Economic phenomenon

  • Author : Angelo Venardos
  • Date : January 2009
ABOUT THE AUTHORAngelo Venardos TEP is Executive Director of Heritage Fiduciary Services PTE Ltd

T o truly understand the current interest in the development of Islamic banking and finance in Southeast Asia and how it is different from the conventional banking system, one must first understand the religious relationship originating from the Quran, and then trace the historical, geographic and political developments of Islam over recent centuries. Only on this basis can policy-makers and market participants, without prejudice or cynicism, begin to appreciate Shari’a law and Islamic jurisprudence. With this appreciation, government and multinational corporations will understand the challenges in the development, and benefit from the growing Islamic finance trends in Southeast Asia.

The following is an examination of Islamic banking and finance developments in Southeast Asia.

Malaysia (first to market mover)

Malaysia is regarded as the leader in Islamic banking in Southeast Asia. In May 2006, the Dow Jones Citigroup Sukuk Index was launched, becoming the first index to measure the performance of global Islamic sukuk (bond). It is a benchmark for investors seeking exposure to Shari’a-compliant instruments. Malaysia holds the largest share of the global sukuk market, with an estimated total of USD29.94 billion (MYR110 billion) and make up 44 per cent of the domestic bond market.1

The Financial Sector Masterplan, which was implemented by Bank Negara Malaysia (BNM) in 2001, aims to have 20 per cent of Malaysia’s banking and insurance industry comprised of Islamic banking and takaful (co-operative insurance, joint guarantee) by 2010.2 Currently it is about 12 per cent of the country’s banking sector.3

To further assist the development of Islamic banking in Malaysia, the 2008 Budget announced substantial tax incentives to boost the Islamic banking and finance industry

Indonesia (the sleeping giant)

Despite being the world’s largest Muslim country, Islamic banking in Indonesia is lagging behind Malaysia. Shari’a banking is only 1.5 per cent of Indonesia’s overall banking industry. However, the relatively new industry has experienced some growth. Assets managed by Indonesia’s Shari’a banks increased from IDR7.85trillion (USD865million) in December 2003 to IDR26.72trillion (USD2.94) billion in December 2006.4

To stimulate more growth in Shari’a banking in the following year, an acceleration programme was launched. It aimed to boost the Shari’a banking industry to about five per cent of the overall banking industry by the end of 2008.

Some of the challenges facing Indonesia in its development of an Islamic financial industry include an undeveloped legal and supervisory framework, absence of institutional players, limitations in human resource, taxation issues, risk management and mitigation and the lack of a secondary market.

Brunei and Labuan (offshore niche markets)

In recent years, Brunei, an independent sovereignty, has been moving away from its role as an oil and gas producer and towards that of an international finance centre. With the establishment of the Brunei International Financial Centre (BIFC), the government has enacted policies and legislation to assist Islamic banking and finance to be an integral part of Brunei’s plans of positioning itself as an international finance centre in Southeast Asia.

The Brunei Darussalam’s Syariah Financial Supervisory Board was established and came into effect in January 2006, serving to facilitate regulators and players, in ascertaining that all transactions, products and services offered are Shari’a-compliant. The Islamic banking industry in Brunei has seen a consistent growth of 19 per cent per annum since 1993 and a market share of 32 per cent.

In March 2006, Brunei’s first ever Islamic bond, the Short Term Government Sukuk Al-Ijarah programme was launched. This was a definite step towards establishing an Islamic capital market in the country. Brunei has also signed an MoU with Bahrain, thus linking it to this developed Islamic banking market.

Labuan is more likely recognised as a Malaysian international finance centre. In addition to this status, the Malaysian government has included this island off the coast of Sabah in its plans of being on the forefront of Islamic banking in Southeast Asia. The Labuan Financial Services Authority (LOFSA) is one of the participating members of the International Islamic Financial Market (IIFM) which began in April 2002. The IIFM serves to provide a cooperative framework to encourage the growth of an Islamic financial market that is in accordance with Shari’a.

In October 2006, the Labuan International Offshore Financial Centre (IOFC) conducted the primary listing of the world’s first exchangeable and equity-linked sukuk issued on the Labuan International Financial Exchange (LFX). The USD750million sukuk pushed the exchange’s Islamic capital market capitalisation to USD2.8billion, representing 18.5 per cent of the total market capitalisation of USD15.1billion.5

Singapore (a regional Islamic financial hub)

Singapore has emulated the UK model of accommodating Islamic banking and finance within the existing banking system by i) levelling the playing field so that tax inequalities on Islamic transactions were eliminated; and ii) allowing banks to offer products and services such as Murabaha (a cost-plus-sale contract where a financier purchases a product for another party who does not have his own capital to do so) and Mudaraba (a profit-sharing partnership, which one party with capital forms with another party with skills).

In late 2005, Singapore launched its first Murabaha facility – a USD96million facility offered by the Singapore branch of Standard Chartered Bank for Baitak Asian Real Estate Fund, a joint venture between Singapore-based Pacific Star and Kuwait Finance House.

