Does Malaysia prioritise profits over Shari'ah? Islamic Business & Finance travelled to Kuala Lumpur to dispel the myths surrounding Malaysia's Islamic banking sector, and discover the real secret behind its success.
Islamic banking may have been born in the GCC, but it grew up in Malaysia. To the casual observer, this has much to do with its supportive Government and majority Muslim population, who we are led to believe demanded banking products that complied with their faith. However, a wide cultural divide exists between the GCC and Malaysia; while the Middle East banks on faith, Malaysia appears to have faith in banking; its more relaxed population, unlikely to be swayed simply by an Islamic brand, haven't just demanded Shari'ah-compliant banking, they've demanded more for their money.
"There is a very different approach," said Dato' Jamelah Jamaluddin, Chief Executive Officer of Kuwait Finance House (Malaysia). "In the Middle East they uphold the Shari'ah principle as a priority versus economic benefit and commercial reason. In Malaysia, we tend to be more skewed towards the commercial. Malaysia has grown into the Islamic finance hub because it is all business."
The CEOs Islamic Business & Finance met seemed all too aware that consumers wouldn't choose their bank simply on religious grounds. "Islamic banking is not a requirement of Islam," said Badlisyah Abdul Ghani, Chief Executive Officer of CIMB Islamic. "Islamic banking is just a means for Muslims to fulfil one obligation - the avoidance of Riba - and Muslims can fulfil this by doing many things, not necessarily by doing Islamic banking."
Indeed, it appears to be the modes of finance, rather than the religious aspect, that sells Islamic banking in Malaysia, evidenced by the number of non Muslims who choose Islamic finance. "The majority of our customer base consists of non Muslims and this is testament to the acceptance of the values, fairness and productivity that exist in Islamic banking," said Raja Teh Maimunah, Chief Executive Officer of Hong Leong Islamic Bank. "The concept of 'free from interest', whereby the charging of interest is disallowed, is gaining even more ground with higher understanding of its equitable and just nature which appeals to both our Muslim and non-Muslim customers."
"The demographic of our customers is 50/50 between Muslims and non Muslims," agreed Muzaffar Hisham, Chief Executive Officer of Maybank Islamic. "This is because we are able to price our products to be more competitive. I think the main key for us as a group is that when we come up with a product, Shari'ah is paramount - that's a prerequisite - but the drive for innovation and the drive to make sure that the product is there for Muslims and non Muslims is equally important; value proposition is the priority. You have to ask what the value to the customer is, and to the bank as well. Ultimately, your shareholders are paramount. We've got to ensure right profitability, proper risk management and adequacy of capital is preserved."
FREEDOM OF CHOICE
It's fair to say that Islamic banks in Malaysia aren't focussed on an exclusively Muslim clientele, meaning the Islamic banks are tasked with designing Shari'ah-compliant products with universal appeal. "A Muslim will only look at Islamic banking, whereas a non Muslim will always look for the economic value", said Haji Abd Rani Lebai Jaafar, RHB Islamic Bank's CEO. "Now people are more educated and aware of the benefits of Islamic banking. Of course we have to be competitive."
Jaafar explained that the need to cater to everyone, regardless of religion, has driven Islamic product innovation in the retail segment, resulting in a choice of products that simply don't exist in the GCC. "Last year we started our Islamic pawnbroking; you can pawn your jewellery, we will give you 70 per cent of its value, and we will keep it for six months with no interest. After six months there is a custodian fee of one per cent a month. At the end of six months, you can rollover for another six months. The response has been very good, and we will open at least 10 more branches this year. Islamic pawnbroking is common in Malaysia and complements Islamic finance perfectly, however it is nonexistent in the GCC."
According to Maimunah, equalling conventional banking isn't enough - Islamic banking must surpass it. "Industry players must be able to provide products and services that are not only price competitive, but provide additional features that would appeal to the retail segment over those offered by conventional banks. Expanding the suite of products is critical to the long term sustainability of the industry. Thus investment in product and research development is important."
