Bai Al Inah and Interconditionality Issues

I have been asked recently on the validity on a Bai Al Inah contract that had sparked controversies many years ago by claims that it is not a valid Islamic contract that is rejected by most Shariah scholars.

What do I think? As limited my Shariah knowledge is, the position of Bai Al Inah, and its counterpart Bai Bithaman Ajil (BBA), have always been that it is a structure of 2 standalone contracts of Musawamah (simple sale) and Murabahah (deferred cost-plus sale). The intention of these 2 contracts is for the purpose of obtaining cash or working capital through creation of debt. Both contracts are executed consequentially and valid as all the tenets of the contracts are met perfectly.

SO WHAT IS THE ISSUE THEN?
Generally both contracts of BBA and Bai Al Inah suffers from the same issue ie the existence of “Interconditionality” practices in their legal clauses in transaction documents. Both contracts have 2 standalone contracts i.e. one sale contract and one buy-back contract. Both contracts must be able to stand alone and the aqad is executed sequentially, which makes it valid based on trading rules.

The Aqad for the Bai Al Inah transaction uses the Bank’s own Assets for the underlying transaction, as the customer do not have any Asset to sell to the Bank in the first place. So Banks have been using their own Assets such as pieces of land, office hardware, office furnitures, company shares, investments in securities, machines, and any other valuable Assets that is identifiable, transferable and valuable.

CONTRACT #1 – SALE OF BANK’S ASSET (MURABAHAH) TO CUSTOMER IN BAL AL INAH 

These Assets are to be sold by the Bank to the Customer at a Sale Price (includes profit) and to be settled at a later date or at specific intervals. For example, the Bank sold its ATM equipment to the Customer at a price of RM180,000. This amount is to be paid back within 5 years (Deferred). This is a valid and perfected standalone contract. The debt created here remains valid until full settlement at the end of the 5th year.

CONTRACT #2 – BUY-BACK OF BANK’S ASSET (MUSAWAMAH) FROM CUSTOMER IN BAL AL INAH 

The Bank then makes an offer to Buy-Back the Bank’s Asset from the Customer at a simple sale transaction where the amount will be settled immediately. As the Customer intention is to obtain Cash or Working Capital, the Customer will generally agree to the Bank’s offer to Buy-Back the Asset at the current market price. For example, the Bank offers to buy-back the ATM equipment from the Customer at a price of RM100,000. This amount is to be paid immediately for settlement. Bank takes ownership of the ATM and pays the Customer RM100,000 cash. This is also a valid and perfected standalone contract

BUT WHAT HAPPENS IF THE CUSTOMER, AFTER COMPLETING CONTRACT #1, REFUSE TO ENTER INTO CONTRACT #2 AND DECIDE TO KEEP/TAKE THE DELIVERY OF THE ATM EQUIPMENT INSTEAD? THIS REPRESENTS A RISK TO THE BANK AS THE ASSET (ATM EQUIPMENT) IS NOW RIGHTFULLY OWNED BY THE CUSTOMER UPON COMPLETION OF CONTRACT #1

Because banks want to minimise risks, the interconditionality clauses are added to ENSURE that once the first sale contract (#1) is concluded, the second buy-back contract (#2) MUST be executed (mandatory). It goes on to say that if the second buy-back contract is not executed, then the first sale contract is invalid and restitution (going back to the original state) must be effected to recover the Asset already sold; in this case the ATM Equipment.

From Shariah point of view, it is problematic, because the first Aqad for the sale contract (#1), is a valid contract and completed under Aqad which meets all its trading tenets. To impose that another external event (i.e. the non-completion of the buy-back contract) that will invalidate a valid sale contract (already concluded and perfected), implies that the whole arrangement is superficial and do not carry real value.

This must not be the case, because the Aqad is already validly executed and is now running. Thus having the interconditional clauses is not favoured by Shariah and needs to be removed.

In Summary:
1) The Sale of Asset contract is valid on completion of Aqad
2) The Buy-Back of Asset contract is valid on completion of Aqad
3) If the Buy-Back of Asset contract (#2) is not completed, the Sale of Asset (#1) remains valid as the Aqad is already completed.
4) The requirement to force the Buy-Back of Asset contract to be completed via an interconditionality clause is problematic in substance. The notion of “one contract is only valid upon completion of another contract” does not sit well with Shariah.

Of course, for Banks, removal of such clauses from the documents represents a risk as the assets used for the transaction belongs to the Bank in the first place. The idea that the Customer cannot be compelled / forced to re-sell the assets back to the bank (or banks not allowed to buy-back) is a risk banks are not willing to take. As such impasse, the only way most banks can comply with the requirements to remove interconditionality in their contracts is to remove these contracts from their shelves.

There are still some Banks using products based on BBA or Bai Al Inah, but such usage is now limited to its uses are required by design (such as restructuring an existing Bai Al Inah account) and/or mainly transactions between financial institutions (not between banks and retail consumers) where the interconditionality clauses are not required/ can be ignored.

For the public, Tawarruq or Musyarakah Mutanaqisah or Ujrah structures are now used as acceptable replacements of both Bai Al Inah and BBA products, signalling the demise of these hugely unpopular products.

Wallahualam.

 

Concluding Post : True Islamic Banking is in a Cooperative Bank

By Dr. Rosana Gulzar Mohd

EXCERPT : If you could reform Islamic Banks, how would it be? We would have to think along the lines of PLS since as described earlier, it is among the main tenets of Islamic Banking. PLS, if well-implemented, can result in higher financial equality and stability, thereby improving the economy. But experience shows that not everyone tells the truth so banks have been swindled. The solution perhaps lies in Germany, where for almost 200 years, cooperative banks have thrived. The way they focus on people as opposed to profits stands in stark contrast to our Islamic banks. This means funding projects that benefit the community and sharing profits with customers since they are also owners of the banks. This ownership structure has also kept non-repayments low.

In the final piece, Dr Rosana proposes that the Islamic Banking model can use to benefit exploring the existing structures of Cooperative Banks, that embodies closely what is envisioned as Islamic Banking can be. There are fine examples of what are available in Germany and Indonesia where structures are receiving good support and responses by the community. Take the opportunity to consider Cooperative Banks as an option that can meet the expectations of Shariah.

For more writings under Dr Rosana, visit the page in this site which houses more of her writings by clicking below:

Continuing Post : True Islamic Banking is Not in a Commercial Bank

By Dr Rosana Gulzar

 EXCERPT : This is the ‘square’ that the ‘round’ Islamic Banks have been fitted into. So although Islam encourages a range of objectives that include communal welfare and profit-making (Note: NOT profit-maxisiming), Islamic Banks, as Commercial Banks, are almost single-mindedly pursuing the highest profits they can make for shareholders. They do this through all kinds of loans that look eerily like the riba they are supposed to replace. This is the outcome of a decision made by a group of founders in the Gulf Cooperation Council (GCC) countries in the 1970s. They wanted to quickly absorb the people’s newfound wealth from the oil boom. Several earlier attempts at genuine PLS in Egypt failed so the fastest build-up for Islamic banking would be by replicating conventional finance.

This is the continuing discussion by Dr Rosana on the above topic, which puts in the case for Cooperative Banks to be a more suitable testbed for Islamic Banking concepts and contracts. Perhaps a new look on what financial structure is most suitable adopt the requirements of Shariah banking is required. What do you think? Do give your comments and contribute to the discussion. Read the full article here or click on the above diagram.

For more writing under Dr Rosana, visit the page in the site which houses more of her writings by clicking below:

New Post : Dr Rosana Gulzar

Sometimes we are obsessed with an idea that we are not able to step back to take a look at the bigger picture.

This is what Dr Rosana is attempting to do, to ask us to take stock of what Islamic Banking is all about and how to recognise the need to call the model as it really is. The idea of Islamic Banking cannot be just a single textbook idea, but must consider other models that is already doing it in substance instead of just form. She intends to outlay the shortfall of Islamic Banking and perhaps offer an insight of what can be the solution to it all.

Do visit her page by clicking on the above pictures or access her opening gambit to her upcoming articles in the following page.

  1. How About We Stop the Wayang in Islamic Banking?

Shariah Resolution in Islamic Finance (SAC BNM 2nd Edition)

One of the more important books that we usually refer to is the Shariah Resolutions in Islamic Finance issued by BNM. A lot of issues that we usually faced in designing a product has actually been deliberated at length as evidenced in the book. Useful guidance for all.

Resolutions of Shariah Advisory Council of BNM 2nd Edition

Waiting for the softcopy of the latest edition. Please send me one!

