Distinguished guests,
Ladies and gentlemen,
I. Introduction
1.1 It is my great pleasure to be here today to speak at this Nomura Investment Forum in conjunction with the 10th Anniversary of the establishment of Nomura Islamic Asset Management here in Malaysia. The subject matter I have been invited to speak on is “Investment for Good and the Leadership Role that the Islamic Finance Industry can have in the Global Economy”. Let me first congratulate Nomura on its 10th Anniversary. While Islamic finance does not operate in Japan, the Japanese financial industry has taken the lead to participate in Islamic financial systems in the global financial system. The total assets of Islamic finance in the global financial system has now surpassed the US$2 trillion mark and currently operates in more than 50 countries including several non-Muslim countries.
1.2 The lessons following from the financial crisis in the developed economies in 2008-09 has resulted in greater focus on the soundness and stability of the financial industry. The financial reforms that followed precipitated the introduction of more robust and rigorous regulatory and supervisory regimes. It also saw the demand for the rebuilding of trust and confidence in the financial system. Increased attention was given to transparency, governance and ethical standards being practiced in the financial industry. Following from the financial crisis, there has been increased global demands for finance to refocus on the impact of finance on the economy, on society and on the environment.
1.3 The focus of my remarks today will be on this aspect of finance — the value that it brings to the economy, to humanity and to environmental sustainability. Finance should thus be about the ‘investment for good’. This refers to the role of finance of mobilisation of capital for the good it brings to the economy, to society and the good it generates to the environment. The focus is therefore on the impact for finance on the ultimate goals that we want to achieve for the economy, for society and for the environment. In relation to this, my remarks will focus on the role that the Islamic finance industry plays in meeting these demands and its potential to provide a leadership role in driving this agenda.
II. Investment for Good
2.1 The global focus following the 2008-09 financial crisis, has been on delivering financial stability. Ten years hence, it has indeed not only produced soundness and stability of financial systems throughout the world but it has also delivered financial systems that are more resilient and that are better able to withstand the challenges emanating not only from the economic cycle but also the more volatile global financial markets. While this financial stability is important, the expectations and demands on financial systems are much more. It has to be beyond about the compliance to the rules and regulations and to the prudential and accounting standards. In essence, finance needs to deliver and add value to the economy, to society and to environment sustainability.
2.2 The origins of finance is that it should serve the economy by the mobilization of savings and the allocation of the financial resources to productive investments. In doing so, it facilitates and drives growth and the development of economies. Finance was essentially a means to an end. It was when finance became an end in itself that the linkage between finance and the economy was eroded. This was when finance became inherently unstable and at times having a damaging impact on the economy. Financial crisis frequently resulted in high cost to the economy and to society.
2.3 The investment for good is about returning finance to it’s basic function – to provide financial services that adds value to the real economy. Three important features of finance can be identified to enhance their potential to add value to the economy. The first relates to the focus on the longer term orientation and on the sustainability of the investments. In avoiding short-termism in the performance of companies it protects the interest of the beneficiaries and thus brings value to the economy. The second element is the avoidance of excessive risk or speculative investment activities that are not sustainable. The experience has shown that the build up of such risks becomes highly damaging to economies. The third element relates to the rapid rate of financial innovation. Financial innovation needs to bring benefits to the economy. It is when it is allowed to proliferate and becomes irresponsible that it generates disruptive and damaging consequences on the economy.
2.4 The role of finance has also been reexamined in terms of its potential impact of bringing meaningful value to society. While financial practices towards societal aspects are less clearly identified and defined, it is about focusing on the end outcome to society. It involves achieving social good in terms of providing goods and services that benefit society or in doing social good that enhances wellbeing of communities. It essentially concerns optimising the positive impact on society. There is increased demands for greater stewardship in the financial industry to consider societal issues and to contributing to the economic wellbeing of communities whilst pursuing their financial goals.
