Malaysia has established itself as one of the world’s leading centres for Islamic finance. With growth in the sector now outstripping that of conventional finance, Malaysia could be on the brink of establishing its pre-eminence.
Cheah King Yoong, a Kuala Lumpur-based vice-president of equity research at Alliance Research, says Islamic banking in Malaysia registered a compound growth rate of 23% between 2008 and 2011, far exceeding the 11.4% growth rate of total loans in the Malaysian banking system. In the first seven months of 2011, Malaysia’s Islamic banking assets rose by 15% to reach M$389 billion ($126 billion).
In the bond market, two-thirds of global outstanding sukuk issuance, $165 billion, has been issued in Malaysia. As a result, many experts are lauding Malaysia as the global hub of Shariah-compliant financing.
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| Rani Bin Lebai Jaafar, managing director and CEO of RHB Islamic Bank in Malaysia |
And its burgeoning popularity is not based solely on religion. “People choose Islamic banking for various reasons – for ethical, religious or commercial reasons,” says Rani Bin Lebai Jaafar, managing director and CEO of RHB Islamic Bank in Malaysia. “But what matters most is creating a competitive product that is fair and that will serve the needs of the individual.” Competitive Islamic products have drawn in customers. At Standard Chartered Saadiq, non-Muslims account for half its business.
Some argue that disillusionment with conventional banking practices has pushed people towards considering Shariah-compliant products as an alternative. “In light of the banking crisis faced by the west – stemming from the sub-prime crisis and the most recent scandals involving renowned international banks – consumers are looking for alternatives,” says Rani. “This presents a good opportunity for Islamic finance as an ethical, risk-averse alternative to conventional banking.”
Malaysia has a legitimate claim to the title of leading Islamic centre, but doubts remain about the depth of its market, particularly when compared with conventional financial centres.
“Today, it is among the largest Islamic finance centres, but in conventional banking it hasn’t reached the level of excellence that defines an international finance hub such as Hong Kong or Singapore,” says Wasim Saifi, CEO and global head of consumer banking at Standard Chartered Saadiq in Malaysia.
Part of this is attributable to size. In terms of market share, Islamic banking accounts for a mere $1.1 trillion of global banking assets, less than 1% of the total. “We have to accept that the global banking sector is dominated by, and will continue to be dominated by, conventional banking,” says Rani.
This is a key battle for Islamic finance, not just in Malaysia but globally. Growth in Islamic banking does not come from accessing the unbanked, but through converts from conventional banking. “For this to happen, we need the continued support of the regulators,” says Saifi.
Analysts and bankers point to Malaysia’s unique financial ecosystem, which has vigorously supported Islamic banking during the past 30 years. The Islamic Banking Act in 1983 brought Islamic banks and financial institutions into the regulated realm, but it was the establishment of the Malaysia International Islamic Financial Centre (MIFC) in 2006 that spurred the country’s efforts to create the first international centre for Islamic finance.
After its establishment, the MIFC – in partnership with Bank Negara Malaysia, Malaysia’s central bank – issued a number of preferential tax laws and other incentives aimed at attracting conventional bankers and Muslims who had preferred more conventional routes to Islamic banking.
Some of the latest incentives, as outlined in the MIFC’s most recent 10-year blueprint, include a 20% stamp-duty exemption on all Islamic financing and even a 100% stamp-duty exemption for the refinancing of conventional loans through an Islamic structure. The main aim of preferential treatment by the regulator is to create a level playing field for Islamic banking and conventional banking – not to create arbitrage opportunities for Islamic bankers.
“Islamic banking needed to be nurtured for faster growth to achieve scale, size and for people to get experience of the market,” says Saifi. “So incentives and tax breaks for Islamic finance are justified. To promote Islamic banking, there initially need to be advantages to using it. This will also help people to become comfortable with an alternative way of banking.”
