11 June 2018

Current trends in Malaysian Islamic finance: value-based intermediation

The Islamic banking industry in Malaysia is paving the way for a new phase of development. A comprehensive market infrastructure and a robust and progressive regulatory framework is already in place. Realising the need to explore new opportunities to bring Islamic finance to the next level, Malaysia has recently introduced value-based intermediation (VBI) principles.

In 2017, Islamic banking accounted for 71% of the increase in Malaysia's financial sector, overtaking conventional banks’ growth (RAM Rating Services Bhd). Malaysia's central bank, Bank Negara Malaysia (BNM) defines VBI as "an intermediation function that aims to deliver the intended outcomes of Shari’ah through practices, conduct and offerings"[1] to contribute positively and sustainably to a wider range of stakeholders (environment, community and overall economy) without compromising shareholders’ financial returns and long-term interests.[2]

The intended outcome of VBI is to encourage ethical values comparable to established frameworks such as Corporate Social Responsibility and Corporate Governance; Environmental, Social and Corporate Governance; and Ethical Finance and Sustainable, Responsible, Impact Investing albeit underpinned by Shari’ah principles as its distinguishing factor. The emphasis is on the strengthening of the role and impact of Islamic Banking Institutions (IBI). Essentially, VBI sets a new global standard that determines the moral compass and underlying values in everyday business dealings by IBIs. The aim is to improve the products and services they offer by considering the impact of their activities not only to their consumers, but also to wider stakeholders.

BNM introduced VBI in a strategy paper that was issued in March 2018, with nine major IBIs committing to integrating its principles into their own core practices. For example, Standard Chartered Saadiq is now applying a risk-based approach that assesses environmental and social risks in identified sensitive sectors to meet the highest standards for its clients.

BNM is also developing a VBI scorecard to measure adoption of the initiative. This is expected to launch in October this year in conjunction with the Global Islamic Finance Forum in Kuala Lumpur. The scorecards will be used as a self-assessment tool and will also be publicly disclosed to allow stakeholders to compare the performance of IBIs.

Given the size of the IBI market share and the industry's current level of maturity, Islamic banking players have the necessary capacity to drive this initiative to ensure sustainable growth. However, the intended outcomes of VBI are universal and may be relevant and beneficial to conventional financial institutions. It is already apparent that IBIs which focus on sustainability by adopting elements of VBI are experiencing higher return on asset and return on equity ratios, and are less volatile when compared with conventional banks.

According to BNM, IBIs must ensure that their strategy manifests the four underpinning VBI principles:

  • entrepreneurial mindset
  • community empowerment
  • good self-governance
  • best conduct.

For example, VBI addresses issues relating to unfair contract terms in consumer contracts via its elements of good self-governance and best conduct. "Greater attention will be devoted to value creation and value-based businesses that reflect the true essence of Islamic finance", says BNM Governor, Muhammad bin Ibrahim.

The adoption of VBIs promotes transparency and fairness in doing business, thereby resulting in greater consumer confidence. Its impact-focused assessment encourages awareness of the socioeconomic impact of any action taken in order to ensure successful sustainability and to reduce negative externals. Nevertheless, in addition to committing to respective timelines in advancing this initiative, coordinated efforts amongst IBIs and collaboration between the industry's key stakeholders are crucial for effective implementation of VBI in order to yield significant positive impact and sustainability on the wider financial ecosystem.

[1] http://www.bnm.gov.my/index.php?ch=57&pg=137&ac=693&bb=file

[2] http://www.bnm.gov.my/index.php?ch=57&pg=137&ac=612&bb=file

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