The New Shariah Governance Policy Document (2019)

SHARIAH GOVERNANCE POLICY DOCUMENT (2019)

One of the most anticipated documents by the industry is the renewed Shariah Governance Framework, which was last issued in 2011. Many were waiting with bated breath on what changes were made to the document. I had a quick look at it also and generally, there were a few fine-tuning done to existing regulations.

A quick summary of the points in the Shariah Governance Policy Document (2019) are as follows:

  1. The responsibilities of the Board of Directors are to approve the policies regarding Shariah governance, oversee the implementation of SAC’s ruling and internal control framework, oversee the performance of senior management and promote a culture of Shariah compliance in the bank.
  2. The Board of Directors also must interact sufficiently with the Shariah Committee including giving due regards to the Shariah Committee decisions, paying attention to facts and rational and the implication of implementing the decision, with proper conflict resolutions and record of all deliberations on the issues.
  3. The Board of Directors must also assess the performance of the Shariah Committee formally, at least annually and ensure the remunerations reflect members’ accountabilities.
  4. The key responsibilities of the Shariah Committee themselves are defined as follows:
    1. Provide a decision or advice on the application of SAC ruling and BNM standards on Shariah matters
    2. Provide a decision or advice on matters that requires a reference to be made by the SAC
    3. Provide a decision or advice on matters that may trigger Shariah Non-Compliant event
    4. Deliberate and affirm Shariah non-compliant findings
    5. Endorsing rectification measures for Shariah non-compliance event
  5. The Shariah Committee shall be accountable for the quality, accuracy and soundness in their decisions and advices.
  6.  The Shariah Committee must establish a robust methodology to guide decision making process including taking into account relevant business and risk practices.
  7. If Shariah decides to place additional restrictions on the business in applying SAC ruling (meaning : stricter than SAC rulings), the bank must document the deliberation, obtain Board of Directors view on the decision, and immediately notify BNM on the decision.
  8. The Shariah Committee must exercise objectivity in making a judgement or deriving a decision to avoid impairing professional objectivity. Sufficient time is to be devoted to prepare for and attend Shariah Committee meetings.
  9. The Shariah Committee must continuously develop reasonable understanding of the business and keep abreast of the latest market and regulatory development, to be led by the Chairman of the Shariah Committee.
  10. The Chairman of the Shariah Committee must be able to apply relevant procedures for Shariah deliberations, liaise with Board of Directors, ensure sound decisions are made, encourage healthy discussion on issues, and ensure maintenance of records supporting Shariah decisions.
  11. Shariah Committee meetings must be conducted at least once every 2 months  (at least 2 times a year for Islamic Banking Windows operations) and attendance of each member must be 75%. This information to be reported in the bank’s annual report.
  12. Appointment of the Shariah Committee must fulfil the following:
    1. the person is a Muslim
    2. the person is “fit and proper
    3. the person is either Shariah qualified person or an expert possessing skills, knowledge and experience (to support the Shariah function)
  13. Shariah Qualified Person means the person:
    1. hold a minimum bachelor degree in Shariah which includes studies on Usul Fiqh (principles of Islamic Jurispruedence) or Fiqh Muamalat (Islamic transaction/commercial law)
    2. possesses solid knowledge in Shariah with reasonable Islamic finance knowledge and experience
    3. demonstrates strong proficiency and knowledge in written and verbal Arabic.
  14. A Shariah Committee member shall not serve in the same Bank for more than 9 years, must not accept appointment on more than 1 licensed banks, 1 licensed takaful operator and one prescribed institution. The member must also not be an active politician.
  15. The Shariah Committee composition must consist of a Shariah qualified Chairman of Shariah Committee and the majority of the Shariah Committee Members are Shariah qualified.
  16. The Shariah Secretariat must provide the Shariah Committee adequate time to deliberate all Shariah matters.

HOW MUCH POWER DOES THE SHARIAH COMMITTEE REALLY HAVE?

As expected, the Shariah Committee must have full accountability in making decisions via robust deliberation of the issues, including considerations of business practices. This idea is consistent with BNM’s expectation that Shariah Committee must reach a certain level of competency in advising the banks. BNM, it seems, is prepared to provide authority for Shariah Committee to decide on the business direction, in line with the overarching SAC decisions. This indicates that the Shariah Committee is meant to be influential in the Islamic Banking industry.

