The Rise of Qardh

I wrote earlier in July 2014 about re-branding Wadiah following discussions the industry had with BNM. In that meeting, the key take-away was that there is an intention to re-brand Wadiah into Qard, to which the industry reacted negatively as Wadiah has always been used for short-term deposit structures where discretionary hibah “gifts” are given to depositors. BNM contention was that Wadiah do not meet the practice of the Bank where Wadiah was supposed to be taken as “safe-keeping based on trusteeship” (Wadiah Yad Amanah) or “safe-keeping with guarantee” (Wadiah Yad Dhamanah). The main argument was the under the Wadiah structure, the ownership of the fungible asset remains with the customer and the Bank has not obtained sufficient consent from the customer to utilise their funds, specifically for Wadiah Yad Dhamanah.

Wadiah 2014

The solution for the above conundrum, offered by BNM, is therefore, migrate to Qard-based products, where by virtue of it being a loan from the customer to the Bank, the ownership is transferred to the Bank allowing the Bank to utilise it as it pleases, while guaranteeing the loan amount upon demand (you have to repay back the loan).

As mentioned in my earlier writing, some industry players has clear reservation to convert Wadiah to Qard, seeing that the various guidelines are coming thick and fast to comply with requirements under Investment Accounts. Handling another major change in regulations will just hamper the industry’s growth.

Now, 16 January 2015. The revised Concept Paper for Wadiah was issued. We are given 1 month to respond with our feedback.

Wadiah CP

The biggest shock is that the paper has re-defined Wadiah as only Wadiah Yad Amanah i.e. safe-keeping trusteeship. There was NO mention of the contract that most Banks are currently using for Current Account / Savings Account i.e. Wadiah Yad Dhamanah (safe-keeping with guarantee) which allowed the Banks to utilise the funds for Bank’s activities. What this removal of definition means:

  1. The Bank takes Customer Assets and safely keeps as Wadiah in the Bank until a request to withdraw the Asset is made by the customer. The Bank must return the initial Asset to the customer upon request, with no obligation to provide any other benefits.
  2. The Bank does not have the right to utilise this Asset under Wadiah anymore #.
  3. If the Bank intents to utilise the money for purpose of generating returns, then the rules of Qard must apply i.e. for the Bank to obtain the right to utilise the money, the ownership of the money must be transferred to the Bank i.e. the customer no longer has financial and ownership rights when the funds are utilised by the Bank to generate returns. It is a loan by the customer to the Bank. As owner of the money now, the Bank has full rights to the returns. The Bank has no obligations to the customer except of return of the loan on demand. Discretionary hibah “gift” may be given, but questions may soon come on its validity when it is deemed as “Urf” (customary, no longer discretionary).

# Previously under the rules of Wadiah Yad Dhamanah, if the Bank intends to utilise fungible Assets deposited by customers to Banks such as money, sufficient consent must be obtained before the Bank utilise the money for other purpose (including for generating returns). In reality, this consent is really lacking especially for a daily product such as Current Account or Savings Account, resulting in insufficient rights to use customer’s fund to generate returns. The Banks are also not allowed to agree the returns up-front for the use of the money yet circumvents this by publishing historical rates of returns instead. This “historical return” soon was construed as non-discretionary and deemed as returns that is treated as Urf’. Therefore, Wadiah Yad Dhamanah was totally removed by BNM as a viable Islamic Banking concept, and now to be replaced by Qard (where ownership of funds are wholly transferred to the Bank).

Utilisation of Money

In any circumstances, Banks do utilise the Customers’ money for banking activities, including investments. If we retain Wadiah under this new BNM definition, then it will greatly impair Islamic Banks if we are not able to utilise collected funds for generating profit. The Wadiah moving forward will only apply for Safe Deposit Box services where the Bank can charge a minimal fee for safe-keeping services. Trying to apply it to anything else will be a challenge.

Wadiah 2015

The Qard guidelines needs to come sooner than later. At least the Exposure Draft or the Concept Paper needs to be available for discussion and for Banks to assess the Impact going forward. The impact by IFSA 2013 will be fully felt right after the coming months of June 2015, and this new regulation will further add to the re-branding of Islamic Banking currently taking place in Malaysia.

Equity-based Financing vs Debt-based Financing

Recently I have been asked again on why Islamic Banks still uses a lot of Debt-based Financing products, instead of moving to Equity-based Financing products, which on perception was supposed to be more “Islamic”.

Yes, ideally an equity-based financing do equate to a more “Islamic” structure, if your definition of being more “Islamic” is risk-sharing. Not all structures must be risk-sharing; transfer of risks are definitely acceptable in Islamic Banking circle. The idea is an age old idea; if you undertake a low-risk structure or there is no risks for the bank (where all risks are transferred to customers) then technically the bank should earn low returns for it. If the risks are higher i.e. Bank carries the risks, Banks would be entitled to higher returns. High risk equates to High returns.

TYPES OF RISKS 02

BUT IN REALITY, ARE COMMERCIAL BANKS SET UP LIKE THESE?

If an Islamic Bank operates in the same environment as a conventional Bank, it is difficult to imagine having two models running side by side I.e. the Islamic Banks operating an equity-based business and conventional Banks operating a debt-based business. The risk profile of these banks would be significantly different, and this affect many areas in banking; risk rating, cost of funding, profile as well as capital requirements. The bank with the perceived higher risk rating will ultimately become less competitive.

The real truth is that the shareholders of traditional banking set up expects the following: medium to high returns on their equity at the lowest risk and operating cost as possible. In short, their “investment” must record the best Return on Investment (ROI) as possible. Based on this view, debt-based financing can fill that criteria.

SO WHAT ARE DEBT-BASED FINANCING STRUCTURES?

EQTYvsDEBT

Many have the perception that equity-based structures and debt-based structures are dependent on the types of contract employed by an Islamic Bank. To a certain extent, this may be true. Certain contracts by nature promotes the sharing of risks (which is equity financing) while others rely on the transfer of risks (which is debt financing). For example, a Musyaraka (partnership) structure is traditionally an equity financing structure, where the Bank and customer enters into a partnership arrangement with both parties giving capital into the venture. Risks on the venture is shared according to equity ratio, and so is the returns where it will also be shared. The risk factor is therefore elevated because there is a possibility of losses being shared between Bank and customer.

Musyaraka

So, many Banks prefer the safer haven of Debt-based financing. How, then, do you change a Musyaraka structure into debt-based? Simply by providing a purchase undertaking, a document agreed and signed which states that should the venture go bust, then the customer agrees to undertake the purchase of the Bank’s remaining share in the venture thus making the amount to be immediately due by the customer. This is in a way, an indemnity given by the Customer to provide assurances during contractual breaches. By having a purchase undertaking document, the risks are effectively transferred to the customer in times of default. The Musyaraka therefore still works where profits are shared during the good times, but dissolves in spirit during bad times when purchase undertaking document takes effect.

Equity Financing2

The talk about having an equity-based financing is usually moot with the use of purchase undertaking document. The element of risks is removed for the Bank, and puts the product on par with its conventional banking product equivalent.

So will we ever see Equity-based financing?

I believe you need real political will for this. You need:

  1. Shareholders who understand the risk nature of equity based contracts, the way venture capitalist understand venture capitalism. Risk and return are greatly considered but more importantly, the possibility of losses.
  2. Bank with a risk appetite outlined for greater risk-taking. The risks to be understood and accepted. Then the venture in entered into with eyes open although it will take time for a Bank to understand the business risks they take under equity-based structures.
  3. Customers willing to stomach the losses or share the spoils of profits. It will take even longer time for customers themselves to be able to accept the structures under equity-based. Customers must be able to understand that they are active partners in a venture, the responsibilities and also the sharing aspect of it; they don’t just share the losses with the Bank, but also the profits or gains with Banks as well and this can be above and beyond what they can traditionally accept.

To achieve this, it will take significant paradigm change for everyone when they have only the financing structures in mind. In actual fact, such structures are already common in the consumer psyche as there are similar structures when they deal in unit trusts, shares or other types of investments, where risks are taken. But to flip it into an “equity financing” concept will remain a challenge to Islamic Banks that are serious to offer something significantly “Islamic”.

Session #1

Today I had the pleasure of sharing experiences with some post-graduate individuals on the new happenings in Islamic Banking in Malaysia. I thoroughly enjoyed the session and answering their “tough” questions and happy to see so many passionate people in Islamic Banking in one room.

One of the questions that resounded loudly throughout the room was the question regarding product development. I was asked if businesses greatly influence the development of a product or does the Sharia Advisory Council have a stronger say. An interesting question but I think the room agreed that the main influence will come from consumers; it is still consumer demand that drives it.

