Bai Al Inah and Interconditionality Issues

Posted on June 19, 2020 by Amir Alfatakh

I have been asked recently on the validity on a Bai Al Inah contract that had sparked controversies many years ago by claims that it is not a valid Islamic contract that is rejected by most Shariah scholars.

What do I think? As limited my Shariah knowledge is, the position of Bai Al Inah, and its counterpart Bai Bithaman Ajil (BBA), have always been that it is a structure of 2 standalone contracts of Musawamah (simple sale) and Murabahah (deferred cost-plus sale). The intention of these 2 contracts is for the purpose of obtaining cash or working capital through creation of debt. Both contracts are executed consequentially and valid as all the tenets of the contracts are met perfectly.

SO WHAT IS THE ISSUE THEN?
Generally both contracts of BBA and Bai Al Inah suffers from the same issue ie the existence of “Interconditionality” practices in their legal clauses in transaction documents. Both contracts have 2 standalone contracts i.e. one sale contract and one buy-back contract. Both contracts must be able to stand alone and the aqad is executed sequentially, which makes it valid based on trading rules.

The Aqad for the Bai Al Inah transaction uses the Bank’s own Assets for the underlying transaction, as the customer do not have any Asset to sell to the Bank in the first place. So Banks have been using their own Assets such as pieces of land, office hardware, office furnitures, company shares, investments in securities, machines, and any other valuable Assets that is identifiable, transferable and valuable.

CONTRACT #1 – SALE OF BANK’S ASSET (MURABAHAH) TO CUSTOMER IN BAL AL INAH

These Assets are to be sold by the Bank to the Customer at a Sale Price (includes profit) and to be settled at a later date or at specific intervals. For example, the Bank sold its ATM equipment to the Customer at a price of RM180,000. This amount is to be paid back within 5 years (Deferred). This is a valid and perfected standalone contract. The debt created here remains valid until full settlement at the end of the 5th year.

CONTRACT #2 – BUY-BACK OF BANK’S ASSET (MUSAWAMAH) FROM CUSTOMER IN BAL AL INAH

The Bank then makes an offer to Buy-Back the Bank’s Asset from the Customer at a simple sale transaction where the amount will be settled immediately. As the Customer intention is to obtain Cash or Working Capital, the Customer will generally agree to the Bank’s offer to Buy-Back the Asset at the current market price. For example, the Bank offers to buy-back the ATM equipment from the Customer at a price of RM100,000. This amount is to be paid immediately for settlement. Bank takes ownership of the ATM and pays the Customer RM100,000 cash. This is also a valid and perfected standalone contract

BUT WHAT HAPPENS IF THE CUSTOMER, AFTER COMPLETING CONTRACT #1, REFUSE TO ENTER INTO CONTRACT #2 AND DECIDE TO KEEP/TAKE THE DELIVERY OF THE ATM EQUIPMENT INSTEAD? THIS REPRESENTS A RISK TO THE BANK AS THE ASSET (ATM EQUIPMENT) IS NOW RIGHTFULLY OWNED BY THE CUSTOMER UPON COMPLETION OF CONTRACT #1

Because banks want to minimise risks, the interconditionality clauses are added to ENSURE that once the first sale contract (#1) is concluded, the second buy-back contract (#2) MUST be executed (mandatory). It goes on to say that if the second buy-back contract is not executed, then the first sale contract is invalid and restitution (going back to the original state) must be effected to recover the Asset already sold; in this case the ATM Equipment.

From Shariah point of view, it is problematic, because the first Aqad for the sale contract (#1), is a valid contract and completed under Aqad which meets all its trading tenets. To impose that another external event (i.e. the non-completion of the buy-back contract) that will invalidate a valid sale contract (already concluded and perfected), implies that the whole arrangement is superficial and do not carry real value.

This must not be the case, because the Aqad is already validly executed and is now running. Thus having the interconditional clauses is not favoured by Shariah and needs to be removed.

In Summary:
1) The Sale of Asset contract is valid on completion of Aqad
2) The Buy-Back of Asset contract is valid on completion of Aqad
3) If the Buy-Back of Asset contract (#2) is not completed, the Sale of Asset (#1) remains valid as the Aqad is already completed.
4) The requirement to force the Buy-Back of Asset contract to be completed via an interconditionality clause is problematic in substance. The notion of “one contract is only valid upon completion of another contract” does not sit well with Shariah.

Of course, for Banks, removal of such clauses from the documents represents a risk as the assets used for the transaction belongs to the Bank in the first place. The idea that the Customer cannot be compelled / forced to re-sell the assets back to the bank (or banks not allowed to buy-back) is a risk banks are not willing to take. As such impasse, the only way most banks can comply with the requirements to remove interconditionality in their contracts is to remove these contracts from their shelves.

There are still some Banks using products based on BBA or Bai Al Inah, but such usage is now limited to its uses are required by design (such as restructuring an existing Bai Al Inah account) and/or mainly transactions between financial institutions (not between banks and retail consumers) where the interconditionality clauses are not required/ can be ignored.

For the public, Tawarruq or Musyarakah Mutanaqisah or Ujrah structures are now used as acceptable replacements of both Bai Al Inah and BBA products, signalling the demise of these hugely unpopular products.

Wallahualam.

The New Shariah Governance Policy Document (2019)

Posted on November 15, 2019 by Amir Alfatakh

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:

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.
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.
The Board of Directors must also assess the performance of the Shariah Committee formally, at least annually and ensure the remunerations reflect members’ accountabilities.
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
The Shariah Committee shall be accountable for the quality, accuracy and soundness in their decisions and advices.
The Shariah Committee must establish a robust methodology to guide decision making process including taking into account relevant business and risk practices.
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.
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.
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.
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.
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.
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)
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.
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.
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.
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 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 to all stakeholders. 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 for being in multiple boards, 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:

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.
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 for more than 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.
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 3 months to 6 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.

Concluding Post : True Islamic Banking is in a Cooperative Bank

Posted on November 11, 2019 by Amir Alfatakh

By Dr. Rosana Gulzar Mohd

EXCERPT : If you could reform Islamic Banks, how would it be? We would have to think along the lines of PLS since as described earlier, it is among the main tenets of Islamic Banking. PLS, if well-implemented, can result in higher financial equality and stability, thereby improving the economy. But experience shows that not everyone tells the truth so banks have been swindled. The solution perhaps lies in Germany, where for almost 200 years, cooperative banks have thrived. The way they focus on people as opposed to profits stands in stark contrast to our Islamic banks. This means funding projects that benefit the community and sharing profits with customers since they are also owners of the banks. This ownership structure has also kept non-repayments low.

In the final piece, Dr Rosana proposes that the Islamic Banking model can use to benefit exploring the existing structures of Cooperative Banks, that embodies closely what is envisioned as Islamic Banking can be. There are fine examples of what are available in Germany and Indonesia where structures are receiving good support and responses by the community. Take the opportunity to consider Cooperative Banks as an option that can meet the expectations of Shariah.

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

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

Posted on September 26, 2019 by Amir Alfatakh

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

Posted on September 4, 2019 by Amir Alfatakh

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:

New Post : Dr Rosana Gulzar

Posted on August 25, 2019 by Amir Alfatakh

Sometimes we are obsessed with an idea that we are not able to step back to take a look at the bigger picture.

This is what Dr Rosana is attempting to do, to ask us to take stock of what Islamic Banking is all about and how to recognise the need to call the model as it really is. The idea of Islamic Banking cannot be just a single textbook idea, but must consider other models that is already doing it in substance instead of just form. She intends to outlay the shortfall of Islamic Banking and perhaps offer an insight of what can be the solution to it all.

Do visit her page by clicking on the above pictures or access her opening gambit to her upcoming articles in the following page.

How About We Stop the Wayang in Islamic Banking?

INCUBATING ISLAMIC BANKING DREAMS

Posted on July 20, 2019 by Amir Alfatakh

CAN ISLAMIC FINANCIAL INSTITUTIONS DO IT ALL? MUST ISLAMIC FINANCIAL INSTITUTIONS DO IT ALL?

