A pioneer in its field: Local Islamic banks are gaining ground in the global arena

After more than a decade of coordinated effort between the government, financial authorities and private sector players, Malaysia’s Islamic finance services (IFS) sector now boasts the world’s largest sukuk (Islamic bond) market, second-largest takaful ( sharia-compliant insurance) market and a major Islamic banking and securities industry. IFS is a major employer, contributor to value added and flag bearer for the country in international markets. Malaysia has also established itself as an intellectual capital in IFS globally, with many research and training initiatives in sharia law and finance that are unmatched elsewhere.

TAKING IT FORWARD: The sector continues to evolve, with progress outlined in a variety of policies including the new Financial Sector Blueprint (FSB), the central bank and government’s programme for taking the sector forward to 2020; the Economic Transformation Programme (ETP); and via a string of supporting measures announced in the 2012 budget (see analysis). The expectation in the sector is that growth is set to continue, with Malaysian IFS also taking an increasingly large part in international business.

SECTOR BODIES: The main regulator and supervisor for IFS is the central bank, Bank Negara Malaysia (BNM). The BNM in turn reports to the Ministry of Finance and thus the government, with the governor of the BNM being Zeti Akhtar Aziz. All business based on sharia principles comes under the bank’s Sharia Advisory Council (SAC), which was set up in 1997. In 2009, the SAC’s powers were strengthened by the BNM Act of that year, which made the SAC the sole authoritative body for the sector. The sharia committees at each individual bank and takaful company must bow to the SAC’s authority, with its rulings forming a body of precedent.

As the variety of products has widened and become more complex, the SAC’s procedures have become a lot more crucial. New products in Islamic finance, once cleared by the financial institution’s own sharia committee, are then forwarded to the Sharia Secretariat (JPIT) at BNM, which looks at the structure and concept of the product. After examining this from both a sharia and prudential point of view, the product is then sent to the SAC with the JPIT’s recommendations.

The secretariat has also begun setting up case management committees to look at specific, more complex, products, with the aim of making the process as rapid, yet as thorough, as possible. The National Fatwa Council (NFC) advises on all transaction matters not covered by the SAC and Securities Commission (SC). The NFC may also make pronouncements on financial matters, recently ruling in February 2012 that individual spot foreign exchange trading through electronic platforms was haram (forbidden) – although foreign exchange conducted through licensed money exchanges and commercial banks are permissible.

Overseeing the capital markets, is the SC, whose board members are appointed on the minister of finance’s recommendation. A dedicated section of the SC looks over the Islamic capital market, with its own sharia committee to examine compliance issues.

PLANNING: In addition, the government as a whole has long pursued an active policy in the sector, supporting its development. Thus the prime ministry and Ministry of Finance have also taken an important role in IFS. This began with the introduction of the Islamic Banking Act of 1983, which set the legal framework, followed by the launch of the Islamic Banking Scheme (IBS) in the 1990s by the government and BNM. This initiative aimed to encourage the establishment of Islamic commercial banks, merchant banks and finance houses. Since then, IFS has been specifically targeted for development in successive national plans and accelerated development plan (see analysis).

Meanwhile, on the professional side, the Association of Islamic Banking Institutions Malaysia (AIBIM), established in 1996, has 23 member institutions – 11 of them domestic, two financial development institutions and the rest incorporated foreign banks – operating in Malaysia. For Islamic insurance (takaful) there is the Malaysian Takaful Association (MTA), which has 17 registered operating members, according to its website. The MTA also works with the conventional General Insurance Association of Malaysia and the Life Insurance Association of Malaysia through the Joint Insurance and Takaful Council.

VITAL ORGANISATIONS: Another important sector institution is the Malaysian International Islamic Finance Centre (MIFC). This provides a one-stop shop for IFS entities wishing to participate in the Malaysian market and brings together the government, sector players, BNM, the SC, Bursa Malaysia and the Labuan Financial Services Authority (LFSA). The latter administers the Labuan International Business and Financial Centre, which offers a range of tax and other incentives based on the Eastern Malaysian island of Labuan. The LFSA implemented the world’s first “omnibus” IFS legislation, covering banking, takaful, retakaful and capital market action all under one rule.

