Islamic Banking

Islamic banking and finance are increasingly becoming an attractive form of financial intermediation among Muslim and a growing number of non-Muslim countries, Governor of Bank Negara (Malaysia), Tan Sri Dr. Zeti Akhtar Aziz, said.

The international community now looks at Islamic finance as "interesting," and several countries such as Britain and Singapore, have revised their legislation to accommodate Islamic finance. Islamic banking is also picking up in the United States and Europe - some mainstream banks are opening up divisions within their institutions to develop and provide these products and services to their clients, she told Malaysian journalists.

"We believe that the global development of Islamic finance has gathered momentum," said Dr. Zeti, who lead a Malaysian delegation to the annual World Bank/International Monetary Fund meetings in September 2005.

Islamic banking and finance started with Muslims looking for financial services which met Islamic principles. "Now it has moved further than that - non-Muslims look at it as an attractive form of financial intermediation, " she said.

Islamic banking currently accounts for about 11 percent of Malaysia’s financial system. Dr. Zeti said, the Islamic Financial Services Board (IFSB), which sets prudential standards for Islamic finance, ensures the soundness of the system and brings about harmonisation of standards across the international community. "What I find is that this (Islamic finance) has really gained significant momentum," she said.

EuroMoney magazine Sunday awarded her the World’s Best Central Bank Governor of the year for overseeing successful reform of the exchange rate, the capital markets and the banking industry. "With her encouragement, the country has also become a hub for Islamic finance," the prestigious magazine said.

Malaysia provides 40 different products under Islamic finance. One budding industry is Takaful, or Syariah-compliant insurance. In May-05, Bank Negara announced several measures to strengthen the infrastructure of the Takaful industry, which included guidelines for the licensing of new Takaful operators and brokers.

Another growing area is the local Islamic bond market. In 2005, local companies had sold RM15.76 billion of bonds by the end of July, of which 84 percent was Islamic debt. This compares with RM9.1 billion of Islamic corporate debt in 2004, according to Bank Negara. The biggest source of bond issuance stems from the water, power, oil and gas industries. Euromoney said foreign entities were also offering Islamic bond products denominated in local currency. The World Bank, for example, sold RM760 million of Islamic bonds in April while its private sector arm, the International Finance Corportaion, raised RM500 million through an Islamic structure in December.

"The ability of multilateral and multinational corporations to raise ringgit-denominated debts has expanded the volume of Islamic instruments in the market," Dr. Zeti said.

Risk management is one area that needs more attention, she said. The lack of effective hedging instruments has not proved to be an issue yet, but the Governor is aware of the pitfalls that might show up should market conditions turn suddenly. In June, Bank Negara hosted a seminar on "Derivatives in Islamic Finance" to make market participants aware of the need to manage risks more prudently.

"Another challenge is to define what exactly is an Islamic product. One of the big problems is the lack of a clear definition of Syariah law in the Islamic world. "At its most basic, Syariah law prohibits payment and receipt of interest, but for complex financial transactions, disagreements have emerged over the definition of interest," the magazine noted.

In April, the central bank introduced the Syariah governance framework to help develop a better understanding of the approaches taken by different jurisdictions in their Syariah interpretations. Bank Negara has also invested RM200 million to support Syariah scholars in their research and capacity-building work.

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