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Saturday, 23 February 2008

"The Evolution and Opportunities of Islamic Finance" - Governor of Bank Negara Malaysia's Keynote Address in Tokyo

TOKYO (Nikkei)--Government officials and private-sector leaders from home and abroad shared their views on the current state of Islamic finance at the Nikkei Islamic Finance Symposium in Tokyo Saturday.

Zeti Akhtar Aziz, governor of Bank Negara Malaysia, gave a keynote speech on "The Evolution and Opportunities of Islamic Finance."

Following are highlights of Aziz's speech.
1.The evolution of Islamic finance is evidenced in five dimensions of its development
*Islamic finance is a viable and competitive form of financial intermediation
-- Seen by borrowers as an alternative means of financing
-- Seen by investors as a new asset class
-- Exceptional growth both in Muslim world where the growth is premised on religious and business considerations, and also in the Western world where the growth is much more commercial and business driven.
-- Islamic finance is among the fastest growing financial segments in the world with an estimated annual growth in the region of 15-20 percent.

*scope of Islamic finance today has been enlarged and diversified with significant product innovation in the recent years
-- scope of Islamic finance includes private equity, project finance, the origination and issuance of Sukuk, and; fund, asset and wealth management activities
-- these products are competitive both in terms of product structure and pricing
-- Increased breadth and depth of the financial services industry due to:
○ Significant product innovation
○ Emergence of many diverse Islamic financial institutions and development of the Islamic financial markets
○ Enhanced depth and effective functioning of the Islamic financial markets.
*significant regulatory, supervisory and legal reforms undertaken
-- Reforms are taking place in many jurisdictions to create an enabling environment for Islamic finance to grow.
-- The establishment of the Islamic Financial Services Board (IFSB) in 2002 marked an important milestone in the development of internationally accepted prudential regulatory standards and best practices. [BIS equivalent for Islamic finance]
-- IFSB contributes to the harmonization of Islamic finance across jurisdictions.
*Islamic finance increasingly becomes important part of the international financial system and becomes poised to contribute towards greater global financial integration.
- Islamic financial institutions have ventured beyond their domestic borders.
-- Funds raised in Islamic financial markets have drawn investors from financial centers across the globe " diversified investor base and enhanced cross border financial flows.
-- Increased diversity and greater participation in inter-regional investment has allowed for enhanced financial linkages among the major regions.
-- The expansion of inter-linkages among intermediaries and markets contributes to a more efficient allocation of financial resources across borders.
-- Now there are more than 300 Islamic financial institutions worldwide in more than 75 countries both in the Muslim and non-Muslim countries.
*Human capital development in Islamic finance has become more structured and focus to ensure an adequate supply of talent and expertise
-- As the industry evolves and matures, development of talent must be focused on driving innovation and leveraging on advancement in technology to raise the level of performance.
-- High caliber professionals with combined knowledge of Shariah and finance are now in great demand.
-- International Center for Education in Islamic Finance (INCEIF) in Malaysia offers programs to support the global development of Islamic financial services industry.
2.Distinctive Features of Islamic Finance
*Islamic finance operates in accordance with Islamic rules referred as 'Shariah' (pronounced as 'Sha-ree-ah').
*Islamic financial transactions must be supported by an underlying productive activity
-- Islamic financial transaction must be accompanied by genuine trade and business related transactions, thereby avoiding interest-based financial transactions.
-- Instead, Islam encourages business and trade activities that generate fair and legitimate profit.
-- This principle contributes towards insulating the Islamic financial system from potential risks of financial stress triggered by excessive leverage and speculative financial activities.
*The risk and profit sharing feature of Islamic finance allows for better management of risks
-- The Islamic financial institutions share in the profit or loss incurred by the entrepreneur.
-- As such, the risk sharing feature requires a high level of disclosure in the financial contract so that the accountabilities of the respective parties involved are clearly defined.
-- This provides a strong incentive for Islamic financial institutions to appropriately manage its risks. It also allows the market to assign the appropriate risk premiums to the respective companies and thus plays an instrumental role for the market discipline to take effect.
-- The above features provide in-built checks and balances, which serves to promote greater financial stability in the Islamic financial system.
3.The Malaysian Experience in developing Islamic Finance and initiatives to position Malaysia as an Islamic financial gateway to Asian region
*The Islamic financial system in Malaysia has evolved as a competitive component of the overall financial system with a significant number of diverse players in the Islamic banking and takaful industry as well as vibrant Islamic capital and money market. This is supported with institutional development, robust Shariah framework, legal and regulatory framework, wide ranging products and a sustainable human capital development.
*The Islamic financial industry in Malaysia has been expanding at a double digit growth rate. The Malaysian Sukuk (Islamic bonds) market is now the largest Islamic bond market in the world with more than 62% (or US$60 billion) of the global outstanding Sukuk originated from Malaysia. In the equity market, 86% of the listed stocks are Shariah compliant with market capitalization of US$193 billion.
