Islamic banking is a growing industry across Asia, with alternatives to conventional banking being developed to cater for the region’s huge Muslim population. Kimberley Long looks at its progress.

Meezan Bank

Despite being home to about 60% of the world’s Muslim population, the number of Islamic-compliant banking facilities across Asia is surprisingly low. This is changing, but there are big variations between countries. 

According to data published by Pew Research in 2015, the four countries with the highest Muslim populations in the world are in Asia, with Indonesia, India, Pakistan and Bangladesh home to a total of 743 million people of the religion. However, Asian countries are only just beginning to introduce regulation on the creation of Islamic finance institutions. 

Malaysia has taken the lead in establishing Islamic banking in Asia. The country’s first Islamic finance institution was established in 1969 to manage the hajj pilgrimage of local Muslims to Mecca, while its first Islamic bank was established in 1984. More recently, Maybank Group formed the Maybank Islamic subsidiary in 2008. 

The Malaysian government has taken a focused approach to expanding Islamic finance across the country. Masumi Hamahira, executive adviser of the Islamic banking window at MUFG Bank (Malaysia) Berhad, says: “In Malaysia, recent government initiatives continuously emphasise Islamic finance as an important strategic agenda. The country’s national development blueprint moving forward has included the vision to further grow its Islamic business as part of its key economic growth activities. Islamic finance is one of the seven strategic thrusts contributing to Malaysia’s overall prosperity by 2030.” 

Individual approaches

Across Asia, each country is taking its own approach to Islamic finance. The Philippines government, for example, has regulated on the creation of Islamic finance institutions. It passed the Republic Act 11439 in August 2019, which provides for the regulation and organisation of Islamic banks.

Asghar Ali Syed, principal counsel at Asian Development Bank’s (ADB) office of the general counsel, says: “This act paves the way for local and foreign banks to establish fully fledged Islamic banks and Islamic banking windows in the Philippines. From a financial inclusion perspective, this is a very positive development, especially for the Muslims in the Bangsamoro Autonomous Region in Muslim Mindanao and other regions in the Philippines.” 

Meanwhile, in Indonesia the government created a 10-year Islamic finance plan in 2018. The Financial Service Authority launched its own sharia finance roadmap in June 2017, and followed with the creation of the National Committee for Islamic finance in July 2019.

After the concept of Islamic financing was introduced in Sri Lanka in 1997, there has been continued development in the country. Hisham Ally, head of Islamic banking at Sri Lanka’s Hatton National Bank (HNB), says: “At present there are more than 15 banks and finance companies with window operations, while a fully fledged bank has also been established in the country with total asset portfolio of about SLRs250bn [$1.37bn]. Almost all of the top-ranked conventional banks and finance companies have commenced window operations to capture their share of the growing market.” 

Taking market share 

Islamic banking is now on a growth trajectory across much of Asia. The Islamic banking department of the State Bank of Pakistan stated that the share of Islamic banking in the country was up to 15.9% of total deposits during the second quarter of 2019. 

The need for compliant banking facilities is thus increasing in tandem with the growing prosperity in the region. In its Islamic Banking – Bangladesh note, published in September 2019, rating agency Moody’s argues that there is a need for greater accessibility to Islamic banking in the country, as Bangladesh’s real gross domestic product is forecast to grow by up to 7.5% in the fiscal year to June 2020. The country’s population is also becoming wealthier, increasing the demand for formal banking services, although at present Bangladesh has not established a separate law to cover sharia-compliant banking. 

Furthermore, institutions from countries with small Muslim populations have been experimenting with issuing Islamic bonds, called sukuk. As interest cannot be paid in the way that it is with a traditional bond, the issuer provides a certificate to the investors and uses the funds to purchase an asset. The asset is partially owned by the investors, and the issuer promises to pay back the bond in the future, with investors earning a share of the earnings from the asset. 

Mr Hamahira says: “In 2014, we initiated the first issuance of a yen-denominated sukuk under a 10-year multi-currency sukuk programme. The issuance provided Mitsubishi UFJ Financial Group (MUFG) with the ability to diversify its sources of funding against the increasing Islamic financial business in our book. This success also received acclaim for being the first yen-denominated sukuk to be issued in the global markets.” 

MUFG’s experience in Malaysia has enabled it to expand its reach back into its home market. Mr Hamahira adds: “During 2019, we obtained clearance from the Japanese authorities to market sukuk in Japan, becoming the first Japanese bank to do so.” 

But not all countries are willing to embrace Islamic financing, even those with a sizeable Muslim population. In 2017, the Reserve Bank of India (RBI), the country’s central bank, stated it would not be pursuing the formal adoption of Islamic banking in the country. Proposals had initially been made around its introduction as a means to increase financial inclusion across the country, as millions of Muslims were shunning conventional bank accounts on grounds of faith. Despite the RBI’s decision, however, there are still some smaller financial institutions across India that offer compliant products. 