However, BNM also allows the challenge on Shariah Committee decisions if the bank deems the decisions have not taken into considerations the practical and business sense, especially for decisions stricter than the SAC. In such circumstances, the Board of Directors provide a view on the decision, and must be escalated to BNM. To ensure that this scenario does not happen as often, both Shariah Committee and the business must align the understanding on the business direction and mitigate the discrepancies in understanding. The role of the Chairman of the Shariah Committee is important to manage the interactions between the Board of Directors and his Shariah Committee members.

The above underlines the seriousness of the Shariah Committee function. With great powers comes great responsibilities. To hold such authority, the Shariah Committee must reflect quality, accuracy and soundness in all their decision-making.

WILL A SHARIAH COMMITTEE FUNCTION REMAIN A PART-TIME JOB?

Books

Personally, I understand there are challenges for Shariah Committees to devote a sizeable amount of time to provide banks with high quality, fully deliberated decisions that is valuable. There are still a number of Shariah Committees only choosing to stay in their areas of expertise while concentrating on their day jobs. We hardly see a scholar having a full-fledge research house coming into the market with resources that can support the business requirements of an Islamic Financial Institution (IFI).

Nothing is mentioned on the expected level of research to be done by a Shariah scholar. That level is still left to interpretation although with the requirement to be “conversant in Arabic” implies Shariah scholar should be referring their research and decisions more consistent with global standards, where text, references and decisions are discussed and derived in Arabic.

IS AVOIDING CONFLICT OF INTEREST MORE IMPORTANT THAN KNOWLEDGE SHARING?

One wish that I had for the Shariah Governance is the composition of Shariah Committee itself. While the limitation of service of not more than 9 years is good for an IFI (to encourage rotation in the industry), I still feel the knowledge growth and development of Shariah Committees may not be as fast as the anticipated industry growth. What more, I feel that the limitation of a Shariah scholar to only serve in 1 (one) Islamic Bank, 1 (one) Takaful Company, and 1 (one) Islamic Development Bank do not allow the sharing of knowledge between entities and industries. Perhaps there is a concern where there could be a conflict of interest? I do not know. All I know is that globally, it is common to see one advisor sitting on multiple boards and from the knowledge gathering, can be a substantial resource for the IFI.

WHY NOT THE CURRENT STRUCTURE?

In my opinion, there is a real shortage of knowledge between the old guards and the new challengers in the areas of Islamic Banking. What I see nowadays are issues being re-discussed again and again, and some have been discussed at length in different forums or decades earlier, with solid resolutions. The new scholars do not have the full understanding of history, background and context on many issues (some of which have already been discussed), and the older guard of very prominent scholars are not able to share the history, perspective, experience, background and earlier discussions on matters of Islamic Banking. This gap remains huge as the young scholars run to catch up in terms of the understanding that the older guards have. This resulted in many real, new and current issues being somewhat ignored as past issues are again discussed.

SO WHAT IS MY DREAM TEAM FOR A SHARIAH COMMITTEE?

In my perfect world, I would love to see a combination of the following:

  1. The Shariah Committee Chairman. Senior person in the industry leading the committee, with vast experience of Islamic Banking operations, as well as Shariah Qualified and conversant in written and spoken Arabic. Must have leadership qualities to be able to manage the Shariah Committee.
  2. Prominent Scholar. One prominent scholar should sit in as part of the Shariah Committee for the purpose of providing guidance, mentoring, advising and coaching to new Shariah Committee members and Industry Experts. This scholar should come from a list of 10-15 “A-Rated” Shariah scholars who have been in the industry of more then 15 years. Must have some capacity in BNM’s Shariah Advisory Council or is a Consultant with a reputable Shariah research house. Must have international exposure or sitting in an international Shariah board. Is allowed to sit in up to 5 (five) local Islamic Banks, Development Banks or Takaful Companies. Also conversant in Arabic, both written and spoken.This list of “A-Rated” Shariah scholars must be maintained or endorsed by BNM, just like how the Shariah Advisory Council (SAC) of BNM is maintained.
  3. Combination of Shariah Scholars and Industry Experts. Can be appointed based on expertise and academic background with strong background in research. Must be Shariah Qualified and conversant in written and spoken Arabic. For Industry Experts, must be a specialist in the give area and have sufficient experience. This group is to be groomed to be included into the “A-Rated” Shariah Scholars upon completion of tenure. Training and exposure to be given, with the assistance of the Prominent Scholar, on how to upscale and up-skill the knowledge in Islamic Banking.   And to be included into the “A-Rated” Shariah Scholars list, the scholars must undergo an overseas / international attachment with an international Islamic Bank as part of the Shariah Committee, perhaps for a period between 1 month to 3 months. This attachment should ideally be sponsored by BNM as part of the development of the Shariah Scholars exposure and capabilities.

