international analysis and commentary

Expanding Islamic finance: the case of Malaysia


The modern Islamic finance industry traces its origins back to the mid-1970s in Egypt. Today, Gulf countries, with their oil wealth and strong Muslim identity, are often thought of as its teeming heart. Nevertheless, this subset of the global financial system has long found a welcoming home and bustling center in Southeast Asia as well, particularly in Malaysia. Here Shari’ah -compliant banking, capital markets and insurance have experienced tremendous growth in the last 40 or so years, thanks to the right mix of cultural, economic, legal and political ingredients. Increasingly, with its dedicated and well-developed regulatory framework, and its deep expertise, Malaysia is seen as a model for the healthy expansion of Islamic finance across the Asian region and the world.

“A number of factors have made Malaysia a vibrant Islamic finance hub for all players, as a strong Islamic finance environment needs the support of all the ancillary components of the eco-system such as legal, regulatory, judiciary, tax, political, to ensure its success and sustainability,” says Maya Marissa Malek, Managing Director of Amanie Advisors, a global advisory firm specializing in Islamic finance solutions. “In Malaysia there has been a concerted push from all stakeholders, complete with specific incentives by authorities, to drive this industry forward, while the level of understanding of the intricacies of Islamic finance is high. So the take-up from the market is very encouraging.”

A rapidly developing country, with a population that is 60% Muslim and whose central bank (Bank Negara Malaysia) has long made financial inclusion a priority, it was only natural that Malaysia would become fertile territory for Islamic finance products. But the industry didn’t just materialize out of nowhere. Rather, Malaysian authorities had the foresight to lay the groundwork for its development well ahead of time. “The Islamic finance legal framework and infrastructure was put in place even before we had specialized financial institutions,” says Mohamad Akram Laldin, Executive Director of the International Shari’ah Research Academy for Islamic Finance (ISRA) in Kuala Lumpur.

The first attempts at Islamic banking in this country date back to the 1960s, when a couple of Shari’ah-compliant savings schemes to fund pilgrimages to Mecca were born and then merged. But the industry would have until 1983 before legislators were ready to take the next step with the Islamic Banking Act, rapidly followed, in 1984, by the Takaful (or Islamic insurance) Act. From there, things proceeded gradually and, for a period of about ten years, there was only one Islamic bank active in the country. Further regulations followed in 1989 with the Banking and Financial Institutions Act (BAFIA) and then again in 1997, when the Shari’ah Advisory Council (SAC) of Bank Negara Malaysia was established. More recently, in 2009, the Central Bank of Malaysia Act further strengthened this framework by making the SAC the sole authority on all Islamic finance matters, from banking to insurance to capital markets, where Shari’ah-compliant securities and bonds, or sukuks, are increasingly popular financing instruments for corporate- and sovereign-entities alike. Finally, the Islamic Financial Services Act was passed in 2013, a comprehensive law combining the Islamic Banking Act and the Takaful Act into one. In parallel, Malaysia has also been at the forefront of study of Islamic finance. “Not only do we have dedicated departments in our universities doing research on Shari’ah compliant finance,” says Akram Laldin. “We also have institutions like my own, ISRA, the Global University of Islamic Finance (INCEIF) and the Islamic Banking and Finance Institute Malaysia (IBFIM).”

Today, Islamic securities and sukuks have both overtaken their conventional counterparts on the Malaysian stock exchange and represent, respectively, nearly two-thirds of all issuances by number and more than 50% of all bonds outstanding. So far this year state-owned oil company Petronas issued a $5 billion sukuk and the Malaysian government followed with a $1.5 billion one, making this country the world’s most important market for Islamic bonds. In the meantime, Islamic banking has reached nearly 30% market share while takaful remains less common but still relevant, with about 10% of the overall insurance market.

Though Malaysia is far ahead of the curve when it comes to Islamic finance, many other countries in Asia are beginning to emulate Kuala Lumpur’s efforts in this regard. “There have been Islamic finance initiatives, to varying extents, in many places, with Kazakhstan passing the new Islamic banking law, and activity in other countries in Central Asia as well as in Indonesia, Singapore, China,” says Malek. “It is just a matter of finding which niche in the Islamic finance market they wish to focus on.” Increasingly, even non-Muslim countries in Asia are investing resources to try and foster this promising industry, which clearly has an appeal that goes beyond the merely religious.

In fact, because it follows different legal principles and therefore has a different – according to its proponents, lower – risk profile than conventional finance, and because it claims to embrace and promote a more ethical approach to capitalism and the market economy, Islamic finance offers an increasingly attractive alternative, or at least complement, to traditional instruments – particularly so since their massive failure during the recent global financial crisis. “From the purely commercial perspective, Islamic finance products are at par with traditional products right now, and are gaining prominence as an alternative source of funding, with costs that are equal to or, in some cases, lower than traditional financing,” says Malek. “Islamic finance also provides a wider investor/client base as both traditional and Islamic investors are not precluded from it.” Additionally, with its ban on interests, its stress on profit- and loss-sharing – which replaces the traditional lender/borrower relationship with an array of arrangements depending on the type of contract (from seller/buyer to co-ownership to leasing) – and the requirement that any transaction be directly linked to a real underlying asset, Islamic finance is said to provide a higher degree of transparency and security to investors. Indeed, it has avoided the mushrooming of those infamous derivative products now so common in traditional finance.

While it has potential and is growing at breakneck speed, Islamic finance still represents only a tiny piece of the world’s financial system, approximately 1% of global financial assets. “The challenge going forward is to get people who are invested in the 99% to understand how Islamic finance work, its value proposition,” says Akram Laldin. “Ever since the crisis, people have been talking about Islamic finance but those in the industry have not been fully able to capitalize the concerns that exist to push this agenda.” According to Akram Laldin, a second challenge arises from the need to train far more people than there exist now with in-depth knowledge of the legal and financial bases of Islamic finance and who can then structure dedicated products that are truly original in nature – not just simple replicas of conventional instruments with an Islamic twist. Finally, for an industry that has expanded simultaneously and often independently in a variety of very different countries, from Iran to Pakistan, from Malaysia to Brunei, the harmonization of standards across jurisdictions is also becoming an increasingly urgent goal.

If these issues are addressed, experts say, the sky is the limit for Islamic finance. “Individual Asian countries that seek to be industry leaders are in a position to create their own niches,” says Malek. “Malaysia for instance has always strived to be the leader in sukuk issuances but that doesn’t mean that a country like Singapore couldn’t be the leader in Islamic Wealth Management, should they choose to do that. The pie is large enough for all to share.”