We could have developed the most Sharia compliant structure that even conventional banks do not offer and create significant differentiation, but again the next question would be: Would consumers understand, accept and buy the product? A lot of resources will be invested into such development, but the key question is that who is going to take it. While it is ideally attractive but practically defective. Not because there is a Sharia issue or product design, but whether it will suit the consumers  needs simply and practically.

So, Islamic Banking is also driven by the same consumers who drives the conventional businesses. How then, do we change the mindset that Islamic Banking should be more than just a copy of conventional products? Economically, we are set In thinking that banking as a way to expand wealth. One of the participants asked if there is a possibility to change a whole culture to understand and view Islamic Banking as a viable distinct alternative to capitalist conventional banking. Whether culturally the mindset of consumers can be changed to demand Islamic Banking provide different solutions to the same problem, specifically introducing a totally different way of banking. An interesting thought if it can be done, but it feels nothing short of re-genesis to make that cultural change. Someone has to start that spark, and we really need that someone.

In all my sincerity, I am glad to know there are individuals who do understand the challenges in Islamic Banking, no matter what their aspirations. I am but a tiny speck in their learning development and hope to see more individuals like these who are able to one day make a difference in Islamic Banking.

As requested, I attach the presentation slides used today and hope it can be of some use to its readers.

Pool Management, Profit Calculation & Distribution Mechanism (ppt)

Thank you friends, for your support, and don’t give up the good fight, no matter how tough the challenges might seem.

Is Risk Based Pricing Compatible with Islamic Banking?

As the deadline of 1st January 2015 to comply with the new Reference Rate Framework looms closer, Banks are scrambling to ensure the system is adequately able to cater for the new pricing regime.

To refresh what this initiative is all about, BNM has earlier in March 2014 issued the final paper for the Reference Rate Framework, the purpose being to move Banks to be more transparent in their pricing regime and start thinking about risk-based pricing more seriously. It is also expected to push Banks to be more efficient in their operations; the more efficient the funding infrastructure, collections and recovery teams in the Bank, the lower the expected risks associated to the pricing which means bigger “savings” on the margin for the Bank.

Which was fine when I read it a few months ago. For a quick recap, do read my earlier post:

Please Click Here

But the more we go into this Reference Rate project, the more confused I get. Reading again and again and comparing it with the earlier Guideline issued by BNM on Risk Informed Pricing (issued 13 December 2013), I realised while earlier we understood the concept of “building the element of risk into how we calculate pricing”, this Reference Rate Framework talks about something else. Something I am inclined not to agree to.

Before that, what is Risk-Informed Pricing or Risk-Based Pricing?

I am not sure if there is a difference between the two, but the general understanding of what is Risk-based pricing and the explanations in the BNM paper on Risk Informed Pricing sound similar; both  talk about Expected Loss being the justification of charging a higher financing rate to consumers deemed to be “credit unworthy”. There is an element of discrimination but certain rules have been put in place such as factors that should NOT be used to determine price, such as race, colour, religion, national origin, gender, marital status or age, but that leaves a lot of interpretation by Banks on what can be defined as “risk” factors of a consumer. Wiki even went to comment that the pricing convention hurts the financially disadvantage from access to affordable capital or financing. This leads to predatory lending where Banks may offer exorbitant rates to desperate customers as they have no choice but to enter into an unsustainable financing schemes that they will eventually default.

Does Risk-Based Pricing make sense for Islamic Banking?

In that sense, how do we, Islamic Bankers, deal with Risk-based pricing in the context of the new Reference Rate regime? Is there such as thing as risk-based pricing for Islamic Banking?

Personally, I view Risk-Informed Pricing to be in contradiction to Islamic Banking and what we are supposed to do for consumers. Many efforts have been made to ensure consumers are not unnecessarily burdened but instead to provide assistance. We understand the Bank’s needs to discourage consumer “who couldn’t afford it” to not borrow further and bring themselves into unsustainable debts. But the way of the world, with the Basel II accord being an important international standard,  risk is deemed to have a direct impact on Bank’s capital and therefore must be addressed accordingly via effective risk management where one of the methods for this is to have risk-informed pricing. Therefore, upon assessment of an application from a consumer, a “risk-informed” price will be offered for their consideration; a price where all the elements of risks (including Expected Loss) are built into additional costs and premiums.

Islamic Banking, like it or not, will still fall under such standards, and therefore will already “penalise” a certain unfortunate consumer upfront with a “risk-informed” pricing. Not something consistent with what I feel Islamic Banking should do.

What is it that I am confused about with the Reference Rate Framework?

While we have woken up and accepted that the world now is moving towards “risk-informed pricing”, we try to find ways to soften the burden to  consumers by regulating “late payment charges” and”early settlement charges”. The Late Punitive pricing was also off the radar for both conventional banking and Islamic banking.

But with this new framework, there is not only “Risk-Informed pricing” or “Risk-Based Pricing” but also “Risk-Adjusted Pricing”. Adjusted means Banks can adjust pricing AFTER a future event happening.

This concern basically boils down to this particular clause in the framework paper.

Risk based pricing

Usually, risk-based pricing means initially a price that is adjusted to cater to the risk are given upfront. But with 8.10, what this means is that if the credit risk profile or creditworthiness of the customer changes during the tenure of the financing, the pricing i.e. the Bank’s spread may be revised to compensate for the higher risks. Definition of changes of the “credit risk profile” or “creditworthiness”, based on our clarification with BNM, refers to default situation. Therefore, if a customer’s creditworthiness is compromised and becomes worse-off, then the Bank, in its facing additional risk for continuing to finance the customer, may revise the Bank’s spread to mitigate the higher risks. If you are a good paymaster for 1 year but on the 13th month is out of a job and unable to pay your home instalments, you are now “not-creditworthy” and the Bank has the “right” to mitigate that risk and charge a higher spread i.e. higher returns.

Unless I’m reading this standard wrong, this is a gross expansion to risk based pricing, where the facility rates are adjusted based on the customer’s prevailing risk profile.

RAP

Yes, if the customer’s risk profile shows good credit standing (therefore deemed a “low credit risk”), theoretically the customer may enjoy a low financing rate for their facility due to the low possibility of default to the Bank. This is definitely a benefit to the customer. But on the flipside, if the customer initial credit rating is already “marginal or bad”, they possibly will be offered an “elevated” Bank’s spread to mitigate the potential risks of financing an “unworthy” customer. Therefore the initial pricing will be higher than usual. This is the basis of risk-based pricing, which can be a beneficial tool for the Bank.

To make things worse, should the customer have no choice but to take the financing at a higher rate, they are open to further “elevation” if during the course of the financing, things go sour in their payment. The event of default will trigger the option to “revise” the rate further. This means a “marginal or bad” customer will be holding on two levels of risk-adjusted pricing; the first during the initial approval, and the second on default events during the financing period.

It seems there is now a backdoor to the Late Payment Charges (LPC) that the Islamic Banks have been restricted to. While it is difficult to charge Penalty (Gharamah) due to various restrictions, allowing Banks to directly revise upwards the banking spread actually resolves the issue of cost compensation that Banks were not able to charge before. In fact, if you really think about it, there is really no need for the LPC guidelines anymore; on default, Banks can raise the pricing spreads and it goes directly (and fully) into its income books.

How will this be acceptable to an Islamic Banking structure? Allow me to express my utmost shock to this.

Shocked

Simply put, risk-adjusted pricing and Islamic Banking do not make good companions. I understand the intention is to ensure customers don’t over-finance beyond their means, but to impose this for “default” customers  does not seem right as this looks very similar to a punitive action to consumers. I hope I am wrong about this, but as I know it, my conventional banking counterpart is already building this capability in their system. As this is a BNM standard now, I wonder how soon until we are asked to follow suit to comply with such requirements.

I am recording my official concern to this to my organisation’s Sharia committee. Hopefully it is a misunderstanding on my part. I would welcome this correction in understanding on my behalf.

Istisna’a Concept Paper

Yet another concept paper for us to read; BNM is really making us work hard for our salaries. The contract of Istisna’a is covered in this concept paper, traditionally used in a hybrid arrangement of a mortgage product for properties under construction. In the Middle East we are used to see Istisna’a as a standalone arrangement, and with this concept paper, it seems like a step by BNM in aligning the contracts used by Malaysian Islamic Banks with the practices in the Middle East.

With this Concept Paper, the way is paved for Istisna’a to finally stand alone as it’s own contract rather than part and parcel of another overarching structure, such as Musyaraka or Ijara.

