POLICY CONSIDERATIONS IN DEVELOPING A DUAL FINANCIAL SYSTEM IN MALAYSIA ISLAMIC FINANCE INTELLECTUAL DISCOURSE 20 TH OCTOBER 2016 NOVOTEL MELAKA

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1 POLICY CONSIDERATIONS IN DEVELOPING A DUAL FINANCIAL SYSTEM IN MALAYSIA ISLAMIC FINANCE INTELLECTUAL DISCOURSE 20 TH OCTOBER 2016 NOVOTEL MELAKA Rustam Mohd Idris Islamic Banking & Takaful Department

2 Disclaimer This document is solely for the use of the participants of the Islamic Finance Intellectual Discourse (18 20 October 2016) All information in this document shall not be circulated, copied or reproduced in whole or in part, nor publicly referred to or discussed unless with the prior written approval from Bank Negara Malaysia (BNM) or the information has been officially released by BNM to the public. The information was not prepared with the specific consideration of any particular individual or entity. Any views expressed in this document are those of the author and are not necessarily those of BNM. While every care is taken in the preparation of the information, no responsibility can be accepted by BNM for any errors and any liability for any loss or damage arising from the use of, or reliance on, the information contained in this document. 2

3 Where we are now How we reach to this level What are the policy considerations What s next 3

4 IF has entered its third decade of development Asset: RM685.4 billion Domestic market share: 26.8% Islamic banking Source : BNM s Financial Stability & Payment System Report 2015 Takaful Islamic AuM: RM132.4 billion Market share: 19.8% Source : Bi-Annual Bulletin of Malaysian Islamic Capital Market Islamic fund Sukuk Contribution: RM6.8 billion Domestic market share: 12.9% Source : BNM s Financial Stability & Payment System Report 2015 Outstanding: RM749 billion Global market share: 54.3% Sources : Zawya Islamic, Thompson Reuters All figures as at end

5 ..with a comprehensive IF ecosystem Legal certainty to conduct IF Central Bank of Malaysia Act 2009 Islamic Financial Services Act 2013 Harmonisation of IF matters in existing laws Dispute resolution mechanism Established Shariah-compliance framework Two-tier Shariah Governance Structure Shariah Governance Framework Shariah & Operational Standards on key Shariah contracts Comprehensive prudential regulations Adopts BASEL & IFSB standards Legal, Shariah & Regulation Institutional development Diversified range of players, including 16 Islamic banks (8 leveraged model) 11 Islamic windows 6 development financial institutions (2 are full-fledge DFIs) 11 takaful operators 3 retakaful operators Established supporting infrastructure Malaysia Deposit Insurance Corporation safety net Professional ancillary services providers (law firms, accounting firms, rating agencies, trust companies, consultancy firms etc.) Wide-ranging products cater for discerning market needs Efficient liquidity management Lender of last resort facilities Specific Islamic instruments to support liquidity management operation Active Islamic interbank money market Bursa Suq Al-Sila facilitates efficiency in commodity murabahah transactions Product & market Knowledge & education Several learning institutions offer IF courses Dedicated training institutions to develop IF professionals Dedicated Shariah research institute conducts focussed Shariah research for the industry Continuous industry-led awareness programme 5

6 Islamic banking, takaful & Islamic wealth management Shariah compliant securities Sustained growth Sources : BNM s Financial Stability & Payment System Report 2015, Securities Commission Dec

7 Similarly for sukuk market 7

8 Spearheaded several key IF initiatives Host to IFSB & IILM MIFC initiative - initiative that triggers several IFC initiatives in other parts of the world Dedicated post graduate university in IF Largest repository of Shariah research Sources: Bloomberg, The Malaysian Reserve, Islamic Finance News, Reuters, The Banker 8

9 Where we are now How we reach to this level What are the policy considerations What s next 9

10 Driven by four key enablers Supportive Government Facilitative central bank Responsive markets Receptive public 10

11 Government of Malaysia has been very supportive National Agenda Provides enabling Enabling legal legal environment through:- environment Dedicated legislation & IF provision in conventional legislation Non- discriminatory policy through tax neutrality framework Dedicated High Court & i-arbitration for IF Continuous sukuk issuance GII, Islamic Treasury Bills, sovereign sukuks 11

