The New York Times

December 2, 2009
Op-Ed Contributor

Malaysia's Next Big Thing?


KUALA LUMPUR — The threat of Dubai’s billion-dollar debt default is casting a shadow here in Malaysia, the would-be global center of the fast-growing Islamic finance industry. Islamic finance is designed to comply with Shariah law, forbidding interest on loans and investment in gambling, alcohol and other industries deemed unethical in Islam. It substitutes profit-sharing for interest, though profit shares can be pre-set to mirror interest on conventional loans.

It may seem unlikely that a country where only half the population is Muslim would seek to be the standard-setter in this field. But if Islamic finance keeps growing, Malaysia’s comprehensive system of products and regulation may enable it to become a significant trading center.

Islamic finance is estimated to be growing at over 20 percent a year, fueled partly by oil wealth but also by ethical demand. Some non-Muslim trading centers have created their own systems. London has been particularly active. France has changed some tax laws to enable some products to have equal footing, but efforts to allow sukuk, or Islamic bonds, have fallen afoul of the country’s constitutional court. The French Finance Ministry backs changes to help compete with London, but many secularists object.

Malaysia is now the leader in sukuk issues, with 60 percent of a global market of around $100 billion. It has little direct exposure to Dubai, but the prospect of a $4 billion default next month by Dubai’s Nakheel group is hurting the whole sukuk market and could weaken the attraction of Islamic products generally. One of the selling points behind the recent expansion of Islamic-based finance has been the belief that it remains rooted in the real economy, avoiding the derivatives and excessive leverage that undermined conventional banking. Though that remains true in principle, excessive exposure to over-ambitious Gulf countries could damage its image.

Moreover, beyond Saudi Arabia and the Gulf countries, Islamic finance, despite its rapid growth, is still just a niche market. Even in Malaysia it accounts for only 20 percent of financial sector assets, despite efforts to promote it by the government-linked institutions that are major factors in this economy. But promoters see huge potential in Muslim and non-Muslim countries alike.

The surpluses of Muslim oil-exporting countries have been a major factor in its growth. But these surpluses have been dwindling; even before the Dubai shock some issuers of Islamic paper in the Gulf and Saudi Arabia had run into difficulty.

In some Muslim countries, poorly managed experiments have given Islamic banking a bad name. In others, many Muslims — including in Malaysia — seem not to be concerned about whether conventional banking is contrary to the Koran. Many argue that in practice so-called Islamic products simply copy conventional ones. Differing interpretations by Islamic scholars of what is permissible have created confusion and inhibited cross-border trading.

Nonetheless, Islamic finance seems likely to continue to spread in countries with significant Muslim minorities and in secular but predominantly Muslim nations like Indonesia and Turkey. Moreover, Japan, South Korea and other wealthy countries have been changing tax laws to encourage investment from Islamic countries.

In Malaysia, the industry has evolved from basic banking to bonds, insurance and fund management — all within a framework consistent with the same supervision as the conventional finance sector. The net result is that the biggest players in Islamic finance now include international names like HSBC. In mortgage finance, insurance and fund management there is competition between the systems based more on price and performance than piety. Many non-Muslims here buy Islamic products.

Whether Kuala Lumpur can truly develop as a major trading center is another matter. So too is the question of whether Islamic finance will ever be more than a minority system, even in most Islamic countries. But it seems likely that — despite the Dubai mess — the sector can bring rewards to Malaysia’s innovators.