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Viewing cable 08KUALALUMPUR781, Malaysian Islamic Finance Sector Performs Well During the

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Reference ID Created Released Classification Origin
08KUALALUMPUR781 2008-09-05 08:44 2011-08-26 00:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Kuala Lumpur
VZCZCXRO6023
RR RUEHBC RUEHCHI RUEHDA RUEHDE RUEHDT RUEHGI RUEHHM RUEHJS RUEHKUK
RUEHLH RUEHNH RUEHPW RUEHROV
DE RUEHKL #0781/01 2490844
ZNR UUUUU ZZH
R 050844Z SEP 08
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 1593
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1607
RUCNASE/ASEAN MEMBER COLLECTIVE
RUCNISL/ISLAMIC COLLECTIVE
UNCLAS SECTION 01 OF 02 KUALA LUMPUR 000781 
 
STATE PASS USTR - WEISEL AND BELL 
STATE PASS FEDERAL RESERVE AND EXIMBANK 
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN 
USDOC FOR 4430/MAC/EAP/J.BAKER 
TREASURY FOR OASIA AND IRS 
GENEVA FOR USTR 
SENSITIVE 
 
SIPDIS 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV MY
SUBJECT:  Malaysian Islamic Finance Sector Performs Well During the 
Sub-Prime Crisis 
 
REF A:  07 Kuala Lumpur 1462 
REF B:  07 Kuala Lumpur 1429 
 
 
1.  (SBU) Summary:  Malaysia continues to trumpet the virtues of 
Islamic finance and its role as a key player in the issuance of 
Islamic bonds.  With no exposure to collateralized debt instruments, 
the Islamic financial sector has held steady during the sub-prime 
crisis.  Secondary effects of the global financial downturn remain 
muted largely because of a widespread perception that Islamic 
financial products, which are required to be based on tangible 
underlying assets, are safe.  As issuers struggle to meet the demand 
for Islamic investment products, Malaysia strives to be a global hub 
for this niche industry.  Challenges include a dearth of talent and 
a lack of consensus by Shariah scholars on what is permissible under 
Islamic law.  The success of sukuk (Islamic bonds) illustrates much 
potential for success when Shariah scholars agree.  While Malaysia 
offers an array of incentives to develop the country's Islamic 
financial sector, the GOM's poor track record on the conventional 
side of the financial industry could make it a hard sell in the 
global marketplace.  End Summary. 
 
ISLAMIC BONDS (SUKUK) SEEN AS A SURE BET 
 
2. (U) At a recent conference on Islamic Finance Dr. Zeti, Governor 
of Malaysia's central bank, told participants that issuances of 
global sukuk  increased by 70 percent in 2007 and "held their 
ground" in the first half of 2008.  The outstanding global sukuk 
market now surpasses USD 100 billion, she said, with more than 60 
percent of those originating in Malaysia.  While sukuk remain only a 
small fraction of the global bond market, they represent more than 
half the outstanding bond market in Malaysia.  According to Moody's 
Investor Services, sukuk represent the fastest-growing segment of 
the Islamic finance market. 
 
3. (U) Sukuk pay a fixed rate of return on certificates of ownership 
backed by income-generating tangible assets.  Often, the rate is 
benchmarked to interest rates (usually LIBOR) in an effort to remain 
competitive with conventional financial products.  While some 
Islamic scholars point out that this is simply interest by another 
name, many Muslim investors still prefer sukuk to conventional 
bonds, all other factors being equal.  Most practitioners are 
willing to tolerate some level of "impurity" in Islamic financial 
practices in an effort to build the industry, with the hopes that 
someday Islamic finance will command a large enough segment of the 
market to be able to have its own benchmarks (ref A). 
 
4. (U) Compared to the lack of consensus among Islamic scholars 
regarding practices undergirding many other Islamic financial 
products, sukuk enjoy widespread acceptance both in the Middle East 
and in Southeast Asia.  This near-consensus is largely responsible 
for their success, particularly with large amounts of petrodollars 
and sovereign wealth funds looking for safe, profit-bearing (and 
preferably Shariah-compliant) investments.  One Saudi banker told 
Econoff that an added driver was that many Middle Eastern investors 
wanted to diversify their holdings, particularly in a post-9/11, 
post-Dubai Ports World environment of distrust. 
 
 
ASSET-BACKED INVESTMENTS ARE PERCEIVED AS SAFER... 
 
