Malaysia’s experiences in the
development of Islamic Finance
Practical Seminar: Advantages of Islamic Banking &
Insurances Business Model in Rusia
Moscow, Rusia
4th December 2009
Ahmad Hizzad Baharuddin,
Director
1
Table of Contents

Financial System Landscape

Regulatory, Shariah & Legal Framework

Human Capital Infrastructure

Islamic Government Instruments & Sukuk

Strategic Partnership

Challenges
2
2
Emerging interest on Islamic finance as viable alternative to the
global financial system …
Germany
South Korea
 Saxony-Anhalt state
issued government sukuk
UK
 First Islamic bank to
 Gov’t sets an objective to ‘entrench
operate in 2010
London as a global gateway for
Islamic finance
Turkey
 Announced IFC Istanbul in Sep
’09 with focus includes interestfree financial business
 5 FSA-approved Islamic banks and
Takaful operators
 Plans to issue sovereign sukuk,
amend tax law on IF
France
Malta
 Passed rules/regulations
 Plans to position
to support Islamic
finance activities
 In process of licensing
Islamic banks
adjustment for IF
transaction i.e. taxation
guidelines on sukuk &
murabaha
Japan
Law passed allowing
banks to do Islamic
finance
Bahrain
Qatar
Saudi UAE Pakistan
Arabia Kuwait Thailand
as Islamic
finance hub for
the
Mediterranean
Sudan
Hong Kong
 Aims to become Islamic
finance gateway to China
Indonesia  Plans to issue sovereign
sukuk
Jordan
 Made fiscal & legal
Parliament expected to
pass the law related to
offering of tax waiver on
foreign investors’
interest income from
sukuk issued
 Hang Seng Islamic China
 Plans to tap sukuk market
to finance its deficit
Singapore
 Established first Islamic bank
 Introduced tax neutrality for Islamic
finance
 Aspiring to be centre for Islamic finance
Index Fund in 2007
Brunei
Aim to become
Islamic financial
services hub for
Asia
 Launched Islamic ETF
Muslim-majority countries offering Islamic finance (IF)
Non-muslim countries starting to offer IF
3
Malaysia’s gradual & holistic approach to Islamic finance…
Increase number of players,
develop financial markets &
enhance Shariah governance
Building foundation of
legal, regulatory &
Shariah framework
Market liberalisation, upgrading
infrastructures, strengthen overall
Islamic finance landscape
Advanced stage
Strategic positioning &
international integration
Intermediate stage
Institutional building, stimulate
competition, activity
generation & market vibrancy
Inception stage
Instituting foundations of
Islamic finance
• Financial inclusion to fulfill Muslim’s
needs
• Islamic windows
• 2nd Islamic bank
• FSMP – 10 year
roadmap
• IBFIM
• Foreign Islamic banks
• ISRA
• Islamic subsidiaries
• Central Bank Act 2009
•
• Mobilisation of deposit started by
Pilgrimage Fund (1963)
• 2nd takaful company
• Relevant acts were enacted
• Islamic money market
• New takaful & retakaful
licences
• 1st Islamic bank & takaful operator
• Shariah Advisory Council
• Tax neutrality policy
• INCEIF
Talent &
research
development
• Shariah Committee
• 1st Islamic Sukuk
1983
1993
2001
2010 &
beyond
FSMP – Financial Sector Masterplan, IBFIM - Islamic Banking and Finance Institute of Malaysia, SIDC – Securities Industry Development
Corporation, INCEIF - International Centre for Education in Islamic Finance, ISRA – International Shariah Research Academy for Islamic Finance
4
Government & regulators have pivotal role in developing
progressive and sustainable Islamic finance…
Islamic
Banking

Regulates banks &
insurance/ takaful

Ensure financial sector
stability with sound
financial institutions &
functioning financial
infrastructure

Formulates policies/
strategies to develop
financial system
Islamic
Money
market
Islamic
Capital
market
Takaful

