It is hard to imagine Malaysia’s financial sector without a heavy element of sharia compliance (adherence to the requirements of sharia law and the principles of Islam). But five decades ago, this was little more than an item on the wish lists of the country’s Muslims and a glint in the eyes of policymakers.
These aspirations fuelled efforts to introduce an alternative financial system built on the sharing of risks and profits, the requirement that financial transactions be supported by underlying productive activities, and the prohibition of usury (lending at unreasonably high interest rates), ambiguity, speculation and involvement in certain businesses such as gambling and liquor.
By the end of 1990, Malaysia had the beginnings of an Islamic finance industry, with an Islamic bank, a takaful (cooperative insurance) operator and a maiden sukuk (sharia-compliant bond) issue. Since then, the sector in Malaysia has completely shed its niche status, and an unmistakable sign of broader acceptance is that many customers and investors are non-Muslims and corporations.
Close to 31% of the assets in the country’s banking system are in Islamic banking, while 65% of the capital market is sharia-compliant. The Malaysian Takaful Association says the domestic penetration rate of takaful rose from 15.9% in 2019 to 16.9% last year.
Systemic importance
In the eyes of the Islamic Financial Services Board, an international standard-setting organisation, Islamic finance in Malaysia ‘has achieved systemic importance’, with the country becoming a leader in a global field that swelled from US$1.76 trillion in assets in 2012 to US$2.88 trillion seven years later.
That was before a pandemic upended the world.
As a result, the latest Islamic Finance Development Report – published jointly by an arm of the Islamic Development Bank Group and Refinitiv, a financial markets infrastructure and data provider – expects industry growth to slow down between 2020 and 2024, with total assets nevertheless reaching US$3.69 trillion by the end of the period.
‘Islamic finance’s main advantage is the considerable degree of overlap between sharia principles and environmental, social and governance principles’
In a September 2020 discussion draft, the Islamic Development Bank states: ‘The Covid-19 pandemic poses challenges for liquidity, resilience and capital for the Islamic banking sector, the largest component of the Islamic financial industry.’
According to the Islamic Finance Development Report 2020, several Islamic banks reported losses or reduced profits in the second quarter of 2020 compared with the same period the previous year. It adds: ‘This reflected higher loan impairments reported by the banks in expectation of large credit losses and weakened asset quality.’
New lens
But what matters most is how the industry positions itself so that it emerges stronger after Covid-19.
In a speech last December, Securities Commission executive director Sharifatul Hanizah Said Ali, who oversees Islamic capital market development, said: ‘The pandemic has given us a new lens through which to view how and what we finance, fund and invest in.’
‘The pandemic has given us a new lens through which to view how and what we finance, fund and invest in’
There is widespread agreement that the way forward is to better address digital transformation, financial inclusion and the pursuit of sustainability, while remaining focused on the goals central to Islamic finance, including wealth distribution, and social and economic justice.
Bank Islam Malaysia CEO Mohd Muazzam Mohamed says that the pandemic has pushed the bank to reimagine its contribution. ‘We believe our role must go beyond a mere financial intermediary to also include social intermediation for creation of social benefits,’ he says.
PwC Malaysia executive chairman Dato’ Mohammad Faiz Azmi, meanwhile, points out that the current environment can increase the industry’s accessibility and expand its potential as an instrument of social change.
Principled finance
Given the pandemic’s once-in-a-lifetime circumstances, leveraging the edge that Islamic finance has over conventional finance may prove pivotal.
‘Islamic finance’s main advantage is the considerable degree of overlap between sharia principles and environmental, social and governance [ESG] principles,’ says Faiz, who chairs the Islamic finance consultative group of the International Accounting Standards Board.
To Muazzam, this is about delivering on ‘the higher purpose of sharia’, which nurtures an industry mindset revolving around ensuring the generation of positive and sustainable impact.
In her speech last December, Hanizah dismissed the idea that the sustainability agenda has taken a back seat because of Covid-19. ‘If anything, the pandemic has provided greater impetus, urgency and motivation to consider ESG factors in how to move forward,’ she argued.
Bank Negara deputy governor Datuk Abdul Rasheed Ghaffour offered a possible scenario in a speech last October.
‘Sharia contracts can deploy a diverse range of capital that is risk-absorbent, patient and philanthropic in nature, using instruments such as risk sharing, waqf [endowment] and sadaqah [donation] to support inclusive finance,’ he explained.
‘The flexible nature of such capital encourages allocation of resources towards entrepreneurial ventures and social impact projects that can improve and rebuild wellbeing of society. It can also to some extent help smoothen structural adjustments in the economy.’
Fintech partnership
Because of social distancing measures during the pandemic, the Islamic finance industry, like others, has embraced fintech and accelerated the implementation of other digital ideas, says Azura Othman FCCA, CEO of the Chartered Institute of Islamic Finance Professionals.
‘The key takeaway is innovate and integrate or be left behind,’ she adds.
With or without a worldwide healthcare crisis, technological advances and adoption go hand in hand with efforts to raise access to and use of formal financial services. ‘The global digital revolution is having a significant impact in promoting financial inclusion,’ the World Bank noted in an October 2020 report on Islamic finance and financial inclusion.
More to accomplish
The bank added that Islamic finance has institutions and mechanisms (among them the sharing of risk and social finance) that support financial inclusion.
In other words, there is a lot more that Islamic finance can accomplish as it extends its reach and deepens its use of technology. ‘As we’re well into the second year of the pandemic, more can be done to explore the untapped Islamic finance market,’ Faiz says.
When put together in the unprecedented intensity of the Covid-19 crucible, these factors present a compelling case for Islamic finance to be among the industries leading the way in the journey to recovery.
Malaysia leads the way
In the world of Islamic finance, Malaysia is the little engine that could. It accounts for less than 2% of the combined population of the Organisation of Islamic Cooperation’s 57 member states and barely 1% of their total land area. Yet, it is the clear number one in Islamic banking and Islamic capital markets.
According to the Islamic Finance Development Report 2020, Malaysia is the most developed country in Islamic finance by a wide margin. The country has also held top spot in the Global Islamic Economy Indicator every year since the introduction of the index in 2014.
In an October 2020 report on Islamic finance and financial inclusion, the World Bank pointed out that many have recognised Malaysia’s ascendancy.
Malaysia’s success is largely the result of farsightedness and focus. The country was among the earliest to see that Islamic finance could be a high-growth, mainstream market, and Bank Islam Malaysia, the country’s first Islamic bank, was established in 1983 as part of the government’s plans to develop Islamic finance domestically. This objective swiftly evolved into an ambition to become a major international player in this arena.
