Dr Zeti Akhtar Aziz, central governor

Despite Malaysia's reticence in establishing itself as a globally recognised financial centre, it is now moving forward fast. Bank Negara Malaysia governor Dr Zeti Akhtar Aziz discusses the role of Islamic finance products in the country's push. Writer Silvia Pavoni

The traditionally reserved nature of Malaysians has tended to damage the country's aspirations of being recognised as an international financial centre. However, things have changed a lot in the past few years and Bank Negara Malaysia, the central bank, has embarked on a number of wide-reaching initiatives to boost its global presence, from monetary stability measures to microfinance initiatives.

Central governor Dr Zeti Akhtar Aziz is particularly interested in developing the country's financial centre. "We'd like to enhance the international dimension of Islamic finance and our linkages with other financial centres - not only to international financial centres but also other financial systems in other emerging economies."

In addition, says Ms Zeti, Islamic finance has inherent features which contribute to financial stability. "It is all about returning to basic banking," she says, adding that there are two reasons why Islamic finance has grown so significantly before the crisis, and even during the crisis.

The first is that it offers the financial products and services that businesses and consumers require. The second is that it is competitive in terms of its pricing.

For its part, Malaysia's central bank has provided a stable, prudential and open regulatory framework to operate within. Regulatory oversight on capital adequacy, government standards and risk-management standards have all been intensified. The increased capital requirements imposed on banks from 2001 are indicative, and pushed the country's much-needed consolidation in banking and financial services. In particular, local banking groups had to shore up RM2bn ($584m) from the previous minimum of RM300m, which helped create larger groups. Malaysia now has nine banking groups and 17 investment companies.

Open economy

Malaysia has developed into a liberalised, open economy, with a financial system that remained resilient during the crisis. While fiscal stimulus and accommodating monetary policies have been partially supporting demand, the more significant push has come from good credit flows. "This is a very critical point that is not very much appreciated," says Ms Zeti. "We [also] expect growth in 2010. We've already seen positive signs of growth in the fourth quarter of 2009 and have low unemployment, low leverage and high rate of savings."

Some fear, however, that such an open economy might lead to the introduction of a tax on financial capital inflows to protect the country's financial system from becoming overheated. However, Ms Zeti is confident that this will not be necessary. "We're not planning any controls on capital inflows. Our financial system is more developed and diversified now and we're able to absorb this increase in volatility. In the first quarter of 2008 we were able to absorb the massive inflow that caused our currency to increase sharply. Since we moved to a flexible regime in 2005, our currency [has] appreciated cumulatively 20%."

Sukuk leader

The financial system's strength is certainly visible in capital markets, where Malaysia's sukuk issuance is stronger than ever. Thanks also to government-owned oil company Petronas's $1.5bn global sukuk - the world's largest ever sukuk - the country hosts 60% of the global sukuk issuance. In addition, Malaysia has successfully managed a secondary sukuk market, and Standard & Poor's has indicated that it would like the market to have a sukuk index should it become more liquid.

Sukuk are the most developed product in Islamic finance but just one of the offerings that Malaysia has developed over the years. Sharia-compliant insurance, re-insurance, and commodity related products have been studied, regulated and successfully launched. Bakarudin Ishkan, assistant governor of Malaysia's central bank, says: "We've tested almost every product, every sharia principle, and we have modified our laws accordingly." Nomura Asset Management has even managed to have a commodities fund approved under the European UCITS III scheme. A fund investing in commodities would not receive the UCITS seal because of the volatility of that market. Thanks also to the Islamic finance principles of direct ownership of the underlying assets, Nomura's fund did receive the approval from the authorities and was launched from the Luxembourg market. "This was the first time commodities were allowed in a UCITS III structure," says Nor Rejina Rahim, managing director of Nomura Asset Management. "The Luxembourg regulator was also convinced because of the Islamic nature [of the product]."

International ambitions

Malaysia has a very pragmatic approach to Islamic finance and has developed a good, clear operating framework. Both aspects support the country's ambitions as an international Islamic finance centre.

"We have a business to run, and we work on the basis of what people demand," says Musa Abdul Malek, chief executive of HSBC Amanah. "There is no point in producing very strict sharia-compliant products if there isn't much demand for them."

The growing success of Islamic products is confirmed by interest from non-Muslim investors, as Dr Zeid Ayer, chief executive of CIMB-Principal Islamic Asset Management points out. "In some of our funds, up to 35% of investors are non-Muslims and in others it's even 50%." This interest might have been spurred by the fact that, in a downturn, Islamic funds do better than conventional funds. During an upturn, however, Islamic products tend to underperform, and it remains to be seen if they will be used purely as an anticyclical measure or whether interest from the wider investment community will stick. "The [Islamic finance] industry is in its infancy," says Mr Zeid. "After the credit crunch, we're seeing more interest from investors for capital protection solutions."

Expert offering

Malaysia is also keen to establish itself as an expert on how to develop Islamic finance products. International financial centres around the world have been looking to add Islamic finance to their offering, in order to tap into the Muslim investor community, but developing such a market is no easy task. The right structures, framework and clarity need to be put in place, particularly should disputes arise. "In the UK, there still is some limitation on how far it can go [in terms of Islamic finance]," says Dr Nik Ramlah Mahmood, managing director of Malaysia's Securities Commission. "What we can offer [in Malaysia] is experience on how to issue sukuk and on compliance.

"For Islamic finance to be truly global, you need a lot of centres to be involved. Islamic finance can't work with only a couple of centres. Islamic products are providing an alternative to traditional products. That's why sukuk are over-subscribed, that's why Islamic funds have lots of interest."

Within Asia, competition from larger, more developed centres is tough. "It would be difficult for Malaysia to compete with Singapore and Hong Kong as a financial centre," says Agil Natt, chief executive of academic institution INCEIF. "But we have a lot to offer in terms of Islamic finance. We are collaborating with the UK, France, Bahrain and South Korea, and others are starting to approach us."

John Zinkin, chief executive of financial training organisation the Securities Industry Development Corporation, adds: "Malaysia needs a transport system to improve the financial centre. Having two or three meetings in one morning is difficult here while it's very feasible in Hong Kong or Singapore."

Financial inclusion push

As part of Malaysia's liberalisation programme, the country has allowed foreign banks to add four new branches to their operations this year. For every two branches in urban areas, banks are required to open two branches in rural locations in an effort to include a wider part of the population in banking services.

"We told [foreign banks]: 'you benefit from [our] social stability and the positive economic environment'," says Ms Zeti. "So they must also do their part. They've been massive profit centres and massive profits are being repatriated every year by their foreign [parents]."

In addition to those new branches, foreign banks will be free to open any microfinance branches they wish without applying for additional licences, to allow banks to create some scale and make their microfinance ventures viable.

This is just the last push towards financial inclusion in a country that prides itself as being the world leader in this area. "We're using the term 'financial inclusion' more," says Ms Zeti. "It's a catalyst for development. Malaysia is a place where income disparities are not so great. We have a balanced growth between urban and non-urban areas, and banking branches are spread around the country. We have one of the highest levels of financial inclusion measured by the number of people who have deposit accounts."

Malaysians may still be reserved, but the country's regulatory efforts and good policies speak volumes.

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