The Investment Account

Posted on June 30, 2015 by Amir Alfatakh

Investment Account Notice

Link to Standard Chartered Saadiq Announcement on Investment Account

It has been a busy 2 months for me and my team in launching the Investment Account to replace the out-going Mudharabah Current Account and Savings Account. No longer are these accounts classified as “Deposits”; as at 1 July 2015, they are officially re-born as “Investment Accounts”.

What does being re-born as Investment Account means?

The customers relationship with the Bank is re-iterated as “Fund Provider and Entrepreneur”. The relationship of Mudharabah has always been the same either before or after 30 June 2015. But now we re-emphasize this fact again.
We also re-emphasize that “Investments” should behalf as its namesake. Investment carries risks, and we outline the risks in our Product Disclosure Sheets, on the possible risks and returns to customer investments. There is a potential for the customer to earn more if the investment performs above expectation. But the opposite may also happen during a crisis, putting customers cash at risk. To that extent, the Investment Account would take on the feature of a pure investment, with its risk and return trade-off
By reclassification of the Current Account / Savings Account into the “Investment” definition, PIDM no longer can cover the products (since PIDM stands for Perbadanan Insurans Deposit Malaysia).
Customers now will need to be risk-rated for going into Investment Account. Customers will be asked questions to determine the risk-tolerance level and whether the product will be suitable for them. The current reincarnation of the Mudharabah product carries very little risks, so it is most likely almost all customers will qualify for the Investment Account.
Customers will have more information about the use and deployment of their funds as Banks are required to be transparent to the customers. Customers will know where their money is being invested into, the potential risks and returns and hopefully with the availability of all disclosures and information on the investment, will be equiped to make a decision to go into investments.
Banks will be more involved in managing the customers’ funds as Banks need to manage the assets that is allocated to the investment pool from which the actual returns will be paid to the customer. In the near future, we foresee that the function in the Bank involves active management of the investment pool, much like what a fund manager would have to do on a daily basis.
For customers who was unsure of the Investment Account and its impact to them, they would not have opted into the Investment Account; instead they are converted into a less riskier “guaranteed principle” contract of Wadiah. Wadiah is a “Safe custody” contract which guarantees the return of principal on demand, but offers nothing else. Any returns paid will be as a gift (“Hibah”) and such Hibah is purely discretionary (not obligatory).
My advice : For customers whom have been converted into Wadiah arising from the Mudharabah migration exercise, do visit your Banks and ask to explore Investment Account, as essentially the accounts remains tightly managed by the Bank to generate the desired returns.

We are all excited to take this contract forward and see its response. We note the feedback from customers on Investment Account and it will be a challenge for us as the market slowly wakes up to this new understanding. It could take years of educating the public on Investment Accounts, and it will be a while until we ourselves reach peak efficiency in understanding its dynamics.

I am sure my other colleagues from the various Banks are also basking in the struggles and achievements of launching the Investment Account. It was a team effort to have the product on-board and we can only get better from now on. The market will warm up to the idea sooner rather than later as all the Banks try to meet what is expected of the under the IFSA.

In the meanwhile, I attach an entertaining clip from my good friends from Maybank Islamic, whom also launched their version of the Investment Account. Hopefully the Colourful Maybank Investment Account clip (You Tube) will serve as a good introduction to all.

The Mudharabah, The Deposits and The Investment Accounts

Posted on January 2, 2015 by Amir Alfatakh

Investment Account 2015

2015 promises to be an interesting year as the IFSA 2013 comes into effect for Malaysian Banks. We will finally see that shift in the industry as the 30 June 2015 deadline approaches where Banks will draw the line in the sand, separating their Current Account / Savings Account portfolio into the following:

Banks that will migrate their Mudharaba deposit account into either a Wadiah deposit account or Qardh account
Banks that will convert their Mudharaba deposit account into Mudharaba Investment Account
Banks that will introduce a totally new structure to the Mudharaba deposit customers, such as Tawarruq deposit or something fantastical.