5.  (U) Since Islam forbids the payment or collection of interest, 
financial transactions must be based on tangible assets.  This solid 
basis provides investors with a sense of security.  In addition, 
Islamic investment vehicles such as mutual funds exclude debt-ridden 
companies as well as those which rely heavily upon collecting debts 
from others.  Islamic jurists tolerate some level of interest, 
invoking the Islamic "rule of necessity" in recognition that they 
could not realistically exclude every company that had an 
interest-bearing account or loan.  The standards developed in the 
1990s by the Dow Jones Islamic Indices have been adopted by 
practitioners across the globe:  companies are excluded if their 
receivables are more than 45 percent of their assets, or if their 
debt is more than 33 percent of their market capitalization (based 
on a moving average).  In some cases, companies with significant 
interest income (more than five or ten percent of their total 
income) also are excluded. 
 
...BUT TRACKING WHO COMPLIES IS A CHALLENGE 
 
6. (U) While in principle these cutoffs can result in a portfolio of 
 
KUALA LUMP 00000781  002 OF 002 
 
 
safer investments, implementation can be a problem:  there is no 
effective mechanism to track the relative debts and assets of each 
company.  Debt to asset ratios can change from week to week.  As the 
sector grows, so does the challenge of keeping track of which 
companies comply with these standards. 
 
 
A BIGGER CHALLENGE:  TALENT 
 
7. (U) By far a bigger barrier to the development of the Islamic 
finance industry is finding enough financial sector professionals 
versed in Islamic law, or enough Islamic scholars with a background 
in finance.  Language is another challenge:  the language of Islam 
is Arabic, while the language of finance is generally English.  In 
the Middle East there is no limit to the number of Shariah boards a 
scholar can sit on, so a single scholar might officially sit on 
fifty boards but contribute little to each one.  In Malaysia Shariah 
scholars are limited to a single board, and there simply are not 
enough scholars to go around.  The differences in Islamic practices 
between Southeast Asia and the Middle East add yet another layer of 
complexity to training experts.  In spite of the differences, 
though, Middle Eastern countries routinely recruit Islamic finance 
practitioners from Malaysia.  Last year the GOM exempted Islamic 
finance experts from paying income taxes in an effort to make local 
jobs more competitive  with the higher salaries being offered in 
some oil-rich countries without income tax regimes. 
 
 
GOVERNMENTS GETTING IN ON THE ACTION 
 
8. (U) In an analysis for the RGE Monitor, Rachel Ziemba noted that 
Gulf Cooperation Council (GCC) sovereign funds and government 
investment vehicles were scaling up their investments in Islamic 
finance.  She speculates that this increased interest comes not only 
from the surge of petrodollars and the outperformance of many 
Islamic financial products during the credit crisis.  It also is 
intended to promote domestic financial centers in an effort to keep 
money at home.  Moody's suggests that government involvement lends 
credibility to skeptics concerned about whether such practices are 
truly compliant with Islamic law.  Wider acceptance of Islamic 
banking practices could also result in expanding financial services 
to citizens, an important concern for countries where large segments 
of the population remain unbanked. 
 
9. (SBU) Rather than continue to hope Shariah scholars someday adopt 
an agreed set of underlying principles, one analyst pointed out that 
if Islamic finance reached critical mass in Malaysia, its national 
set of principles could become the global standard by default.  As 
the sector grows, Hong Kong and Singapore are ramping up their 
interest in Islamic finance.  The benefit to Malaysia is that these 
markets tend to lean toward the more lenient Malaysian model, 
offering some legitimacy to its standards.  The risk is that these 
better-established financial centers could quickly surpass Malaysia 
as a global hub, particularly in light of Malaysia's reputation for 
heavy-handed, rather than even-handed, regulation of its 
conventional financial sector.  One international banker told 
Econoff that Islamic finance was increasingly popular in Malaysia's 
domestic market; however, whether its bid to become a global 
financial center will be taken seriously in the global marketplace 
remains an open question. 
 
COMMENT: 
 
10. (U) The fledgling Islamic financial sector has received 
increased attention of late, largely due to its resilience during 
the ongoing sub-prime crisis.  Despite gentle cajoling by the GOM, 
Islamic scholars are no closer to reaching consensus on what is 
permissible and what is not.  Nevertheless, the niche market 
continues to grow in spite of the obstacles, and critical mass might 
determine which set of principles will be adopted in the global 
marketplace.  In spite of Malaysia's best efforts to stay ahead of 
the pack, it could easily be surpassed by better-established 
financial sectors. 
 
KEITH