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Press Release > 2019

Keynote Speech by H.E. Dr. Zeti Akhtar Aziz, Former Governor, Bank Negara Malaysia at the 14th IFSB Summit 2019 - Islamic Finance for Sustainable Development in the Era of Technological Innovations

Date posted: 26 November 2019

Date : 13 November 2019
Event / Venue : 14th IFSB Summit 2019 - Islamic Finance for Sustainable Development in the Era of Technological Innovations | Jakarta Convention Center | Indonesia
Speaker : H.E. Dr. Zeti Akhtar Aziz, Former Governor, Bank Negara Malaysia

Assalamu alaikum wa rahamatullah wa barakatuhu, and a very good afternoon to all of you.

1.1 It is my honour and great pleasure to be here this afternoon to speak at the 14th IFSB Summit in Jakarta, Indonesia. The theme of this summit - “Islamic Finance for Sustainable Development in the Era of Technological Innovations” – underlines some of the important global shifts that are taking place that is reshaping the financial services industry and its potential role in the economy. In being well-anchored to the economy, this presents significant potential for the Islamic financial services industry to drive the sustainable development agenda. The changing dynamics of the financial services industry is however also taking place in an environment of heightened uncertainty in the international financial system and in the global economy.
 
1.2 The industry, the policy makers and the standard setters need to have an awareness of the need to rise up and respond to the changes brought by the emerging new landscape. For the financial services industry, it will be to recognise the new opportunities and risks that they present. For the standard setters, regulatory authorities and policy makers, it will be to set the new financial stability priorities to strengthen further the resilience that has been achieved. Also important will be the need to provide the enabling environment that will support sustainable economic activity and development. The responsibility and hence accountability is thus to have the right balance between facilitating the change from the rise in innovation and safeguarding the security and safety of the financial system.
 
 1.3 My remarks this afternoon will first touch on the key global policy considerations for the Islamic financial services industry arising from the emerging global trends and the consequential imperatives for the financial stability agenda in this fast-changing world environment. Allow me to first highlight the key trends that can be expected to change the landscape of the financial services industry. This will be followed by a discussion of the opportunities that this changing environment presents for Islamic finance. The third and final part will be on the emerging risks and financial stability considerations before concluding my remarks.

The Changing Landscape of the Financial Services Industry

Your Excellencies,
Distinguished Guests, Ladies and Gentlemen,
 

 2.1 The future of the financial system is inextricably linked to the major trends that are being addressed by the theme of this Summit and of which have important implications on policy considerations. Allow me to highlight three of the major trends.
 
 2.2 First, is the transformation of the financial sector arising from the extraordinary advancement in technology which has been highly pervasive in the extent of its scope and in terms of the speed of the realisation of the technological breakthroughs. Such technology-led innovation has in particular advanced very rapidly in the financial services industry. It has already dramatically changed the way financial systems operate across the globe. While it may have been disruptive to the current structure of the financial services sector, it has also presented tremendous potential to enhance the effectiveness and efficiency of the financial system. It has also extended the outreach of financial services to completely new areas.
 
 2.3 Second, is the growing awareness of the economic, social and environmental challenges being faced in the global environment and the greater consciousness of the broader potential role of the financial sector in supporting the long-term sustainable economic growth agenda. In relation to this is the recognition that the objectives of the financial sector including that of profitability are not at variance with the objectives of sustainable development. While there is the need to ensure that the interest of shareholders will continue to be preserved, there are demands for the financial sector to deliver sustainable of long-term growth and development.
 
 2.4 Following the great financial crisis of this decade, a great deal of global attention was focussed on prudential regulatory and supervisory reforms aimed at building the resilience of the financial sector. The interest following this is for a more catalytic role for finance to support growth and development. In particular, priority is being accorded to the impact of finance on the economy, the value it brings to society and to environmental sustainability. Greater importance is now being directed to the considerations related to environmental, social and governance (ESG) and for the need of its integration into finance. Cumulatively, the overarching goal to be achieved is sustainability.
 
 2.5 The world is also being confronted with greater demands for balanced growth and development. Discontent arising from increasing income inequalities has manifested itself in highly-disruptive social unrest in different parts of the world. The issue of rising inequalities has brought to the forefront the issues of financial inclusion, for a greater outreach of finance to all segments of society. At one point, the growing inequalities were also attributed to the highly-accommodative unconventional policies. In pushing up asset prices to record highs, owners of assets benefited from this trend, while wages during this period remain stagnated. While the debate on this continues, the rising inequality in several parts of the world continues to be an area of concern. Indeed the advances in technology has made it possible to address this challenge in the most pervasive manner. In responding to this challenge, significant transformations have taken place in the payments system and in the conduct of financial transactions.
 