In addition, an important part of the development plan for IFS in Malaysia has long been that of providing the intellectual capital necessary to provide the sector with sharia scholars schooled in finance, along with the research facilities necessary to create new products. Thus, the International Centre for Education in Islamic Finance (INCEIF) was established, with the International Sharia Research Academy for Islamic Finance (ISRA) contained within it. The government also established the Fund for Sharia Scholars in Islamic Finance, a $62.5m endowment fund. These steps enable Malaysia to staff a coordinated sharia-compliance structure across the financial industry. At least three members of each bank’s sharia committee must have sharia law backgrounds. In addition, these members cannot be members of more than one banking committee, although they may also sit on one takaful body. In addition, plans are being made to set up an Association of Sharia Advisors (ASAS), which would be similar to a Bar Association. In future, all sharia board advisors will likely have to be members of the ASAS, with this setting qualifying and supervisory standards.

HARMONISATION: Efforts to harmonise standards within the sector are also the business of the Law Harmonisation Committee (LHC) at the BNM, which is headed by the former chief justice of Malaysia, Abdul Hamid Mohamad. In addition to working to achieve consistency in rulings across the country, the LHC is also working to establish Malaysian IFS law as a benchmark international standard. Currently, domestic players also work to international, IFS Board guidelines, with a right to defer. Indeed, the need for greater international harmonisation of IFS standards is widely recognised, both in Malaysia and elsewhere.

The process of bringing into alignment the sharia interpretations and prudential rulings of countries as diverse as Indonesia and Qatar is not an easy one. Still, differences are less common than agreements. “With most countries, we don’t have a difference of opinion,” Ashraf bin Md Hashim, CEO of ISRA Consultancy, told OBG. “In two or three areas we are perhaps more lenient in our interpretations, while in others we are stricter than in the Gulf and elsewhere.”

Working towards the harmonisation of international standards is likely to continue being a major part of the work of Malaysia’s IFS authorities though, as under the FSB the internationalisation of the sector is a major priority (see analysis). As Islamic financial instruments become more complex, ensuring that products meet sharia standards for investors from other jurisdictions is becoming increasingly crucial.

A further step in this direction was taken in June 2012, when the SC announced it was tightening its rules on which equities could be counted as sharia-compliant and thus could be objects for Islamic investment. To qualify, companies will now be required to have a much lower level of exposure to investment in haram products, such as alcohol, while excessively cash-rich or indebted companies will also be filtered out, as these may be exposed to monetary speculation and interest payments – both haram activities.

In addition, BNM had earlier launched an Islamic interbank facility, which should also make Malaysia’s banking sector a more attractive prospect for Gulf-based Islamic banks wishing to invest.

BANKING FACTS & FIGURES: The Islamic banking sector includes dedicated Islamic banks and the Islamic subsidiaries or windows of conventional banks. In 2012 10 of the AIBIM’s members were Malaysian incorporated branches of foreign banks, such as the Saudi Al Rajhi Banking and Investment Corporation, HSBC Amanah, Kuwait’s Elaf Bank and Kuwait Finance House, Singapore’s OCBC Al Amin, Standard Chartered Saadiq, Bank Muamalat Indonesia and Bahrain’s Alkhair (as Alkhair Malaysia). Citibank and BNP Paribas also conduct Islamic banking operations.

Asian Finance Bank is backed by four large Middle Eastern investors, with Qatar Islamic Bank its primary shareholder. Malaysian banks with Islamic arms operating in the sector include CIMB Islamic, Alliance Islamic Bank, AmIslamic Bank, Hong Leong Islamic Bank, Public Islamic Bank, Maybank Islamic, Affin Islamic Bank and RHB Islamic Bank.

