The All New Shariah Advisory Council BNM Website

THE ONE-STOP SHARIAH ADVISORY PAGE OF BANK NEGARA MALAYSIA       

Finally it is here, the website dedicated to the works and reference regarding the Shariah Advisory Council (SAC) of Bank Negara Malaysia. There is a wealth of information on the decisions and fatwa of the SAC, and this will provide valuable reference point on how a particular decision is made. Good insights especially to leaners interested in knowing the methodologies and depth of deliberation that the SAC employs for a decision.

The Centre of Shariah Reference in Islamic Finance

The website itself looks clean and uncluttered and holds various sections of interest. They include:

  • Shariah Standards & Operational Requirements. Currently it covers the 12 Islamic contracts standards that has been issued up to today (21 April 2018). You can view the various standards individually as you scroll down the page. Click on the banner below to go to:

  • Shariah Resolutions 1997 – 2010. This is the English-language compilation of the various resolutions when the industry was in the infancy stages. Lots of very fundamental discussion happenning during this period in the industry. Click on the banner below to go to:

  • Shariah Resolutions 2011 – 2017. This is the continuing compilation cover a more advance level of discussions, as the products in the market become more sophisticated, More importantly, the introduction of Islamic Financial Services Act 2013 (IFSA 2013) provided a more robust consideration of operationalisation of the Islamic contracts. Personally, I learned quite a number of concepts during this segment of time. Unfortunately at the moment, the compilation is in Bahasa Malaysia (Malaysian language). Click on the banner below to go to:

  • Educators’ Manual. This section interestingly mentions the existence of manuals for learning organisations that teaches Islamic Banking and Finance courses. I am sure these are useful documents if it is coming from the SAC. But you need to sign up and agree to adopt the standards for your institution to access these. Therefore I can’t really comment on the contents. Click on the banner below to go to:

  • Latest Shariah Rulings (Individual SAC Meeting Resolutions). This section allows the reader to have access to the decisions made on certain specific issues. It aims to provide the reader the understanding of how a decision is derived, based on relevant Fiqh evidences. Interesting read and quite comprehensive. Click on the banner below to go to:

  • Infographics. I believe this is part of the efforts to educate the public on the understanding on the workings of Shariah contracts as well as the process flows (and Shariah requirements) of a particular Islamic structure. As at current date, there are only 3 Infographics available ie Tawarruq, Istisna’a and Murabahah, but I am sure over time, the number of contracts infographics will grow. Click on the banner below to go to:

  • List of Shariah Committee Members in Islamic Financial Institutions. This is an interesting section because of the willingness to disclose to public the Shariah scholars responsible for the resolutions or opinions at the institutional level. It provides transparency and also reference of the Shariah Committee strength compared between Islamic Financial Institutions. Click on the banner below to go to:

There are many other sections in this website and I personally believe that this site will be one of the most complete point of reference for all the Shariah-related banking decisions. It   may provide a better understanding of how the SAC makes a resolution that impacts the overall industry. I personally encountered a few glitches but I hope the content accumulates further to finally become one of the prominent sites when it comes to Islamic Banking.

Also, hoping someday the website will publish a hardcopy of the resolutions because some of us do read actual books. But if there is a plan for an e-book, do let me park it here on my website. For free.

Overall, I think the SAC website looks awesome and would definitely be one of my reference website for Islamic Banking products, processes and issues.

P/S Somehow I am not able to register as a subscriber yet (April 2018). Maybe still developing this area of the website? Hope it is sorted out soon.

Where Regulations on Islamic Banking Lives

Many times I have been asked, during talks and sharing sessions, where we can find all the Regulations, Frameworks and product Policy Documents issued by Bank Negara Malaysia. Many are not aware that I do house most of the relevant documents right here in my site. It is hidden (actually, not hidden…) in my REGULATIONS (MALAYSIA) tab.

Most of it are very technical documents and perhaps will make sense more for the practitioners in the industry. But there are many documents that is very useful, even for academicians and students, which is concisely well written and captures the essence of what needs to be conveyed. Especially documents such as the Islamic Banking contracts, which you can find at the PRODUCT STANDARD / POLICY DOCUMENTS (PRODUCTS) section of the same page.

Also there, the latest Shariah Advisory Council (SAC) Resolutions and Updates on various resolutions under under SHARIAH RESOLUTIONS.