VALUES FOR MONEY
Islamic banks in Malaysia seem keenly aware that their prices have to remain competitive with conventional banks. "The value proposition would make a consumer choose," said Ghani. "When you scrutinise Islamic banking, you get much better value for money than you do with conventional products. There is automatically no interest, which automatically makes it superior in terms of value to a consumer... In terms of penalty charges, Islamic banks do not make money from your problems. They will still charge the penalty in order to stop people taking advantage, but the amount of money the customer pays goes to charity. Islamic banks do not make money from your problems. There are lots of pros and benefits for society." No interest with Islamic banks is a given, however surely the fees make up for conventional charges? "One of the most commonly-heard myths is that Islamic banking products are more expensive than conventional ones," said Maimunah. "This myth arises as the profit amount on a fixed rate financing facility is presented up-front and it appears as a ballooned figure when compared to the borrowing costs based on floating rates. More often than not, the overall costs are comparable with conventional loans. Further, what is rarely known is that customers are granted rebate for early redemption of a facility, duty remission on financing documents for new property purchases, full stamp duty waiver on financing documents when you refinance from existing conventional home loans, late payment charges are capped and no penalty charges can be imposed."
This is all very well for the customer, but how does this bode for Malaysia's business savvy banks? "Banks moan about it, because you don't make as much money as a conventional bank," said Badlisyah. "In the end, however, you have customer loyalty, customer retention, so you make more money over time. When you scrutinise, in terms of profitability, we are fairly competitive, if not better than conventional banks. I dare say we make more money in an Islamic bank than a conventional bank - our yield is better. Our cost finance compensates for the charges that we do not make."
"We've got some advantages from the Government as well," added Hisham. "There are some key tax incentives - not big ones, but small ones just to square the retail space, and that helps a little bit. The net profit margin will see a contraction, but it's about how effectively you run your balance sheet. I think for Maybank Islamic, we are blessed with the best of both worlds with the commercial and the retail side so that allows us to manage our balance sheet more effectively. But we also need to manage our asset pricing, both the liability and assets to ensure price competitiveness."
COMPETITION TIME
Jaafar explained that plans to expand Islamic banking in Malaysia are getting even more competitive. "The second financial sector blueprint that Governor Zeti launched third quarter last year said that by 2020 Islamic banking in Malaysia will be 40 per cent of conventional. For the next 10 years, Islamic banking must grow at least two per cent a year. It's very ambitious, but we are fully geared up to meet it."
In order to do so, however, there is still much work to be done. The retail side continues to lag behind the corporate side, much as it does in the GCC. "I believe, in part, this is due to the understanding of Islamic banking products," said Maimunah. "The more sophisticated segment, i.e. the corporate side, are encouraged to subscribe to the Islamic finance following tax incentives and a wider investor base - the Sukuk market. The retail side is driven primarily by price and familiarity with traditional conventional banking products. I believe as Islamic banking products become more mainstream, we will gain greater traction in the markets."
Muslim or not, it is as challenging for a consumer to understand the terminology and complexities used in Islamic banking as it is for any consumer trying to grapple with the small print in a conventional bank. Maimunah believes that this can be combated with better awareness.
"Education is key," she explained. "Islamic banking remains unfamiliar to a large proportion of consumers. We need to collectively continue to promote product awareness."
GENDER GULF
This does, of course, mean everyone - not just Muslims. Another key difference between Malaysia and the GCC seems to be inclusiveness. Another example of this would be that almost half of the CEOs Islamic Business & Finance interviewed were women, as are many prominent people in Malaysia's financial sector, its Central Bank Governor being a shining example.
"Women are the future market," said Jaafar. "In Malaysia, about 70 per cent of graduates are women - I think the men have been a little bit lazy! Sixty per cent of our bank's staff are women... Our records show that the default rate [on loans] for women is very low, which is why we can offer them a special rate." Jaafar explained that Az Zahra, RHB Islamic's Privilege Ladies Banking service, the first and only of its kind in Malaysia, was launched last year for premier banking customers; however Jafaar revealed that, owing to its popularity, it has now been made available to all female clients of the bank this year.
Aside from the economic benefits that come from the financial inclusion of women, it demonstrates how Malaysia is culturally very different from the GCC, and explains how a perception that it is more liberal about Shari'ah came into existence.
LOSING MYR RELIGION?
"There is a common myth that Islamic banking products in Malaysia are not Shari'ah-compliant, as most models adopted in this region are not recognised by 'standard' Islamic banking practices of the Middle East," explained Maimunah. It is a myth, however, that she is keen to dispel.