In February 2006, the Singapore Exchange Securities Trading, together with FTSE Group and Yassar Research, launched the FTSE SGX Asia Shari’ah 100 index, which tracks 100 Shari’ah-compliant stocks from Japan, Singapore, Taiwan, Korea and Hong Kong. This was developed to encourage the launch and management of Islamic unit trusts and exchange-traded funds in Singapore.

In May 2006, the Singapore Exchange Limited (SGX) launched the SGX AsiaClearTM, an over-the-counter (OTC) clearing facility for oil derivatives and dry bulk forward freight agreements (FFA). SGX AsiaClearTM presently clears 21 different OTC trades, and currently, it has over 60 country-party accounts.


In May 2007, the Development Bank of Singapore (DBS) invested USD250 million (SGD380.2million) into the first Singapore-based Islamic bank, the Islamic Bank of Asia (IBA). DBS owns 60 per cent of IBA while the remaining 40 per cent lies in the hands of 22 investors from the Gulf Cooperation Council (GCC). In September 2007, the IBA completed its final closing, bringing its paid-up capital to USD500million. As a result, DBS will retain its majority stake in IB Asia at 50 per cent plus one share.

Product development

To the uninitiated, the increased appeal of Islamic banking as an alternative to conventional products may be viewed as a purely economic phenomenon, particularly where, in Malaysia, more than 75 per cent of the customers of OCBC Bank and Maybank consumer banking, are non-Muslims.

However, the increase in Islamic financial products is not merely an economic phenomenon that may lead to a bubble. It is the result of the development of an alternative banking and finance structure that is faith based. Investors are seeking investments that are permitted within the teachings of the Quran and that offer same returns and quality as similar conventional banking instruments.

The growth of the Islamic finance sector has seen the involvement of global banks, such as Citibank, HSBC, Deutsche Bank and UBS and the diversification of Islamic structured products, such as real estate, aircraft financing, shipping and trade, as well as project financing.

However, it is the capital markets that have attracted much of the attention of the institutional players. Sukuks that are traded and listed will contribute to the eventual liquidity of their trading, hence the aim is to issue more and more sukuks that are rated and listed. Sukuks are regarded similarly to bonds and buyers are using them for booking and risk management.

Islamic finance products can be employed rather suitably in real estate as the projects can yield returns equivalent and even greater than other markets and the appropriate financing vehicles, which are Shari’a-compliant, can easily be formulated. An increasing number of conventional realtors have been using Islamic financing vehicles for the competitive advantage and greater returns that it yields.

Islamic financing structures are increasingly used in the project finance domain, particularly in projects in the Middle East. In most Islamic financings incorporated within a multi-sourced project financing, the Islamic financing element of the project is provided pari passu with the other senior debt. Istisna (a kind of sale where a commodity is transacted before it comes into existence) and ijara (leasing) elements are frequently used. For example, Dolphin Energy signed a USD1billion Islamic financing agreement with 14 local and international banks in September 2005, which was the largest Shari’a-compliant funding to be completed in the oil and gas sector at the time. Banks involved included BNP Paribas, ABN AMRO, Citigroup, Dubai Islamic Bank and Gulf International Bank. The loan has a four-year tenor and is structured as an istisna.7

The current debate between innovation and imitation in product development concerns the construction of a product from a pure halah (permissible by Islamic law) perspective or the alternative method of developing products through ‘Islamicising’ conventional products. However conventional products work on principles which may not be Shari’a-compliant, such as speculation, involving uncertainty and no purchase of the underlying asset. The second method will point to a direction where Islamic finance apes the conventional banking system. This is a rather short-sighted way of developing products.8

There appears to be a future trend and window of opportunity concerning product development as Southeast Asia is the fastest growing economic region in the world. The subsequent relocation of Swiss private banking to Singapore, to cater for the growing wealth management industry, is now starting to focus on the creation of Islamic products for high net worth individuals (HNWI) ranging from India to China. In particular, fund management, third-party product distribution to HNWI will create a demand for capital, equity and property product development. These products will originate from Malaysia and Singapore, as they are both located between the two largest emerging economies of India and China and form the nexus of conventional and Islamic banking in the region for distribution to lucrative markets such as Indonesia and GCC.


The economic development and future of Islamic Finance in Southeast Asia is anticipated with excitement as the individual countries attempt to take a stake and be credible participants to the market leader in the region, Malaysia. The developing awareness and competition of this faith-based economic phenomenon will bring out the best of practice in Indonesia, Brunei, Labuan and Singapore in areas of product and regulatory development, to attract global investors, especially those from the GCC.

Yusli Mohamed Yusoff, ‘Global Acceptance of Malaysian Islamic Products’, Malaysian Islamic Finance Report 2006, p30
Bank Negara Malaysia, ‘The Financial Masterplan’, 2001, p79
Yaroslav Trofimov, ‘Malaysia Blazes a Trail in Global Islamic Finance’, Zawya, 3 April 2007
Bank Indonesia, ‘Publication of Shari’ah Banking Data’, December 2006
Labuan Offshore Financial Services Authority, ‘Annual Report of the Members of the Authority for the Year Ended 31 December 2006’, 2006
Kok, ‘Singapore Exchange’, p109-11
Charlton and Shoker, ‘Islamic Structured Products’, p7-8
Alam, ‘Evolution of Products’


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