*Malaysia is now positioning itself as an Islamic financial gateway through wide ranging liberalization measures and concerted efforts by the Malaysian Government to promote Malaysia as the International Islamic Financial Center.
-- To position Malaysia as a center for origination, distribution and trading of sukuk, further steps have been taken to liberalize the market to allow foreign corporations including multinational corporations and multilateral agencies to raise funds in the Malaysian bond market. Funds raised by these entities may be used to finance investment activities in other jurisdictions.
-- To raise the significance of the international dimension of the Islamic financial system, wide ranging liberalization measures were implemented, including the issuance new Islamic banking licences and through increasing the strategic stakes possible by foreign interest in our Islamic financial institutions, to up to 49 per cent.
-- Foreign exchange administration rules have also been progressively liberalized. In this regard, liberalization of capital account through the removal of restrictions to foreign exchange transactions has increased foreign participation in our financial markets.
4.Opportunities in Islamic Finance
*Japan's economic relationship with Malaysia through investment and trade is well established, there is a significant potential for strengthening further the financial linkages in future. The potential areas of further financial linkages are in the Sukuk market and the Islamic banking as well as takaful.
*Japan as the largest bond market in Asia and as one of the largest economies in the world can jump start the journey in Islamic finance by capitalizing on Malaysia's strong brand and experiences in Islamic finance
*Opportunities in Sukuk market
-- Sukuk market has become an important avenue for fund raising and investment activities. Conventional financial institutions may enter into alliances with Islamic financial institutions to be co-arrangers, to structure sukuk or other Islamic products based on Shariah compliant assets in this region.
-- The wide ranging availability of such assets and the massive financing needs of the new growth areas in the region will be attracting funds from surplus economies such as from the Gulf economies. Efforts can also focus on facilitating cross listing of sukuk in multiple jurisdictions. Additionally, the viability of setting up of Asian Sukuk Fund as an extension of Asian Bond Fund can also be explored.
-- Huge potential in Sukuk market is evident by active participation of many global players such as investment banks, Islamic banks and securities firms in the issuance of Sukuk.
-- Sukuk brings great benefits to both issuer and investors.
○ For issuers, Sukuk can meet different funding requirements ranging from large infrastructure and developmental projects to capital and business expansion.
○ The issuer also benefits from the competitively attractive pricing of Sukuk ranging from 10 to 20 basis points lower than mainstream bonds.
>> This resulted from the continuous over subscription of Sukuk which ranged from 2 to 13 times.
>> This phenomenal demand for Sukuk is further reinforced by excess liquidity in the global financial system.
>> This demand comes from a wide investor base that comprises both the conventional and Islamic investors.
○ From the investors' perspective, besides the intrinsic value of Sukuk which is largely asset-backed, convertible to shares and exchangeable with shares, there are benefits of diversification.
>> Sukuk is fast becoming a new asset class and as attractive alternative to conventional bonds.
>> Sukuk also generates good investment returns for investors that resulted from the higher pricing of Sukuk in the secondary market due to the "buy and hold" preference and the scarcity of Sukuk.
*Opportunities for greater participation and strategic alliance by foreign players in Malaysia by taking up stake in the domestic Islamic financial institutions. There has been a strategic alliance between one of the world largest Japanese insurance groups with Malaysia's domestic insurance company which resulted in the establishment of Takaful company. As the Takaful industry now has more than 50 Takaful companies worldwide with a total contribution at around US$3 billion and is expected to grow at 20% per annum, there are tremendous opportunities for strong and credible retakaful operators to complement the encouraging growth and expansion of Takaful industry.
*Opportunities for new licences for International Islamic Bank and International Takaful Operator for the conduct full range of Islamic banking business as well as takaful and retakaful business in international currencies.
-- Tax holiday of ten years under the Income Tax Act 1967 is given.
-- Stamp duty exemption for ten years beginning last year has been granted on foreign currency instruments executed by these participants, and on instruments relating to the ringgit and foreign currency Islamic securities.
-- Full exemption for non-resident from withholding tax on any profits or income derived from holding non-ringgit Islamic securities including Sukuk issued in Malaysia.
Japan could also use Malaysia as a platform for innovation and research as we have various institutions, including the industry owned research and training institute in Islamic finance, the Islamic Banking and Finance Institute Malaysia (IBFIM), INCEIF and universities which have undertaken research on Islamic finance. Through smart partnership between Japan and Malaysia, we would create greater synergy, which may bring about new approaches, new technologies and new areas of specialization.
Japan and Malaysia cooperation would contribute towards unlocking potential opportunities in Islamic finance for mutual prosperity.
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Alfalah Consulting-Kuala Lumpur: www.alfalahconsulting.com 
Islamic Consultant & Trainer: www.ahmad-sanusi-husain.com 
Islamic Investment Malaysia: www.islamic-invest-malaysia.com

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