But that doesn’t mean that it is not without its challenges. If Istisna’a is bundled amongst a variety of other contracts, many issues can be catered for in the other contracts and its documentation. Now, reading the CP, few glaring challenges needs a rethink if Istisna’a is to be the viable answer to properties under construction.

Istisna

Risk

The first, and perhaps the most significant item is the role of the Bank which leads to the next significant issue ie ownership. The CP envisioned scenario where the role between Bank and Customer is Bank as developer and Customer is, well… customer. This is a role reversal to what many banks are used to. The Istisna’a that I am used to seeing in Malaysia is that the Customer undertakes to construct the property (via their selected property developer); by this the construction risks remains with the Customer who undertakes the role of developer. The customer therefore ensures that the property is eventually delivered. Without recourse especially in cases of project abandonment.

But with the CP, the game changes. The Bank now must act as the party that’s responsible in delivering the property; effectively this means the role of the developer itself. The construction risks now lies with the Bank. The Bank must ensure that the property is delivered to specifications else the customer have room to renegotiate the terms of the Istisna’a, including cancellation of the whole transaction if the property is deemed to be “not as per requirements”. While the risks of such things happening is remote, the risks remains there and is real. Especially if we are dealing with small developers developing projects in remote areas. There is a real risk these small developers disappearing and the property, even if it got completed, is unsaleable due to location or market factors.

Ownership

The Sale & Purchase Agreements (S&P) is a document signed between the customer and the construction developer. The bank is not a party to this transaction, therefore the Bank’s name do not appear there. So how then, do we evidence ownership transfer and validating the contract between the Bank (as developers) and Customer? The developer will hardly want to transfer its rights and responsibilities to a Bank unless the Bank outright purchases the property, and during construction, how will it be possible?

Back in the day when Bai Bithaman Ajil (BBA) was the “deal of the day”, this curious creature called Novation Agreement was used. It is an agreement used to bind 3 parties to the arrangement, a tri-part ate agreement that developers sign to allow to transfer beneficial ownership to the Bank to allow the sale transaction between Bank and Customer. Not many developers want to sign this, but in instances where they did, it provided a way out on the issue of ownership before the sale. Yet this curious being has disappeared from the landscape, as many users gets jittery when there are more and more documents to sign.

It could be worth to consider this approach again, on an industry-wide basis rather than individual practitioners. Make it an industry document, get standard legal opinion, get buy-ins from developers on the need for this document and remove all the doubts on ownership. Novation Agreement might not be a bad thing but maybe some work needs to be done to satisfy the legal peculiarities relevant to each stakeholders.

Expertise

This is where the Banks lack when you consider Istisna’a contract in its spirit. Under Istisna’a, the responsibility to ensure the properties are completed, functional and deliverable to the customer rests on the shoulders of Banks. As a matter of principal, Banks are traditionally financial institutions, not geared to be engaged as “property developer”. The risk of development is always transferred to the developers, and not held by Banks. To have a unit set-up to monitor the construction of the properties requires specialised personnel who understands the nitty gritty of property development is hardly effective or efficient. Developers would also be wary of Banks trying to trespass into their territory of expertise. My view, let the developers be developers and Bankers remain bankers.

Istisna’a structures are fairly new in Malaysia; while it is being used in the market, but it always has been part of the larger collection of contracts in a financing arrangement. To have it stand-alone on its own, there is a need to re-think the legal requirements to ensure the Istisna’a can be accepted as a viable Islamic contract.

Rebranding Wadiah

A few days ago we had an interesting session with the Malaysian regulators. The agenda listed as “Discussion on the Wadiah Concept Paper”, a paper which was issued in December 2013, and had caused quite a stir in the industry. The main content of that paper was the treatment of Hibah (gift) payments on balances maintained in the Wadiah accounts, and the underlying rules of Wadiah.

For clarity, Wadiah (safe keeping) contract is used in Malaysia for savings / transactional type of accounts. The intention is that the customer enters into a relationship with the bank as a Wadi’ (custodian of deposit) and Mudi’ (owner of capital / depositor). The mandate is purely on a custodial basis. In practice, the customer places funds with the bank for the purpose of safe keeping, therefore the bank must become just a custodian of the depositors money. However, it is unlikely that the bank just receives the funds and not utilise it for an economic activity.

Because of this use of funds by the bank, Malaysian scholars view it is only fair as a good banking practice, that some discretionary returns may be given to customer for the use of the customer’s funds. This returns, while not promised up-front, has over a period of time, become customary (Urf’) in its execution and distribution. The whole arrangement is known as Wadiah Yad Dhamanah (safe custody with guarantee). As I understand it, only Malaysia offers this contract for Savings and/or Current Account products in the world.

In all other geographies, the Current Account and/or Savings Account commonly use either the Qard (interest-free loan) contract, or the Mudharaba (profit sharing entrepreneurship) contract.

Wadiah vs Qard Update

All these years, we are of the view that there is a identifiable difference between Wadiah and Qard. Under Qard, the arrangement is where the customer provides the bank with a loan i.e. the deposit amount which must be returned to the customer upon demand. While Wadiah also operates the same way, the only difference is that Wadiah allows for the granting of discretionary Hibah arising from the use of the customer’s funds.

So it was a small surprise to note that in the Wadiah Concept paper issued in December last year, there is a specific mention that while there is a differentiation in relationship for Wadiah and Qard, the rules of Qard will also apply to Wadiah. The issue of discretionary Hibah is also raised that if the Hibah is paid consistently, it becomes customary (Urf’) and therefore can no longer be viewed as “discretionary”.

That is why I was surprised that the meeting a few days ago asked this question; “What are the views of Islamic Banks if the Wadiah contract is now demised and replaced by Qard, while the practice of paying discretionary Hibah is retained even for Qard? Would the banks be open to this “change in name only” while the principles of the product remains the same?”

My concerns with this direction are:

  1. Such allowance to continue to provide Hibah on a Wadiah (in name only) will only be temporary and will eventually turn to what is practiced in the middle east i.e. no payment of Hibah.
  2. Confusion may ensue as there will be two separate rules governing a Qard i.e. different rules in Malaysia and what is being practised elsewhere. This opens up the Malaysian-version of Qard to criticism and I believe, sooner than later, consolidation of practice and understanding will happen.
  3. The investment effort to be spent into Wadiah products will now no longer make sense. Eventually, Wadiah will cease to be a savings-and-deposit-building proposition for the Bank. It will revert into a basic, transactional and low balance proposition, which might not be attractive for Banks to further invest into. Other options will now take prominence.

Will Wadiah also survive this re-branding of Islamic Banking in general in Malaysia? We are expecting some changes to surface this end of year and it will put further pressure on the industry which is already reeling from the existing changes that was introduced. From where I am sitting, it seems that soon, Wadiah will be re-branded into a version of Qard, as a pre-cursor of eventually becoming “pure” Qard.

Looks like another one will soon bite the dust.

Interconditionality in Bai-Inah

One of the most controversial contracts that resides in Malaysia is the Bai Inah contract. For many years, Malaysia have been taking heat on its use from international forums. The major reasons for this critique is that Bai Inah, while having an underlying transaction in its structure, argues critics, smells suspiciously like a loan with interest. There have been many opinions to this, but I must admit that each argument has its own merits and rationale, and it is difficult to draw the line here.

What is Bai Inah?

But before going further, what is Bai Inah? Why is it always under the Islamic finance microscope for scrutiny? Why are feathers always ruffled when discussing Bai Inah?

Bai Inah Malaysia

 Please Click Here

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.

Goods and Services Tax on Islamic Products

Goods Services Tax (GST)  will be one of the hot topics for the years to come in Malaysia, when the GST finally comes into place in 2015 to replace the Services Tax. Many arguments have been made on both side of the political divide but the reality is that GST will be implemented and have a huge impact on how services and goods are being priced.

A quick look at the GST finds that Sharia compliant banking, while having all its contracts requiring underlying transactions, asset ownership and movement of actual goods, the impact that the GST may have on Islamic contract will remain similar to what impacts a conventional banking product. There is not expected to have a “worse-off” effect on Sharia compliant banking.

GST

It is heartening to see that Customs has made an effort to understand the various Islamic banking contracts and how it works, and identify potential transactional points where a GST may be imposed. I find the attached document (GST Industry Guide – Islamic Banking (As at 1 November 2013)) extremely useful summary of the intended GST implementation on Sharia banking contracts.

10 particular contracts have been identified and the GST points are outlined accordingly.

Please Click Here

The Consequence of Choice

It was a day where nerves were frayed and feathers ruffled.

A huge potential customer comes. The intention is that they wanted to move all their accounts to Sharia-compliant banking, as they intend to “Islamicize” their business. All the available structures were laid out to the customer, the processes and the documentary procedures were explained for their understanding.

