Malaysia’s Islamic finance overhaul boosts protection for depositors

Under the new rules, firms with composite licenses that cover both sectors will have five years to separate the two. Malaysia had 12 direct takaful operators with a combined 19 billion ringgit in assets as of December 2012, central bank data showed. The majority of those assets – 85 percent – were in family insurance, up 13.3 percent from a year earlier. Companies need to establish a new board and capital base for each business under the IFSA, making operations more capital-intensive.

Progress on Housing Finance Reform

Still, any government guarantee gives rise to moral hazard, since investors will naturally seek to obtain government backing on risky mortgages that provide a high private upside if the loan works out, and a loss for taxpayers if it does not. The Corker-Warner legislation creates an empowered regulator with a mandate to ensure that underwriting standards remain high. This is helpful, but not enough by itself after all, regulators failed to prevent the previous bout of poor lending behavior. An important insight, however, is that requiring substantial private capital to take losses ahead of the government guarantee helps to mitigate the moral hazard. This is because the investors with their funds at stake have a powerful incentive to enforce prudent underwriting. The presence of first-loss private capital thus brings market discipline to bear by aligning private interests with those of the government.

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