Zeti Akhtar Aziz: Metamorphosis into an international islamic banking
and financial hub
Special address by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the
ASLI's World Islamic Economic Forum, Kuala Lumpur, 1 October 2005.
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Distinguished guests, Ladies and gentlemen,
I am honoured to deliver this luncheon address on the occasion of the inaugural World
Islamic Economic Forum organised by the Asian Strategy & Leadership Institute (ASLI).
Allow me to take this opportunity to share with you Malaysia's experience in evolving a
comprehensive domestic Islamic financial system that has now become an increasingly more
internationally-integrated financial system, thereby strengthening our economic and financial
inter-linkages with the rest of the world.
In evolving the Islamic financial system, important considerations include the development of
a system that is able to meet the changing requirements of the consumer and business
community, that is efficient and competitive, that is safe and sound and that is robust and
resilient and able to withstand a more challenging and uncertain world environment. These
considerations are vital to ensure the sustainability of the system not only as a form of
financial intermediation in the domestic economy but also as an integral component of the
international financial system.
Evolving a robust islamic financial system
Malaysia has adopted a holistic approach in developing its Islamic financial system. Our
initial focus was to develop a comprehensive domestic Islamic financial system. The strategy
has been to institute the entire financial system chain to ensure its smooth functioning
thereby contributing to a balanced allocation of financial and economic resources within the
economy, and a greater diversification of risks within the system, and thus achieving overall
stability of the Islamic financial system. The initiatives taken include building the required
financial institutions, robust regulatory and supervisory framework, effective legal and
Shariah framework, the financial markets, effective payment and settlement system,
reinforced by the development of the skill talents, and putting in place the mechanism for the
operation of the Central Bank. The development of this chain has promoted greater linkages
and integration within the domestic Islamic financial system.
Attention has therefore been given to the development of the key structural components of
the system, comprising the Islamic banking industry, the takaful industry, the non-banking
institutions and the Islamic interbank and capital markets. These respective components of
the Islamic financial system have now become highly integrated and interdependent. This
more diversified financial infrastructure has also enhanced the efficiency in the functioning of
the overall financial system.
The development of the Islamic financial system in Malaysia started with the establishment of
Tabung Haji in 1969 as the first Islamic savings institution. This was followed by the
establishment of full-fledged Islamic banking and non-banking institutions. A year after the
establishment of the first Islamic Bank in 1983, a takaful or Islamic insurance company was
established under the Takaful Act. These developments were subsequently expanded with
the introduction of Islamic windows by conventional banking institutions where Islamic
products and services could be offered by these banking institutions. At the same time,
adequate firewalls have been instituted to ensure absolute separation of banking operations
to avoid co-mingling between the Islamic and conventional funds so as to ensure the integrity
of the Islamic banking operations.
More recently, this structure has been strengthened. Conventional banking institutions that
have achieved a critical mass in their Islamic finance operations have the option to transform
their operations into a dedicated Islamic subsidiary. Within this framework, Islamic finance in
Malaysia has proven to be resilient and able to function effectively and efficiently alongside
the conventional financial system. The ability of the Islamic banking institutions to arrange
and offer products with attractive and innovative features at competitive prices has appealed
to both Muslim and non-Muslim customers, reflecting the competitiveness of Islamic finance
as a form of financial intermediation. Since 2000, the domestic Islamic banking industry has
been growing at an average of 18% per annum in terms of assets, while growth in the takaful
industry was at an average of 28% per annum, with an increasingly more important role in
supporting the growth and development process of the country.
Attention has also been given to develop both the Malaysian Islamic money market and
capital market. A wide range of instruments has been developed to facilitate the effective
management of liquidity and funding by the Islamic financial institutions. This has facilitated
the smooth flow of funds in the Islamic financial system. With the development of the bond
market in Malaysia which now accounts for 81% of GDP, the Islamic private debt securities
account for about 44% of the total outstanding amount of private debt securities in the
market, while the monthly traded volume of the Islamic money market is now about RM30 to
RM40 billion. The money market also effectively serves as a channel for the conduct of
liquidity operations by Bank Negara Malaysia as part of its monetary policy.
The rapid expansion of the Islamic financial services industry in Malaysia is also supported
by a conducive legal and Shariah framework. In terms of the legal infrastructure, the Islamic
Banking Act 1983 and Takaful Act 1984 governs the conduct of the Islamic banking
institutions and takaful operators respectively. There is also the Government Funding Act
which governs the issuance of government Islamic instruments. A dedicated High Court
judge has also been assigned to preside over cases relating to Islamic banking and finance.