But suddenly, comes the golden question… “Do you have any products that looks and behave like a conventional product that we are familiar with? We are not comfortable with all these Islamic terms and documentations, so can we have something that does not require us to sign all these documents?”.

I was left speechless.

Sharia-compliant banking is based on contractual relationships. There are many relationships; Musyaraka, Murabaha, Ijara, Mudharaba, Istis’na… Various and many depending on use, intention, and desired outcome. There must be an underlying transaction, governed by specific rules and tenets, and pays attention even to sequencing requirements, ownerships, rights and usufruct.

Documentary Islamic

Fundamentally it is different from a conventional banking structure, which is loan based and interest charging. Thus documentation for a non-Sharia banking product is essentially one core document; Facility Agreement. But that may not necessarily be the case for Sharia banking, where documents are crucial evidence for the underlying transaction, ownership and obligations.

To make that conscious decision to shift to Sharia-banking is admirable. But to insist on a structure they are used to in conventional banks makes this effort superficial. It is frustrating to explain that each Sharia-compliant product behaves in a certain manner and must comply with the tenets captured in various documents; no matter how much a customer envision the product feature and documentation should be instead. A Sharia-compliant 1-month Term Deposit based on Qardh (ease of documentation) but with guarantee of returns? How would we pull that off? It is a contradiction in concepts.

Customers need to understand that to choose Sharia-banking is to accept the rules and trimmings that comes with this model. It is not the same as the conventional model, although at many times we try to replicate what’s available in the conventional space to avoid confusion. Replication is there for convenience but the DNA of Sharia-compliant banking is different. With replication then enhancement and eventual replacement, we hope awareness in Sharia-compliant products may come in gradual stages.

I think it all boils down to the lack of understanding what is required for us to offer Sharia-compliant banking. The layers we go through are numerous, stricter regulatory requirements and Sharia rules to follow. Turnaround times for Sharia-compliant product is understandably slower, where there is intense scrutiny on contractual relationships, legality and Sharia-sensibilities.

It is tough to be an Islamic banker. We manage perceptions, expectations and responsibility not only to the Bank’s customers, but also to general consumers. To choose this model, consumer must be open to the fact that Sharia-compliant banking is similar but definitely not the same as a conventional model. There is a lack of awareness of what is involved but we need to be open to an idea. Everyone knows the conventional model, therefore do take time to understand Sharia-compliant banking as a new learning instead on trying to hammer a conventional-familiarity into a model which works based on risk-sharing, relationships, and contractual certainties and tenets.

May I have a calm week ahead.

New Reference Rate Framework (Concept Paper)

To read the New Reference Rate Framework Concept Paper, click here

One of the papers currently being floated around for discussion is the new Reference Rate paper. While no date is indicated for the paper to be effective, [Update : today it was announced that effective date by 2 January 2015] its implication will be significant to both the banking system in Malaysia, Islamic and non-Islamic. The main purpose of the paper is the way Banks price their financing product must now be different. Gone will be the Base Lending Rates (BLR) and Base Financing Rates (BFR), and welcome the new defined term; Prime Financing Rate (PFR).

The intention is this; a lot of the things that go into the BLR/BFR are pricing related to risks, and these premiums are loaded into the base borne by customers. This leaves the margin (or customer spread) that is charged becomes somewhat “clean” as a return to the bank, with the exception of impairments (loan/financing defaults). In addition, banks earn “additional” returns from the “savings” built into the BLR/BFR itself. As a lot of risk premiums are built into the base rate, if these risks do not materialise, the bank technically “earns” this savings. You charge the customer in the base rate some premium for the expected risks, but you get the benefit for it. Ideal scenario.

It is therefore no surprise that some good banks, that are able to manage their risks effectively, are pricing their financing at a base-minus rate. It is now common to see home financing packages being priced at BFR minus 2.0% p.a., and the BFR being 6.60% p.a., the pricing is therefore 4.40% p.a. In theory, taking into account the actual cost of funds, adding only the “necessary” premium to cater for risks that is beyond the bank’s control, the base-minus rate still makes decent money for the Banks.

Therefore, even at 4.40% p.a., there is still room for the Bank to earn a margin, after deducting actual cost of funds. I believe the new Reference Rate framework aims to address this issue somewhat.

The concept paper was issued in January 2014 and this will change the way we price the financing portfolio. Under the concept paper, the base pricing shall only consist of the following:

  1. Cost of Funds (COF) – this is essentially the equivalent to interbank borrowing rate or cost of capital
  2. Statutory Reserve Requirement (SRR) – this is a regulatory reserve requirement for financial prudence

As you can see, these components of the new Prime Financing Rate (PFR) leaves very little room for Banks to manoeuvre the rates. COF is market driven, based on interbank lending rates, while SRR is a regulatory requirement based on specific percentage. BNM know that these are the most rigid components to pricing, therefore this may be a deliberate composition selection by BNM aimed at institutions to re-think the pricing formula.

And under the new regime of PFR, the following should no longer be built into the base rate. These costs, if the Banks want it, should be a part of the margin to the Banks loaded into the customers.

  1. Operating Costs
  2. Administrative Costs
  3. Credit Risk Premium
  4. Liquidity Risk Premium
  5. Any profit margin

Prime Financing Rate

These cost, if to be taken by the Bank, must therefore be part of the margin charged onto the customer. Customer will now know what components go into their financing i.e. The margin is now reflective of the risk the Bank perceive onto the customer. The higher the customer’s risk profile, the higher the margin can be.

As such, the 2.50% p.a. maximum margin chargeable onto the base rate should no longer be applicable. As at January 2014, the BLR / BFR is 6.60% and at a margin of +2.50%, the maximum rate chargeable is 9.10% p.a. Under the new regime, the dynamics may now be different for example the PFR could be 3.90% and the margin +5.00% which adds up to 8.90%. In absolute terms it’s cheaper but the customer might balk at the +5.00% margin when they are used to +1.00% or even -1.00% margins.

This is actually a good framework as Banks will have to be more competitive in pricing as the lower the margin, the more risks you are taking on your customers as the risk pricing is built into the margin. Additionally, the concept paper restricts the bank from quoting a price lower than the PFR, and this will make sense because it won’t eat into the Bank’s Cost of Funds. While you can have a BFR-2.00% (i.e. 4.60%), a PFR-2.00% won’t make sense as the PFR component, for example priced at 3.90% will give a net financing rate of 1.90%, and eats into the cost of funds.

In short, the pricing for financing moving forward will be based on the creditworthiness of the customer. Any changes in pricing will be reflecting the changes in operating costs, portfolio defaults or funding strategies. It gives the Bank more flexibility to determine pricing based on agreed scenarios or specific events.

This is a positive development. Banks now have the ability to decide on how to price a product based on real strategies and existing capabilities. Customers will have more transparencies in terms of what they are being charged. This will also spur competition among Banks, and provide better products and services to consumers, especially if the Bank gets its risk profiling right and able to effectively manage its default. All this will require a critical re-think on how a product profitability is determined, and a re-think of how the right management can provide a sustainable financing portfolio.

Note: On the Deposit Rates requirements, there are not much in the Concept Paper itself. Most of the requirements on Deposits are captured under the various EDs such as Wadiah, Hibah, Wakalah and the Investment Account Concept Paper. The only notable mention on the Deposit Rates section is that for Basic Savings Account, returns should be paid irrespective of the account balance and shall not be lower than 0.25% per annum. Also, there is a clause that mentions for Islamic Current Accounts, any hibah/dividend payments should not exceed 2.00% per annum. This, in my opinion, runs counter to the ED on Wadiah (which allows the Bank pure discretionary payment of Hibah, and therefore should not be governed by a capped rate) and the Investment Account Concept Paper (which states that the Bank must reward the customer dividends due to them, based on actual portfolio performances, therefore should not be limited to only 2.00% per annum). These point are against the spirit of Wadiah and Mudharabah, as well as against the Competition Act. We understand BNM is discussing this point internally after receiving industry feedback, and may consider removing this from the framework. We wait with bated breath for this framework to be properly issued.

UPDATE : The 2.0% per annum maximum cap on the Islamic Current Account has been removed via BNM circular dated 20 March 2014. Indeed this puts us back on the right playing field with conventional banking.

For some news on the above topic, please find the following newspaper articles:

 

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.

Banking with Non-Islamic Banking Institutions

I remember many years ago being in an interesting conversation with my Bank’s Sharia Advisor on the topic of accepting funds from an organisation which deals with non-sharia compliant activities. What was the view on taking funds you know were generated from doubtful sources. Whether it is reputationally acceptable to take in deposits from customers involved in gambling, usury and prohibited activities.