"This situation arises due to different interpretations amongst Shari'ah scholars and the result is that some products may be deemed Shari'ah-compliant in some countries, but not others. For example, Malaysian Islamic banking products are deemed Shari'ah-compliant in most Gulf countries. This situation is similar to Islamic products from other countries in which some would be recognised and some not, depending on the opinions of the dominant Shari'ah scholars in that particular location. In addressing this issue, Bank Negara Malaysia is working to introduce guidelines to ensure the uniform application of certain Shari'ah concepts to avoid confusion - such as for Murabaha, Ijarah, Musyaraka and other Islamic banking products."
Despite this misconception, one could describe Malaysia as being stricter when it comes to keeping its banks Shari'ah-compliant. For example, Islamic banks in Malaysia are forbidden from doing commodity Murabaha with conventional banks, which is permissible in the GCC.
Banks in Malaysia are also strongly encouraged to operate Islamic subsidiaries, rather than windows, to ensure a firewall between conventional and Islamic assets. "We are encouraged very much by the Government to operate as an Islamic subsidiary," said Badlisyah. "From a customer viewpoint, they would prefer to deal with an Islamic subsidiary rather than a window."
SUBSIDISING SUCCESS
However, in spite of the strict separation, that doesn't stop an Islamic subsidiary leveraging on its conventional bank's resources. "Subsidiaries have economies of scale," said Badlisyah. "When we first established our balance sheet after acquiring our sister bank. We acquired an Islamic subsidiary with an independent model, with its own branches, separate management, its own credit scoring... We took the decision to dismantle that. At the time they had one branch with two more being constructed. We dismantled everything, and overnight we had 350 branches across the country because we decided to leverage the resources of the conventional bank, and therefore change the branch model to a two-in-one model - two banks in the same location. Separate banks, but using the same infrastructure. Immediately we are economies of scale. That model has allowed us to grow to become the second largest Islamic bank in the country within five short years."
"In 2005 they allowed Islamic banks to become subsidiaries," said Jaafar. "Around that time, a lot of development happened in terms of legislation, regulations, development of human capital... The Government was determined that Islamic banking would be a core sector."
CARVING A NICHE
It is interesting that Malaysia was the country to take this initiative, when the first Islamic bank was opened over 4000 miles away and a more populous Muslim country was living next door. "Malaysia found the need to be the centre of excellence for Islamic finance because we had to find a niche," explained Jamaluddin. "For us, we need to be specialised because we don't have the population to support it. How do we compare ourselves with the rest of the world? In conventional finance, we're nowhere. But with Islamic finance? Now we're getting somewhere!"
"We have a very deep and broad Islamic capital market," explained Badlisyah. "We have one of the more dynamic and exciting Islamic banking centre which we have developed from the ground up very strongly in terms of our domestic business. Over time that grew to include offshore banking and international banking. It's just a natural progression for the Malaysian market to build itself into an Islamic finance centre, because it has a very strong base. Our domestic market started way back in 1963. With that comes stability of business. And it is because of that market confidence Malaysia is seen as an international hub for Islamic finance. It's just a natural process."
Of course, this couldn't have happened without careful planning. "At the same time as retail Islamic banking, Malaysia began to develop its Islamic capital market," said Jaafar. "That's why it accounts for about 60 per cent of the Sukuk market today. Malaysia's 10-year master plan for the banking industry in 2010 included a specification that Islamic banks have to have a 20 per cent market share. Along the way, 21 banks have been issued Islamic banking licences. We have 16 commercial banks, four or five of which are international, and they also issued about five international currency licences. So for the last 40 years Malaysia has gained a lot of experience in Islamic banking - in fact the whole world is coming to Malaysia to learn Islamic banking."
FOREIGN FRIENDS
Foreign banks have certainly arrived in force to lap up the local knowledge. "The arrival of Islamic banks, such as Kuwait Finance House, Al-Rajhi Bank and Asian Finance Bank signals the appeal of Malaysia as an international Islamic financial centre in addition to the Islamic arm of the global banks, i.e. Standard Chartered Saadiq, and HSBC Amanah," said Maimunah. "Their presence has enhanced competitiveness which I feel is good for the development of the industry as a whole. The market has benefitted from the introduction of new products which some foreign banks have brought to our shores."
"We brought different concepts and products," said Jamaluddin, the CEO of the first foreign Islamic bank in Malaysia. "Most of their local banks benefited from that."
Although, according to Maimunah, local Islamic banks still have the edge in the retail market. "Local Islamic banks are recognisable brands in the Malaysian market arising from greater geographical coverage/wider branch network and longer operating history. With this comes a higher level of familiarity and comfort, a valuable tool in penetrating the market," she said.