SAC 2nd Ed

Books

To get more books, click on the picture.

No Pork No Lard : The Shariah-Neutral Transactions

TO COMPLY OR NOT TO COMPLY, BUT THERE IS A THIRD OPTION

Following my earlier writing on the Digital Wallet / ePayments and how such transactions may have not breached Shariah requirements but lacks the validation to ensure all elements do not touch the prohibited elements, I am called to further expand on the topic. In my opinion, there are possibilities that more Shariah-Neutral products and transaction enter into the space of Islamic Banking, but without the validation of Shariah scholars or committees and yet, it will remain acceptable. It is possible, and it is already happening now.

“NO PORK NO LARD”

It is an interesting situation in Malaysia now, when it comes to food. In general, Malaysia as a Muslim country, the expectation is that the food consumed must be Halal and more importantly certified as such. The reason for it is that it gives comfort to the public that certain standards are adhered to according to religious requirements. To walk into a restaurant with the Halal signage gives us Muslims confidence to consume the food till our bellies are filled.

But there are challenges. The desire to ensure the standards are met has resulted in difficulties for restaurants getting certification quickly. The process is detailed and granular, and this is a good thing, but can be disheartening when the certification drags. And in some cases it is impossible to obtain, especially if the eatery has halal standard food but also offers alcoholic drinks to its non-Muslim customers. The Muslims know (or assume) the food is halal if they see there is no pork on the menu, and will ignore the alcoholic drink. This is now a common sight in Malaysia.

And thus the loop-hole or short-cut is discovered. Rather than going for certification of Halal for their restaurant, many owners now deemed it sufficient that the signage “No Pork / No Lard” will result in a Halal understanding. And this may be true; many small roadside businesses do not carry a Halal certification but is nonetheless patronised by Muslims as it does not carry pork on the menu. That cue is taken by the restaurant owners and over a period of time, the “No Pork / No Lard” now is understood to be serving halal food but without Halal certification.

DOES “NO PORK / NO LARD” MEANS IT’S SHARIAH NEUTRAL?

Taking that concept into the banking world, will consumers eventually be accepting Shariah Neutral products and services as the new norm? A product or services with no prohibitive elements that is deemed acceptable by both the producer and consumers but without any Shariah Committee validation. For many years some conventional banks have been offering Shariah compliant third party Takaful or Unit Trust products which was vetted by the Shariah Committee of the providers.There is total reliance on the providers validation for Shariah compliance.

Additionally, there are products and services that is by nature, very close to meeting the Shariah requirements in a contract. For example the leasing products which is perhaps 95% in line with Shariah requirements for Ijarah such as rental arrangements, ownership transfers and roles and responsibilities of lessor / lessee. The contention will always be the penalties and perhaps some operational practices, but in my view, these can be amended.

THEY WALK AMONG US

Believe it or not, there are already efforts on becoming Shariah-neutral where it is deemed acceptable practice for attracting Muslim consumers. Some non-Islamic banks have been aligning some of their products features to be consistent with Islamic banking practices under the guise of responsible financing or sustainable banking. For example, the compounding late payment interest which some non-Islamic banks no longer practice. Another example is that some are considering to remove “Commitment Fees” from unutilised financing balances in overdraft / revolving credit to align it to Islamic banking practices. We are starting to see non-Islamic banks realigning themselves to be on par with Islamic banking practices. Just to regain the competitive edge.

This will eventually lead to offerings that remove the prohibited elements and validated as acceptable by the public themselves, without further validation of Shariah scholars. Can a non-Islamic bank eventually offer products that it deemed as meeting the Shariah expectations? Surely, Shariah Committee will not have jurisdiction over a non-Islamic bank offering Shariah-Neutral offerings.

The more crucial question is perhaps : Will the public eventually become not so demanding for a stricter (or complicated)  Shariah Compliant product, and begin accepting Shariah-Neutral products that is offered by non-Islamic banks? Is that possible?

Such offerings may be offered via the digital world where the contractual lines are not so clear. Rebranding of a product can be done with minimal effort. The terms used can be made Shariah-friendly. How a transaction is handled behind the scenes may be less important  with the convenience of using Apps or Mobile Banking. And without Shariah scholars prohibition or decision on such matters, the public will hold to the opinion that it is deemed compliant and thus acceptable. Eventually, this opinion will become customary and generally accepted.

No Pork No Lard” may one day become the new acceptable norm in the non-Islamic banking space. And my suspicion, a lot of sceptics of Islamic Banking already hold this view. Maybe it is time to make clear of the colours of the offering; is it white or is it black? Otherwise, the colour of grey will become the new white.

To read the earlier posting, click on the following: https://islamicbankers.me/2019/01/15/e-wallets-did-you-forget-us-again/

Why Choose Islamic Home Financing in Malaysia?

ISLAMIC FINANCING HAVE SHOWN SUSTAINED GROWTH. WHY?

In the course of our job, we are often asked what are the value proposition and selling points of taking an Islamic Financing product as compared to a conventional loan. Are there certain conditions to qualify a person for taking Islamic Home Financing? There are misconceptions that Islamic financing are expensive, but if that is true, why would there be a growth in Islamic financing? Would people have to be extremely religious to accept an expensive / inferior product no matter what just because it is Shariah compliant?

There are certain features in-built in an Islamic structure that gives benefits that appeal to certain types of customers, based on their needs and requirements for the product. On the flip side there are also consumers that prefer other features not possible for an Islamic structure. It depends on your requirements when it comes to your usage.

BENEFITS OF ISLAMIC HOME FINANCING

  1. No Lock-in Period or Early Settlement Penalty for financing . In the banking world, there is a lot of effort to on-board a customer for a particular financing, and home financing is one of them. The process can take 3-9 months and involves a lot of people and it is natural for a bank to want to earn income as much as possible, as long as possible from the customer. That would not happen if the customer settles early. The bank will impose a minimum “lock-in” period of between 3-5 years where customers are prohibited to sell, settle or refinance their houses. If they do, an early settlement penalty (usually 1.0% on the amount to be settled) will  be imposed. Under Islamic financing, this feature is not generally accepted due to the concept that “Debt Cannot be Forgiven, even in Death”. Therefore to impose a penalty when a customer is attempting to pay off its debt remains an issue in the area of Islamic Banking. This is outline in the Ibra (Rebate) Guidelines issued in 2011 which prohibits such charge (Item 8.3). But that is not to say any penalties cannot be charged for the product. Such allowances are given if the product is sold based on a promotional rate, for example 2.0% p.a. lower than the normal financing rate for special campaigns or conditions. In such cases, the bank can recover the “discount” if the financing is settled within the lock in period. Actual cost or loss incurred by bank can be recovered (to avoid abuse). Another example is when a bank absorbs the legal fees for the financing, that actual expense can be recovered if early settlement is made within the lock in period. This Shariah requirement have proven popular for customers seeking short-term financing (plans to upgrade their properties within a few years) as well as property investors seeking for options to dispose properties when opportunities arises.
  2. 100% Stamp Duty waiver for Home refinancing. This feature is available in Malaysia where the government agrees to allow for a 100% stamp duty waiver for Islamic Financing when it is refinanced from a conventional bank. This is to encourage the refinancing market as it appeals to customers seeking additional financing on a property’s capital gains. For example, 10 years ago the customer took up  a loan for RM500,000 on a RM600,000 property which is now worth RM1,000,000. As the balance outstanding on the loan now is RM300,000, the customer is seeking another RM400,000 cash to finance a renovation. If the customer intends to move the loan, the customer will incur a stamp duty for RM700,000 (i.e. RM300,000 existing + RM400,000 additional). However, moving it to an Islamic bank, the existing  stamp duty for RM300,000 will be totally waived and only the additional (top-up) amount of RM400,000 will incur the normal stamp duty. This waiver is applicable for all refinancing from conventional bank to Islamic banks on the amount refinanced (provided the original loan has already paid for the stamp duty prior to the refinancing). This applies for individual customers as well as companies.
  3. Ceiling Rate Price Protection. While many years ago, this feature is mis-sold by many sales person as being oppressive and expensive, with the current climate of changes, this have instead become a competitive benefit for Islamic Banks. The key changes that happened in the past few years was first the Ibra’ (Rebate) guidelines issued by BNM in 2011 and also the Reference Rate Framework in 2014 (Item 8.10). The Ibra’s guidelines says it is ok for the bank to charge a ceiling rate to formalise the Aqad, but the day-to-day charging of the customer must be based on a mandatory rebate mechanism where the effective rate is at par which what a conventional normal benchmark rate is. This means that the customer is not overcharged. More importantly, the customer will not be charged more than the ceiling rate should the normal benchmark rate increase to above the ceiling rate. This provides the customer price protection against high fluctuations of the benchmark rates. Some might say that there is no way rates will breach the ceiling rate but if you look at the length of a financing product of up to 30 years, who is to say the benchmark rates won’t breach during an adverse economic cycle? More importantly, the Reference Rate Framework allows for punitive pricing where banks are allowed to increase the loan/financing rates based on customer’s risk profile to up to Effective Rates +3.50% p.a. If a commercial financing of BFR + 3.50% is about 10.30% p.a., that is not too far away from a normal ceiling rate ranging from 12% to 15% p.a. So, with a Ceiling Rate you get the best of both worlds; if the benchmark rate is below the ceiling rate, you enjoy the benchmark rate (same as conventional loans), and if the benchmark is above the ceiling rate, you only pay based on the ceiling rate (not the same as conventional loans).