Regulates capital markets
activities & fund
management

Conducts regulatory
functions (e.g. processing &
approval of sukuk, licensing
& supervising licensed
person, ensuring proper
conduct by market players)


Government
Issue Islamic government
securities to create
benchmark yield curve

Providing tax neutrality
platform

Supportive visa application of
expatriate & employments
Ultimately responsible to
protect the interest of
investors
Sources: Central Bank of Malaysia (Bank Negara Malaysia), Securities Commission Malaysia, Malaysia Deposit Insurance Corporation
5
Longer term strategy & solution help to achieve sustainable growth and
stability - Financial Sector Masterplan (FSMP) …


10-year plan (2001-2010) outlining
strategic focus & actions to be taken,
including safeguards to maintain financial
stability
Diagram: FSMP encompasses 6 sectors
Alternative Modes
of Financing
5 main characteristics:
Islamic
Banking &
Takaful
a. Efficient
b. Stable
Banking
c. Prudential
Development
Financial
Institutions
Insurance
d. Regulations
e. infrastructure

Broad strategies with 119 recommendations
– Implementation in three stages
Phase 1
• Building domestic
capacity & capability
• Enhance financial
infrastructure
Phase 2
• Intensify competitive
pressure
• Level playing field
Labuan IOFC
Phase 3
• Assimilate into global
arena
• Introduce new foreign
competition
6
Malaysia has a comprehensive Islamic financial system…
GOVERNANCE
Legal & Regulatory
 Central Bank Act 2009
 Islamic Bank Act 1983
 Takaful Act 1984
 Government Funding Act 1983
 Capital Market Services Act
2007
 Malaysia Deposit Insurance
Corporation Act 2005
Shariah Advisory Council
 Bank Negara Malaysia
 Securities Commission
Dispute Resolution
 Judicial system – dedicated
High Court
 KL Regional Centre for
Arbitration
 Financial Mediation Bureau
Islamic
Banks & Takaful
Companies
Islamic
Money
Market
Islamic
Capital
Market
Malaysian
Financial
System
Dual
banking
system
Money
market
Capital
market
Conventional
Banks & Insurance
Companies
Supported by human capital infrastructure
FINANCIAL MARKET
Money Market
 Islamic interbank money market
- Daily average transaction RM1 bilion
 Bursa Suq Al Sila’
Capital Market
World leader in Sukuk market
 58.2% of outstanding private debt are sukuk
 88% permissible counters at Bursa Malaysia
 143 Islamic funds
DIVERSIFIED PLAYERS
Islamic Banking
 17 Islamic banks
 10 Islamic windows
 6 DFIs offering Islamic
banking services
 3 International Islamic banks
 15 International currency
business units (ICBU)
Takaful
 8 takaful operators
 4 retakaful operators
 1 International takaful
operator
 9 ICBU
Fund Management
 9 Islamic fund management
companies
 35 fund management
companies with Islamic
mandates
7
Commendable growth in Islamic finance…
RM billion
(Islamic Banking)
RM million
(Takaful)
Islamic banking
• Average annual growth rate: 19% (2000-2008)
• Market share in terms of asset: 18.8% accounted
for RM275 billion (Q2 2009)
Introduction of Financial Sector Master Plan
(FSMP) 2001-2010
Takaful (Islamic Insurance)
• Average annual growth rate: 24.1% (2000-2008)
• Takaful asset share: 7.7% (Q2 2009)
Slide 25
Outstanding Private Debt Securities
(Jan – March 2009)
Islamic capital market
• 3rd largest capital market in Asia (after Japan
Conventional 43%
& Korea)
Islamic 58%
• Malaysia’s outstanding sukuk (public & private):
USD66 billion (end June 2009)
• 62% of total outstanding sukuk globally
• 58% of outstanding corporate bonds are sukuk
Source: BNM Statistics
8
8
Malaysian Islamic money market has grown over the years…
Islamic money market
Islamic Short Term Instruments-Trading Volume
RM billion
100
NID
• Total money market transactions
recorded significant growth
- Average monthly turnover
80
IAB
RM8.7 billion (Sept 2009)
60
BNM Notes
40
MITB
140
120
20
• Diverse types of short-term Islamic
financial instruments
– Government Investment Issues
0
2005
2006
2007
2008
– Bank Negara Sukuk Ijarah &
Notes
– Malaysian Islamic Treasury Bills
(MITB)
Mudharabah Interbank Investment
Volume
RM billion
600
– Islamic Accepted Bills (IAB)
491.1
500
410.4
400
311.6
239.4 247.0
300
282.3
293.4
235.3
152.0
200
100
280.6
– Negotiable Islamic Debt Issues
(NID)
242.0
151.4
98.8
15.2 39.9
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009*
• Increasing sophistication of
Islamic instruments contracts
• Additional tool in managing
monetary policy
Source: BNM Statistics
* Figure as of 30 Sep 2009
9
9
Robust regulatory & supervisory framework in ensuring financial
stability of Islamic financial system…
 Formulation
of separate
guidelines to reflect distinct
features of Islamic finance
 Capital
Adequacy/ Solvency
& Liquidity, Corporate
Governance, Risk
Management & Disclosure
 Protect
depositors’ in
the event of liquidity
crisis
PRUDENTIAL
REGULATION

