Is Islamic Finance Suffering from the Wrong Model of Implementation?


One of the things that attract me to maintain this website on Islamic Banking is the opportunity to interact and share ideas with the various practitioners and academicians in the industry. There are many discussion topics and we intend to bring such discussions to the open table as constructive as possible. Interaction with Ms Rosana is always interesting as she dare explore the Islamic Banking model itself, making comparison to other similar models in the market across geographies. And I do share some of her views on the industry, and I have written about it to some extend in my earlier postings. What is interesting about Ms Rosana is that she is taking the discussion a necessary step further in evaluating the existing Banking model, as to whether it is the right model to begin with. She has written a short discourse on this topic and looking to explore in-depth its implication in the near future.

She welcomes constructive feedback, comment and discussion points for this posting and hopes to decide on the next step forward gauging from your kind response. Do read and give us your opinion and comments. Thank you.

Is Islamic Finance Suffering from the Wrong Model of Implementation?

By Rosana Gulzar Mohd

In this blog’s latest post ‘Disruption: Islamic contracts’, there holds an imminent danger. The Islamic banks in Malaysia are not so much inching towards becoming just like the interest-based conventional banks they were supposed to replace but in fact, running towards them. Even as the industry celebrates its trillion size assets and formerly astronomical growth, there lies a darker truth. In a recent class I taught on the dichotomy between Islamic banking theory and practice, a participant, a new ‘Islamic’ banker, came up to me and wanted to discuss commodity murabaha. She said her team had just tabled the product for the bank’s approval but she did not feel comfortable. The head of the Shariah committee also seemed disappointed. His comment, according to her, was that we no longer need Shariah advisers. The industry only needs commodity murabaha experts now.

Post-IFSA 2013 which fines and jails CEOs and everyone above and below for any wrongdoing and a flurry of policy documents telling banks how to implement Shariah contracts, ‘Islamic’ banks in Malaysia are seeking refuge in tawarruq. Musharakah and mudarabah? All that is left of profit and loss sharing contracts, which some scholars say are at the heart of the ideal Islamic financial system, is the policy documents by Bank Negara Malaysia (BNM). I would be pleasantly surprised if anyone can show me a bank which is genuinely implementing them. The supposed mudarabah-based products brought on by IFSA, namely the investment accounts and the IA platform, are currently being mutilated to look almost like any guaranteed and fixed return deposit. The IAP, I believe, are unlikely to be successful for laughable reasons.

When commercial banking, with its inherent tendencies for excesses, profit maximisation and desensitisation to social welfare, is the problem, how does crowdfunding through commercial banks become the solution? Won’t the banks still look for credit-worthy companies with an almost guaranteed future to fund? Who then takes care of the small and medium-sized entrepreneurs who are also seeking financing? Are not the SMEs the backbones of the economy? Not to mention, where is the upholding of Islamic values such as justice, equitability and social well-being? Granted there are other organisations in Malaysia meant to help the lower incomes and SMEs but why do ‘Islamic’ banks call themselves ‘Islamic’ if they are far from embodying the ideal values in Shariah? Unfortunately, this sad state of affairs extends to other parts of Islamic finance such as takaful (apparently ‘Islamic’ insurance), sukuk, the other beauty pageant contestant in this parade, and other capital market products such as interest rate, oh wait, ‘profit’ rate swaps.

How did BNM envision the success of IFSA with no changes to the current environment? We are still in a dual system where ‘Islamic’ banks are pitted head-to-head against interest-based conventional banks. ‘Islamic’ assets are still only a quarter of the entire system despite the country allowing all sorts of controversial contracts such as bai al dayn, bai al inah and the one that takes the cake, tawarruq. Where are the educational campaigns to explain to customers this shift in the industry that the central bank expects to happen?

When customers, including ‘Muslims’, have been accustomed to deposit guarantees and fixed returns their whole lives, how do banks suddenly sell them an ‘investment account’ that promises neither? Is it any surprise that conventional bankers are using this as a selling point? They are telling customers to avoid ‘Islamic’ products because there are no guarantees. Theirs still do. When the chiefs of ‘Islamic’ banks themselves seem cloudy in their understanding of the new regulations, how did BNM envision people on the street, who are banking with its ‘Islamic’ banks, to embrace the changes? A deputy director unfortunately got defensive when I asked. Other central bankers claimed ignorance because they “are not from that department”.

