How Islamic Banking Can Drive Australia’s Finance Sector

That means Islamic finance, even if it’s slowing down, will still enjoy a headier pace of growth than China’s economy, or global banking, or very likely any western stock market this year. Indeed, the jury is still out on whether it’s even slowing at all: Daud Vicary Abdullah, President and CEO of the INCEIF Islamic finance university in Kuala Lumpur, reckons that in the six most important markets for Islamic finance (Qatar, Indonesia, Saudi Arabia, Malaysia, the UAE and Turkey) Islamic banking assets are still expected to grow by an average 19.7% a year until 2018.

This still-vibrant future is one reason it’s still well worth Australia considering what it might achieve in Islamic finance. It’s true that it lacks a sufficiently large Muslim population to be an obvious candidate for a successful industry – just over 2% of the national headcount – but there are two important points to consider beyond the population. One is that that Islamic finance products, properly created, can be useful to anyone, not just Muslims. And the other is that, if Australia aspires to be a true regional financial hub, it must be accommodative to any area of the financial world that a customer in Asia Pacific might need.

“The government has said that if we want to be a financial services hub for this part of the world, then developing a Shariah-compliant industry is important to us,” says Paul Drum, head of policy at CPA Australia.

In this ambition, the UK is instructive. Its own Islamic finance industry has developed along two separate tracks: there is a homegrown set of institutions serving the approximately 5% of British people who are Muslim, with the usual mainstream services such as the Shariah-compliant equivalents of mortgages, car loans and insurance; and then there is state encouragement, exemplified by the UK issuing a sukuk (the Islamic equivalent of a bond) at a sovereign level in 2014, not because it needed the funds but because it recognised that doing so might galvanise an Islamic capital market in London. The British capital unashamedly wants to be home to every feasible form of finance, be it a metals exchange or a clearing centre for the Chinese renminbi or Islamic securities, and so it does what it needs to do in order to encourage that money to come.

Beyond launching a sukuk, one practical example that it (and other jurisdictions with the same idea, like Luxembourg) has undertaken is a levelling of the playing field, particularly by reducing any danger of double taxation for Islamic securities, a common problem when Islamic structures meet a conventional mainstream regulatory environment. “We have some problems like that in Australia, including double taxation, and it would be very useful if it changed,” says Almir Colan, founder of the Australian Centre for Islamic Finance, though he notes exemptions do exist, such as in Victoria. “Regulations are important: they give a signal. By the time a big bank approves anything it has gone through 10 different teams for every different compliance issue. They are not going to go through that where there is uncertainty.”

On the other point – that Shariah products aren’t just for Muslims – the international capital markets give us the clearest illustration of potential. It is commonplace for sukuk issues from the Middle East or from Asian sovereigns to have as much as half their distribution to conventional investors who couldn’t care less about religious compliance, but just like the risk profile and the yield (or the Shariah equivalent of it). Partly for this reason, sukuk tend to price more cheaply than conventional issues in the Gulf now, which in turn gives issuers more reason to follow the Shariah-compliant route, and attracts more investors, creating a virtuous circle.

“The growth of Islamic finance and its adoption, advocacy and promotion by Muslim-minority countries and by non-Muslim industries,” says Vicary, “is a testament to its benefits, fairness and equitable approach to business and enterprise, where risk and reward are shared in equal measure.”

Malaysia is the world capital of sukuk issuance, as well as being the country with the most sophisticated regulatory environment. According to the Securities Commission of Malaysia, Islamic assets made up 17.9% of the fund management industry as of June 2015; Vicary expects Shariah-compliant financing to reach 40% of total financing in Malaysia by 2020; and the total outstanding sukuk in Malaysia were worth RM580.71 billion (US$137.9 billion) in June, representing 53.7% of the total outstanding bonds from Malaysia. In many recent years, the country has accounted for more than half of all global sukuk.

“Malaysia’s embracing of Islamic finance has made it the largest Islamic finance hub in the Asia Pacific region,” says Vicary. “Its status has won it a world-class regulatory framework and engagement model” that combines the central bank, securities commission, stock exchange and financial services authority. “The comprehensive regulatory framework in Malaysia can be taken as an example for other key markets in advancing their own Islamic systems.” To do so, he says, is to embrace a school of financing “which is inexorably linked to transparency, ethics, efficiency, prudence, fairness, and the sharing of risk and reward – human fundamentals that are often absent from the conventional banking model.”

