‘Mainstreaming’ of Islamic finance

When talking about the mainstreaming of Islamic finance, my initial thought about it is words like ‘murabaha’, ‘shariah’, ‘takaful’ and ‘zakat’ would no longer need translation because they have become familiar features of many financial transactions and agreements run by the majority of financial institutions in Malaysia these days.

On a larger view, it is highly common to see ‘’ being mentioned in any economic publication, or even on any TV business programme.

However, it was during my research to revisit this subject — I featured Islamic finance on BizHive Weekly way back in 2011 under the headline ‘It’s All About Shariah’ (Sept 11–17) — that I realised the ‘mainstreaming’ aspect of this sector was beyond the non-necessity to translate several of the terminologies.

The numbers



I would like to begin with the basics — the figures.

The Islamic finance industry grew 11 per cent year-on-year in 2017 and is set to sustain double-digit growth – buoyed by capital market products and the adoption of financial technology, according to a study by Thomson Reuters released in November.

Nor Shamsiah delivers her keynote address at GIFF 2018.

This industry is now represented in 56 countries through 1,389 shariah-compliant financial bodies, and the combined global worth is US$2.4 trillion in assets.

Islamic banks still retain the lion’s share of this industry, accounting for 71 per cent of total assets, but their growth remained muted at five percent, with consolidation pressures mounting in its core markets of the Gulf and Southeast Asia.

In contrast, capital market products such as Islamic bonds and investment funds fared better, posting nine per cent and 16 percent growth, respectively, said the study.

The market for Islamic bonds, or ‘sukuk’, accounted for US$426 billion in deals outstanding in 2017, with 19 countries issuing sovereign sukuk worth a combined US$85 billion.

Malaysia remains the world’s largest market for sukuk and it is now opening to retail investors, while Saudi Arabia has added US$26 billion in new sukuk issuance in both domestic and international markets.



Islamic investment funds posted a 16-per cent gain to reach US$110 billion in assets, concentrated mostly in Iran, Malaysia and Saudi Arabia.

The mainstreaming

With such growth characters, it should not be surprising to see Islamic finance making presence in non-traditional areas – say, green economy.

In this respect, Bank Negara Malaysia () governor Datuk Nor Shamsiah Mohd Yunus explained it quite comprehensively during the Global Islamic Finance Forum (GIFF) 2018 in Kuala Lumpur in October.

She observed that it had become increasingly clear that economic prosperity, in the long run, could not exist without social equity and environmental responsibility.

“While the governments of 150 countries are committed to realising the United Nation (UN)’s 17 Sustainable Development Goals (SDGs) by 2030, this must be a shared responsibility.

The private sector has a key role to play – a role, with finance at its centre, that has yet to live up to its full potential,” she said in her keynote address before more than 1,000 delegates.

Nor Shamsiah also argued that with much at stake, the call to action for sustainable finance should be one that the financial sector – perhaps more particularly Islamic finance – could not afford to ignore.



She said encouragingly, more – though not nearly enough – Islamic financial institutions had been moving beyond shariah-compliance to performance and risk management practices that reflected social and environmental impacts.

In this regard, she posed this question – how the value propositions of Islamic finance could be further developed, towards the reality of ‘finance beyond profit’.

Interestingly, she indicated the answers in three imperatives – a rethinking of value, a rethinking of risk, and a rethinking of human capital.

On the first imperative, Nor Shamsiah said the industry must elevate the fundamentals of shariah to realise its full promise, adding that the business models of Islamic financial institutions should be guided by the overarching objectives of the ‘Maqasid Al-Shariah’ – aimed at preserving and advancing the common interest of society at large, by preventing harm and maximising benefits.

The ‘Maqasid al Sharia’ highlights the higher purposes of sharia law, said to be built upon three objectives – purification of the soul, upholding justice and protecting interests of all sides.

In Malaysia, said Nor Shamsiah, the industry with the support of the , had been taking concrete steps to drive strategies aimed at increasing the positive impact of finance on society – through a strategy paper on Value-based Intermediation (VBI), which was released in July 2017.

“The commitment to adopt VBI is a significant step by the industry to clearly identify Islamic finance with sustainable practices, as it should.

It has also set in motion initiatives that will raise the bar for processes, practices, offerings and conduct that promote sustainable businesses and communities,” she said.



VBI: Intermediation that engages shareholders, non-shareholders alike

The VBI concept refers to the intermediation slated for the intended outcomes of shariah through practices, conduct and offerings, aimed at generating positive and sustainable impact on the economy, community and environment, without compromising the financial returns to shareholders.