Do use it if you are looking for a place for your reference. Also you can click on the above banner to go straight to Bank Negara Malaysia Website to search for items that are not in my page.

Happy Reading and do share the page if you find it useful.

Connecting the Dots : Islamic Fintech

REVOLUTION OR EVOLUTION?

This posting is in the danger of being written too long, but I think it is necessary to close this year with this topic, simply because it looks at the future. The word “Islamic Fintech” has been buzzing for quite some time now and there have been pockets of excitement on what it should mean. Many financial institutions have jumped onto the bandwagon declaring they are also part of this new wave of what a bank could offer.

While all these are still early stages of development, I do notice a lot of effort is built into “digitalisation” and “apps-based application” and “efficiently and convenience” of EXISTING banking processes and relationships. These enhancements are still driven by financial institutions and centred around improving traditional processes for banking services, or short-circuiting the credit processing elements of financing. Although enhancements via technology is an important aspect, these should not be defined as “fintech”. There is an element of fintech in process improvements, but PROCESS IMPROVEMENT itself are not fintech.

DO PEOPLE NEED BANKS?

Traditionally, banks always hold the impression that “People need Banks, one way or another”. It is this understanding that the bank can continue investing into their brick and mortar business model, with customers always coming to them when they need capital, financing funds or products and services. The competition is that who can deliver existing products in the most efficient manner, with technology as the enabler. Money is spent to improve accessibility to the bank’s EXISTING products, services and proposition.

In improving processes, banks just needs to concentrate on all the products and services offered and build the corresponding infrastructure to ensure efficient delivery with technology. It can be “Apps-driven” based on inquiry or transaction-based, with new features attached to existing products. It is just creation of new delivery channels which will deliver existing products to customers faster than before.

But that in my view is NOT what fintech is all about.

IF FINTECH IS NOT PROCESS IMPROVEMENTS THEN WHAT IS IT?

The easiest google/cut/paste definition of Fintech is that “fintech is a new financial industry that applies technology to improve financial activities and FinTech is the new applications, processes, products, or business models in the financial services industry, composed of one or more complementary financial services and provided as an end-to-end process via the Internet”. The key words I believe are:

  • New Financial Industry
  • New Application
  • New Processes
  • New Products
  • New Business Model

While “Process Enhancement” can help support the “New Processes” element, but I think it falls short of the idea for fintech i.e to re-think the business model of financial services. The idea of fintech should be this: Understanding what the requirements of the Gen Y customers are and how they work, develop the products and services on platforms that they are most familiar with, and the proposition that the bank can offer on their chosen platform. It is a total re-think of delivering products and propositions to the up-coming Gen Y potential customers.

SHARING OF FINANCIAL WALLET

As much as banks and financial institutions like to believe the financial wallet cannot exist outside the regulated financial system, the evidence is slowly being presented as otherwise. Companies are finding ways to survive, live and thrive outside the banking system with facilities and opportunities in the New Economy, slowly eroding the traditional banks’ share of financial wallet.

Big Data companies have proven that their database is far more powerful (and valuable) than the database an individual bank would have on its existing customers. Bitcoin and other cryptocurrencies goes through thousands of transactions within blockchain and is only realised into banks network when actual physical cash is needed. eWallet lets value resides in tech platforms for purchasing and sales of goods and services (more like barter or exchange of goods and services), and up to a certain extent provides microfinancing. Prepaid and loaded value arrangement provides free seed funding and capital for businesses, without the cost of borrowing incurred via banks. Peer to Peer (P2P) arrangement links crowdfund Investors to Entrepreneur without complicated documentation with speed and transparency levels never seen before. Sharing of risks and profits (including potential pay-offs) are now more understood as compared to traditional financing arrangements. Mudharabah, Musyarakah, and Ijarah may now have a place in an economy where equity participation is expected and sought after.

“FINANCIAL SOLUTIONS” ARE JUST A SINGLE ELEMENT IN THE UNIVERSE

Technology can now provide a single-point possibility of all our needs; goods, services, food, shopping, bills payment, money transfers, investments, borrowing, deliveries, medical, transport, social interaction, travel, holidays, education, careers development, information and even branding. Financial services can be integrated into all these elements, now driven via apps. But for this new infrastructure, the various “relationships” are needed to be identified and re-looked and re-engineered. With the proper Shariah compliance consideration.