12 Consistent facilitator of IF agenda since 80s Firm believer of financial inclusion & viability of IF s contribution to national growth Islamic Finance is one of BNM s key agenda Strong advocate of financial stability Regulator & supervisor of licensed IFIs Comprehensive regulatory / supervisory oversight for IFIs Comprehensive prudential policies to achieve stability & compliance. Develop Islamic money markets & liquidity instruments Dedicated department (JPIT) to deliver IF mandates 12

13 Strong buy in from markets due to its economics' viability & commercial considerations Consistent outreach programmes to create awareness Markets that are responsive Effective distribution of IF products & services Innovative in designing new products 13

14 Strong acceptance from Malaysian population Initial objective to cater for Muslim religious needs evolved into commercial consideration. Non-Muslim becomes important component of IF s growth. Malaysian population is a very important determinant that ensures success of IF 14 14

15 Where we are now How we reach to this level What are the policy considerations What s next 15

16 4 main principles in formulating policy considerations. Implications to financial stability Phased in approach Comprehensive and structured framework Shariah compliance as key oversight 16

17 1980s What were the concerns then? Dual role of BNM The appropriateness for the Islamic bank to be placed under BNM Issue of treatment between Islamic bank vs conventional bank Possible disruption of the banking system Possibility of a large migration of funds from conventional banks into Islamic bank. Pressure for more Islamic banks Demand for more Islamic banks Possible conversion of existing banks, especially Government-owned bank Containing the fear of non-muslim Racial harmony non Muslims may view that the establishment of an Islamic bank is an attempt to impose Islamic principles on the entire economic system. Effects on foreign investments Possible concerns on Foreign Direct Investments These concerns were addressed establishment of 1 st Islamic bank becomes a reality. 17

18 1990s Anchored on Governor Jaafar s speech. His dream for Malaysia to have a complete financial system i.e. conventional & Islamic financial system Islamic window requires clear segregation of funds Adequacy of Shariah scholars well-versed in finance Possible formation of a central Shariah council 4 Shariah considerations 1 Approach in disseminating IF nationwide Adequacy of instruments to meet liquidity requirements 3 1 Available options o Issue more Islamic banking licenses o Allow conventional banks to setup Islamic branches o Allow conventional banks to setup Islamic windows Readiness of Islamic banks & TOs 2 2 Readiness of Islamic bank to compete with Islamic window Adequacy of single TO to absorb expanded IF business Larger number of players warranted the need to match deficit & surplus unit Viability of Islamic money market 18

19 1990s Some key initiatives & outcomes Nation wide dissemination from 40 branches to 1000 branches Establishment of Islamic money market Separate system for fund segregation Market share increase from virtually nil to 5% Increase in number of takaful operators Formation of SAC. 19

20 2000s : Policy considerations guided by FSMP Realising a comprehensive Islamic financial system number of Islamic banks & TOs to stimulate competition Deepen Islamic financial market 20% market share by 2010 Financial Infrastructure development Strengthen regulatory framework for Islamic banks & TOs Establish an effective legal structure Codified dual financial system in CBoM Act 2009 Regulatory framework development Institutional capacity enhancement Benchmarking Enhance knowledge & expertise Strong management team 20

21 2000s : Some key initiatives & outcomes Positioning Malaysia as an Islamic financial center (formation of MIFC) Capacity building Transformation of IBFIM Establishment of INCEIF & ISRA Creating strong & highly capitalized Islamic banks & TOs Liberalising policy for foreign players Transformation of windows to subsidiaries Strengthened legal & Shariah framework New CBoM Act SAC as apex SGF Establishment of multilateral institutions in Malaysia Development of new market & financial infrastructure Sukuk dominates IF growth Bursa Suq As-Sila 21

22 2010s &current: Policy Considerations guided by FSBP Islamic Financial Services Act 2013 Shariah contract based regulatory framework Investment intermediation Enhance professionalism of IF talent 22

