410 – 012 – Islamic Finance In Southeast Asia

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Islamic Finance In Southeast Asia

Sharīʿa, as it does in everything else, provides the basis of Islamic banking.  The teachings of Islam include the essence of economic well-being and the development of the Muslim at the individual, family, society, state, and ummah (Islamic universal community) levels (Bank Islam Malaysia Berhad, 1994; Saiti, et al., 2017).

Islam is comprised of three basic elements: aqidah, Sharīʿa, and akhlāq. Aqidah concerns all forms of faith and belief by a Muslim in Allah and His will, from the fundamental faith in His being to the ordinary beliefs in His individual commands (ahkam).  Sharīʿa covers all forms of practical actions by Muslims manifesting their faith and belief.  Akhlāq concerns the attitude and work ethic with which Muslims perform their practical actions (Bank Islam Malaysia Berhad, 1994; Saiti, et al., 2017).

Sharīʿa is then divided into another two categories: ʿibadat and muʾamalat.  ʿIbadat is concerned with the practicalities of worship, in the form of the human-to-Allah relationship.  Muʾamalat is concerned with the practicalities of daily life, in the form of person-to-person relationships.  One of the most significant segments of muʾamalat is the conduct of a Muslim’s economic activities (Bank Islam Malaysia Berhad, 1994; Saiti, et al., 2017).

Therefore, in the Islamic way of life and Sharīʿa framework, a Muslim’s banking and financial activities can be traced to their economic activities, to muʾamalat, to Sharīʿa, to Islam, and finally to Allah.  This is the root of Islamic banking and finance, and it is vital to ensure the balance between the spiritual and the material needs by conducting a proper Islamic financial system.

What is Islamic finance?  The main differences between conventional and Islamic finance are the prohibition of interest (ribā), uncertainty (gharar), gambling (maysir), and any other elements or transactions that are harmful to society from the Islamic perspective.  The conventional financial system operates purely by relying on the interest from selling money for money.  However, Islamic finance advocates sale-based (murābaḥah, salam, istisna, tawarruq, etc.), service-based (ījārāt, wakālah, ḥawālah, etc.), and partnership-based (muḍārabah, mushārakah, mushārakah muntanaqisah, etc.) contracts that eventually bring real value to the society.  In addition, Islamic finance calls for greater financial stability by eliminating contagious, exotic contracts such as financial derivatives.

Origin And Development Of Islamic Finance In Southeast Asia

Southeast Asia has two distinctive different geographic regions: mainland Southeast Asia, which includes Cambodia, Laos, Myanmar (Burma), Thailand, Vietnam, and West Malaysia (Peninsular Malaysia); and the Indo-Malay archipelago, which is comprised of Brunei, East Malaysia, all the islands of Indonesia, the Philippines, Singapore, and Timor-Leste (East Timor).  It is home to multiracial groups with diverse beliefs and regions where Islam is the majority religion.  The following will examine the origin and development of Islamic finance in five countries or regions: Malaysia, Labuan, Indonesia, Brunei, and Singapore.

Malaysia

Malaysia represents a role model of Islamic finance globally, due to its successful development of a complete Islamic financial system (which includes Islamic banking, an Islamic capital market, Islamic insurance, and other Sharīʿa-compliant securities).  This system operates parallel to the conventional financial system.  The first phase of the development of Islamic finance started in Malaysia in 1963 with the establishment of the pilgrimage fund locally known as Tabung Haji (National Bureau of Asian Research, 2008).  The first Islamic bank was established in 1983 (Bank Islam Malaysia, or IBM) and the Islamic Insurance Company (Takaful) was established in 1984.  There are several regulatory bodies such as Bank Negara Malaysia, Bursa Malaysia, Securities Commission Malaysia, and Sharīʿa Advisory Council to regulate the Islamic finance industry in Malaysia.  Also the Malaysia International Islamic Financial Centre (MIFC) took several initiatives to develop Islamic finance; for example, it helped to fund education and human capital for the Islamic industry.  Malaysia not only provides alternative investment opportunities, but also assures stability and security in terms of adequate legal and regulatory frameworks for Islamic finance.  The main milestones of Islamic finance in Malaysia are presented in Table 1, page 10.

As of the end of 2017, the Malaysian Islamic finance industry’s assets increased by 9.5 percent to reach RM783 billion, which also represents 28.8 percent of the country’s total banking assets (“Malaysia’s Islamic finance assets rise 9.5pc to RM783 billion,” 2017) in 2016, the size of total Islamic capital market reached RM1,691.64 billion which is almost 60 percent of total capital market.  The number of ṣukūk issued was 32 and total ṣukūk outstanding was RM393.45 billion, which is 74 percent of the total corporate bond and ṣukūk outstanding (Securities Commission Malaysia, 2017).

