This article first appeared in Forum, The Edge Malaysia Weekly on December 2, 2024 - December 8, 2024

Malaysia’s becoming one of the global leaders in Islamic finance stands as a testament to decades of visionary planning, commitment and strategic alignment between the country’s public and private sectors.

In 2023, Malaysia was the world’s top issuer of sukuk, and its Islamic banking and takaful assets were ranked third in the world, according to the ICD-LSEG Islamic Finance Development report. Moreover, Malaysia’s Islamic finance has been ranked first in the Islamic Finance Development Indicator for the 11th consecutive year.

These achievements reflect Malaysia’s long-term commitment to developing a sustainable and globally integrated Islamic finance ecosystem.

Malaysia’s foray into Islamic finance dates as far back as 1963, when the Hajj Provident Fund Corporation (Perbadanan Wang Simpanan Bakal-bakal Haji) was established to enable Muslims to save for their pilgrimage to Mecca. It was merged with the Pilgrims Affairs Office in 1969 to form the Pilgrims Management and Fund Board of Malaysia, which is commonly known as Tabung Haji.

Since then, several milestones have marked the development of Islamic finance in Malaysia.

According to the Malaysia International Islamic Financial Centre Leadership Council, there were different phases of development in the country’s Islamic finance. The 1980s saw the establishment of the first Islamic bank — Bank Islam Malaysia Bhd — and the first takaful operator — Syarikat Takaful Malaysia Bhd — to provide Malaysians with essential shariah-compliant financial services.

The 1990s saw notable advancements both on the Islamic Capital Market and regulatory fronts. These included the launch of the first sukuk (the Shell MDS sukuk), the introduction of the Islamic Interbank Money Market and the establishment of the Shariah Advisory Councils of the Securities Commission and Bank Negara Malaysia.

In the phases that followed, the development of Islamic financial system infrastructure and products alongside the regulatory and shariah frameworks have been embedded in Malaysia’s Financial Sector Blueprint and Capital Market Masterplan.

In 2006, the launch of Malaysia as an Islamic financial centre (MIFC) agenda marked a key milestone with a clear objective to position the country as the centre for the offering of Islamic financial products and services to the global market.

Apart from regulatory reform, product development and infrastructure expansion, Malaysia’s success story in Islamic finance is anchored in a cohesive strategy that includes the support of both its public and private sectors.

The public sector has played a crucial role in the development of Islamic financial instruments. To support the development of the sukuk market, the government regularly issues Malaysian Islamic Treasury bills and Malaysian Government Investment Issues alongside conventional Treasury bills and government bonds.

Notably, Malaysia pioneered the first global sustainability sukuk in 2021. As at March 2024, the outstanding amounts of conventional government bonds and sukuk stood at RM618 billion and RM574 billion respectively. Meanwhile, Bank Negara conducts Islamic money market operations using separate Islamic accounts to ensure shariah compliance and uses shariah-compliant instruments to manage liquidity in the Islamic money market such as Islamic BNM notes.

The private sector has also been proactive in contributing to the development of Islamic finance. Malaysian banks adopted an “Islamic First” strategy, prioritising Islamic banking products to serve customer needs. This helped to foster a rapid growth in Islamic banking. According to Bank Negara, Islamic banking accounted for nearly half (45.6%) of the country’s total financing, registering loan growth of 7.7% in 2023 compared with 3.4% for conventional banking services. In May this year, the first Islamic digital bank, Aeon Bank, was established.

On the capital markets side, the corporate sector has been active issuers of sukuk. The outstanding corporate sukuk was RM395 billion, more than three times that of conventional corporate bonds (RM113 billion). Malaysia was also the pioneer in green sukuk, with the world’s first green sukuk issued in 2017 by its home-grown company, Tadau Energy Sdn Bhd, to finance a solar project.

While Islamic finance can be seen as a major growth sector domestically and globally, it faces some hurdles.

Among the major issues at the global level is cross-border standardisation, which arises as each jurisdiction may have its own regulations and practices based on its own interpretation of the shariah. Such differences in shariah interpretations are due to differences in scholarly opinions and the practicality and implementation of shariah rulings in addressing specific needs and interests of a particular society. Consequently, the lack of cross-border consensus on some key financial products, such as Islamic repos, could hinder the development of cross-border repo facilities that may be needed during times of stress.

As one of the global leaders, Malaysia’s proactive approach offers solutions to address the key challenges and complex issues facing global Islamic finance. Malaysia established the Islamic Financial Services Board as an international standard-setting body headquartered in Malaysia, as well as the Centralised Shariah Authorities Forum, an international networking platform among the central shariah boards of various jurisdictions, to deliberate current and emerging shariah issues. Specific to the exploration and operationalisation of Islamic repo, progress has been made to create an Islamic repo that is acceptable to shariah councils, Global Master Repurchase Agreement standards, global regulators and market players.

Malaysia’s Islamic finance journey demonstrates how long-term policy planning, committed leadership and effective implementation combined with active participation by stakeholders have helped Malaysia reach its goal and become one of the global leaders in Islamic finance today, while offering invaluable insights for building a resilient, globally integrated Islamic finance ecosystem.

Runchana Pongsaparn is group head and principal economist at the ASEAN+3 Macroeconomic Research Office (AMRO)

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