23 Reflecting Shariah in Islamic Financial Services Act 2013 Scope of Business Definition of Islamic banking business Definition of Islamic deposit & Investment account Islamic Financial Services Act 2013 BNM s Role in Regulating Shariah Compliance Regulatory objectives promote financial stability & Shariah compliance Duty of authorised person to ensure compliance with Shariah Power of BNM to specify standards on Shariah matters Non-compliance with Shariah as trigger for intervention & enforcement actions Shariah Compliance & Governance Requirements Establishment of Shariah committee Duties & functions of Shariah committee Requirements relating appointment & cessation of Shariah committee 23

24 Clarity of BNM s role under IFSA that include Shariah Monetary Stability Efficient Payment System Financial Stability Shariah Compliance Regulatory Role Formulation of comprehensive regulatory framework, institutional & infrastructure building with effective & efficient consumer protection Supervisory Role Development and implementation of a sustainable, progressive and robust Shariah supervision framework to ensure the safety and soundness of financial institutions in accordance with Shariah Developmental Role Formation of strategic initiatives aimed to institute a comprehensive financial infrastructure supported by key ancillary institutions through holistic developmental plans 24

25 Defined regulatory framework for IF anchored on two regulatory objectives Preserve sound Islamic financial system Preserve sanctity of Shariah conducts 1 Protection of depositors, investment account holders & policyholders Preventing mismanagement of public funds Objective: Ensure financial stability 1 Understand the fundamental Shariah as backbone of Islamic finance Specific approach taken to ensure compliance with Shariah principles 2 To preserve public confidence Setting minimum standards that all industry players must adhere to 3 To correct market imperfections Protecting consumer interests e.g. issues on information asymmetry, monopolistic or noncompetitive behavior 4 Need to moderate the problem of moral hazard Counter the negative effects of safety net arrangements such as tendency for excessive risk taking by industry players 2 Appreciate the uniqueness Recognise unique structures of Islamic finance Identify distinctive risks for Islamic finance 3 Recognise the environment Understand local industry, customise regulatory & supervisory approach to nature of Islamic finance Resolve pressing & emerging system-wide issues 4 Acknowledge the challenge Identify pre-requisites for sustainable system e.g. human capital, infrastructure, capacity & capability Balancing the need for prudential regulation & strategic aspiration 25

26 FSMP & FSBP has facilitated in transforming IF into a modern, advanced & comprehensive IF ecosystem Financial Sector Masterplan ( ) Financial Sector Blueprint ( ) 26

27 Legal & Shariah Development LAWS OF MALAYSIA Act 701 CENTRAL BANK OF MALAYSIA ACT 2009 The financial system in Malaysia shall consist of the conventional financial system and the Islamic financial system. Section 27, Central Bank of Malaysia Act 2009 LAWS OF MALAYSIA Act 799 ISLAMIC FINANCIAL SERVICES ACT 2013 The principal regulatory objectives of this Act are to promote financial stability and compliance with Shariah Section 6, Islamic Financial Services Act 2013 Dato Dr. Mohd Daud Bakar SAC Chairman Authority for the ascertainment of Islamic law for IF industry Decision of SAC is binding on IFIs, court, arbitration & BNM Dedicated judge to adjudicate Islamic finance cases Shariah Resolutions in IFaims to be an essential guide and reference point for the Islamic financial community. Tun Abdul Hamid Former Chief Justice of Malaysia/ Chairman of LHC Ensures Malaysian Law is facilitative for IF transactions for greater certainty Made recommendations for the amendment of relevant laws Rules of High Court, Land laws 27

28 Key Strategic & Regulatory Policies TRANFORMATION of Islamic windows into licensed Islamic banks ISSUANCE OF ISLAMIC BANK LICENSES to qualified foreign institutions ISSUANCE OF KEY PRUDENTIAL POLICIES Capital Adequacy Framework Liquidity Framework Shariah Governance Framework Investment Account Framework Takaful Operational Framework Shariah & Operational Standards Late Payment Charges & Ibra GL on Islamic windows ISSUANCE OF TAKAFUL LICENSES to qualified parties, including foreign parties market share met in 2010 Target of market share by 2020 A palm oil bourse to facilitate tawarruq transactions 28

