An Overview of Islamic Banking and Finance in Asia

ARX Administrator    Akbar Komijani, Farhad Taghizadeh-Hesary
05 Nov 2018
Categories: Macroeconomics, General Market Analysis, Islamic Finance

Country or region: Indonesia, Malaysia, Pakistan, Singapore, Brunei Darussalam, Bangladesh, China, Hong Kong SAR

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The Islamic finance industry has grown substantially in Asia over the last 2 decades. The Muslim populations in different Asian countries, especially in Southeast Asia, are increasing. Rapid Muslim population growth and improving living standards may enhance the popularity of Islamic finance as a keen alternative to conventional financing mechanisms. In addition, investors from the Middle East and Asia are increasingly seeking to invest in products that are in line with their religious beliefs. The governments and financial authorities in several Asian countries have played active roles in promoting the development of Islamic financial markets in line with the efforts to boost investments and achieve sustainable funding to enhance economic growth by tapping the huge liquidity from oil- and commodity-producing countries. The ethical character and financial stability of Islamic financial products may increase their attraction. Islamic financial products have an ethical focus (notably excluding investment in alcohol and gambling) with a risk profile that appeals to wider ethically conscious investors. Given that in Islamic banking returns on investments are based on underlying economic activities and/or assets that structure the contractual relationship between transacting parties, it is possible to use the asset-based nature and risk-sharing aspects of Islamic finance for greater integration with the real economy and to improve the overall economic balance between the real and the finance sector.

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The transformation of Islamic economic and financial systems started in the late 19th century when protests against the payment of interest gained momentum. In the 1890s, Barclays Bank opened a branch in Cairo to finance the construction of the Suez Canal (Kettell 2010). The establishment of an interest-based bank in a majority-Muslim country aroused some opposition and led some jurists to declare in 1903 that the interest paid to depositors in the post office contradicted Islamic rules and values. 

Islamic scholars designed alternatives to conventional banking by extracting Shariahcompliant contracts. Due to the high demand for Shariah-compliant banking services, many Islamic banks were established in the Middle East and parts of Asia, including Malaysia (1963), Bangladesh (1983), and Indonesia (1991). The foundation of the Islamic Development Bank (IDB) in 1975 as a regional development institution had the goal of promoting the economic development of Muslim countries and providing Shariah-compliant finance. 

The Islamic Financial Services Board (IFSB) is an international institution that designs and publishes Shariah-compliant standards aiming to enhance the health and stability of the Islamic financial service industry, including guidelines for the banking, insurance, and capital markets. The activities of the IFSB complement the measures and activities of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors. The IFSB, which is based in Kuala Lumpur, was officially inaugurated in November 2002 and started operation in March 2003.

Islamic capital markets have experienced substantial growth. Securities with the backing of Islamic assets are known as Sukuk. These securities have appeared in various structures in Malaysia, Indonesia, Iran, and other Islamic financial centers. Private corporations and international organizations such as the IDB, the World Bank, and governments are among the issuers of Sukuk, including the governments of Indonesia, Iran, and Malaysia. A number of high-profile non-Muslim Asian jurisdictions, including Singapore and Hong Kong, China, have also now issued sovereign Sukuk (ADB–IFSB 2015). Several funds based on Shariah-compliant shares emerged during the boom years of the 1990s (Iqbal and Mirakhor 2007).

Since the early 2000s, the global Islamic capital market has been growing in depth and size across jurisdictions, with numerous entities across sectors raising capital in ways that comply with Islamic principles. Today, the global Islamic capital market is a multisector segment that includes holistic financial instruments, including Sukuk Islamic equities, Islamic funds, and other Islamic structured products, such as real estate and investment trusts (REITs) and exchange traded funds (ETFs). The Islamic equity sector has firmly established itself in key global bourses and jurisdictions, and the world’s major financial index providers, such as Dow Jones, Standard & Poor’s, and the FTSE, all have Shariah-compliant equity listings, which have allowed the Shariah-compliant equity and fund markets to blossom. As an example, the Dow Jones Islamic Market indices cover market capitalization of more than $10 trillion in over 40 countries. These developments have enhanced the attractiveness of Islamic financial markets as an asset class for investment (ADB-IFSB 2015).

This document briefly covers the principles, characteristics, and features of Islamic banking and finance to clarify the differences from conventional banking and finance practices.

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