ROLES AND CONTRIBUTIONS OF THE ISLAMIC CAPITAL MARKET IN THE DEVELOPMENT OF THE ISLAMIC BANKING AND FINANCE SYSTEM
Wan Abdul Rahim Kamil Wan Mohamed Ali
Internationally, Islamic banking and finance (Islamic Banking and Finance) has been around for more than 20 years but it was only in the 1990s that it has become a booming niche business with assets estimated at a conservative value of US$180.0 billion.
With more than 150 Islamic financial institutions sprawling from London, New York and Zurich to the Middle East and Asia, Islamic Banking and Finance has become an international institution a preferred system for many Muslims and a viable alternative for others.
The same can be said of the situation in Malaysia.
Today, Malaysia is renown for its Islamic Banking and Finance system and is among one of the very few countries that are blessed with a dual-mode financial system whereby the Islamic financial system runs parallel with the conventional financial system.
In this regard, credit must be given to the various regulatory authorities for their conscious, concentrated and dedicated efforts of turning the aspiration of having an Islamic financial system running alongside the conventional system into a reality.
Presently, the Islamic Banking and Finance system in Malaysia has grown since the gazetting of the Islamic Banking Act in 1983.
As at the end of last year, the total assets of the Islamic Banking and Finance system had seen almost 8 fold increase to approximately RM47.0 billion from a mere RM6.0 billion back in 1995.
During the early development years of the Islamic financial system in Malaysia, the Islamic Capital Markets role was very minimal.
Instead, the Islamic Banking and Finance system, which began in the early 1980s, played a more prominent role in the said development of the Islamic financial system by virtue of their funding capacity for the Islamic economic activities.
Nevertheless, significant developments in the Islamic Capital Market and its contributions towards the development of the Islamic financial system were more obvious from the mid-1990s onward.
The Malaysian authorities had by then provided the necessary infrastructures and incentives to facilitate a more frequent usage of the Islamic Capital Market by both the corporate sector as well as the individual.
Amongst others, the infrastructures and incentives includes the establishment of the Islamic Money Market, the provision of tax-exemption incentives and the introduction of the Syariah approved list of securities i.e. halal securities for investment purposes.
b) Islamic Capital Market
At this juncture and before we proceed any further, it would be beneficial if I may briefly highlight the various components of the financial system in Malaysia as well as the location of the Islamic Capital Market.
The Malaysian financial system comprises the banking system, the non-bank financial institutions and the financial markets. It is within the financial markets sub-sector that both the conventional and Islamic capital markets are located.
Commonly, the capital markets are referred to as the markets for longer-term financial assets -- comprising all public and private debt instruments with maturity period exceeding 1 year, corporate stocks/ shares for which there are no fixed maturity periods including futures and options.
Accordingly, the Islamic Capital Market would have the same definition except that the financial assets are Syariah compliant.
In addition, I have excluded the market for futures and options when capital market is being referred to in this particular paper.
As for the term Islamic Banking and Finance System in the rest of this presentation, it refers to the conventional banks, merchant banks, finance companies and Discount Houses offering Islamic banking products as well as the two existing Islamic banks.
THE DEVELOPMENT OF THE ISLAMIC CAPITAL MARKET
The development of the Islamic Capital Market can be looked at from two distinct aspects. The first being the Islamic Equity Capital Market and secondly the Islamic Debt Capital Market.
a) Islamic Equity Capital Market
Prior to the availability of any form of infrastructures and clear guidelines pertaining to the permissibility i.e. halal of any equity securities, the Muslims in Malaysia have no alternatives to invest their hard earned monies.
Accordingly, their participation in development of the Islamic Capital Market in general and the Islamic Equity Capital Market in particular were restricted.
In light of this, the various regulatory authorities and market players responded by providing the necessary infrastructures and guidelines to ensure that the Muslims have a permissible alternative avenue for their investments which will eventually contribute to the development of the Islamic financial system in Malaysia as a whole.
During the early days, Bank Islam Malaysia Berhad, being the first Islamic bank in Malaysia, had taken the initiative to review and identify companies listed on the Kuala Lumpur Stock Exchange considered permissible for Muslims to invest in.
Their efforts were a significant event as it provided the much-needed break through for Muslims to participate in the stock market.
The break through was further boosted by the introduction of the Syariah Approved Securities list in June 1997 by the Securities Commissions Syariah Advisory Council.
