It is 2019. BBA and Bai Al Inah are Old News.

Posted on January 9, 2019 by Amir Alfatakh

WHY ARE YOU STILL ASKING ME ABOUT BBA AND BAI AL INAH?

It remains a mystery when people ask me why Malaysia continues to offer Bai Bithaman Ajil (BBA) and Bai Al Inah products, as according to them, these structures are based on elements of Hilah (trickery). It is a mystery because starting from 2012/2013 period, the instructions on Interconditionality issued by BNM to Islamic Financial Institutions requires that the provisions of “mandatory buy-back” must not appear in financing contracts such as Bai Inah and BBA. Because of this, Malaysian Islamic Banks have slowly weaned itself from such products and have since moved to other Islamic contracts.

Read the circular issued by Bank Negara Malaysia in 2012 on the practice of Bai Inah and their expectations by clicking this link (BNM Circular).

WE ARE STILL READING OLD BOOKS AND ARTICLES

In general, I still find that some learning institutions are incorrectly teaching students that the contracts are still alive and well in the Malaysian market. The text books used are still ones that predates 2011 and really, this is a disservice to students. When they come for interviews with our bank, it does not give the students any advantage or good impression as the syllabus remains outdated. Many do not know about the Policy Documents issued by Bank Negara Malaysia or the contracts covered by the policy documents. This really should be covered in a learning module as the latest requirements are captured in these documents. It is a good reference read, but it seems only practitioners and Shariah scholars are aware of these documents.

This is true as my last few interns also impressed the same. Tawarruq structures sounds alien to some of them, as their teachers prefer to teach BBA and Bai Inah to unlock its controversies as points for discussion. Let us be clear that most banks NO LONGER offer Bai Inah or BBA, and those which does, offer it as a continuation for a legacy arrangement or due to certain unavailable scenarios, such as fresh new documentations are not obtained for Tawarruq arrangement (such as Wakalah to buy commodities). It is no longer offered as a product to the public and this is evidenced from the Banks website where the structures can no longer be found. And most of the time if used, this is a temporary fix allowed until the deal reaches expiry or the Tawarruq appointments are obtained.

And with Tawarruq arrangements now being ably supported by good infrastructure such as Bursa Suq As Sila trading platform and other commodity brokers worldwide, there is no issue of Darurah (emergency) to justify the continued usage of Bai Al Inah or BBA.

SO, WHERE HAVE WE GONE TO SINCE 2011?

In short, we have moved to the following contracts:

Bai Bithaman Ajil (BBA) – Usually BBA is used for purchasing of properties (Home financing or Commercial properties financing), or sometimes for trade financing products. These usage is now done under the Tawarruq arrangement (using Commodity Murabahah) where the proceeds from the sale of Commodities is used to settle the purchases of houses or commercial properties. Alternatively, Musyarakah Mutanaqisah arrangement (Diminishing Partnership) is also used by many banks where houses or properties are purchased by the Bank and leased out to the customer, who then pays rental and gradually purchases the shares of the house and properties over time. So now, BBA has been replaced with Islamic arrangements of Tawarruq or Musyarakah Mutanaqisah. Other Islamic contracts has also been known to support some elements of BBA, such as Istisna’a (property construction), Murabahah (good sale at profit) or Ijarah / Ijarah Mausufah fi Dhimmah (forward lease).
Bai Al Inah – Usually Bai Inah is deployed for Personal Financing or Working Capital Financing and even Islamic Credit Cards. Again, Tawarruq arrangements has generally replaced these usage with the end result of providing cash. On a smaller note, the contract of Ujrah (Services) is also deployed to support some requirements of personal financing (where purchase of goods and services are required) and Islamic Credit Cards. So now, Bai Al Inah has now been replaced by Tawarruq arrangements or Ujrah contract to meet the cash and working capital requirements.

The final controversial contract that Malaysia currently deploy is the Bay Ad Dayn (Discounted Sale of Debt), which serves a specific purpose in trade financing products. Eventually a common ground must be found to make this contract more globally accepted, or replaced with a better solution.

UPDATE YOUR STUDY NOTES, PLEASE

The main challenge nowadays is to innovate further by improving what we have. Criticisms are good, especially on the old structures. But we practitioners do hope the learning academia afford us a bit more confidence and trust, especially these criticisms and consequent issues are not “unknown” to us, since we lived and breathed in its controversies many years ago. The comments made in recent times are something we had encountered and resolved 10 years ago. We enhance and evolve, and it will be good to see new students coming into the market armed with the latest updates of what is happening and let’s move forward.

