Continued support: Plans and programmes strengthen sector prospects

A major reason for the success of the Islamic finance services (IFS) sector in Malaysia has been the sustained support it has been receiving from the government and the financial sector authorities. This support has included the creation of a comprehensive legal framework for the sector, the provision of education and training, and a raft of incentives and programmes. The political and financial authorities have taken a major role in the creation of a complete ecosystem for Islamic finance.

KEY TO DEVELOPMENT: Indeed, in 2010 the government recognised the sector as one of the key elements of its Economic Transformation Programme (ETP), the national plan to accelerate Malaysia’s progress towards developed-nation status. Within this, financial services form a National Key Economic Area (NKEA), with the goal of Malaysia “becoming the indisputable global hub for Islamic finance” identified as one of the NKEA’s 10 entry point projects (EPPs).

In tandem with this, the new Financial Sector Blueprint (FSB), which runs from 2011 to 2020, also takes Islamic finance and its internationalisation as one of its nine key areas – further demonstrating that the full weight of the government and central bank continues to be behind the sector’s development.

HISTORY OF SUPPORT: The authorities’ first coordinated moves to back up the sector date back to the blueprint’s precursor, the Financial Sector Master Plan (FSMP). This was launched by the central bank, Bank Negara Malaysia (BNM), in 2001.

This 10-year programme targeted capacity building, infrastructure and regulatory strengthening across the financial sector – conventional and Islamic – with IFS specifically identified as a pillar of future development. All four basic segments of the nation’s IFS – banking, takaful, capital markets and money markets – were to be given a boost in a coordinated fashion, with the government, the financial authorities and private sector players all involved in the process.

In tandem with this was the Capital Markets Master Plan (CMP), which among its goals explicitly sought to establish Malaysia as an international centre for Islamic capital markets. The FSMP also worked within the framework of a series of government five-year plans – specifically, the Eighth and Ninth Malaysia Plans – and the 30-year Vision 2020 plan. The FSMP also set a target for Islamic banking to grow from 6.9% of total banking sector assets in 2000 to 20% by 2010.

To achieve this, a number of recommendations in the plan had to be implemented. These included strengthening the Islamic Banking Act of 1983, with Islamic banks being given their own capital adequacy, liquidity and reserve requirements, while further harmonising sharia standards across institutions. Takaful companies also benefitted from a strengthening of the Takaful Act of 1984, while more Islamic banks and insurers – both foreign and domestic – were encouraged to enter the market, making it more competitive.

NEW LICENCES: As it turned out, the FSMP overachieved its targets. The 2010 figure for Islamic banking’s share of sector assets reached 22.4%, while the IFS part of the plan was fast-tracked some three years ahead of schedule. This meant faster liberalisation of the sector, opening it up to more foreign players, alongside a speedier introduction of enabling legislation.

The tangible result of this was the granting, in 2006-07, of Islamic banking licences to the Saudi Al Rajhi Bank, Kuwait Finance House and Qatar Islamic Bank.

Two more Islamic banking licences were also made available in 2009, with the possibility of 100% foreign ownership. Foreign equity limits in onshore Islamic banks and takaful companies were also raised from 49% to 70%, ahead of schedule. The FSMP also stressed the importance of building the sharia and educational components of the sector.

Building on its reputation as the first country in the world to establish a Sharia Advisory Council (SAC) at the central bank in 1997, dedicated SACs were also established for banking, takaful and the capital and money markets. At the same time, Malaysia became a pioneer in training and education in Islamic finance. The country established the International Centre for Education in Islamic Finance and the International Sharia Research Academy for Islamic Finance, while also creating a $62.5m endowment fund called the Fund for Sharia Scholars in Islamic Finance.

These moves have helped address the human resources concerns that are prevalent throughout the IFS world, while also establishing Malaysia’s interpretation of sharia in Islamic finance as a global standard – albeit one that is sometimes contested by its rivals.