DEDICATED TO IFS: Bank Islam and Bank Rakyat are Malaysia’s two dedicated Islamic banks. The later is an Islamic cooperative bank now under the auspices of the Ministry of Domestic Trade, Cooperatives and Consumerism. In addition, Bank Muamalat is 70%- owned by Malaysian conglomerate DRB-HICOM and 30% by Khazanah Nasional, the state investment arm. The original post office savings bank, Bank Simpanan Nasional also offers Islamic banking and takaful. Indeed, in 2011, it ranked eighth in the world in terms of asset growth among Islamic institutions – the highest of all Malaysian banks, according to The Banker magazine.

Market leaders in terms of asset size have for some years been Maybank Islamic, CIMB Islamic, Bank Islam, Public Islamic Bank and AmIslamic. These five accounted for around 58% of total Islamic banking assets in 2010, according to Ernst & Young. This may change, however, if new Islamic mega-banking licences are issued, which the BNM was still seeking to accomplish as 2012 drew to a close. GCC-based banks were widely thought the likely recipients of these new licences, which would only be available to banks with a minimum paid-up capital of $1bn each.

Over the decade in which the Financial Sector Master Plan (FSMP) was in operation – up to 2011 – the Islamic banking sector in Malaysia expanded from 6.9% of total banking assets to around 22.4% at the end of 2011, with the FSMP’s successor, the FSB, expecting this to grow to 40% by 2020. Financing based on Islamic principles is also forecast to increase to 40% of total financing by 2020, up from 29% in 2010, according to the FSB.

According to the BNM, total Islamic banking sector assets stood at RM364bn ($117.5bn) in September 2012, up from RM308bn ($99.36bn) in the same month of 2011 and RM326.8bn ($105.4bn) at year-end 2011. This represents 18% growth between September 2011 and 2012, or 11% since the end of 2011.

The BNM figures show that total deposits for the Islamic banks stood at RM286bn ($92.26bn) in September 2012. This was up from RM266.4bn ($85.9bn) at year-end 2011 and RM239bn ($77.1bn) at the end of September 2011. This represented around 7.4% and 19.7% growth over the nine-month and one-year periods. In terms of financing, the average financing rate for Islamic financial institutions in September 2012 was 5.98%, a slight decrease from the 6.35% average financing rate posted in September 2011, according to statistics from the central bank. The average financing rate at the end of the year 2011 was 6.37%, meaning the average rate fell by slightly over a third of a percentage point in the first nine months of 2012.

These are remarkably good numbers, especially considering they cover a period of global financial turmoil, with the eurozone crisis, the effects of the Arab Spring, sluggish growth in the US and a gradual slowdown in Chinese economic expansion. Indeed, according to Ernst & Young, this asset growth was in line with a four-year compound average annual growth (CAGR) for 2006-10 of 19.3% for the sector, as well as a CAGR in financing of 19.9% and deposit growth of 21.6%.

TAKAFUL MARKET: Islamic insurance has also performed well. Malaysia’s takaful companies come under the regulatory authority of BNM, which registered 11 operators in 2011 as well as two retakaful companies.

Between 2010 and 2011, the fund assets of the sector also grew, from RM14.7bn ($4.7bn) to RM16.9bn ($5.5bn), as did net contribution income, which rose from RM4.4bn ($1.4bn) to RM4.9bn ($1.6bn) over the same period. BNM statistics show that net benefit and claims payments also increased from RM2bn ($645.2m) to RM2.2bn ($709.7m) between 2010 and 2011. These give annual growth figures of 15.13% in fund assets, 9.9% in net contributions income, and 8.17% in benefits and claims. As a percentage of gross national income, family takaful accounted for around 0.5% both years and general takaful some 0.1%.