An arbitration centre is also available to deal with disputes. The Central Bank Act has also
been amended to provide for the establishment of a Shariah Advisory Council at the Central
Bank as the sole authority and reference on all Shariah matters. The treatment of tax
neutrality has also been accorded to Islamic financial transactions.
To ensure the soundness and stability of the Islamic financial system the regulatory and
supervisory framework has also been improved for the Islamic financial institutions, with the
incorporation of stronger standards for corporate governance, transparency, disclosure,
accountability, market discipline, risk management and customer protection. In addition, the
payment system has also been continually upgraded to ensure efficient and effective clearing
and settlement of payments. It is now highly automated with the ability to handle scriptless
debt securities trading, processing and settlement. By providing a real time settlement
system for inter-bank fund transfers, the credit and settlement risk in the Islamic financial
system has been minimised.
Attention has also been given to human talent management to create a sufficient pool of
competent bankers essential to spearhead innovation in Islamic financial products and
services. To meet the increasing manpower requirements, institutions of higher learning and
the Islamic banking and finance institutes have also initiated new programmes on Islamic
finance.
Leading initiatives in the global integration
Islamic finance in Malaysia has now taken on a new dimension to become more
internationally integrated. This is part of the strategy to evolve Malaysia as an integrated
international Islamic financial hub that will have a greater role in facilitating international
economic and financial flows.
The liberalisation of the Islamic financial system in Malaysia commenced in 2004 with the
issuance of three new Islamic bank licences to foreign Islamic financial institutions. These
new entrants with distinct capabilities and strengths will not only participate in the growing
domestic Islamic banking industry, but will also be able to tap new markets in the region. This
initiative will also promote healthy competition, thereby contributing to elevate the domestic
industry to new levels of dynamism. In addition to this initiative, up to 49% foreign interest is
permitted in the Islamic subsidiaries of the conventional banking institutions and in the takaful
companies. The increased international integration is also reinforced by our own institutions
venturing beyond our domestic borders, in particular to the Asian region and to the Middle
East. This international integration would contribute towards facilitating greater cross-border
flows in terms of increased trade and investment transactions, thereby strengthening the
global economic and financial inter-linkages.
Apart from banking, Malaysia is also initiating efforts to promote takaful internationally. This
is being done in close coordination with the Islamic Development Bank where a taskforce
has been established to spearhead, among others, the development and promotion of trade,
investment, Islamic banking as well as takaful and retakaful industries among OIC member
countries. Among the main initiatives to be undertaken under a Memorandum of
Understanding signed between Malaysia and the Islamic Development Bank is to specifically
promote and expand takaful and retakaful businesses in the member countries.
A further initiative by Malaysia was to access the international capital market with the
issuance of global Islamic financial instruments. The Government of Malaysia made this
inaugural primary issuance of a globally-accepted sovereign Islamic sukuk in 2002. Since
then, there have been several other issues by other countries. To-date, the total issuance of
the four global sovereign sukuk has exceeded USD3.5 billion. The sukuk has broadened the
investor base by creating a new asset class for both Islamic and conventional investors. This
has also been followed by the issuance of global corporate sukuk, which now amounts to
USD12 billion. Several of these products are listed on the Labuan international financial
exchange.
In 2004, Malaysia liberalised the foreign exchange administrative rules to allow Multilateral
Development Banks and multinational corporations to raise ringgit-denominated instruments
in the Malaysian capital market. Towards this end, two institutions, the International Finance
Corporation and the World Bank, have issued ringgit-denominated instruments based on
Islamic principles in our market. This has contributed to enhancing the depth of the market.
At the international level, Malaysia has also participated actively in initiatives to develop the
supporting international Islamic financial architecture. The formation of the Islamic Financial
Services Board (IFSB) in 2002 is one of the most important achievements in this
development to set the international prudential standards for Islamic finance. To-date, the
IFSB has made commendable progress, and this includes the issuance of two exposure
drafts on capital adequacy and on risk management. Work is in progress for three other
standards that relate to corporate governance, transparency and market discipline, and the
supervisory review process. The IFSB has also played a catalytic role in expanding its
membership and outreach, thereby contributing further to the global recognition of the Islamic
financial system. Today, the IFSB has 78 members from all over the world. This will
contribute towards the standardisation of the prudential rules and more importantly contribute
to the soundness and stability of the Islamic financial system.