For the longest time, Bank Negara Malaysia (BNM) have been conducting their experiments on Islamic Banking institution to build a viable business model that can be the example to the world. Islamic Banks are naturally seen as the prudent, stable and right platform to design, build and test new structures and conditions. That exploratory mode has resulted in an industry that is not just adaptive and innovative, but also strongly built around Shariah.

EXPECTING THE MULTI-TALENTED BANKS TO DELIVER ALL THE FUTURE ENDEAVOURS.

Yet, it has not always been smooth sailing. Although there is stability in financial institutions, adding new roles and functions to the institution can sometimes result in instability, uncertainty and financial pressure. When a bank has been operating successfully for many years under a certain operating model, a new requirement will certainly result in material changes; some of which may be disruptive.

Due to the changing nature of the financial markets and the entrance of new disruptors to the industry, financial institutions including Islamic ones, are asked to innovate, adopt and adapt to remain competitive in the “new” industry.

Perhaps it is worth to list down the roles that Banks are asked to play over a foreseeable period of time, either evolving into or playing multiple roles at the same time:

TRADITIONAL BANK : Based on the old and tested conventional banking model, we are generally a traditional bank, which is a blue sturdy truck. The Bank’s commitment is to provide sales and services easily useable by each customer and the products on offer are what is very much familiar to consumers in the market. Common, generic, with some sophistication to cater for different individuals, but mostly safe products. The level of risks that is to be willingly undertaken by a traditional bank’s shareholders (capital providers) are generally low risk to medium risk. Products generally offered are Debt-Based or Sale-Based, with little risk appetite for high risk products. Risks are mitigated by pricing of products i.e. the higher the risks associated with a product, the higher the pricing will have to be (Risk Informed Pricing). Most of the Islamic Banks in the market start of this way, and still prefer this model, simply because the bank is SET-UP based on THIS model since inception. All the bank’s infrastructure is set-up to manage the operations of a traditional bank.
EQUITY BANK : Traditional Islamic Banks are the “expected” to move into the “equity investment and financing” model, simply by virtue of the notion that equity or investment intermediation is more “Islamic” than debt-based financial intermediation. While scholars are encouraged by the efforts to introduce contracts such as Ijarah, Musyarakah Mutanaqisah or Istisna’a for financing, and Mudarabah and Wakalah bi Isthihmar for investments, this does not mean that the banks are moving into “equity” structures. Far from it, as the banks, which remains traditional in nature, retains the same level of risk appetite and infrastructure. Really, what has changed from the traditional model into the intended equity model? The risks appetite from the shareholders remains low to medium, and thus not logical to undertake high risk investment and equity financing products. We are not set up like that! If you assess the contracts under the so-called equity structures, many times there are undertaking clauses (Wa’d) that allows for a debt-based recourse should things go wrong or into default. It is arguable that having some equity-based structure qualifies the bank to transform from a traditional bank to an equity bank.
VALUE-BASED BANK : What is a value-based bank? Ever since the introduction of the strategy paper of Value Based Intermediation (VBI) by BNM to re-align some of the concepts with widely-accepted global standards of ESG’s and SDG’s, the Islamic Banks have been wondering what is the best approach to move into this space. There is a fine line between CSR activities, ESG adoption in practices, and VBI which aims to be an all-encompassing standard for Islamic Banks based on the Maqasid Shariah (objectives of Shariah). Not many Islamic banks have a clear understanding of the requirements, as they are asked to service and support a narrower group of customers operating in sustainable, green, environmental friendly business, that has a positive social impact to the community, while retaining a good level of profitability. It is a small group of customers in Malaysia that is aware of the benefits of operating a “value-based” business. There is no direct incentive from financial institutions for going green. Again, the set-up of a traditional bank is to maximise returns at the lowest possible acceptable risks. Financing into industries which are green and sustainable and new tech and unconventional and requires new understanding of business model is NOT AN EASY SWITCH in thinking and credit decisioning for any traditional banks. Thus so far, Islamic Banks are only focusing on communal activities instead of financing and investment activities into the community (which is a new segment for many banks). Again, the infrastructure is not necessarily set up to handle VBI.
DIGITAL BANK : This is really a stretch to expect Islamic Banks to also look at structures involving blockchains, smart contracts, eWallets, cryptocurrencies, P2P and crowdfunding platforms. There have been many forums and seminars on these topics of Disruptions in Banking as well as Islamic Banking. There is no model to refer to at the moment. The banks are out of their element when it comes to fintech. There is uncertainty in the types products that can be offered. There are no guidelines or regulations from BNM yet. While the Digital Revolution 4.0 envisioned banks becoming a new value proposition breaking away from traditional products, the set up is again the main deterrent factor where banks are not designed for the virtual world. The Digital Bank will be more attractive to a different set of customers who are different from the Traditional Bank’s customers. It is however, trendy to be “Digital” but whatever digital transformation that we see happening today are mostly “digitalisation of existing banking products and processes” to improve efficiency and turn paperless. Converting a manual process into an automated process is hardly becoming digital. All the products and processes are still very traditional. The proper term is Automation or Digitalisation. That’s it.

WHY MUST IT BE A SINGLE ENTITY TO DO EVERYTHING?

I feel it is unfair to expect everything from the Bank. For many years Islamic Financial Institutions were asked questions such as “Why don’t Islamic Banks do more Musyarakah products or Mudarabah products?” and “We should share the risks between the customer and bank” and “Why not you help the community to give more charity?” or even “Banks shouldn’t charge profits so high but instead give interest-free loans to customers” statements.

My answer is this: Why must Banks? We are set up based on a certain criteria, with restrictions in our capital, governed by the financial ratios similar to conventional banks, able to handle only a certain type of risks, and serves a particular market segment. The idea of banks is very much different from what we envisioned Islamic Banks to be able to do. It is like a wooden box where you keep adding new stuff. It won’t expand. The new stuff WILL NOT FIT.

THIS CONCEPT OF HAVING AN ECOSYSTEM

In my last posting, I mentioned about Islamic Banking ecosystem, where different entities set up for different purposes should live separate but with connected lives. A Bank is set up to handle financing based on low-risk debt at the lowest cost of capital; leave them be. It will be unreasonable to ask them to take higher risks products while their capital is provided by low-risk investors and shareholders. There will be reluctance to engage in higher risks without higher returns.

So each institutional variation should be part of the larger financial ecosystem where each institutions have a specific role to play. Then the capabilities of each institution will be enhanced based on their function. It is true that some of the function can overlap into multiple models, but more of complimentary offering but not primary.

My suggestion: Stop asking one entity to do what they are not set-up to do in the first place.

I like this idea of an ecosystem where one party interacts and lives off other parties, at the same time contributes to other parties. If I may propose the components of the ecosystem:

