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Islamic Financial Market in Malaysia

Prof. Saiful Azhar Rosly

International Center for Education in Islamic Finance
10th 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

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 activiitesof 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.