It is now 2019. Do not get stuck in the muddy past. These contracts have gone into the history books. We have so much to do in the future arena.

The Tawarruq Dilemma

Posted on December 25, 2017 by Amir Alfatakh

Islamic Banking in Malaysia is fast reaching a crossroad. While Islamic Banking continues to offer like-to-like conventional structures, the requirements by Shariah Committees and Policy Documents by Bank Negara Malaysia continues to challenge the way Islamic Banks implement and operationalise the products within a viable banking structure. Islamic Banks are becoming mindful of the need to comply fully to each policy requirements.

It is precisely this fear of being “non-compliant” to these requirements that pushes many Islamic Banks to develop the Tawarruq-based products into its most efficient form. As I have written earlier in Disruption : Islamic Contracts where I felt the Tawarruq arrangements has become the “go to” structure that Islamic Banks can easily comply with, the notion that other contracts such as Musyarakah or Ijarah or Mudharabah may now be left behind in its development due to perceived complexities. Or in some cases, difficulty to comply due to the existing banking set-up, especially in matters of risks, capital and operational processes which is intrinsically based on conventional banking infrastructure.

BUT CAN TAWARRUQ ALWAYS BE THE ANSWER?

It is generally accepted that a lot of processes in the Tawarruq arrangement can be complied with. There were strong operational support and infrastructure both internal and external, such as the London Metal Exchange (LME) and Bursa Suq Al Sila which has an efficient commodity platform specifically designed to support Tawarruq with or without commodity brokers, to the choice structure that bridges the middle-east players to most of the rest of the Islamic Banking geographies. But that is by no means that Tawarruq is a perfect solution for Banks.

Despite Tawarruq is now greatly used over the last decade or so, there are still contention points that remains amongst financial practitioners and Shariah scholars. Most scholars want to have the view that Tawarruq should be the “contract of last-resort” but what we see now are quite the opposite. It is the preferred choice being used not just for Working Capital requirements, but now also for Asset Financing, Mortgages, Trade Financing, Fixed Deposits, Structured Investments, and even Savings Account. Whenever an Islamic Bank hits a roadblock with a particular product being developed or requiring compliance to the latest rules, the tendency is always to consider Tawarruq as the solution.

If this is the approach, how much do we really need other Islamic contracts which only addresses a single problem or requirement? Shouldn’t we develop Tawarruq as far as it can take us and make other contracts as “supporting” contract to cater for specific nuances?

THE UNANSWERED QUESTIONS ON TAWARRUQ

Each year when Bank Negara Malaysia audit comes around, there will always be new compliance points to be proven and tested. Even at the level of understanding and interpreting the Policy Documents into processes and banking operations. Each Bank interprets the rules differently, and each banking set-up have different operational capabilities which more often than not, requires exceptional Shariah indulgence. So, the questions will remain unanswered whenever dispensation is obtained.

Many argue that the main issue of Tawarruq is actually the “intention” of the contract itself, and that intention is not to “trade in commodities” but to create debt via a trading transaction. This has been debated at length for many years in all types of forum, but we concede on some of the arguments by virtue of there being no other viable solution to cater for certain banking requirements. Islamic Banks, and its scholars, had to choose either:

Allowing for the Tawarruq arrangement with strict adherence to requirements until a solution arrives, or
Disallowing the Tawarruq arrangement which may result in customers being impaired in their Islamic business, which may result in the customer reverting to a conventional banking solution.

Is there a case of choosing the lesser of two evils?

Nonetheless, I won’t discourse what have been extensively discussed, but instead look at the operational issues of Tawarruq arrangements that I pick up going through the Tawarruq Policy Document. Among them that are still being debated in different forums are:

