This decade has witnessed the significant growth in Islamic finance. Nowadays, Islamic finance principles are not only being practiced by financial institutions in Muslim countries, in fact, there have been an increasing number of banks and financial institutions in non-Islamic countries offering Islamic financial products and services which are shariah compliant. This indicates the rising acceptance of Islamic financial products around the globe. Apparently, one of the major contributions for the rapid expansion in Islamic financial industry since the past few years is the remarkable growth in the issuance of sukuk, the Islamic investment certificates which often referred to as Islamic bonds.

Sukuk, as defined by Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is the certificates of equal value representing after closing subscription, receipt of the value of the certificate and putting it to use as planned, common title to shares and rights in tangible assets, usufructs and services or equity of a given project or equity of a special investment activity. The characteristic of sukuk which is acceptable under Shariah law is that it is asset-based investment securities. Sukuk is always regarded as equivalent to conventional securities. However, in practice, this type of financial instrument is significantly different from conventional one. Shariah law prohibits the transactions involving riba as being practiced in the conventional bond market. Furthermore, companies that are engaged in prohibited industries such as alcohol and pork related industries are not permitted since the underlying assets to be securitized


The year 2006 saw the world¶s first issuance of Shariah-compliant exchangeable sukuk by Khazanah Nasional Berhad. Malaysian government issued the first global sovereign sukuk which became an international benchmark for the issuance of global sukuk. In 2002. with trade totaling about USD25 billion. Malaysia has been the pioneer in the sukuk issuance. The dramatic expansion in the size of global sukuk market began after the first global corporate sukuk worth USD150 million issued in 2001 by Kumpulan Guthrie Berhad. Malaysian government and regulators have been active in developing a strong and vibrant domestic Islamic Capital Market. The active participation of Malaysian corporate sector and government in sukuk market brought competition from Gulf Cooperation Council (GCC) countries specifically Bahrain.must comply with Shariah principles. In line with its reputation as the leader in global sukuk market. In the global perspective. According to Islamic Finance Information Service (IFIS) report. the price discovery process. The development of the market involved initiatives to facilitate an efficient issuance process. the establishment of a benchmark yield. Malaysia remain¶s the world¶s leader in sukuk issuance by both number and value. the broadening of the investor base. the liquidity in the secondary market and 2 . a Malaysian company. despite the fall in corporate sukuk issuance due to economic downturn in 2007. The innovation of sukuk structures recently provides the Muslim investors a wide range of asset which impressively becomes increasingly popular among non-Muslim investors in the recent years.

Secondly. the number of studies focusing on Islamic finance in the corporate perspective is still few. Other than that of Gait and Worthington (2008) and Nagano (2009). section three is the statement of hypothesis. Including this introduction part. the aim of this study is to provide the analysis on Malaysian sukuk market both in macro and micro perspectives. this research proposal is organized as follows: section two critically discusses the findings of previous literatures. this study attempts to examine the factors that motivate firms to choose Islamic bond as a tool of financing instead of bank loans. 3 . section four provides the data description and research methodology and finally. Therefore. Nevertheless. no attempt has been made to measure the state of Islamic bond market using the bond market indicators. access. As the result. Furthermore. up to now. efficiency and stability. this study seeks to evaluate the development of Malaysian sukuk market based on four variables or indicators introduced by Financial Sector Development Indicators (FSDI) namely size. On top of that. the remarkable growth of Islamic bond market results in the increasing number of studies in this area. section five presents the significance of this study.the strengthening of the regulatory framework (Zeti. there is an increasing preference for sukuk among local and foreign institutions in Malaysia. 2007). no other empirical studies have yet been specifically examined why firms prefer Islamic bonds compared to bank borrowings. First.

there has been increasing participation in sukuk issuance from both Muslim and non-Muslim countries. The mismatch between short term liabilities and long term assets has caused the banks vulnerable to the crisis. 4 . Thereafter. Since then. The development of Islamic bond market has initiated in 1990 since the first sukuk issue by Shell MDS Sdn. Malaysia accounted for 67 per cent.1 Statement of Research Problem Asian financial crisis in 1997 had given a severe impact on Asian economic region including Malaysia. amounting to about USD47 billion (Zeti. Bhd. a multinational corporation operating in Malaysia. about two-thirds of the global sukuk outstanding. Malaysia was the first Muslim country to issue sukuk followed by Bahrain in 2001 and Indonesia in 2002. 2009). After the 1997 financial crisis.1. This double mismatch hampered the financial market activities which led to economic turmoil. the government realized that the lack of a developed domestic bond market caused the over reliance on bank borrowings and foreign loans amongst firms. This was due to over reliance on bank borrowings and foreign loan. By January 2007. Part of the Malaysian bond market comprises of Islamic securities or sukuk which has become increasingly popular over the past decade. government and regulators has been committed in fostering the development of sukuk market. In 2000. heavy dependent on foreign loans exposed the economy to the risk of mismatch between domestic currency asset and foreign currency liabilities. Furthermore.