29 Capacity Building & Talent Development Promotes applied research in the area of Shariah & IF. Recognised by Thomson Reuters as the top global contributor in dedicated IF researches ( ) An industry-owned institute to enhance technical skills & knowledge of IF practitioners Trained more than 30% of total IF industry workforce Robust KMC 63 titles published & more than 11,000 books stored Association for Shariah advisers & Shariah officers to enhance professionalism SHARIAH LEADERSHIP EDUCATION Specialised programs to educate Shariah advisers on banking & finance Professional body responsible to promote highest standard of professional practice amongst IF practitioners. 29

30 International Initiatives Malaysia play host to IFSB supported via IFSB Act 2002 An international standard-setting organisation that formulate standards for IFIs globally Issued 24 standards & guiding principles Several regulators including BNM have adopted IFSB standards Malaysia play host to IILM & supported via the IILM Corporation Act 2011 An international corporation that facilitates crossborder Islamic liquidity management through issuance of sukuk. Outstanding sukuk issued as at end Dec USD 1.85 bil amount of Malaysia has earned its position as an international marketplace for Islamic finance. 30

31 Malaysia s MIFC initiative greater international integration and inter-linkages on Islamic finance Established in 2006 Malaysia's Islamic finance marketplace is open to global industry players and market participants to collaborate with and mutually benefit from a highly conducive business environment of innovation, expertise and deal flow. CAPITAL MARKETS BANKING TAKAFUL TALENT DEVELOPMENT PROFESSIONAL SERVICES Mark Mobius, Ph.D Executive Chairman, Templeton Emerging Markets Group March 2015 David Cameron Former Prime Minister of the United Kingdom October

32 From IF MEETS IN MALAYSIA SHAPING IF TOGETHER MALAYSIA WORLD S IF MARKETPLACE 32 32

33 Where we are now How we reach to this level What are the policy considerations What s next 33

34 Key drivers to advance IF to the next level New trajectory to capture 40% market share by Investment intermediation Contract-based regulatory framework Value-based financial system Education and awareness 34

35 Enhancing role of Islamic banks to further strengthen its intermediary functions & promote risk sharing To reduce reliance on banking activities as main source of finance for IFIs, the latest regulation, IFSA 2013, introduced Investment Account (IA) as an alternative source of funding i. IFSA redefines Islamic deposit and IA for greater clarity IA demonstrated strong exponential growth since its inception in July 2015 (110% growth after a year from RM32.3 billion to RM67.8 billion) Industry-led digital innovation led to the development of the IA Platform (IAP) - bridge investors with prospective ventures to facilitate efficient operationalisation of IA Investment intermediation Contract-based regulatory framework Value-based financial system Education and awareness 35

36 REGULATORY FRAMEWORK Requirements under Investment Account (IA) Framework 1. Bank accept IA funds from customers 2. Bank channels IA fund to financing assets Provide disclosures on the corresponding assets of each IA fund & related risk-return profiles Conduct suitability assessment on customers eligibility & risk appetite Recommend appropriate products based on customers risk appetite Propose Shariah contracts which will define bank s intermediary s role & basis for attributing returns generated to bank & IA holders Conduct due diligence on prospective financing assets to ensure that risks undertaken are aligned with the investment mandate Match funds received with underlying assets according to the investment mandate Ensure proper governance to safeguard customers interests & bank s reputation Maintain clear separation of funds for: Distribution of principal & returns Resolution on winding-up 3. Bank s continuous roles Conduct regular monitoring Report performance to customers Distribute profit to customers at preagreed terms Identify exit mechanism & perform recovery, if required 36

37 Industry-led initiative on Investment Account Platform facilitates efficient operationalisation of IA by bridging investors with prospective ventures Key features Centralised platform channelling funds from investors to viable entrepreneurial projects Incorporates robust disclosure regime Operates on secured internet-based architecture 37