GIVING BETTER SOLUTIONS THAT SATISFY SHARIAH REQUIREMENTS

The top 3 reasons above are some of the main drivers for Islamic Financing. For item 1 it is the BNM effort to provide Islamic Banks with a competitive edge based on Shariah instructions. For item 2, it is the government of Malaysia initiative to provide stamp duty incentive for a specific segment ie refinancing segment. For item 3, it is the Shariah requirement to have a ceiling rate which protects the consumer from uncertainty. All these 3 elements come together to provide a competitive advantage to banks and benefit to consumers.

There are a few smaller advantages to an Islamic financing structure (based on specific products such as No Commitment Fees for Islamic Revolving Credit or Overdraft), but it is too many to list down. Granted, these features are incentives and assistance by relevant parties to make the products attractive, and may not be applicable for products outside Malaysia.

In conclusion, the above demonstrates the ability to take a Shariah requirement to make it into a benefit for consumers. This aligns with the idea that Islamic Banking products must contribute to the sustainable practices that offers fair an equitable solution to consumers.

E-Wallets : Did You Forget Us Again?

THE SHARIAH CONSIDERATION FOR E-WALLETS AND PAYMENT APPS.

Apps are everywhere. Everyone has a mobile phone where people start to get used to online banking, e-money, e-wallets and e-payment. All at the touch of the screen. I use it extensively and there are a few very convenient ways to survive a city without the need of actual cash in your wallet. Everything is digital and floating somewhere out in the clouds.

As I no longer use credit cards, I relied heavily on Debit Cards as my main payment medium which is linked to my Islamic Current and Savings Account. So the Debit Card deducts the amount from my account for each purchase for settlement. Technically, it is a Service (Ujr) where the Debit Card serves as a payment instrument, linked to the account based on Wadiah or Qard or Tawarruq or Mudarabah.

But at the same time, I am all-in into the tech-thingy as well. And no doubt, there must be a future in these thingies… For the past few months, I have been using these few apps. Here is a short review of 2 apps that I have to admit as my favourites.

Boost was one of the first eWallet that I downloaded. It requires me to “fund” the wallet, and when you make payment using the money in the eWallet, you can shake your phone to get “digital rewards”. So far, I have only gotten maximum RM2 for my phone shaking, with the promise of random potential rewards. I am motivated to shake, maybe I can win the grand prize (it changes from period to period). What is the Shariah contract here? Boost eWallet is funded from my Islamic bank account, so what is the contract for the eWallet? Is it a Qard (loan), or Wadiah (safekeeping)? We potentially may get a return (profit?) after a purchase by shaking our phone. Is that considered discretionary returns i.e. Hibah? Promised returns? In a way it is a promised returns but the amount is based on luck. And what does Boost do with our money when we are not using it and is it used for Shariah compliant purposes? Is it potentially a Musyarakah (partnership) or Mudarabah (profit-sharing) arrangement as customers are the Rab Ul Mal (Fund Provider) and Boost is the Mudarib (Manager) or Shirkah (Partnership). The Capital is guaranteed so it is maybe a deposit arrangement. The fact that we can transfer it back to our account sound like it is a Qard arrangement where we can ask our cash back on demand. But getting to shake for a guaranteed reward (even though it is RM0.20) may pose Qard as problematic for offering rewards.

 Fave is another app that I use, which is slightly different from Boost. Where Boost is an eWallet, Fave is a Payment Gateway where the cash is taken directly from your Bank account to settle a purchase. And depending on the merchant, you get cash back on your purchases which could be deducted from the your next purchase amount, ranging from 5% to 10% (some don’t offer cashback, but rarely). In Fave’s case, Fave do not retain any cash from you, as your cash still remain in your Bank account. So Fave seems to be more of an Ujrah arrangement, where we presume the service fee is collected from merchants instead of you. To encourage you to use this App so that Fave collects their fees, Fave gives the cash-back based on % of your purchases which seems like Hibah (gift) to me. For example, I pay for RM100 and gets a “cash-back” of RM5 for my next purchase at the merchant, so that sounds like a gift. Or is it a commission that we get for using the App, redeemable for the next purchase? I don’t know.

THE SHARIAH IMPLICATION

When we use these Apps, it is not clear the modus operandi of the operator and it seems obvious that no Shariah consideration took place on the usage as well as the contractual relationship. Should there even be any consideration or is it necessary?

In my view, a lot of products and services in the market fall into the category of “Shariah Neutral” instead of Shariah Compliant / Non-Shariah Compliant. For example a transaction may look like an Ijarah where the payment is based on rental but its documents may not be completed or contain all the tenets of the contract. Without the elements of all the shariah tenets, will it fall into either Shariah-neutral or non-compliant?

The question : If the transaction is Shariah Neutral, is there any requirement to look at by Shariah scholars? How do we decide if it is Shariah Neutral and therefore should be ignored from Shariah oversight?


Have Shariah Scholars considered the digital world or are we still only concerned on the traditional products to see their process validity and documentation? I feel there is a growing gap of what we see developing in the fintech, mobile banking and digital commerce space where Shariah may or may not have an issue on.

For example, the issue of Aqad in the digital space. The questions that I have are the following:

  1. Are the minimum tenets the same between a transaction between people, and a digital transaction? For example the tenets of a Murabahah in the digital space. Buyer / Seller / Price / Asset / Offer Acceptance. Will the tenets in the physical world still apply in a digital world?
  2. I presume the Buyer is the customer. But the Seller is a program that shows a picture of a product and is automated. Will the Seller as an Apps (representing the Seller) qualify as a real seller under the tenet? Generally I would think so but the responsibilities of the Seller must be clear somewhere.
  3. Would an Apps Pop-Up notice sufficient to conclude an Aqad. These are sequential programming that gives notice/remark at certain points and can be timed to meet Shariah requirements. Is this sufficient for Shariah?

Maybe I have been too distracted by work that I have missed these discussions, if it has happened before and concluded.

SHARIAH NEUTRAL : IS THERE A NEED TO VALIDATE?

As far as I understand it, Shariah Neutral means a product or services that is not breaching any Shariah rules or prohibited items in its execution. For example, a remittance service, where the customer gives cash to a remittance company to transfer the amount to another party. The company provides a service and earns a commission for the service. There are no prohibited elements in such service even to the point that generally the tenets of the contract are deemed as embedded in the processes, intention and basic forms and documents. You don’t see the arabic terms or formal contractual relationships mentioned; by virtue that there are no prohibited elements, we deemed it Shariah sufficient.

WHAT IS SHARIAH’S REAL VIEW OF SHARIAH-NEUTRAL?

I may be ignorant in this area, but what is Shariah’s view on Shariah-Neutral transactions? Why is it deemed that certain transactions requires a written / documented contract with all relationships and responsibilities outlined and agreed upon for it to be Shariah-Compliant, while others are okay to remain in a Shariah-Neutral state and still be acceptable? What is the deciding criteria for qualification of Shariah-Compliant?

As we move into the digital world where buying and selling online become a norm, and payment of goods and services are effected via a mobile app, is there a need to see whether there is any presence of prohibited elements in the transactions? Is there a need to decide if there are elements of a Riba (usury), Ghrarar (uncertainty) or Maisir (gambling) in the transactions? How about justice, fairness and trickery in the documents or operations of a mobile commerce? Is it safe to assume at least Shariah-Neutral and therefore Shariah scholars can skip looking into it?