2.5 Finally, there has been increased attention on the role of finance in contributing towards the ultimate outcome of achieving environmental sustainability. This has arisen from the growing global recognition of the risks that climate shocks generate to macroeconomic conditions and to financial systems, and to its potential profound disruptions and impact on the overall economy. Related to this is also the consideration that in achieving the economic goals, it should not be pursued at the expense of future generations.
2.6 Key to meeting these demands is the development of measures to assess the impact and value added that finance brings to the economy, the value it brings to society and not least is its impact on the environment. Two other aspects to facilitate this are the governance and risk management practices to ensure that the assessments are undertaken in a rigorous manner.
III. Islamic Finance and the Investment For Good Agenda
3.1 Finance that facilitate investment for good are thus those forms of financial intermediation which brings such value to the overall economy, to society and to environmental sustainability. Islamic finance is such a form of financial intermediation. It operates according to the Shariah which specifies the permissible financial transactions that do good for others while those that do harm to the economy and to the community should be avoided. In Islamic finance, it is this core set of values that overrides other criteria that becomes the defining parameter. The moral purpose of “doing good and prevent harm to others” constitutes the main underlying principle of Islamic finance.
3.2 The role of finance in the economy is explicit in Islamic finance. The central tenet in Islamic finance requires that financial transactions be supported by genuine economic activity. Financing is thus provided to real economic activities that generate economic value. It also advocates for the creation of wealth through trade and commerce. It is thus a form of financial intermediation that explicitly aims to meaningfully facilitate adding value to economic activity.
3.3 The focus of Islamic finance is also on achieving social good. Islamic transactions require strict adherence to the permissible, that is Halal. The term Halal encompasses everything that brings value, whether by doing good or providing social good and in doing so, to not cause harm. It is therefore aligned towards the ultimate goal of uplifting social wellbeing.
3.4 An element that is distinctive to Islamic finance is the oversight that is undertaken by Shariah Boards or committees at both the institutional and national level. This arrangement provides a mechanism for ensuring that the financial product and service offerings are in accordance with the principles of Shariah thereby providing a safeguard against irresponsible and unethical practices. This feature allows for innovation while ensuring that such innovation adds value. Innovations are assessed against the Shariah parameters and objectives with the primary objective being the realization of its benefits to society.
3.5 Finally, the underlying principle and the moral purpose of “doing good and preventing harm to others” is also consistent with the achievement of sustainability, including environmental sustainability. Equally explicit in Islamic finance is the principle that in pursuing economic activities, there is a duty to make the best use of resources and to not inflict harm to others. The principle of custodianship and trust further states that the earth and all its contents are entrusted to mankind so that it can be protected from harm for the next generations. These broad sustainability principles are embedded in the respective Shariah contracts and are used to govern the relationship between the Islamic financial institutions and its customers.
3.6 These elements of ‘investment for good’ are thus evident in Islamic finance. It explicitly incorporates these intrinsic elements that contributes its positive impact on the economy, to society and to the environment but also to achieving sustainability. This is also reinforced by the financial stability elements that are embedded in Islamic finance. In promoting profit sharing, it in turn is supported by the sharing of risk. These arrangements not only limit the extent of leverage but it also places emphasis on transparency and disclosure which are explicitly required in the documentation of the contracts of Islamic financial transactions.
3.7 These built-in financial stability elements in Islamic finance have encouraged discipline, and its orderly development financial stability is further reinforced by the prudential and accounting standards for Islamic financial institutions. This in turn enhances the ability to support the investment for good agenda. The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOFI) which was established in 1991 sets the accounting standards and the Islamic Financial Services Board (IFSB) which was established in 2002, sets the prudential standards for the Islamic financial industry. In 2007, the Bank of Japan became a member of IFSB.
3.8 While the development of the Islamic financial industry has been focused on the compliance to the tenets of the Shariah, an imperative for its next phase of development is to give focus of its role in the economy, in bringing benefit to society and in contributing environmental sustainability. Frameworks therefore need to be developed to assess the impact of the financial activities of Islamic finance on the ultimate outcomes. In assessing the impact on the economy, it would bring into focus the activities that generate growth and development. In assessing the impact on society, the focus will be on those activities that uplift social well-being. Finally, it is the focus on those activities that will impact the environment.