The issue of Commodity Delivery – To demonstrate that the Tawarruq being practised by the Bank is real, the test of delivery of Commodity is a key qualifying factor. The Bank must have in place a mechanism that allows the customer an option to take delivery of the commodity whenever the customer calls for it, bearing in mind that may have not been the intention in the first place i.e. taking delivery of commodities. How a Bank prove this to Shariah Committee and regulators are crucial to demonstrate “real transaction” and paper transactions.
The issue of Price Fluctuation – Depending on commodities, its price tend to fluctuate periodically, because these are actual live commodities being traded. Because of this, Banks have not been able to be precise in its documentation or price disclosures. Whatever price per commodity unit at 10am, it might change at 2pm, so how do you lock-in a specific price when the buy and sell of the commodity was not concluded immediately? The fact that Bursa Suq Al Sila states in its guidance notes that an Islamic Bank could not hold the commodities for more than 2 hours implies the issue of price fluctuation is a valid concern for Shariah Committees.
The issue of Discrepancies of Terms – Because the Murabahah transaction in the Tawarruq arrangement is the most crucial contract, Scholars always insist on the details of the transaction to be as precise as possible to ensure what was offered was eventually rightly accepted. For example in a Personal Financing structure, the customer makes a credit application according to certain terms such as financing amount, or financing tenure, but what eventually gets approved might be a lesser amount or shorter tenure, which means differences in the initial “Agency” instruction to transact the commodity. Scholars question how do Banks re-engage customers with such “counter-offer” for their acceptance? At which point after the credit approval?
The issue of Delay in Transactions – Some banks are more efficient than others. Some banks are able to conduct commodity trading on the same day while others can only do it in the next day after the day’s batch run. End of day batch runs are what conventional banking live by, and there is no motivation to conclude and consolidate all transaction in real-time; there is no requirements to do so. Batch runs allows for more systematic consolidation of records. But that becomes an issue for Islamic banks running next to a conventional banking proposition. So if an Islamic bank is limited to only end of day batch run to consolidate its records, it means the end of week transactions requirements will only be fulfilled on the next working day (across the weekend). This is a delay in the conclusion of the initial instruction given by customer to conduct Murabahah which may impact specific terms including price of commodity and its availability. There is also the danger of missing out delayed transactions as those instructions are not “current” anymore. There is a provision in the Policy Documents that “delay” in transaction should not be more than 2 days (T+2), but there are also periods where the off-days are more than that due to public holidays and other disruptions.
The issue of Qard in Tawarruq – An extension of the above scenario where Commodity transactions are delayed, the next question will be “what is the status of the funds when no transaction is done?” Is it a Qard (Loan) contract until the transaction is fulfilled, or is it an Amanah (Trust) arrangement? In either case, for the scenario of Tawarruq Deposits, how do you accrue the profit for both contracts which forbids “interest” or “returns“? Profit is only realised once the Murabahah (trade) takes place. Without the trade being transacted, profit accruals can only be justified by arguing that Islamic banks should not penalise customers who, in this case, has done nothing wrong. Dispensation is always given for the reason of fairness. And this “Incidental Qard” issue has also been discussed at the Shariah Advisory Council of Bank Negara Malaysia, where the fatwa on Incidental Qard and its conditions were issued. But the fact that it was discussed, indicated that this issue is not as easily brushed aside as one like to think.
The issue of Agency and Dual Agency – There are still some banks that feels the Dual Agency structure contributes greatly to the notion of “arranged” Tawarruq and thus stays away from it. The Dual Agency structure is where the customer appoints the Bank as both the Buying Agent and Selling Agent. This gives the Bank the full right to conduct trading without any Customer intervention (given mandate), which makes the “ability or option to take delivery of commodity” redundant or unnecessary requirement. It effectively removes the proof of Murabahah i.e. deliverability of the Commodity.
The issue of Physical Commodity – One of the main contention is the ability to ascertain the availability of Commodity. While on paper it can be evidenced but nonetheless the challenge is to ensure the Commodity is identifiable and deliverable according to quantity. Efforts have been made to split into smaller denominations whenever needed, and commodities like Crude Palm Oil (CPO) is easier to be allocated. But there is always suspicion whether this is superficial where proof of otherwise is actually much more difficult to obtain. Where is the certainty that the assets being traded are the right physical ones?

THE REAL QUESTION IS WHETHER THE ABOVE CAN REALLY BE RESOLVED

So is there any other alternatives to Tawarruq? The above questions have so far not been answered satisfactorily and scholars while do not prohibit its usage, still frown on how much Tawarruq has impacted everyday banking life. It is truly a “love/hate relationship,

I believe there is such “replacement” contract that can address most, if not all, of the above concerns. But it needed to be proofed and challenged and at the end of the day, we question such necessity and thus the rising dilemma to replace it after all the work done. Tawarruq has really taken root with so much invested in perfecting the structure, and expertise in its documents and mechanism. It solves a lot of problems, yes. But will Tawarruq be the end of innovation for Islamic Banking?