Can I now design a product that on the outset can look and feel consistent with a Shariah-Neutral approach?  With more and more Apps for commercial transaction being introduced, should I start to think about avoiding the prohibitive elements, without the need of complicated documentation and Aqad? As long as it avoids the prohibited elements, I guess it can survive unquestioned.

Does Shariah have a view on Shariah-Neutral transactions? How far do they see to decide if a transaction is Shariah-Neutral and therefore “outside” their jurisdiction.

SUMMARY

As we look forward to living into a progressively digital world, I cannot help but wonder on the necessity to have Shariah oversight online. The Apps developer won’t be going to Shariah scholars to get Shariah endorsements anytime soon, but are they aware of what they developed contains any prohibitive elements from Shariah? Often we are left out of such discussions; perhaps we ourselves feels such development falls into Shariah-Neutral and therefore requires no oversight. But then how do we decide how it falls into Shariah-Neutral territory? Are there checklists we can refer to?

These are the things that comes to my mind while I wait in line to purchase my next drink. And wondering how much I will get from shaking my phone for the rewards. I am hoping for something more than RM5 this time. Happy shaking your phone. What a different world we are living in now. Wallahualam.

The All New Shariah Advisory Council BNM Website

THE ONE-STOP SHARIAH ADVISORY PAGE OF BANK NEGARA MALAYSIA       

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

The Centre of Shariah Reference in Islamic Finance

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

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

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

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

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

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

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

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

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

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

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

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

Where Regulations on Islamic Banking Lives

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

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

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

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

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

Connecting the Dots : Islamic Fintech

REVOLUTION OR EVOLUTION?

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

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

DO PEOPLE NEED BANKS?

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

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

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

IF FINTECH IS NOT PROCESS IMPROVEMENTS THEN WHAT IS IT?

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

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

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

SHARING OF FINANCIAL WALLET

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

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

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

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

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

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

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

CONNECTING THE DOTS

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

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

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

WHAT NEEDS TO BE DONE?

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

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

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

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

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

Sustainable Vs Halal Practices

Today I had the privilege of attending the Sustainable Development Goals Forum at Sasana Kijang, and it is interesting to have a different perspective to the idea of Islamic Banking. I have always had the impression that Islamic Banking is the means of reaching the Maqasid of Shariah (objectives of Shariah). However, listening to the forum, I realise Islamic Banking is probably only the START of the journey to the Maqasid of Shariah.

THE MAQASID OF SHARIAH

In general, the development of Usul Fiqh is to ensure the 5 objectives of Shariah are met, and the legal framework revolves around these understanding. To remind ourselves what those are:

  1. Protection of Religion
  2. Protection of Life
  3. Protection of Intellect
  4. Protection of Lineage
  5. Protection of Property

In the same breath, it is envisioned that Islamic Banking is also designed to help achieve the Maqasid of Shariah. But if you really look into it, banking per se has been so far developed to mainly fulfil the 5th objective which is “Protection of Property“. It deals mainly on the Muamalat element (economic relationships) of humans in daily life. Thus so far, most of the objective elements in a banking perspective revolves around:

  • Are the funds deployed by bank used to finance Shariah compliant activities?
  • Are the transactions valid and follows the minimum tenets of the contract?
  • Are the processes following minimum Shariah requirements that avoid Riba (usury), Gharar (uncertainty) or Maisir (Gambling) elements?
  • Are the features of the products and services resulting in justice and fairness to the customers?
  • Are the products and services deliberated and assessed by the Shariah Committee to be in compliant to Shariah law and its veritable sources?

A lot of banking activities aims to comply with “Shariah requirements”. However, this is a snapshot of just one portion of the whole Islamic value chain, which simply looks at only the part where the bank’s processes and practices satisfy the minimum requirements to ensure transaction validity. This makes the process “Halal”. But is being “Halal” enough?

WHY IS HALAL NOT ENOUGH

In a Muslim’s daily life, many aspect revolves around “Halal”. In particular we prefer Halal food, which means the food is prepared the right way according to Muslim traditions, which excludes liquor, un-slaughtered animal meat, and pork or lard. In the banking proposition, these are Riba, Gharar, Maisir and unjust practices. But these are still within the control of the banking institutions. Avoiding these, surely Islamic Banking practice equals Shariah compliance.

But is merely being Shariah compliant sufficient to meet the objectives of Shariah?

Halal, in my view, only corresponds to the minimum requirements in meeting Maqasid of Shariah. Stopping at “meeting Shariah compliance in terms of products, services, and operational requirements” does not necessarily satisfy Shariah in a larger worldview.

One of the reasons of why I posted the picture of the Sustainable Development Goals (SDG) by the UN is that business activities should also take into consideration the environment in which it operates. The idea is to practice the business in a way that it provides a “Social Impact” to the community in particular and even for the country. Using propositions such as SDG provides a starting point beyond just “Halal”. It talks about taking responsibilities and accountabilities to the local community to ensure that the product on offer are not just “Halal” but also helps the community with meaningful improvements.

This is where “Sustainability” suddenly moved to the forefront.

SUSTAINABILITY : BEYOND HALAL

The idea is not new. It has gone through various incarnations, and the more popular terms are Ethical Banking, or Sustainable Banking. These ideas however, are still very much internal arrangements, but rarely a view of the whole value chain. The idea is that not just being halal, but also being clean, fair, compassionate, helpful, and humane. This is where the objectives of Shariah can be met.

A fair illustration of the above (which I picked up at the forum and it is a good one) is the conditions of rearing chickens. You have a chicken farm to supply chicken to your area. You supply the chicken which have been halal slaughtered and as far as your are concerned, you have met the “Halal” requirement ie slaughter in the traditions of Islam.

But how about the value chain of chicken rearing? Yes, the minimum requirement is met i.e. halal slaughter, but the end-to-end practices in this single transaction have not been looked at. Will it meet the standard that will be imposed by Shariah if they are made aware of it? Let’s look at the value chain of chicken rearing.

  1. Chicken eggs incubated for chicks or small chicks bulk purchased from suppliers
  2. Chicken are reared in cramped caged farms, or allowed to run free-range within the compound
  3. Chicken are fed for 46 days to maturity with natural feed, or processed pellets which may/may not have antibiotics in them
  4. Upon mature age, chicken are taken to be slaughtered under the Islamic traditions

Therefore, the Halal portion of the whole process is only No (4) which is the slaughter. Items (2) and (3) have the potential of making the value chain “Un-Islamic”. The question will be :

  • If the chickens are kept in cramp places with diseases, is this considered acceptable under the objectives of Shariah?
  • If the chickens are fed continuously with pellets containing growth hormones and antibiotics, is it ethical in the eyes of Shariah?

This is where Sustainability comes into the picture. There is a word that can aptly fit into this : “Thoiyyib” which means “pure”. A bank should look at the whole value chain of things to then decide whether a business activities is only “Halal” or “Halal + Thoiyyib”. This should be the new standards, when we think about achieving the objectives. There are many propositions on Sustainable  practice which banks and customers can take cue from and develop further. Incentives to companies that adopt sustainable practices should be given, as sustainable practices are meant to be more humane, fair, just and gives bigger social impact than just being Halal. It is a skeleton than supports the whole community in sustainable activities. This includes concepts such as environmental friendly, non-polluting disposal, good waste management, people inclusion to jobs and equal opportunities, providing safety and security to communities, involvement in clean / renewable energies, and also providing education and equality in pay and relationships.

THE CHALLENGE

In my view, achieving “Sustainability” is a bigger challenge to overcome. But the rewards can potentially be bigger, as all institutions in the value chain become less “profit driven”. There are too many elements to choose from, and it is expected to take years to achieve. There will be cost to implement this but there is a need to rely on the well-being of the overall community for you to potentially profit. Choosing sustainability suggest choosing positivity, and continuity.

These concepts are also covered under the Value Based Intermediation (VBI) initiative that is promoted by BNM. Click link to see the Strategy Paper for VBI. 

Making the jump from Halal to Thoiyyib takes political will and commitment as well as collaboration with all parties in the value chain. Some sacrifices are needed as there will probably be some costs to the processes. However, with clear objectives to be met, being Halal cannot be the end-game.

Halal” should now just be minimum requirements, but can we be bold enough to take the next leap to take banking beyond Halal?