The arrival of foreign banks, has, or course, stiffened the competition even further. "Everyone is going for the same segment," said Jaafar. "You have to differentiate yourself in terms of service, products and innovation. Our view is that you have to give all your customers the premium service. We spend a lot of time, money and effort training our people."
However, it seems to be generally agreed that competition is healthy. "I'm a true believer in competitiveness and liberalisation in order to ensure an efficient market - I think we have that," said Hisham. "In fact, in Malaysia, Islamic finance was the first sector in the financial sector that opened up to liberalisation, so people like me had to run a bit faster than my conventional colleagues! However, it brings out the best of the players."
NEW HORIZONS
With the local market feeling settled, Malaysian Islamic banks are now setting their sights on stranger shores. "There is a lot of oil money in the Middle East, and if those funds can be mobilised there is a lot of opportunity over here. That is why Malaysia is trying to become the Islamic finance hub, where we can provide that expertise. So in the financial sector master plan, one of the initiatives set by the Government is for us to go regional and international. Locally, we are very grounded," explained Jafaar.
Because of this, Islamic banks in Malaysia are now harbouring some pretty ambitious expansion plans. "Maybank Group has a whole market base in Indonesia, Singapore... We want to see how we can complement that growth," said Hisham. "Last year we saw a nice cross-border transaction out of Indonesia, both for Malaysian corporate investing in Malaysia and Indonesian companies raising Shari'ah-compliant funds. So it's a good step from ground zero."
Hong Leong Islamic Bank is also looking to spread its wings. "From a regional perspective and in furtherance of our evolution, while we have strategic intent for regional foot-printing, this would initially be done on an opportunistic basis and driven by wholesale or corporate deals," said Maimunah. "HLISB continues to keep abreast of regional market opportunities that match our strategic intent and capabilities for conversion into tangible business benefits - whether this is in Islamic retail or wholesale markets.
"HLISB's initial focus would be to leverage on HLB's existing regional infrastructure and presence in markets such as Singapore, Hong Kong and China to expand its business base. We are also looking at emerging Muslim countries as part of our business strategy to increase our market penetration. Entrance into these countries, i.e. without an existing HLB presence, would either be through collaboration with local players or through direct HLISB involvement in the said country, depending on the market outlook as well as cost efficiency studies."
According to Jamaluddin, KFH Malaysia aims to derive 20 per cent of its income base from regional expansion by 2015. "We are growing our business in the form of capitalising on the banking licence that we have," she said. We think there is a lot of potential for us to expand into the region - we hope that by 2015, 20 per cent of our income base will be contributed by our regional expansion, that is to say rather than domestic Malaysia, we want to go into places such as Indonesia and China and derive 20 per cent of our income from there."
PROBLEMS AT HOME
There is, however, still more work to be done at home. "In Malaysia we practically have everything; the only thing I'd say is missing is perhaps the public sector component," said Ghani. "It's there, but it's not completely there. You have a very vibrant Islamic market in the private sector - all the ingredients are there - but when you look at the public sector... For example, conventional banks have Islamic windows, but you don't see an Islamic window in reserve management, for example.
"All government bonds should be Islamic - Sukuk can be purchased by any bank, however conventional bonds exclude Islamic banks from the market. If Islamic bonds attract a wider market you get better pricing. Naturally, this is not yet done in the market in the public sector. Perhaps moving forward all treasury papers issued by the Government should be Islamic, then you will see the market complete.
"The other element that would complete the whole ecosystem is the concept of Waqf, which translates to a foundation of trusts. If we look back into our history, Waqf played a significant role in public funding. It's long term funding that is easily sourced. If both of these were readily available then the Islamic market in Malaysia would be complete."
Not quite, it seems, according to Maimunah, who believes that asset and fund management in Malaysia have been sadly neglected. "We need to develop the equity market, because we don't have much expertise in that field. The industry in Malaysia was very much focussed on banking, not very much on fund or asset management, whereas in the Middle East it is the other way around."
It seems that when it comes to Islamic banking in Malaysia, a lot of things are the other way around from the Middle East. There is little need to reiterate the regulations and framework which are often credited for being behind the industry's success; I think what the Middle East could usefully learn from Malaysia is its determination to give Shari'ah and commerciality equal priority. The reason Malaysia is an Islamic finance hub is that it gave its population a reason to choose it.
© Islamic Business and Finance 2012