Finding the standard

While Islamic finance is making inroads across Asia, unlike conventional banking there are not yet clear, agreed definitions from one financial institution and the next. This is because the final decision on what is deemed sharia compliant is made by a board of Islamic scholars appointed at each institution. 

Bashar Al-Natoor, global head of Islamic finance at Fitch Ratings, says: “It can be a fragmented industry. All rules start from a system of beliefs revealed in the Koran and the Sunna, but there can be significant differences in interpretation between the various schools of Islamic religious scholars and different jurisdictions.” 

The extent of the differences can impact business, even within the same country. Mr Al-Natoor adds: “This can go as far as cases of syndications having two sharia tranches and a conventional tranche, as the participant Islamic banks may not agree with each other’s fatwas [legal opinions]. There is definitely a large space for the development of standards and a legal framework in the industry.” 

There are instances of standards being introduced at a country level. The ADB is working with the Indonesian Ministry of Finance and the Otoritas Jasa Keuangan financial services authority to implement standards across banking, capital markets and insurance sectors. 

Developments are also being made on standards that can be implemented globally. A spokesperson for Pakistan’s Meezan Bank says: “The Accounting and Auditing Organisation for Islamic Financial Institutions, a standard-setting body based in Bahrain, has issued more than 55 sharia standards and 26 accounting standards. The Islamic Financial Services Board, a Kuala Lumpur-based organisation, serves as an international standard-setting body of regulatory and supervisory agencies that have vested interest in ensuring the soundness and stability of the Islamic financial services industry.” 

Financial inclusion 

Even in countries with a majority Muslim population, conventional banking is still flourishing, as the decision on whether or not to use conventional or sharia-compliant accounts comes down to the individual consumer. 

Mr Al-Natoor says: “Consumers can be divided into those who want to follow Islamic guidance strictly so won’t use a conventional bank; those who do but would prefer to do it with similar quality and offering as conventional; and those who want the high customer service of the conventional banks and would only use Islamic [banking] if it is offering something more.” 

For those who follow the teachings strictly, this can mean completely eschewing any banking facilities. Under Islamic teaching, using bank accounts that accrue interest is forbidden. In these markets, introducing Islamic finance may be the missing piece needed to bring wide-scale financial inclusion. 

Mr Syed believes the lack of information on sharia-compliant banking products may be a barrier. “Studies repeatedly indicate a strong demand for Islamic finance," he says. "However, barring some notable exceptions, the take-up of Islamic finance even in the more developed Islamic finance markets tends to be low. This points to a lack of public awareness on the Islamic finance products and services that are available. There is, therefore, a pressing need to raise awareness of Islamic finance, especially among Muslim populations. Muslims, especially in developing countries, need to know that there are banking products available that are not contrary to their religious beliefs.” 

For those who will not use conventional banks as a matter of religious principle, informing them of how Islamic financing works is paramount. Mr Ally says that HNB has been proactive in reaching the community in Sri Lanka. “Many people do not yet understand the concept of Islamic banking and that it complies with the rules of their faith," he adds. "To tackle this, HNB representatives will go out into the community to meet people and explain the concept to them. There needs to be a direct approach to encourage people to use banks, which includes adapting information to different languages.” 

Meezan Bank suggests there should be a more direct approach to getting consumers to sign up to sharia-compliant bank accounts. “The [Pakistan] government should direct its ruling bodies to have its employees account with Islamic banks,” a bank spokesperson says. The bank also suggests banking licences should not be granted to any new conventional banks. 

Ethical finance 

Islamic finance also has restrictions on where funds can be invested, prohibiting the payment of interest, as well as transactions to industry sectors that are considered unlawful, such as alcohol, tobacco and gambling. Islamic banking also requires transactions to have an underlying tangible asset, and the parties in the transaction to share the potential risks of profit and loss. 

Such requirements have seen Islamic finance work alongside a number of environmental and social governance (ESG) instruments. The arrival of the first sukuk in 2001 was only a few years ahead of the first green bond, issued in 2008. The two facilities have found a natural partner in each other. The first green sukuk was launched in Malaysia in 2017. 

But deciding what fits into the category of halal investments is not always an obvious process. Dato’ Mohamed Rafique Merican, Maybank group CEO for Islamic banking and Maybank Islamic CEO, says: “Touching on ESG, a good example is the issues surrounding palm oil. We need to understand better which part of palm oil is damaging. Peat soil, deforestation, the effects on the habitat and the communities living around those areas, but equally on what part is the economic driver component to Malaysia. How do we take a view on that? Is it going to be transitional or will it be abrupt? We need to understand that and get it aligned at the national level.” 