Risk-based Supervision
Framework

Risk assessment taking into
account the uniqueness of
Islamic banking & takaful
SUPERVISORY
FRAMEWORK
DEPOSIT
INSURANCE
SYSTEM
Islamic
deposit insurance
operating parallel with
conventional deposit
insurance

 Separate
FINANCIAL
SURVEILLANCE
Continuous
surveillance at macro
& micro level that
includes Islamic
Financial Institutions
PAYMENT &
SETTLEMENT
SYSTEM

Minimise settlement risks

Separate Islamic accounts from
conventional at national levels
10
Islamic Financial Services Board (IFSB) as an international standard
setting body…
Standards issued
Capital Adequacy Standard (Dec 05)

Guiding Principles on Risk Management
(Dec 05)
IFSB established in 2002 – Malaysia as a
host country

International standard-setting issuing
global prudential standards & guiding
principles

Significant progress in addressing
regulatory framework for Islamic financial
institutions
Capital Adequacy for Sukuk, Securitization
& Real Estate Investment (Jan 09)

Promote international convergence of
standards
Guiding Principles on Governance - Islamic
Collective Investment Scheme (Jan 09)

Provide platform for knowledge sharing

193 members to date, including 46
regulators

Malaysia’s guidelines consistent with
international best practices, i.e with IFSB
– regulatory convergence
Guiding Principles on Corporate
Governance (Dec 06)
Transparency & Market Discipline (End-07)
Supervisory Review Process (End-07)
Approved Standards to be issued
Guiding Principles on Governance for
Islamic Insurance (Takaful) Operations
Conduct of Business for Institutions
offering Islamic Financial Services (IIFS)
Guiding Principles on Shariah Governance
System
11
A credible Shariah governance structure that promotes integrity
and confidence…
Malaysia’s experience:

Shariah as overarching
principle in Islamic finance
MANAGEMENT
BOARD
SHARIAH
COMMITTEE
Shariah Compliance Functions :
Proper governance provides multi-layer
assurance on Shariah compliance
1.
Shariah Advisory Council given legislative
stature as highest authority for Shariah
matters in Islamic finance
2.
Accountability of Shariah committee of IFIs
on decision, views & opinions related to
shariah matters
3.
Board & senior management with sufficient
expertise & capability in dealing with issues
specific to Islamic financial transactions
4.
Emphasise the function of Shariah review &
Shariah audit to provide check & balance
5.
Timely disclosure on fatwa rulings
6.
Institutionalise mutual respect by recognising
differences of Shariah interpretations in
various jurisdiction
 Shariah Review
 Shariah Audit
12
Holistic legal framework & infrastructure supporting Islamic finance…
Islamic Banking Act
1983
Capital Market
Services Act 2007
Central Bank of
Malaysia Act 2009
Takaful Act 1984
Development
Financial Institutions
Act 2002
Government Funding
Act 1983
Banking & Financial
Institutions Act 1989
Central Bank of Malaysia Act 2009
Dispute Resolution Mechanism
Islamic Financial System
Judicial System
– dedicated High Court