The Syariah Approved Securities list contains a list of stocks that are listed on the Kuala Lumpur Stock Exchange of which Muslims can invest in. Currently, there are 606 stocks on the said list.
Besides the equity securities, the Securities Commissions Syariah Advisory Council had also approved other conventional market instruments such as call warrants and Transferable Subscription Rights for investments by Muslims.
In order to accommodate the possibility to participate in the stock market, various Islamic stock-broking services began to emerge with the first being BIMB Securities Sdn Bhd, which was established in 1994. In addition, there are also other conventional stockbrokers that had seized the opportunity to operate Islamic windows side-by-side with their conventional stock-broking services since then.
Presently, the Islamic Equity Capital Market has grown to a point where Muslim investors could allow professionals to manage their funds via the various Islamic Unit Trust Funds and Asset Management Companies.
As for benchmarking the performance of the Islamic Equity Capital Market, various indices were created. There are currently two main Islamic indices used by the various market participants namely, the RHB Islamic Index introduced in 1996 and the KLSE Syariah Index introduced in 1999.
All in all, the availability of the Syariah Approved List, the stock-broking services as well as the indices enables more participants, either individuals or corporate, to be involved in the Islamic Equity Capital Market.
This, we believe, will eventually lead to a more dynamic and mature market, which are prerequisites for the development of the Islamic financial system.
b) Islamic Debt Capital Market
The growing interest to source funding from the Islamic Debt Capital Market can be traced back to the early 1990s when major corporations such as Shell MDS Sdn Bhd, Sarawak Shell Berhad and Petronas Dagangan Berhad raised significant amount of funds from the Islamic Debt Capital Market.
The said funding exercises were mainly carried out via the issuance of Islamic debt securities akin to conventional bonds usually structured under the Syariah principles of Qardhul Hasan, Musyarakah and Al-Bai Bithaman Ajil.
Besides the major corporations, the Malaysian Government also issued Islamic debt instruments in the form of Government Investment Issue (formally known as Government Investment Certificates) to provide liquidity as well as to facilitate the management of assets in the Islamic Banking and Finance system.
The first issuance of the Government Investment Issue was carried out in 1983 upon the inception of Bank Islam Malaysia Berhad while the demand for these Islamic debt instruments increased significantly since March 1993 following the establishment of the Islamic windows and Interest Free Banking Scheme in Malaysia.
Subsequently, the Islamic Debt Capital Market was accorded further depth by the issuance of the first Mudharabah Bonds by Cagamas Berhad in 1994.
In a more recent development i.e. 1997, the Malaysian Government, through Khazanah Nasional Berhad, had also issued Islamic debt instruments in the form of the Khazanah Benchmark Bonds.
These Benchmark Bonds were structured under the Syariah principle of Al-Murabahah and were intended to facilitate the price discovery process at both the primary and secondary level of Islamic Debt Capital Market. The Khazanah Benchmark Bonds were also issued as part of the broader effort by the Malaysian Government to deepen and widen the Malaysian Bond Market.
In spite of the various efforts taken by the Malaysian regulatory authorities to broaden and deepen the Islamic financial system since 1983, it was only in the last few years that we have seen a significant increase in the number of corporate companies accessing the Islamic Debt Capital Market for funds.
As at today, there are approximately RM28.9 billion worth of Islamic private debt securities raised by the corporate sector from the Islamic Debt Capital Market, out of which RM5.5 billion alone was raised in the last 5 months.
ROLES AND CONTRIBUTIONS OF THE ISLAMIC CAPITAL MARKET IN THE DEVELOPMENT OF THE ISLAMIC BANKING AND FINANCE SYSTEM
With the brief summary on the Islamic Capital Market as a backdrop, we can now proceed with the roles and contributions of the same in the development of the Islamic Banking and Finance System.
As we are all aware, the Malaysian financial system in general and the Islamic Banking and Finance System in particular serves many functions. Chief among them is the role of an intermediary between the various surplus and deficit units of the economy.
It is precisely in this area that the Islamic Capital Market can contribute towards the development of the Islamic Banking and Finance System in Malaysia.
The Islamic Capital Market enables various individuals, institutions, the corporate sectors with varying degree of needs to meet, just like the Islamic Banking and Finance System.
As such, it provides a complementary platform for the inter-mediation of funds from those with surplus funds to those who are seeking funds and from one market to another.