Traditional Bank : Debt-Based products, SImple Products, Low Risk/Low Returns, Fixed Returns or Floating Returns, Financially Stable with observance of regulatory ratios, Service Provider, Asset Management. Highly Regulated. Product Replication and Financial Supermarket.
Equity Bank : Equity-Based products, Sharing arrangeent, Medium to High Risks, Potentially above average returns, Requires strong capital and liquidity, Sustainable business strategy needed, Investment Management, Highly Regulated, Product Differentiation compared to conventional bank offers.
Value Based Bank : Combination of Debt-based and Equity-based products. Product embedded with value elements (CSR, charity, financial inclusions, community outreach), requires strong flow of income, sustainable strategy required, micro-financing and bespoke financing, Cash Flow Management, Shariah-centric, Ethical Banking values, Product partnerships.
Cooperative Bank : Shareholders value, investment driven, community based. High RIsks / High returns, serving unbankable and micro financing and consumer needs. Sustainable income flow. Self sufficient and self generating income. Local impact. Operates outside the capital markets. Highly Regulated but different regulations. Consumer-based products. Profit and loss sharing.
Digital Bank : Outside the traditional banking environment. Core system based on blockchain infrastructure. Alternative currencies such as Ethereum and Bitcoin. Services driven, but allows for financing via crowdfunding or P2P and alternative sources. Digital contracts, smart contracts and robo-advisers. Linked into Big Data and digital Apps. Fintech based. Speed, Accuracy, Security, Reliability and continuous building of technology.
Challenger Bank: Serving the underbanked, unbanked and minority communities. High returns due to the higher risks, but potentially more lenient credit requirements. Requires high capital, and high liquidity to service the segment. Can be fintech based and offers traditional products. Serving the medium-high risks customers that is rejected by traditional banks. Less collateralised requirements.
Waqf Bank : Deploying unutilised assets and converting it into economic assets that generate returns. Potentially profit sharing arrangement as preferred method. Cheap source to generate economic activities. May be hampered by country’s regulations and mismanagement of the Waqf operator, but medium risk of default. Under-developed structure with high cash-release potential.
Takaful Institutions : A key component in an Islamic ecosystem. Provide mutual protection for member contributors and having large cash reserves for investment and funding deployment. Long term sustainability business, and strong understanding of risk and its correlation to returns. Potential liquidity provider.
Zakat Institutions : An important wealth aggregator and distributor. Set up to cater for very specific segment of the market aimed at improving the economic condition of the segment. Potential source of funding for the economy.
Fintech and Crowdfunding : An alternative digital solution aimed at providing greater access to liquidity and funds at the fastest and most efficient manner. Higher risks but will serve a certain segment, similar to venture capitalist structures. Potential Disruptor.

BUILD THE ISLAMIC BANKING ECOSYSTEM

Since no one is telling, let me suggest what do we need to have a working Islamic Banking Ecosystem.

Interbank Market – While liquidity is available in the real world, a mechanism should be designed to flow money from the interbank physical into the blockchain digital.
Financial Institutions Model – There could be various financial institution models but each must have clear objectives and reason for being. Be specific and focus in building capabilities. Overlap can occur but generally each institution must focus in a single purpose.
Fintech – Fintech must be the bridge between the real world and the blockchain digital world. Apps must be able to transfer money seamlessly and link to relevant records. All fintech development should focus on linking the two worlds.
Interconnectivity – All elements in the blockchain and all financial institutions must be linked to facilitate transactions between both staging areas.
Alternative Structures – There are still many underdeveloped structures that lives in a very small space. It is not greatly promoted or known thus letting it gather dust. Some great ideas may have been overlooked or demised but the industry must relook and ask how much does such structures contribute to the overall economy.
Products – Products in both Digital world and Physical world may look and function differently because of the infrastructure they are in, but both Digital and Physical MUST be able to talk to each other despite the difference.

SUMMARY

Stop asking the Islamic Financial Institutions to load on new structures, concept or products that are not suitable for them. Develop infrastructure in separate operating model with the resources available that can fit into the overall ecosystem. Let those models grow side by side with the rest of the financial institutions in the same space. A financial ecosystem needs to be built where all the important components and institutions are linked and working together for a single purpose : to build a sustainable ecosystem for financial institutions.

Making Islamic Banking Resilient

Posted on July 15, 2019 by Amir Alfatakh

Recently, I was invited to be part of a panel to present our views at the International Islamic University of Malaysia (IIUM) on how to make Islamic Financial Markets resilient. With great excitement I prepared my slides (panelists are given 20 minutes to present) and tried to figure out the best approach to present it in such a short time. However, when the session came, due to time overshoots and constraint, me as the last speaker was only left with 10 minutes. I had to make it count, so I talked fast.

Afterwards, however, I do not feel as if it was mission accomplished. Time was too short for me to put my argument properly and I had to drop many points in fear of cramming too much information into that 10 minutes. So I decided to post my slides up, and make a proper short commentary on what I meant to be communicated. Bear with me.

The Financial Industry Must be Resilient

STABILITY : The public must be confident on the resilience of the financial markets where the public is assured that there is not misconduct of public funds in the day to day operations of the banking industry. BNM has put in great lengths to ensure stability via sufficient capital, liquidity and funding. The operations of the bank must always meet the statutory requirement on financial stability with the introduction of the Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR), Rate of Return Framework (ROR), and Risk Informed Pricing.
SUSTAINABILITY : Any business, must intend to survive in the long run. Selecting your customers are important, and risk mitigation mechanisms must be available to defend the business. But at the same time, re-investment of profits must also be made for future growth, so it is a balance to be maintained.
INTEGRITY : As Bankers, integrity always plays an important, and fundamental, part. But Islamic Bankers, another layer of integrity is also imposed which is Shariah. Banks are expected to be more and more of a moral champion in support of the various SDGs and ESGs where the idea of being good will eventually lead to better profits and prosperity. BNM’s Value Based Intermediation aims to expand the role of banks to be more than just profit driven, but more inclusive to embrace a wider range of customers and cater for their needs.

The Challenges are manifold.

Being resilient is always a challenge for the Banks, especially with so many moving parts in the financial world. New regulations, new competition, new structures, new products and new models continue to plague the banking industry. To change our mindset to make Banking and Financial Market more better requires a lot of soul searching and will power to make the change. I summarised the challenges into 3 broad categories:

Consumer Market. Any major change in the banking model is not taken well by the consumer market. Customers come to the Bank mostly for advise on their banking services. The Banks struggle to introduce differentiating products, from the debt structures and into the thought of creating value through investments. I am not sure how successful introducing the VBI into the consumer market, but the has been a lack of awareness programmes to introduce to the public.
Corporate Market. Corporates are driven by profits and benefits. It is their core function ie to increase shareholder value.
Financial Markets. We lack sufficient financial instruments in the market. That is why the industry can only grow organically. It needs the strong-will to pump more capital into the market and creation of structures that do not mirror the conventional books.

The Reality is that Traditional Banks need to keep up.

Traditional Banks. Heavily regulated to ensure financial stability. But the speed of adaptation to new thinking and new technologies are too slow. It is high cost to make the change, but also it is high cost just staying where you are. Ask Nokia. If all Islamic Banks do is replicate, they are in danger of becoming obsolete in the near future.
Challenger Banks. Provides alternative banking structures or arrangement, with little or no hassle, with or without the use of technology. A lot of customers now by-pass banks to opt for the most convenient and fast banking products. With very minimal regulatory requirements.
Digital Banks. This new breed of banks are definitely very interesting. There are two differentiators i.e. 1) Banks that only digitalise their processes and paperwork and speed, but the fundamental bricks are the same, and 2) Banks that try to be different and offer a totally new proposition with a new set of bricks. Yet, Islamic Banks are expected to do all and adopt more stringent requirements when entering into the Digital space, while dealing with old issues such as constructive ownership and Aqad. More importantly, these issues can probably be resolved by NON-BANKS, offering the same terms and conditions, sometimes with slightly better proposition such as speed, accuracy and low cost. For example, big data companies such as Facebook and Grab intend to open their own “bank”. Facebook just launched its Libra bank trading in cryptocurrencies. Grab is rumoured to enter as well and these Big Data companies already have their database of ready customers for them to roll out their Digital Banks.

Stop Looking at Your Feet. Stretch out your hand and move to touch new Horizons.

A lot of discussions have been held between the academia and practitioners. It seems we are always looking ways to innovate and integrate into the future, but without any real solutions on how to actually do it. As mentioned, the will-power to affect change remains a huge challenge. Instead of “What Is….” to be turned to “What If…” where solutions are always been discussed and developed for a solution, and “What Next…” clearly implying the shift in banking products from traditional to new developments.

It is no longer sustainable to just replicate. True innovation is on the rise. New solutions are needed to be offered to the customers.

The Next Generation bankers must familiarise themselves with all the blockchain and Internet of Things language and terms currently floating around. More importantly, there should be a look at the whole ecosystem to see where the Shariah elements can be included, and where others must be excluded. Collaborative discussions, between regulators, academicians, practitioners and Shariah scholars must work together for the growth in the industry. It is not just any growth, it involves a total paradigm shift to adopt the new ecosystem.

