International Islamic Financial Market

LABUAN LECTURE SERIES 2000
23-24 November 2000
International Islamic Financial Market
By
Dato' Dr. Syed Jaafar Aznan ~ Vice President
Islamic Development Bank, Jeddah, Saudi Arabia

Bismillahir Rahman Nir Rahim
AssaIamuaIaikum Warahmatutlahi Wabarakatuh.

I would like to thank the Labuan Offshore Financial Services Authority (LOFSA) for inviting me to this Conference which has brought together such a distinguished group of scholars, policy makers and market practitioners in Islamic banking and finance. Hopefully, together we would be able to address the many challenges facing the development of the International Islamic Financial Market in the context of Islamic banking.

2. Islamic banking is not a new idea. However, its growth had accelerated only in the last few decades. The Islamic Development Bank was established in 1 975 and since then had vigorously promoted the application of Islamic banking in the conduct of businesses. We have to date made great strides, and Islamic financial institutions have been set up in all parts of the world, and are continuously being established until this day.

3. Islamic banking provides a choice to consumers and monetary authorities It provides for an alternative financial system that has begun to gain worldwide recognition. Indeed, the initial reaction of some consumers and bankers towards Islamic banking and finance was skepticism. Today, it is received with significant interest. Major international banking institutions with a significant amount of assets under their management have also established Islamic window offering Islamic financial products and services. With about USD170 billion of funds managed by more than 170 Islamic financial institutions, including in countries such as the United Kingdom and the United States, Islamic banking has proven itself and survived. Rising interest and preference among consumers all over the world to conduct business based on Shariah principles and growing awareness of the virtues and value-oriented system of Islamic banking have contributed to this positive development.

4. Although the amount of funds managed through Islamic banking is only a fraction of the total assets of the international financial system, it represents that portion of financial activities that is truly supported by underlying productive capacity that generates growth of nations across continents. It is this form of financial activities that we should encourage, as opposed to speculative financial flows that are not only unproductive but also destabilising and Destructive as has been seen to have occurred during the last financial crisis.

5. Despite the remarkable achievements of Islamic banking and finance, a considerable amount of funds from Islamic countries are still invested in conventional markets. The flow of financial resources from Muslim countries to the conventional financial markets is because a viable global Islamic financial system as an alternative 4o the conventional system is not yet well established. This deficiency is now being addressed by many and effectively presented as the challenge facing the Muslim Ummah in the new millennium.

6. Towards this end, I wish to congratulate Malaysia, through the Labuan Offshore Financial Services Authority or LOFSA for initiating and spearheading the effort to establish an International Islamic Financial Market, or IIFM, as a mechanism to match the surplus and deficit units of funds, in terms of region and institutions. I would also like to record my appreciation to the other countries and financial institutions around the world that have participated and cooperated in the development of IIFM. I would now like to share with you some insights into the development of the IIFM.

Ladies and Gentlemen!

7. The dearth of Islamic financial instruments has led to serious liquidity management problems for Islamic financial institutions, and has curtailed the development of a global Islamic financial market. Thus, the establishment of the IIFM is not only necessary but needs to be implemented on an urgent basis. The market will provide an avenue for an efficient management of Islamic assets and liabilities at the international level.

8. In light of the above, I am indeed pleased to inform this gathering that the initiative to develop the IIFM has received strong support and interest from a number of Islamic countries. The 1DB is committed to the project. Five parties have signed Memorandum of Understanding, namely 1DB, LOFSA, Bahrain, Indonesia and Sudan, giving their commitment to extend resources and expertise to implement the project. Major players from the private sector are also actively involved. A Working Group comprising 1DB, LOFSA, Bahrain Indonesia, Sudan and Brunei has also been formed to implement the project.

9. The working group has made commendable progress through the meetings that have been held in Bahrain, Labuan, Jeddah and Brunei. A common working model for the IIFM has been worked out, and 1DB has agreed to be the coordinator for the project. Yesterday, the Working Group held its meeting here in Labuan, and I am delighted to inform you that the implementation process of the IIFM will now be on a faster track. LOFSA and Bahrain have agreed to lead separate action teams on the implementation aspects of the IIFM and this will further accelerate the implementation of the IIFM. The target now is to make the IIFM operational by the middle of 2001. lnsya Allah with fullest support from all Islamic nation, this project will be a success.

Ladies and Gentlemen,

10. Basically, the IIFM will help achieve three major objectives:

i) Firstly, it will provide Islamic countries a more efficient and cost-effective financial intermediation. It should facilitate capital inflows to Islamic countries that are necessary for development. More importantly, the IIFM will provide the catalyst for the development and promotion of a larger supply of Shariah compatible financial products and this should also help to meet the growing demands from private and institutional investors, especially those from the Islamic countries, thereby enhancing investment opportunities. At the same time, the market will also generate spin-offs for other services and activities such as custodial services, broking, funds, advisory and treasury activities.

ii) Secondly, the IIFM will create an interactive framework for cooperation worldwide among different market players with varying needs to help deepen the global financial market, particularly that of Islamic countries. It will also contribute to strengthening the architecture of the international financial system as participation in the market will be opened to all, including the conventional banks. The IIFM can enhance liquidity of the Islamic financial institutions who will be able to manage their assets and liabilities more effectively, while abiding by Shariah principles, through the sale and purchase of universally acceptable Islamic financial instruments and direct placements under Mudharabah inter-bank investments.

iii) Thirdly, the IIFM will promote better business environment in Islamic countries and foster the establishment and regulation of regional and national financial markets. In the process, market regulation will evolve in a developmental manner and non-restrictive way, where nonetheless strict Shariah compliance should remained observed at all times creating expedient shortcuts to Shariah compliance would inevitably undermine customer trust and institutional credibility. Indeed, it is important to maintain trust and confidence both for the market and for its future development.

