Toshihiko Fukui: Islamic finance - developments, diversity and
challenges
Opening remarks by Mr Toshihiko Fukui, Governor of the Bank of Japan, at the Nikkei
Islamic Finance Symposium 2008: "Islamic Finance: Constant Evolution and Emerging
Opportunities", Tokyo, 23 February 2008.
* * *
Introduction
It is a true honor and pleasure to be invited to the Nikkei Islamic Finance Symposium, and to
have the opportunity to share my thoughts about Islamic finance along with Governor Zeti of
Bank Negara Malaysia and distinguished guests.
The Bank of Japan joined the Islamic Financial Services Board (IFSB) as an observer last
year. We believe that this will help us deepen our understanding of the latest developments
in Islamic finance, which has rapidly evolved and come into the spotlight of global finance.
Development of Islamic finance
Islamic finance has developed phenomenally in recent years. There are no precise figures
that show the market size of the Islamic finance industry, but according to an estimate by the
IFSB and other Islamic institutes at the end of 2005, more than 300 financial institutions in
more than 65 jurisdictions manage financial assets in a Shari'ah compatible manner, which
total between US$700 billion and 1 trillion. From this figure, Islamic finance represents a
modest 1% of global financial assets, but its growth in recent years is notably impressive.
Islamic finance related assets have continued to grow at a robust 10-15% per annum on
average since the mid-90s, and are expected to maintain this speed of expansion over the
next few years.
Among others, Asia is one of the regions characterized by the dynamic development of
Islamic finance. To give a few examples, Islamic finance products are estimated to comprise
more than half of the financial services provided in the Gulf Cooperation Council region by
2015. In Malaysia, more than half of private debt securities are Islamic bonds. The credit for
this must go to the leadership of Governor Zeti, who has adopted a variety of policy
measures to make Malaysia an Islamic financial center.
Islamic finance has a long history. As a place where the three continents of Asia, Africa and
Europe meet, the Middle East has flourished as a trading center since antiquity. In those
days, there were active financial transactions in funding and settlement for trade. It is said
that bills and checks already circulated in the 11th century, and that the word "check" has its
origin in Farsi.
Islamic finance has a long-established tradition, yet, it is only rather recently that Islamic
finance has developed in a global context. The recent rise takes place against the
background of an increase in financial assets supported by Middle-East petrodollars and a
growing number of Muslims seeking to have their assets managed under religious tenets. An
equally important factor that propelled growth in Islamic finance is recent advances in
financial technologies, namely, structured finance. The Islamic finance industry has been
able to introduce a scheme of profit sharing instead of prohibited interest payments. This has
led the way to the development of a range of financial products, including the Islamic bond,
or sukuk.
Islamic finance brings greater diversity
The development of Islamic finance brings diversity to financial markets and financial
transactions.
When market players with different sets of values enter a market, they increase the variety of
financial transactions, which in turn promotes financial market development and creates
business opportunities. At the same time, it has a positive effect on the real economy through
more efficient resource allocation.
Against this backdrop, I have a keen interest in what kind of new financial services Islamic
finance will provide in the future. To date, Islamic finance institutions have provided many
products that replicate those of conventional finance while respecting Islamic values, where
interest, or riba, is prohibited. In other words, Islamic financial institutions have successfully
provided conventional intermediary functions by utilizing the latest financial technology. I look
forward to seeing further developments which will enable Islamic finance to carry out new
functions that conventional financial instruments can not serve. Such innovation will improve
the allocation of resources, while operating in accordance with Islamic values.
There are of course a variety of conventional transactions, but basically, all are a
combination of two factors, risk and return. Islamic finance is expected to offer further
possibilities to finance by adding a new dimension to risk and return, which is Islamic values.
An example would be the development of microfinance under a framework that places great
importance on Islamic values such as fairness and equality of social economy and business
partnership.
Islamic finance that offers a broad range of products and services is also important from the
perspective of financial market and financial system stability. In principle, in a time of stress,
a market with diversified participants and transactions is robust compared to a market of
homogeneous participants and limited types of transactions. Since the Asian currency crisis,
Asian countries have been striving to create diversity in the source of funds, including bonds,
instead of relying heavily on banks. I believe that the growth of Islamic finance will also
contribute to resolving these problems.
Challenges ahead
Islamic finance is making impressive growth and is expected to continue to do so in the years
ahead. Still, there are many unknown factors in this financial sector, as new types of Islamic
finance transactions have evolved relatively recently.
For instance, how does arbitrage between Islamic finance transactions and conventional
financial transactions take place? With greater presence in the global market, what kind of
impact will Islamic finance have on the pricing mechanism in the global financial market?
The size of cross-border capital flows generated from Islamic finance products is growing.
How will this impact the stability of the global financial system? I have expressed my view
that diversity in the market will bring about stability. However, the rapidly growing modern
Islamic finance industry has never been exposed to serious stress in the global financial
market. Stress tolerance can only be acquired through the experience of riding out numerous
crises in the financial market and financial system. In this regard, I would like to watch closely
developments in Islamic finance in the coming years.
One of the potential vulnerabilities in the international financial system is the global
imbalance problem. There is a huge gap between the deficit in the US current account, and
the surplus in the current accounts of Asian countries and oil producing countries. The gap
has been filled by the smooth flow of a significant amount of capital. In this context,
understanding the flow of Islamic finance capital originating from oil money has certainly
become the key when considering sustainability of the current state of the global economy.
On the regulatory front, there are ongoing discussions on how to develop risk management
and a regulatory framework to match the rapid expansion of the Islamic finance industry in
order to maintain stability of the financial system. The key to addressing this issue would be
consistency with conventional risk management and regulatory frameworks. This is a matter
of great importance for the coexistence of the Islamic financial system with conventional
financial markets and systems, and for providing beneficial diversity to the global financial
system.
Islamic financial standard setting organizations play an important role in bridging the gap
between Islamic standards and conventional global standards. Such organizations include
the IFSB, of which Governor Zeti served as Chairperson last year, and the Accounting and
Auditing Organization for Islamic Financial Institutions, which sets accounting standards for
Islamic finance. To give a few examples, the IFSB has issued the capital adequacy standard
and guidance that complement existing global standards for Islamic banks. Exposure drafts
of guiding principles for Islamic collective investment scheme and Islamic insurance, or
takaful, will follow. I look forward to the significant role that these Islamic financial standard
setting organizations play in the provision of sound and stable Islamic finance services.
Epilogue
Islamic finance has grown into an industry that is indispensable in understanding the global
financial system. The Bank of Japan will closely follow developments in the Islamic finance
industry through its IFSB observer membership status.
Japanese financial institutions and companies have just stepped into the world of Islamic
finance. We hear that some financial institutions are already actively engaged in Islamic
finance business by cultivating new markets and setting up local companies. Some
companies are already introducing the framework of Islamic finance to finance their projects.
I am convinced that we will be seeing more in the near future.
I would like to close my remarks by expressing my hopes that the proceedings of this
symposium will deepen understanding of Islamic finance among Japanese financial
institutions and companies, and that it presents an opportunity for the creation of new
financial services.
Thank you for your kind attention.