PLAYERS: The MTA records 15 member organisations in 2012, with these being – as in banking – a combination of local operations by international giants and Malaysian outfits. Among the internationals are AIA AFG Takaful and AIA Takaful International, HSBC Amanah Takaful and Prudential BSN Takaful. Local players include AmFamily Takaful, Etiqa Takaful, Syarikat Takaful Malaysia (which is listed on Bursa Malaysia) and Hong Leong MSIG Takaful.

CIMB Aviva is a local/international tie-up, and in mid-2012, it was the subject of a bidding war as Aviva sought to sell its participation. Another tie up was ING Public Takaful, tying ING with Public Islamic Bank and Public Bank. The two retakaful entities in the MTA were Munich Re Takaful and ACR Re Takaful SEA. The takaful market is likely to continue expanding, in part because of low penetration rates. Average spend per capita on family takaful was just RM129.50 ($41.80) in 2011, while general took RM40.50 ($13.10). Given that more than 60% of the population is Muslim, this market is largely untapped (see Insurance chapter).

CAPITAL MARKETS: While globally known for its sukuk market (see analysis), Islamic capital markets (ICMs) contain much more besides, making them some of the most developed in the world. As the regulatory body for the markets, the SC is responsible for the ICM, with the Islamic Capital Market Development (ICMD) unit within the commission dedicated to research and development and long-term planning of the ICM’s progress as it continues expanding.

The most recent SC figures – for the second quarter of 2012 – show that 825 sharia-compliant securities were listed on the bourse, or 89% of the total. Reuters figures for April 2012 showed 165 Islamic mutual funds, with combined assets of RM29.9bn ($9.6bn). The number of Islamic wholesale funds, according to the SC, was 30 in the second quarter of 2012 out of 154 in total, up from 24 out of 122 in the same period of 2011. Islamic wholesale funds accounted for 31% of net asset value in June 2012.

In the same period of 2012, there were some RM63bn ($20.32bn) of Islamic assets under management (AUM), or 14% of the AUM total. There was one Islamic exchange-traded fund (ETF), out of five in the industry as a whole, with this taking 32% of the ETF total for the country, or RM300m ($96.78m). There were also three Islamic real estate investment trusts, with a combined market capitalisation of RM3.3bn ($1bn), or 18% of the industry total.

The Bursa Malaysia has two indices tracking sharia-compliant securities – the FTSE Bursa Malaysia EMAS Sharia Index (FBM EMAS Sharia), and the FTSE Bursa Malaysia Hijarah Sharia Index (FBM Hijarah Sharia). The second index has much more stringent filtering attached to it to ensure that those companies listed meet sharia-compliance standards from other jurisdictions, most notably the Gulf.

There is also the Bursa Suq Al Sila, a commodity trading platform aimed at Islamic banks wishing to undertake liquidity management and financing. This is linked closely to the Malaysian palm oil industry, with palm oil often used as the underlying asset in Islamic financial transactions in Malaysia.

OUTLOOK: With a strong level of government support and a range of well managed and capitalised companies – in banking, takaful and the ICM – Malaysia looks set to take the leap envisaged by the second FSB and the Capital Markets Master Plan 2. This involves the further internationalisation of the sector, with the critical mass already achieved likely to see Malaysian IFS outfits become much more of a global presence. Underpinning this will be success in determining acceptable sharia-compliance rules, primarily between Malaysia and the Gulf countries, its closest rivals for the international IFS crown.

Part of making this outreach successful will be in the provision of increasingly innovative, well-structured and clearly sharia-based products.

Daud Vicary Abdullah, president and CEO of the International Centre of Education in Islamic Finance (INCEIF), said, “As GCC countries become increasingly more competitive in Islamic finance, Malaysia will have to reassert its role in the sector to maintain its current relative positioning.”

A major intellectual effort is thus also required, along with a financial and legislative one. In this too, Malaysia has established the tools it needs for the job, in the form of the INCEIF and ISRA. It is also likely that the years ahead will see both global IFS entities heading more frequently to Malaysia, while domestic IFS outfits venture more frequently into the wider world.