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Survey Papers 12-04 Dec. 01, 2012
- Research Topic Other
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Ⅰ. Concept
Islamic finance refers to a form of finance where capital is raised and managed under the social and economic principles of Shariah law. All Islamic financial products have to be approved by a Shariah committee consisting of experts in Islamic jurisprudence.
Although each nation has different standards regarding whether an activity complies with Shariah, the basic fundamentals are universal: Restrictions on receiving interest, sharing profit and loss, prohibiting uncertainty, speculative transactions, storage of funds, and haraam (any act that is considered sinful in the context of Shariah).
In order to conform to Shariah principles of no interest payments, special Islamic contract structures are used, e.g., use of real assets, joint investments, and other alternative transactions. More specifically, Islamic transactions include Murabahah (the sale of goods at a price), Istisna, Ijarah (lease), Mudarabah (partnership), and Musharakah.
Ⅱ. Islamic Financial Products
Islamic financial products can be classified into banking products, capital market products, and insurance products in a similar way to conventional financial products. Until the late 1970s, Islamic banks were strictly run by Shariah principles, and hence there were very few financial products. It was only after the 1980s when Islamic banks adopted loose interpretations of Shariah and expanded to Asia with diverse products. In the 1990s, global banking giants expanded into Islamic banking. And since then, Islamic finance has grown dramatically with diversified product lines similar to conventional banks.
With a stronger market foundation, Islamic capital markets have achieved a steep growth mostly around Malaysia in the 2000s. Basically, most capital market products run against Shariah principles. But as more flexible approaches are used in interpreting Shariah, Islamic financial products are becoming similar to traditional securities products, and the number of products has ballooned. More recently, even derivatives, whose inherent uncertainty were regarded as inappropriate, were introduced in Islamic finance. Today, Shariah-compliant products are as diverse as traditional capital market products.
The Islamic insurance market has also grown dramatically as institutional grounds for Islamic finance have developed.
Muslims well recognize the need for insurance, but they cannot use conventional insurance products due to their speculative and uncertain features. Instead, they use an alternative called Takaful, a cooperative system based on small contributions by members. Takaful is one of the most promising Islamic financial products.
Ⅲ. Current Status of Islamic Finance
The history of today’s Islamic finance dates back to the 1980s, when Islamic finance institutions in Malaysia and Bahrain began to provide small-sized personal financing. At the beginning, the scope of service was limited to personal loans, but soon expanded to a more flexible approach toward Shariah-compliant financing. With the growth of Sukuk in the 2000s, Islamic finance began to attract worldwide attention.
As of 2011, Islamic finance holds over $1.2 trillion worldwide and grows by more than 10% each year. Islamic banks hold over 80% of the total Shariah-compliant assets, and they are followed by other key players like Islamic funds and Sukuks. Most of the Islamic bank assets are held in the Middle East. Islamic banks in Malaysia, Turkey, and the UK also have significant portions.
Sukuk is one of the most significant Islamic financial products. Although representing only 10% of total Islamic finance, they are growing the fastest. Malaysia accounts for over 70% of Sukuk issuance, and is leading the growth by exporting Sukuk-related infrastructure.
Islamic financing assets are concentrated in the Middle East as well as the GCC and MENA countries. Moreover, they are expanding to other regions such as Turkey, Sudan, and Egypt, as well as non-Muslim countries.
With the steep growth in Islamic finance, western financial institutions introduced Islamic finance by opening separate bank windows inside their conventional banking branches around the 1990s. Although market systems related to Islamic finance were not in place at the time, western banks used loose interpretations of Shariah to build up Islamic product portfolios that were close to conventional ones. Not only commercial banks, but also investment banks introduced Shariah-compliant finance. They are now leading players in the Islamic capital markets, and contribute to developing and internationalizing modern Islamic finance.
In line with these trends, the middle class population is increasing in the Middle East, in Muslim countries in the
Southeast and Southwest Asia, and these regions increasingly use Islamic financial institutions. Moreover, as the Middle East increases its investments in Asia, the number of Islamic financial institutions is on the rise in Asia including Hong Kong, Singapore, and China. In western economies, such as the US, France, and the UK, Islamic ethics is attracting more attention and Islamic financial institutions are proliferating.
Ⅳ. Introducing Islamic Finance into non MENA region
1. Malaysia
Malaysia developed Islamic finance through government-led efforts and has accumulated know-how related to Islamic financial markets and products since the 1960s. As a result, Islamic financing and its techniques proliferate and are more advanced in Malaysia than any other nation. Currently, Malaysia adopts a dual banking system, which simultaneously operates a conventional banking system and Islamic one, with the policy giving some advantages to Islamic financing. As of 2009, Islamic financing accounts for 16% in banking, 8% in insurance, 21% in asset management, 57% in debt, and 88% in equity in Malaysia. The figures show that Islamic financing is more active in capital markets than in traditional financing.
Malaysia is a Muslim country and used loose interpretations of Shariah to expand Shariah-compliant financing and products. Also, the nation took the lead in its bid to become a key player in the market segment. It built the necessary infrastructure, e.g., devising Islamic finance regulations and establishing regulatory and educational institutions.
Malaysia also introduced the Islamic money market earlier than others and paved the way for a developed Islamic capital markets. Thanks to these efforts, Malaysia became the center of global Islamic capital markets in the 2000s when Sukuk grew significantly. The Malaysian government exerted diverse Sukuk market-related efforts, for example, issuing government bonds as diverse forms of Sukuk. Now, over 70% of Sukuk is traded in Malaysia.