This “single point” proposition is where tech companies play a crucial part. Rethinking the financial model must happen with the involvement of tech companies due to the advantage of everything being on the internet (internet of things). There are still a lot of limitations to what a bank can do, understandably due to financial regulations. The space of where banks are continuously competing (or evolving) is the “FINANCIAL SOLUTIONS” box above, and maybe payment gateways linked to service providers. But tech-companies? The revolution of technologies move so quickly that regulations will continue to struggle to catch up.

In the diagram above, I attempt to identify some of the areas of traditional banking where fintech can come in and provide a like-for-like solution or even fully replace the proposition by traditional banks. Certainly a lot of the consumer touch-points can be easily replicated in a technology platform, and crowdfunding and crowdsourcing can replace traditional financing and working capital requirements as well. Some services are still embedded into a banking structure (such as Current Accounts or Treasury product propositions) but over time, such products may be linked to fintech and the banks may eventually become ancillary service providers rather than main bank, earning just fees for services provided.

The landscape of what a bank offers will ultimately change in the next few years, when consumers no longer go to banks for financing, services, remittance and settlement of business transactions. As the new generation grows up with tech and becomes financially affluent, their expectation of how a banking experience should be will also dictate the model a bank adopts.

CONNECTING THE DOTS

So where do I see the banking industry in the next 5 years? Personally, I think a “price-comparison platform” will emerge, as seen nowadays in the travel/hotel/tourism industry. Information from all the financial service providers are flowed into a single platform, and consumers are able to immediately compare products, services and prices on a single platform and choose their solutions. Instead of customers subscribing to multiple banks offering different products and services (at different pricing), they only need to subscribe to a single platform where all information on the products are available to select. This is where the promise of fintech can thrive; accuracy of information, convenience of access, and speed of transaction.

It is a matter of time the various industries converge. We may think regulatory pressure will halt some of the progress but mostly it have been reactive regulations. And the challenge is that these developments are driven by tech companies which has no loyalties to banking regulations as their scope of business cuts across various industries. It will be a period of “non-regulated” until the market starts to recognise the need to regulate and managing the risks. A regulatory sandbox will be usefull, but if the “New Economy” moves faster than the speed where regulations are being formalised, there will be a lot of speculative and arbitrage opportunities for the market to gain.

This also means the New Economy brings new risks that the consumers are not aware off. While the banks have been fine-tuning its risks that it takes over the past half-century or so, the fintech companies may not see the elements of risks other than technology risks or systemic risks. Almost all the risks faced by banks are also prevalent in fintech companies or non-banks, plus the specific risks by fintech companies. They might be great at integration of technology, but banks are still masters when it comes to understanding financial risks.

WHAT NEEDS TO BE DONE?

As I mentioned, banks understand risks better than a tech company. A tech company understand speed, efficiency and channels better than any banks can have. At the moment, banks are developing “fintech” on their own which is mostly a process improvement project. Tech companies are developing “banking services” on their own as well, where it linked investor’s money and economic entrepreneurs via technology. The question is really, “why not a bank consume or enter into a partnership with tech companies to provide a solution beyond traditional banking?” We have started to see this trend where banks attempt to purchase outright a tech company and use the company as an incubator for new products and services. It should look into having a different operating structure which encourages new ideas, innovation, internet-based solutions, as well as delivering to a larger segment of consumers (including the Unbanked segment).

The end-result might not look like what we recognise as banks we see today. This could be a separate line of business for banks, where the element of technology integrated into the wider economy is more dominant than its traditional banking products and services. You could have Bank A offering the traditional products and services, and Bank A-Tech offering fintech solutions to a new generation. The same bank catering to 2 business lines, employing different delivery channels.

But breaking away from such traditional infrastructure may take time, and the greatest fear is that the market cannot wait. Fintech companies may be able to offer similar proposition in half the time required, and this will not motivate fintech companies to join-venture with a financial institution. In an environment where new opportunities arise at the blink of an eye and regulations have yet to be formalised, the temptation to go on its own will drive innovation by the fintech companies, leaving behind banks. Fintech companies have the capability to look at consumer needs and develop the solutions from the bottom, and flow the linkages to the top. Connect the dots where the solutions provider are linked together in a platform.

