Many months ago, there was this posting by Dr Daud Bakar, CEO of Amanie Group and Chairman of Shariah Advisory Council (SAC) of Central Bank of Malaysia (BNM) where he stated Profit Loss Sharing (PLS) structures are not suitable for Islamic Banks. It caused quite a stir in the market as there have been a lot of push by Shariah circles on Islamic Banks to develop Islamic Banking products based on PLS. People were surprised that such comments were made by the Chairman of SAC, when BNM have been active in pushing Islamic Banks to develop these very contracts.
So what is the story then? Do we want to see Equity Products such as Mudarabah or Musyarakah Financing in the market, and is it feasible as a business model under current banking structures?
As much as I want to say we are ready for it, the reality is that there are other considerations where offering these financing products is maybe not the right fit for Islamic Banks. We may attempt to develop them nonetheless, but we have to be wary of the requirements set out in the Policy Documents and comply with it.
As I have written before in Disruption Islamic Contracts the industry is entering the era of Compliance rather than Innovation. If we were to develop for example Ijarah products, we will not be able to comply fully with the contract requirements (such as ownership risks and force majure), and Islamic Banks will opt for “easier to comply” contracts. The risks inherent in the contracts will also hamper full-blown development of such contracts into workable compliant structures. It is unfortunate; the Policy Documents issued by BNM are very extensively written but a challenge for Banks to fully comply with.
And when you expand your intention to go into equity-based financing (PLS), the risks would remain with the Bank as these Islamic structures do not allow for transfer of risks from the Bank to customers. This greatly hampers Banks used to mitigating only certain types of risks, or in the best case scenario, Banks are only willing to introduce basic or safe-feature products, with a lot of legal mitigants to protect Bank’s interest. It is an uncomfortable territory for Banks where the issue of Banks holding “unconventional” risks cannot be satisfactorily addressed.
In Dr Daud’s assessment, he identified Five (5) reasons why PLS do not fit Islamic Banks, in this current, general model:
- Banks are set-up as Financial Intermediaries
- Fiduciary Relationship resulting in Conflict of Interest may arise from Bank’s participation
- Cost Required to ensure compliance
- High Cost of Capital for PLS
- Re-think of Accounting Standards for PLS
Click this link to go to the discussion page on this topic. I looked at the points by Dr Daud with comments based of my own personal view. Building a Participation Banking Model : Comments by Datuk Dr Daud
Why do we need to discuss PLS?
Our discussion are now becoming more relevant moving forward. In my view, traditional Islamic Banks and the way it was set-up, caters more for debt-based structures where risks are traditionally understood. The template used for building Islamic Banks was conventional banking. While we have “Islamised” the operations, systems, processes and products, the similarities between Islamic and conventional banks remains prominent. Leveraging on conventional banking infrastructure was a necessity.
That is essentially what traditional Islamic Banking did. Replication, compliance, and competition.
Needing a new Banking model. An Alternative Banking model.
So if PLS is not the right fit for Islamic Banks, where can it exist then?
I believe this is the right time and opportunity to ask this question of where PLS should thrive. With all this talk about Value Based Intermediation (VBI), Fintech, Investment Accounts, Crowd Funding, Private Equity, Venture Capitalists, Participation Banking and Challenger banks, perhaps the PLS structure should be the next inclusion into these discussion. The sandbox is open, and I sincerely believe this opportunity allows for the serious consideration to include PLS. The risk profile you see in these types of Fintech forums cater for a different thinking; banking the un-bankable, understanding of unconventional risks, investment into entrepreneurial ventures and community involvement in sharing of risks.
And more interestingly, most of the structures are already available in this “alternative banking model” and have significantly similar characteristics and behaviour expected from Islamic Banking practices. Especially on the sharing of risks and returns.
It is something that interest me immensely. I believe the next wave in Islamic Banking must be in this new digital world where speed, access, and business model (without financial intermediation) forces a monumental shift in banking practices. As we are starting from ground zero, why not put PLS / equity-based structures / participative banking / as the focus for all these new developments? If not now, then when?
Leave the debt-based structures with the traditional banks, where the familiarity with credit, collateral, sources of payment and audited financial statements will continue to drive traditional businesses.
Let PLS force a re-think into alternative Islamic banking, where entrepreneurial ability, direct investors, sharing of returns, performance of business, risks understanding, speed, low costs, access to the un-bankable population, big data mining, and technology-driven solutions become the main priorities for development.
There is little choice for us where change is now required. If change is needed, why not put PLS as part of the necessary change? The next wave must start. Watch this space. More on Fintech and alternative models soon.