11. At the core of the market, is an institution called the Market Management Centre or MMC. The roles of the MMQ which will be pivotal to the operation of the market are to endorse the issuance of Islamic financial instruments for the market; to set guidelines and procedures for the market and to facilitate Shariah approval and rating of instruments introduced for the market. Another important element of the IIFM structure is the creation of a series of Liquidity Management Centres (LMCs). The LMC will help manage country liquidities, serve as regional hubs or centres and enhance the efficiency of the IIFM operations. The operation of the IIFM will be quite unique when compared to the conventional one because it may be possible to operate 7 days a week due to the difference of public holidays in Islamic countries. While the holidays in gulf countries are on Thursdays and Fridays, that in the Far East are Saturdays and Sundays, hence the 7 days a week concept.


12. Once implemented, the IIFM will serve the needs of all participants willing to deal in Shariah compatible instruments of banking and finance. It will not be limited to Islamic institutions and market forces will determine the growth patterns of Islamic products, roles of institutions and their market shares within the IIFM.

13. The IIFM will also help Islamic financial institutions to manage their assets and liabilities in a more efficient and cost-effective manner while abiding by Shariah principles and serving the economic development of the Islamic countries. The liquidity surpluses and deficits of participating financial institutions can be matched by:

i) One, sale and purchase of Islamic financial instruments; and
ii) Two, direct placements under the Mudharabah Inter bank investment. In this case, the yield could be based on expected rate of return and adjusted in actual terms at maturity to remain in full compliance with Shariah requirements. The availability of the direct placements is crucial to the operations of the financial market.


14. Indeed, the structured mechanism of the IIFM will enhance greater liquidity and efficiency in the system and accelerate the trend towards securitization and growth of liquid Islamic financial instruments and trade financing.

Ladies and Gentlemen,

15. The critical success factors in developing the IIFM are, one to have a broad number of players, and two a wide range of financial instruments. Without these two elements, there is' no market. Hence, the support of the governments and multi-lateral institutions is very critical to provide the push for more players to join the market. It is strongly encouraged that Islamic countries who have not participated yet, to get involved to add more breadth and depth to the market. It is for this reason also, members of the Working Group will be organising a promotional program to selected Islamic countries

16. In the area of developing financial instruments, again the catalyst will probably come from the governments and large corporations to issue sukuks to help kick-start the market. Strategically, it makes very good sense for a corporation to diversify its source of financial funding to ensure that it can remain liquid in times of critical needs. The recent Asian financial crisis has shown that relying on just the conventional financial markets is simply not enough. Hence, the development of the IIFM will provide the alternative for organisations to diversify their source of funding.

1 7. As for the liquidity in the Secondary Market, the IIFM will create an environment that will encourage both the Islamic based and conventional financial institutions to be active players to ensure that there will be market makers and sufficient liquidity for the Islamic Securities. To be successful and viable, Islamic financial instruments should be targeted at broad range of players and investors, both Islamic and conventional.

Ladies and Gentlemen,

18. The IIFM project clearly shows that cooperation among Islamic Financial Institutions can provide tangible results that will enhance the level of economic activities among countries. Insya Allah, the success of this endeavor should spur the formation of more cooperative economic framework of such nature. Such cooperation is very important as we operate in an environment that is becoming more and more challenging.

19. As you are aware, Islamic banking and finance is conceptually and fundamentally different from conventional finance and is increasingly being used worldwide. There is, therefore, a need for proper standards and supervisory regulations to be put in place. The Islamic Development Bank (IDB) has together with some financial institutions established some time ago the Accounting and Auditing Organization for Islamic Financial Institutions (MOIFI) which is based in Bahrain. This body has issued numerous recognized standards in its fields that are being used by Islamic financial institutions. The 1DB has also, together with other Islamic banks and financial institutions agreed on the establishment of a rating agency, the International Islamic Rating Agency (INRA) which will soon be registered in Bahrain. The INRA will provide rating services for the benefit of Islamic financial institutions. In addition, IDB is also coordinating with the International Monetary Fund (IMF) and other monetary authorities and financial institutions to create an Islamic Financial Services Board (IFSB) which will be in charge of issuing prudential and supervisory regulations and guidelines to be applied on an international level on all institutions that provide Islamic banking and financial services. All these institutions will complement and support the creation of the IIFM and will enable the IIFM to promote further the development of Islamic banking for the benefit of the Ummah.

20. In conclusion, I wish to reiterate the full support and unwavering commitment of the 1DB in the establishment of the IIFM. I am very glad that the project will now move at a faster pace and will soon be operational.

With that, I once again would like thank the organisers for inviting me to this conference.

Assalamualaikum Warahmatuhlahi Wabarakatuh.