The push by Bank Negara Malaysia (BNM) is really quite clear; Mudharaba as the flagship product that introduces the customers to the world of risk-taking and therefore, potentially higher returns. And if the Mudharaba is to be classified as an Investment Account, then it should behave as one.

But in all honesty, Mudharaba has always been an “investment or entrepreneurial” contract. Worldwide, the concept of Mudharaba means; take customers funds and enter into an investment and share the profits (if any) and should there be a loss, the customer will take that capital losses. This definition does not change, post-June 2015 when the IFSA for deposit comes into effect.

What has changed is that Mudharaba will now be classified as Investments, instead of investments that behaves like a Deposit. There is no fundamental difference between the “now” Mudharaba and “future” Mudharaba. The clause where the capital investment of the Mudharaba is open to potential losses has always been there. The terms and condition contains this. But due to the classification of Mudharaba as Investments post-June 2015, the treatment on how a Mudharaba Investment is processes, managed and executed now changes.

Under a Mudharaba Deposits, the following happens:

Customer comes in as an Investor, and sees the historical returns on the deposits
Customer enters into a Mudharaba contract, which allows the Bank to manage the funds on a pooled basis on predetermined terms
Bank deposits the funds into a managed General Investment pool. Bank will manage the allocation into the financial assets according to Bank’s investment direction
At a determined period, or maturity, the Bank calculates and accrues the “distributable” profits to the customer
Bank distributed the profit to the customer, based on the individual Profit Sharing Ratio.

But what happens if the Mudharaba must now behave as an Investment? The process looks very similar to how you onboard a customer as an Investor in a more sophisticated product, such as Unit Trusts or Structured Investment products, or even equity shares on the stock exchange. Notice the types of product that the Mudharaba is now being aligned to; higher risks, specific investments, strategy allocation as well as potentially higher returns, depending on the prevailing market conditions,

So if Mudharaba Current Account or Savings Account is to be deemed as Investments, the following must happen:

Customer comes in as an Investor, and must come with their eyes wide open. They will see the historical returns on the investments. Customer will also be informed of where their Investments are being invested into and the risks and potential future rewards of the investment. Both for worse case and best case scenario of the investment. This includes the part where the risks to their capital must be clearly be made known to them.
Customer understands the risk and is evaluated via the Investment Suitability Assessment. A risk grading is assigned and the customer is presented by a list of Investment that their risk grading qualifies for.
Customer, with all the information available to him, makes his own decision to either enter into a Mudharaba Investment contract for the “right” Investment, decline it, or chose to undertake a higher risk profile Investment with the indemnity to the Bank.
Bank takes the customer on as an Investor, and invest the funds into the “specific” Investment Asset (This makes the Bank sound like it is now a Fund Management company!!!). The Bank now manages the funds as a Specific Investment pool. If re-allocation of asset in this pool is required, the Bank is to inform the investor of the change in the portfolio.
At a determined period, or maturity, the Bank calculates and accrues the “distributable” profit to the customer. If the Asset is an external investment, there will be a “market value” to be calculated (Mark-To-Market) and any early redemption may result in loss of capital/equity. In some cases, profit needs to be “realised” to be “distributable”.
Bank distributes the actual realised (or accrued) profit, if any, to the customer based on the individual Profit Sharing Ratio. The investment is either divested based on prevailing market value, or re-invested into a new tenure with new investment terms or parameters.

So you see, the Mudharaba now is defined closely into what a real investment is; capital not guaranteed, returns based on risks, and real valuation. Some will even carry redemption risks i.e. loss of capital if redeemed before maturity.