5 Reasons Why PLS Financing Does Not Fit Islamic Banks

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

Many months ago, there was this posting by Dr Daud Bakar, CEO of Amanie Group and Chairman of Shariah Advisory Council (SAC) of Central Bank of Malaysia (BNM) where he stated Profit Loss Sharing (PLS) structures are not suitable for Islamic Banks. It caused quite a stir in the market as there have been a lot of push by Shariah circles on Islamic Banks to develop Islamic Banking products based on PLS.  People were surprised that such comments were made by the Chairman of SAC, when BNM have been active in pushing Islamic Banks to develop these very contracts.

So what is the story then? Do we want to see Equity Products such as Mudarabah or Musyarakah Financing in the market, and is it feasible as a business model under current banking structures?

As much as I want to say we are ready for it, the reality is that there are other considerations where offering these financing products is maybe not the right fit for Islamic Banks. We may attempt to develop them nonetheless, but we have to be wary of the requirements set out in the Policy Documents and comply with it.

As I have written before in Disruption Islamic Contracts the industry is entering the era of Compliance rather than Innovation. If we were to develop for example Ijarah products, we will not be able to comply fully with the contract requirements (such as ownership risks and force majure), and Islamic Banks will opt for “easier to comply” contracts. The risks inherent in the contracts will also hamper full-blown development of such contracts into workable compliant structures. It is unfortunate; the Policy Documents issued by BNM are very extensively written but a challenge for Banks to fully comply with.

And when you expand your intention to go into equity-based financing (PLS), the risks would remain with the Bank as these Islamic structures do not allow for transfer of risks from the Bank to customers. This greatly hampers Banks used to mitigating only certain types of risks, or in the best case scenario, Banks are only willing to introduce basic or safe-feature products, with a lot of legal mitigants to protect Bank’s interest.   It is an uncomfortable territory for Banks where the issue of Banks holding “unconventional” risks cannot be satisfactorily addressed.

In Dr Daud’s assessment, he identified Five (5) reasons why PLS do not fit Islamic Banks, in this current, general model:

  1. Banks are set-up as Financial Intermediaries
  2. Fiduciary Relationship resulting in Conflict of Interest may arise from Bank’s participation
  3. Cost Required to ensure compliance
  4. High Cost of Capital for PLS
  5. Re-think of Accounting Standards for PLS

Click this link to go to the discussion page on this topic. I looked at the points by Dr Daud with comments based of my own personal view. Building a Participation Banking Model : Commenting on Datuk Dr Daud’s points

Go to Datuk Dr Daud Bakar's views

Click here to go to discussion

Why do we need to discuss PLS?

Our discussion are now becoming more relevant moving forward. In my view, traditional Islamic Banks and the way it was set-up, caters more for debt-based structures where risks are traditionally understood. The template used for building Islamic Banks was conventional banking. While we have “Islamised” the operations, systems, processes and products, the similarities between Islamic and conventional banks remains prominent. Leveraging on conventional banking infrastructure was a necessity.

That is essentially what traditional Islamic Banking did. Replication, compliance, and competition.

Needing a new Banking model. An Alternative Banking model.

So if PLS is not the right fit for Islamic Banks, where can it exist then?

I believe this is the right time and opportunity to ask this question of where PLS should thrive. With all this talk about Value Based Intermediation (VBI), Fintech, Investment Accounts, Crowd Funding, Private Equity, Venture Capitalists, Participation Banking and Challenger banks, perhaps the PLS structure should be the next inclusion into these discussion. The sandbox is open, and I sincerely believe this opportunity allows for the serious consideration to include PLS. The risk profile you see in these types of Fintech forums cater for a different thinking; banking the un-bankable, understanding of unconventional risks, investment into entrepreneurial ventures and community involvement in sharing of risks.

And more interestingly, most of the structures are already available in this “alternative banking model” and have significantly similar characteristics and behaviour expected from Islamic Banking practices. Especially on the sharing of risks and returns.

It is something that interest me immensely. I believe the next wave in Islamic Banking must be in this new digital world where speed, access, and business model (without financial intermediation) forces a monumental shift in banking practices. As we are starting from ground zero, why not put PLS / equity-based structures / participative banking / as the focus for all these new developments? If not now, then when?

Leave the debt-based structures with the traditional banks, where the familiarity with credit, collateral, sources of payment and audited financial statements will continue to drive traditional businesses.

Let PLS force a re-think into alternative Islamic banking, where entrepreneurial ability, direct investors, sharing of returns, performance of business, risks understanding, speed, low costs, access to the un-bankable population, big data mining, and technology-driven solutions become the main priorities for development.

There is little choice for us where change is now required. If change is needed, why not put PLS as part of the necessary change? The next wave must start. Watch this space. More on Fintech and alternative models soon.

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

ISLAMIC BANKING PRODUCTS ARE EXPENSIVE?

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

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

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

Amazing

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

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

YES, THERE ARE DIFFERENCES

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

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

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

FINDING THE REASONS

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

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

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

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

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

In some scenarios, I do believe so.

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

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

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

Wallahualam

 

Religiosity

Sometimes, as a practitioner, we wonder what motivates a person to subscribe to Islamic Banking products. Is it really based on the attractive features of a product, trying out something new, or is there an ingrained desire to subscribe to a Sharia compliant product? I know many non-Muslims subscribe to Islamic Banking products based on the intrinsic benefits afforded by the products, such as a more fairer penalty terms, transparent fees and charges, and flexibility in settling the accounts early.

But what of Muslims? How can we understand the triggers that encourage a Muslim to subscribe to a Sharia-compliant product?

I came across this writing by Dr Hanudin Amin which mentions a term that I hardly hear in the industry; Religiosity. It refers to the conceptual level of a person’s “piousness” to be marked into different levels (index), and he aptly split it into 3 general categories i.e. 1) Pious Religious, 2) Moderately Religious, and 3) Off-Hand Religious. His paper suggests that the Pious Religious group tends to accept Islamic Banking products more compared to other groups (in his study it’s focused on Home Financing-i). It also proposes that perhaps it is worthwhile to consider packaging Islamic Banking products based on the different levels of “Religiosity” to better appeal to them. This may indeed widen the scope for acceptance as products may be perceived differently by different people, although essentially it is the same product.

To read a bit more on the study, do have a read on the research below.

RELIGIOSITY INDEX FOR ISLAMIC HOME FINANCING IN SABAH

By Dr Hanudin Amin*

Excerpt :Earlier muslim scholars have supported the finding that a consumer’s religiosity has a significant effect on consumption in a muslim context (e.g. Elgari, 1990). Someone who approaches an Islamic bank for a mortgage is endowed with a certain level of iman. Bendjilali (1995) believes that choosing interest-free financing is blessed by Allah (SWT), hence it is rewarded. Bendjilali (1995) points out that:  “A muslim consumer who approaches the Islamic bank to get a loan for a real transaction to be financed through murabaha mode is endowed with a certain level of iman. The degree of iman will indicate the degree of compliance to the Shariah”.

For full Article, click on this link.

Tell us what you think. Should Islamic Banking products designed to a specific level of religiosity or can the one-size-fits-all approach appeal to everybody? Comments appreciated.

*The author is an Associate Professor/Dean at the Labuan Faculty of International Finance, Universiti Malaysia Sabah, Labuan International Campus. He has a PhD from the International Islamic University Malaysia (IIUM) in Islamic Banking and Finance (PG310163). He can be contacted at hanudin@ums.edu.my

Islamic Banking Operating Model

For the past few months, there have been some earnest discussions on whether Islamic Banking is operating under the right model or type of institutions. Comments by prominent scholars on the suitability of certain Islamic contracts in a financial institution sparked debate on the types that are suitable for operating Islamic contracts. Before I attempt to also put my piece in the mix, there were also questions asked to me on which of the existing models can actually be the right fit. There is still confusion on the types of institutions operating in the market.

Before we look deeper, it is worthwhile to recap the available models in Malaysia.

THE ISLAMIC WINDOW OPERATING MODEL

We  have to start somewhere. Islamic Windows as a starting point, provides the best opportunity to build capabilities at the lowest costs while the business is being developed. The intention is to identify the requirements for system and invest minimally to assess feasibility and operational gaps. This allows the Bank to build the infrastructure at an acceptable pace. This is also a pre-cursor to further/larger infrastructure investments if there is a decision to expand the business into a subsidiary.

This model relies on the existing conventional infrastructure where all the processes, operations, sales, channels, finance, branches, compliance, audit and all functions are provided by the conventional bank. It is a leverage model where the Islamic Banking Windows are more like a “manufacturer” of products. Islamic Banking Windows churn out the products and services (like a factory), and delivers them to the conventional team as part of the suite of products offered by the conventional bank. In such structure, Islamic Banking Windows are just a “segment” of products on offer. Just like Corporate Banking products. Commercial Banking products. Wholesale Banking products. Private Banking products. Retail Banking products… and Islamic Banking products.