The International Islamic Financial Market, or the IIFM, which is another leading international
initiative, will also contribute towards promoting the development of both the primary and
secondary international Islamic financial market. IIFM provides the environment to link all the
financial centres around the world that participate in Islamic finance, thereby encouraging
active participation by both Islamic and non-Islamic financial institutions in the secondary
market for Islamic financial instruments. As the volume increases, it would strengthen the
inter-linkages and integration amongst the Islamic financial centres.
In the area of Shariah, Bank Negara Malaysia is currently promoting intellectual discourse on
Shariah issues. Our own Shariah scholars have contributed towards the rapid growth of the
Islamic financial products. Earlier this year in conjunction with the IDB Annual General
Meeting that was held in Putrajaya, the opportunity was taken to bring the international
Shariah scholars together to deliberate the issues and to foster greater understanding and
convergence of the practices of Shariah. Bank Negara Malaysia has established a RM200
million dedicated endowment fund to facilitate regular dialogues among the Shariah scholars,
to finance research and scholarships, and to facilitate enhanced interaction between the
Shariah scholars and the industry practitioners.
Malaysia will continue to initiate international endeavours and collaborate closely with the
Islamic financial community on developing the global Islamic financial system by dedicating
our resources and commitment.
Key challenges moving forward
One of the key challenges in promoting greater linkages within the domestic Islamic financial
system and integration with the international financial system is having the pool of talent and
professional skills. Talents are an important pre-requisite for the national and global
development of the Islamic financial system. They are important assets that will drive
innovation in the Islamic financial business and sustain its competitive strength.
As the industry moves forward, the need to develop the range of products and services
including risk mitigating products intensifies. These products are a necessity for the Islamic
financial industry not only to meet the new and changing requirements of the domestic and
international economy but also to allow for hedging against potential adverse events and
uncertainties. This is important to strengthen the resilience and risk management framework
of the Islamic financial industry amidst the increasingly more challenging and competitive
global financial environment.
To fast track the creation of a pool of talents and skill set to meet the increasing manpower
requirements, Malaysia is currently undertaking an initiative to establish an international
centre for education in Islamic finance. It will be designed to act as a professional certification
body and a training institute for post-graduates. In addition, Malaysia established the
International Centre for Leadership in Finance (ICLIF) in 2003 to also provide leadership
development and management training for the Islamic financial institutions.
Closely linked to having the talent is the need to have strong and well established Islamic
financial institutions. This presents another challenge for the Islamic financial industry as
there are currently not many large Islamic financial institutions. Many of the players are not
large enough globally to finance large development projects, particularly in Muslim countries
and are not strong enough to underwrite the needs of the Islamic financial community on a
large scale. Currently, some of the project financing in Muslim nations are undertaken by
large conventional banks because of the under capitalisation of the Islamic financial
institutions. We therefore need to have strong and highly capitalised Islamic financial
institutions that are able to offer the comprehensive and complete range of Islamic financial
products and services.
Besides having large Islamic financial players with the required pool of expertise, the
integration of the Islamic financial system with the international financial system needs to be
supported by the development of a full Islamic financial system at the national level, thereby
increasing the potential to effectively participate in a more liberalised and globalised
environment.
Towards this end, Malaysia together with other OIC countries, are collaborating with the IDB
and IFSB to formulate a ten-year master plan for the future global development of the Islamic
financial services industry. The Master Plan will provide a road map to achieve a
convergence towards the common vision among countries in the development of an Islamic
financial system.
Conclusion
In developing and strengthening our Islamic banking and financial system to become more
integrated with the international financial system, Malaysia is positioning itself as an Islamic
financial gateway to the East Asian region. In emerging on the radar screen of international
investors, Malaysia thus not only offering financial communities that want to deal in Islamic
financial transactions, but also the international investment community at large, the potential
for further opportunities for financing and investment in productive activities.
In closing, I wish to say that our mission is for the development of an increasingly
international integrated Islamic financial system. I am confident that in taking this approach, it
would contribute towards facilitating increased trade and investment transactions,
strengthening the global economic and financial inter-linkages, and thereby raising the
prospects for more balanced global growth and shared prosperity among the Ummah,
InsyaAllah.
Thank you.