Disclaimer: Warwick ASEAN Conference would like to clarify that all opinions expressed in this article are the authors’ and editors’ own.

BY ADRIAN ANG

It is not something you will have likely heard of or understood, but Islamic finance, in its relative obscurity, has been an increasing fixture of not only ASEAN, but broadly Asian growth and investment. ASEAN countries alone hold more than 20% of the global share of Islamic finance banking assets; assets that have seen an estimated annual growth rate of 17.6% growth rate over the last four years with an expectation to almost double in 2018. These almost ridiculous statistics are hard to come by in any sector in what has become a fairly sluggish global economy, but these numbers are understandable when taken into consideration the fact that Asia houses over 60% of the world’s Muslims, where Indonesia alone is home to 13%. Moreover, the Malaysian International Islamic Finance Centre (MIFC), quotes a mix of strong political support, large investor base and generous tax incentives as further enticements to tout Asia as the next leader for Islamic finance.

Now in the midst of all this, you may be itching to know exactly what Islamic finance is. Put simply, it is a banking and financing method that is compliant with Sharia (Islamic) Law. Broken down into its core “pillars”, Islamic finance avoids perceived haram (harmful) activities such as the charging of interest, gambling, speculation, and investment in forbidden sectors such as alcohol, pork and pornography to name a few. If you are as baffled as I was at the principle of no interest, a concept that seems almost quintessential to the notion of banking and finance, it would comfort you to know that it is replaced by a system of risk-sharing. The bank and the customer, no longer assured or charged predetermined rates of interest, now enter into any investment on agreed terms, dividing any profits between them.

Take home ownership for example, where one can participate in a rent-to-own scheme, paying a monthly rent which will attribute to a constantly increasing share of ownership (an acquisition payment) in the home until a “locked in” price is eventually paid over, or such a time that the consumer is ready to buy. The bank is, therefore, owning a decreasing share of the home with time as your share of the ownership eventually reaches 100%. Compare this to a typical mortgage in which an entire lump sum loan is essentially taken to pay off a house, ensuring a growing indebtedness for most homeowners for decades to come. In this aspect, Islamic finance would encourage greater stability amongst younger buyers especially, who do not necessarily have the cash in hand to or the appetite for debt to foot the down payment.

Take as well, the Islamic finance equivalent of a bond, known commonly as a “sukuk”. The main difference being between the two is that a sukuk represents ownership of a real asset or assets, where conventional bond holders are owners of debt. In an asset-backed sukuk, holders are closer to an equity position as they will own the underlying asset and will have “no recourse to the originator in the event of a payment shortfall” as the FT puts it. Each sukuk, therefore, has a face value, based on the underlying asset value, and may be bought and sold at a premium or discount, similar to a bond, meaning that it is a liquid instrument when sold on the secondary market. As opposed to interest, investors’ cash flows come in the form of profits generated by the assets until the determined maturity date. However, given the nature of risk sharing and the fact that these are physical assets or services, not all sukuks have repurchase guarantees, and investors could bear losses as maturity payoffs are linked to the performance of the asset.

Now, in order to answer the questions pertaining to the potential of Islamic finance in acting as an impetus to ASEAN growth and investment, one can do a simple analysis of the dynamic forces of supply and demand in the sector. With an already majority Muslim population, only forecasted to grow in ever-increasing proportions, one can already see the source of effective demand for “sukuk” based instruments and sharia-compliant forms of financing. From the supply side, we are seeing larger initiatives by ASEAN’s largest regional banks, CIMB and Maybank, to push forward on increasing provisions of Islamic finance instruments and funds. Green Islamic bonds are already being talked about where climate focused investments are to be made and sovereign issues of these are expected to come to market. This would be the first of its kind in any Asian country, and may be the beginning of truly regional offers of Islamic finance products.

With the growth of such products such as these and many more, the fundamentals and dynamics of finance in South-East Asia could become increasingly distinct from that of which is familiar in the West and in Europe, and that is an interesting prospect to say the least as I have written before about how the nature of the banking infrastructure and its relation to segregated fiscal bodies in the EU to have been one of the main causes of the downfall of the Euro and the Greek economy. Now, the growth of Islamic finance is not going to be some tectonic shift from the nature of finance and banking as a whole, but the principles that it carries along with it may bring promising changes to the overall nature of volatility and turbulence we are familiar with in modern financial markets. Introducing the Islamic finance system That would be a welcome change, especially in an ASEAN that wants to foster greater regional collaboration and investment, however, it would be far too early at this stage to make accurate judgements on the size and nature of Islamic finance’s true impact on ASEAN in the future.

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