The advantage of this model is the low set-up cost. The business rides on existing infrastructure and hires specialists in each function. There is no need to set up a different branch as those Islamic products are sold directly by the existing branches and channels sales team. Balance Sheet discloses Islamic Banking Window performance as part of the Notes to the Account. Shareholders’ Capital, however must be separately allocated, accounting ledgers managed separately and the Single Customer Exposure Limit (SCEL) will be 25% of the allocated Capital. A head of Islamic Banking Windows will report directly to the conventional banking CEO, where business decisions are made.

Not many banks operates under the Islamic Banking Windows model. The main reason is the lack of product range i.e. competing with conventional banking products of the same branch, and the small scale of business limited to its SCEL, and no autonomy of business decision which must be aligned with conventional products.

THE ISLAMIC SUBSIDIARY  MODEL

Islamic Subsidiary rides on the strength of the Parent Bank, which is the conventional bank. The model used is still a leveraged model, but the Islamic Subsidiary can choose which services or function they want to “outsource” to the conventional bank (at a fee chargeback, of course). The idea of a Subsidiary is to be independent, so all cost consideration must be taken into account. Decision to open Islamic Banking Branches can also be made, and BNM supports this expansion via Islamic Banking Branches.

However, being a Subsidiary Bank can also be a burden to set-up. A differentiated system or process or operation team requires cash for its set-up. At the early stages, such investment cash will be limited, and when cash is available for investment, the development of the Subsidiary Bank must then align with the conventional bank. So it can be a chicken and egg situation where to expand you need to earn but to earn you need to expand (and spend).

Most of the conventional banks offers Islamic products via Islamic Banking Subsidiary. The main advantage is that decisions are autonomous in a Subsidiary, there is more control of marketing and sales and branches, and the Bank (as an independent entity) can chart its own course. However, there will still be influence from the parent (as the majority shareholder) and the products and services offered are generally aligned to the products and services offered by the parents. The SCEL for Subsidiaries are also dependent on the strategy of the parent Bank, where it can choose to invest heavily or adequately for the operations of its subsidiary.

FULL FLEDGED ISLAMIC BANKS

These are standalone banks that generally are not under any conventional banking influence. The products and services may be consistent with the offerings in the market, but it is not an obligation to follow. In theory, Full Fledged Islamic Banks have the capacity to offer new-to-market products, based on the approvals obtained from Shariah Committees and BNM.

There is room for innovation and experimentation of new structures via Full Fledged Islamic Banks, although they must still governed by the financial ratios and controls for other types of banks and financial institutions, using conventional measuring tape which could lead to a “penalty” cost for doing business.

For example, a debt based home financing based on Tawarruq will incur a capital charge of 50%-100% but in a Musyaraka Financing, that capital charge will cost 100%-400% which will be an “expensive” proposition simply because it is measured against conventional financial ratios.

Personally, I believe Full Fledged Islamic Banks should follow a different set of financial ratios catered to reflect the type of risks an Islamic Bank CAN take, should the Islamic Bank look to offer products such as Mudaraba, Musyaraka, Istisna’ or even Salam. To allow for pure innovation, the financial ratios and treatment of capital and assessment of risks should be differentiated to reflect the nature of the products offered. While Basel requirements can be used as benchmark to ensure stability, an “Islamic” Basel will be even more meaningful where it can fully address all the real risks faced by Islamic Banks deploying Profit Loss Sharing (PLS) and equity-based structures such as Mudaraba and Musyaraka. Slowly, BNM is recognising these differences for measurement and has taken small steps to differentiate, such as the introduction of treatment of Investment Accounts (IA), the Liquidity Coverage Ratio (LCR) treatment, Capital Adequacy Framework for Islamic Banks (CAFIB), and the removal of Reserve Funds (reserves from paying of dividends) from Islamic Banks recently. It is my sincere hope to one day see an “Islamic” section in future Basel releases as well.

The main challenge for a Full Fledge Islamic Bank, is the costs of building the franchise from ground zero. To compete with a conventional bank, the Islamic Bank must invest similarly in its infrastructure and achieve operational efficiency and scale as soonest as possible. The payback period and Return on Investment and Return on Equity remains important for long term sustainability. SCEL is dependant on how big the Bank intends to grow. Another key consideration is the ability for the Islamic Bank to build a strong source of cheap deposits for the funding requirements.

NOTE

Of course there are other structures that can be attributed as Islamic Financial institutions such as cooperatives, development banks, and investment banks. But the most common are the above variations and these structures fit into strategies identified by the bank. In most cases, BNM prefers to see development coming from the Full Fledged Islamic Banks and Subsidiaries. These should be the drivers for the growth of Islamic Banking.

Wallahualam

The Wayang Kulit of Islamic Finance: Book Review

Islamic Finance in The Global EconomyIslamic Finance has seen many criticisms for the past decades, ranging from whether the right model was introduced in the first place, to questions on the mirroring of conventional products into islamic alternatives, accusations of Hilah and back-door riba, suitability of certain contracts in the banking space, and even the end accomplishment of the Maqasid of Sharia via a financial intermediary model.

Practitioners and regulators (including Sharia scholars) have been hard at work to address these issues (which the public seems to assume we are not aware of in the first place!!!). To a certain extent, a lot of the issues have been / are being addressed (whether to its full satisfaction or otherwise), but it is also important to be able to sit and identify areas where further improvements can be made.

Ms Rosana has become an avid observer of Islamic Finance practices and its shortfall, and found literatures that she hopes to bring forward into the constructive discussion with the industry. Her review today covers the book by Ibrahim Warde : Islamic Finance in the Global Economy (2010).

Review by Rosana Gulzar (Excerpt)

This book by Ibrahim Warde, a US academic, is among a few in the genre of political economy of Islamic finance. Although a much needed subject, it is hardly discussed in classrooms apparently due to political sensitivities. That may be the reason why this book stands out in its contribution but it can also very well stand on its own merits. The content is refreshingly intellectual, critical and direct. But even as I find it to be the most enlightening book I have read on the subject, I wish for more.

The question is, what is ‘political economy’? Or what does the subject cover? It is a fascinating field of economics which goes beyond the simple study of processes. Instead of describing production and trade as if they operate in silos or the often used phrase in economics, ceteris parabus (assuming all else stay constant – seriously, which world is that?), the study of ‘political economy’ combines theories from political science and sociology to bring about a fuller and more realistic perspective on how a country is run. A branch of political economics even draws from other academic areas such as culture and history. This definition from Investopedia is to me, the most appealing though it is arguably not the most reliable source: “International political economy is ultimately concerned with how political forces like states, individual actors, and institutions shape systems through global economic interactions and how such actions effect political structures and outcomes”.

The study of political economy is vital, I argue, in Islamic finance because how does one begin to understand a phenomenon without a frank discussion on the forces shaping it. To borrow from the Indonesians, who are the real dalangs (puppeteers) in this wayang kulit (traditional puppet-show)? Who are pulling the strings? As Warde says, “Quantity, not quality, is the defining feature of writings on Islamic finance. The recent boom in Islamic finance has resulted in a flood of writings that add very little to our understanding of a complex and multifaceted phenomenon. Overall, scholarship is marred by four flaws: the ‘authorised’ nature and pre-ordained conclusions of a significant portion of it; narrow geographic focus and lack of comparative analysis; reductionism (religious, financial, and legal); and faulty assumptions about the relation between theory and practice (p. 8).” In short, we have barely scratched the surface.

TO READ FULL COMMENTARY ON THE BOOK, CLICK ON THIS LINK

TO GO TO MS ROSANA GULZAR PAGE, CLICK ON THIS LINK 

To have an open and honest discussion, do have a read a give us your thoughts, especially on the political economy aspect of Islamic Finance. Comments and feedback welcome.

Popular Islamic Finance Terms

While Islamic Banking in general has been codified since early 1980’s in Malaysia, the familiarity to Islamic Banking or Finance terms remain a challenge. Terms like Mudarabah or Musyarakah or Wakalah remains difficult to remember but also it’s meaning have been lost to many, although there has been many attempts to communicate the various glossaries already available.

This makes the layman to go back to something more familiar, in most cases it is conventional banking, simply because of the ingrained understanding of conventional banking terms and terminologies. Some become “allergic” to Islamic terms simply because of the fear of failing to explain and understand the “arabic” terms. It does seem a daunting task to remember the terms, and understand what they mean.