Financial system shall consist of conventional & IFIs
Shariah Advisory Council as highest authority
 The
KL regional Centre of
arbitration
court or arbitrator shall take into account
published rulings of BNM’s Shariah Advisory Council
(SAC) & to refer to any Shariah questions to the SAC
for its ruling
 Rulings
Financial Mediation
Bureau
of SAC shall be binding on Islamic financial
institutions, courts or arbitrators and rulings are final
MIFC
 BNM
has the role to develop Malaysia as an
international financial centre
13
Comprehensive talent development infrastructure – focusing in
education, research and training…
• Established in 2003
• Leadership development program for financial institutions & business
corporations
INCEIF
ISRA
Asian
Institute of
Finance
ibfim
• Established in 2006
• Global university in Islamic finance offering certification & post
graduate studies in Islamic finance
• Attract > 1000 students from > 50 countries
• Established in 2008
• Leading centre in Shariah & fiqh muamalat research
• Platform for discourse among scholars academicians, regulators &
practitioners
• Established in early 2009 to reinforce cooperation between 3 financial
training institutions
• Further improved quality, efficiency and effectiveness of human
capital development infrastructure in financial industry
MII
ICLIF – International Centre for Leadership in Finance
INCEIF – International Centre for Education in Islamic Finance
ISRA – International Shariah Research Academy for Islamic Finance
IBBM
14
IBFIM – Islamic Banking and Finance Institute Malaysia
MII – Malaysian Institute of Insurance
IBBM – Institut Bank-Bank Malaysia
14
Table of Contents

Financial System Landscape

Regulatory, Shariah & Legal Framework

Human Capital Infrastructure

Islamic Government Instruments & Sukuk

Strategic Partnership

Challenges
15
15
Established Islamic financial system provides natural demand for
Islamic assets, including Islamic government instruments
25%
Proportion of outstanding Islamic government
instruments to total government securities (%)
20%
Proportion of Islamic banking assets (%)
15%
10%
12%
7%
8%
2000
14%
18%
16%
15%
17%
19%
13%
9%
11%
5%
4%
13%
22%
4%
4%
5%
2001
2002
2003
6%
7%
2004
2005
– for portfolio management (e.g. Islamic unit
trusts)
2006
2007
2008
Oct'09
Composition of Malaysian corporate sukuk
27%
36%
38%
41%
46%
50%
56%
56%
57%
– short-term: Islamic banks
– long-term: takaful, pension funds
60%
40%
– help establish benchmark yield curve for Islamic
instruments issued by private sector
 Diversity of players provide demand for
different spectrum of instruments
100%
21%
– meeting statuary needs of IFIs (e.g. liquidity
reserve of Islamic banks & liquid assets for
takaful)
– facilitate better asset-liability management
0%
80%
 Roles of Islamic government instruments
(GII)–
79%
73%
64%
62%
– also demanded by conventional investors,
including foreign
59%
54%
50%
2005
2006 2007
20%
44%
44%
43%
0%
2000
2001 2002
2003
2004
2008 Oct'09
RM294b
Total RM159b
Conventional
* Assets of Islamic banking, takaful and Islamic
asset management as at Sept ’09
Islamic
Source: Bond Info Hub
16
Malaysia is the largest Sukuk market globally…

Malaysia has one of the most established bond
markets in Asia

Combined with corporate sukuk, Malaysia
is the largest sukuk market in the world
– 62% of total outstanding sukuk globally
Japan
145
Korea
51
Malaysia
45
Singapore
45
Thailand
48
60
36
13
42
16
China
44
8
17
Philipines
Indonesia
18
Vietnam
14
0
Size and composition of bond
markets in selected Asian countries
(% to GDP)
34
33

