Islamic finance presents a rapidly growing opportunity for Southeast Asian markets, and continues to post impressive growth. The International Financial Services of London estimated that at the end of 2008 the global market for Islamic financial services had reached close to $951 billion. A February 2010 report by the Director General and Chairman of the Arab Monetary Fund states that close to 300 Islamic banks in 51 countries have grown annually in value between 10 and 15 percent.
Illustration by Phil Couzens
Restrictions on high-risk investments, emphasis on profit sharing, and prohibition on interest distinguish Islamic finance from the forms of finance more familiar to western investors. These unique features, combined with an uncertain regulatory regime, have proven a hindrance to Japan taking a share of this lucrative financial services market. By contrast, regional competitors such as Singapore and Malaysia continue to embrace and thrive in this growing market.
Experts agree that recent amendments to the Japanese Banking Law meant to stimulate Islamic investment do not go far enough. Currently, only subsidiaries of Japanese banks engaged solely in the finance or the securities business, may engage in Islamic financing. Apart from regulation, there are difficulties with respect to how Islamic transactions should be taxed. A common example is interest payments. Interest payments are typically subject to withholding tax, but interest is prohibited under the principles of Islamic finance. The question is therefore how payments to lenders should be characterized and whether withholding tax should be applied. The net effect of these unresolved issues is that Japan is precluded from becoming a full participant in the international market for Islamic finance.
“Japan’s slow reaction to the Islamic market can be attributed to a number of factors, but the key component is the underlying financial structures of the transactions in question,” says Paul Previtera, co-head of the International Tax Education Program at Temple University Japan. “Simultaneous compliance with both Islamic finance principles and Japanese banking law is a difficult path to maneuver. Japan has demonstrated some willingness to accommodate Islamic finance but it now needs to take urgent steps to continue that trend.”
Changes may need to be made sooner rather than later. Malaysia and Singapore continue to revise their regulatory framework and tax structures to facilitate more Shariah (Islamic law)-compliant financial products. However, despite its slow start, Islamic finance in Japan continues to show positive trends. At least six Japanese institutions are current members of the Islamic Financial Services Board and the Japan Bank for International Cooperation has appointed four Shariah scholars as advisors on religious finance.
“One thing Japan has going for it is that most of the groundwork for conducting Islamic finance transactions has already been laid,” says Brandon Boyle, vice president of Foreya Partners, a Japanese-based venture capital firm. “All that remains is some fine-tuning of the banking and tax regulations to ensure that firms investing in Islamic-compliant structures are not put at a competitive disadvantage.”
The amendment to the banking law marked a positive step but Japan must take decisive action if it wishes to become a leading participant in the international market for Islamic finance.
Dean Page is CEO of Tokyo-based venture capital and advisory firm, Foreya Partners. He is qualified as both an attorney and as a CPA and was formerly a partner with Ernst & Young. Dean.Page@VentureCapital.Asia
Paul Petrequin is an associate at Foreya Partners and is currently completing his legal studies at the University of Miami in Florida. Paul.Petrequin@VentureCapital.Asia