While BNM seems keen to reform the industry, perhaps the answer it has been looking for is that the Islamic finance industry, and within it, Islamic banking, has been built the wrong way. Trying to make it work in the commercial banking space is what has led to the frequent comment that it is like squeezing a square peg into a round hole. Commercial banking, with its profit maximisation mantra and desensitisation to social welfare, is antithetical to the Shariah ideals of justice, equitability and social well-being as embodied in the maqasid. And isn’t it the one that has been leading the world from one crisis to another? Why then are we so busy emulating them? Isn’t it time the powers that be wake up and face facts?

So why did all the big organisations in Islamic finance, from the global standard-setters such as AAOIFI and IFSB to each country’s central banks and each ‘Islamic’ banks’ Shariah committees condone these practices? Perhaps because they were the easiest thing to do and allows for a fast build if the intention is to grab fame and fortune through one’s achievements in Islamic finance. The countless Islamic finance awards and conferences and the effusive back slapping there are testaments to this. Bankers are such happy people.

So what is the solution? I believe it is cooperative banking. The true, genuine type practiced in Europe and not the ones in Muslim countries because they are largely used to fund political cronies and thus suffer from questionable management and corruption. My next article will thus explain cooperative banking, how the model works and why they are a better fit for Islamic finance than the current commercial banking model. In the meantime, I look forward to your thoughts. Students of Islamic finance intuitively get it when I explain these arguments while some practitioners acquiesce (quietly agree). Another group reminds me of this statement in a book by Upton Sinclair, who ironically was also an investigative journalist (uncovers scandals and corruption) as I was in my former life and whose solution to the 1930s Depression in California is to create cooperative ventures for the unemployed. The idea, to his surprise, received wide support but his bid to run as governor was waylaid, according to him, by the oppositions’ “dirty tricks”. He wrote this statement in his book about the political adventure, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” The reaction of the other group of bankers brings to mind this quote.

What do you think about her assessment and commentary on the Islamic Banking model? Do give us your feedback in the comment box. Thank you.

Check out her other contributions in the following page : Writings Rozana Gulzar Mohd 

Disruption : Islamic Contracts


Under IFSA 2013, it is no longer about Product Innovation. It is about Product Compliance.

2 weeks ago I had a session with some bright individuals discussing the Islamic contracts commonly used in Corporate Banking financing structures. We went through almost all the available Islamic financing contracts such as Murabaha, Ijara, Musyaraka and Mudharaba, where I highlighted that all these contracts now have their own Policy Document issued by Bank Negara Malaysia (BNM). The Policy Documents, in my opinion, are a concise version of a lot of Sharia regulations and great reading source. It becomes a reference point where management roles and responsibilities are outlined, operational behaviour laid down, and theoretical basis is justified and explained.

It is a matter of time, I told the participants, that these Policy Documents are taken in their full context and finally developed into a comprehensive structure with clear compliance to Sharia requirements. We, as Islamic Bankers, are in for an exciting period of development where we will have a chance to develop “real” Islamic banking contracts.

The moment I said that, I realised it is NOT TRUE!!!


The popular belief is that IFSA 2013 is meant to realign all the Islamic Banking regulations in the Islamic Banking Act, Takaful Act and various major guidelines into a single overarching Act. IFSA 2013  consolidates the various practices into more clarity and re-classification of concepts. However, the perception that Islamic Banking in Malaysia as an innovative development hub would no longer hold true. “Innovation” was the key thinking and pride-point prior to IFSA 2013; now I believe the right word is “Compliance”.

163170_477596024332_7522334_nWhen we first started the Islamic Banking journey in late 1990’s and early 2000s, BNM encouraged a lot of product innovation from Banks as there were no existing guidelines. We looked at the various structures that provides the desired outcomes and discussed with Shariah Committee on the design and component of products without breaching Sharia rules. BNM was supportive on us developing these “innovative” products. Some may have been controversial (such as Bai Inah, Bay Ad Dayn, Wadiah and Bai Bithaman Ajil) but it encourages discussions alongside the mantra that “whatever is not explicitly prohibited, is permissible“. Sometimes we were forced to think outside of the box, especially for sophisticated products mirroring conventional. We also received support from Sharia Committees whom temporarily approved “innovative” products with the understanding that over time, a better solution were developed as replacements.