Some institutions were reluctant to take in these institutions as customers, even though they were huge, cash-rich corporations. The worry is on the perception that we Islamic bankers are supporting them via our activities, that they benefit from their patronage of our bank. Some even said that taking their “dirty” money and putting it into our pool of “clean” funds will result in co-mingling of the funds. The fact that we provide services to non-Sharia compliant institutions, bothered some quarters.

My advisor said it simply. Why not we take their funds? If you don’t take it, where would it then go? It will go back into the conventional system, generate more money, providing more funds to allow the conventional banks to loan the money to more customers. This will grow the conventional pool of funds, increase the loans portfolio in interest-lending and further strengthen a conventional banks profit. Islamic banks will then have to grow organically, fighting for the piece of pie that’s available against huge conventional banking giants.

Take the money. Invest in Islamic industry. Grow our books. Invest in Sharia-compliant manner. And provide good returns to the conventional depositors and investors. Change their mind by proving that Islamic banking is universal. That the model is viable. Innovative, competitive and fair. Provide the alternative for a feasible banking structure. Give da’wah and awareness on Islamic banking and its underlying principles. Prove we can co-exist side by side.

Probably one of the wisest things I have heard. Although not many will have the same sentiment to this. So it is ok to agree to disagree.
Investment by Conventional Banks
But what if it is the other way around? Can an Islamic Bank invest or place their deposits with a conventional banking counterpart, who deals in non-compliant activities? The answer is obviously a NO. Depositors funds, taken under a Sharia-compliant contract, should be used for sharia approved activities only. Morally, it is wrong to paint a picture that the Bank is Sharia-compliant but is actually a deposit collection arm of the Non-Sharia-compliant bank. It’s misleading and damaging to the Islamic bank to have this reputation.

Investment in Conventional Bank

Yet, is there a solution to this argument? What if we still deposit funds into a conventional bank, yet with a strict condition put on the use of these fund for Sharia compliant investments only? Will that be enough to allay the concerns? If it does, what is the relationship that will be between us and a conventional bank? Can we appoint a conventional bank as our “Wakeel” to execute Sharia compliant transactions?

Personally, I do have reservations on this. Conventional banks do not have any compulsion on the execution of a transaction whether Islamic or otherwise. They do not bother about its use or matters such as sequencing or ownership. Their law is civil law, and is dependent on the legal documentation. This, then, is merely passing of money to a conventional entity, when our depositors have trusted us to invest in Sharia compliant activities. Can we be assured that the monies passed over be used according to our requirements? How do we get this assurance?

What is your Bank doing? Can this be a possible model?

Sharia Compliant Banking in Malaysia

One of the long running arguments on Islamic Banking in its current state is the level of compliance to the rules of Sharia. There are still many believers out there who are not really believing in Islamic Banking. There are many suspicions in the industry. The main one is that Islamic Banking is a copy of conventional banking with merely a Sharia wrapper around it.

Sharia CompliantThis view is admittedly hard to dispel, unfortunately. Especially in a market where the industry is running 2 parallel banking systems ie Islamic Banking and Conventional Banking side by side. Sometimes, there is an additional element ie Islamic Banking Windows where an Islamic Banking operation resides in a conventional banking, leveraging totally on the conventional banking infrastructure.

The Middle-East has been able to gain more focus on the development of Islamic Banking. Despite Malaysia being one of the prominent pioneers of the industry, the stability of what we are seeing in the Middle-East has been the focus of ensuring the products they offer are deemed more Sharia compliant. While Malaysia is coming out with innovations to catch up with competition from conventional banks, the Middle-East is looking to products they already have and improving them to ensure Sharia compliance, fully backed by an international Shari’a framework.

This is clearly a different approach to the development between the two Islamic Banking industry.

In my view, the Middle-East has a clear advantage when in comes to sustainability. The advantage is simply this; the wants of the consumer. The Middle-East consumer simply WANTS Islamic Banking. No question about it. The consumers are split to either want Islamic Banking or does not want Islamic Banking. The trend is shifting away from the view that they are indifferent to any banking structure. There is a growth in preference for Islamic Banking, and this is the main driver for the development of the industry.

Malaysia, on the other hand, has a different set of consumers. The Malaysian consumers, whom may be just as pious as their Middle-Eastern brothers, continues to view the Islamic offerings with deep suspicion, which mould the attitudes towards Islamic banking industry. Admittedly, some Islamic Banking contracts have been disputed, tested and contested in a court of law, and in some cases the banks are not able defend these contracts properly. Reputational damage done; and some quarters have taken advantage in making the molehill bigger than it really was.

In Malaysia, the consumers only want and expect certain things from their banking product; cost savings features with full benefits, cheap pricing and easy to use. There is strong preference for Islamic Banking products but if there is a better alternative in the conventional banking space, the attitude is “Why not?”. At the end of the day, it all comes down to dollars and sens; “How much does it cost, what savings do I get, how much do I save”? Islamic or non-Islamic? It is all about what money I earn or save which I can use for my family and myself.

Maybe economic standing of the consumers do play a part. A product in Malaysia seems to be more about justice, even if it is just a misplaced perception, and therefore it must be cheap. Islamic Banking products in Malaysia have evolved significantly since its inception in the early 80’s. It is now more equitable, competitive and in many cases, has more “justice” elements in its structure. The issues that may arise 10 years ago, in my view, has already been looked at and smoothed out.

Bank Negara Malaysia (BNM) has introduced many measure to support this idea of justice. The Ibra guidelines to ensure equitable settlement. Regulated Late Payment Charges to ensure consumer rights are protected. Synchronisation with the conventional banks on Responsible Financing and Product Transparency. Tight regulations of the Fees and Charges that an Islamic bank can charge to consumers. Does anyone know how rigorous the process BNM has imposed to approve fees and charges that an Islamic Bank can charge? 4 levels of approval at BNM, even after the Bank’s internal Sharia Committees have approved those charges. To get approval from the internal committee is already tough; to go to BNM to get the final approval is not something we look forward to.

These are good steps, but is it enough? Will the Malaysian consumer take that quantum shift to buy into Islamic banking products?

SSBAs I mentioned earlier, the main difference between what’s happening in the Middle-East and Malaysia is the consumer preference. In Malaysia, the consumer wants a product that provides justice to them, whether it’s pricing or features or convenience. Islamic or otherwise, it’s the job of Islamic Banks to win them over.

Therefore, this difference in the consumers mindset in the Middle-East may eventually be an important factor. Since Middle-East consumers just WANT Islamic banking, the industry there is given the benefit of the doubt for its development. Because of this, the emphasis of the development is more on Sharia compliance rather than just pricing, features and innovation.

fatwa

My limited experience in the Middle-East led me to one important conclusion; consumers want the comfort that when they choose Islamic Banking, the product must assure it meets the Sharia compliance required. By this, it is important to know the people who develop and approve the products. Great weight is placed on the names and reputation of the Sharia scholars themselves. Consumers genuinely want to know who approves the product structure, and want to see the scholars stamp on it. Requests for a copy of the fatwa governing the approval of the product is a norm in the Middle-East. As mentioned, the emphasis is on Sharia compliance, more than merely pricing. There is a huge trust and confidence in the Sharia scholars themselves, in their ability and the quality of decisions made on the products.

For that, I do applaud the consumers who chose Islamic Banking for looking beyond pricing. Many times I have been asked to furnish details and profiles of the Sharia scholars who approved the products. The decision to buy the product is more often than not, based on these profiles. The assurance of Sharia compliant banking became more important, even though there are better pricing elsewhere. And I believe that product innovation will have to come naturally once the performance of the Islamic banking industry is in the upswing. Competition and customer feedback drives innovation, but in the first place we need the right customers asking for the right solutions to be banking with us. As pricing and feature becomes the second priority, the Middle-East banks will be well placed to take a step back and assess compliance and therefore build consumer confidence organically.

Furthermore, many corporates and government-linked institutions mandates their financial dealings to be Sharia compliant, even making it part of their constitution and governance. This will drive the demand for Sharia compliant banking even more. With a ready market seeking, looking and wanting Islamic products and services, one can foresee a sustainable growth in the industry.

I don’t know what can possibly change the consumer mindset for this in Malaysia. Until then, we will always be playing catch up with the conventional banks even when BNM is pushing for a more wholesome Sharia compliant banking system. It could be a painful transition that the Banks will find difficult to stomach when the existing structure seemed to be working well. But without this change, will the industry ever make that quantum leap?

It’s catch-22. Someone needs to be bold enough to see it out, bite the bullet and draw that line in the sand; take a chance on Islamic banking with confidence and without so much suspicion. Maybe that is what is needed to make that paradigm shift in consumers.