Will fintech companies be the next driver in providing financial solution? I know my answer to that question. It is perhaps just a matter of time where future banking is done outside of a bank. Perhaps the model of banking needs to be re-imagined.

Wishing all my readers a Happy New Year in 2018. I appreciate the support I have received so far. But the new world beckons and hopefully we can do enough to ensure the continuation of the banking industry. I hope Islamic Banking can play a bigger role in taking the industry into this exciting online generation.

5 Reasons Why PLS Financing Does Not Fit Islamic Banks

Click on picture to go to point-by-point commentary on the above

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:

  1. Banks are set-up as Financial Intermediaries
  2. Fiduciary Relationship resulting in Conflict of Interest may arise from Bank’s participation
  3. Cost Required to ensure compliance
  4. High Cost of Capital for PLS
  5. 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 : Commenting on Datuk Dr Daud’s points

Go to Datuk Dr Daud Bakar's views

Click here to go to discussion

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.

Is There a Secret Book I Don’t Know About?

ISLAMIC BANKING PRODUCTS ARE EXPENSIVE?

It is one of the mysteries of the universe that there is this perception that Islamic Banking products are MORE EXPENSIVE than the Riba products counterpart. It never fails to surprise me that in Malaysia, whenever I open the session for Q&A after a talk on Islamic Banking, that the question put to me was “Why is Islamic Banking financing products more expensive than conventional banking products?”.

Honestly, I wondered if this question comes from the possibility of everyone reading from the same exact book published many many years ago, making that one point of contention again and again. Which book have people been reading? Can someone pass me this book? It seems everyone is reading or referencing the same book which says “Islamic Banking products are expensive”. Can someone tell me about it?

So I decided to ask around. I asked the persons asking the question on why does he/she say that? In what scenario? Which product? What feature of the product makes it expensive? In all attempts, they replied “It is the general view that Islamic Banking is more expensive”. But they have yet to give me any evidence when I asked for their source.

Amazing

This is like a scary bedtime story that parents tell their children if they don’t behave. So now I am asking around for specific scenarios on why they made such comments. From what I gathered, these are some of what I think people are referring to. But I couldn’t be 100% sure, so please, do leave your comments and scenarios (and details) for me to evaluate and respond to.

Because, for the past 20 years (in Malaysia at least), this claim of “Islamic Banking products are more expensive than conventional banking” are simply not true.

YES, THERE ARE DIFFERENCES

Of course, before I delve deeper into this perception, there are differences in Islamic Banking that requires additional items or costs, but mainly these are operational costs or documentary costs or management costs which are linked to mainly Shariah requirement on Aqad. For conventional banking, it is just a loan agreement, For Islamic Banking, a trading transaction may occur, and if it does… there may be additional costs.

But these costs are usually absorbed by the Bank itself, and hardly passed on to the customers. So why would it be more expensive for the customer, if the Bank is absorbing these “costs” as part of their cost of doing Islamic Banking business?

And additionally, the costs borne by the Bank for doing Islamic Banking business are not significantly higher. The Bank have to remain competitive as well, either against conventional banks or other Islamic banks as well. So the costs, if significant, will not be passed to customers to remain competitive. It should be on par with other players in the market.

FINDING THE REASONS

As far as I can tell, some of the perception on Islamic Banking is more expensive than Conventional  products are based on these:

