Islamic finance was the topic for some high level discussions in Kuala Lumpur this week, with the Islamic Bankers' Forum calling for greater creativity and range.
Organised by the General Council for Islamic Banks and Financial Institutions, the forum saw Central Bank Governor Tan Sri Dato' Sri Dr. Zeti Akhtar Aziz tell delegates in her keynote address that "innovation is key to sustaining growth and securing the competitive advantage."
She then explained, "Innovation is about developing new Islamic financial products and services and increasing the range of products and services to meet the more sophisticated and complex requirements of today's consumers and businesses."
Senior figures from the international Islamic banking community had gathered for the event in one of the sector's largest markets worldwide. Islamic banking has thrived in Malaysia since it began here with the opening of Bank Islam Malaysia in 1985. The legal framework for conventional institutions to open Islamic windows came in 1993, just in time for the sector to ride the general upswing among the "Asian Tigers" until the 1997 financial crisis.
Since that event, Malaysia's Islamic financial institutions (IFIs) have bounced back with impressive results. This has coincided with the market for Islamic finance reaching an important level of development around the world, requiring greater co-ordination of activities - both in terms of existing operations as well as in the research and development of new products and services within the sharia framework.
Estimates say Islamic finance currently accounts for as much as 10% of the Malaysian financial system, with some forecasts claiming this market share could leap to as high as 20% by 2010.
This trajectory shows up in the current numbers. A look at demand deposits shows that while those in the conventional banking system grew by 12% in the 12-month period prior to April 2005, demand deposits among IFIs in the same period grew by over 15%.
However, before talking about growth, the first statistic anyone mentions about Islamic banking in Malaysia is that more non-Muslims are customers than Muslims. The fact is that IFIs have offered higher returns since 1997 than many conventional banks. Their products have therefore been more attractive. Some say this has been accomplished by taking a relatively loose approach to sharia interpretation, especially when compared to more conservative parts of the Islamic world.
Some analysts point to the fact that Islamic bonds, or sukuk, do not necessarily have to be underwritten by a tangible asset in Malaysia, as they do in other markets. Much of the project financing in Malaysia is sharia-compliant though, and this puts the sector in a strong position.
However, the realisation that Islamic funds for investment are flowing from more conservative regions such as the Arabian Gulf, which are currently awash with excess liquidity, has meant that moves are underway to bring sharia interpretation in Malaysia closer to other regions and to harmonise strategies for ensuring the sector can build on its increasingly firm foundations.
These were strong themes in the governor's speech at the forum. The role of partnerships and collaboration were particularly highlighted alongside the interlinked themes of generating new products and services and developing human capital for the sector.
"In Malaysia, an industry-owned research and training institute in Islamic banking and finance, the Islamic Banking and Finance Institute Malaysia (IBFIM), has been established," added the governor at the forum. This will "spearhead greater collaborative efforts with universities to undertake research in areas that are key for the progressive development of the Islamic financial industry."
One particularly important and interesting point made at the forum involved the education and development of sharia scholars and financial professionals. Those seeking to develop the industry have realised the need for both parties to be more familiar with each other's roles and the technicalities they involve.
This is a key component of being able to structure new products and get them approved. It means the scholars can suggest how proposed products could be made halal (in accordance with Islamic law) while the bankers can better understand how to conform with sharia. In the case of Malaysia, where interpretation has thus far been more liberal than in other markets, this could well mean a tightening up of the approval process. The hope, however, is that this will not dent the attractiveness of the products.
In any case, the Malaysian Central Bank is not just working on the supply side. Whilst various initiatives have been put in place to develop the staff and encourage the innovation necessary for the sector to thrive, plans are also being implemented to educate and inform consumers on the demand side. A 10-year, structured consumer education programme is expected to increase the level of consumer awareness about Islamic financial products.
"This awareness," explained the governor, "will in turn drive demand for a more Islamic products and services." These new offerings will be customised to meet consumers' requirements and be placed "at more competitive prices and through more convenient channels".
Meanwhile, given the strength of the Malaysian market, foreign IFIs have been keen to enter for a while and in 2004 the Central Bank granted three licenses to foreign IFIs. Prior to this, foreign conventional banks had operated Islamic windows in the country.
Kuwait Finance House, Al Rajhi Banking and Investment Corporation and a consortium of IFIs led by Qatar Islamic Bank will all begin operations in Malaysia soon, with the first of these expected to launch sometime during the third quarter of 2005. The anticipated effect is that the three locally established Islamic banks will react well to competition in a bid to remain attractive to customers. The new institutions are expected to first target high-net-worth individuals and institutional clients, offering a full set of services to the general public later.
Other moves will affect the local IFIs more directly. A white paper currently under scrutiny proposes that the current set of established Islamic windows operated by conventional banks become wholly owned subsidiaries. However, whilst some institutions are already structured in a manner that would comply with this, others are not and would likely be reluctant to restructure.
The increased cost of loans as a result of a reduced asset pool, as well a fear that the Islamic and conventional subsidiaries of the same institution would be forced to compete, are among the reasons why some would not be willing to comply.
Overall though, the sector is shaping up well. Having established a strong domestic market, moves are now underway to open up further and strengthen the infrastructure available to customers. The market will also hopefully continue to prove a tempting pull for Middle Eastern funds.
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