Conclusion : The Shariah Governance Policy Document remains a strong upgrade from the previous SGF and should provide a more serious undertone to the overall workings of a Shariah Committee. This shall lead to stronger governance but I am not convinced on the development of Shariah Committees with the limitations imposed on appointments into Islamic Financial Institutions.

Wallahualam.

Continuing Post : The Problem with Transplanting the ‘Sustainability’ Movement on Islamic Banking

By Dr Rosana Gulzar Mohd
EXCERPT : In ‘Islamic’ Banking, we dance around issues as if vying for a Bollywood Oscar. The latest theme, on ‘Sustainability’, is fashioned after the United Nations (UN)’ Sustainability Development Goals (SDG), in concert with other large organisations such as the Islamic Development Bank and the World Bank. While they may seem like a natural fit with goals such as peace, justice and decent work for all, a closer look uncovers a few fundamental flaws. Firstly, while championing social and environmental wellness, we continue to evade the main issue, which is that profit- and loss-sharing, arguably the main tenets of Islamic Banking, have been replaced with tawarruq, which resembles riba in form and spirit. Secondly, and related to the first argument, this concept of ‘Sustainability’ is at odds with the modern financial system. One is about preserving for future generations while the other belies a winner-takes-all mentality. There is a view that like Islamic Banking, ‘Sustainability’ cannot be sustained in Commercial Banks even though several of them, from Singapore to London, have adopted the practices. In Islamic Banks’ (blind) pursuit of Commercial Banking, are we being set up for failure?

Following up her article earlier this month, this discussion focuses on the “Sustainability” revolution undertaken by Islamic Banks, and whether “being compassionate” adds value to the Islamic banking proposition which still practices debt-based banking. What do you think? Read the full article here or click on the above diagram. Comments and feedback welcomed

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

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

By Dr Rosana Gulzar

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

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

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

No Pork No Lard : The Shariah-Neutral Transactions

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

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

“NO PORK NO LARD”

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

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

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

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

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

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

THEY WALK AMONG US

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

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

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

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

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

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

Why Choose Islamic Home Financing in Malaysia?

ISLAMIC FINANCING HAVE SHOWN SUSTAINED GROWTH. WHY?

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

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

BENEFITS OF ISLAMIC HOME FINANCING

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

GIVING BETTER SOLUTIONS THAT SATISFY SHARIAH REQUIREMENTS

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

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

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

Risk Management in Islamic Banking

IS THERE SUCH A THING AS ISLAMIC RISK MANAGEMENT?

I had this conversation recently until the wee hours of morning, and although I never thought a lot about it, I have come to the conclusion that there cannot be an exact replica of the Risk Management in the conventional sense.

Risk Management is a tool used by all conventional banking institution in the name of good governance, risk mitigation and prudent practice. It looks at financial exposures and its inherent risks to the business, and deeply believe in the risk-rewards pay-off within the generally accepted risk appetite of the organisation. It focuses a lot on control processes, performance monitoring, collateral value, and decision making policies for credit, market and systemic risks.

To a large extend, the risk management framework employed by the conventional banking businesses can be easily adapted by Islamic Banking counterparts. The components are the same, and there is little argument on its applicability under Shariah law. However,  the risk management framework for Islamic Banking institutions must be inherently different as well, or maybe extended to include a bigger scope. It cannot just be seen as a replica of the conventional business; the foundation of Islamic Banking is definitely different.