  1. Selling Price – In some Islamic Banking products, there are trading requirements (Murabaha / Tawarruq / Istisna’a / BBA) and one of the tenets of valid sale is that there must be a Selling Price. Selling Price is the sum calculation of all the Installments the customer has to pay over the period of financing. The formula is that Selling Price = Monthly Installment x No of Months of Financing. Once this is agreed, it cannot change; anything above and beyond the agreed Selling Price (maximum) is considered Riba. Conventional Banking products do not have this as they only declare the Installment amount per month based on prevailing rate. Truth is, no one really know how much they eventually pay under conventional banking product, because there is no capping of the amount they may pay. The tenure can be extended, the installment can be increased, the rates may be revised upwards under conventional banking. There is no control of how much (maximum) conventional banking can collect from the customer. If conventional banking products add up the installments over the period of time, they can also see the amount equivalent to a Selling Price ie total amount payable over the tenure. But they don’t, because it ties their hands from collecting more. So, is Islamic products more expensive? It is possibly the opposite i.e. cheaper than conventional due the maximum Selling Price compared to a conventional loan without any maximum amount (sky is the limit).
  2. Ceiling Rate – Islamic Banking products may work on either a fixed rate structure or floating rate structure. If the structure is a fixed rate structure, it looks similar to the above. If is floating rate structure, then there is a need to put up a Ceiling Rate (a maximum rate that Shariah allows us to charge) for the purpose of the Aqad, where the certainty of price is required.  However, once the Aqad has been concluded (Selling Price is contracted), the day-to-day running of the financing is charged at the Effective Profit Rate (usually below the Ceiling Rate) which is reflective of the prevailing market rates. Which is what the conventional banking products are charging. This makes the actual amount paid for Islamic Banking product at par with conventional banking products. The difference between the Ceiling Rate and the Effective Profit Rate is not charged on the customer therefore given as a Rebate on price (Ibra’). For example, if the Ceiling Price for the Aqad is 10% and the Effective Rate for day-to-day is 6.0% (ie customer is charged only 6.0%), then the difference of 4.0% is a pricing rebate to the customer. So, is Islamic products more expensive? No. It is on par after pricing Rebate. In fact, having a Ceiling Rate provides additional “protection” for an Islamic Banking customer i.e. during times of high volatility of Base Rate / Funding Rate, the Ceiling Rate serves as a rate protection for the customer. For example, should the all-in rate of the financing increase to be 13% or 14.0%, the customer’s rate will not exceed the Ceiling Rate of 10%, therefore saving the customer the excessive rate during periods of uncertainty. So, during period of high volatility of rates, the Ceiling Rate will not be exceed thus making the product cheaper than the Conventional product.
  3. More Documents – I acknowledge that some Islamic products do require additional products as a package. But as for main documents, where the most charges are incurred including stamp duties, are usually the same as any conventional banking product. Maybe there are earlier perception that because of the Selling Price based on Ceiling Rate, the stamp duty will be more expensive. It is not true. Stamping will still be made based on the principal amount even for an Islamic facility. Furthermore, secondary documents are usually stamped at nominal amount i.e. $10 per document. The additional documents for Islamic product, if we assume requires 5 additional, will cost the customer $50 extra. That is not significant.  So, is Islamic products more expensive? For documents, maybe. But it is dependant on structure and the additional documents will be stamped nominal value.
  4. Early Settlement Rebate – I probably understand and agree with this point, provided it was made 15 years ago! Traditionally, when a customer takes a loan with a conventional bank and want to do an early settlement after a few months, an early settlement penalty was charged. For an Islamic Banking products, when BBA was offered many years ago, the method was to give a “reduced discretionary rebate” on the unearned profit. This means maybe some Islamic Banks want to earn the same early settlement penalties (like a conventional bank) via a reduced rebate as rebates are by nature, discretionary in the eyes of Shariah. However in 2011, BNM issued a specific guidelines on the treatment of rebate for early settlement of Islamic sale-based financing products. The guidelines ensures that the rebate given is mandatory, with a specific formula to be adhered to. The guidelines also included the required disclosures for transparency purposes. In short, Islamic Banks cannot charge early settlement compensation (only a couple of scenario where it is allowed) and the rebate given must follow a strict formula. So, is Islamic products more expensive? There might be a case for this argument before 2010 (for early settlement cases only) but with the Ibra guidelines issued in 2011, the product would possibly result in at par or cheaper than a conventional bank product.
  5. Commodities Trading Fees – This is a recent phenomena. A lot of structures are riding on the popular Tawarruq structure, and this structure involves the buying and selling of commodities via brokers or established trading platform and there are Trading Fees being charged. Generally, for retail consumers, the trading fees are absorbed by the Banks; you will never notice it. But for Large Corporates dealing in hundreds of million deals, a trading fee may be noticeable. However, these fees are also deemed small enough to be ignored. The standard trading fees at Bursa Malaysia is $15 for every $1,000,000 commodities traded. That’s 0.0015% charge. For a $100 million transaction, the trading fee will only be $1,500. I have not seen any Corporate customers refusing to pay this trading fees. And there are some brokers who are even charging lesser rates. So, is Islamic Banking more expensive? Only for Tawarruq, there is additional costs but for the quantum, I do not believe 0.0015% is considered significant, or expensive.