2.6 These emerging trends represent a sea change that is transforming the entire financial sector and the wider economy, altering the way in which the financial system operates. While such changes come with numerous benefits and opportunities, it will also require continuous monitoring and careful assessment of the associated risks to financial stability which in turn needs to be effectively managed.

Opportunities for Islamic Finance in a Changing Environment

Your Excellencies,
Distinguished Guests, Ladies and Gentlemen,
 

3.1 Let me now turn to the opportunities that the prevailing wave of technological disruption and rising concern on environmental sustainability can present to unlock new frontiers for Islamic finance.
 
3.2 Islamic finance has progressed admirably in the recent three decades. The Islamic finance sector has reached systemic importance in 12 jurisdictions. Collectively, these jurisdictions account for 91% of global Islamic banking assets. This is made possible as the financial infrastructure and ecosystems necessary to support and facilitate its growth have been well developed and nurtured. In addition, the existence of international organisations like IFSB where prudential and governance standards have been developed facilitates and supports the orderly development and growth of the financial industry while safeguarding its soundness and stability.
 
3.3 Against this backdrop, technological progress has resulted in financial disintermediation and in some cases, the democratisation of finance. Wider internet access at high speed and at affordable rates coupled with the powerful cost-effective smartphones have enabled those who had previously fallen through the cracks and become financially excluded to now gain extraordinary access to financing.
 
3.4 New technology is having a key role in advancing the financial inclusion agenda. Financial inclusion is key as a means for communities and small businesses to participate in a modern economy. These innovations involve facilitating payments through efficient and reliable payment systems, facilitating savings opportunities, and facilitating access to credit and insurance. New technologies such as smartphones and web-based financial services have advanced the financial inclusion agenda in unimaginable proportions. M-Pesa in Kenya, a mobile money provider has become one such mobile money transfer provider, financing and allowing for microfinancing service. Then there is Alipay in China and PayTM in India. This has significantly reduced the cost of transactions, extended its outreach thereby increasing economic participation. These developments will however require regulations and standards that guide the provision of such financial services so that potential risks that arise from the improper use of data, fraud, cyber security and money laundering will be addressed. IFSB can have an important role as a repository of policy responses to such financial innovation as well as facilitate the coordination and harmonization of such responses across borders.
 
3.5 Through the smartphone, provision of finance, making investments, getting insured and even currency exchange can additionally be conducted, including on a peer-to-peer basis where the role of formal financial institutions may be reduced to merely receiving and transferring funds, or a fund manager. Although the scale is yet to be achieved relative to the offerings of formal financial institutions, it is growing rapidly and becoming more widespread.
 
3.6 Technological advancements have also altered the DNA of a typical bank customer. Today, the “network effect” shifts factors of production from within a firm, directly to the platforms. Size is no longer a deterrent as the network allows for scope and scale to become within reach. Companies that belong to platforms not only create value for themselves, but also for those on the platforms. With repeated and broader use of the platform, a given platform will experience increased market value. With more users, scale is achieved, and the resulting digital ecosystems becomes inordinately powerful. Platform enterprises and ecosystems are now gaining momentum.
 
3.7 Platforms do not own inventories, assets or capital traditionally associated with a company’s size and financial strength. Insurable interest of such platforms requires an entirely different approach and interpretation for obvious reasons. In this regard, the traditional banking and insurance business models will require recalibration to meet the needs of this changed economic landscape. A possible solution to this conundrum can be in how the inherent features of Sharīʻah is re-interpreted in the context of platform economies where risk sharing is a pre-requisite to earning returns. The striking similarities of the features of muḍhārabah, muṣhārakah and even takāful are already seen in many peer-to-peer platforms. It is observed that many larger traditional banks have already changed and adapted their business models to accommodate this new normal.
 
3.8 For Islamic finance, what is needed is to go back to the fundamental essence of what Sharīʻah requires and to reinterpret how they are practiced to better suit the digitalised economic environment. Change is imminent as the banking business model that we know today is being disrupted in a manner that is more intense than has been imagined.
 
3.9 It is often said and well recognised that the overarching values and objectives of ethical and moral conduct and the emphasis on social welfare is entrenched in the Sharīʻah principles. The principles of Islamic finance calls for a financial system that is both anchored to the real economy and that which has a positive social impact while adopting good governance. Thus, if practiced and grounded with these principles, Islamic finance is a model that is ethical, moral, inclusive and sustainable. With increasing focus on expanding the product offerings, new growth areas have emerged. Examples include thematic sukūks including green, blue and SDG ṣukūk, Sharīʻah -compliant impact investing and ethical investing as well as banking products anchored on sustainability.

Emerging Risks and Financial Stability Considerations

Your Excellencies,
Distinguished Guests, Ladies and Gentlemen,
 

4.1 There are several areas for consideration in terms of new and emerging risks to financial stability in this highly dynamic and rapidly changing financial system. Regulatory authorities and central banks have the responsibility of balancing between creating an enabling environment for innovation while ensuring the soundness and stability of the financial system.
 