Meanwhile, the CMP, launched by the government and the Securities Commission (SC) in 2001, also sought to broaden and deepen the Islamic Capital Market (ICM) via tax incentives, a stronger regulatory framework, coherence in sharia compliance via the SC’s own SAC, and the launch of Bursa Suq Al Sila, the sharia-compliant commodities trading platform of the Malaysian stock exchange, Bursa Malaysia.

The Malaysian International Islamic Finance Centre also dovetailed with the CMP. Success was impressive: during the period of the CMP, growth in Malaysia’s ICM was faster than in conventional capital markets, with expansion at an average 13.9% per annum between 2000 and 2010. ICM thus grew from around RM293.7bn ($94.7bn) to some RM1.05trn ($338.7bn). In addition, by 2010, some 88% of all companies listed and 39% of all bonds outstanding in Malaysia had become sharia-compliant, according to the SC.

MOVING FORWARD: Introduced in 2011, the BNM’s FSB now aims to take the sector to the next level, within the strategic structure provided by the ETP.

The focus this time is on the further internationalisation of Malaysia’s IFS sector, making the country into more of a hub for the mobilisation of larger flows of global Islamic finance through the domestic sector. These funds are to be attracted by the provision of more innovative products, as well as by a strengthened legislative and regulatory IFS framework. Central to the latter part of this agenda will be the creation of a supreme authority on sharia matters in Islamic finance.

At the same time, CMP2 has also been launched. This is very much a post-global financial crisis plan, seeking to address new international requirements in liquidity and capital adequacy, as well as governance, while building on the success of the original CMP.

One area also being encouraged in IFS is the growth of more venture capital and private equity initiatives, based on risk-sharing and active partnership. Another strategy for development leverages on the fact that the overwhelming majority of assets listed in Malaysia are sharia-compliant. This makes the market hugely attractive to global Islamic funds, looking for investment opportunities, and clearly also implies a further leap in the global harmonisation of sharia compliance, which Malaysia is keen to promote.

INCENTIVISING SECTOR EXPANSION: For its part, in 2011, the Malaysian government announced a new string of benefits for the sector in its 2012 budget. These include a tax deduction on expenses incurred for sukuk wakala – a variety of sukuk backed by a pool of assets deemed sharia-compliant, rather than by one specific physical asset. This tax deduction will run for a three-year period. Another benefit outlined in the budget is an extension of income tax exemption for non-ringgit sukuk issuance and transactions until 2014.

There will also be further promotion of sharia-compliant exchange-traded funds via a RM200m ($64.5m) seed fund from I-VCAP, a venture capital outfit ultimately owned by a series of government-linked companies and pension funds. This fund will be accessed by firms in the form of matching loans up to a maximum of RM20m ($6.5m) in value.

FURTHER BUDGET SUPPORT: The budget also provides for a five-year extension of a 10% concessionary tax rate on dividends for non-corporate institutional and individual investors – a move aimed at boosting Islamic real estate investment trusts. In addition, the budget also includes the establishment of a RM2bn ($645.2m) sharia-compliant financing fund for small- and medium-sized enterprises (SMEs) to be managed by Islamic banks, with the government financing 2% of the profit rate (see analysis).

There will also be a Commercialisation Innovation Fund set up to help sharia-compliant SMEs turn new ideas into marketable products and services. Finally, assistance will be provided for the development of sharia-compliant housing financing for houses costing less than RM600,000 ($193,560).

Given so much financial backing for the sector from the political and sector authorities, a question that sometimes arises is whether the industry is overly dependent on this support. The size and growth of Islamic finance products and services suggest that this is not the case, however, with critical mass either achieved or not far off in many segments. Add in the continued commitment of the government and financial authorities to the growth of the sector, and it seems that even were the incentives to gradually wind down, the Malaysian IFS industry would likely keep sailing, full steam ahead. For now, implementation of the FSB and CMP2 continues, with plenty already there to build on.