Islamic finance is ethical finance
Question:What is the Islamic finance market learning from the global financial crisis, and how is it positioned both to survive the current period and perhaps even to emerge more successful?
Dr. Zeti: First of all, when Islamic finance is practiced, it should be embraced in its entirety, in full Shariah compliance – that is the lesson that I think has been continually reinforced over the course of the global financial crisis. In its essence, this means that all financial transactions must have an underlying economic activity; that you will not be involved in excessive risk – that the value of the financial transaction cannot exceed the value of the underlying income stream; and in this way we will avoid overleveraging, or speculative activity not based on the underlying value activity.
Second, Islamic finance must continue to focus on producing results – near term results, but also results that are sustainable over a long period of time. Embedded in Islamic finance is the idea that profit-sharing is also risk-sharing – and that entails strong risk management and governance practices. If the different components of the Islamic financial infrastructure, which includes the money market, where we manage liquidity – if these components are supported by a strong system that enables effective functioning of the intermediation process, then we can withstand the periods of difficult conditions and hopefully emerge stronger as a result.
Third, we come to the regulatory process. One of the lessons we learned from the current crisis is that there were gaps in the global financial regulatory regime – in this case, for example, investment banks were not properly regulated, hedge funds were not regulated, and there are other gaps in the regulatory regime that have led to this problem. The regulatory regime of Islamic finance has been quite extensively developed. For example, some time back, a group of us came together and agreed to work to establish an agency that would address the prudential regulations that were necessary for a healthy market, and as a result we established the Islamic Financial Services Board in 2002. That was a major milestone, and since that time the IFSB has been active in issuing measures and standards to promote capital adequacy management, disclosure and transparency. It is necessary to continue working towards implementing these prudential standards.
Finally, the values embedded in Islamic finance – fairness, justice, equity – these are the values that will help us not only to survive the current crisis but to sustain and grow our presence in the economic cycles to come. In fact I believe the Vatican issued a statement on March 4 in reference to Islamic finance [reading from press release]: “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,” according to the Vatican’s official newspaper “Osservatore Romano.”
That’s going back to basics, back to values, back to what banking used to be, and back to what is necessary to succeed going forward.
Q: How do you see the development of Islamic finance in the Asia Pacific region and beyond? How does Malaysia intend to maintain its preeminent position, given the level of competition that appears to be emerging from other economies in the region?
Dr. Zeti: The very survival of Islamic finance depends in part on how competitive it is from an economic standpoint in an environment where the conventional system dominates, as it does, throughout the Asia Pacific region. So competition is healthy in this regard. Given that, we have seen this market grow in a very robust way, with significant participation by non-Muslims as well. Recently I came across one statistic – that about 70 percent of the clients of one of our large Islamic banks are non-Muslim. They were attracted not for reasons of faith, but because of the competitive structures on offer.
Additionally, looking beyond Asia Pacific, we see interest growing in Europe – in traditional financial centers like Frankfurt, London and Paris. In fact I just came back from London and found there to be immense interest over there, evidenced for example by a Memorandum of Understanding we signed with the U.K. Trade & Investment [UKTI]. We noted a number of areas of interest in which they want to follow up.
Also in regard to the U.K., we have the example of the agreement between INCEIF (International Center for Education in Islamic Finance), and Reading University, the fifth-ranked MBA program in England and a truly forward-looking business school. The arrangement allows their students to come here (to INCEIF) for one semester to learn about Islamic finance, and the credits they gain from INCEIF count towards their MBA in Reading.
To sum up in terms of how we see the growth of this market outside Malaysia – I first gave a speech regarding Islamic finance (in my capacity as Governor of Bank Negara Malaysia) in 2001, in Bahrain, and since then I have given numerous talks and presentations in other markets in Asia and Europe, in Japan (where there is considerable interest in the subject), in Hong Kong several times, London and also Washington. We don’t look at other markets as competition – we want to enhance our linkages with as many as possible so there will be financial flows from one sector to another and also trade linkages, investment linkages – this in our opinion is a recipe to enhance prosperity overall.
Q: Do you have any specific plans to extend linkages in the United States in the near term?
Dr. Zeti: I do meet with different groups on the subject when I am in the U.S. and hope to continue to do so. I can recall one event – in 2001, I was invited by then-Secretary of the Treasury Paul O’Neill to speak at a G-7 conference and was able to subsequently publish my remarks. At the time they were interested to know more about Islamic finance from the standpoint of whether it could be used as a conduit for terrorist financing. I replied that in Islamic finance, the fundamental principles – for example the very strict requirement that every transaction be based on real underlying economic activity – make it much less likely that terrorist financing could be manipulated through Islamic financial vehicles than through conventional mechanisms.
The ministers – and there were representatives from major countries outside the G-7, like Brazil and China as well – were also interested to understand more about Islamic financial products – for example, how can you issue bonds which do not bear interest? I explained to them the concept of “sukuk” and how we incorporate concepts like “murabahah” (cost-plus), “musharakah” (partnership) and “ijarah” (leasing) into these instruments to make them both Shariah-compliant and economically attractive to capital markets participants.
Q: Is there a talent deficit in Islamic finance, and if so what are you doing to nurture and develop new talent?
Dr. Zeti: I think we foresaw the potential for a talent deficit as we took account of the growth in this market and our own moves to liberalize Malaysia’s financial system to allow more foreign participation. One of the principal things we have done in this regard has been to establish INCEIF (International Center for Education in Islamic Finance). [Note: Dr. Aziz currently serves as chancellor of INCEIF]. We undertook this effort five years ago and our primary motivation was to ensure that when Islamic finance is practiced in our market there will be a sufficient pool of qualified talent able to practice it correctly. As the market grows, we have to ensure that the participants realize what it entails. It is not just about replicating conventional products: We must embrace the Shariah principles on which this market is founded, and it is important to have this education accessible to practitioners. That is how INCEIF started – for practitioners to gain the necessary qualifications. I was quite pleased to see the first group of graduates – 32 individuals from six countries. They will be the supply of talent as Islamic finance evolves to its next level.
At INCEIF, people can participate via distance learning as well. We have alliances with Indonesia, Abu Dhabi, Bahrain and Dubai, among others. We supply them with our materials, they take our exams, and in this way we maintain our high standards. We are also currently in the process of expanding our international faculty to help us maintain these standards.
And of course, recently INCEIF was accorded university status and thus has begun to offer Master’s and Ph.D. programs as well – truly a unique academic institution.
Q: What else would you want a United States-based reader of “The Washington Times” to know after reading this report on Islamic finance?
Dr. Zeti: Mostly, I would like the readers of this report – in the U.S. or anywhere else – to understand the following: that Islamic finance as a system represents the fundamental aspects of what we know traditional finance to be, supported by ethics and values that have meaning, not only for those who follow Islam, but that are really universal in nature. In a time of crisis in global financial markets, Islamic finance can help contribute to overall financial stability due to the inherent nature of checks and balances embedded in Islamic financial structures that act as protection against the worst excesses of leverage and speculation that we have witnessed recently. These universal ethics and values are something that all financial systems aspire to promulgate – but in Islamic finance they are not just desired, but they are an inherent and inseparable part of the very essence of the system.