Labuan

As a financial center Labuan in Malaysia has seen a surge in interest in Islamic finance services in the early twenty-first century, and is getting closer to being an Islamic finance hub for the Asian zone.  In 2014 the report showed a huge growth in new companies registered in Labuan, as the Labuan International Business and Financial Centre (Labuan IBFC) recorded a growth of 12.3 percent (Labuan FSA Annual Report, 2016).  Furthermore, the total assets of the companies and the banks grew in 2015 by 3.7 percent to reach USD $44.34 billion, and therefore “the increasing demand for Islamic finance in Labuan saw Islamic finance transactions grow by 28 percent from USD 776 million to USD 993 million” (Labuan FSA Annual Report, 2016).  There are sixteen banks in Labuan that provide Islamic financial services, three Islamic Banks, two Islamic Investment Banks, and eleven Commercial Banks with Islamic Windows (Labuan FSA Annual Report, 2016).  In 2017 Labuan Islamic Banking total deposits were between USD $145 to USD $150.4 million made by non-bank customers only.  And finally, in 2017 the Labuan total Islamic private fund size was about USD $2891.3 million and only USD $21 million was approved (https://www.labuanibfc.com).

With 87.2 percent of the population identifying themselves as Muslim (i.e., approximately 225 million Muslims out of the estimated 2016 population of 261 million), Indonesia is the most populous Muslim-majority country, and is catching up in the area of Islamic financial organization.  Bank Muamalat, the first Islamic bank, was established in 1992.  As of late 2016 Islamic banking made up around around 5.3 percent of total banking assets.  In the case of the Islamic capital market, Indonesia issued its first retail Sharīʿa-compliant ṣukūk (Islamic bond) in 2009.  The demand for ṣukūk in Indonesia is quite high, and it is seen to be one of the most promising financial instruments that the government of Indonesia uses to finance the budget deficit.  For instance, in 2008, the Sukuk Negara contributed directly to Indonesia’s budget.  In 2016 the total sovereign ṣukūk issuance in the international market recorded USD $43.56 billion, whereby, the report of 29 April 2016 showed that Indonesia contributed 23.3 percent (USD $10.15 billion) of the total international sovereign ṣukūk issuance (Pakpahan, 2016).  The current outstanding ṣukūk of Indonesia is seen to be at USD $9.5 billion, which represents the largest outstanding international sovereign ṣukūk (Pakpahan, 2016). As of 2016 Indonesia is home to the second largest ṣukūk market in the world just after Malaysia according to Fitch Ratings (Ambrose, 2017).

Islamic financial institutions in Indonesia include not only banks, insurance, and capital markets, but also Baitul Maal wat Tamwil (BMT) which is a form of Islamic financial micro-institution (micro-finance). BMT in Indonesia is not under the monetary authority but under the cooperative department.  Basically, Baitul Maal wat Tamwil is a combination of two different business entities, Baitul Maal and Baitut Tamwil.  Each of them has different principles and products despite having a close relationship in creating an economy that is equitable and dynamic.  The principles and products of BMT are presented in Table 2, page 10.

Due to such determinations and efforts, Indonesia is home to the largest Islamic micro-finance in the world.  As of the end of the second decade of the twenty-first century there are 5,500 BMT and 22,000 outlets with a membership of around 762,000 members and total assets reaching Rp 5 trillion to Rp 8 trillion (Islamic Economic Society) which is approximately USD $580 million.

Brunei

Islamic finance is only one instrument among many in the diversified economy of Brunei.  There the establishment of Tabung Amanah Islam Brunei (TAIB) gave birth to Islamic finance in the country in 1991. Since its establishment, TAIB has two subsidiary companies, Insurans Islam TAIB Sendirian Berhad (Takaful/Insurance) and Darussalam Holdings Sendirian Berhad (Haj/Umrah Services, Travel Agent), in both of which TAIB holds 100 percent of the shares (www.taib.com.bn/abouttaib/profile.htm).  In January 1993, after the establishment of Tabung Amanah Islam Brunei, the Islamic Bank of Brunei (IBB) was established to assist citizens in using Islamic banking facilities, and the IBB offers a full range of commercial banking facilities (Bashir, 2013).  On 15 January 2000 the Development Bank of Brunei was converted from a conventional bank into an Islamic financial institution known as the Islamic Development Bank of Brunei (IDBB), becoming the second Islamic bank in Brunei (Bashir, 2013).  Moving on, it is worth noting that Takaful companies are more active in introducing new products which are in line with the current developments (Siddiqui and Athemy, 2008).  The development of Islamic finance in Brunei is shown in Table 3, page 11.

