IFR Asia Malaysia Islamic finance report: Zeti interview

IFR Asia Malaysia Islamic finance report, September 2009

The regulator – Dr Zeti Akhtar Aziz, Governor, Bank Negara Malaysia

Dr Zeti Akhtar Aziz has been arguably the single most important person in the drive towards making Malaysia a hub for Islamic finance. The idea has consistently had the backing of government and the Securities Commission too, but by dint of longevity – Zeti has held the governorship of Bank Negara Malaysia since May 2000, and has now worked with six different finance ministers while in that role – she has perhaps been the most instrumental in ensuring a consistent drive in Islamic finance.

It’s fair to say that Malaysia has already built a successful, credible and well-regulated domestic Islamic banking industry, whether in banking, takaful or funds management. Zeti’s vision now, like that of Malaysia generally, is to bring foreign expertise and capital in.

Consequently Islamic finance was a mainstay of the banking liberalisation measures announced by Bank Negara and the government in April. Liberalization has consistently been more generous to foreigners in Islamic banking than conventional, and that continues to be the case: domestic Islamic banks may now have foreign equity ownership of up to 70%, a level that is not permitted for conventional banks.

Alongside a number of new commercial banking licences – the most significant of which, for “world-class banks”, won’t come into effect until 2011 – two new Islamic banking licences were announced to take effect in 2009, for foreign players “to establish new Islamic banks with paid-up capital of at least US$1 billion to enhance global interlinkages, leverage on global developments in Islamic finance and reinforce Malaysia’s position as an international Islamic financial hub,” to use Bank Negara’s own words. These institutions can be 100% foreign-owned. At the same time two new family takaful licences will be granted. On the conventional side, only two new licences will be awarded in 2009, for banks with “specialised expertise”, and at the time of writing no formal bids had been lodged for these and there was some doubt as to whether any would be.

The new Islamic bank licences have become known as the mega-bank licences – and that US$1 billion minimum paid-up capital is strikingly, almost off-puttingly large. (The new takaful operators, by contrast, will have a capital requirement one tenth of that size.) Why raise the bar so high?

“We already have quite a number of Islamic financial institutions, but they are all quite small in size,” Zeti tells IFR Asia in her expansive Kuala Lumpur office in the Bank Negara Malaysia complex. “That is sufficient for retail, financing and other domestic business. But in order to see an increase in international activity, you would need the kind of capitalisation to be able to conduct international business that would originate out of Malaysia. Therefore you need capitalisation and scale in terms of technology, human talent, the expertise that is required, and international networks. So it really is the international financial institutions, very different from what we already have.”

The deadline for these licence applications comes up on October 31 and Zeti says that firm bids have been lodged already. It is interesting to contemplate who these might be: the biggest players in the Middle East – Al Rajhi and Kuwait Finance House – are here already, while other heavyweights from that region, such as Saudi Arabia’s National Commercial Bank or the Egyptian based EFG Hermes, have been hit by the financial crisis. Of the true multinational Shariah operations, HSBC, Citi and Standard Chartered are also already here in various licensed forms, although not always with the degree of freedom the new licence seems to afford. It is possible that bids have come from some of these groups that wish to upgrade their status in the country, although Asian Finance Bank, which holds an Islamic licence already, has ruled itself out of applying.

Zeti was one of the driving forces behind the Malaysian International Islamic Financial Centre (MIFC). In some senses this appears successful: a number of entities are licensed within it, particularly in asset management. (See the article on foreign businesses for more on this.) But there is widespread conjecture about whether it has yet achieved its real investment of bringing money from outside Malaysia (particularly the Middle East) to be managed from Kuala Lumpur.

Asked if MIFC has achieved what she wanted it to, she says: “Within less than three years we have made quite significant progress. Malaysia is a centre now for the origination and the raising of sukuk, and more than one third of new sukuks are issued out of Malaysia. If we look at outstanding sukuk we have 60% of the outstanding.” This is true, but it was also true without MIFC: Malaysia’s standing in the global sukuk market has been a point of differentiation for at least five years. “We have also issued licences to foreign entities to conduct foreign currency business. We are offering the international community to participate in our system for the conduct of international business. That is how we are evolving ourselves, as an international financial hub: it is a meeting place of those who need to raise funds, or those who have surplus funds for investment from any part of the world.”

And has it brought in foreign capital? “Yes it has, in terms of investments by various entities, particularly from the Gulf,” she says. “They have been coming out here in terms of joint ventures, strategic alliances with local businesses, and direct foreign investment in projects here, as well as fund management out of Malaysia.” Zeti points to the 300 financial products and services that have been developed; “we are at the frontier of innovation. We also participate aggressively to facilitate convergence in interpretation of Shariah.” But what about portfolio investment? “Directly it has brought investment by these institutions; indirectly they have brought investors, and have opened up potential for trade. This is one area we want to enhance, and there is some growth already,” she says, highlighting the Middle East. “The financial institutions who have a presence here will facilitate this kind of investment and we are already seeing this happen.” She declines to put a number to inflows generated by MIFC. “That would be difficult because in terms of the direct investment, you can see it obviously in terms of the strategic stakes they have taken in our local banks and takaful companies. But the indirect one, you can’t attribute it.”

Bank Negara is ultimately responsible for approving sukuk issuance, which tailed off notably in line with all debt or debt-like markets around the world over the last 18 months before receiving a major boost with the Petronas issue in August, in which $1.5 billion of $4.5 billion raised was Shariah compliant. This, says Zeti, was something of a landmark. “It was significant because it was the first foreign currency sukuk issue out of our market,” says Zeti. “We have liberalised to allow for foreign currency sukuk issuance out of our market but because of the crisis in 2007 and 2008 there was no issuance. And so although there were many that had actually submitted [for approval to launch], they had deferred because of international financial conditions. And most of the issuance was ringgit denominated even though it was by foreign corporations and entities.” So the Petronas deal, in dollars but out of Malaysia and by probably the most important state-owned company in the country, was a big step and is hoped to be the first of several – hence the fact that Bank Negara has developed a new designation, Emas, to apply to foreign currency issues out of Malaysia.

Domestically, Zeti says the pipeline for sukuk issuance is coming back “tremendously.” She also highlights a new credit enhancement institution designed to allow issuers to reach the debt markets at attractive pricing.

Observers admire Zeti as a central banker, and consider her one of the most able in the region; there is also respect for what has been achieved domestically in Islamic finance. But implementing this next step of the vision, of truly going global and bringing the world of Islamic finance to Malaysia, is perceived by many as being a tougher challenge still, particularly because of the differences in interpretation of Shariah between the Middle East and Malaysia (which MIFC has tried to get around by saying that any school of Shariah thought is permissible within it). “Islamic finance has been a major success in this country but I really struggle to see how it gets beyond where it is today,” says one banker in Kuala Lumpur. Still, Zeti has seen off both an Asian financial crisis and now a global one and come out intact, so she’s not unfamiliar with challenge.