Synopsis of 2013 BNM Exposure Drafts

The following is what I understood from the various Exposure Drafts issued by BNM on 9 December 2013. Of the 7 exposure drafts that we received, I have earlier summarised the Wadiah Exposure Draft, and I will ignore the Bai-Inah Exposure Draft as we are no longer subscribing to the Bai Inah structure at the workplace.

Please find the remaining Exposure Draft review for your understanding.

Kafalah ED

2013 ED – Kafalah – One of the key issues for a Kafala (Guarantee) contract is the charging of fees for providing the guarantee services. The main issue has always been the quantum of fees charged, either in percentage of the financing or via a fixed charge for all financing amount. The justification of this charge is always tricky, because technically the fee should not be imposed if there is no call for the guarantee (in cases of no default). The guarantee will only materialise if the customer defaults, that’s when the work happens to justify any fees. Issuing a piece of paper at the start of the relationship to guarantee the amount does not amount to too much work, and there no funds disbursed to any parties (unfunded). To justify the charging of any fees based on percentage instead of actual work, especially for huge amounts of financing guarantee, can be problematic to justify in the eyes of Sharia.

Waad ED

2013 ED – Wa’d – At one point of time, Wa’ad (Promise) seems to be the answer to many structures, where a promise is given without any requirement to transact before a specific event. The terms therefore can be negotiated and re-negotiated without the need to strictly specify the terms of the transaction and re-signing of documents. This gives a lot of leeway for deals to happen.However, at the end of the day, Wa’ad remains as only a promise, legally distanced from a contract or an agreement. Enforcement at the courts are therefore without full confirmation of all the terms, and makes for a loose structure and potential disputes. This flexibility and enforceability remains one of the key risks to a Wa’ad contract, which is why until today Wa’ad is generally transacted between known parties i.e. between established and trusted Financial Institutions.

Wakala ED

2013 ED – Wakalah – Wakala (Agency) will remain an integral contract for Islamic Banking as it validates a lot of action that can be done by the Bank, in order to remain efficient. In general, Banks hold a lot of expertise in various fields, such as investments, financing, leasing and trading; something a normal customer may not want to be involved in on a daily basis. An Agency arrangement conveniently provides for this. Anything that improves the efficiency by leveraging on the Bank’s expertise and infrastructure, can be arranged via Agency. However, the way we practice it usually is transparent to the customer. In practice, Agency Fees are the right of the Agent, and the waiver of such fees, although allowed, is sometime seen as not adhering to the spirit of Agency and entrepreneurship. You do the work as an Agent, but don’t earn any fees as it is waived. In real life, this does not happen as whenever a work is completed, you should earn something.

Tawarruq

2013 ED – Tawarruq – As Tawarruq (Three-party Murabaha Sale) becomes more prominent in the Malaysian market, I was surprised that the ED was not more comprehensive than this. There are sequencing issues not addressed but more importantly, there is a lack of illustration on what is defined as Tawarruq. Is there any difference between a Tawarruq and Commodity Murabaha, which essentially is a 4 party transaction? The issue of interconditionality is adequately addressed in the ED but I would love to have seen more details related to products, such as for Islamic Credit Cards and Revolving Credit with a rebate structure (Ibra’) based on a floating rate financing. It mentions that the discount can be given based on certain benchmark agreed by the contracting parties. This opens the clause to various interpretation as it is without real detail.

I will look at the Hibah (Gift) ED but essentially, it is related to the Wadiah ED. Most of what’s covered under the Hibah ED is relevant to the Wadiah product, such as the discretionary Hibah issue and the giving of Hibah becoming a business practice (Urf Tijari) which can be construed as Riba (Usury). Wait for the posting.

Thank you for reading, hope everyone have an enjoyable holiday period ahead. Wasalam.

Readings : December Papers x 3

Murabaha

And to close off the year, BNM gave us a further 3 reading gifts for us to enjoy our holidays:

  1. Murabahah (2013)
  2. CP Mudarabah (SR,OP, OR)
  3. CP Musharakah (SR,OP,OR)

The Murabahah Standards looks interesting, and so is the Mudarabah Concept Paper. Do have a read and tell us what you think.

Looking forward to the coming holidays.

Exposure Draft : Wadiah

Image

One of the panic buttons we are pressing now is the new Wadiah Exposure Draft (ED). As a rule, Wadiah is a “safe-keeping with guarantee” arrangement, where a Bank agrees to take on-board customers deposits as a loan (Qardh). And in the rules of loan under Islamic Banking, a loan must be returned on the same amount when required; any amount above and beyond the loan amount, if put as a condition at the start or during of the deposit placement, may be construed as “Riba”. If the Bank utilises the deposits for any business activities, the Bank is given the discretion to award “Hibah” or gift payments allocated based on the balance outstanding.

With the introduction of the IFSA and the requirements that Malaysian Banks comply with the Investment Account Framework  if Mudarabah continued to be offered to Customers, the common wisdom is to migrate lock-stock-and-barrel into a Wadiah account. In my earlier writings, I already mentioned that to comply with the Investment Account Framework, a massive shift in thinking, processes, and management is required. Therefore to convert into a Wadiah structure may not be the ideal solution, but it will provide an “easier” route towards retaining Customers’ deposit.

Wadiah ED

However, in this chess game between the Islamic Banks and Bank Negara Malaysia (BNM), the new ED is introduced on Wadiah has effectively further tied the hands of the industry players. BNM had anticipated the industry intentions to move the Mudarabah structure into Wadiah, and promptly outlined further restrictions on Wadiah itself. The industry is now caught between a cold and hard place; stay with Mudarabah and comply with Investment Account Framework, or migrate into Wadiah and comply with the new Wadiah Guidelines.

Wadiah Concept Paper

As we know, Wadiah also puts significant limitation on the marketing of returns and benefits to customers for their deposits. BNM took this a step further; to emphasize that returns on a Wadiah account should always be discretionary, as Wadiah is now seen as a loan. The impact comes in several clauses in the Exposure Draft:

  1. Wadiah Yad Dhammanh is considered similar in nature to Qard. Therefore the rules of Qardh should also apply to Wadiah.
  2. A majority of customers should not be getting a return on the deposit under Qardh. Generally this is saying that out of 100 customers, only 49% of customer will be given a “gift” on their deposits
  3. The payment of the discretionary “gift” should not be construed as regular or common business practice (Urf’ Tijari) else it will imply that the “gift” is a constant return to the customer. Historical performance can be shown to customers.
  4. Any benefits, monetary or otherwise, deriving directly from the placement in the Wadiah account may be construed as “Riba” as well.
  5. Any benefits includes scenarios where should the Wadiah account be opened as part of a financing facility, and benefits enjoyed in the financing facility from amounts available in the Wadiah account (for example a rebate structure to off-set an obligation), shall be construed as riba’ as well.

My main question is; now that Mudharabah is turned into a pure investment account, and Wadiah carrying so many restrictions, what other solutions are there? It cannot be that BNM only expects us to comply but do not help with a viable solution on these restrictions. Yes we are looking at the Commodity Murabahah structures, but operationally this will be a challenge for the Banks to control the cost of commodity trade.

Wadiah ED

And how do we define majority, then? The system must now be enhanced to determine who gets the discretionary “gifts” based on which formula. Even if they qualify for the discretionary “gifts”, to award them on a regular basis will also lead to it be construed as “Urf Tijari”, where consistent payment of Hibah will imply a similar future returns. How do we define this “non-majority” of Customers whom qualifies for Hibah but do not get regular awards of Hibah? What system logic can we build and will what we build be acceptable to Sharia? More importantly, would the customer even accept such “discretionary” practice?

Now that BNM has issued a new Concept Paper on Shariah Requirements, Optional Practices and Operational Requirements of Mudarabah today, we get a somewhat watered-down requirements to Mudarabah products. I have read it and saw that under this new Framework, the Mudarabah structure remains viable as it is, with enhancements needed for documentation and disclosures. Manageable and workable. The next steps must be; if we were to stick with Mudarabah, which Framework will take precedent. Mudarabah is an Investment structure. So, would we follow the Mudarabah Framework, or to comply with the Investment Account Framework? Both Frameworks makes reference to each other; yet one is stricter than the other.

I am putting all my hopes on the new Framework. That will give me some leeway of having both Wadiah structure and a viable Mudarabah structure (not based on the Investment Account Framework). This is definitely the light at the end of the tunnel. But as usual, indications are to take the “stricter” guidelines into account, rather than keeping hope for an easier implementation.

Exposure Drafts for 2013

ImageToday we are given additional reading materials; Exposure Drafts!!!

