Islamic Financial Market in MalaysiaProf. Saiful Azhar RoslyInternational Center for Education in Islamic Finance10th October 2008.

The establishment of the Malaysian Islamic Financial Center (MIFC) in August 2006 to spearhead Malaysia’s leading role in global Islamic finance is a significant and critical milestone in Malaysia’s financial sector development. Since 1983, when the first Islamic bank in Malaysia was set up, the government in general and the Central Bank of Malaysia in particular, has been proactive in providing suitable infrastructures for Islamic banking business operations to take off in a modern capitalist economic system. In 1992, Islamic windows were introduced to expand Islamic banking services nationwide and further enhancement was made in 2002, when Islamic windows converted into Islamic banking subsidiaries to give greater autonomy to Islamic banking outfit that operates under a conventional bank holding company.

The Islamic Banking Act 1983 provides new avenues of financing for Islamic banks where products bearing trading, leasing and partnership contracts are allowed in the banking business. It opened up vast opportunities for new product innovation beyond traditional lending and borrowing facilities found in conventional banking. Islamic contracts such as murabaha, ijarah, istisna, salam, wakalah, mudarabah and musharakah can be readily applied to deposits and financing activiites of Islamic banks. With current market share of Islamic deposit and asset at about 14 per cent each, it is a great challenge for Islamic banking to achieve the 20 per cent market share target in year 2010. Hence product innovation is critical. Prevailing financial crisis in the US saw greater effort in risk and capital management of Islamic banks.

The Islamic capital market gradually developed in 1990s and was identified in the Capital Market Masterplan (CMP) as a niche area where Malaysia was competitively placed to play a leading international role. In 1999, the KLSE Syariah Index was introduced as a barometer of Islamic equity market activity. Earlier in 1997, the inaugural list of Syariah approved securities were released in June 1997 with around 50 per cent of stocks listed as Shariah compliant. The East Asian economic crisis prompted the birth of the Islamic bond market to relieve stress on banks in providing capital to

business. In 1990, the first al-bai-bithaman ajil Islamic bond worth RM125million (USD33 million) was issued by Shell MDS Sdn. Bhd. The Malaysian government further issued RM2.2 billion (USD600million) global sovereign sukuk in 2002 that uses ijarah as the income generating vehicle, a vast departure from local Islamic debt securities commonly structured under bay al-inah contract. Islamic bond grew at an average 150% over 1999-2003 peaking at RM14 billion in 2002. The world largest sukuk issuance of RM15.35 billion (USD4.8billion) went to Binariang GSM in 2007.

The Islamic fund market lifted off in 1997 with two funds at 3 % market share and grew steadily 52 Islamic funds in 2003 with a total asset value (NAV) of around RM4.6 billion. As of end 2007, the number of Islamic unit trust funds in Malaysia has grown to 134 funds with a net asset value of RM16.9 billion (USD4.8 billion).

With the fast changing landscape in global finance, challenges to Islamic finance are enormous. First, it has to deal with the complexities of modern financial markets where the elements of interest (riba) and gambling (maisir) are evident in banking products, fixed income instruments and financial derivatives. This concerns Shariah risk when Shariah scholars were found to approve new products without significant departure from conventional practices. One example concerns the sukuk products, where AAOIFI has declared that when beneficial ownership of underlying asset is not with the investors, the sukuk is deemed Shariah non-compliant. Based on this important ruling, about 80% of existing sukuks have failed the Shariah compliance test. On scale economies, Islamic financial institutions, especially Islamic banks were found too small to compete with large superbanks in matured economies. This may increase transaction cost of Islamic banks and make them less competitive. Education on Islamic financing in colleges and universities remains marginal and public understanding of the products are still at the infancy stage. Thus, the industry lacks the manpower to operate the Islamic finance business to exploit huge potential markets.