Dr. Zeti Akhtar Aziz, Governor of Bank Negara Malaysia, and one of the leading lights of the Islamic finance industry, shares some insights with Paul McNamara on what the industry can learn by watching what is going on in other markets.
Across the globe there is a small number of key figures who are responsible for pushing forward the development of the Islamic finance community. One of the leading names on this list would have to be Governor of Bank Negara Malaysia, Dr. Zeti Akhtar Aziz. Governor Zeti has been one of the most thought-provoking speakers at many Islamic finance conferences around the globe for some years now. Indeed, her collected speeches have been brought together and published as a book called Islamic Banking and Finance Progress and Prospects Collected Speeches: 2000-2005. The book itself is a useful chronicle of the maturing of the industry and reflects the development in the depth of thinking in the industry.
Governor Zeti has developed a reputation as a keen thinker and a straight talker, and has a pedigree to back it up. She became Governor of the Central Bank in 2000 after joining the bank in 1985, and has worked in a variety of fields covering monetary and fiscal policy and reserve management.
We caught up with Governor Zeti at the Central Bank recently to talk about some of the main issues concerning the growth and development of Islamic finance.
What are some the main issues Islamic banks face when it comes to getting to grips with corporate governance?
In the area of corporate governance, you need to ensure corporate responsibility so that we have the correct governance in place to cover different types of financial transactions. It is very important that the governance framework is principles based rather than rules based and that means that we need to have broad rules and guidelines rather than restrictive rules.
We also need to have greater disclosure and greater transparency. We need to make sure that institutions have the capacity and the mechanisms to be compliant. The board has to have accountability in terms of its relationship with the shareholders. The structures have to be in place to address that issue to make sure the accountability is there.
How far must the Central Bank go in trying to develop a culture of best practice within banks?
This is an area where the Central Bank has an important role but not in a prescriptive manner. Banks have got to have systems and mechanisms of checks and balances in place, a level of transparency and exposure, and the board and management that has the knowledge to undertake investment. This is very important because you need to have people who understand the nature of risk.
They also need to have the risk management system in place within the institution so that when we exercise the regulatory function and we meet with the board, we can finalise the issues that need to be addressed. Now, more recently, we have moved towards the position where we don't just tell them where the weaknesses that need to be addressed are, we also require the management to sign a letter of undertaking to agree within a specified timeline to address the various issues that need tightening.
Does this presume that the quality of people is there within the management to begin with?
In the current environment, yes we do have to presume that.
What are your predictions for an Islamic capital market that is truly global?
Well, Malaysia was the first country that issued a global Sukuk and we were the first Sovereign that issued a Sukuk. This attracted a lot of interest from the international financial community and immediately drew a lot of interest from Middle Eastern investors, which meant that we could widen our investor base. We also had investors from Hong Kong and Singapore. There was significant demand across the board. Since then, there have been several more issues so we believe that there will be a growing supply of Islamic financial instruments.
As part of our role in promoting growth, we have also liberalised our domestic bond market for foreign multinationals and for multilateral agencies to issue paper, domestic denominated paper, to raise funds. We also have in place a plan to help the international financial architecture for Islamic finance and of course the IFSB is working on prudential standards for Islamic finance. We also have IIFM that can play an important part in Islamic financial markets, including the capital markets. What is important now is concentrating on the supply that we hope will expand. IIFM could facilitate cross-border listings of, for example, Sukuk across a number of international exchanges. They can also play an important role in standardising documentation for issues. It is also important that they conform to the Shari'ah interpretation. This would promote global expansion of such Islamic financial instruments.
What can be done to help foster a deeper understanding of instruments like derivatives within the industry?
There has to be more investment in research and development to promote innovation. I think it is the most important area if we are really to see major advances in the development of the industry and if we want to see derivatives become internationally accepted. There has to be research and development to facilitate development of products to meet the new and changing requirements of the economy and the international economy in particular. Islamic finance needs to be able to respond. In view of the increased risk in the current environment, products need to be developed to be able to help manage that risk.