By my last count, 7 new Exposure Drafts was published by BNM yesterday and now it is time to digest them. As it is, there is so many to digest already. Quick and fast after the Bai-Inah clarifications in late 2012, we were given tight deadlines for the IFSA bill to comply. Add to that, the IFSA “forces” us to re-look at the Investment Account Concept Paper and the Rate of Return Framework if we were to look at retaining a Mudaraba or Wakala deposit structure. Then comes the deadline that the compliance to the Investment Account concept paper is to be met by 30 June 2014.

More sleepless nights? Yes, especially since the industry is struggling in coming up with a Current Account Savings Account alternative to Mudaraba.

Now we welcome the new Exposure Drafts and the boss has given me 2 days to read the relevant ones. Will I be able to digest them? The names of my new friends as follows:

  1. Exposure Draft for Wakalah
  2. Exposure Draft for Wa’d
  3. Exposure Draft for Bai Inah
  4. Exposure Draft for  Hibah
  5. Exposure Draft for Tawarruq
  6. Exposure Draft for Kafalah
  7. Exposure Draft for Wadi`ah

And generally, Exposure Draft is like the engagement before a marriage. You may give feedback, but the deal is already on. It is just a formality.

This will make for an interesting reading, and an even more interesting new year.

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.

The Islamic Financial Services Act

IFSA

The Islamic Financial Services Act (IFSA) 2013 was introduced to streamline the Islamic Banking definitions and practices. With the introduction of this Act, we obtained clarity on many matters, but not all of it is in our favour. From the Act, we see a significant re-defining of the Deposit product. Needless to say, the Islamic Banking industry is at arms on this new definition.

IFSA DEF

But to classify it as a new definition is also not entirely accurate. We have been taking in Mudaraba-based deposits as our main method of accumulating deposits in the Bank. Mudaraba by nature is profit-sharing investment arrangement for the purpose of obtaining a return. Any profits arising from this investment will be shared amongst the entrepreneur and the capital provider based on agreed ratio; whereas for any losses, it will be borne by the capital provider, unless the entrepreneur is proven negligent. In all intent and purposes, this is an investment, rather than deposits.

However, while there is a risk to the investment, this is mitigated by way of investing in low risk intruments, profit equalisation or even gift (hibah) to ensure a customer’s capital is not lost. Technically an investment, but with indirectly guaranteed capital due to the above mechanisms. Furthermore, this is augmented with the deposit insurance offered by the Malaysian Deposit Insurance Corporation (PIDM) which insures the customer’s deposit with the Bank, should a Bank goes belly-up.

With such assurances, Banks have taken these Mudaraba placements as “Deposits”, categorised internally as part of the Core Deposits calculations i.e. low risk deposits. Why this is important is because if you have higher Core Deposits in your books, you can therefore fund a higher proportion of your financing portfolio, without adding more Shareholder’s capital. Technically, under the Loans to Deposit Ratio (L/D Ratio), the Bank can hold a bigger financing portfolio the higher the Core Deposit amount.

This is the desirable outcome. To collect higher “Core Deposits” via Savings Account, Current Account and General Investment Account (Term Deposits).

With the new IFSA, the Core Deposit definition is redefined.

  1. If the return of the customers deposit (capital) can be guaranteed, this capital is classified as Deposits.
  2. If the return of the customers deposit (capital) cannot be guaranteed, this capital is classified as Investments.

With this, the industry is turned on its head.

Redefining Deposits

Obviously, a Mudaraba, or Wakala fi Istihmar (Agency for the purpose of Investment) will be classified as “non-Core Deposits”. The nature of Mudaraba is investment, and no matter what mechanism one puts into the product to “protect capital”, one cannot GUARANTEE capital due to the potential of loss. This risk sharing is one of the key tenets of a Mudaraba arrangement. By keeping to this tenet, Mudaraba should be classified in its rightful place i.e. Investment.

As mentioned, removing the deposits as reclassifying it into Investment has significant impact on the L/D Ratios.

But also, what’s worrying is that to keep Mudarabah (or Wakala), now defined as Investments, there is a separate Investment Account Guidelines which the Banks will have to comply with. Now that’s another story.

As an industry, we are faced with an option of either:

  1. Building our Core Deposits via an alternative product which Guarantees the capital. We have the readily available Wadiah structure, which is similar to a Qard deposit structure where no benefits can be offered or promised to the customer for their deposits; or
  2. Comply with the Investment Account Guidelines to keep with Mudaraba or Wakala Investment, but will not be able to include those amount into the Core Deposit calculations; or
  3. Develop new deposit structures that will meet both the Deposit definitions and meet customer demands for returns on their deposits and savings. Unfortunately, the available structures in the market requires extensive capital and technological enhancement, while operationally not viable. The industry as a whole has so far not come up with any viable proposition. Research has been done but the disadvantages of such structures outweigh the benefits.

This re-classification, may on the onset, looks a simple thing. But the impact is huge. The risk of capital flight is significant, possibly flight into conventional banking if the consumers are not able to accept the risks of investments or the returns uncertainty of deposits. It will be interesting to see what the industry comes up with.

I remember following BNM briefing on the re-classification back in 2011, the boss has asked me to come up with a Term Deposit under the contract of Wadiah. He knows it is not feasible, but still he asked for it. It only reflects how desperate the time will become when the full significance of the Act is enforced on us.

Now that it is enforced, I wondered if the rope around my neck is long enough.

Conversations on Islamic Banking in Malaysia

Malaysian Islamic Banking industry is undergoing a massive structural change. I was a bit surprised when we had visits from several research institutions asking Islamic Bankers on opinions on how to make Islamic Banking in Malaysia more “Islamic”. From those discussions, I got the impression that the Central Banks is really pushing the Islamic Banking agenda, which will be a quantum jump away from the current model of “replicating” the conventional cousin’s model. This quantum leap also means that the model that Central Bank envisioned will be substantially different to the Islamic Banking model practised in the major geographies in the Middle East.

What we practitioners picked up in the discussions were the persistent questions of:

  1. Why has banks not started to offer products based on more “Islamic” products such as Musyaraka financing or Mudharaba financing?
  2. What does bank think about contracts such as Salam?
  3. What does the bank think about the leveraging model i.e. the management of Islamic funds via the conventional Treasury function?

This line of question leads to the impression that the standard banking model should be evolved into a more “Islamic” structure of risk-taking, profit-sharing, venture-financing and cleaner utilisation of customer investments and funds. This is a clear departure from the traditional way a bank is set-up, whether pure Islamic Bank or Islamic-windows operation. The only response we can give was: The above products requires a different view on risk-taking and credit, and moves closer to the model of venture-capitalist and development banks. Traditional bankers will not be able to assess the risks on such products, and shareholders will be open to a higher risk-profile to demand a higher return on their funds.

ISLAMIC BANKING MODEL : HOW DIFFERENT IS DIFFERENT?

This envisioned model will be something not entirely new. There are already working models, but generally the stakeholders, including the customers, MUST understand (and accept) the concept the risk vs return pay-off of such model.  Something very similar to the risk-taking vision of Islamic financing is Venture Capitalism (although many shudder to the word “capitalism”).

Venture capitalist works on the ratio that in 100 customers, maybe 5 or 10 customers are able to survive their start-up period and have decent returns, and the returns to the venture capitalist is sufficient to cover the losses incurred from the remaining customers. The risks of losing the capital is high, and in the cases of Development Banks, government backing usually covers for loss-making enterprises, so long as it serves a purpose toward the national agenda. But this is the essence of risk-taking, and its corresponding rewards. If Islamic Banking want to expand, the thinking must therefore be expanded into this space, i.e. the realm of Mudharabah financing.

Musyarakah

Other models includes a co-operative model where typically a group of “investors” enter into a collective and co-operative agreement to embark on an entrepreneurial endeavor. The money is pooled to create capital and business is run by the “elected committee” and performance is reported regularly to all stakeholders. Profits are shared according to agreed payout ratios or to be re-invested into the business; losses are borne according to equity of each investor.  And the manager of the business earns a management fee. This is a typical Musyarakah arrangement.

Such models can be easily formalized under Islamic Banking, but we realized the fact that there is a huge monster in the shadows, ready to pounce on efforts to grow the Islamic Banking envisioned by the Central Bank that falls along this route.

CONVENTIONAL BANKING. HUGE, OLD, RICH MONSTERS.