We mention this because it also has lessons for Australia. Not all sukuk issuers in Malaysia are Malaysian; not all fund managers running assets there in a Shariah-compliant way are Malaysian either. The Malaysian International Islamic Financial Centre (MIFC) was launched in 2006 with exactly this objective – to use the country’s homegrown expertise to attract international capital to be managed or raised there. Attracted by seed capital provided by Malaysia’s Employee Provident Fund, a major pension scheme, international fund managers who set up Shariah-based operations through the centre include Aberdeen Asset Management, BNP Investment Partners, Principal (in partnership with CIMB), Franklin Templeton and Nomura Asset Management.

And the retail side shouldn’t be ignored. History shows us that even in the most pious of Muslim states, notably Saudi Arabia, it’s not really institutions who tend to implement Shariah investment practices (Saudi’s central bank, SAMA, doesn’t do so, for example) but ordinary mums and dads.

In fact, companies have offered simple Islamic home financing in Australia for these needs for more than 20 years. “We estimate that maybe A$4 billion of Shariah-compliant home financing has been done in Australia, though most of that was in the last 10 years,” says Colan. He believes the segment is now taking off, with fund managers also taking the idea more seriously, and other individuals simply structuring private arrangements in a Shariah-compliant way. “I think different sectors have different potential,” he says. “Obviously there is great potential for anything that younger people need: home financing, business financing, insurance.”

Certainly, a modest Muslim population should not be seen as a reason not to try to build an industry in Australia. “When we see the energy and commitment being applied to the Islamic finance sector in Malaysia, and more broadly in Indonesia and elsewhere, I can’t help but feel Australia’s modest uptake is something of a missed opportunity,” wrote CPA Australia CEO Alex Malley in Malaysia’s New Straits Times in November. “So too is the potential for enhanced business, finance and cultural linkages in key Asia Pacific and Middle Eastern markets that would come with a deeper engagement in Sharia-compliant finance.”

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Breakout: What’s the difference?

Shariah-compliant finance differs from the mainstream in two key ways. One is straightforward: Islamic investors must avoid certain sectors, including pornography, alcohol, gambling or armaments.

The other is an avoidance of the concept of interest, and that’s where things become a bit more complicated. Many Shariah-compliant structures look, superficially, just like their conventional counterparts, but are built in such a way that the outcome is not just interest (that is, money turning into more money without having done anything along the way) but profit.

What’s the difference? Well, a key point is that in order to generate a return, the money must have served some purpose, perhaps being invested in a business or building. Also, whatever underlies these transactions must be real and tangible: lots of derivatives are therefore ineligible in Islamic finance. Also, there is meant to be an equal sharing of risk and reward among parties to a transaction.

Breakout: All about the name?

One interesting area of common ground occurs where Islamic finance overlaps with ethical finance – a field that is much better developed in Australia than Shariah-compliant financial services.

The two schools have a lot in common: a refusal to invest in anything related to armaments, porn, alcohol and gambling; and an aversion to heavy leverage or unnecessary debt. Clearly there are then divergences – no Islamic investor can invest in a conventional bank because of the prohibition on interest in Shariah financing, which is not in itself a concern to ethical investors; and conversely uranium or nuclear energy can be a no-no for ethical investors but causes no problem for Muslims – but the similarities are marked.

Careful marketing can bring Islamic products to a much broader group in this way. Tirad Al Mahmoud, CEO of Abu Dhabi Islamic Bank, says that while his bank’s core customer base is still predominantly Muslim, it is seeking more non-Muslim expatriates opting for Islamic banks, and believes they can best be attracted by marketing the products on their ethical foundations and morally sound business models rather than their religious compliance. Another example is the fund manager Arabesque, whose signature fund is 100% Shariah compliant but never really mentions it in its marketing, instead pitching itself as a quant fund that combines socially responsible ESG information with other fundamental considerations. CEO Omar Selim describes it as “the Prêt A Manger of asset management:  a healthy meal that tastes good.”

There is a level of grass-roots public suspicion about the encroachment of Muslim practices in Australia, one that won’t help the marketing of Islamic products to the conventional mainstream. The industry could do worse than market itself as a way of banking that is less about faith than about sustainable and ethical practice.