Report : Islamic Finance Development Report 2017

Posted on by
Reply

Click on picture to go to report

Information on Islamic Banking and Finance performance has always been an interest of many practitioners, myself included. Yearly we scour the best looking and informative reports on the internet that is full of data on the industry, especially when it covers the global markets as well. Sometimes we find an average one, but nowadays there seemed to be an abundance of available reports. Some have “good” contents, but when I come across “great” one, I am tempted to put it on my site. For future reference, off course!

What we always love to find out is the performance of the Islamic Banking industry locally and globally, as it will provide reliable data to management on the latest trends that contributes to the bottom line. And presented in simple and clear infographics will only ensure some of the slides will be “cut and pasted” for speaker presentations, being quoted in many sessions. This reports provide all those opportunities.

More interestingly, this report provides insights on what has been going on in the world. For example, items such as Value Based Intermediation (VBI) espoused by BNM was also mentioned. There is talk about Islamic Fintech, Awqaf Funds and other local going-ons, including CSR initiatives. I would say this report covers many new areas of interest in Islamic Banking and Finance.

It also has a four-slide presentation on the most recent dispute on Sukuk involving Dana Gas. This was a real concern by many many parties over an extendable period of time. Nonetheless, this report make a good job summarising the key issues about the Dana Gas case, until its resolution. What a good write up for layman.

I hope these kind folks don’t mind me posting their report on my site. As mentioned, this website was maintained aimed to be a repository of the many discussions on old and new issues. If you want to download the report yourself, click REPORT : ISLAMIC FINANCE DEVELOPMENT REPORT 2017. Also find other reports and this report in the Knowledge Centre.

Happy Reading

Sustainable Vs Halal Practices

Posted on by
Reply

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

Posted on by
1

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.

i-FIKR (Islamic Finance Knowledge Repository)

Posted on by
Reply

img_4891

I am all about repositories. Simply because there is too much for me to remember when it comes to Islamic Banking and Finance. This website was borne right from such need i.e. to become my resource centre that I can share with friends, colleagues and general public.

Coming across the efforts by ISRA (International Shariah Research Academy for Islamic Finance) to create such a repository under i-FIKR is commendable. A quick look at the website gave me a sense of the wealth of contents available to those seeking resource materials for the on-going developments in Islamic Finance. For a small subscription fee, this will prove to be a valuable option for them.

Among the items listed in their website are:

Also, download the publication of the Islamic Commercial Law Report 2017 by ISRA & Thomson Reuters here.

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

Posted on by
10

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

 

Capital Adequacy Ratio

Posted on by
Reply
IBRC100

Page to full collection of articles appearing in the Borneo Posts

While I like to think that I know a sizeable amount of Islamic Banking regulatory literature, I have to admit to procrastinate when it comes to the “ratios in Islamic Banking”. It started with the Liquidity Coverage Ratio guidelines issued about 2 years ago, and also the Capital Adequacy Framework for Islamic Banks, which I promised myself to read by September. And all I know about the Tier 1 Capital is that this capital allows you to continue business in event of losses while Tier 2 Capital is used in a winding up scenario. I know where my gap in knowledge for this topic.

So, finding this little gem written by  Dr Hanudin on the above is a real treat. Reminds me that there is still a whole topic to be digested and written about. Below is the extract, and you can find the full article in his page on this website. (Click Here)

Understanding CAR in the context of Islamic banking

Published by The Borneo Post (Sabah), 19th June 2017

By Dr Hanudin Amin

Extract:

BANK capital serves as a liquid bulwark to warrant the smooth operations of both Islamic and conventional banks, turning the banks into a better likelihood of endurance in the banking market. In general, a bank capital is viewed as the source of funds provided by the owners of the bank, which acts as a cushion to thwart a bank failure’s occurrence.

         This week I draw your attention pertinent to capital adequacy ratio (CAR) in the context of Islamic banking. For this purpose, three questions are answered using an analytical technique: Question #1 – What is meant by the term CAR?  Question #2 – What makes CAR’s components? Question #3 – Does an Islamic bank have a better CAR?

 By definition, CAR is a measure of the amount of the capital owned by the bank that typically captures Tier 1 Capital and Tier 2 Capital and are divided by risk-weighted asset (RWA). CAR plainly acts as an enabler to protect depositors of CASAFA (i.e. current account, savings account & fixed account) in which their deposits are principally guaranteed for consumer protection. In addition, CASAFA is also subject to Malaysia Deposit Insurance Corporation’s (MDIC) protection up to MYR 250,000 limit per account includes both the principal amount of a deposit and the interest/return, separately applied to Islamic and conventional deposits.