The industry has to make substantial and continued investment in the area of research and development. From the Central Bank as a regulator, we need to put in place the infrastructure to facilitate this. This has to include financial support for universities and institutions of higher learning. We also need to form strategic partnerships in these areas and this might involve high cost. The issue is that innovative financial products in one jurisdiction can be expanded and become acceptable in another jurisdiction with these sorts of strategic alliances.
In Malaysia we have the Islamic Banking and Finance Institute of Malaysia and this looks at collaborating with the Islamic universities to undertake research to help in the development of new areas of Islamic finance.
Of course, the pool of talent and expertise has to be built up. This involves training and is absolutely vital. So this year Malaysia, in conjunction with the IDB, has allocated $200 million to set up a fund for Shari'ah scholars to fund annual meetings and discussions by scholars from all over the world. This happened for the first time this year during the IDB meeting, and we have decided to make this an annual event.
What do you see as being the main barriers to growth of the Islamic finance industry in Malaysia?
You have to have a conducive legal environment for Islamic finance to grow anywhere. This has got to take the unique nature of transactions in Islamic finance into account. We have put in place a law review committee to look at common law to see where Shari'ah principles could be applied. We also want to have tax neutrality, to ensure that Islamic transactions are not disadvantaged in any way. In some places, Islamic finance transactions are taxed twice, and we need to make sure that doesn't happen.
The introduction of the tax neutrality policy can create a more equitable tax treatment of Islamic finance when compared to conventional finance. Under the policy, the Inland Revenue will invent additional instruments to accommodate this.
How can other countries learn from the Malaysian experience?
We need to learn from other countries that have developed Islamic finance, but one area where Malaysia is ahead is that we have developed a comprehensive Islamic finance infrastructure. Having the various components of the financial system, the banking system, Islamic insurance, financial markets, the bond market, the equity market, are all important. In our bond market, one of the biggest in Asia, 44% of the issues are Islamic. Others can learn from this when it comes to capital market development. Of course, our Takaful market is also growing very fast. Over and above that, we have the supervisory, regulatory and Shari'ah framework to ensure the governance structure for compliance. All of this is supported by legal infrastructure to offer a complete Islamic financial system.
But we have moved beyond this, and have taken steps to integrate our complete system with the rest of the world. This is through our participation in the international financial markets, by issuing Islamic based instruments and then allowing for Islamic-based instruments to be raised by foreigners here, and by inviting foreign players to take part in our system. This enhances our international links with other parts of the world.
What can be done to help Islamic finance institutions integrate more closely with their conventional counterparts?
As you know, we allow our conventional banks to have Islamic windows that offer Islamic finance products and services, and we have put in place all the firewalls necessary to ensure that there is no co-mingling of funds. We built the Islamic finance system under this structure. We have now established a new structure that allows them to establish Islamic subsidiaries. They have a special license to operate like a bank within a bank, with their own board, management and dedicated capital, which allows them to invite foreign partners to the bank. Through this, the conventional banks have been able to participate in the development of Islamic finance.
The fact that Islamic finance is growing about 19%, faster than conventional finance annually, means the sector as a whole just keeps growing as a proportion of the overall system. Conventional banks are certainly participating in this.
What do you see as being the biggest challenge ahead for the Islamic finance industry?
We need a bigger pool of talent due to the rapid expansion of the industry. The challenge is to invest in training. This is happening, and we have a number of initiatives that we will be announcing later this year. The training arm of the industry and many universities are also running programmes that will help in this regard.
This is a precondition for the other challenge; to develop the products and services to meet the changing requirements the national economy.
The third area is to promote convergence in the Shari'ah interpretation. In terms of ensuring the proper governance of the industry, we already have the IFSB which will play a very important role in the dissemination of prudential standards in areas like capital adequacy and standards for corporate governance.
© Banker Middle East 2005