For instance, with the introduction of the Syariah Approved List of securities, a new avenue for the investment of funds have been created. In this regard, Muslims can now confidently invest their monies in the approved stocks listed in the Kuala Lumpur Stock Exchange.
As such, the Islamic Capital Market via the Islamic Equity Capital Market, is inter-mediating between the various individuals that requires funding i.e. selling of stocks or having excess funds i.e. investing in stocks.
In turn, those who receive dividend payments or capital gains can then deposit the same into their banking accounts, presumably Islamic bank accounts. On the other hand, some may even seek financing from the Islamic Banking and Finance System to invest in stocks from the Islamic Equity Capital Market.
Consequently, the two distinctive markets are bridged and thus, the Islamic Capital Market automatically broadens and provides further depth to the Islamic Banking and Finance System and vice versa.
Ultimately, the critical mass required for the Islamic Banking and Finance System to be efficient and effective in allocating scarce resources will be attained.
b) Alternative Funding Market
Besides the banking system, the Islamic Capital Market is also an alternative market to raise funds.
Firstly, Islamic capital seekers can turn to the Islamic Capital Market to raise funds for their economic activities.
Without this alternative avenue and restrained by the Single Customer Limit and the Capital Adequacy Ratio requirements of the Islamic Banking and Finance System, the Islamic capital seekers will then be force to either stop the economic activities or carry out their economic activities with funding from the riba based financing of the conventional financial system.
The latter would not only deprive the Islamic Banking and Finance System of additional depth but would instead assist the growth of the conventional financial system.
Further to this, the Islamic Capital Market can also be an alternative avenue to raise funds for the long term funding requirements e.g. capital expenditure whilst the Islamic Banking and Finance System can instead concentrate on extending shorter to medium term funding requirements only.
In this regard, the Islamic Banking and Finance System will be minimizing the risks associated with the extension of short and medium term funding for long term financing requirements.
Thirdly, the various commercial banks and finance companies including the two existing Islamic banks can access the Islamic Capital Market for their own funding requirements or financing operations.
And in the process of doing so, they are able to draw more Islamic funds into the Islamic Banking and Finance System from the various participants of the Islamic Capital Market such as Tabung Haji etc.
The excess funds, in turn, can be utilized by financing more viable Islamic economic activities, thus assisting in the development of the Islamic Banking and Finance System.
c) Off Balance Sheet Funding
Another area of benefit to the Islamic Banking and Finance System is the opportunity in the Islamic Capital Market to provide Off Balance Sheet Funding.
In this area, it has been proven that the banking industrys capacity to extend more financing facilities will increase when both the capital market and the banking systems are bridged.
In a process known as Securitization, the assets from the Balance Sheet of the Islamic Banking and Finance System will be removed and sold to a third party. The Balance Sheet will then have less assets i.e. equals to more space in their books for further extension of financing facilities.
In the process, the third party will pay the Islamic Banking and Finance System, which in turn are able to use these funds for their financing operations.
The third party, in this instance, will purchase these assets e.g. Islamic house financing facilities by utilizing funds obtained from the Islamic Capital Market.
A clear and definite example would be the Cagamas Bonds.
Further to this, the Securities commission had recently introduced guidelines on asset securitization, which we believe, will allow for further innovations in financing economic activities.
Currently, the pricing process of the Islamic Banking and Finance System is very much dependent on the conventional benchmarks.
In this regard, it is one of our aspirations that the Islamic Capital Market would eventually assist in the pricing of the Islamic Banking and Finance Systems products.
By developing the Islamic Capital Market in terms of the numbers of products and participants would inevitably, we hope, liberate the Islamic financial system from the need to benchmark the pricing of Islamic Banking and Finance System products against the conventional riba based ones.
Having said these, we are still far behind. Nevertheless, as the saying goes; A million Miles Journey begins with a Single Step.
In conclusion, we believe that with further development of the Islamic Capital market in Malaysia, we will broaden and add further depth to the overall capital market.
By doing so, we hope that the Islamic Capital Market can provide a significant contribution to the overall objectives of the Islamic Banking and Finance System as set out in the Financial Sector Master Plan.
Primarily, we hope that the developments in the Islamic Capital Market would assist and enable the Islamic Banking and Finance System to capture at least 20% of the banking industrys market share by the year 2010.
However, we must ensure that the plans lay out in both the Capital Market and Financial Sector Master Plans must be undertaken in order for us to reap the fruits of a developed Islamic Banking and Finance System.
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