For the full article, click on the following link: Understanding CAR in the context of Islamic banking – Borneo Post 19th June 2017

Go to Dr Hanudin’s page : click here

Happy reading & have a good remaining Ramadhan ahead.

Real Cost of Tawarruq

Posted on by
Reply

Recently, the topic of Tawarruq & Commodity Murabahah has been popular in the industry as both BNM and Shariah scholar have been asking operational questions on the implementation of Tawarruq arrangement in the industry. It seems, even with the Policy Documents, there are still some divergence in terms of operations and understanding of the minimum Shariah requirements for Tawarruq. Each financial institutions have their own operational abilities and processes that differs from one another; to have a standardised platform may be a bigger challenge than imagined.

The rise of Tawarruq in recent years should really not be a surprise to many observers. We are seeing that most financial institutions in Malaysia now consider a Tawarruq structure a “must have”, because there really is no options as other Banks also deals in it. It has become norm, and while scholars might take a view that Tawarruq should be a “last resort” option, there have been so much effort invested into making Tawarruq an efficient machine. Just take a look at the Bursa Suq Al Sila and what it is capable today.

Question : Is it Cash or Committed Limit?

The latest consideration of Tawarruq is on the treatment of Tawarruq funds after the transaction. What is it exactly and how is it been managed within the Bank, with the Capital Adequacy Framework for Islamic Banks (CAFIB) implemented a few years ago (latest update this year 2017). In particular, when a customer is approved a certain limit (let’s say $1,000,000) and a single Tawarruq is done for $1,000,000 for the line (instead of multiple small Tawarruq for each usage of the amount within the $1,000,000 limit), where does the money goes, and what is it exactly in the eyes of Sharia?

To clarify, upon the completion of Tawarruq, real money of $1,000,000 is generated. Cash. It is not a “line” in the conventional terms, but it is money (actual cash) now belonging to the customer. He can draw out the money anytime.

But the practice is that the money is kept in the Bank’s books unless requested by the Customer, and by keeping this the Bank will give a “rebate” on the money kept in the Bank, similar treatment as if a “principal payment” is made (although it is re-drawable). In the meantime, the Bank utilises the money (taken as principal payment made) for its own banking business activities.

The question that I believe we will have to eventually address are on the following:

  1. The Tawarruq is done on a single transaction for the full amount, therefore it is a full release of capital (i.e. fully funded). As such, it should have a “capital charge” consideration if it is not fully utilised by the customer. Bank has released fully the funds to customer (therefore Bank should be entitled to earn a full profit on the amount). The formula for profit would be $1,000,000 x Profit Rate – Cost of Capital. Note the Cost of Capital is on the full amount.
  2. Then, the subsequent mechanism instead is as follows: since the customer did not fully utilise the funds, the customer is given a “rebate”. For example the customer only uses $50,000 of the $1,000,000. The formula for rebate is that ($1,000,000 less $50,000 = $950,000) x Profit Rate x period unutilised. Banks earn full Profit Rate on $50,000 and gives rebate based on $950,000.
  3. Of course, Banks will utilise the $950,000 meanwhile but at what I imagine are for short-term instruments because the $950,000 is customer’s money (i.e. committed amount) and can be requested at anytime. Bank needs the funds to be as liquid as possible. So the Bank do not earn a lot from this “short term investment”.
  4. Also, there is concurrent discussion as to when the amount is kept and used by the Bank, what is the underlying contract used for this “unutilised, principal payment which is drawable on demand” amount? Is it kept by the Bank as Qard (loan), Wadiah (safekeeping), Amanah (trust) or can it be taken as Tawarruq deposit (monetised obligation) or Mudharaba (investments)? Different Banks have differing views on this, but I suspect BNM is trying to standardise this understanding and practice.
  5. But more importantly, while the Bank is giving customers “rebate” on the amount they do not utilise (but committed by the Bank), is there also “rebate” on Cost of Capital then? It seems unfair when it doesn’t. Tawarruq proceeds are deemed fully drawdown (based on full amount) and incurs full Capital Charge but is earning returns based on “only” the utilised amount. The rebate formula is very specific, and it does not contain the amount for “rebate” Capital Charge.

In the conventional Banking world, this is not so much of an issue. Their approach is simple: if the amount is “committed” to the customer, 2 things will happen:

  1. Once the amount is drawdown i.e. utilised by the customer (lets say $50,000 utilised of the $1,000,000), then full price is charged on the $50,000
  2. On the amount unutilised i.e. $950,000 the Bank will charge a “Commitment Fee” of 1.0% per annum (or any negotiated rate) on the unutilised (but committed) portion. While 1.0% per annum do not usually cover the full Capital Charge on the $950,000 it somewhat compensates the charge as the Bank (because $950,000 is still a “limit” and not Cash payout) can still use the unutilised amount in its day to day banking activities i.e. investment in short term financial instruments.