Active secondary sukuk market

Sukuk as a new asset class

Wide investors base – from both
conventional & Islamic investors

Increase participation from foreign
multilateral institutions, e.g.:
30
Average
Hong Kong
17
- Islamic Development Bank (RM1 billion)
Government
4
Corporate
2
Ratio to
GDP (%)
1
50
Source: Asian Bond Monitor, Sep ‘09
100
- IFC & World Bank, largest supranational
Ringgit sukuk (RM1.26 billion)
150
200
• Issuances by multinational companies,
e.g.:
- Inaugural sukuk issuance by Shell MDS
in 1990, world’s 1st sukuk (RM125
million)
- Tesco Stores (RM700 million)
Sukuk offers a viable option for governments and corporates to diversify
their sources for funding & tap new investor base
17
Highlights - Petronas USD1.5 billion Emas Sukuk…
Sukuk
Bond
Rating
A1 (S&P)/A- (Moody’s)
Rating
A1 (S&P)/A- (Moody’s)
Issue Size
USD 1.5 billion
Issue Size
USD 3.0 billion
Maturity
5 years
Maturity
10 years
Spread to
Treasury
1.625%
Spread to
Treasury
1.625%
Yield
4.279%
Yield
5.322%
Issue Price 99.871

Oversubscription rate = 6.28
times

Shariah principles – Ijarah

Largest USD global sukuk since
Dubai Ports issuance in 2007

Largest USD issuance (combined
both bonds & sukuk) of USD4.5
billion in Asia (ex-Japan) for 2009

World’s 1st USD corporate sukuk
in 2009

1st to be accorded Emas dollar
sukuk

Amount upsized from USD1
billion to USD1.5 billion
Issue Price 99.447
Bursa Msia, Labuan
S.E, Luxembourg S.E
Listing
Facts:
Bursa Msia, Labuan
S.E, Luxembourg S.E
Listing
Sukuk attracts wider investor base :
BY GEOGRAPHY
BY INVESTORS
US 6%
Middle
East 7%
Europe
27%
Others
8%
Insurance/
Pension 4%
Asset
Management
40%
Private
Banking
22%
Rest of
Asia 47%
Malaysia
13%
Banks 24%
18
High demand for Islamic papers – recent major international Sukuk
IDB (Sep ’09) – 2.4x
oversubscribed
1
2
GCC
25%
Other
2
%
Europe
16%
Spread
AAA
Size USD850m
77 bps + UST
44 bps + mid swap
INDONESIA SOVEREIGN
(Apr ’09)- 7X
3
Asia
40%
Europe
11%
Size
Europe
20%
Rating
AA
Spread
390 bps + UST
230 bps + mid swap
4
Size
DUBAI SOVEREIGN
(Oct ’09) – 3X oversubscribed
Rating
A+
Spread
406 bps + UST
370 bps + mid swap
Size