I like to think there must life beyond Tawarruq. It just needed courage to acknowledge the big task required for such massive structural changes in replacing Tawarruq. Such replacement must not just be an equal substitute but also addresses the Shariah concerns. That is the ultimate test of any Islamic Banking contract; the reason for being.

The Unbanked

Posted on November 30, 2017 by Amir Alfatakh

YOU EXIST IF YOU HAVE MONEY

Throughout our banking life, we were always reminded on the privilege of having a Bank that supports you for your financial needs or your businesses for expansion and growth. The banking products are designed to provide SOLUTIONS and access to these products and services relied on the following:

Your scope of business : What is your business and industry and more importantly, what’s the potential for your business to grow? Is it a sunset industry or emerging business? What is the long term outlook of the industry?
Your credit standing and payments conduct : How strong are you financially? Is your business reliant of project or is there continuous flow of business? Is there any issue in collections and payments? What is the payment track record? Is the Bank able to obtain evidence of your businesses credit strength via Audited Financial Statements, Bank Accounts, Invoices records and any other documents?
Your collateral : Is your business able to provide any form of collaterals that is acceptable to the Bank? What is the valuation of these collaterals? Is there a secondary market for the collateral and what is the likely protection towards the Bank’s capital?

These are all the tested ways of traditionally assessing your credit worthiness or financial viability. These are what Banks call you if you qualify: BANKABLE CUSTOMERS.

BUT WHAT IF YOUR BUSINESS DO NOT HAVE ANY OF THE ABOVE?

So now, you don’t have any or some of those, or you never really cared. You are a small business, with young people running it, utilising tech as your business platform. You source your materials and goods directly from suppliers, shipped to your home (or just resides at supplier’s premise), advertise on FaceBook and Instagram, and receive your orders online. You shipped them out to your clients via DHL or any decent courier service, and all your payments and receipts are done via epayment. Business is good and you want to grow.

You seek a financing facility with the Bank.

But the Bank promptly tells you : Your business is no good because you don’t fit the criteria that Banks have for their “target clients”. No track record. No financial statements. No collateral. You are officially UN-BANKABLE or UN-BANKED.

WHERE DO THE UNBANKED GO, THEN?

As much as the Banks like to think that the only way for your business to grow is to comply with the requirements to qualify for a banking facility, you have discovered that it is not necessarily so. Many have managed to grow without going through the banking red tape; in fact they avoid the Banks altogether. Options are starting to emerge to help you build your business, and most of them are not even Banks. Is it a scam or a money-game fly by night operation? Dare you take the risks? But it seems that they are willing to take a risk on your business, and since there is little other options, why not give it a try.

The banking world is ultimately changing. We hear all the new words being used; Fintech, Bitcoin, Ethereum, Blockchain, Crowdsourcing, Crowd funding, Big Data, Antminers, Challenger Banks, Venture Capital, Seed Funding, Angel Investors, Digital Banking, ePayments, eWallet, Mobile Banking, Apps Banking, Tribe, etc. All these new “non-banking channels” appeals to a different type of customers; ones that understand technology and has a lot of trust in its capabilities.

Now the first experience for a new business in obtaining funding may no longer be via a banking experience. It could be a social media platform, a tech company or even the greater public (peer to peer). The digitalised “banks” (which are consequently NOT banks) offers the following benefits:

Creation of relationships without transactions or track records
Reduced Costs of doing business i.e. cheaper transactional costs
Speed and mobility
Less regulatory requirements (which could be a bad thing…)
Ease of Cross Border transactions
Digital interface instead of human connection

WHERE ARE WE HEADED?

I agree with the view that the form of traditional banks must change in 5 years time to offer products and services that’s totally different from what we have now, reaching out to a wider group of Gen-Y and Millennials. But how do we attract such emerging generation whom are now glued to their mobile devices?

This is where the Social Economy will be prominent. Just as the ease of the social media connects the Gen-Y to everything quickly and effortlessly, the new generation will not subscribe to the old tedious banking model. It will be about conveniences, and life which is more online 24/7. And if they are not able to obtain a required facility, they will be more likely to look at their own community for support, or else “Do-It-Yourself” solutions which taps on the fintech, internet or mobile infrastructure. They will become Digital Entrepreneurs, and Banks have yet to create a space for these young tech-savvy entrepreneurs to occupy.