Now with the issuance of the Policy Documents, such innovation becomes limited. Innovation is now ring-fenced around compliance to Shariah rules (either from regulators or internal Shariah Committee), and the Banks are expected to follow these rules to the letter. Breaches to these rules becomes the responsibility of the Bank’s Shariah Committee and detailed deliberation is greatly expected to provide the solution. Compliance first; if it is not covered in the documents, it probably cannot be done without a lot of effort.


With compliance now being the vogue vocabulary with BNM, Banks had to look hard to the Policy Documents to ensure the requirements are identified and gaps filled for fear of breaches or fines. The gap analysis falls into the line whether “are we complying to the requirements?” and not “how do we do this without it becoming a gap or compliance issue?”. Both Shariah and Bank’s Product teams would now look on how to comply with Policy Documents instead of using the Policy Documents as a reference to develop a product.

What I noticed since 2014 is the obsession to comply with Islamic contract requirements, and if the team feels it is difficult to comply, the next logical step is to avoid such contract altogether and seek an alternative contract which is easier to comply with. For example, the Murabaha Policy Document issued in 2014. I have to say it is a beautiful document, and outlines the requirements for Murabaha Purchase Orderer (MPO) that reflects the full Sharia requirements of ownership transfers, risk taking, profit and management of actual assets.

These requirements, which in the eyes of many Banks, may be difficult to fully comply with due to many reasons: shortage of expertise, systems infrastructures limitation, people understanding, complicated processes, operational risks, credit issues and fund management requirements. Instead of the risk of breaching the Policy Documents, Banks opt for something less “complicated” which offers “similar” structure. The default solution is Tawarruq Arrangement i.e. Commodity Murabaha.

Or, the teams looks at Ijara Policy Document. It outlines further the roles and responsibilities of lessor and lessee, while the asset remained in the Bank’s ownership throughout the lease tenure. Again, if a roadblock occurs where a Bank cannot fully comply… Tawarruq Arrangement provides a quick solution. With very defined rules outlined in Tawarruq Policy Documents, the Banks are confident that offering Tawarruq will not breach any guidelines.

Tawarruq, therefore becomes the default Islamic contract in the market. When I asked the participants during case-studies to the question “What contracts should be used for this structure?”, the answers are unanimous “Tawarruq”. And they are not wrong.


155228_469014969332_6259944_nMaking Tawarruq as the “all-problems-solved” structure is having an unfortunate result to the industry. While the issuance of the Policy Documents as a reference was to galvanise the development of various Islamic contracts, the Banks have an easy way out in Tawarruq. Now, the rest of the contracts are in danger of being sidelined in favour of continuous development in Tawarruq.

For example, the Home Financing product which had evolved from BBA in the 1980s to Diminishing Musharaka in the 2000s. When BBA was introduced, practitioners and Sharia teams identified several practical issues that over a period of time needed to be resolved such as ownership transfer, rights to sell, and sale of properties under construction. These issues led to the development of Diminishing Musharaka as an alternative solution.

But with Diminishing Musharaka, there are still operational and legal issues that have yet to be resolved until today. For example, the “right” contract to be used for period of construction, the application of Ijara and the extensive outlining of Wakalah roles and responsibilities. Failure to understand the issues and provide real solutions puts the Bank at risk. There are also legal infrastructures that have yet to be addressed such as land joint-ownership by the Bank (as a partner), and different practices of land offices for the registration of Bank as a partner. These are roadblocks (and credit risks) to the Banks to take the structure further.


25547_378676189332_2665364_nMalaysia is in danger where I foresee that one day the industry itself will became the absolute global expert in Tawarruq and Commodity Murabaha. With Bursa Suq Al Sila as the leading commodity trading platform for the country, backed by the government (as a national bourse), the Tawarruq structure is expected to evolve into an efficient Islamic-structure engine. The processes of Commodity Murabaha will become seamless, and may even integrate into a Bank’s core banking system, the operation for buying and selling commodity will become commonplace and familiar, and this will result in effective processing, awareness of Shariah risks, compliance to trading requirements and well as reduction in overall operational risks.

Banks will one day become so well versed in Tawarruq, they will question the need for other types of Islamic contract, where they may not able to fully comply with.

With such development, more and more:

  1. capital investments will be made into perfecting the Tawarruq infrastructure, and Banks will also be able to comply with BNM requirements by investing in human capital familiar with Tawarruq.
  2. product structures will be developed around Tawarruq and once these products are established, it will be difficult to unwind as a prefered product simply due to the ease of the Tawarruq contract requirements.
  3. variations and hybrid products will be introduced based on Tawarruq, or containing elements of Tawarruq to solve “difficult scenarios” for compliance.