There are a few divergence in the reason an Islamic Banking institutions should (ideally) follow. This is an on-going argument on the fact while Islamic Banking claims to be a different business model, but it is still engineered by the rules of a conventional organisation. But what are these divergent reasons for setting up an Islamic Banking business?

The lending of money to make money is forbidden.

This may seem like a trivial thing for Islamic Banking as many will say there is no difference between profit and interest. But for us practitioners, there is a big difference in its concept. Because of this difference, the way we think about how a product can be structured is paramount. Underlying contracts, assets, ownerships and roles and responsibilities becomes different from a tranditional / conventional bank (whom are essentially a money lender). To validate a transaction, all tenets and requirements in an Islamic contracts must be met or else it becomes an invalid transaction and any gains from it must be given to charity. Any gains obtained without fulfilling the transactional can be deemed as usury (riba’).

There are specific Shariah requirements that takes Islamic Banking beyond banking.

Some terms are pretty alien to traditional banks, such as commodity purchase, operating lease and rentals, sequencing and ownerships. This is where the divergent begins, because Islamic Banks espouses the concept of “trading” and “entrepreneurship” and “partnership” and “service provider”, away from the “lender-borrower” arrangement. Traditional banks struggle to understand issues of ownership of assets, risk and loss sharing, purchases of commodity and rental of assets. These activities are beyond traditional banking, and may become an operational risk issue if it is not fully embraced.

Islamic Banking should be more closer to a venture-capitalist, crowd-funding model than traditional banking.

The fundamental requirements for earning a profit (and to a bigger extent, how much we can earn from a transaction) is the element of risk sharing, which mean both customer and financier takes some form of the risks of the venture. At the same time, such “risky” venture is mitigated by way of ensuring it is not overstretched i.e. the transactions must be either asset-backed (including the presence of collaterals) or asset-based (evidenced by real trading or assets or commodities) to reflect economic activity.

The amount of risk taken under an Islamic contract can be higher (for contracts such as Mudharabah or Musyaraka financing) but it must be reflective of the economic reality and available assets.

The risk assessment of an Islamic contract must then be enhanced to behave similarly to what a venture capitalist can accept. There will be direct risks on equity, investments and returns. There will be corresponding returns as well. But such concepts will be difficult to digest if the bank is set up based on traditional banking fundamentals, which caters for a totally different profile of stakeholders.

As far as possible, the Shariah committee draws a line for transparency, fairness, and justice.

Islamic Banking should be an extended but integral part of economics. Islamic Banking is supposed to be more than a bank. It shoulders a broader responsibility to the people by looking at needs and providing products that serve a purpose. The idea of responsible financing, transparency and customer service should be the by-word of an Islamic Bank. The payment of Zakat (tithe) on profits which goes back into the community recognises the financial role that it needs to play. Corporate Social Responsibilities also play a role.

In this repect, the Shariah committee plays an important role as gatekeepers to the products and services on offer. Because of the unfamiliar territory of Islamic products, Shariah insists that transparency is critical to avoid uncertainty (gharar), the terms to the products are fair and the banks are ethical in its conduct to ensure justice. Fees and charges must reflect actual costs. Efforts are made to help a customer in distress. And conduct of the bank must comply with the requirements of Shariah.

SO, BASED ON THE ABOVE, WHAT ARE THE  OF RISKS FACED BY ISLAMIC BANKS? 

As a general rule, all risks faced by a conventional Bank must be “transferable” i.e the nature of the financial transaction must, as far as possible, allow for the TRANSFER OF RISKS. Wherever the opportunity arises, the Bank must be able to quickly pass the risk of the asset or valuation to the customer. Such understanding is also apparent in Islamic Banks. Looking at most Islamic Banking contracts, their structure allows for the transfer of risks, which follows the transfers of ownership, responsibilities and obligations from one party to the other. Contracts  such as Murabahah, Musawamah and Qard works by transferring the ownership, responsibilities and obligation from the Bank to the Customer.

Alternatively, mostly exclusive to Islamic Banks, are structures that allows for SHARING OF RISKS. The structure is more “participative” in nature, where there are benchmark by which determines the level of risks a party should have. The regular types of contracts that continues to share risks are Mudarabah, Musyarakah and Ijarah.

