Reliance on Commodity Murabahah

A few days ago, several Banks in Malaysia officially made available Deposit products based on Commodity Murabaha transactions.

Looks like Commodity Murabaha (CM), or in another variation is called “Tawarruq” has now expanded its domain from Financing-based to Deposit-based products. More and more banks will have to rely on this structure on both sides of the balance sheet. Bai-Inah based portfolio used to consist of nearly 80% of the overall financing portfolio of some banks; now with the push for Commodity Murabaha structures in financing to avoid interconditionality issues in Bai-Inah, it is expected that Commodity Murabaha financing to eventually replace the Bai-Inah portfolio.

Now with the introduction of CM for Deposits, the popularity of commodities will take a sharp rise! Bursa Malaysia will have their hands busy supplying the industry with commodities to support the underlying transactions. Islamic bankers will also have their hands full buying and selling commodities between the bourse and the customers, either as buying agents or principal purchasers!

Commodity Murabahah Deposits

I am not sure whether this is necessarily a good thing.

The industry will now shift from having a Bai-Inah-heavy portfolio into a Commodity-Murabaha-heavy portfolio. Concentration risks towards one Islamic contract will grow, and the question is that whether Banks will take the time to develop other contracts into viable propositions instead of just building the CM infrastructure. Do bear in mind that a lot of infrastructural work needs to be done to ensure CM remains the flagship contract for years to come.

The specific risks that Banks faced when offering CM products are manifold; shortage of commodities, delays in transactions,  wrong sequencing of purchase and sale of commodity, errors in commodity prices and description, delivery of commodities issues, ownership issues and ownership evidencing. All these requirements needs to be watertight to ensure income from these CM transactions don’t just go to charity. Whenever there is an Asset involved in the transaction, all the factors need to come together to ensure Sharia compliance.

And the way we are going, it seems that CM will probably have 80% of the financing pie and 70% of the deposits pie in a typical Islamic Bank’s balance sheet in 3-5 years time. With IFSA deadlines on June 2015, this ratio could come sooner rather than later.

Will the development of other contracts be further left behind since the shift now is on CM? Maybe, historically Malaysian Banks follows the “Urf Tijari” route of following what the other bank is doing. We have seen this when Bai Bithaman Ajil (BBA) was introduced; nothing else was developed in the market but BBA. It was the same with Bai Inah.

But there is other opportunities for development of other Islamic contracts, although I don’t imagine this is the case for Malaysia while we busy ourself becoming commodity traders. Oman, on the other hand, has rejected tawarruq totally,  focusing on other contracts such as Ijara and Musyaraka. This is a good development, as no countries has seriously looked at developing complex, high-risk structures. Maybe once the thinking to shift to understand the transactional and Sharia risks of the new products is made, perhaps the market can warm up to the idea that Sharia compliant banking can be a different way of banking.


Back To Wadiah

Investment Account Guidelines

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

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

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

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

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

The easy solution; take a step backwards.

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

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

The Islamic Financial Services Act


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


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

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

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

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

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

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

With this, the industry is turned on its head.

Redefining Deposits

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

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

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

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

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

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

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

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