There is a need to differentiate and upscale the business practices. While we continue to focus on the Traditional Bank in making it more resilient, we might miss this opportunity to join the Industry Revolution 4.0 to revamp Islamic Banking and overlook the threats coming from other financial institutions (NON-BANK). This is the Banking disruption in real life.

Ethica’s Handbook of Islamic Finance

Posted on June 15, 2019 by Amir Alfatakh

One of my favourite places on the web is the Ethica Institute of Islamic Finance i.e. ethicainstitute.com

Over the years, this website has grown in content and there’s a lot of discussions taken up in the website. At a risks of sounding bias, having the quality of content similar to Ethica’s is something my blog would aspire to.

One of the recent contribution by them is the publishing of the eBook on Islamic Finance, which is freely distributed provided it is not being used for commercial purposes and fortunately (or unfortunately for me) my blog is a non-commercial one. So here it is, posted for your own reading pleasure, Ethica’s Handbook of Islamic Finance.

Click below picture to download.

Click on picture to check out other books

Shariah Resolution in Islamic Finance (SAC BNM 2nd Edition)

Posted on June 2, 2019 by Amir Alfatakh

One of the more important books that we usually refer to is the Shariah Resolutions in Islamic Finance issued by BNM. A lot of issues that we usually faced in designing a product has actually been deliberated at length as evidenced in the book. Useful guidance for all.

Resolutions of Shariah Advisory Council of BNM 2nd Edition

Waiting for the softcopy of the latest edition. Please send me one!

To get more books, click on the picture.

Bank Islam’s Application of Shariah Contract in Islamic Banking Products and Services (2013)

Posted on May 15, 2019 by Amir Alfatakh

In conjunction with Bank Islam Malaysia Berhad’s 30 years anniversary (Bank Islam was established in 1983), the kind bank decided to release this useful book of knowledge of the various structures they have in the Bank for the public. Perhaps produced as a gesture for publicity and a bit of chest-thumping, but it is a useful insight on the mechanism that the bank use in its day-to-day operations. And it is written is simple language and illustrated to provide simple understanding, it can be a useful reference to new learners of Islamic Banking contracts and structures.

Have a read and you can get valuable insights on the simplicity of Islamic banking products and services.

Note: This booklet is written prior to the introduction of the Islamic Financial Services Act 2013 (IFSA 2013) so while some of the terminologies may now differ, conceptually I do not see any significant variations to the structures now prevalent in the market.

Download your copy of the Application of Shariah Contracts in Islamic Banking Products and Services (2013) here or on the picture above.

For More Books, click on below picture

No Pork No Lard : The Shariah-Neutral Transactions

Posted on January 30, 2019 by Amir Alfatakh

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?

Posted on January 23, 2019 by Amir Alfatakh

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

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.
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.
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.

E-Wallets : Did You Forget Us Again?

Posted on January 15, 2019 by Amir Alfatakh

THE SHARIAH CONSIDERATION FOR E-WALLETS AND PAYMENT APPS.

Apps are everywhere. Everyone has a mobile phone where people start to get used to online banking, e-money, e-wallets and e-payment. All at the touch of the screen. I use it extensively and there are a few very convenient ways to survive a city without the need of actual cash in your wallet. Everything is digital and floating somewhere out in the clouds.

As I no longer use credit cards, I relied heavily on Debit Cards as my main payment medium which is linked to my Islamic Current and Savings Account. So the Debit Card deducts the amount from my account for each purchase for settlement. Technically, it is a Service (Ujr) where the Debit Card serves as a payment instrument, linked to the account based on Wadiah or Qard or Tawarruq or Mudarabah.

But at the same time, I am all-in into the tech-thingy as well. And no doubt, there must be a future in these thingies… For the past few months, I have been using these few apps. Here is a short review of 2 apps that I have to admit as my favourites.

Boost was one of the first eWallet that I downloaded. It requires me to “fund” the wallet, and when you make payment using the money in the eWallet, you can shake your phone to get “digital rewards”. So far, I have only gotten maximum RM2 for my phone shaking, with the promise of random potential rewards. I am motivated to shake, maybe I can win the grand prize (it changes from period to period). What is the Shariah contract here? Boost eWallet is funded from my Islamic bank account, so what is the contract for the eWallet? Is it a Qard (loan), or Wadiah (safekeeping)? We potentially may get a return (profit?) after a purchase by shaking our phone. Is that considered discretionary returns i.e. Hibah? Promised returns? In a way it is a promised returns but the amount is based on luck. And what does Boost do with our money when we are not using it and is it used for Shariah compliant purposes? Is it potentially a Musyarakah (partnership) or Mudarabah (profit-sharing) arrangement as customers are the Rab Ul Mal (Fund Provider) and Boost is the Mudarib (Manager) or Shirkah (Partnership). The Capital is guaranteed so it is maybe a deposit arrangement. The fact that we can transfer it back to our account sound like it is a Qard arrangement where we can ask our cash back on demand. But getting to shake for a guaranteed reward (even though it is RM0.20) may pose Qard as problematic for offering rewards.

Fave is another app that I use, which is slightly different from Boost. Where Boost is an eWallet, Fave is a Payment Gateway where the cash is taken directly from your Bank account to settle a purchase. And depending on the merchant, you get cash back on your purchases which could be deducted from the your next purchase amount, ranging from 5% to 10% (some don’t offer cashback, but rarely). In Fave’s case, Fave do not retain any cash from you, as your cash still remain in your Bank account. So Fave seems to be more of an Ujrah arrangement, where we presume the service fee is collected from merchants instead of you. To encourage you to use this App so that Fave collects their fees, Fave gives the cash-back based on % of your purchases which seems like Hibah (gift) to me. For example, I pay for RM100 and gets a “cash-back” of RM5 for my next purchase at the merchant, so that sounds like a gift. Or is it a commission that we get for using the App, redeemable for the next purchase? I don’t know.

THE SHARIAH IMPLICATION

When we use these Apps, it is not clear the modus operandi of the operator and it seems obvious that no Shariah consideration took place on the usage as well as the contractual relationship. Should there even be any consideration or is it necessary?

In my view, a lot of products and services in the market fall into the category of “Shariah Neutral” instead of Shariah Compliant / Non-Shariah Compliant. For example a transaction may look like an Ijarah where the payment is based on rental but its documents may not be completed or contain all the tenets of the contract. Without the elements of all the shariah tenets, will it fall into either Shariah-neutral or non-compliant?

The question : If the transaction is Shariah Neutral, is there any requirement to look at by Shariah scholars? How do we decide if it is Shariah Neutral and therefore should be ignored from Shariah oversight?

Have Shariah Scholars considered the digital world or are we still only concerned on the traditional products to see their process validity and documentation? I feel there is a growing gap of what we see developing in the fintech, mobile banking and digital commerce space where Shariah may or may not have an issue on.

For example, the issue of Aqad in the digital space. The questions that I have are the following:

Are the minimum tenets the same between a transaction between people, and a digital transaction? For example the tenets of a Murabahah in the digital space. Buyer / Seller / Price / Asset / Offer Acceptance. Will the tenets in the physical world still apply in a digital world?
I presume the Buyer is the customer. But the Seller is a program that shows a picture of a product and is automated. Will the Seller as an Apps (representing the Seller) qualify as a real seller under the tenet? Generally I would think so but the responsibilities of the Seller must be clear somewhere.
Would an Apps Pop-Up notice sufficient to conclude an Aqad. These are sequential programming that gives notice/remark at certain points and can be timed to meet Shariah requirements. Is this sufficient for Shariah?

Maybe I have been too distracted by work that I have missed these discussions, if it has happened before and concluded.

SHARIAH NEUTRAL : IS THERE A NEED TO VALIDATE?

As far as I understand it, Shariah Neutral means a product or services that is not breaching any Shariah rules or prohibited items in its execution. For example, a remittance service, where the customer gives cash to a remittance company to transfer the amount to another party. The company provides a service and earns a commission for the service. There are no prohibited elements in such service even to the point that generally the tenets of the contract are deemed as embedded in the processes, intention and basic forms and documents. You don’t see the arabic terms or formal contractual relationships mentioned; by virtue that there are no prohibited elements, we deemed it Shariah sufficient.