this section builds the literature review related on the sukuk market development. This raises the question of what are the factors that firms prefer sukuk instead of other forms of external financing. Three types of literatures are distinguished as follows: firstly. At the global level. access. secondly. ii. efficiency and stability.0 LITERATURE REVIEW This section critically discusses different author¶s analysis in previous literatures. There has been an increasing number of non-financial institutions issuing sukuk. To assess the development of Malaysian sukuk market in terms of four dimensions namely size. 2.This exceptional progress made by Malaysian sukuk market has been supported by growing demand and interest on the Islamic securities. the literatures on the corporate decision in selecting financing types are discussed critically.2 Objective of the Study General Objective: To study the development and determinants of Islamic bond market in Malaysia. Specific Objective: i. It is noteworthy that the primary sukuk market is dominated by corporate sector. over 86 percent of total historic issuance in 2007 was corporate sukuk. 56 percent of total outstanding corporate bonds are Shariah-compliant. 1. In Malaysia. To determine factors that motivate firms to choose sukuk as a tool financing instead of bank loans. 5 . analysis in relation to firms¶ attitude towards Islamic finance is built and finally.

The largest proportion of corporate sukuk was issued in the financial services sector followed by real estate and utilities (Jobst et al. Asia. yet they do not react to conventional bond announcement.2. Elfakhani et al (2005) evaluated the performance of Islamic mutual funds where they found that Islamic mutual funds have shown strong performance during the recession period. Despite the market size seems modest by global standard. Thus they concluded that conventional investors can consider Islamic mutual funds in their portfolio collection especially during economic downturn. which have accounted for over 86 percent of total historic issuance through end of 2007. These results are consistent with that of Nagano 6 . specifically Malaysia accounted for the size of all issues in 2004 which is almost 90 percent. 2.1 Sukuk Market Development In the global overview of sukuk market. the sukuk market has been registering an impressive average growth of 40 percent per annum (BNM. 2008). A latest empirical study by Zariyawati et al (2009) revealed that on average. In another study regarding the Islamic financial market. 2009).2 Firms¶ Attitude and Perception towards Islamic Finance Almost all analysis done by researchers agreed that there is an increasing interest by local investors and companies in the introduction of sukuk market as an alternative to conventional bonds. the primary sukuk market is dominated by corporate sector. investors in Malaysia do react to the Islamic bond announcement which later gives positive wealth effect that is an increase in stock returns.

one of that is reputation. was the most used facility for financing. Whilst. firstly. sukuk is preferred as a funding scheme as it brings higher stock returns. this literature did not examine other possible factors that motivate the firms to choose sukuk issuance. This author examined the determinants of Islamic finance use from the theory of capital structure. 2. sukuk is chosen by firms that have past issuance experiences and finally.3 Determinants of Corporate Decision on Type of Financing A latest empirical study on the choice between Islamic bond and Islamic bank borrowing was done by Nagano (2009). The same result holds for Islamic bank borrowing. The results suggest that. Norafifah Ahmad and Sudin Haron in their study regarding the perceptions of corporate customers towards Islamic banking system in Malaysia found that overdraft. It is worth noting here that 80 percent of the respondents are non-Muslim. Thirdly. Secondly. Diamond (1991) developed a theory of bank loans and role of monitoring to deal with moral hazard in circumstances in which reputation effects are important. It is found that firms with high credit ratings acquired reputation from lender 7 .empirical study. followed by bank guarantee. The theories of the choice between bonds and loans have been developed in the corporate finance literature and one of the popular literatures reviewed by many researchers is from Diamond (1991). However. Nevertheless. bond and note issuance facilities are not popular among the respondents. the information cost is not an important factor in the case for Islamic bond issuance. the firm size is positively related to the sukuk issuance which indicates that large firm can access the sukuk funding market more easily.