Continuous strong
appetite for Sukuk
despite current global
financial crisis

Highly demanded oversubscription of Sukuk

Competitive pricing
USD1b
US
19%
M iddle East
30%
Rating
Asia
20%
Middle East
60%
Rest of Asia
33%
Asian
25%
Rating
ABU DHABI TDIC (Oct ’09) –
7x oversubscribed
USD1.25b
BB-/Ba3
USD650m
19
Malaysia continues to promote & facilitate foreign Sukuk issuances in
Malaysia via MIFC initiative…
Sukuk Origination
Cost Effective
Efficient Time-to-Market
Supportive Framework
• Tax neutrality
• Stamp duty exemption
• SPV not subject to tax or tax
administrative procedure
• Tax deduction until 2015 on
expenses incurred on issuance
of Islamic securities
• Wide investor base –
competitive pricing
• Active secondary trading
• Facilitative approval process
 Deemed approve for AAA (local
rating) or BBB (international
rating)
• Expertise in structuring and leadarranging sukuk deals
• International credit rating allowed
• International documentations allowed
• Efficient payment, clearing and
settlement system
• Platform for ringgit and foreign
currency denominated sukuk issuance
• Centre for innovative structures
• Liberal foreign exchange rules
 Free to repatriate proceeds
abroad
 Free to hedge positions
• Various Shariah interpretations
recognised
Cost Effective
Facilitative process
Supportive Framework
• No fees for sukuk listed in 2009
• Approval process – 1 day
• Secondary listing of sukuk issued
outside Malaysia allowed
• Not limited to public limited companies
only
• Can be denominated in ringgit or
foreign currency
Sukuk Listing
20
Islamic finance thought leadership…
Bank Negara Malaysia heads two task forces
Initiatives of:
Islamic
Development
Bank
Islamic Research
& Training
Institute
Islamic Financial
Services Board
11 Task Force on “Islamic Finance and Global Financial Stability”
• To study the strengths of Islamic finance, examine the
building blocks progress of Islamic finance developments
22 Task Force on “Liquidity Management”
• To recommend framework to enhanced liquidity for Islamic
financial institutions
Fostering interlinkages with other institutions and financial centres via Memorandum of
Understanding
• BNM – Central Bank of Bahrain, Bahrain (2001)
• BNM – Japan Bank for International Corporation, Jepun (2007)
• BNM – Qatar Financial Centre Regulatory Authority, Qatar & Dubai Financial Services Authority,
U.A.E. (2007)
• BNM – United Kingdom Trade and Investment , U.K. (2009)
• BNM – Hong Kong Monetary Authority, Hong Kong SAR (2009)
21
21
Synergistic propositions - capitalising on each others’ strengths for quick win…
Leverage on Human Capital Infrastructure
• Leverage on INCEIF, ISRA, IBFIM, CBS & Institute of Higher
Learning’s expertise in areas of human talent & programmes
Malaysia
• Introduction of INCEIF, IBFIM, CBS & Institute of Higher
Learning academic & training modules in Russia
Leverage on ISRA
• Russian Muftis Council to participate in International Shariah
dialogue
Russia
• Leveraging on Malaysian Shariah parameters to facilitate crossborder transactions
Central Bank
of Malaysia
Leverage on Sukuk expertise
• Enhance business activities in both jurisdictions
• Leverage Malaysia’s capabilities in sukuk issuance
• Adoption of Malaysia’s sukuk standards
Financial Market platform
• Leverage on Malaysia’s liquidity management platform - Bursa
Suq Al Sila
• Adopting Malaysia’s standard for liquidity management; eg.
Commodity Murabahah & Wakalah Master Agreement
22
Challenges in developing vibrant Islamic financial system
Regulation in line with international best practices
Regulatory
framework
• Avoid potential of regulatory arbitrage
• Attuned to distinctive features & specificities of Islamic finance
• Ensure consumer protection mechanism is in place i.e.
consumer awareness programme
Talent supply
Shariah
harmonisation
Principle of
neutrality
Increase pool of talent
• Ensure sufficient pool of talent - Shariah & finance conversant
Shariah convergence
• Centralised Shariah model where rulings are streamlined
• Achieve consistency in Shariah pronouncements
Tax neutrality principles
• Equal treatment vis-a-vis conventional banking
• Exempt additional legal instruments necessary to fulfill Shariah
requirement from stamp duty & tax payment
23
23
Informative websites:
 http://www.bnm.gov.my
- Bank Negara Malaysia
 http://www.mifc.com
- Malaysia International Islamic Financial Centre (MIFC)
 http://iimm.bnm.gov.my
- Islamic Money Market
 http://bondinfo.bnm.gov.my
- Malaysian Government Securities Market
 http:// www.sc.com.my
- Securities Commission Malaysia
 http://www.pidm.gov.my
- Malaysia Deposit Insurance Corporation
Disclaimer: While every care is taken in the preparation of this presentation, no responsibility can be accepted for any errors.
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