WHAT IS SHARIAH’S REAL VIEW OF SHARIAH-NEUTRAL?

I may be ignorant in this area, but what is Shariah’s view on Shariah-Neutral transactions? Why is it deemed that certain transactions requires a written / documented contract with all relationships and responsibilities outlined and agreed upon for it to be Shariah-Compliant, while others are okay to remain in a Shariah-Neutral state and still be acceptable? What is the deciding criteria for qualification of Shariah-Compliant?

As we move into the digital world where buying and selling online become a norm, and payment of goods and services are effected via a mobile app, is there a need to see whether there is any presence of prohibited elements in the transactions? Is there a need to decide if there are elements of a Riba (usury), Ghrarar (uncertainty) or Maisir (gambling) in the transactions? How about justice, fairness and trickery in the documents or operations of a mobile commerce? Is it safe to assume at least Shariah-Neutral and therefore Shariah scholars can skip looking into it?

Can I now design a product that on the outset can look and feel consistent with a Shariah-Neutral approach? With more and more Apps for commercial transaction being introduced, should I start to think about avoiding the prohibitive elements, without the need of complicated documentation and Aqad? As long as it avoids the prohibited elements, I guess it can survive unquestioned.

Does Shariah have a view on Shariah-Neutral transactions? How far do they see to decide if a transaction is Shariah-Neutral and therefore “outside” their jurisdiction.

SUMMARY

As we look forward to living into a progressively digital world, I cannot help but wonder on the necessity to have Shariah oversight online. The Apps developer won’t be going to Shariah scholars to get Shariah endorsements anytime soon, but are they aware of what they developed contains any prohibitive elements from Shariah? Often we are left out of such discussions; perhaps we ourselves feels such development falls into Shariah-Neutral and therefore requires no oversight. But then how do we decide how it falls into Shariah-Neutral territory? Are there checklists we can refer to?

These are the things that comes to my mind while I wait in line to purchase my next drink. And wondering how much I will get from shaking my phone for the rewards. I am hoping for something more than RM5 this time. Happy shaking your phone. What a different world we are living in now. Wallahualam.

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

Posted on January 9, 2019 by Amir Alfatakh

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

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

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

WE ARE STILL READING OLD BOOKS AND ARTICLES

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

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

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

SO, WHERE HAVE WE GONE TO SINCE 2011?

In short, we have moved to the following contracts:

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

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

UPDATE YOUR STUDY NOTES, PLEASE

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

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

Steering a Shariah Decision

Posted on December 30, 2018 by Amir Alfatakh

Click on above picture to download the article in pdf

HIDDEN TRAPS IN SHARIAH DECISION MAKING

I came across an interesting article titled Hidden Traps in Shariah Decision Making by bro Ehsanullah Agha (click on picture for full pdf article). The article summarises what we product developers have known for quite some time now, and has now become necessary tools in ensuring the products we design are approved by our Shariah Committee. It summarises the involvement of Shariah in decision-making in an IFI, as well as some of the “traps” that Shariah Committee falls into when making decisions.

The 4 “traps” mentioned are:

Anchoring an opinion
Adhering to the Status Quo
Confirming Evidence to support a decision
Framing of information

While the above is referred to as “traps”, I would rather refer these as “approaches” to solicit a decision, and perhaps all the above can come together (not exclusively) in considering a decision. Reading the above exclusively may give the impression that a product team can resort to a specific tactic in order to extract a certain decision. Admittedly, there are such cases, especially where management requires a specific decision to support a business. But Shariah Committees are often expected to be the gatekeepers for such decisioning.

A quick comment on the above points:

Anchoring. While product teams do not consciously try to anchor an opinion before presenting to Shariah Committee, we often do so to provide perspective on the rationale for such proposal. This can be done by highlighting a crisis or regulatory danger to support the proposal. It becomes the baseline discussion point during the deliberation stage. And we do it to keep the discussion in focus to achieve the objective ie resolving the crisis.
Status Quo. By far this is one of the main consideration of an approval by Shariah Committees. Usually we call it Urf ie customs or acceptable market practice on a certain product behaviour. Personally, decisions based on Urf is not something I prefer but it is sometimes necessary to quote as such, especially if there is no major criticism on its usage and practice by the public (which also includes religious scholars). There is nothing wrong with accepting the norms of the society; my only contention is that I may not fully understand the deliberation points when such decisions are made by other parties for the fear of missing out a critical argument that should have been known and resolved by my team. Two things come to mind; Ignorance is bliss, and Blind leading the blind.
Confirming Evidence. This is also a key point where a certain decision is preferred over the other. When there is a bias for arriving at a certain decision, the product research, analysis and design (including practicality in operations) are equally biased in finding evidence to support reaching of that decision. Rightly so as mentioned in the article, the evidence to support the contract of Bai Inah in Malaysia is generally extracted from the Shafie school of thought while sidelining the rest of the opinion that is equally valid. The evidence provided for the acceptability is biased to enable the consideration to approve the structure.
Framing. In my opinion, framing is a necessary tool for product development teams simply due to the amount of information available in the market. While we understand the need for a robust deliberation session with the Shariah Committee, the forums available to us (and the allocated time given) are usually restrictive. To go into full academic and technical discourse will be challenging especially when a quick decision is required. The information that we provide are those we deemed most relevant to support the proposed solution. There may be other decisions that the Shariah Committee can arrive at, if only we had provided more information. But the danger lies where the inclusion of too much information may result in indecisiveness or confusion. Sometimes too much information clouds the real issue further, and it takes time to bring things back into focus. Therefore, we frame the information relevant to the issues. The intention is not to exclude, but to include what is relevant.

A GOOD DECISION COMES WHEN ALL PARTIES ARE ENGAGED

When a product team goes into a proposal, discussion or request for a certain decision, the Shariah Committee is expected to be conversant with the topic at hand to be able to engage in a meaningful discussion. The product team brings in the technical requirements, with some general Shariah background information, market analytics and practical implication on process requirements expected by Shariah. The Shariah Committee must bring in their expertise in Shariah knowledge to dissect and analyse the team’s proposal, not just what is being presented as information but also the rationale, the intention and the technical nuances proposed for the product.

Asking the right question is important for the Shariah Committee, just as providing the right context and intention is also important for the product team. In general, the product team must not go into a Shariah proposition with the intention to manipulate, coerce or blindside the Shariah Committee into a “business” decision. The effort must show full consideration in compliance with Shariah. As much as the heavy burden placed on the Shariah Committee shoulders are real (with fines and jail-time outlined under IFSA2013 when there’s failure to execute their duties), the same burden must also be felt by the IFI’s product team whenever a product is being designed and launched. The people I work with, I see strong commitment and awareness on the need to do the right things, all the time.

WISH LIST FOR 2019

It is easy to expect Shariah Committee to be well versed in all aspects of banking and finance when the decision is required. And it is also easy to expect product development teams to be fully aware of all “relevant” information to be able to share them objectively with the Shariah Committee. Such an ideal scenario will mean all parties come to the table fully aware of all the potential issues, with sufficiently extensive information and in-depth theoretical research to support all the argument. This does not always happen in real life.

I believe the only way to bridge this expectation is to significantly increase the knowledge of all parties. We see this starting to happen at the Shariah Committee level where BNM now encourage at least 1 industry expert to sit in the Shariah Committee, even without a Shariah background. This is to promote knowledge sharing and a different point of view during decisioning, and take notice of any attempts to coerce a decision.

On this same vein, I believe the next natural step is to have Shariah-trained individuals to become product developers in IFI. Most Shariah-based graduates that we see, enter into the banking world via the Shariah department. But how about entering other departments such as sales, credit or more importantly product-development? Such background knowledge in Shariah may itself force a self-regulating approach when designing a products. The Shariah arguments will be the first filter when assessing a product; if it fails at that filter, it will not see the light of day. And Shariah Committee can take some comfort that the Shariah deliberation has already started at the onset of the product development process.