It really is testament that the men and women in the industry were always looking to enhance, resolve and improve on contentious practices to serve the public. The products were always evolving to be better for the consumers. In fact, I believe we are at the stage that some of the offerings under Islamic Banking is CHEAPER than the conventional banking products due to certain fees and charges and treatment on the account are instructed by Shariah Committee.

IT IS A PERCEPTION THAT NEEDS CORRECTION. IT IS NOT CLEAR WHICH PART OR PRODUCT FEATURE THAT THE PUBLIC PERCEIVES AS MORE EXPENSIVE. IS IT THE RATE, THE PRICE, THE PENALTIES?. IS THERE ANY UNFAIR TERMS LEADING TO THIS PERCEPTION.  

COULD ISLAMIC BANKING FINANCING PRODUCTS ACTUALLY BE CHEAPER THAN CONVENTIONAL LOANS?

In some scenarios, I do believe so.

There are many areas that is governed by Shariah decisions formulated to protect or benefit customers for fairness. Especially in areas of fees and charges and compensation. IF YOU WANT TO KNOW MORE ABOUT ISLAMIC BANKING PRODUCTS BEING CHEAPER THAN A CONVENTIONAL BANKING PRODUCT, CHECK OUT MY COMING POST.

I really hope someday someone will pass me this mystery book to read. We are in 2017 and so much have changed in the past decade. Huge and big regulations have been introduced and most of it with heavy input and consideration from the Shariah Advisory Council (SAC) of BNM. These are learned individuals that I believe are not greatly motivated by money. There are huge responsibilities on their shoulders thus the decisions made will be for the benefit of customers in mind.

Again, I invite readers to provide me with the latest findings where it is believed that Islamic Banking is more expensive than conventional banking products. Let us discuss and evaluate them based on actual facts.

Wallahualam

 

Real Cost of Tawarruq

Recently, the topic of Tawarruq & Commodity Murabahah has been popular in the industry as both BNM and Shariah scholar have been asking operational questions on the implementation of Tawarruq arrangement in the industry. It seems, even with the Policy Documents, there are still some divergence in terms of operations and understanding of the minimum Shariah requirements for Tawarruq. Each financial institutions have their own operational abilities and processes that differs from one another; to have a standardised platform may be a bigger challenge than imagined.

The rise of Tawarruq in recent years should really not be a surprise to many observers. We are seeing that most financial institutions in Malaysia now consider a Tawarruq structure a “must have”, because there really is no options as other Banks also deals in it. It has become norm, and while scholars might take a view that Tawarruq should be a “last resort” option, there have been so much effort invested into making Tawarruq an efficient machine. Just take a look at the Bursa Suq Al Sila and what it is capable today.

Question : Is it Cash or Committed Limit?

The latest consideration of Tawarruq is on the treatment of Tawarruq funds after the transaction. What is it exactly and how is it been managed within the Bank, with the Capital Adequacy Framework for Islamic Banks (CAFIB) implemented a few years ago (latest update this year 2017). In particular, when a customer is approved a certain limit (let’s say $1,000,000) and a single Tawarruq is done for $1,000,000 for the line (instead of multiple small Tawarruq for each usage of the amount within the $1,000,000 limit), where does the money goes, and what is it exactly in the eyes of Sharia?

To clarify, upon the completion of Tawarruq, real money of $1,000,000 is generated. Cash. It is not a “line” in the conventional terms, but it is money (actual cash) now belonging to the customer. He can draw out the money anytime.

But the practice is that the money is kept in the Bank’s books unless requested by the Customer, and by keeping this the Bank will give a “rebate” on the money kept in the Bank, similar treatment as if a “principal payment” is made (although it is re-drawable). In the meantime, the Bank utilises the money (taken as principal payment made) for its own banking business activities.