“ISLAMIC BANKING” OUTSIDE ISLAMIC BANKS

While the banking industry continue to develop traditional Islamic Banking products and services, there are many small initiatives that has taken the practices of Islamic Banking (knowingly or unknowingly) and made it into a viable business model. Even now we have real life example such as EthisCrowd.com that’s able to raise funds within 45 days for affordable property development projects to complete within 1 year via Mudharabah arrangement; this basically means there is no longer a need for banking institutions as a source of funding.

And ironically, some of these alternative banking models are so aligned with Islamic Banking principles, and borders more of “socialism” more than anything else. The desire to “share risks” and “support the community” and “fund a worthy cause” moves the financial model away from “money making” and “return on investments” that we often associate “banking” with. This smacks familiarity with what the Islamic Banking industry has been created for in the first place; the realisation of Maqasid Sharia.

Even Musyarakah (partnership) structures are already at work, where risk sharing translates to appropriate risk rewards for investors. This is also a relevant to the idea of Investment Account where the sources of Mudharabah funds are used to finance a project directly and returns are based on actual performance. Equity financing (as per my previous month posting on Dr Daud Bakar’s commentary on Profit Loss Sharing) is already being practiced by non-Banks, thus begging the question whether a Bank can really be as effective (or quick) to support equity-based structures as a non-Bank initiative.

While this is yet to be a mainstream phenomenon but do remember as the Gen-Y and Millennials grow up into the bankable space with credible financial strength, their views of what banking should be may be far different from what we think it is now.

SHAKING UP THE TREE

With all the alternatives happening around the Islamic Banking industry, it really is time for practitioners and industry to consider the model that we have always wanted to build. That is where the discussion must happen to embed the Islamic Banking industry into the “Social Economy” and “Alternative Banking”:

Challenger Banks. The funding structure offered by these non-bank entities may/may not be based on crowdsourcing or crowdfunding. These essentially can be arranged as a Mudharabah (profit sharing), Musyarakah (partnership), Wakalah (Agency) but without the regulatory shackles. The question is on the rights and warranties for the crowd. Extra due diligence may be required but it should not be a tedious process. Otherwise, the crowd will see this as just another “banking” entity which they wanted to avoid in the first place.
Crypto-currency. Much has been debated on the presence of bit-coin and ethereum where these “currency” were raised from algorithms processed by “mining” machines. So it may or may not be real money, but the more prudent definition of crypto-currency is “stored value”, “work-credit” or “medium of exchange”; not currency yet. And Shariah discussion on what these really are in the Islamic transactional context shall continue at least for the next few years
Online Payments & Mobile Money. A key part of the process where the transactions may by-pass regulated banks and go straight from Peer to Peer (P2P). All online payment structures will be validated via blockchain infrastructure, at the fraction of a price and even faster speeds of transaction. Shariah will also be interested in the sequencing and the process flow and issues of ownership of the cash when it is done at the blink of an eye.

I admit all of these are still new terminologies and understanding to me, but it represents such a huge opportunity to rebuild the industry on the right footing, learning from past mistakes, taking the best practices from non-Bank models and moving away from simply debt-financing. It is an exciting world that is still evolving, and will be driven by the new generation so comfortable with technology, community and convenience. The banking model must change to meet this reality, the question is how to also get the Shariah elements into the various key processes.

There is no better time to incubate this. Especially in the Islamic Banking space of equity-based structures. Welcome to the new world, and it is a big world out there.

Synopsis of 2013 BNM Exposure Drafts

Posted on December 24, 2013 by Amir Alfatakh

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

Please find the remaining Exposure Draft review for your understanding.

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

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

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

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

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

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

Exposure Draft : Wadiah

Posted on December 20, 2013 by Amir Alfatakh

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

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

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

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

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

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

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

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

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

Exposure Drafts for 2013

Posted on December 11, 2013 by Amir Alfatakh

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

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

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

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

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

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

Back To Wadiah

Posted on September 9, 2013 by Amir Alfatakh

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:

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

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

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

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

The easy solution; take a step backwards.

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

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

The Islamic Financial Services Act

Posted on April 17, 2013 by Amir Alfatakh

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

IFSA DEF

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

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

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

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

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

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

With this, the industry is turned on its head.

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

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

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

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

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

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

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

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

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