VBI: Intermediation that engages shareholders, nonshareholders alike
The VBI concept refers to the intermediation slated for the intended outcomes of shariah through practices, conduct and offerings, aimed at generating positive and sustainable impact on the economy, community and environment, without compromising the financial returns to shareholders.
According to Nor Shamsiah, the adoption of VBI is expected to provide a significant impact on business models of Islamic financial institutions, including the drivers of profitability and risks.
“VBI- oriented Islamic financial institutions can, and indeed should, also play an important role in mobilising resources to finance climate change mitigation and adaptation initiatives.
“Funding for climate adaptation, in particular, remains critically low, despite millions already at risk from the effects of climate change and in need of assistance to cope with the effects.” She cited the agriculture sector as an example, where resources could be channelled towards building flood defences and developing local structures and facilities that are more resilient to harsh weather conditions.
Takaful solutions could also play a vital role in strengthen- ing resilience against climate events, added Nor Shamsiah.
“These developments are likely to see important changes to the way financial institutions make decisions, and to the characteristics of banking and takaful portfolios.” In supporting these changes, BNM had published two new tools for public consultation – a VBI Impact Assessment Framework (VBIAF) and the VBI Scorecard.
The VBIAF provides guidance on the assessment of financing and investment applications taking into consideration economic, social and environmental impacts, while the scorecard supports the implementation of performance measurement frameworks for Islamic financial institutions that drive positive value and impact on society and the environment.
Rethinking of risk
On the second imperative, Nor Shamsiah said it called for a rethinking of risk by Islamic financial institutions, adding that non- traditional forms of risks such as social, political and environmental ones should be viewed as ‘business threats’ that simply could not be ignored.
According to the BNM governor, research indicates that there are material benefits to managing these risks more proactively.
A survey by the International Finance Corporation ( IFC) on global banks showed that around 86 per cent of respondents that integrated social and environmental risks in their operations, yielded positive business results.
There had also been growing calls by shareholders for financial institutions to play a more proactive role in the sustainability agenda.
“I am among those who believe that the true mark of a sustainable financial system ultimately lies in the extent to which, the market’s and management’s view of risks reflect sustainability factors.
“In June 2017, the Financial Stability Board published recommendations for helping businesses disclose climate-related financial information.
“In the context of ‘finance beyond profit’, this was a significant development by a global standard setting body, and the broader G20 community, to encourage the provision of better information on climate-related risks and their financial impact.
For many, this is both a reflection of, and catalyst for, the closer examination of risk- and impact-adjusted returns, by capital and funding providers.” Nor Shamsiah said as natural stewards of sustainable finance models, Islamic financial institutions should be well placed to develop richer perspectives of social and environmental risks Nonetheless, this would call for a review of internal risk decision-making processes and input within the financial institutions, alongside enhanced disclosures to market participants.
“Yet little, if anything, is done today to consider how such risks need to be managed – both for existing portfolios and future growth strategies. Actions taken by financial institutions to mitigate, transfer or control the risks have the potential to generate corresponding, broader responses by policymakers, businesses and other financial institutions. This, in turn, can create new markets for sustainability services, and a virtuous cycle of mutually reinforcing market forces, that promote sustainable business
practices across the economy.” Nor Shamsiah stated that as the BNM strove to develop the VBI systems for Islamic finance in Malaysia further, this would be an area of important focus.
This work, she added, would also address the role of domestic regulations towards creating a level-playing field for valuebased banking practices – wherever appropriate.
To date, policy documents developed on 14 Shariah contracts would be set to provide a clear and consistent framework for lending, underwriting and investment activities of Islamic financial institutions.
“I am encouraged by efforts among some Islamic financial institutions to introduce valueadding innovations, building upon these shariah contracts, and further differentiating their solutions from conventional offerings.
I would of course like to see much more traction in this direction going forward,” she said.