Scholars generally do not agree with the concept of Commitment Fees, and there is specific BNM guidelines prohibiting the charge of Commitment Fees in these specific scenarios.

The Capital Charge factor

I still think there is a disconnect somewhere that while we aim to achieve the same end result by the practice of Ibra’ i.e. “Rebate”, but with Capital Cost coming into play, it may eventually seem that the cost of running an Islamic Banking business can be higher than a conventional Bank. It really depends on how we interpret the guidelines and the treatment on Tawarruq especially the single Tawarruq structure where the full amount is transacted i.e. whether it is a full Capital Charge or otherwise.

I know what BNM usually advise i.e. it is a full Capital Charge. But this concurrently means, without Commitment Fees on the unutilised Customer portion, it may result in extra costs for the Bank. Now I am not suggesting we introduce Commitment Fees for Islamic Banking; this idea of Commitment Fees is a conventional banking concept for recovering opportunity costs, which may not sit well under Shariah consideration.

But in the world we operate today (where each $$$ is risk weighted to a cost), this translates to “Actual Costs” incurred by the Bank, based on the interpretation for the “single full amount Tawarruq transaction”. And Shariah may want to consider this as it is a real “Actual Costs” and not opportunity costs. By letting the money sit still, the Bank incur real, actual costs which is not recoverable as per guidelines. It may have started as “recovering opportunity costs” but if you really think about it, this is above opportunity costs. Maybe in the conventional space, they may even revise Commitment Fees to recover BOTH Opportunity Costs as well as Capital Charge.

So, my question is this: should both the industry and Shariah scholars re-look at the basis of Commitment Fees (in the context of how Tawarruq works), or re-think about the “Rebate” mechanism and perhaps have an adjusted formula to factor in a “Rebate on the Capital Charge”?

Can Shariah consider this mechanism to recover a real cost incurred by an Islamic Bank?

In the meantime, Happy Ramadhan to all, and may you have blessed month ahead.

Religiosity

Posted on by
2

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

Malaysian Business : Revival

Posted on by
Reply

We Are Back!

That was the rebirth issue of the Malaysian Business in April 2017.

Malaysian BusinessThis magazine was one of my main reading requirements when I was still a relationship manager for Business Banking and Commercial Banking way back in the early 2000’s. It gave me some insights for my daily conversation with customers. Nowadays I hardly read an actual magazine; all been replaced by this thing called Mobile Phone. So it was a surprise to see this magazine making a comeback.
Acquired by the Amanie group owned by Datuk Dr Daud Bakar, I was expecting the contents to be Islamic Banking-heavy. But I think in keeping with the original spirit of its readership, it is Malaysian Business as usual (no pun intended!). There are some contents on Islamic Banking and Services, and I guess the editors are taking it one subject at a time.

Ahmad FaizalSo I spoke to my trusted counterpart, Ahmad Faizal (pic), to ask his opinion on the magazine and his thoughts on the comeback. The common magazines come to mind; Personal Money and TheEdge. Simply because of the established contents and great stories that grab attention. Malaysian Business needs to benchmark itself to these magazines. Especially during times that there is insufficient readerships of physical magazines. Faizal also observed that there is no emphasis on Islamic Banking, which may well be a differentiation factor. Faizal also have fond memories for Islamic Banker magazine edited by Mushtak Parker. Many new information covered in the magazine for example the latest structure of deals etc. and hoping that Malaysian Business adopt certain areas based on this magazine.

Early days yet. I love the rebirth, and hope to have more. Heard the May issue is out.  Gotta get it. Click on the picture below to go to www.malaysian-business.com & happy reading!

pg4-2

[Excerpt from Datuk Dr Daud Bakar FB page]

Revival of Malaysian Business Magazine – Amanie Media – New Editor in Chief

DDDBI am happy to share with you that we have launched Malaysia’s Premier Business Magazine in April 2017.

First published in 1972, the magazine, now to be published by new owner Amanie Media Sdn Bhd with founder and renowned Global Entrepreneur and Shariah scholar Datuk Dr Mohd Daud Bakar as the Editor in Chief, is set to hit the news-stands in April 2017.

With the theme of Hope for The Malaysian Nation, Malaysian Business is on a mission to be at the forefront of motivational and inspiring business establishments’ stories. From financial advice for start-up companies to success stories from millionaire business founders, Malaysian Business aims to help readers at enlivening their passion and business goals in life.