Developing the Islamic Banking in its present form of replication and innovation alongside the huge monster of Conventional Banking has already proved to be a challenging task. Developing a truly “Islamic” Islamic Banking will pose an even greater challenge. Can Islamic Banks afford another gestation period of regulatory upheaval, customer re-education, corporate buy-in, legal re-thinking and more importantly the impatience of shareholder dollars while the kinks of the new model are being smoothened out? Can we afford to fall further behind while we get our new act together? The so-called great momentum of Islamic Banking growth will be lost, and at a risk of losing even further ground as Conventional Banking takes up the slack left opened by Islamic Banking. It is hard to win back customers, if customers’ confidence in the model is no longer there (albeit temporary). To switch to a different banking model, no matter how noble the intention, will put the Islamic Banks right to the sword. It will be “make or break” for all.

TYPES OF IFI

We will go up against a huge giant which will only get stronger with this. Political-will can help, together with strong regulatory push for industry survival. But the next question to be asked is that, will the market itself be ready for such a shift in thinking? Can they accept that a Bank is no longer a Bank, but instead a partner in their businesses? Do they even want Banks to partner them? Are they willing to share the risks, and therefore the equivalent returns with the Banks? If today they are paying a cost of capital financing at about 7.00% per annum, and earning a net margin on their business at about 15% per annum, under the regime of profit sharing at 70%:30%, are they willing to share their net margin of about 10.50% with the Bank? Alternatively, will the Bank be willing to take the risk of sharing profits if the returns are lesser than 7.00%? What about loss making endeavours? Will only riskier businesses be interested in such models, since presumably such business will not have been able to obtain funding coming from the “conventional” credit assessments? It will be a scenario where the Islamic Banks will “share risks” if it is a high risk customer, and conventional Banks will “transfer all risk” to its low-medium risk customers they onboard.

It will be interesting to finally see the Central Bank’s plans for the future. I am sure there is something in the works, especially after we just had a third research team ask us the same, same question again. “What are the things holding back the Bank from introducing these types of “Islamic” Islamic products?”. The one answer that crops up in my mind.

“That huge, rich monster standing right next to us. Ready to pounce.”

Similar Article: Old Qahwah in a New Cup?

The Death of Bai-Inah

It looks like it’s going to be a very busy year in Malaysia.

It was with surprise that the Islamic Banking practitioners are called to Bank Negara Malaysia (BNM) for the briefing pertaining the use of the contract of Bai Inah. The date was 16th November 2012 and it was a packed room at Sasana Kijang. Something was in the air, and little did we know that it is a meeting the Bai-Inah will be officially “killed” in that meeting.

But before we go further, BNM again reiterate that there is nothing wrong with the Bai-Inah as a concept, and the contract is valid in practice. However, the main concern that BNM has were mainly on the way the contract is executed, that it no longer reflects the orginal intention envisioned for the contract. One of the key issues that BNM highlighted is on the issue of “Interconditionality”. This simply means that should if one party sells its asset to another party, at a selling price, the original owner of the asset should not impose on the other party to on-sell it back to the original owner. One party should not compel the other party to re-sell the asset back to the same party. This smacks of shades of “arranged trade” i.e. the use of hilah to validate an Islamic sale, and this compulsion is explicitly captured in legal documents to protect the interests of the original owner. Interconditionality means that for the customer to obtain cash, the customer MUST sell back the asset to the Bank, and failure to do so will result in the whole transaction being void, even if the first sale contract has been completed and concluded.

Bai Inah Pre 2013 (Old Practice)

This doesn’t invalidate the Bai-Inah transaction in the first place, as it is a “willing buyer willing seller” scenario. But the issue arises where the buyer is not willing; what is his options then?

BNM highlighted that the Bai-Inah structure must therefore remove the “interconditionality” where the customer is compelled to sell back the asset to the Bank. The customer, as in any real trade, must be given the option to either sell the asset back to the Bank, or sell it on the open market, where the customer takes the pricing risks for such sale.Bai Inah New

The contention is that the Bank must not compel the customer to only trade with the Bank, but also provide an option to sell this asset into the open market. This effectively separates the Bai-Inah contract into 2 separate Murabaha contract i.e.

  1. the first contract is when the Sale of Asset by the Bank to the customer at a Selling Price (and Asset ownership is transferred to customer), and
  2. the second contract is for the customer to on-sell the Asset now owned by him to a third party or if he chooses, back to the Bank. The customer may even keep the Asset in his ownership, while paying off the debt to the Bank. One contract will therefore not be dependant on the other i.e. the interconditionalty of the sale is now removed.

The uproar in the industry was therefore expected. Many Islamic Banks have built up a substantial portfolio for their personal financing, credit cards and corporate working capital based on the contract of Bai-Inah. The options given by BNM was to either comply with the removal of the interconditionality in the Bai-Inah contract, or move to another contract where interconditionality is less than a problem, such as a Tawarruq or Commodity Murabaha structure. Many Banks have chosen the route of trying to comply with the removal of interconditionality, while other Banks view that the Tawarruq option was the right direction.

Personally, I feel trying to comply with the Bai-Inah requirements without “interconditionality” is at best a temporary measure. The way forward is to look at the Sharia structure of Tawarruq (Commodity Murabaha) and finding ways of making it efficient as soon as possible. This will be the key driver in the Islamic Banking industry in the coming year. And the death of Bai-Inah will be good news for our Middle-Eastern colleagues; one less controversial contract to talk about.

Like I said. It’s going to be a busy, busy year for us, as BNM gave the Banks until 30th January 2013 to either buck up or ship out. Time to burn that midnight oil.

Choosing The Right Option

It is interesting that one conversation I had recently on why there is reluctance acceptance by some Muslims on accepting Islamic Banking products and transaction in their everyday lives. A huge number of Muslims still subscribe to the non-Islamic, riba-based products despite the inroads made by the Islamic Banking industry in coming out with innovative, if not similar products to conventional banking. More importantly, some Muslims still comes up to me and tells me that they do not believe in Islamic Banking products and that the products are a sham or a “hilah” to legitimize riba-based practices. There is no true Islamic Banking products, as most of the products mirrors conventional products, while the remaining products requires substantial documentation and has a higher cost to implement than its conventional competitor. The view is that, if the Islamic Banking products is a sham, then it will be no better than its conventional competitor.

This comes as a surprise as although they are Muslims, their opinions are somewhat harsh on the industry that I feel very attached to.

Someone made a comment that he cannot understand why Muslim puts a lot of emphasis in “pure & clean” food, but do not apply the same concern to the their daily banking transactions. In fact, Riba is the most hated crime in Islam, and even the AlMighty has declared “war” on Riba, and no other sins are accorded such privilege. There are 73 doors to Riba, and the door with the least sin on Riba is equal to the sin of incest between mother and son. To go against Riba-based banking is a fight called upon to all Muslims, and this means total rejection of the conventional banking.

My argument will be that the Islamic Banking is only 3 decades old in some parts of the world; conventional banking has been around much longer. There is a long way to go, and there is a lot of infrastructural work to be done; legal, taxation, land offices, government agencies, central bank regulations. Everything is near greenfield, everything needs to be developed. There will be frustration but it needs to be done and it takes time.

Islamic Banking industry, and its products are not perfect, and no one is claiming as such. There will be a development and gestation period that the industry needs to go through. Outsiders may feel that what has been developed is not good enough, but the internal workings has been in development to satisfy all parties interested in Islamic Banking. Some we replicate from an existing conventional platform to suit our own requirements. There are also various efforts to develop something on our own, instead as just staying as an alternative proposition.

Operational Challenges

A friend said to me, in bafflement of why some of the Muslims still criticize Islamic Banking instead of supporting it, that even if only 10% of the product or service is Islamic, it is still better than 0% that you get under a conventional product. That 10% showed commitment to the industry. 10% is more than nothing. 10%, if that is all it is, it is more than enough for me simply because it is an Islamic alternative to riba-banking.

What we need are solutions, not just highlighting of problems. It is long way ahead for us practitioners but that is part of the fight we have chosen in our profession. The fight to build Islamic Banking industry into a viable, standalone proposition that will benefit all customers. We hope someday the Muslim population especially will make Islamic Banking products as an automatic choice whenever they think about money and financing.

Sukuk Illegal?

The Islamic Banking fraternity was shaken by the view of the prominent Shariah scholar, Sheikh Muhammad Taqi Usmani, that up to 85% of the Sukuks issued up to now may not have been fully Shariah-compliant.

This has forced scholars and practitioners to go back to the drawing board and re-look at their existing Sukuk structures, and the Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI) quickly issued guidelines on Sukuk to ease the market worries. Depsite this, the debate is still on-going on how “Islamic” are the current structures of Sukuks and what can be done to mitigate or improve this.

Of course, the Ijarah-based structure of Sukuks remains viable as a Shariah-compliant structure, based on the prominent scholar’s view. Read more below on these issues:

(Help me add more to this by providing links and articles. Thanks)