The results suggest that firms with the highest credit quality exhibit a strong preference for public debt. 8 . Meanwhile. with more reputable borrowers having a higher probability of choosing international bond issue. The recent study which contributes the literature in this area through theoretical framework is done by Tanaka (2006). Hale (2001) addressed that borrowers from the countries with more political stability are more likely to issue bond while those who are from countries with better developed financial markets and institutions borrow relatively more from banks. Esho et al (2001) examines the choice of financing source among large Asian firms over the period 1989-1998 in international debts market and found that borrower reputation is a significant determinant of debt choice in Japan. Tanaka (2006) emphasis that. the crisis cost of default and the cost of debtor moral hazard. There are a large number of empirical researches done on financing decision of the firms. In the international debt instruments aspect.that enabled them to retain issuing public debt or bond. Denis and Milhov (2003) found that the choice among financial instruments strongly linked with the credit history of the issuing firm and the current credit quality of the issuer. if borrowers can be publicly monitored by a rating agency that disseminates the information about their creditworthiness. but not for the other Asian countries. The finding of these two studies supports the analysis of Diamond (1991) on the choice between bank loans and public debt. the choice between the two types of financing determined by the trade-off between two deadweight costs.

the information costs (Nagano. Johnson (1997) examined the determinants of corporate debt ownership structure empirically. 2008). For examples. 9 . Hale (2001). the internal funding ability affect the decision to choose the financing types.d) and Johnson (1997). this study hypothesize that firms¶ characteristics such as size. Loncarski et al (2008) also examined the effect of taxes and they found that taxes have no significant effect on the wealth effect associated with the announcement of convertible debt offering. Loncarski (2008). First. Secondly. The first two studies found that debt issue is not affected by the cost of acquiring fund. 3. the reputation of Malaysia as the world¶s largest sukuk market attracts local firms to participate in the market as it will bring the benefits to the firm. Thirdly. this study comes out with hypotheses based on the findings of previous literatures. Nagano (2009). Norafifah Ahmad and Haron (n. profitability. lower probability of costs of inefficient liquidation and fewer incentives to take actions harmful to lenders. The results suggest that firms use more public debt if the information and monitoring costs are lower. the remaining of three studies agreed that the cost relating to acquiring the financing significantly affect the decision or the choice among financing type. there were many literatures examined the relationship between the cost of acquiring the financing and the choice among financing types. For instances. 2009) and agency costs (Loncarski. In contrast.0 STATEMENT OF HYPOTHESIS For empirical analysis on the determinants of firms¶ decision to choose sukuk instead of other financial instruments.Besides the reputation issue.

The ratios are as follows: 10 . Thomson Reuters financial data. efficiency and stability.2 Research Methodology To gauge the development of sukuk market.1 Data Description This study uses both primary and secondary data. To measure the size.perception and knowledge on Islamic finance may be the significant factor for Muslim firms to choose the Shariah-compliant financing tool like sukuk. 4. Data on Islamic bond market indicators is collected from various sources such as ISI Emerging Market. The details of the indicators are as the following: 4. 4. this study employs the financial ratio analysis based on four indicators introduced by Financial Sector Development Indicators (FSDI) namely size. and Securities Commission over the period of 20012008. public.2. access. this study will provide both quantitative and qualitative analysis which respectively using the data collected from sukuk issuers¶ financial report and survey. and The World Bank. In order to investigate the factors motivate firms to choose sukuk instead of bank loans.1 Size The size dimension comprises the most commonly used measures of bond markets.0 DATA AND RESEARCH METHODOLOGY 4. private and international Islamic bonds are included.

III. Based on daily return indices.4 Stability Stability of a bond market is an important criteria considered by investors and it would have impact to an economy. Ratio of sovereign sukuk to GDP Ratio of corporate sukuk to GDP Ratio of international sukuk to GDP 4. II.2. volatility 11 .2 Access Access into the domestic market is useful and effective only when the cost of capital is low and the process of obtaining capital for the domestic private sector is relatively easy. FSDI primarily focuses on government bonds. Ratio of domestic sukuk to total bonds outstanding.3 Efficiency To measure the efficiency of bond markets.2. the secondary market transaction for this type of securities is limited that turnover ratio may be less accurate measure for efficiency of sukuk market 4. two indicators are employed: I. Due to paucity of high frequency data on corporate bonds. To measure the cost of capital. FSDI focuses on the liquidity of markets as reflected by the tightness of the quoted bid-ask spread and the turnover ratio. sovereign sukuk yields will be used as the proxy measure.2. Ratio of corporate sukuk to total domestic sukuk outstanding 4. since sukuk certificates usually held to maturity. II.I. To measure the ease of access. However.