The magazine spans on a range of business topics, technology insights, business culture, personal financing tips as well as stories of successful entrepreneurs who share secrets of their success from the ground up.

Sections in the magazine will include:

  • Trending Facts and News – Highlights of International and Local News
  • Corporate and Market Capital Roundup – review on latest market updates
  • MB Preneur – Stories from the Unsung Heroes of SME’s
  • Walking down Memory Lane – Stories on how we can recreate success histories
  • Reader’s Page – Pour your thoughts out, we want to hear from you!
  • After Biz – an insight into the latest gadgets, automotive and trends

Come and join our network of trade leaders and key players by subscribing to Malaysian Business!

Islamic Banking Operating Model

Posted on by
Reply

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

Posted on by
6

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.

“Gotong Royong” Bank?

Posted on by
6

To the uninitiated, the term “gotong-royong” means cooperation in Bahasa Malaysia. It is a concept where the community may come together to assist its community members without expectation of returns. In Malaysia, this is a community event to achieve a certain purpose for example a village wedding.

But how about having a “gotong-royong” Bank? Ms Rozana Gulzar, who contributed an earlier article on this site, made this interesting proposition that while the current Islamic Finance system set-up based on the conventional banking model is working sufficiently, a different model of banking may provide a closer structure espoused under the Maqasid of Shariah (Objectives of Shariah). A more inclusive and less profit driven model? It may provide a refreshing alternative to the existing financial system. Maybe not as a full 100% replacement of the existing models (where it caters for a large scope of requirements) but to complement and complete the Islamic Banking financial infrastructure.

Read about what she wrote below, as well as her earlier writings on this site.

DOWNLOAD : Cooperative Banking as the Solution for Islamic Banking Woes (pdf)

Excerpt from Rosana’s being cooperative:

While there are some differences in the models of cooperative banks in various regions of the world, a basic common feature is that they are owned by members, who in turn tend to be their depositors and borrowers. That’s mutuality built right into the system. This form of ownership then sets the tone for a business model that is more Islamic than ‘Islamic’ commercial banks. For example, because cooperative banks are owned by members who may be their borrowers, profit maximisation is not the main objective. Their raison d’être is in fact to charge reasonable enough rates so that those who cannot get financing from blood-sucking commercial banks can do so through the cooperative banks. And yes, they are not Islamic in form but I think they are more Islamic in spirit.

Bankers of cooperative banks are also known to have close relationships with their customers. A Turkish German once told me that his neighbourhood banker would come regularly for tea. When he notices a child in the household is old enough for a bank account of his own, the banker will ask the parents if he should indeed open one for him. Germany by the way is home to the largest network of cooperative and savings banks in the world. This close relationship has important implications. One it answers a call by some quarters for a move towards relationship-based banking as opposed to the transactions-based frenzy that characterises commercial banking and has been blamed for the crises. Secondly, it addresses a key issue that has been plaguing Islamic finance since its modern birth: How to implement profit and loss sharing (PLS) contracts such as musharakah and mudarabah which are at the heart of an ideal Islamic financial system when early attempts failed due to moral hazard and adverse selection issues.

Additionally, she makes a call to academia to rise to the occasion of re-looking the existing model and having more research to support the building of the new model. She throws the challenge that the road is still long and hard and only the ones who are able to persevere will make a difference.

DOWNLOAD : Islamic Finance Academia – We Can Do Better (pdf)

Excerpt from Rosana’s war cry to Academia:

Firstly, we need to address the controversies. Islamic finance is suffering from a dichotomy between theory and practice. What is taught in schools is a world away from what is being practiced. While ‘Islamic’ bankers keep an almost sole focus on producing the best ROE for shareholders, at the obvious expense of social welfare, Islamic finance professors go on and on about the ideals that shape this form of finance, oblivious to the divergence in practice. It is thus not surprising that the ‘solutions’ they come up with have no semblance to reality. I keep thinking, ‘We are not yet in jannah so how will this work in the real world?’

To come up with better solutions, I think we need to first face facts. Don’t gloss over them. I would prefer an honest (and mature) discussion of how we have gone wrong in Islamic finance and how to address them. This obviously needs rigor in thought and analysis. And critical thinking. Just because someone is from the IMF or World Bank does not mean he knows what he is saying or his intentions are purer than pure. We still need to evaluate the rigor of his arguments. On the other end, those who do not understand Islamic finance need to keep silent. The problem in Islamic finance is that we have many talking heads who really sound like empty vessels. And you know what they say about empty vessels right? (They make the most noise).