3.9 Islamic finance thus has significant potential to adopt this approach. This will involve extending the operating framework that includes the Shariah process to also include the assessment of the impact of finance on the economy, on society and on the environment. This needs to be derived from the clarity of intent, the strategies that are being adopted and the performance of such finance that takes into account not only how it contributes to the returns but also its impact on the economy, society and the environment.
IV. Further Imperatives for Islamic Finance
4.1 What more does Islamic finance need to do to contribute to the global drive for ‘investment for good’? While Islamic finance has demonstrated its competitiveness as a form of finance, and its resilience in highly challenging economic and financial conditions, there are further steps that are needed to support its role in driving the agenda of ‘investment for good’ in the global economy.
4.2 Firstly, there needs to be greater global awareness of the unique value proposition of Islamic finance and its potential to perform financial intermediation that will bring meaningful value to the economy, to society and to the environment. The opportunity should be taken to intensify efforts to create a greater understanding and appreciation of the inherent elements of Islamic finance and its potential to contribute to growth and stability.
4.3 Secondly, there needs to be greater leverage on technology. Indeed we are now living in an era of technological disruption and the digitalization of finance. Such new technologies are known to contribute to new innovative products that can contribute towards greater efficiencies, connectivity and outreach. This trend has also resulted in the emergence of technology companies that are in the business of financial services and e-commerce. To optimize the benefits from the greater digitalization and the increased leverage on technology, steps need to be taken to facilitate its orderly development.
4.4 It proposed that for the effective transition to greater digitalization of the industry it would be timely to develop an Islamic Finance Digital Transformation Blueprint. Such a Blueprint would cover the necessary building blocks, the key supporting infrastructure required to achieve the digital readiness, and the development of appropriate regulatory regime and to reorganise the necessary talent for this purpose. Equally important is the necessary legislation and public policy and systems that would contribute to the orderly transition for the industry into being digitally enabled.
4.5 Finally, the international dimension of Islamic finance needs to be further strengthened. Islamic finance is still very much domestic centric with its focus on the domestic financial system and economy. As its international dimension is strengthened, it can contribute towards the more efficient cross border mobilisation and allocation of funds across jurisdictions in the global economy. It will also facilitate greater cross border international trade and investment activity. Given the inherent strengths embedded in Islamic finance including its embedded financial stability elements, it has significant potential to contribute positively towards global growth and stability.
V. Conclusion
5.1 Allow me to now conclude with the following remarks. Given that the universal propositions that are inherent in the Shariah principles and given that these are consistent with and are aligned to the sustainable finance agenda, the Islamic finance industry is well positioned to take a leading role in driving the investment for good agenda in the global economy. In focusing on the impact of its activities on the economy, on the benefits it brings to society and to the environment, it will be in alignment to other forms of ethical and responsible finance that focus on the positive impacts of such finance. That includes the value it brings to economies, the community and to the environment.
5.2 In addition to the financial stability element embedded in Islamic finance, it also operates within a regulatory and supervisory regime that is well developed and gaining maturity. Also emerging are the development of Islamic financial markets that include the capital markets, in particular the Sukuk market and the Islamic money market that has enhanced the liquidity management capability of the industry.
5.3 In taking on a leadership role, the Islamic financial industry therefore needs to clearly demonstrate its impact and contribution to the ultimate goals of the global economy. The aspirations for the global economy are for a greater shared prosperity that is mutually reinforcing, soundness and stability of financial systems and the sustainability of this agenda over the medium and longer term. Embraced in its entirety, Islamic finance has tremendous potential to contribute meaningfully to advancing this agenda in the global economy.
Tan Sri Dr. Zeti Akhtar Aziz is The Group Chairman at Permodalan Nasional Berhad (2018 Recipient of Royal Award for Islamic Finance)