Rethinking human capital
On the third imperative, Nor Shamsiah highlighted the challenges in building internal human capacity to support sustainable practices, which she viewed as ‘continuing to be left largely unattended to’. She pointed out that for Islamic financial institutions, this would extend beyond strategy alignment and culture towards building or acquiring the fundamental skills-set required to implement sustainable financing and risk management practices. “Without these, VBI cannot hope to progress very far,” she stressed, citing a study by the National Bureau of Economic Research to illustrate this. According to the study, jobs requiring a higher intensity and concentration of ‘green skills’ to support the transition to greener economies, lie among ‘high-skilled professional profiles’. “In other words, if Islamic financial institutions are serious about adopting VBI, the com- plement of skills-sets at the management levels of the organisation would need to be fundamentally re-assessed.
“Relevant skills that need to be brought into the organisation include engineering and technical skills in the design, construction and assessment of technology; science skills; and monitoring skills focusing on observing compliance with environmental laws and standards.
“Even the boards too have to learn and adapt to the demands of the new operating environment,” said Nor Shamsiah, also stating that the relevant skills-sets were also critical towards supporting innovation within the financial sector to capture opportunities and improve the delivery of Islamic financial solutions.
“Indeed, technology can be better optimised to revolutionise the way Islamic finance operates and offer innovative solutions to customers.
For example, blockchain or artificial intelligence (AI) applications hold enormous potential for simplifying documentation requirements associated with shariah contracts; thus improving the overall efficiency of business operations.” Most importantly, Nor Shamsiah said it should be abundantly clear to any financial institution serious about adopting VBI that the task of building the human and intellectual capital to achieve and sustain value-based business models could not be left solely to the human resource departments.
“It requires nothing less than strategic direction and resourcing decisions at the highest levels of the organisation.”
More than a fad
Stressing further, she said the VBI must be seen as ‘being more than a current and passing fad’ – rather, it must be regarded as ‘a deeper conviction of the critical need to begin the process of changing mindsets in a lasting way’.
“Financial institutions are a key, but not the only catalysts in this process.
“Customers and investors need to be supported with relevant information, along with the means and ability to compare such information, in order to better understand the value propositions of Islamic finance.”
According to Nor Shamsiah, the Islamic finance industry today faces an important, strategic choice – to either continue on a path that largely ignores the stark social and environmental realities that confront humanity, or to thoughtfully chart a new path that fully embraces the idea and philosophy of finance beyond profits.
“The latter will be an unfamiliar path in many respects, but one that is far closer to the fundamental premise of shariah on which Islamic finance is based upon.
“Embarking on this path will require deep conviction and visionary leadership across financial institutions, governments and policymakers, but the pay-offs will be immeasurable.
“For many in society, it will also make the difference between economic freedom and opportunities, and a lifetime of hardship.”
Challenges ahead
As in any sector, Islamic finance in Malaysia cannot be without its own challenges – one of which is rivalry.
The Global Islamic Finance Report (GIFR) 2018 has put Malaysia as still topping the list of countries leading the Islamic financial industry, ahead of Iran, Saudi Arabia, United Arab Emirates (UAE) and Kuwait.
However, the report also views Indonesia as exhibiting tremendous progress, having moved a step upwards to sixth position among the world’s most influential markets as far as the shariah-compliant system is concerned.
“It is true that Malaysia and Indonesia are the two most steadfast countries, in terms of growing Islamic banking and finance.
This is largely owing to their political stability, steady GDP growth, rich natural resources and solid business infrastructure,” said DAR Wong, the chief strategic advisor at Bain Partners & Management Ltd.
He believed that conservatively, these two countries – being based in Asean – would be abstained safely from any warfare and social disorder.
He opined that Indonesia, having a larger geographical scale of land size, population and economy than Malaysia’s, there could be a possibility for it to surpass Malaysia in Islamic financial industry — if Indonesia could maintain its political stability and social security in the post-election after April 2019.
“This is a possibility, especially when we are sniffing the sign of another market rout amidst various economic uncertainties in 2019.”