Resilience underpinned by robust foundations

Why should investors look to Islamic finance?

What Islamic finance can give is protection at a time of adverse shocks. Investors have looked more to alternative asset classes since the global financial crisis, including Islamic products. Research shows that Islamic products are not highly correlated with other asset classes – they offer a different risk profile and can be a vehicle for diversification. What we don’t know is why Islamic finance was resilient to the crisis – was it because of the investment principles adhered to? Or did the youth of the asset class mean that it was less exposed in the first place? We need to verify this. We can’t take the robustness of Islamic finance for granted – we need to track and assess risk.

What role can INCEIF play?

Our objective is to provide linkages with the industry and to make sure that the foundations of the Islamic finance industry are based on sound research and not just personal opinions. We need to subject claims made to scientific verification or nullify those claims if they are not proven.

We need to answer questions. Have the large inflows into the industry since the financial crisis been because we are an attractive place to invest? Or is it because there was a glut of capital? We have to make sure that we offer an attractive product or the industry will suffer when there is no longer a glut of liquidity.

What’s holding the industry back?

The constraint is that often market participants have skills in Islamic law but lack training in finance or they have training in finance but require input from elsewhere on Sharia law. People seldom have both. The challenge for an academic institution of putting both elements into a curriculum is that both will be diluted. We try to combine the rigour of finance and Sharia law.

I believe that the rigour of training in finance must be there as well as an understanding of the principles of Islamic law. This is especially important because the rapid development of the industry in Malaysia is bringing more risks but also more opportunities. It’s important to beware of new risks emerging as cross-border transactions and integration rises.

Islamic finance is still small relative to conventional finance but it will grow faster and faster. Islamic finance is here to stay.

Is Malaysia’s edge sustainable?

Islamic finance operates under certain unchangeable principles such as the prohibition on the payment of interest. But there are certain principles which are changeable according to context – such as national customs. This provides flexibility and allows Malaysia to differentiate itself by emphasising protection of investor rights when it comes to transferring property rights, for example. This is important because Islamic products are typically secured by real asset collateral.

The law in other countries is not as conducive to developing the finance industry. This is similar to the difference between legal systems based on civil and common law. This is why Malaysia will continue to be the dominant player in the sukuk market in the future, for example. Because when it comes to putting a proper regulatory structure in place, Malaysia leads. This is a core thrust of the government’s financial master plan.

What are the risks?

One risk is non-compliance risk. After a product is offered to market, it’s possible that it may become non-compliant with Sharia law. Malaysia has put in place a regulated structure, with concrete mechanisms to look at non-compliance, for example. This helps investors and issuers assess this risk.

Exposure to other types of risks is standard. Islamic finance emphasises risk-sharing not risk-shifting. But this does not mean there is no risk. Risks still need to be managed properly. We cannot look at Islamic finance in separation from the financial system – from the people who manage it.

If you look at Muslim countries they do not rank highly when it comes to the quality of institutions in those countries. We need to develop more tools to benchmark performance – from an Islamic finance competitiveness index to an Islamic finance stress index. We need these kinds of indicators to guide us.