We will one day have an innovative and world class Tawarruq product, but no development in the other major Islamic contracts. Innovation will stall and Banks will choose quick returns and operational ease of Tawarruq. It is a dilemma of the industry where it is heading to “one” major solution for almost all “sale-based products”.

It is unfortunate if Banks chose to abandon the other contract alternatives, where such contracts will never reach its full operational and theoretical potential.

Hoping that a Bank will take the lead to develop products based on all the various Policy Documents instead of relying on only Tawarruq and its variations. The industry needs expansion and enhancement and by focusing on only Tawarruq, the industry will not be able to explore exciting products and expand its horizon. The Policy Documents, as beautifully written as they are, may tragically one day just becomes an academic relic issued by BNM.


Earlier writings on Tawarruq and Commodity Murabahah:

  1. Reliance on Commodity Murabahah
  2. Financing : Commodity Murabahah and Tawarruq

Interesting article in LinkedIn

Reliance on Commodity Murabahah

A few days ago, several Banks in Malaysia officially made available Deposit products based on Commodity Murabaha transactions.

Looks like Commodity Murabaha (CM), or in another variation is called “Tawarruq” has now expanded its domain from Financing-based to Deposit-based products. More and more banks will have to rely on this structure on both sides of the balance sheet. Bai-Inah based portfolio used to consist of nearly 80% of the overall financing portfolio of some banks; now with the push for Commodity Murabaha structures in financing to avoid interconditionality issues in Bai-Inah, it is expected that Commodity Murabaha financing to eventually replace the Bai-Inah portfolio.

Now with the introduction of CM for Deposits, the popularity of commodities will take a sharp rise! Bursa Malaysia will have their hands busy supplying the industry with commodities to support the underlying transactions. Islamic bankers will also have their hands full buying and selling commodities between the bourse and the customers, either as buying agents or principal purchasers!

Commodity Murabahah Deposits

I am not sure whether this is necessarily a good thing.

The industry will now shift from having a Bai-Inah-heavy portfolio into a Commodity-Murabaha-heavy portfolio. Concentration risks towards one Islamic contract will grow, and the question is that whether Banks will take the time to develop other contracts into viable propositions instead of just building the CM infrastructure. Do bear in mind that a lot of infrastructural work needs to be done to ensure CM remains the flagship contract for years to come.

The specific risks that Banks faced when offering CM products are manifold; shortage of commodities, delays in transactions,  wrong sequencing of purchase and sale of commodity, errors in commodity prices and description, delivery of commodities issues, ownership issues and ownership evidencing. All these requirements needs to be watertight to ensure income from these CM transactions don’t just go to charity. Whenever there is an Asset involved in the transaction, all the factors need to come together to ensure Sharia compliance.

And the way we are going, it seems that CM will probably have 80% of the financing pie and 70% of the deposits pie in a typical Islamic Bank’s balance sheet in 3-5 years time. With IFSA deadlines on June 2015, this ratio could come sooner rather than later.

Will the development of other contracts be further left behind since the shift now is on CM? Maybe, historically Malaysian Banks follows the “Urf Tijari” route of following what the other bank is doing. We have seen this when Bai Bithaman Ajil (BBA) was introduced; nothing else was developed in the market but BBA. It was the same with Bai Inah.

But there is other opportunities for development of other Islamic contracts, although I don’t imagine this is the case for Malaysia while we busy ourself becoming commodity traders. Oman, on the other hand, has rejected tawarruq totally,  focusing on other contracts such as Ijara and Musyaraka. This is a good development, as no countries has seriously looked at developing complex, high-risk structures. Maybe once the thinking to shift to understand the transactional and Sharia risks of the new products is made, perhaps the market can warm up to the idea that Sharia compliant banking can be a different way of banking.

Pro-Active Compliance of Regulatory Guidelines

There are days I wish I was a multi-millionaire with vast resources, cool regulatory connections, tech-savvy and excellent people motivator. Someone who sees the new regulations for the opportunity it is and the potential in it.

If I was, I’d quit my cosy banking job and set-up my own company that provide services to all Malaysian Banks to support the compliance of the new guidelines. Instead of all the banks scrambling to meet the requirements, they can just outsource all their problems to my set-up to run it. One stop solution to all your headaches.

