Types of Murabahah

One of the common questions I get with regards to the Murabahah Standards issued by BNM is on the types of Murabahah covered under the standards. Murabahah is essentially a Sale of goods (cost plus profit) where there is a “deferred” element which validates the profit earned arising from the sale transaction. To understand the difference, it is key to analyse the “deferred” elements, and the risks associated to the deferment.

Essentially, there are two types of deferment in a Murabahah i.e.:

1. Deferment arising from future settlement of Sale Price – This is the most common form of Murabahah where risks to the Seller is minimised by the almost immediate transfer of ownership of the goods.

Murabahah Deferred Sale

This is generally used for debt creation where the Seller (usually a Bank in the case of financing products) purchase goods into its ownership and quickly Sells the goods to the Buyer (usually customer) where the Sale Price (inclusive of profit) is concluded with the future settlement terms agreed. Once the debt creation is completed, the ownership transfers from the Seller to the Buyer and the Buyer will start to make payments on the agreed Sale Price.

All risks on the goods (valuation, pricing, ownership) are transferred quickly from Seller to Buyer; the Seller only holds the credit risk of the debt i.e. the risk that the Buyer may not able to pay the Sale price at the future date as agreed.

2. Deferment arising from future delivery of goods sold – This structure is more riskier than the earlier mentioned deferment of Sale Price settlement. Deferment of delivery of goods means the Seller purchases the goods now but do not enter into a Sale transaction with the Buyer until much later.

Murabahah Deferred Delivery

Instead, the Seller holds the ownership of the goods for a period of time and enters into a contract at an agreed future date. The Seller will carry the ownership risks and valuation risks until the goods are sold at the Sale Price (inclusive of profit). Once the Buyer enters the contract, the ownership of goods is transferred on settlement of the Sale Price at spot (either a Murabahah arrangement or Musawamah Simple Sale transaction).

Due to the riskier nature of the above, the Buyer is usually required to undertake to enter into the Sale contract (via Letter of Undertaking in favour of the Seller).  On then the Seller procure the goods from Supplier, creating a legal obligation on the Buyer to complete the sale at the agreed future delivery date, even if the Buyer decides not to complete the Murabahah transaction (default on the arrangement). By this undertaking, the Buyer takes on the pricing risks as at the date of Sale transaction; the price of goods on the open market may be higher or lower than the contracted Sale Price.

Additionally, with the Letter of Undertaking, the risks on the Seller is mitigated, resulting the credit risk of the Buyer to be similar/equivalent to the “debt” structure of Murabahah arising from deferment of Sale Price.

This arrangement is commonly referred to in the market as “Murabahah Purchase Order” or MPO where the Seller will only proceed to purchase goods to hold it for a period of time with the surety of the Letter of Undertaking as a risk mitigant.

Both the structures are sufficiently addressed in the Murabahah Standards issued in 2013.

 

Interconditionality in Bai-Inah

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

What is Bai Inah?

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

Bai Inah Malaysia

 Please Click Here

Goods and Services Tax on Islamic Products

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

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

GST

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

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

Please Click Here

Pro-Active Compliance of Regulatory Guidelines

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

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

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

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

Balancing Act

Compliance with the Investment Account Guidelines.

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

Tawarruq Guidelines.

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

Special Purpose Vehicles (SPVs).

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

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

Readings : December Papers x 3

Murabaha

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

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

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

Looking forward to the coming holidays.

Back To Wadiah

Investment Account Guidelines

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

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

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

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

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

The easy solution; take a step backwards.

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

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