38 Initiatives to advance Islamic finance to the next level Investment intermediation Contract-based regulatory framework to reflect underlying Shariah tenets of the respective contracts Contract-based regulatory framework The framework supports the effective application of Shariah contracts in the offering of Islamic financial products and services The diverse spectrum of Shariah contracts provides the opportunity for Islamic banks to expand their product offerings beyond the traditional debt-based products To increase dynamic offerings of Islamic banks that can effectively match the diverse needs of customers Value-based financial system Education and awareness 14 Shariah Standards have been developed to facilitate the implementation of Shariah & operational requirements 38

39 Shariah contract-based regulatory framework for Islamic finance Islamic banks conduct financial intermediation functions using various Shariah contracts IFSA reflects Shariah contracts specificities and enables issuances of - Shariah Standards Islamic financial system Practice Guides Compliance with fundamental requirements of respective Shariah contracts Strengthen risk management, legal, accounting and other operational aspects of applying Shariah Standards Supports effective application of Shariah contracts in Islamic banking business Towards achieving value propositions of Islamic finance Financial intermediation that serves real economy Distinct risk and reward profiles based on Shariah contracts 39

40 Shariah standards & operational requirements Murabahah (cost plus mark-up sale) Musharakah (profit & loss sharing) Mudharabah (profit sharing & loss bearing) Qard (loan) Major Shariah contracts Istisna (sale of asset to be constructed) Wakalah (agency) Kafalah (guarantee) Tawarruq (commodity murabahah) Hibah (gift) Ijarah (lease) Wa d (promise) Wadi ah (safe custody) Rahn (pledge) Sarf (currency exchange) due for completion by

41 Initiatives to advance Islamic finance to the next level Strengthening role of Islamic finance as value-based finance that shapes a valuebased financial ecosystem IF has inherent characteristics, in line with values, to spearhead efforts of shaping a valuebased financial ecosystem Currently developing proposal to measure performance of IFIs beyond financial aspect Investment intermediation Contract-based regulatory framework Corporate value intent (CVI) as a key parameter to measure IFIs performances based on 5 key elements: i. Good self governance ii. Entrepreneurial mindset iii. Community empowerment iv. Best conduct v. Greater transparency Value-based financial system Education and awareness 41

42 Community empowerment initiative Linking Islamic finance through waqf and sadaqah Potentials for Islamic finance Efficient waqf &sadaqah management Opportunity for Islamic banks to give back to society Alternative funding sources for waqf land development 4 innovative solutions currently being offered by Islamic banks 1) Wakaf Selangor-Mumalat is a cash waqf collaboration channelled for education and health benefits 2) Bank Islam introduced e-donation terminals in mosques 3) Affin Barakah Charity account-i is a deposit product where earned profit/dividend (hibah) can be donated 4) Maybank Islamic collaborating with Majlis Agama Islam Perak (MAIP) to collect cash waqf from the public Desired outcomes Increase in size of waqf & sadaqah collected Expand range of cash waqf & sadaqah products Finance more social projects that are impactful to community Note Community empowerment initiative is referring to social finance 42

43 Initiatives to advance Islamic finance to the next level Investment intermediation Contract-based regulatory framework Value-based financial system Continuously promote greater understanding of IF s value propositions Towards greater acceptance & avoiding misconception on Islamic finance Education and awareness 43

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45 Educator s Manual for Murabahah Standard Pilot project A collaborative effort BNM,ISRA and IBFIM. To assist the teaching faculty to infuse relevant practical elements of murabahah into the current academic syllabus. It exposes the students and academicians to the operational aspects and practical application of murabahah. Universiti Sains Islam Malaysia (USIM) and Universiti Islam Antarabangsa Malaysia (UIAM) have agreed to adopt the Educator's Manual in their teaching syllabus The principles, pillars and components of murabahah including the recommended best practices are deliberated in an illustrative and attractive format Educator s Manual of other Shariah contracts will be issued in gradual 45

46 Disclaimer: While every care is taken in the preparation of this publication, no responsibility can be accepted for any errors. Copyright: All or any other portion of this presentation may be reproduced provided acknowledgement of the source is made. Notification of such use is required. All rights reserved. 46