I have seen some impressively good work done by Shariah-based product developers. This should be the way forward in finding new Shariah-compliant banking solutions. Hope I get this wish next year. Looking forward to 2019.

Two Types of Rebate (Ibra’) for Sale-Based Financing

Posted on September 12, 2018 by Amir Alfatakh

UNDER ISLAMIC FINANCE, YOU HAVE TO PAY FULL SELLING PRICE NO MATTER WHAT.

One of the misconceptions that plague the Islamic Banking financing in Malaysia is that once the Customer agrees on a price in an Aqad (Offer and Acceptance of Sale & its Terms), there is no backing out of the Selling Price and other considerations. If a house at current Value of RM400,000 (Principal) is purchased from a Bank at a Selling Price of RM1,000,000 to be paid in instalments over 35 years. This means the profit earned by the Bank over 35 years is RM600,000. The misconception is that when the Customer intend to Sell-Off or Pay-Off the financing in let’s say Year 8 of 35, the whole amount of RM1,000,000 must be paid to the Bank due to the concluded Aqad, where RM1,000,000 is contracted. So, if at year 8 the Customer has paid a total instalment of RM110,000, the remaining RM890,000 is still payable by the Customer. Whereby the Principal Outstanding for the Financing is RM320,000 in this scenario.

For a Conventional Loan, the amount payable is the Principal Outstanding of RM320,000 + any interest outstanding (earned but not yet paid) + any early settlement penalties.

(The above figures are for illustration only. For a more accurate calculation, scroll down to the examples below)

SETTLEMENT OF THE SELLING PRICE.

Because of this misconception, a lot of Customers think that a Shariah-compliant financing is More Expensive than the Conventional Loan. This is just a half-truth. While the Selling Price Outstanding is RM890,000 as contracted in the Aqad, Islamic Banks are required to provide “Rebates” (Ibra’) on the Selling Price Outstanding to be fairer to the customer. Although entitled to earn the full amount of Selling Price from the Aqad, a Rebate on the Selling Price should always be given.

HISTORY OF GIVING REBATES

Traditionally and by nature, Rebates are discretionary on the financier, to be given to the Customer as the Aqad allow for the collection of the full contracted Selling Price. To achieve parity with the Conventional Loans, Islamic Banks have opted to give rebates on the Selling Price, based on their discretionary calculations. This may include early settlement penalties or other charges, which improves the Bank’s profit ratio. This has resulted in inconsistencies to the amount of rebate given; one Bank may charge differently to another.

MAKING REBATES MANDATORY

BNM issued a Guideline for Rebate (Ibra’) for Sale-based Financing in 2011 to address this inconsistent practice by making it MANDATORY (not discretionary) for Islamic Financial Institutions to provide rebates under specific scenarios. Under the guidelines, a specific formula is given for 2 scenarios where rebate may arise:

Rebate arising from differences between the contracted Ceiling Profit Rate (CPR) and the Effective Profit Rate (EPR).
Rebate arising from the waiver of Unearned Profit due to Early Settlement of Financing.

REBATES ON THE CEILING RATE

This is applicable where the structure allows for pricing based on floating-rate, usually prevalent for long term structures such as a 30-year home financing. The structure allows for the customer to be charged based on a floating rate ie prevailing market rate which moves in tandem with the various base rate benchmarks. The benchmark can also be a conventional pricing rate that moves with the market. For example, the prevailing rate consists of a Base Rate of 4.05% + Margin of 1.45%, giving us an effective rate of 5.50% pa.

Therefore:

Financing Amount : RM1,000,000
Base Rate : 4.05% (moving rate)
Profit Margin : +1.45% (fixed or movable based on event)
Effective Profit Rate (EPR) : 5.50%.
Tenure : 3 years
Instalment Amount (EPR) : RM30,195.90 per month

However, for the purpose of Aqad, all the terms must be agreed upon execution and perfection of Aqad. If the Rates are moving, how can all the rates be agreed upon up-front? Thus there is a need to agree on one Rate where Islamic Banks can conclude the Aqad with an agreed-upfront Selling Price. To conclude the Aqad by formalising the Selling Price, the following is required.

Financing Amount : RM1,000,000
Base Rate : 4.05% (moving rate)
Profit Margin : +1.45% (fixed or movable based on event)
Effective Profit Rate (EPR) : 5.50%.
Tenure : 3 years
Instalment Amount (EPR) : RM30,195.90 per month
Maximum Ceiling Profit Rate (CPR) : 10.0% (fixed)
Installment Amount (CPR) : RM32,267.19 per month (unchangeable if higher than 10.0%)
Maximum Selling Price (CPR) : RM1,161,618.74 (unchangeable if higher than 10.0%)

Therefore, for the purpose of Aqad, where every detail needs to be agreed upfront, the following is used:

Financing Amount : RM1,000,000 (fixed)
Tenure : 3 years (fixed)
Maximum Ceiling Profit Rate (CPR) : 10.0% (fixed)
Installment Amount (CPR) : RM32,267.19 per month (unchangeable if higher than 10.0%)
Maximum Selling Price (CPR) : RM1,161,618.74 (unchangeable if higher than 10.0%)

And for the purpose of day-to-day charge of Instalment and Profits, the following applies:

Financing Amount : RM1,000,000
Base Rate : 4.05% (moving rate)
Profit Margin : +1.45% (fixed or movable based on event)
Effective Profit Rate (EPR) : 5.50%. (moving rate)
Tenure : 3 years (fixed)
Instalment Amount (EPR) : RM30,195.90 per month (changeable based on EPR or events)

This means, the Aqad we have contracted is based on CPR of 10%, but on day-to-day basis, the EPR is 5.50%. Therefore, Rebate on the Ceiling Profit Rate is:

10.00% less 5.50% = 4.50%

In value, the monthly rebate is RM2,071.29 and TOTAL rebate based on Price is RM74,566.27

REBATE ON EARLY SETTLEMENT

The second element of misconception was what mentioned earlier. That to early settle you have to pay ALL the remaining balance of the contracted Selling Price. This proved to be a major contention by customers, although it is NOT TRUE in Malaysia.

Mandatory Rebate must be given in the following early settlement scenario, and a penalty for early settlement cannot be imposed as it will be deemed as trying to earn additional profit on top of whatever profit is rightfully yours. Upon early settlement, the Unearned Income or Profit must be waived from being charged to the customer. A Bank can therefore claim profit that is rightfully theirs ie “earned”.

The scenarios where mandatory Rebate must be given are:

Financing when early settlement has occurred including from prepayments
Financing where there is a restructuring into a new financing contract
Financing settlement in cases of default
Financing settlement where the customer cancels or terminates the financing before maturity date.

Looking at the above example, the illustration is as follows:

Principal Amount : RM1,000,000
Selling Price : RM1,161,618.74
Total Profit : RM600,000
Tenure : 3 Years
Early Settlement Date : Month 22 of 36 months
Total Instalment Paid as at Month 22 : RM664,309.84
Outstanding Selling Price on Month 22 : RM497,308.90
Outstanding Principal on Month 22 : RM408,559.26
Earned Profit Not Paid on Early Settlement Date : RM2,001.79
Unearned Profit Outstanding on Early Settlement Date : RM14,183.36 (AS REBATE)

Therefore for Early Settlement, the numbers are:

Early Settlement Amount is RM485,127.69 on Month 22 i.e Outstanding Selling Price (+RM497,308.90) less Unearned Profit Outstanding on Settlement Date (-RM14,183) plus Earned Profit Not Yet Paid on Early Settlement Date (+RM2,001.79). This amount is at par to what a Conventional Loan figure for Early Settlement would be. In fact, in some circumstances, a Conventional Loan figure may include additional Early Settlement Penalties that generally are not allowed under an Islamic Banking financing.