Malaysia has a population of 29 million, of whom 17 million are Muslims. As Saifi points out: “There is clearly an opportunity and demand for Islamic banking [in Malaysia]. But for Muslims, they have traditionally been banking in the conventional sector and often put off the decision to change. Once there is a regulatory push, and when the advantages of Islamic banking are brought to the surface – be they religious or commercial – people are encouraged to take tomorrow’s decision today.”
Today, Islamic finance in Malaysia has reached 20% of the total banking industry. “Authorities here are looking for growth and developments in this sector, so customers are given clear signals that investing in the Islamic banking sector is encouraged and will continue to develop,” says Saifi.
The government’s aim is for a robust financial market where both the conventional and Islamic banking sectors are strong. Once this target has been achieved, tax incentives will probably be removed.
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However, before that happens, and in spite of its progress, Islamic finance remains some way from reaching any kind of parity with conventional banking. “Once everyone is part of a level playing field, then that’s fine,” says Jaafar. “It’s getting there that can be an issue. This is why incentives and favourable tax rates are needed right now.” Domestic growth is being nurtured by the regulator, central bank and government in Malaysia, but they must also look internationally to tap more potential sources of growth. As the banking sector at home becomes saturated, regional expansion is crucial for domestic banks to sustain growth, according to Saifi.
There is no shortage of opportunities for Malaysian banks to expand their Islamic banking operations overseas. In Asia alone, there are 1.3 billion Muslims, around 32% of the population in the region and offering huge untapped potential. Indonesia, Malaysia’s neighbour, is the first choice for Malaysia’s Islamic banks and branches as they seek to tap into demand from the 204 million-strong Muslim population there.
Indonesia’s own Islamic banking sector is extremely underdeveloped and only 4% of the banking sector is Islamic. Indonesia’s Islamic banking assets account for Rp147.9 trillion ($15.7 billion) compared with Malaysia’s M$389 billion equivalent.
Conventional banks in Malaysia often have Islamic offshoots that rely on their parents’ extensive and established networks. The same can be replicated through Indonesian banks. Maybank and CIMB Group, Malaysia’s two largest banks by assets, are leading the pack when it comes to regional expansion. In 2008, Maybank bought a controlling stake in Bank Internasional Indonesia, beating bids by Bank of China and HSBC.
However, it is CIMB that has the most widespread coverage of the Asean region since its acquisition of Bank Niaga in 2002. There were widespread reservations about the deal when it was initially signed, as the economy struggled in the aftermath of the Asian financial crisis – but the deal paid off. Now Bank Niaga accounts for 30% of CIMB’s profit before tax.
“In five years’ time, CIMB predicts that the earnings contribution of the Indonesian market will exceed that of Malaysia,” says Alliance Research’s Yoong. Indeed, CIMB’s recent acquisitions of Bank of Commerce in the Philippines and RBS’s selective cash equities and associated investment banking businesses in the Asia-Pacific region completed the bank’s coverage of the main Asean markets.
Malaysian banks have also set their sights on other countries, particularly Pakistan, Bangladesh and China, where large Muslim populations would be naturally drawn to Islamic finance. Bank Muamalat Malaysia, one of Malaysia’s standalone Islamic banks, has recently signed a memorandum of understanding with Bank of Shi Zui Shan, based in Ningxia, China, to offer the region’s Muslim population Islamic banking solutions. It also hopes to set up an Islamic banking window in the region within the next 12 months, and aims to set up a joint Islamic bank in the province in two years.
However, for all the progress, obstacles remain to a meaningful expansion. In Malaysia, a strong Islamic banking framework exists, having been pushed forward by the MIFC. Similar frameworks do not exist elsewhere in the region. Several countries, including Indonesia, are playing catch-up to Malaysia’s established Islamic banking framework.
Meanwhile, Bank Muamalat might run into trouble while trying to navigate China’s often complex regulatory framework. “China is a big market, with a huge Muslim population, but it will take a long time for Beijing to open up the banking sector to Islamic finance,” says Jaafar. “As it stands, China doesn’t have a framework that will allow Islamic finance to operate at even the lowest levels.”
