Never mind the global impact of interest rate hikes by the United States Federal Reserve or of British exit from the European Union now that London has officially invoked Article 50 of the Lisbon Treaty, thus signalling the start of divorce negotiations with Brussels, or the downturn in Chinese gross domestic product (GDP) growth, the standout segment of the Malaysian financial system, the country’s Islamic banking sector, continues its impressive growth.
Reading between the lines of Bank Negara Malaysia’s (BNM) 2016 Financial Stability Report, which was released last week by Governor Datuk Muhammad Ibrahim, the market share of Islamic banking assets of the total banking assets in Malaysia could very well break the 30 per cent barrier this year if it maintains its upward year-on-year growth trajectory of the last few years. Last year, the market share touched 28 per cent, up from 26.8 per cent in 2015.
This would be almost three years ahead of the 30 per cent target by 2020 set by Prime Minister Datuk Seri Najib Razak in 2016 for the country’s Islamic banking sector and indicates an entrenched resilience of an industry, which like its conventional counterpart, continues to be faced with both internal and external challenges relating to financial stability risks, market volatility, financial inclusion and embracing fast-evolving alternative finance technology solutions. For instance, household debt in Malaysia, though lower as a proportion of GDP at 88.4 per cent last year compared with 89.1 percent in 2015, is still relatively high.
But, in the context of the International Monetary Fund (IMF) definition of what constitutes a banking system of systemic importance — that is 15 per cent market share of the overall banking system assets — Malaysia’s Islamic banking industry assumes increasing systemic importance. If its growth continues unabated — and there are no indications or any reasons why this growth should suddenly flatten out — it is reasonable to conclude that it is only a matter of time that this growth trajectory should hit a 50 per cent market share over the next decade or two.
The Islamic banking asset growth has been phenomenal, increasing from RM495 billion in 2012 to RM685 billion in 2015, to RM742 billion last year. The growing impact of the industry on the Malaysian economy is further highlighted by its market share of the total financing of the economy through consumer and corporate loans. Last year, Islamic financing accounted for a third of all bank financing at RM550 billion — some RM55 billion up from the previous year. The same is true for the market share of Islamic deposits and investment accounts, which stood at RM602 billion, or 31.8 per cent.
BNM is expecting syariah-compliant financing to account for 40 per cent of total financing in Malaysia by 2020, with the reality that this figure could reach 50 per cent before the following decade, as it is happening in other key Islamic finance markets such as Saudi Arabia.
A major development here is the increasing role of commodity murabahah or tawarruq, which is well-established in the Gulf markets, but which has been gaining prominence in Malaysia over the last three years. Last year, tawarruq financing grew over 34 per cent to account for 22.4 per cent of total outstanding syariah-compliant financing. The growth has been largely spurred by the commodity trading operations of Bursa Suq Al-Sila, which has reduced costs and risks associated with such transactions.
London has the most comprehensive commodity murabahah platform largely through warrants on the London Metals Exchange, followed by platforms in Dubai, Kuala Lumpur and Bahrain. With e-trade facilitation platforms now becoming the norm, it would make sense for these platforms to cooperate instead of competing, thus offering a one-stop comprehensive universal platform, which would lead to economies of scale and cost savings.
It would also widen the underlying commodity asset universe, which are restrictive for some of the platforms, and also facilitate a more sophisticated, competitive and much-needed cross-border short-term liquidity management mechanism for the global Islamic finance industry.
Compared with other major Islamic finance markets such as Saudi Arabia, the United Arab Emirates, Qatar and Kuwait, the Malaysian market differs in a crucial way in that it is as comprehensive and holistic as its conventional counterpart, effectively mirroring it in terms of architecture complete with a syariah-compliant interbank system, cheque clearing and payments, and deposit insurance scheme.
However, mere targets are not going to achieve Malaysia’s lofty ambition. “In meeting the demand for syariah-compliant financial products and services,” stressed Muhammad, “Islamic financial institutions are expected to assume a larger role in value-based intermediation, beyond existing credit intermediation roles, to contribute more effectively towards the broader economic and social development. Over the next two years, the development of the Islamic finance industry will focus on enabling greater business diversification, driven by technology, to sustain its growth trajectory and deliver better value to customers.”
Another challenge for Malaysia’s Islamic finance industry going forward is its impact on the real economy especially in trade finance facilitation, where, according to BNM, business opportunities using technological capture have remained largely untapped by the industry.
The Islamic finance industry currently represents only 3.4 per cent of total trade, and less than a third of overall trade finance from the banking system. BNM is keen for the industry to support 10 per cent of Malaysia’s total trade in the next three years.
“There is significant growth potential for trade finance facilitation to support halal exports, which can be seen through the increasing participation of small- and medium-scale enterprises in the halal economy, initiated by the government, to meet the strong demand for halal products and services globally,” stressed BNM.
The acid test is for BNM and other agencies to regularly assess the economic and societal impact of Islamic finance, like its conventional counterpart, given the huge amounts the Malaysian taxpayer has invested in developing the two systems. The good news is that BNM, in collaboration with the industry, is in the process of developing a number of such initiatives.
Mushtak Parker is an independent London-based economist and writer