COMMON RISKS 

As mentioned before, the risks faced by a conventional bank and Islamic Bank should be very much the same, except for risks arising to the execution of Islamic contracts or pronouncement of the Shariah. While there will be common elements of risks for both types of Banks, the importance of Shariah ruling and decisions result in Islamic Banking becoming so unique. The following are the Risks commonly faced by Islamic Banks:

GENERAL RISKS – Risks existing in both conventional and Islamic banks. 

  • Credit  Risks – Arises due to counterparty risks (possibility of default by the party taking financing) where the counterparty fails to meet its obligations, in terms of payment, uncertainty of industry,  change of direction or diminished collateral value. This lead to settlement risks which means the Asset quality has diminished.
  • Market Risks / Interest Rate Risks – More macro in terms of effect on the risks. It relies on the performance of the market as well as the quality of the financial instruments (price, performance, valuation, demand, yields and inability to reprice. It leads to exposure to interest rate risks, where the risk of the bank increases with movements in the rates.
  • Liquidity Risks – Refers to the risk of inability to return cash to investors or stakeholder in stressed scenarios, resulting in forced borrowings from the market (usually at higher price) coupled with the possibility of not able to dispose assets. This may lead to valuation risks.
  • Operational Risks – Due to inadequate control of internal processes and operational practices, the risks may result in real loss of income and potentially reputation. Human errors may be difficult to unwind especially if there is financial implications. There may also be legal risks as it may be considered a breach in contract by the bank.

ISLAMIC SPECIFIC RISKS – Risks arising from operational and processing function

  • Transactional risks – Especially under Islamic Banking structures, transactions play an important role as part of the Aqad, where required.  For example, the sequencing of a Murabahah transaction. Failure to ensure compliance to the Aqad requirements will lead to potential invalid transaction and loss of income (or flow to charity).
  • Valuation Risks – Due to the nature of some Islamic Banking contracts, especially equity based structures, there will be challenges in valuation of the portfolio.  Reduction in valuation will result in real losses for the investors.
  • Displaced Commercial Risks – Displaced Commercial Risk (DCR) refer to the risk of mismatch between the fixed/contracted obligation to the depositors vs the uncertain returns on the financing (income) which may result in the income is insufficient to meet the obligations to the depositors. For example, the commitment for Islamic Fixed Deposit is 4% (contractual) but the Financing portfolio into which the Fixed Deposits is deployed into only earns 3% (actual returns). Therefore, the 1% shortage is the DCR where the Bank will have to flow 1% of  income from other portfolio to meet the deposit obligation of 4%.

SHARIAH RISKS – Risks arising to non-compliance of Shariah decisions and Shariah instructions.

  • Shariah Compliance Risks – The operation of an Islamic Bank is hugely dependent on the requirements of the Shariah Committee and approvals obtain on the process and procedure. Inability to comply with Shariah requirements puts the operations of the Islamic bank at risk as the department may be regarded as non-Shariah compliant business.
  • Fiduciary / Ownership Risks – Some of the structures under Islamic contract requires the bank to operate outside the scope of a financial intermediary. It requires the bank to hold property or trade commodities or own and lease assets, with various contracts using various roles and responsibilities. The risk of multiple roles and function must be clearly defined and implemented.
  • Regulatory / Reputational Risks – Changes in regulations requires quick adaptation to ensure compliance to regulation and maintaining the banking reputation intact.?

SO HOW DO YOU MANAGE ISLAMIC RISKS AND SHARIAH RISKS

As mentioned, Islamic management of risks should not be any different for the base of conventional bank’s methodology of measuring risks. There must be deep understanding of the products and structure for the bank to be able to assess the risks associated. To manage an Islamic Bank and its risks, the bank must first identify each of the risks and form safeguards to settle the above. Then only an Islamic bank can formulate suitable controls to ensure the Shariah specific processes and Shariah pronouncements are being monitored and implemented with sufficient support (internal or external). Wallahualam.

The All New Shariah Advisory Council BNM Website

THE ONE-STOP SHARIAH ADVISORY PAGE OF BANK NEGARA MALAYSIA       

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

The Centre of Shariah Reference in Islamic Finance

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

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

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

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

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

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

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

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

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

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

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

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