The agriculture sector is an example where resources could be channelled towards building flood defences and developing local structures and facilities that are more resilient to harsh weather conditions. — AFP photo

According to Nor Shamsiah, the adoption of VBI is expected to provide a significant impact on business models of Islamic financial institutions, including the drivers of profitability and risks.

“VBI-oriented Islamic financial institutions can, and indeed should, also play an important role in mobilising resources to finance climate change mitigation and adaptation initiatives.

“Funding for climate adaptation, in particular, remains critically low, despite millions already at risk from the effects of climate change and in need of assistance to cope with the effects.” She cited the agriculture sector as an example, where resources could be channelled towards building flood defences and developing local structures and facilities that are more resilient to harsh weather conditions.

Takaful solutions could also play a vital role in strengthening resilience against climate events, added Nor Shamsiah.

“These developments are likely to see important changes to the way financial institutions make decisions, and to the characteristics of banking and takaful portfolios.” In supporting these changes, BNM had published two new tools for public consultation – a VBI Impact Assessment Framework (VBIAF) and the VBI Scorecard.

The VBIAF provides guidance on the assessment of financing and investment applications taking into consideration economic, social and environmental impacts, while the scorecard supports the implementation of performance measurement frameworks for Islamic financial institutions that drive positive value and impact on society and the environment.

Rethinking of risk

On the second imperative, Nor Shamsiah said it called for a rethinking of risk by Islamic financial institutions, adding that non-traditional forms of risks such as social, political and environmental ones should be viewed as ‘business threats’ that simply could not be ignored.

According to the BNM governor, research indicates that there are material benefits to managing these risks more proactively.

A survey by the International Finance Corporation (IFC) on global banks showed that around 86 per cent of respondents that integrated social and environmental risks in their operations, yielded positive business results.

There had also been growing calls by shareholders for financial institutions to play a more proactive role in the sustainability agenda.

“I am among those who believe that the true mark of a sustainable financial system ultimately lies in the extent to which, the market’s and management’s view of risks reflect sustainability factors.

“In June 2017, the Financial Stability Board published recommendations for helping businesses disclose climate-related financial information.

“In the context of ‘finance beyond profit’, this was a significant development by a global standard setting body, and the broader G20 community, to encourage the provision of better information on climate-related risks and their financial impact.

For many, this is both a reflection of, and catalyst for, the closer examination of risk- and impact-adjusted returns, by capital and funding providers.” Nor Shamsiah said as natural stewards of sustainable finance models, Islamic financial institutions should be well placed to develop richer perspectives of social and environmental risks Nonetheless, this would call for a review of internal risk decision-making processes and input within the financial institutions, alongside enhanced disclosures to market participants.

“Yet little, if anything, is done today to consider how such risks need to be managed – both for existing portfolios and future growth strategies.  Actions taken by financial institutions to mitigate, transfer or control the risks have the potential to generate corresponding, broader responses by policymakers, businesses and other financial institutions.  This, in turn, can create new markets for sustainability services, and a virtuous cycle of mutually reinforcing market forces, that promote sustainable business practices across the economy.” Nor Shamsiah stated that as the BNM strove to develop the VBI systems for Islamic finance in Malaysia further, this would be an area of important focus.

This work, she added, would also address the role of domestic regulations towards creating a level-playing field for value-based banking practices – wherever appropriate.

People queue up to exchange money at a mobile-banking unit of Indonesia’s Central Bank at a street in Jakarta. It is possible for Indonesia, having a larger geographical scale of land size, population and economy than Malaysia’s, to surpass the latter in Islamic financial industry – if it could maintain its political stability and social security in the post-election after April 2019. — AFP photo 

To date, policy documents developed on 14 Shariah contracts would be set to provide a clear and consistent framework for lending, underwriting and investment activities of Islamic financial institutions.

“I am encouraged by efforts among some Islamic financial institutions to introduce value-adding innovations, building upon these shariah contracts, and further differentiating their solutions from conventional offerings.

I would of course like to see much more traction in this direction going forward,” she said.

Rethinking human capital

On the third imperative, Nor Shamsiah highlighted the challenges in building internal human capacity to support sustainable practices, which she viewed as ‘continuing to be left largely unattended to’.

She pointed out that for Islamic financial institutions, this would extend beyond strategy alignment and culture towards building or acquiring the fundamental skills-set required to implement sustainable financing and risk management practices.

“Without these, VBI cannot hope to progress very far,” she stressed, citing a study by the National Bureau of Economic Research to illustrate this.