So, I picked up a simple slide from a friend from IBFIM ie Haji Razli Ramli (his introduction available here in this website – click here) and made it into  a simple slide.

Get familiar with the terms for Islamic Finance, the easy way. Click on this 1-minute video. Share this video with friends. Know the meaning of those Arabic word. It’s quick and simple. In both English and Bahasa Malaysia. Comments are also appreciated.

Also, you can download the file into your desktop or mobile at the following links:

Share out to your friends. Thank you.

 

Disruption : Islamic Contracts

img_2034

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

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

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

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

THE IMPACT OF IFSA 2013

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

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

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

CHOOSING THE SIMPLEST ALTERNATIVE

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

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

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

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

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

DISRUPTION IN ISLAMIC CONTRACTS

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

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

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

THE DOUBLE-EDGE SWORD OF TAWARRUQ

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

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

With such development, more and more:

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

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

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

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

Wallahualam.

Earlier writings on Tawarruq and Commodity Murabahah:

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

Interesting article in LinkedIn

Employee Provident Fund – Becoming Shariah Compliant

Simpanan Shariah

8th August 2016 was the date the Employee Provident Funds (EPF) in Malaysia announced the opening of its registration counters to move t he existing funds into Shariah-compliant Employee Provident funds.

The response was monumental where people came to line up to register since 7 am and lines can be seen snaking out of the offices. People had to come personally to sign the conversion form (which includes Agency appointments as part of the Aqad) and agree to the terms. There’s great relief that finally there is a Shariah compliant fund for contributors, although it will not happen immediately. Conversion starts 1 January 2017.

As to date, about 45,000 people have signed the conversion.

But many questions still arise from whether EPF will really pull it off. As usual, the suspicions and sarcasms arise on the whole process of “complying with Shariah” and what is required. The common questions are whether they have the infrastructure to manage such a big fund in an Islamic market which is perceived to be not that huge. Can it support the whole fund, or will any excess funds not invested in Islamic instruments “flow” back to the mixed market?

I am sure EPF have able fund managers. But I am surprised to hear questions whether EPF is really going “Islamic” or just another ploy to hoodwink the public. Questions such as, do they really know which company is Shariah compliant, are the Shariah Advisors reliable, do they just advice or do they have any authority or power to influence the investment strategies of EPF to comply. Can we trust them?

Before I write further, I have to say that the Shariah Advisory Committee of EPF consist of 5 heavyweights in the industry. Dr Aznan, Dr Akram, Dr Zahar, Dr Engku and Dr Kamaruzaman. Someone implied that they will eventually cave in to organisational pressure when “tough investment decisions” have to be made, but this comment do not fully appreciate the role of SAC in any Islamic Financial institutions. The SAC has a huge responsibility to ensure the operations of the funds are Shariah compliant, the income is Shariah compliant, and the distribution of dividends are Shariah compliant. Consistently. Continuously. Automatically.

So what is the process that usually happens in an Islamic Financial Institution (IFI)? How influential are the SAC to the operations of an IFI? I cannot fully vouch for EPF but the governance framework should be consistent throughout the industry. The following is what usually happens in the process of determining Shariah compliance investments for EPF to enter into, and the control processes to ensure it remains Shairah compliant.

Shariah Compliant Investment Selection, Deployment, and Dividend Distribution.

In general, the SAC and IFI must start to build a framework that meets the Shariah rules to invest and deploy these Islamic funds. The following steps usually applies:

  1. The IFI first start identifying Shariah compliant counters, companies and investments that meets the criteria set by the SAC. There are several benchmark in the market that guides these criteria such as the Securities Commission criteria for Shariah Compliant Companies, BNM listing of Shariah Prohibited Activities, or even using the Accepted Bills-i which lists non-Shariah compliant goods (if a company trades in these goods). Based on the above, the benchmark of what is acceptable is decided by SAC. Deliberated and discussed. SAC will also decide whether to follow market benchmark or adopt a more stricter stance than the market.
  2. For mixed counters or companies, SAC will also decide on an acceptable benchmarks. For example, companies which has more than 5% clearly non-Shariah compliant activities are excluded from the “approved” listing. If the activities are not clearly identifiable, the “unidentifiable” activities should not be more than 20% of all the company’s activities. Different IFI adopts different benchmarks. Looking at EPF SAC, it is likely the benchmarks are stricter.
  3. An Investment Mandate, based on the rules defined by SAC above is then formulated to outline the type of acceptable counters/companies/investment, the deployment strategy, the monitoring and reporting requirements, escalation processes, calculation and declaration of income, distribution of dividends and finally the financial disclosures.
  4. The Investment Mandate should be guiding instructions for Treasury to follow in managing the funds. Based on the mandate, Treasury finds the companies/counters/investments that meet the criteria and manage the funds accordingly.
  5. The list of the investments / companies are reviewed regularly to ensure they still remain as Shariah compliant throughout the investment period. Any companies that fall out of the criteria will be removed from the lists. Any non-compliant incidences will be escalated to the SAC.
  6. On an interim basis, Internal Audit (reporting to Board of Directors) and Shariah Review (reporting to SAC) will do their periodic audits to ensure that the Shariah parameters are always met and adhered to. Any incidences of non-Shariah compliant investments will be tabled to SAC for a decision. The decision will be whether to exit the investment, make rectification, or worse case scenario, deem the investment non-Compliant and remove the dividends received from the pool and pay them out to charity.
  7. At the end of the investment period (declaration dates), the SAC will look at the financial results, the investments made, the exclusion of non-Shariah compliant income/dividend, and overall operations of the funds. Once satisfied, the SAC signs off and income/dividend may then be distributed.

In short, the SAC not only outline the mandate for Shariah compliant investments, they are also responsible in the various aspects of the management of the funds to ensure what is paid out are “clean” dividends not tarnished by non-Shariah compliant components. There is a huge responsibility for the SAC towards the general public who rely on them to formulate the right investment mandate for them. I don’t envy such position; the burden is great but I have to say EPF had it right by appointing such heavyweights to their SAC.

May Islamic EPF continue to be a choice that is taken by the public. Wallahualam

For a full collection of the videos on Shariah Compliant EPF, click on this link: EPF-I http://www.kwsp.gov.my/shariah/videos.html

 

German Banks: More Islamic than Islamic Banks?

In one of my engagements a couple of years ago,  I had the fortune to present my views on the Islamic Banking industry and its challenges in front of an audience in INCEIF. One of the bright participants there had subsequently proceeded to complete her MSc Research and recently gotten in touch with me. I had a read of what she had published, and it is a remarkable piece of academia. I have since asked for her permission to publish it on this site, for the benefits of other readers. Good food for thought.

Thank you Ms Rosana Gulzar Mohd, for your allowance to this request.

Overall, I find the research quite enlightening and overall accurate. It is also a good reminder of what we still need to achieve to ensure Islamic Banking remains focused and strong for the foreseeable future. Happy reading and do give your constructive feedback on the paper for our discussion.
Note : Ms Rosana was a student from INCEIF : The Global University of Islamic Finance and recently finished her MSc thesis concluding that a) Islamic banks are not really ‘Islamic’ and b) the recommendations for reforms. The analysis centres on the industry in Malaysia. She is keen to pursue her PhD. (Click this link for alternate site to download research)
Middle East Institute – National University of Singapore
Abstract:
This study, which compares the German system with Malaysia in the hope of improving Islamic finance, uncovers four paradoxes. Germany is chosen because its focus on mutuality and small enterprises, at the expense of profit maximisation, not only embodies the Shariah principles of justice and social welfare but also makes the system more stable. The banks’ profitability and stability between 2006 and 2014 are compared. This covers their performances before, during and after the global financial crisis. The indicators used are the banks’ return on average equity (ROAE), return on average asset (ROAA) and net loan to deposits and short-term funding. While this study finds that Malaysian banks, including Islamic ones, are indeed significantly more profitable and efficient than German banks, it uncovers four paradoxes. Firstly, it is ironical that Malaysian commercial banks are less aggressive than the Germans in their loans-to-deposit ratio. Secondly, the profitability of Malaysian development financial institutions (DFIs) and banking cooperatives are comparable, if not higher, than its commercial banks. Thirdly, the ROAE for Malaysian banking cooperatives rose 41% during the 2008 crisis when other banks’ fell. The last paradox is that while Malaysian commercial banks seem prudent in their lending, the DFIs and banking cooperatives are leveraged to an alarming extent. This study concludes with two reform recommendations: a rethink of the economic drivers in Malaysia and a sprucing up of the DFIs and cooperatives’ balance sheets towards national standards.