EARLY SETTLEMENT PENALTIES

In essence, Islamic Financing is govern by the understanding that debt must be settled (debt cannot be forgiven) and efforts to repay debts early should not be taken as opportunity to earn additional returns. If actual cost is incurred from the early settlement of the debt, that cost can be recovered but not additional income. Under the Ibra guidelines, it allows the Banks to charge reasonable estimates of “Actual Costs” incurred if early settlement is made within a “lock-in period” based on the following conditions:

Costs that has not been recovered arising from a discount element in a specific period in the financing. For example, the Bank offers a Home Financing rate of 1.88% p.a. for the first 2 years and BR+1% thereafter. The reasonable costs in this case is the differential between BR+1% less 1.88% ie the shortfall from the promotional period against normal board rates.
Cost borne by the Bank during initial stages of the financing for example Legal Fees absorbed by the Bank. If the package offers a Zero-moving cost solution, it means the Bank pays the legal and stamping fees for the customer to move from the other Bank. The cost will be recovered by the Bank.

Consequently, any reasonable costs incurred by the Bank as a direct result of the Early Settlement can be considered to be recovered by the Bank. The Shariah Committee of the Bank can take into consideration to approve the request to charge such fees, based on acceptable justification. This includes any “break funding costs” incurred by the Bank.

CONCLUSION

The common perception is that for Islamic Banking products in Malaysia, the Selling Price (which includes future profits ie Unearned Income) must be paid to early-settle an Islamic Financing is inaccurate. Currently, there are provisions to waive the unearned profits from the final settlement amount as guided by BNM. In essence, the settlement amount should consist of only the Outstanding Principal Amount + any due amount or earned amount still outstanding on the settlement date. This means, the settlement amount for Islamic Financing is NOT more expensive than a conventional loan, and in some cases, is even cheaper than the conventional settlement amount.

Risk Management in Islamic Banking

Posted on June 1, 2018 by Amir Alfatakh

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

Posted on April 21, 2018 by Amir Alfatakh

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.

Sadaqa House : The Crowdfund That Could Circulate Good

Posted on April 19, 2018 by Amir Alfatakh

HOW TO CROWDFUND GOOD?

Little by little, we learn there are many ways to spread good. I recently had a sit-down with Umar Munshi (EthisCrowd) and we had a fine chat. About his new project, Sadaqa House with Bank Islam, which aims to collect donations to support good causes, such as funding for a child’s operation (with the National Heart Institute of Malaysia), and other small infrastructure projects. Some of the causes are well funded, but some still fall short. But what it shows is that; if the cause is believably genuine, it may well get to raise the funds it needs.

This initiative is not so much different from the Tabarru’ concept of Takaful, which means mutual assistance using donations, and it can achieve so much more than Takaful.The idea of Takaful is “the many contributors helping the few“. Here, in the EthisCrowd space, the understanding is that it is “the many contributors helping the one“. For example the funding of the operation’s cost of a heart patient (child) where the contributors of funds are asked to fund the cost of getting heart treatment. It is basically a rougher/simpler form of Takaful.

Well I say job well done, and this is testament to the power and innovation of Islamic structures where it can go further than just collections, finance and banking functions. It espouses the concept of mutual assistance and takes it to the next level of donation-giving. It is purposeful, transparent and convenient. My first experience was that the whole process of donating is seamless and easy. I urge friends to give Global Sadaqa and Sadaqa House a try and maybe spread a little cheer to the needy. The initiatives are simple and it helps spreads goodness in people’s heart (no pun intended!).

I do applaud the efforts by EthisCrowd because it does really provide an alternative platform where there is funding facilities outside the safe confines of a banking institution. With Global Sadaqah, hopefully charity is taken to a new, higher level where donations are hard to come by (as they provide no monetary gain to customers). This is where appealing to someone’s religious or moral consideration play its part in attracting individuals keen on doing good, even from Non-Muslims individuals. At the moment, they have amassed a huge number of followers / community to support their initiative, regardless of race and religion.

But most of all, this platform is easy to use and this is what Islamic fintech should be; to provide easy & mobile access to the unbanked segment while adhering to the requirements of Shariah for solutions that work.

Hopefully we see more spreading good initiatives championed by Islamic Banking entities and Institution that cares about the growth of Islamic finance while helping communities. May we find more ways to see these initiatives become successful in the future. Wallahualam.

The Deposit Battle

Posted on April 12, 2018 by Amir Alfatakh

IT IS FAR EASIER TO FINANCE SOMEONE THAN HAVE SOMEONE FINANCE YOU.

It really is easier to build a financing book than a deposit book in Islamic Banking. Companies and individuals constantly seek for financing but when it comes to deposits, it really is a price war. Banks are looking to outdo each other with tempting deposit packages to attract the most cash-rich customers they can get.

But I do not blame Banks for this fight for deposits. Deposits are a part of the whole infrastructure that is required for Islamic Banking. Sources and Application of Funds make up the basis of Mudarabah and Musyarakah, and also other available contract. While the Application of Funds (Financing and Investments) have always seem to have been growing well in the market, the Sources of Funds on the other hand, is always seemed to be struggling.

Technically, the cheaper the cost of a Bank obtaining their deposits, the better it is deployed into various types of financing at a lower pricing where the profit margins can be maintained. The dream will always be to figure out a way to get cheap deposits.

APPLICATION OF FUNDS

It is not to say it is very, very difficult to build a significant deposit book, as you can always “throw” the highest rates onto your Tawarruq deposits, and customers will flock. But more importantly, the funds must be “applied” and “used” in the most ideal way. It is not to say that building deposit products using high pricing will necessary be useful for the Bank as it will be an expensive deposit-building exercise. Bear in mind these deposits should be ideally used to finance/invest into the right types of assets. For example, what type of deposits is most suitable for a 30 years Home financing product? Is there a 30-year long deposit that will fund the 30-years Home financing? If not deposits, what type of funds is ideally used for 30 years financing?

So, can a Current Account / Savings Account fund a 30 years financing? Current Account / Savings Account are very fluid type of accounts, with no tenure restriction and usually available on demand (at any time the customer can withdraw the funds). There will be a tenure mismatch of daily redemption allowed (1 day tenure) and the house financing is paid over a period of 30 years. 30 years financing funded by 1 day deposits? This is a huge gap that on the surface, impossible to resolve.

But the answer is really simple. It all depends on the behaviour of the deposit products. You would think the most appropriate deposits to fund a 30 year financing is the shareholders funds, and that is always a limitation. Maybe raise a 30-year Sukuk but you don’t raise Sukuk just like that; it takes a lot of effort to launch a Sukuk. Or try to find a 5-year investment instruments, but that is a challenge as well.

CORE DEPOSITS VS NON-CORE DEPOSITS

As mentioned above, it depends on the behaviour of the products, or more accurately the portfolio. Within the various types of Deposit products, you can further split them into Core Deposits, and Non-Core Deposits (Variable, transactions, short-term). We understand a lot of customers do withdraw their cash, whether on needs basis, transfers and payment. But if you analyse the portfolio further, you can identify a minimum amount that is always in the account. For example, if you analyse a Current Account portfolio of RM1 million every month, you may find a certain minimum balance is present at a constant, continuous level e.g. RM400,000 is always there i.e. the Current Accounts balance have not gone below RM400,000 and therefore deemed as Core Deposit. And Core Deposits are what you use to fund a 30-year home financing.

SO WHAT IS CORE DEPOSIT?

Core Deposits are amounts of deposits that are at constant levels throughout many cycles. Some Banks have bigger core deposits due to higher proportion of transactional accounts in the Banks, where the balances sit for many days in the account. It may fluctuate but mostly the changes in balances are minimum within the core deposit. Because of the stability in the balances, it is used by Banks to finance longer term commitment and financing.

So, the battle for Deposits is to generally build a strong Core Deposits. This type of deposits are resilient, with long term balances that allow Banks to utilise these balances for long-term financing at the cheapest cost of funds. And depending on the growth strategy of the Bank, the types of deposits that a Bank builds (Sources of funds) must compliment the strategy for the Financing portfolio (Application of funds).