According to the study, jobs requiring a higher intensity and concentration of ‘green skills’ to support the transition to greener , lie among ‘high-skilled professional profiles’.

“In other words, if Islamic financial institutions are serious about adopting VBI, the complement of skills-sets at the management levels of the organisation would need to be fundamentally re-assessed.

“Relevant skills that need to be brought into the organisation include engineering and technical skills in the design, construction and assessment of technology; science skills; and monitoring skills focusing on observing compliance with environmental laws and standards.

“Even the boards too have to learn and adapt to the demands of the new operating environment,” said Nor Shamsiah, also stating that the relevant skills-sets were also critical towards supporting innovation within the financial sector to capture opportunities and improve the delivery of Islamic financial solutions.

“Indeed, technology can be better optimised to revolutionise the way Islamic finance operates and offer innovative solutions to customers.

For example, blockchain or artificial intelligence (AI) applications hold enormous potential for simplifying documentation requirements associated with shariah contracts; thus improving the overall efficiency of business operations.” Most importantly, Nor Shamsiah said it should be abundantly clear to any financial institution serious about adopting VBI that the task of building the human and intellectual capital to achieve and sustain value-based business models could not be left solely to the human resource departments.

“It requires nothing less than strategic direction and resourcing decisions at the highest levels of the organisation.”

More than a fad

Stressing further, she said the VBI must be seen as ‘being more than a current and passing fad’ – rather, it must be regarded as ‘a deeper conviction of the critical need to begin the process of changing mindsets in a lasting way’.

“Financial institutions are a key, but not the only catalysts in this process.

“Customers and investors need to be supported with relevant information, along with the means and ability to compare such information, in order to better understand the value propositions of Islamic finance.”

According to Nor Shamsiah, the Islamic finance industry today faces an important, strategic choice – to either continue on a path that largely ignores the stark social and environmental realities that confront humanity, or to thoughtfully chart a new path that fully embraces the idea and philosophy of finance beyond profits.

“The latter will be an unfamiliar path in many respects, but one that is far closer to the fundamental premise of shariah on which Islamic finance is based upon.

“Embarking on this path will require deep conviction and visionary leadership across financial institutions, governments and policymakers, but the pay-offs will be immeasurable.

“For many in society, it will also make the difference between economic freedom and opportunities, and a lifetime of hardship.”

Challenges ahead

As in any sector, Islamic finance in Malaysia cannot be without its own challenges – one of which is rivalry.

The Global Islamic Finance Report (GIFR) 2018 has put Malaysia as still topping the list of countries leading the Islamic financial industry, ahead of Iran, Saudi Arabia, United Arab Emirates (UAE) and Kuwait.

However, the report also views Indonesia as exhibiting tremendous progress, having moved a step upwards to sixth position among the world’s most influential markets as far as the shariah-compliant system is concerned.

“It is true that Malaysia and Indonesia are the two most steadfast countries, in terms of growing Islamic banking and finance.

File photo shows man standing near the IMF logo at the IMF-World Bank Annual Meeting 2018 in Nusa Dua, Bali, Indonesia in October. In May, the IMF executive board endorsed a proposal on the use of the CPIFR. — Reuters photo

This is largely owing to their political stability, steady GDP growth, rich natural resources and solid business infrastructure,” said DAR Wong, the chief strategic advisor at Bain Partners & Management Ltd.

He believed that conservatively, these two countries – being based in Asean – would be abstained safely from any warfare and social disorder.

He opined that Indonesia, having a larger geographical scale of land size, population and economy than Malaysia’s, there could be a possibility for it to surpass Malaysia in Islamic financial industry — if Indonesia could maintain its political stability and social security in the post-election after April 2019.

“This is a possibility, especially when we are sniffing the sign of another market rout amidst various economic uncertainties in 2019.”

‘Half-glass full, half-glass empty’

As stated earlier, the global Islamic finance industry did grow, but the GIFR 2018 also reported that the growth trend had been on single-digit basis over at least the past four years – versus the strong numbers that this sector registered in the early 2010s.

In giving his input on this, Wong said from the macro angle – ‘when the economists study on Islamic banking and finance’ – they would always begin with the largest GDP economy among the list of predominantly-Islamic countries ranking down from Indonesia, Turkey, Saudi Arabia, Iran, the UAE, Malaysia and Pakistan.

“Following the 2008 crisis, many global investors tend to seek a safer basket of investment vehicles with smaller risk parameters, while borrowers favour better security for their debt-financing deals.

“Thus, these buy-side players have added a booster to tremendous rising exposure in Islamic finance.

