emerging market, active capitalization by banks,
and the reopening of wholesale funding markets. While the Malaysian financial system has
fared relatively well throughout this global crisis and remaining financially sound, well
capitalised and able to withstand the current challenging global financial environment, there
are however, many lessons that we can learn from the current international financial crisis to
ensure the sustainability of this resilience.
The development of Islamic finance in Malaysia that operates in parallel with conventional
finance for almost three decades now has demonstrated its sustainability as a form of
financial intermediation. Today, the Islamic banking system has emerged as a vibrant
financial system with Islamic banking assets currently accounting for 18.8% of the total
banking assets of the Malaysian financial system. The product range has now expanded into
an extensive range of innovative instruments while in the Islamic capital market, the sukuk
market has surpassed the conventional market in terms of market share. An important
aspect that has contributed to financial stability in the overall financial system is the
conscious policy to develop a more diversified financial system that allows for the
diversification of risks.
Potential of Islamic finance in contributing to global financial stability
This current global financial crisis has prompted a search for an enduring solution to ensure
the stability of financial systems. The challenge before us is to build a new financial
architecture that would allow for the more efficient functioning of not only financial
intermediation within national economies but also across borders. Islamic finance, with its
emphasis on a strong linkage to productive economic activity, its inbuilt check and balances
and its high level of disclosure and transparency offers this. Indeed, inherent in Islamic
finance is the explicit elements that address several of the issues that have surfaced in the
conventional financial system during the current crisis. At the centre of this recent global
financial crisis was the breakdown in governance that led to indiscriminate lending, excessive
risk-taking and overzealous financial innovation. This is avoided in Islamic finance with the
requirement that Islamic financial transactions must have an underlying economic activity
and that the process of innovation and formulation of Islamic financial products and services
must be done carefully and in accordance with Shariah. The crisis has provided an important
lesson that the development of new financial instruments embraces this process while being
able to effectively compete in the global arena.
Strengthening the Islamic financial system
As Islamic finance becomes an integral part of the global financial system, it has become
increasingly exposed to the systemic implications of external developments. There is the risk
of the contagion effects arising from financial and economic disruptions that emanated from
the conventional markets. The correction of asset prices and the economic contraction
following this international global financial crisis has been on an unprecedented scale.
Islamic finance is therefore confronted with the risks associated with these second round
effects that need to be managed.
This recent financial market turmoil in the advance economies also demonstrated the
consequences of liquidity constraints. This has underscored the importance of a strong and
well developed liquidity management infrastructure. An important aspect that needs to be
urgently addressed in the Islamic financial industry is the need to enhance the ability of
Islamic financial institutions to manage liquidity. This requires the development of Shariah
compliant financial instruments that facilitate this and a well internationally functioning market
infrastructure to facilitate cross border management of liquidity, so that liquidity risks are
effectively managed. Malaysia has, for more than a decade now, an efficient functioning
Islamic money market which has accorded greater monetary flexibility in the Islamic financial
system. While the market is in domestic currency, it has drawn wider participation from the
international financial community. As part of the global collaborative efforts to enhance the
efficiency of Islamic financial institutions in managing liquidity at both national and across
borders, a Liquidity Management Task Force was established by the Islamic Financial
Services Board (IFSB) and the Islamic Development Bank (IDB) early this year to develop a
liquidity management framework.
Integral to the efforts in the development of Islamic finance, is also the strengthening of the
regulatory and supervisory framework. The IFSB which was established in 2002 has been
instrumental in developing and issuing global prudential standards and guiding principles for
the industry. The IFSB has also contributed to the harmonisation in the development of
Islamic finance across different jurisdictions. Apart from the implementation of these
prudential standards, there is also a need to ensure the supervisory and legal infrastructure
remains relevant to the rapidly changing Islamic financial landscape. In Malaysia, these
efforts are also supported by a comprehensive financial safety net that includes a deposit
insurance scheme and a resolution mechanism, so that not only are depositors protected,
but it also allows for prompt, effective and least cost resolution of the financial system that
can facilitate recapitalization of Islamic financial institutions as well as institute programme to
remove troubled assets from the books of financial institutions.
Greater collective effort by international community to strengthen global financial
stability
In the reform of the international financial architecture, the G20 has launched an ambitious
agenda to reform financial regulations, which include key main areas namely, (1) the
strengthening of international frameworks for prudential regulation, (2) the review of the
scope of regulation, (3) the revision of accounting standards; and (4) more effective oversight
of the credit rating agencies as well as strengthening risk management.1 These areas should
also be looked at in Islamic finance, which has also to deal with additional issues of
harmonised regulation.
The G20 has agreed to establish a new global Financial Stability Board, with a wider group of
developed and emerging countries as part of the new international financial architecture. It
will be responsible for coordinating banking regulation, developing regulatory and
supervisory standards, preparing early warning reports and exchanging information with
supervisors. It is important that this forum gives due recognition to Islamic finance given its
increasing importance in the international financial system and its potential role in
contributing to global financial stability. In the Islamic financial industry, the IFSB is at the
forefront of international efforts to increase regulatory cooperation, and encourage common
rules and enhanced monitoring of international financial risks. The IFSB and the IDB has an
important role in building cross-border consensus and collaboration on the strategic direction
for the Islamic financial services industry for better alignment to the objectives of financial
stability.
As Islamic finance continues to become an integral part of the global financial system, there
is scope for the current framework of cooperation to be strengthened and broadened to
address the new challenges that have emerged.
Islamic finance has been inclusive in its development, not only at the national level but also
across jurisdictions. At the national level the Islamic financial system provides the full
spectrum of financial services from the large multinational corporations to micro-enterprises
and to households. At the international level, the development and expansion of Islamic
finance become important in strengthening financial and thus economic linkages between
emerging economies. It has allowed emerging economies to participate in its development
thus increasing the potential to contribute to the rebalancing of global growth as financial
flows not only provides support to domestic demand but also to greater trade and investment
flows across borders.
Concluding remarks
In this challenging international financial environment, Islamic finance has continued to
demonstrate its evolution and strong growth. Islamic finance in its advancing journey today is
presented with an opportunity to increase the financial linkages with the broader financial
system thereby facilitate a more efficient allocation of capital across borders. Indeed, Islamic
finance as an integral part of the international financial system has the potential to contribute
to global financial stability and to enhance the prospects for global growth.