Life as an Islamic Product Developer

Recently I have been asked on the function of developing Islamic products for the Bank, from one keen graduate looking to start a career in the industry. The graduate was not confident in the future of the industry and was seeking some advice.

 As a career choice, Islamic Banking remains a good option for many reasons. In my view, the industry is still a growing space, with discussions and researches still being done and far from finished. Slowly scholars are going to the forefront, and arguments on structures are becoming more sophisticated. So, it is an exciting time to be in the industry.
But how about product development itself? Is it worthwhile to enter this fray?

Life as an Islamic Banking product developer is not easy. Simply because not many knows what we are doing, and what it takes to be one. I always viewed being a product developer is as hard as being an imam in a community; you hold on your shoulders the responsibility of launching a product that the community must trust to be Shariah compliant. There is no heavier burden than this, and you must be willing to shoulder this responsibility. Not everyone willingly do this.

Eye of the Storm Product Developer

But being a product developer has its intrinsic advantages. Rarely a position in the Bank affords you access to all types of functions. As a developer who have to design, develop and launch an effective and successful product, you need to engage ALL parties in the Bank as your product needs to flow throughout the organisation. The detail involved is enormous and you are expected to be an expert in most of the touch points. Hard questions are asked by stakeholders in the Bank, and you are expected to be able to satisfactorily answer these. They won’t sign off the approvals if you fail this.

That’s why sometimes it takes a long time to develop and launch a product. Many people criticise us for being slow, unresponsive or too technical. But to reach the stage we can satisfy all parties, including Shariah Committees and Central Bank, a product will just remain a concept that is not developed and launched if we do not have a capable team that interacts effectively with all stakeholders.

In addition, Product Development requires us to be experts in various fields after a product is launched. This includes after sales support and damage control, especially if there were mistakes made, misselling of a feature or just general queries by customers. We also have to continue ensuring Shariah requirements are being met, as well as balancing the business requirements (which is generally profit driven).

Life is not easy here, despite appearances. It takes a lot of grit to survive as a developer, and you do need a certain amount toughness to handle the day to day tasks. But the rewards are great as it builds you into a competent and wholesome expert in the field after a few years. Patience is also needed and so is hard work.

To all the graduating students out there, do your best in the industry and fight this good fight. There is a bright future out there, as bright as you want it to be.

Presentation on Careers in Islamic Banking

Most Commonly Used Islamic Banking Contracts

It is reaching the end of the year and I thought it will be good to have a quick look on how many Islamic Banking contracts that we have in and around the industry. Granted, I might miss some of the contracts as there are many banks offering hybrids nowadays. I do apologise for such shortfall, and will endeavour to update this chart as often as possible, should there be some interesting and new contracts being introduced in the Islamic Banking industry.

Common Islamic Contracts

For pdf, please click here

In general, common Islamic Banking contracts can be segregated into a few categories:

  • Gratuitous Contracts

These types of contracts are typically unilateral in nature where the contracts do not require mutual consent to be applied. It is just a one-way arrangement where one party provides a product or service based on mandates or scope of work and is at discretion to vary the terms without requiring the other party to specifically accept the changes. For example, the Hibah contract (Gift). One party provides the gift, and the other party receives the gift. It should be on a unilateral / discretionary basis by it not being “promissory”.

Another example is the contract of Qard (Loan). One party lends money to the other party, and the other party (borrower) undertakes to pay back the loan (original amount) when required by the lending party, without any expectation of additional return. But the other party (borrower) can pay more than the original amount (by way of Gift) but is not obliged to, and such additional gift do not require the borrower to obtain “consent” from the lender to be given. It is simply the payment of the loan, and any other gift (which is not obligatory). Such “gifts” avoid the definition of Riba’ by being not promissory.

Under gratuitous contracts, the Aqad is not greatly necessary (it being unilateral) but it will be ideal for all parties if an Aqad can be concluded upon.

  • Trading Contracts

Trading or transactional contracts are debt-based contracts. Very similar in nature and intention to a conventional loan, but requires specific Islamic contract to be perfectly executed to avoid riba’. Such contracts greatly involves the participation of 2 parties (sometimes 3 or multiple parties) and there is a defined Aqad executed to finalised the terms and conditions to the contract. These terms are to be defined and agreed upon within the Ijab/Qabul period for all parties to accept. Once accepted, any proposed further changes captured in the Aqad must be accepted by all parties by mutual consent.

A common example will be a Murabaha financing transaction, where the terms and conditions are agreed up-front in a bilateral agreement. A purchase price is discussed, together with the profit amount, selling price and the settlement tenure. Ownership of the asset (used as an underlying asset for the Murabaha) is also moved between the parties, and transactional sequence is observed. Any changes that is proposed outside the Aqad majlis will require approval and consent by all parties.

A Leasing contract is also deemed a bilateral contract although the owner of the asset has the right to unilaterally increase or revise the rental amount of the asset under hire / rental, the person who lease that asset will also have a right to remain in or exit out of the leasing arrangement, thus making it bilateral (where there is also a material change in the terms and conditions.

The perfection of Aqad holds great importance to Transactional Contracts to ensure the validity of the transactions.

  • Investment Contracts

These types of contracts deals more on equity and corresponding returns in the subject matter. It follows the concept of investment where such equity-based structures takes on the risks of the investments, and concentrate on the concept of entrepreneurship and risk-sharing. In such contracts, where there is an element of trust, bilateral arrangements are strictly adhered to. Changes to the terms and conditions requires explicit consent especially from the party that is in a disadvantageous position.

The most popular of these contracts is the Mudharabah, which is used in many depository products. However, although this is technically a deposit, these deposits must be utilised or deployed into economic transaction for the purpose of generating a return on the capital i.e. in this case, the Mudharabah deposit. Once profit is recognised (if ever…) then the profit must be distributed to the customers based on the agreed Mudharabah profit sharing ratios. The Bank, usually acting as a Mudharib (fund manager / entrepreneur) , will behave as a pure entrepreneur with the customer (as Rab Ul Mal), acting as the fund provider with the possibility that the investments is not up-to-market returns which can result in both loss in profit and loss of principal (principal not guaranteed).

Another example. Under a Musharakah structure, there  is even more defined roles that the all parties must take and agree under a bilateral arrangement. With Musharakah, each party will be required to contribute equity (or capital) and even contribute expertise into the partnership venture to ensure profit can be made. All terms and conditions are captured as part of the important Aqad. Any profits declared will be shared according to equity ratio or agreed profit sharing ratio, and any losses shall also be shared amongst partners, usually based on equity ratio or equity contribution.

  • Supporting Contracts

Supporting contracts are often important because they act to complete many aspects of services, products and banking. Many supporting contracts are created to cater mostly for specific situation and most of it requires proper Aqad as well. Such contracts are also considered a facility to provide specific outcomes for the customer. It also falls into a bilateral arrangement.

Popular contracts include the contract of Kafalah (guarantee) where a person can enter into a Kafalah to secure a financing facility by providing a letter of guarantee. Other contracts include Rahn (mortgage or pawn broking) that has specific terms to the arrangements, Hamish Jiddiyyah (security deposit) or even Wakalah (Agency for services)

  • Contractual Arrangements

Contractual Arrangement are not necessarily contracts on its own, but can be construed as a combination of contracts to achieve a certain objective. The arrangement itself is not legally binding, but what is inside those arrangements are usually standalone valid Islamic Banking contracts.

Take for example the contractual arrangement of Tawarruq. Inside a Tawarruq arrangement, it consists of several standalone Islamic Banking contracts. Firstly there is the contract of Wakalah (Agency) to purchase the commodities on behalf of the transacting party. Secondly, there is the contract of Commodity Murabahah where the commodities purchased will be sold at a Sale Price to the purchasing party. Once the Commodity ownership is transferred into the purchasing party, the purchasing party can make an offer to another party as a Musawamah (simple sale) to obtain the desired cash.

Other contractual arrangement is the arrangement for Wa’ad (Promise) usually used for FX transactions. A Wa’ad itself is not binding, but it can be enforced upon certain events where eventually an exchange can be made (Sarf) or even a Commodity Murabahah is executed to deliver certain obligations.

Again, these are not exhaustive list of contracts, and can easily be expanded in a short period of time. Innovations are done everyday, and it will be a matter of time until critical mass will push a contract to the forefront. I hope to keep updating this list more in the coming years.

Wallahualam.