As of the end of the second decade of the twenty-first century the Islamic financial ecosystem in Brunei consists of Islamic banks, takāful operators, Islamic investment dealers, ṣukūk, and other ancillary services.   Islamic financial assets are more than 50 percent of the total market share (https://bdif.com.bn/ifb-public/front/aboutbrunei).  Other than that, according to five broad areas of development — quantitative development, knowledge, governance, corporate social responsibility, awareness — as the main indicators, Brunei was among the top ten performing Islamic finance markets in the ICD-Thomson Reuters Islamic Finance Development Report 2017 (https://www.icd-ps.org).

Singapore

Even though Muslims are a minority in Singapore, the country has embraced the trend of Islamic finance. Indeed, Singapore can be considered to be one of the pioneers of Islamic finance, with the launch of the Mendaki Growth Fund (Amanah Saham Mendaki) in Singapore in May 1991, as one of the first few Islamic equity funds in the world. The development of Islamic finance in Singapore is shown in Table 4, page 11.

The Role Of Islamic Finance In The Muslim Community

Islamic finance plays many important roles in the Southeast Asian Muslim community.  The first and foremost role of Islamic finance is to help the greater Muslim community participate in financial and commercial matters by putting their wealth into circulation.  It enables Muslims to participate in the sophisticated Islamic financial system, but also it encourages all levels of society to participate in financial matters through financial inclusion such as Islamic micro-finance, waqf, et

The Islamic financial system helps to foster a safety net for society by means of wealth distribution and redistribution tools such as zakāh, ṣadaqah, and other forms of religious contributions.  Schools, hospitals, and other institutions can be built through such funds and can even fund needy students.

Islamic finance is opposed to the debt-based system by bringing risk sharing contracts into its own system.  In other words, the conventional financial system is based on risk transfer, in which the exposure to loss transfers from one party to the other, whereas the Islamic financial system is based on a risk sharing system in which both profit and risk are shared by all parties.

More importantly, Islamic finance is against the excessive leverage which is often the root of financial/economic crises.  To do this, the Islamic system limits toxic derivative instruments, ensuring debt securitization, and financing the real economic activities through sale-based, service-based, and partnership contracts.  By doing so, the latter system is trying to close the gap between the financial and real sectors.

Some Islamic financial institutions, such as Tabung Haji in Malaysia, are not simply deposit-taking banks, but also perform other services for the community.   For example, some help Muslims perform the pilgrimage, and it has become one of the largest Islamic assets management institutions in the country by preserving and appreciating the wealth of Muslim depositors.

In the case of Indonesia, Islamic micro-finance saved the small and medium enterprises sector during the 2008 financial crisis.  The understanding among many financial professionals was that small businesses and entrepreneurs are the ones who drive the real economy in Indonesia.

Due to its transparency, better performance, and stability during the financial crisis and the limitation of excessive leverage, non-Muslims also participate in Islamic financial system like those in Malaysia, Singapore, Hong Kong, etc.

Conclusion

To date, even though the size of Islamic finance (USD $1.5 trillion) is very small when compared to global financial assets, one cannot deny the role and contribution of Islamic finance in Muslim-majority countries, in particular Southeast Asian counties.  It is an alternative to the conventional financial system that allows Muslims not only to participate in economic and financial matters, but also to contribute to the stability of the financial system.  This includes prohibitions against ribā, ghagar, and other elements that are harmful to human beings from an Islamic perspective, promoting risk sharing instruments, a limitation on excessive leverage and toxic assets, and an emphasis on social equity and justice.  From a social welfare perspective, it has also played an important role in distributing and redistributing wealth by means of zakāh, ṣadaqah, waqf, and other forms of religious obligation and duties.  Last but not least, the Islamic financial system serves Muslims in both ways so they can fulfill their spiritual desire to perform their religious obligations while at the same time addressing the material needs of this world.

An important and final note is that, currently, Islamic banks over-focus on debt-based products and services such as murābaḥah, BBA, tawarruq, and ījārah, whereas equity-based financing such as <muḍārabah and mushārakah are the least popular (Saiti, et al., 2017). The heart of Islamic finance — risk sharing — prevails among Islamic banks.  If the Islamic banks rely too much on debt-based contracts, the general public could become disenchanted with the system.  As a result, both scholars and financial experts have urged Islamic banks to stay away from over-usage of debt-based financing, pushing them instead toward more equity-based products and services.

Table 1: Year & Events

Table 2: The Principles & Products of BMT

Table 3: The Milestones of Islamic Finance in Brunei

Table 4: The Development of Islamic Finance in Singapore

Year                   Events

Islamic Finance In Southeast Asia

410 – 012

https://discerning-Islam.org

Last Update: 02/2021

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