This study will identify the determinants based on firms¶ characteristics such as size. The source of the crisis has been the overreliance on bank loans and foreign currency borrowings. As for qualitative analysis. this study employs the probit regression.(annualized standard deviation). Malaysia is the world¶s largest sukuk market where 60 percent of world¶s sukuk issues in 2007 originate from this country. skewness.0 SIGNIFICANCE OF STUDY This study is significant in view of the growing importance of bond financing after the 1997 Asian Financial Crisis. Hence the development of liquid. 5. internal funding ability and others which can be quantified using information provided in firms¶ annual report. profitability. To achieve the second objective which is to examine the determinants of firms decision to choose sukuk instead of other financing types. Malaysia has the comparative advantage to 12 . a survey will be conducted to capture the information on firms¶ perception and knowledge on sukuk which is not available in any source. There is growing consensus in post-crisis Asia that the effective and efficient means to mitigate the vulnerability of the financial system would be the development of robust domestic bond markets in the region. In fact. sound and deep bond market has become an important policy issue in the financial sector in Asian countries including Malaysia. maturity structure and correlation between bond returns are analyzed.

In Malaysia. Malaysia offers the facilities for the origination. Hence the assessment of Malaysian sukuk market development is relevant and timely. 47 percent of outstanding corporate bonds in 2007 comprised of sukuk.become a global sukuk hub in the future. it is noteworthy that the primary sukuk market is dominated by the corporate sector. distribution and trading of sukuk. Information organized according to the bond market monitoring indicators helps us to understand better the relative development of the sukuk market as well as the strength and weaknesses of each dimension. With the launching of the Malaysian International Islamic Financial Centre (MIFC) initiative in 2006. 13 . Secondly. This raises the question of what are the factors motivate firms to choose sukuk instead of other forms of external financiang? This study attempts to identify those determinants which would contribute to explain the recent development in the sukuk market.

Bonds or Loans? On the Choice of International Debt Instrument by Emerging Market Borrowers. Nasir Mohd. G. I. Canadian Journal of Administrative Sciences. Jobst. Issue 33: 135-141. 2008..psu. Finance and Development. 99(4): 689-721.ist. M. Yatim. 25: 214-236. Kunzel. 2009. International Journal of Islamic and Middle East Finance and Management. International Research Journal of Finance and Economics.edu/viewdoc/download?doi=10. Journal of Financial and Quantitative Analysis. Islamic Bond Issuance:What Sovereign Debt Manager Need to Know. 2008. 10: 276-305.1. and Fulghieri. T. Esho. G. A. Jenke ter Horst and Veld. J. and Wothington.A. Business Firm and Financial Institution Attitudes towards Islamic Methods of Finance. P. 1991. A. CWhy Do Companies Issue Convertible Bond Loans? An Empirical Analysis for the Canadian Market. The Review of Financial Studies. KPMG (2009). Hale. P. http://citeseerx. A.. (2001). Mohd. Mills. A.1. Development of Islamic Bond Market in Hong Kong: What are the Tax Implications? KPMG Publications. Islamic Finance Gears up. Johnson. Diamond. Loncarski. Mohammad El Qorchi. and the Choice between Bank Loans and Publicly Traded Debt. 2001. 2005. International Journals of Social Economics.W. 42(4). 2008. 1994. Gait. Hong Kong. P. J. Monitoring and Reputation: The Choice Between Bank Loans and Directly Placed Debt. D. Chemmanur. 1997. 7(3): 475-506. A. An Empirical Survey of Individual Consumer. An Empirical Analysis of the Determinants of Corporate Debt Ownership Structure. Sukuk (Islamic Bond): A Crucial Financial Instrument for 14 . and Sy.REFERENCES Bokpin. 35(11): 783-808. (1991). Reputation.1..Journal of Financial Intermediation. S. 32(1): 47-69. The Jounal of Political Economy. 1(4). Renegotiation. and Onumah. Choice of Financing Source in International Debt Markets. An Empirical Analysis of the Determinants of Corporate Investment Decision. N.2489&rep=rep1&typ e=pdf.

S. Humanomics. Ram Ratings. 2006. The Truth About Sukuk.com/p/articles/mi_qn6207/is_20090101/ai_n31193777/?tag=co ntent. M. Prospects and Challenges for Developing Corporate Sukuk and Bond Markets. L. The Economic Journal. Conventional vs Islamic Bond Announcement: The Effects on Shareholders' Wealth. 2009. http://findarticles. Bank Loans Versus Bond Finance: Implications for Sovereign Debtors. Tanaka. 15 . 4(6): 105-111. Sole. 2009. 2008. R. Malaysian Business. 1(1): 20-30. 24(3): 170-181. 2008. J. 116(March): C149-C171. 4(10): 166-172. Zariyawati Mohd Asshari and Chun. International Journal of Business and Management. Innovation in the Structuring of Islamic Sukuk Securities. Wilson. International Journal of Islamic and Middle Eastern Finance and Management.col1. 2009.Securitisation of Debt for the Debt-holders in Shari¶ah-compliant Capital Market. International Journal of Business and Management.