Perhaps I am writing this out of frustration because I do not have the resources for it. Or perhaps I am writing this for my own interest, hoping someone like Bruce Wayne takes up the challenge and make all our jobs easier. Maybe some of us can get an offer to join this company. That’s wishful thinking I bet.

What would this company / set-up offer to banks? Hmmm where do we start.

Balancing Act

Compliance with the Investment Account Guidelines.

All Banks do not generally set up their operations to work like fund houses where you have fund managers running their investment desks. Neither are there an infrastructure to manage and monitor the fund or portfolio performance, nor having mechanisms to create mark-to-market valuations of the portfolio. Reading the Investment Account guidelines makes one think that the banking model itself has to change to a pure Mudharaba trading house. A dedicated fund house with ready systems supporting the investment requirements and offering their services to Islamic Banks will ease the burden at Banks to develop their own infrastructure.

Tawarruq Guidelines.

This can be a huge component of businesses in the near future. As BNM place more and more emphasis on the big 3 of Musyaraka, Mudharaba and Murabaha, more and more focus will be placed on building the long term infrastructure to support this. Warehousing infrastructure, including managing physical assets and commodities belonging to the Banks, will support the Murabaha envisioned by BNM. A re-vamp of the credit policies and a different approach to risks assessment will support Musyaraka. Mudharaba will encourage the Bank’s “entrepreneurial appetite”  as Banks take a more hands-on approach to investments. Ensuring a compliant structure and supporting the requirements of Sharia on sequencing, documentation, management of commodities, ownership transfers, usufruct and beneficial ownerships and valuation must be developed for the long run. A company which offers these services, or provides an IT platform for this, are something that can reduce the stress placed on the industry.

Special Purpose Vehicles (SPVs).

There a easy lot of opportunities for SPVs to flourish in the Islamic banking market. To support the ownership issues, an SPV can be a useful conduit for the movement of assets which will then create the underlying transactions. Huge deals are done on SPVs. Complicated structures need them. This is a viable legal solution for across border deals. The only question is; what do we do with the SPVs once the transaction is done? Rent it out to another entity, I presume. Either way, SPVs are created for win-win situations for everybody.

The IFSA 2013 is like a large pool of compliance that needed development. There are many opportunities out there and with the coming of even more complicated regulations, Banks are always finding ways to meet the requirements set in the regulations. Some will be creative solutions, while others will address the fundamental requirements of the transaction. Whatever they may be, it will only provide possibilities where fortune smiles on the brave. Take that chance. Hopefully, you will succeed to make all our lives easier.

Back To Wadiah

Investment Account Guidelines

True to form, BNM have called for an urgent discussion with the industry players on the implementation of the IFSA. The message is very simple; industry players are given time to comply to the IFSA i.e. no later than 30 June 2015. During this time, we are asked to either:

  1. Retain Mudharabah and Wakala structures to comply with the Investment Account guidelines; or
  2. Move the Mudharabah and Wakala structures into an alternative structure.

Obviously no one has the answer to both options. Especially for Current Account and Savings Account now offered under Mudharabah. To retain a simple product such as Savings Account under Mudharabah, the Bank needs to comply with tedious risk profiling of customers and numerous disclaimers on investments. Customers will be confused by this arrangement, and we foresee many will stay away. Marketing wise, it is a nightmare. Operationally as well, if we were to comply with the investment disclosures. Gone will be the simple structures that customers are used to.

Bringing the Current Account and Savings Account into Commodity Murabahah structures is the most viable solution in Shariah’s perspective. However, operationally tedious, money required for system development, revised documentation and more importantly, building customer awareness and acceptance will be the main challenges for the industry to move to this alternative.

Committees were promptly set-up to discuss solutions, and as expected, there can be no commercial viability into moving to Commodity Murabahah, at least not in such a short period of time. For Time Deposits it is possible, but how to address the daily deposits and withdrawals of funds in a Current or Savings Account under Commodity Murabahah?

The easy solution; take a step backwards.

Wadiah is suddenly the solution. Most Banks has decided to migrate back into Wadiah structures, even with limited value proposition. Hang on, this is not the solution. Perhaps only workable for a short term stop-gap measure, but definitely not feasible for moving forward, especially when there is a conventional banking alternative.

Wadiah is definitely not the solution for deposit building. But then, what else is there? Until someone comes up with a brilliant solution, we will have to make the best of what Wadiah has to offer.