Need smart partnerships between banks

How has Bank Negara Malaysia (BNM) been instrumental in helping Malaysian banks attain global perspective?
Dr Aziz: An important precondition for enhancing the global dimension of the domestic financial system is a strong and resilient financial system. Malaysia has therefore directed considerable efforts towards financial reform and financial infrastructure development before liberalising our financial system. This has involved restructuring, consolidation and rationalisation, in particular, of the banking system. It has also involved strengthening corporate governance, the risk management capabilities of the financial institutions, the investment in technology and enhancing the human capital development in the industry. These capacity building initiatives and institutional development of the banking institutions have been instrumental in strengthening and enhancing the capacity of Malaysian institutions to compete effectively both in the domestic and international financial system.
These developments were followed by developing the capital market and progressively liberalising the foreign exchange administration rules that allows for the free inflow and outflow of funds. The progressive relaxation of the rules over the period 2003 to 2005 and the transition to a more flexible exchange rate regime in 2005 have generated a significant range of new business opportunities for the banking institutions.
Finally, issuing new licences to foreign players, increasing the potential for strategic interest of foreign entities in domestic financial institutions and encouraging those domestic institutions with the capacity to operate abroad have encouraged domestic institutions to have a greater global perspective.
Bank Negara Malaysia has also established the International Centre for Education in Islamic Finance (INCEIF) with programmes for developing expertise in Islamic finance. We have participation from forty-six countries at the Centre. The pool of talent will thus be diversified from different countries reinforcing the increased global perspective.

Malaysia has taken the lead over others on issues of global Islamic banking and finance. Please define Malaysian banks and their role and scope for U.A.E and Gulf Council Countries in forging alliance in this region.
Dr Aziz: Malaysia has developed a comprehensive Islamic financial system that not only includes banking but also the takaful and the Islamic money and capital markets. The Islamic financial system is also well supported by a legal, regulatory and supervisory framework that is reinforced by the shariah framework.
There is tremendous potential for forging strategic alliance between the Middle East and Malaysia. With the well developed Islamic financial system and the strong underlying economy, Malaysia represents a potential gateway to the markets in Asia. Three Islamic banking licences have been issued to Middle East banks which are now commencing operations in Malaysia.   Various other foreign banks and investment groups are in the process of taking strategic stakes in Malaysian financial institutions. These partnerships would contribute towards accelerating the process and towards serving as a bridge to strengthen the relationship of the international Islamic financial markets as well as the investment and trade ties between Asia and the Middle East.
In addition, the new licences to conduct international currency Islamic banking business has been introduced to attract global Islamic financial institutions to make Malaysia their hub for their regional business operations. We expect foreign institutions and international investors, including from the Middle East, to explore the opportunities offered through these initiatives and to leverage on Malaysia as an investment gateway to tap the rapidly growing investment opportunities in the East Asian region. Financial activities in international currencies include the areas of the origination, issuance and trading of Islamic capital market and treasury instruments, Islamic fund and wealth management, international currency Islamic financial services market, as well as in takaful and retakaful.
Malaysian banks have also ventured into the Middle East. The smart partnerships and strategic alliances between East and West Asia would mutually reinforce inter-regional integration and provide synergies and opportunities for the diversification of investments and strengthening the inter-linkages amongst the Islamic financial centres and thus facilitate the flows of Islamic investments in the global financial system.

Any keen interest shown by foreign banks in Islamic banking and finance and its products?
Dr Aziz: There is significant interest by foreign banks in Islamic banking and finance. In Malaysia, foreign banks account for about 13 per cent of the total assets. A number of these banks have announced Malaysia as their regional Islamic financial hub. Their participation is likely to increase following the new measures announced in 2006 to allow entities to be established in Malaysia to undertake foreign currency business in Islamic finance.
In the area of takaful, four new licences were issued recently that were joint ventures with foreign participation. There was an overwhelming foreign interest in participating in this sector.
In the capital market, Malaysia has the largest bond market in South East Asia. Two thirds of the papers issued are based on Islamic principles. There is also growing interest by non-resident entities to raise funds from the domestic market. In addition, foreign investors account for significant share of the investment in these papers. For the inaugural global sukuk that was issued by Malaysia in 2001, while 50 per cent of the investors that participated in the issue was from the Middle East, the other 50 per cent was from Asia, Europe and the United States of America.

What are the risks to return ratios in Islamic banking and finance? How is it beneficial to large investors?
Dr Aziz: The quality of management is among the key drivers for returns in the Islamic financial institutions.  In this regard, emphasis has been placed on strengthening corporate governance and risk management in the Islamic financial institutions to achieve strong and sustainable performance.
In Malaysia, Islamic finance continues to be highly competitive. This is evidenced by its rapid expansion with an annual average growth of about 20 per cent. It has also been an important contributor to the strong levels of profitability recorded by the respective banking groups in Malaysia. There are, however, cases of banking institutions that had legacy loans made during the period following the crisis in their balance sheet. These have for the most part been now addressed and almost all Islamic banking businesses are on a profitable growth path.
Any investment by large investors must be mutually beneficial. Following the required due diligence, shareholder activism must be exercised to ensure that the banking institutions are well managed. This is supported by a robust regulatory and supervisory framework to ensure its soundness and stability. Given that Asia represents a strong growth centre and a significantly expanding market, there is every potential for the investments to be mutually beneficial.

What are the regulatory and supervisory roles created by Bank Negara Malaysia basis from which Islamic banking institutions operational capabilities are monitored?
Dr Aziz: Malaysia has adopted a robust governance framework for the Islamic financial institutions. The regulatory framework aims to ensure that the regulatory requirements are consistent with the injunctions of Shariah. It also takes into account the multi-faceted roles performed by the Islamic banking institutions. In addition, as a dual financial system where Islamic financial institutions operate side-by-side with conventional banks, the regulatory approach takes into account the need to promote a level playing field.
Islamic banking operations need to be governed by its own standards and best practices in parallel with the international best practices. The establishment of the Islamic Financial Services Board, IFSB, in 2002 promulgates the international regulatory and supervisory standards for Islamic financial institutions to achieve this objective. For this purpose, the IFSB has already made progress in developing the prudential standards on the capital adequacy and the standard for risk management.