As the banking industry starts to move away from investing in fossil fuels, Mr Rafique Merican suggests there is no simple solution to stop supporting coal-fired power plants completely. “The existing ones we can’t ignore as they are already a core component of energy security. That transition needs to be worked out,” he says. 

Entering the digital age 

The development of Islamic banking has come in tandem with the arrival of digital banking. Banks are already investigating how using modern innovations can simplify compliance with sharia principles. “New technologies such as blockchain are under wide discussion and research by sharia and finance experts. Once the sharia compliance of any new technology is established, the same is adopted by Islamic financial institutions,” says the Meezan Bank spokesperson.   

The most recent forms of banking are finding use cases with, for example, the international Islamic finance market taking steps towards using blockchain. In August 2019, enterprise blockchain tech firm R3 announced it had teamed up with Dubai-based fintech Wethaq to support sukuk issuance. 

Nitish Bhojnagarwala, vice-president and senior credit officer of financial institutions groups at Moody’s, believes blockchain could have practical applications. “Blockchain could help to streamline transactions as the information on where the funds were obtained and how they were used could be stored and accessed easily. It would reduce the complexity of keeping track of the funds,” he says. 

However, other innovations need additional scrutiny before they are adopted. Mr Bhojnagarwala adds: “There is still uncertainty around cryptocurrency as there are no assets backing the currency, which may mean it is not in line with sharia principles.” 

MUFG’s Mr Hamahira says the application of blockchain technologies could help to reduce administrative costs. “The use of technology such as Atomic Swap [when cryptocurrencies are exchanged directly between two entities] has been discussed as a means to enable a seamless process without having centralised commodity intermediaries or exchanges,” he adds. 

Further scrutiny and verification

In the consumer space, there are also issues around certifying the veracity of sharia facilities. Mohd Sani Mohd Ismail, senior financial sector specialist at ADB’s south-east Asia regional department, says: “Sharia-compliant crowdfunding, or peer-to-peer [P2P] lending, needs additional verification to ensure that the lending or investments are continuously sharia compliant. It is similar to green finance, where investors require that their investments are continuously green. 

“But the question for sharia-based fintech is who is responsible for making these checks and disclosures? Can regulators require the P2P or crowdfunding platforms to take on this responsibility or are they merely facilitating investment as middlemen?” 

Technology has also been recognised as a tool for supporting financial inclusion. Mr Ismail says: “Indonesia is committed to using Islamic finance, especially through fintech, to enhance financial inclusion and significantly increase the existing access to finance from 49% of the population towards the 75% target the country has set for itself. It is a key agenda of the government to reduce poverty and inequality levels across the country. The ADB is supporting the Indonesian government’s efforts through a combination of policy advice, capacity-building support and various lending modalities.” 

Before Islamic finance becomes swept up in the fintech wave, HNB’s Mr Ally cautions that efforts should be made to reach out to consumers who need the most basic banking functions. “Technology may help in the future but for now, people need to have face-to-face contact to educate them about banking," he says. "They want to go into branches. When Islamic banking is better understood, we may develop a wider digital offering, but for now the priority is educating people.” 

Making it mainstream 

As Islamic financing develops, it is encountering new issues that may in turn hold it back. For example, as the level of deposits into the banks grows, opportunities will be required to utilise these funds.

“In more developed Islamic finance markets, one of the most significant challenges which will need to be overcome is liquidity management. Islamic banks in these markets tends to have sizeable deposits,” says the ADB’s Mr Syed. “However, there are an insufficient number of viable Islamic financial instruments in which Islamic banks may invest these depositor funds. Accordingly, Islamic banks find it difficult to compete with conventional banks when, for example, sukuk are issued infrequently and on an intermittent basis, whereas the issuance of comparable instruments for conventional banks tends to be far more frequent.” 

Another concern is having enough bank staff trained in Islamic finance to meet the demand in both the corporate and retail sectors – something that is essential, stresses Mr Hamahira. 

Mr Syed says this is where the multilaterals can help. “There is a need to prepare implementing rules and regulations to operationalise Islamic finance and enhance knowledge of Islamic finance," he says. "Under technical assistance for Islamic finance, ADB is providing regulatory expertise and capacity development support. The ADB is also working closely with Bangko Sentral ng Pilipinas [the Philippines central bank] and other regulators and government departments in this regard.” 

With a growing level of experience in developing Islamic finance products, institutions across the region are now looking at how they can take this expertise into Europe and beyond. Mr Rafique Merican says: “We understand that under the Bank of England, there is a team that looks at Islamic finance. So maybe at some point it would be interesting to explore what is the potential in the UK.”


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