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| Maimoonah Hussain, managing director at Affin Investment Bank in Malaysia |
There are few nations with regulatory frameworks to support Islamic finance, so a standardized framework for Islamic finance at the international level is even further off. As Maimoonah Hussain, managing director at Affin Investment Bank in Malaysia, says: “The standardization of Islamic finance products would contribute greatly to the growth of international Islamic finance.” The discord over global rules has been known to fuel disputes between regions. “Each financial institution in Malaysia has its own Islamic council made up of scholars to assess the validity of Islamic products,” explains a Malaysian bank analyst. “But among them, councils and scholars often have contradictory views on what is defined as Shariah-compliant and what is not. One bank might roll out a new product that ticks all the boxes for their Islamic council, but it’s not unusual for a council somewhere else to reject the product.
“In the Middle East, for example, the interpretation of what is Shariah-compliant often differs from that in Malaysia. One of the challenges for Islamic finance is to eliminate this contention.”
Alfred Chan, the Singapore-based director of financial institutions at Fitch Ratings, agrees: “One broad aim should be to streamline standards within Islamic finance, which would enhance the confidence of the investors and promote cross-border flows. There isn’t one clear international standard setter, although there are some efforts to move in that direction.”
Chan points to various Islamic bodies that have sprung up in the past decade. The Islamic Financial Services Board (IFSB) is an international standard-setting organization for Shariah-compliant products, and the International Shariah Research Academy aims to promote research into Islamic finance. The Global Islamic Finance Forum will explore the issue in Kuala Lumpur later this month.
Education is also high on the agenda. The International Centre for Education in Islamic Finance, set up by Malaysia’s central bank, is a university dedicated to teaching Islamic finance and will aim to help educate the 40,000 additional qualified people that will be needed in the industry by 2020.
For some, however, a lack of global standards is not even an issue. “Take for example International Financial Reporting Standards (IFRS) compliance,” says Rafe Haneef, managing director global markets at HSBC Amanah Malaysia. “Malaysian accounting standards for banks are not IFRS-compliant as yet, but when we do business in Hong Kong, we must abide by their rules and regulations. We operate, we do our accounts according to Malaysian standards, and then we consolidate according to IFRS when we work in places such as Hong Kong.
“Likewise, there are different Islamic standards, but when banks such as Maybank or HSBC Amanah go to Saudi Arabia, they need to work in accordance with Saudi standards. Malaysian banks have to adapt according to local standards.”
For Haneef the bigger issue is whether or not Malaysia-based banks are prepared to put up the level of investment required in places such as the Middle East. Entry-level costs for an international bank can be $500 million.
Bankers in Malaysia also talk about a lack of opportunities for international players hoping to tap the domestic market. “The issue is not just one of appropriate Islamic structures but also of the opportunities available for investment in the first place,” says Standard Chartered’s Saifi. “Are there opportunities on the stock exchange for them? Are there opportunities in real estate investment? Are there opportunities in commodities in Malaysia? How these get converted into investment opportunities for surplus capital derived from other regions is equally as important as creating harmonized structures between the Middle East and Malaysia.”
However, do Malaysian banks have the raw capacity to act as international intermediaries? As ambitions move gradually from the domestic to the regional, the next step will be for Islamic banks and branches to function at the international level. Malaysian banks are far from ready for this, explains Rifaat Ahmed Abdel Karim, previously the secretary-general of the IFSB and an expert on Islamic banking.
“In Malaysia, there is not one Islamic bank that is big enough to conduct large transactions at the international level,” Karim says. “This is a real gap in the Malaysian Islamic banking-landscape jigsaw that will need to be addressed if the country is to fulfil its mission to be an international Islamic finance centre.”
In 2009, Malaysia announced it would offer two licences for Islamic mega banks. “If this idea materializes, it will fill the gap,” says Rifaat.