The question that I believe we will have to eventually address are on the following:

  1. The Tawarruq is done on a single transaction for the full amount, therefore it is a full release of capital (i.e. fully funded). As such, it should have a “capital charge” consideration if it is not fully utilised by the customer. Bank has released fully the funds to customer (therefore Bank should be entitled to earn a full profit on the amount). The formula for profit would be $1,000,000 x Profit Rate – Cost of Capital. Note the Cost of Capital is on the full amount.
  2. Then, the subsequent mechanism instead is as follows: since the customer did not fully utilise the funds, the customer is given a “rebate”. For example the customer only uses $50,000 of the $1,000,000. The formula for rebate is that ($1,000,000 less $50,000 = $950,000) x Profit Rate x period unutilised. Banks earn full Profit Rate on $50,000 and gives rebate based on $950,000.
  3. Of course, Banks will utilise the $950,000 meanwhile but at what I imagine are for short-term instruments because the $950,000 is customer’s money (i.e. committed amount) and can be requested at anytime. Bank needs the funds to be as liquid as possible. So the Bank do not earn a lot from this “short term investment”.
  4. Also, there is concurrent discussion as to when the amount is kept and used by the Bank, what is the underlying contract used for this “unutilised, principal payment which is drawable on demand” amount? Is it kept by the Bank as Qard (loan), Wadiah (safekeeping), Amanah (trust) or can it be taken as Tawarruq deposit (monetised obligation) or Mudharaba (investments)? Different Banks have differing views on this, but I suspect BNM is trying to standardise this understanding and practice.
  5. But more importantly, while the Bank is giving customers “rebate” on the amount they do not utilise (but committed by the Bank), is there also “rebate” on Cost of Capital then? It seems unfair when it doesn’t. Tawarruq proceeds are deemed fully drawdown (based on full amount) and incurs full Capital Charge but is earning returns based on “only” the utilised amount. The rebate formula is very specific, and it does not contain the amount for “rebate” Capital Charge.

In the conventional Banking world, this is not so much of an issue. Their approach is simple: if the amount is “committed” to the customer, 2 things will happen:

  1. Once the amount is drawdown i.e. utilised by the customer (lets say $50,000 utilised of the $1,000,000), then full price is charged on the $50,000
  2. On the amount unutilised i.e. $950,000 the Bank will charge a “Commitment Fee” of 1.0% per annum (or any negotiated rate) on the unutilised (but committed) portion. While 1.0% per annum do not usually cover the full Capital Charge on the $950,000 it somewhat compensates the charge as the Bank (because $950,000 is still a “limit” and not Cash payout) can still use the unutilised amount in its day to day banking activities i.e. investment in short term financial instruments.

Scholars generally do not agree with the concept of Commitment Fees, and there is specific BNM guidelines prohibiting the charge of Commitment Fees in these specific scenarios.

The Capital Charge factor

I still think there is a disconnect somewhere that while we aim to achieve the same end result by the practice of Ibra’ i.e. “Rebate”, but with Capital Cost coming into play, it may eventually seem that the cost of running an Islamic Banking business can be higher than a conventional Bank. It really depends on how we interpret the guidelines and the treatment on Tawarruq especially the single Tawarruq structure where the full amount is transacted i.e. whether it is a full Capital Charge or otherwise.

I know what BNM usually advise i.e. it is a full Capital Charge. But this concurrently means, without Commitment Fees on the unutilised Customer portion, it may result in extra costs for the Bank. Now I am not suggesting we introduce Commitment Fees for Islamic Banking; this idea of Commitment Fees is a conventional banking concept for recovering opportunity costs, which may not sit well under Shariah consideration.

But in the world we operate today (where each $$$ is risk weighted to a cost), this translates to “Actual Costs” incurred by the Bank, based on the interpretation for the “single full amount Tawarruq transaction”. And Shariah may want to consider this as it is a real “Actual Costs” and not opportunity costs. By letting the money sit still, the Bank incur real, actual costs which is not recoverable as per guidelines. It may have started as “recovering opportunity costs” but if you really think about it, this is above opportunity costs. Maybe in the conventional space, they may even revise Commitment Fees to recover BOTH Opportunity Costs as well as Capital Charge.

So, my question is this: should both the industry and Shariah scholars re-look at the basis of Commitment Fees (in the context of how Tawarruq works), or re-think about the “Rebate” mechanism and perhaps have an adjusted formula to factor in a “Rebate on the Capital Charge”?

Can Shariah consider this mechanism to recover a real cost incurred by an Islamic Bank?

In the meantime, Happy Ramadhan to all, and may you have blessed month ahead.