4.2 An important area of focus are the new risks that are associated with technological innovation, particularly its potential to significantly change the nature and scope of financial risks as traditionally understood, as well as the potential of new technologies to change traditional business models. Digitalisation has been accompanied by decentralisation and disintermediation of financial transactions in many cases. Distributed ledger technology, the application of which, include crypto-assets and smart contracts, is an example of decentralised services, while new technology-driven business models such as Peer-to-Peer platforms and Robo-advisors have replaced some traditional financial intermediaries, all of which poses distinct challenges for financial service providers and regulators.
 
4.3 Another challenge for regulators is the technology-enabled innovations that do not currently fall under the traditional financial institutions that are within the existing regulatory, supervisory and licensing frameworks. Thus, some of the financial services or functions may be offered by entities other than financial service firms that may not be licensed or regulated by financial sector regulatory authorities. They could range from fintech start-ups to technology giants. In addition, technologies such as machine learning and predictive analytics based on big data and artificial intelligence that are being applied in various financial services, could make data more vulnerable to security breaches. There are also cybersecurity, fraud, privacy, know-your-customer, and consumer protection issues associated with the adoption of new technologies in the financial sector.
 
4.4 One further area concerning the financial stability agenda that has received increased attention is the implications of environmental shocks and climate-related financial risks and its potential effects on financial vulnerabilities. This includes the transition to a low-carbon economy, as well as increased frequency and severity of extreme weather which could translate into economic and financial losses for the real economy and the financial system. Useful for this is knowledge-sharing on environmental and financial risk. Stress tests can also be developed to incorporate climate risks to assess the ability of financial institutions to manage such climate-related shocks. Equally important will be the disclosure of information by companies on aspects of environmental-related factors. Thus, the drive to develop sustainable financial systems also requires the integration of the important ramifications that climate change may generate. A coherent and well-thought-out policy mix will be needed to ensure a smooth transition to low-carbon economies while preserving financial stability.
 
4.5 Given these challenges, as well as the cross-border nature of financial technology, safeguarding the safety and soundness of the financial system is all the more important through supervisory coordination and information sharing. Imperative also, is the development of international benchmarks that will harmonise and guide regulatory and supervisory practices. For the Islamic financial services industry it is about the leverage on technological innovations to bring benefit to the providers and users of financial products and services. It therefore needs to be accompanied by the development of frameworks for the assessment of the risks, and having in place the safeguards, surveillance systems and regulations that are also reinforced by a robust supervisory oversight. This is a further area in which cooperation and collaboration with other regulatory authorities within a jurisdiction and across jurisdictions becomes important. Standard-setting entities such as the IFSB would also benefit from engagement and collaboration with other international standard-setting bodies that have had an earlier start and that operate in more matured financial systems.

Conclusion

Your Excellencies,
Distinguished Guests, Ladies and Gentlemen,
 

5.1 Looking ahead, there are various opportunities that can be harnessed by the Islamic finance industry in order to continue its growth trajectory. As we move into a transformed and more uncertain global environment, it will be even more important for Islamic finance to keep pace with global trends and be well-positioned to respond to the changing demands. Islamic financial institutions has tremendous potential to navigate the emerging challenges and to remain relevant in this fast-changing domestic and international environment.
 
5.2 The emerging trends offer Islamic finance a new frontier for growth, with its focus on value-driven finance and the ability to provide financial solutions that can bridge sustainable development gaps and address financial inclusion issues. Of importance will be to look at strategies for protecting consumers and ensuring the resilience and sustainability of the Islamic financial system. At the same time, in adopting the new innovative technology, will be the ability to balance between the different and competing needs and putting in the appropriate safeguards to emerge stronger and better positioned to provide solutions in this new environment.
 
5.3 Finally, beyond rules and regulation and the adoption of the new technologies, it is still the three fundamental elements that will ensure the sustainability. It is the efforts directed at building resilience, at having the ethics and moral compass integrated into the intermediation process, and to have the drive to stay the course for the longer-term orientation of the business. Then it is also about the investments in building the foundations including the talent and organisational capability for this long haul.
 
5.4 International cooperation is fundamental for wide-scale changes in the financial system. In particular, this is among the international standard setters, multilaterals and regulators with the common objective of ensuring that any disruption associated with emerging trends are well managed and channelled in a way that increases competition, productivity, and innovation in the Islamic financial system, while also ensuring financial stability. In doing so, we must work together to ensure that the legal and regulatory frameworks are consistent, harmonised, and effective in managing new risks, particularly those that may have cross-border implications.
 
5.5 On that note I wish you informative, insightful and productive deliberations at this IFSB Summit.

Wassalamu alaikum, and thank you all.


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