Study probes Malaysia's corporate bond strategy: Offering Islamic bonds expanded corporate financing access

In the late 1990s, Malaysia introduced a new approach for corporations to raise funds by issuing bonds compliant with Islamic law, which forbids the payment or receipt of interest. According to a study co-authored by UC Riverside professor Jean Helwege, this strategy proved successful, attracting billions of dollars in new investments without weakening the market for traditional corporate bonds.

Published in the Journal of Financial Economics, the research titled "The Impact of Introducing a (Nearly) Redundant Security: Evidence from Malaysian Corporate Bonds," examined the effects of Malaysia's 1997 introduction of Shariah-compliant bonds, or Islamic bonds, on the country's bond market over two decades. While often referred to as Islamic bonds, or sukuk, the securities adhere to Islamic religious principles while offering investors returns similar to conventional bonds.

Instead of replacing traditional bonds, the new securities broadened the investor base by appealing to those who wouldn't invest in interest-bearing debt. The study found that the popularity of Islamic bonds increased, not replacing conventional bonds but rather expanding the total capital available to businesses. Helwege explained that Islamic bonds are structured differently from conventional bonds, focusing on profit-sharing or asset-based financing rather than explicitly paying interest.

These bonds also avoid financing companies involved in activities prohibited under Islamic law, such as casinos. Although sometimes described as profit-sharing, these arrangements differ from owning stock in a company. The findings of the study challenge the assumption that new financial products merely divide existing markets; instead, Islamic bonds expanded capital access by attracting new investors.

Over the past two decades, Islamic bond issuance grew sharply, reaching over $20 billion by 2017, while conventional bond issuance remained relatively stable. The study suggests that introducing new securities can expand access to capital when they appeal to investors who wouldn't otherwise participate.