Unfortunately, most of these Islamic economies are closely associated to the production of crude commodity that has been declining for past four years; hence reducing the market confidence to develop more shariah-compliant market.

“In addition, the recent years of civil war involving Syria, Iraq, Libya and Yemen plus Bahrain’s military intervention, and the political dispute between the UAE and Qatar, have all become notorious signs of waning investors’ interest in Islamic banking services, due to flight of funds to the rest of the world.” Still, Wong opined that such reduction in growth more likely reflected a decline in confidence rather than smoothing-through a product cycle.

‘Islamic First’ strategy For sukuk, beginning 2012 in tandem with the slowdown in the global economy – particularly the effects of lower oil prices, Malaysia and the Gulf Cooperation Council (GCC)’s contributions to global sukuk issuance had been on a downtrend.

For Malaysia, the decline was more felt due to BNM’s decision to halt issuance of Islamic securities in the first-half of 2015, observed Ruslena Ramli – head of Islamic finance at RAM Ratings.

Still, she said as at end-October the global sukuk market had performed within RAM Ratings’ estimate of US$75 billion to US$85 billion – recording total sukuk issuance of US$76.1 billion.

“Malaysia continues to be the market leader with a of 35 per cent.” For Islamic banking in Malaysia, Ruslena noted that as at end-September 2018, the year-on-year growth of the country’s Islamic financing, at RM57.5 billion, outperformed the expansion of conventional bank loans, at RM32.1 billion, as several major players’ ‘Islamic First’ strategy gained further traction.

The Islamic banking assets were valued at RM684.2 billion (US$165.3 billion), with a market share of 26.2 per cent as at end-September 2018.

Based on BNM’s Financial Sector Blueprint 2011-2020, the local Islamic banking industry is targeted to represent 40 per cent market share of the total banking assets by 2020.

“The performance of global Islamic finance industry reflects the growth of the various jurisdictions that contribute to its performance.

Over the years, each market has evolved positively to stimulate the growth of its domestic Islamic finance industry.

“In light of the growing awareness of Islamic finance as a viable financing solution, the emphasis to strengthen its eco-system will continue to be on the rise,” she opined.

Shariah-compliant against conventional On putting Islamic financial system up against its current conventional counterpart, Wong said personally, he would not be one to judge one over the other as to which was more ethical in its business integrity.

“However, it is always true that Islamic financial system provides more cushion to the borrowers, while lenders are disallowed to exploit the deals at their unfair advantage.

“When both parties enter into a transaction and depending on the nature of this deal, the terms would clearly define some mandatory guidelines like mutual sharing of profits and losses, joint-ownership of the project and subsequent charge of leasing fee to the borrower, declining balance on shared-equity, instalment-sale of product, zero coupon rate on sukuk – just to name a few here.

“Therefore, I would agree that shariah-compliant financing scheme can be classified as a responsible financing mechanism for all consumers,” said the economist.

Back on the subject of the proposed ‘global mainstreaming’ of Islamic finance, Wong said with shariah-compliant banks having grown to a significant industrial size, they are now playing a more complex role in the international financial sector as a whole.

“Thus, central regulators would need to adopt a new systemic standard to ensure better quality capital and liquidity buffers for Islamic banks and Islamic financial service providers,” he said, referring to the Core Principles for Islamic Finance Regulation and Supervision (CPIFR).

On May 24, 2018, the executive board of the International Monetary Fund (IMF) endorsed a proposal on the use of the CPIFR – developed by Malaysia-based Islamic Financial Services Board (IFSB) in 2015 – with the participation of the Secretariat of the Basel Committee on Banking Supervision.

The CPIFR is meant to provide a set of core principles for the regulation and supervision of the Islamic banking industry, and is designed to take into consideration the specificities of Islamic banks.

It is learnt that the IMF would adopt CPIFR into its financial sector’s assessment and surveillance.

This means that beginning 2019, whenever an IMF team assesses the regulation of the financial sector of a member country, it would cover both conventional and Islamic systems.

In this regard, Wong said the CPIFR standard would enhance the focus on supervisory process and performing stress tests when it comes to compliance with Basel and other international standards, in both banking and sectors.

In his opinion, the implementation of CPIFR would be good to ensure international financial stability, and at the same time, to provide incentives for improving the prudential framework slated for the Islamic banking industry across jurisdictions.

Nonetheless, Wong also remarked: “To give a rating on its effectiveness, we shall await for the next economic crisis to evaluate its worthiness against the conventional banking system.”

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Source: Borneo Post Online





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