LONDON: Zeti Akhtar Aziz, governor of Bank Negara Malaysia, the central bank, took the message of the Islamic finance proposition to the heart of continental Europe when she gave the inaugural global lecture at Goethe University following the opening earlier of the inaugural Official Monetary and Financial Institutions Forum (OMFIF) in early March 2010 in Frankfurt, Germany.
Germany, which ought to be the closest partner of Islamic finance because of its tradition of mutual savings societies and cooperatives, has been relatively absent from the Islamic finance space, allowing US, UK, French, Swiss and Japanese financial institutions to take the first mover lead. This despite the fact that the German state of Saxony Anhalt, was and remains the first European entity to issue a sukuk.
Dresdner Bank when it took over Kleinwort Benson in the UK in the early 1990s, effectively downsized if not closed the latter's thriving Islamic finance business, on the basis that Islamic finance was not a core business line. However, over the last decade or so Deutsche Bank has assumed a much higher profile in Islamic finance especially in asset management, project finance and in sukuk.
As the world emerges from the worst international financial crisis in decades, said Gov. Zeti, there still remain some unresolved issues that need to be addressed. The recovery has prompted focus on exit strategies and on the search for more permanent solutions that will put the financial system on a more solid foundation. "These issues are however being considered during a period of exceptional conditions. Of concern, is that this might significantly influence the direction of the reform agenda with its medium and long-term implications which could be counter to solutions that would lead us to a path of stability and sustainable growth," she added.
Zeti highlighted three trends in the global financial system which she predicted are set to become significantly more pronounced in the aftermath of this global financial crisis. These include the increasing significance of Asia in the global economy; the extensive international regulatory reforms that is being envisaged by the international community; and finally the rapid growth of Islamic finance and its integration into the international financial system.
She was cautiously bullish about the potential role Islamic finance can play in contributing toward financial stability and sustained global growth. The largely uninterrupted expansion of global growth in Islamic finance has drawn significant interest from all quarters. Today, maintained Zeti, Islamic finance has evolved to become a viable and competitive component of the international financial system. Following the global financial crisis, discussions have increasingly turned to the prospects of the potential role and relevance of Islamic finance in contributing to global financial stability and in support of overall economic growth.
Islamic finance is based on the Shariah, the Islamic cannon law which requires that an Islamic financial transaction be supported by an underlying economic activity, thus ensuring that there is a close link between financial and productive flows. "This fundamental principle," she explained, "is all about the basic banking function of providing financial services that adds value to the real economy. Financial flows in Islamic finance are therefore accompanied by the expansion of genuine productive activity. Under this arrangement it also avoids over-exposure to risks associated with excessive leverage."
Islamic finance is also based on profit-sharing and therefore risk sharing. Islamic financial transactions, clearly defines the arrangements at the onset, and provides the incentive for the Islamic financial institutions to undertake appropriate due diligence to ensure that the profits are commensurate with the risks being assumed. Aspects of governance and risk management are therefore strongly emphasized in the arrangements.
Islamic financial contracts, she stressed, "demand higher standards of disclosure and transparency to be observed which, in turn, act to strengthen market discipline and minimize informational asymmetries. There are also clear value propositions in Islamic finance for both investors and issuers. For investors, Islamic financial products offer portfolio diversification and new investment opportunities as they avail themselves to this new asset class. For issuers, Islamic finance allows access to a new source of funds and liquidity in addition to providing new risk management options."
Gov. Zeti like many other participants in the $1.2 trillion global Islamic finance industry, laud the increasing internationalization of Islamic finance over the last decade. This expansion has been accompanied by new emerging global patterns of financial and economic interlinkages, as highlighted especially by the strengthening of ties in between Asia and the Middle East in trade and investments in a wide range areas.
"Both Asia and the Middle East are increasingly recognized as dynamic growth regions in the global economy. The two regions have a history of strong trade ties that flourished on the old Silk Road, which served as a major global conduit between the ancient civilizations in the East and West until about the 14th century. Islamic finance today has revitalized these economic ties with the strengthening of the financial linkages between Asia and the Middle East, a trend that will generate mutually reinforcing growth prospects. The emergence of these new financial centers in Asia and the Middle East and their increased integration has paved the foundations for a New Silk Road," she added.
The good news is that the required regulatory and legal frameworks for Islamic finance have also been established in a number of countries in Asia and the Middle East, and also at the international level in Ireland, Luxembourg, the UK, France, and Malta. Zeti highlighted the development of the Malaysian Islamic financial sector over the last three decades, which in the last years has seen a confident Malaysian market seeing aggressive financial liberalization initiatives to strengthen links with financial markets in other parts of the world. This has also been reinforced by the further liberalization of the capital account of the balance of payments and the implementation of tax neutrality measures.
For the emerging economies in Asia, the banking system remains the largest component of the financial system with greater financial integration is taking place. This financial integration will result in a more efficient recycling of Asian savings into investments within Asia, she maintained. Asia is estimated to invest about $8 trillion in infrastructure development over the next ten years.
The IMF's projection is for growth in the advanced economies for the period 2009 and 2014 to be 1.3 percent per annum, which is half of what was registered during the period 2000 to 2008. The emerging economies, in general, and the Asian region in particular, have emerged with stronger growth.
Strong fiscal positions and Intra-regional trade in Asia has already risen from 32 percent of total exports in 1995 to an average of 50 percent in 2008. Rapid trade liberalization across Asia has improved market access. Rising incomes in the Asian region where more than half of the world population resides has generated a huge cumulative market. This increase in consumption demand has led to the development of an extensive modern retail sector across the region.
Supported by stronger economic fundamentals, emerging economies are expected to grow at higher rates over the next five years compared to the period prior to the crisis in 2000 to 2008. The IMF projects that emerging economies in Latin America, the Middle East, Africa and Asia will, on the average, grow by 6.1 percent in the period 2010-2014, higher than compared to the period 2000-2009.
Zeti highlighted the objectives of global financial reform - strengthening financial regulation; making the regulatory framework more responsive to risk; improving risk management in financial institutions, enhancing safety nets, in particular, in the liquidity support arrangements and deposit insurance; greater disclosure and transparency, particularly on off-balance sheet exposures; agreeing an appropriate incentive structure for financial institutions, and designing an institutional framework for financial stability. But she warned that there has to be a degree of balance of regulation.
Asia's role in the global economy, the international regulatory reform agenda and the development and expansion of Islamic finance is likely to have a growing influence on the global economy and financial system going forward. "As we participate in this rapidly evolving environment, these new trends need to be taken into account in creating a global economic and financial order that is profoundly better than the one we have today," she advised.
By MUSHTAK PARKER
© Arab News 2010