2. UK
Among non-Muslim countries, the UK is the most developed in Islamic finance. It first encountered Islamic finance when the nation became the stronghold for oil money investments in the 1970s. In the 1980s, giant global banks established their Islamic finance arm in London, and this is when large UK banks began Islamic finance. When Islamic finance grew in the 2000s, the
UK government set about reshaping London’s financial environment to make the city a western hub for Islamic finance.
The UK’s goal was to create a new financial environment where Islamic finance and traditional finance are subject to equal laws and regulations. Also, the nation wanted to establish an environment within the exiting legal and institutional boundaries. To do so, the UK government provided tax breaks, so that transaction costs for Islamic finance were equal to those of conventional financing. In addition, regulatory principles were presented. Especially, the government highlighted the principle that all UK citizens should enjoy the same service, regardless of which ethnic or faith group they belong to. For instance, according to the principle, if a Muslim is marginalized from financial services due to his or her religion, it is viewed as discrimination. This justified the need for introducing Islamic finance.
Thanks to the government’s decade-long efforts, the UK now has the most advanced Islamic financial infrastructure among non-Muslim countries. However, the UK is still cautious about issuing government bonds in a Shariah-compliant style. However, the markets are expecting the UK to issue Sukuk and build a new track record in this area.
3. France
Although France holds the largest Muslim population in Europe, it maintained a conservative position toward Islamic finance primarily due to political reasons rather than economic reasons. But as Islamic finance grew rapidly and the UK emerged as the center for the growth, the French government couldn’t hesitate any longer. In 2008, France announced the introduction of Islamic finance. Since then, the additional costs generated in Islamic financial products have been eliminated, and now Islamic loans and Sukuks are traded in France.
In terms of Islamic finance, France has the biggest future potential in Europe. Islamic finance demand in France will come from not only Muslims currently residing in France, but also France’s former colonies in Africa that adopted the French financial system, e.g., Algeria, Morocco, and Libya. In addition, a French financial giant has operated and provided Islamic financial services in the Middle East for a long time.
With enough potential to become Europe’s Islamic financial hub, France intends to attract capital from the Middle East and use it to finance French firms. More specifically, France wants to attract oil money that otherwise would go to the UK. To accomplish the goal, France has continuously revised its laws
and regulations so that Shariah-compliant capital market products, such as Sukuk and Islam funds, can be traded domestically.
4. Japan
In 2005, Japanese financial institutions and Islamic financial institutions in the Middle East and Malaysia formed a business alliance. This is considered the point when Islamic finance was first introduced in Japan. Since then, several revisions were made with regard to financial product transactions and asset securitization so that Sukuk can be issued in Japan.
Japan is Asia’s largest and most mature capital market and foreign exchange market. The country felt the desperate need for Islamic finance when the Japan Bank for International Cooperation was trying to publicize Japan as a long-term investment destination to attract the Middle East’s oil money.
As Islamic finance grew fast in the international financial markets, the Japan Bank for International Cooperation led coordinated efforts with the Financial Services Agency and Bank of Japan to devise a step-by-step approach to introduce Islamic financing.
From 2007, Japan revised capital market related laws several times in order to treat Islamic financing as financial alternatives. This helped increase the number of Sharia-compliant financial products tradable in Japan. Moreover, tax laws were changed so that Islamic financial products receive fair treatment in comparison with other financial products.
The tax breaks and legislative reforms to boost Islamic finance involved tremendous costs and risks. But Japan is willing to take them in order to lead Asia’s Islamic financing in the future.
5. Singapore
Islamic finance first came to Singapore when Islamic financial products were first traded in asset management, insurance, and hedge fund industries in the mid 1990s. Since then, Islamic finance has grown significantly, and more financial institutions in Singapore provide Islamic products. Then, the government started to take actions to introduce Islamic finance under the principle that all types of financial products should be tradable in Singapore, which wants to be a global financial hub. Singapore’s decision was affected by the fact that Islamic finance can provide niche market opportunities to foreign financial institutions such as asset management firms, insurers,
and securities firms. Since then, Singapore has made efforts to build infrastructure through which Islamic financial services are provided under the condition equal to other financial services.
Based on the nation’s advanced financial system, the Singapore financial authorities are making more legislative revisions that will help Singapore to drive development of Islamic financing, and become a center of Islamic finance. In doing so, the country abides by the principle of applying the same tax for similar economic functions. The tax reform is still underway, and the range is expanding.
Geographically, Singapore is close to Kuala Lumpur. But Singapore regards all Muslims in Asia as potential clients and wants to become Asia’s Islamic financial hub by using the nation’s advanced financial system as well as the multiculturalism-based social system.
Ⅴ. Conclusion and Implications
In 2009, the Financial authority of Korea set to revise the regulatory framework to introducing Islamic Finance for facilitating financing from middle east countries. But unexpectedly, the National Assembly opposed the plan and no decision has been reached.
Islamic finance is still a fraction of the global financial markets. But many countries discovered its potential for future growth and already introduced it. Korea should consider the potential, as well as prospective demand from economic cooperation with the Middle East. It is desirable for Korea to view Islamic finance as an alternative vehicle, and adopt it within the boundary of the existing laws and regulations.