I like to make the same challenge to my staff as well; 90% of the practices we see today are derived from decisions, opinion and fatwa made in mid 1990s and has been taken as Urf (custom) and not challenged anymore… but we should re-look at some of them (especially with standing controversies) and see if current regulations and Shariah Advisory Council resolutions and product thinking and market development can offer a better solution. Doesn’t Islamic Banking allow for intelligent discussion to always evolve into something better? Just because it has now become Urf, it does not mean there is no better solution and be happy with the status quo. There’s always room for improvements to this 30 year old industry.

The purpose of this website is to encourage constructive discussions and perhaps find a better solution to the existing ones. Let’s have your views on these topics. Have a read of Rosana’s writing and I know she appreciates honest feedback on her work. Do spend that time reading, and your comments may perhaps resonate in someone’s mind and change the world.

To go to Rosana’s page, click here.

Popular Islamic Finance Terms

Posted on by
Reply

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.

 

Is Islamic Finance Suffering from the Wrong Model of Implementation?

Posted on by
22

1936833_122600669332_6771254_n

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

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

Is Islamic Finance Suffering from the Wrong Model of Implementation?

By Rosana Gulzar Mohd

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

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

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

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

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

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

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

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

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

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

Disruption : Islamic Contracts

Posted on by
8

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

EBOOK : Alternative Financial System Islamic (Halal) Finance – IBFIM

Posted on by
Reply

One of the ongoing efforts that some of us have is to figure out how we provide greater access of Islamic Banking to the mass market. This includes not just to Muslim readers, either here in Malaysia or other global countries, but also to access non-Muslims readers as well. And to do that in their mother tongue will be the ideal method as it will provide familiarity and ease in understanding on what is being communicated.

alternative-halal

Click picture to Download PDF

Realising this, the Islamic Banking and Finance Institute of Malaysia (IBFIM) has just launched a book in Mandarin Chinese titled “Alternative Financial System Islamic (Halal) Finance” with the hope of providing greater understanding on the concepts, rationales and practices of Islamic Banking and Finance. This is in line with IBFIM’s mandate from Bank Negara Malaysia to produce a pool of talent whom will be competent in Islamic Banking issues and practices. Also, IBFIM currently offer courses for various technical levels for the purpose of raising knowledge and awareness toward Islamic Banking in the industry. Over a period of time, IBFIM has become one of the knowledge leaders  and recognised internationally as a place where practical advisory can be obtained.

I have spoken to the folks at IBFIM about posting this book on this site and I am grateful they have consented, for the benefits of readers. Unfortunately I am not able to comment on the book (as I am not a Chinese reader) but I sincerely hope the book helps to provide some insight towards the mysteries of Islamic Banking.

To get a Hardcopy of this book, do get in touch with IBFIM directly at their website www.ibfim.com or look out for their various events nationwide.

To download the PDF copy, please click on this link: (Click Here)

ALTERNATIVE FINANCIAL SYSTEM ISLAMIC (HALAL) FINANCE

Thank you IBFIM for this great effort.

 

 

 

Employee Provident Fund – Becoming Shariah Compliant

Posted on by
2

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?

Posted on by
Reply

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.

Types of Murabahah

Posted on by
1

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/deferred 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.

This category of Murabaha is generally classified as a Debt-Based structure where the Bank only holds the Credit Risks (Valuation Risks is held by the Customer).

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. This category of Murabaha can be classified as either an Equity-Based structure (if the Bank choose to hold the ownership until sale i.e. open to valuation risks without a Letter of Undertaking) or a Debt-Based structure (where the Bank executes the Letter of Undertaking and effectively transferring the valuation risks to the customer).

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

 

Best Wishes for Ramadhan

Posted on by
Reply

It has been quite some time since I last posted here and I do apologise for that. I have recently joined a new organisation at the moment heavily in the midst of launching an Islamic Banking proposition to their customers. Safe to say that the amount of work is monumental but launching an Islamic proposition is always the good fight for me. We expect then “live date” to be sometime July 2016 and hopefully I will have a bit more time thereafter to finally complete the various drafts laying in my box.

So in the meantime, I have added the various guidelines issued by BNM these past few months into my repository. The guidelines issued lately by BNM as follows:

  1. Wa`d Concept Paper (11 April 2016)
  2. Statutory Reserve Requirements (26 January 2016)
  3. Financial Reporting for Islamic Banking Institutions (05 May 2016)

But nonetheless, I would like to take the opportunity to wish my friends, colleagues, subscribers, supporters and casual visitors the best of Ramadhan’s blessings. May we all have good tidings and good health for the many years ahead of us all.

Ramadhan Kareem, and please accept my humble thanks for visiting.