As a start, the Mudharaba Investment Account, migrated from a Mudharaba Current Account or Savings Account, will now carry their own risk profile, depending on the portfolio of the Investment Assets. It can now be categorised into:

Low Risk Investment Account – suitable for short term arrangement, with low returns instruments
Medium Risk Investment Account – suitable for a diversified portfolio
High Risk Investment Account – suitable for a targeted investment expecting high returns, and volatility

Therefore, even for a basic Current Account or Savings Account, once it is converted into an Investment Account, carries some degree of risks post-June 2015. For one, the PIDM cover will no longer include Investment-type of accounts, and while there are questions of its applicability in its current state, the comfort of such cover is now lost to the daily consumers. Having said that, ideally the Banks should reinforce the idea that with higher risk there should be higher returns. Living in the old thinking that Investment Accounts are the same as Deposits Account (Savings or Current Account) will only result in a disconnect to what BNM is trying to do.

The idea of Investment Account is not only limited to Mudharaba-type of contracts. Any contracts that carries an element of risks to the customer’s capital will be classified as Investments. The on-boarding treatment of customers into these contracts will be the same; The risks of the investment must be made known to the customer, customers must be assessed to identify the risk profile, customers must make their own decision on the risks that they are willing to take, and enter as a real investor taking real market risks. Such contracts will include Wakala Fi Isthihmar (Investment Agent) or Musyaraka (Partnership).

As a summary, what will happen in 2015 once your Mudharaba-type of account (Savings or Current Account) be converted into an Investment Account?

Yes some change will happen, and Banks will be looking to seek customers consent whether to allow the conversion into an Investment-type of account, with the additional disclosures and risk warning statements, or to convert the account into a deposit type of account. As I see it from the Bank’s perspective, the management of the funds in the account remains largely the same, with greater level of transparency needed in terms of where the customers funds are invested into (the Investment Assets), the management of returns and valuation of the assets on maturity or early redemption. Sounds complicated, but really it is not. It is business as usual for the Banks, with some additional reporting, management and compliance requirement to adhere to.

Personally, when the Mudharaba account migrates, I do not foresee a significant increase in risks to the customer capital (as it will still be managed similarly as before) and no significant increase (or decrease) in returns on their “investments”. If the Bank keeps the Investment Assets as “low risk”, there should not be any concerns to the average customers.

There will be other options available to the average investor, but the purpose of this post is to highlight to the existing “investors” that there is no panic button to be pressed. There will be a period of awareness building (reinforcement, more likely) on what “future” Mudharaba is all about, in the stricter understanding of its investment nature. But all this while, the Mudharaba structure is already being managed as an “Investment” via the General Investment pool.

The investment risks have always been there, but because the pool has been managed properly and successfully by Banks, it has become Urf’ (customary) to the customer to believe that capital is protected (when actually it should not). It really is not, as Mudharaba is always an Investment arrangement, and is reflected even in existing documentation and product terms & conditions. Now it may look like it is going to be a different animal in June 2015, however if you take a step back, it is actually an increase in disclosures to the customer on the product features; nothing more. Internal banking processes will be adjusted and enhanced to meet the additional disclosure requirements.

Investment Accounts may seems like a huge change, but it is actually a refinement of the contract requirements. It provides greater transparency to customers, and enhance their involvement in the product by understanding the risks undertaken. The definition of Investment Account has already been captured in organisations such as AAOIFI, where Investment Account and its treatment are defined. BNM is now taking steps in the same direction.

Investment Accounts may change the way you bank at the moment, but it really is a similar proposition to the Mudharaba Deposit account with eventually greater transparency and disclosure. We look forward to welcoming Investment Accounts into our midst of products available.

The Islamic Financial Services Act

Posted on April 17, 2013 by Amir Alfatakh

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

IFSA DEF

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

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

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

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

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

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

With this, the industry is turned on its head.

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

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

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

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

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

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

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

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

Learn More About Islamic Banking

Posted on July 5, 2007 by Amir Alfatakh

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Tag Archives: Mudharabah

The Investment Account

The Mudharabah, The Deposits and The Investment Accounts

The Islamic Financial Services Act

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