If such balance is achieved, the Islamic bank will have maximised the cost efficiency of its balance sheet.

So how do we win this battle for deposits to continue funding the growth of Islamic Financing? Where do we find the source of funds to meet the needs of the industry? What Islamic contracts are the most suitable to attract deposits? Can structures such as Waqf or linkages to Zakat help provide a source of deposits to support the liquidity in the market? Or can there be a more efficient way to pool the deposit resources and make it available to the market, accessing to a new group of funders that we have never touched before.

There must be a way to build a platform to access new group of funders or develop a structure where investors can fund a financing portfolio directly. I see some of these platforms available in the market but needs to have it developed on a bigger scale into the banking environment.

Banking fintech, anyone?

Where Regulations on Islamic Banking Lives

Posted on February 11, 2018 by Amir Alfatakh

Many times I have been asked, during talks and sharing sessions, where we can find all the Regulations, Frameworks and product Policy Documents issued by Bank Negara Malaysia. Many are not aware that I do house most of the relevant documents right here in my site. It is hidden (actually, not hidden…) in my REGULATIONS (MALAYSIA) tab.

Most of it are very technical documents and perhaps will make sense more for the practitioners in the industry. But there are many documents that is very useful, even for academicians and students, which is concisely well written and captures the essence of what needs to be conveyed. Especially documents such as the Islamic Banking contracts, which you can find at the PRODUCT STANDARD / POLICY DOCUMENTS (PRODUCTS) section of the same page.

Also there, the latest Shariah Advisory Council (SAC) Resolutions and Updates on various resolutions under under SHARIAH RESOLUTIONS.

Do use it if you are looking for a place for your reference. Also you can click on the above banner to go straight to Bank Negara Malaysia Website to search for items that are not in my page.

Happy Reading and do share the page if you find it useful.

Connecting the Dots : Islamic Fintech

Posted on December 31, 2017 by Amir Alfatakh

REVOLUTION OR EVOLUTION?

This posting is in the danger of being written too long, but I think it is necessary to close this year with this topic, simply because it looks at the future. The word “Islamic Fintech” has been buzzing for quite some time now and there have been pockets of excitement on what it should mean. Many financial institutions have jumped onto the bandwagon declaring they are also part of this new wave of what a bank could offer.

While all these are still early stages of development, I do notice a lot of effort is built into “digitalisation” and “apps-based application” and “efficiently and convenience” of EXISTING banking processes and relationships. These enhancements are still driven by financial institutions and centred around improving traditional processes for banking services, or short-circuiting the credit processing elements of financing. Although enhancements via technology is an important aspect, these should not be defined as “fintech”. There is an element of fintech in process improvements, but PROCESS IMPROVEMENT itself are not fintech.

DO PEOPLE NEED BANKS?

Traditionally, banks always hold the impression that “People need Banks, one way or another”. It is this understanding that the bank can continue investing into their brick and mortar business model, with customers always coming to them when they need capital, financing funds or products and services. The competition is that who can deliver existing products in the most efficient manner, with technology as the enabler. Money is spent to improve accessibility to the bank’s EXISTING products, services and proposition.

In improving processes, banks just needs to concentrate on all the products and services offered and build the corresponding infrastructure to ensure efficient delivery with technology. It can be “Apps-driven” based on inquiry or transaction-based, with new features attached to existing products. It is just creation of new delivery channels which will deliver existing products to customers faster than before.

But that in my view is NOT what fintech is all about.

IF FINTECH IS NOT PROCESS IMPROVEMENTS THEN WHAT IS IT?

The easiest google/cut/paste definition of Fintech is that “fintech is a new financial industry that applies technology to improve financial activities“ and “FinTech is the new applications, processes, products, or business models in the financial services industry, composed of one or more complementary financial services and provided as an end-to-end process via the Internet”. The key words I believe are:

New Financial Industry
New Application
New Processes
New Products
New Business Model

While “Process Enhancement” can help support the “New Processes” element, but I think it falls short of the idea for fintech i.e to re-think the business model of financial services. The idea of fintech should be this: Understanding what the requirements of the Gen Y customers are and how they work, develop the products and services on platforms that they are most familiar with, and the proposition that the bank can offer on their chosen platform. It is a total re-think of delivering products and propositions to the up-coming Gen Y potential customers.

SHARING OF FINANCIAL WALLET

As much as banks and financial institutions like to believe the financial wallet cannot exist outside the regulated financial system, the evidence is slowly being presented as otherwise. Companies are finding ways to survive, live and thrive outside the banking system with facilities and opportunities in the New Economy, slowly eroding the traditional banks’ share of financial wallet.

Big Data companies have proven that their database is far more powerful (and valuable) than the database an individual bank would have on its existing customers. Bitcoin and other cryptocurrencies goes through thousands of transactions within blockchain and is only realised into banks network when actual physical cash is needed. eWallet lets value resides in tech platforms for purchasing and sales of goods and services (more like barter or exchange of goods and services), and up to a certain extent provides microfinancing. Prepaid and loaded value arrangement provides free seed funding and capital for businesses, without the cost of borrowing incurred via banks. Peer to Peer (P2P) arrangement links crowdfund Investors to Entrepreneur without complicated documentation with speed and transparency levels never seen before. Sharing of risks and profits (including potential pay-offs) are now more understood as compared to traditional financing arrangements. Mudharabah, Musyarakah, and Ijarah may now have a place in an economy where equity participation is expected and sought after.

“FINANCIAL SOLUTIONS” ARE JUST A SINGLE ELEMENT IN THE UNIVERSE

Technology can now provide a single-point possibility of all our needs; goods, services, food, shopping, bills payment, money transfers, investments, borrowing, deliveries, medical, transport, social interaction, travel, holidays, education, careers development, information and even branding. Financial services can be integrated into all these elements, now driven via apps. But for this new infrastructure, the various “relationships” are needed to be identified and re-looked and re-engineered. With the proper Shariah compliance consideration.

This “single point” proposition is where tech companies play a crucial part. Rethinking the financial model must happen with the involvement of tech companies due to the advantage of everything being on the internet (internet of things). There are still a lot of limitations to what a bank can do, understandably due to financial regulations. The space of where banks are continuously competing (or evolving) is the “FINANCIAL SOLUTIONS” box above, and maybe payment gateways linked to service providers. But tech-companies? The revolution of technologies move so quickly that regulations will continue to struggle to catch up.

In the diagram above, I attempt to identify some of the areas of traditional banking where fintech can come in and provide a like-for-like solution or even fully replace the proposition by traditional banks. Certainly a lot of the consumer touch-points can be easily replicated in a technology platform, and crowdfunding and crowdsourcing can replace traditional financing and working capital requirements as well. Some services are still embedded into a banking structure (such as Current Accounts or Treasury product propositions) but over time, such products may be linked to fintech and the banks may eventually become ancillary service providers rather than main bank, earning just fees for services provided.

The landscape of what a bank offers will ultimately change in the next few years, when consumers no longer go to banks for financing, services, remittance and settlement of business transactions. As the new generation grows up with tech and becomes financially affluent, their expectation of how a banking experience should be will also dictate the model a bank adopts.

CONNECTING THE DOTS

So where do I see the banking industry in the next 5 years? Personally, I think a “price-comparison platform” will emerge, as seen nowadays in the travel/hotel/tourism industry. Information from all the financial service providers are flowed into a single platform, and consumers are able to immediately compare products, services and prices on a single platform and choose their solutions. Instead of customers subscribing to multiple banks offering different products and services (at different pricing), they only need to subscribe to a single platform where all information on the products are available to select. This is where the promise of fintech can thrive; accuracy of information, convenience of access, and speed of transaction.

It is a matter of time the various industries converge. We may think regulatory pressure will halt some of the progress but mostly it have been reactive regulations. And the challenge is that these developments are driven by tech companies which has no loyalties to banking regulations as their scope of business cuts across various industries. It will be a period of “non-regulated” until the market starts to recognise the need to regulate and managing the risks. A regulatory sandbox will be usefull, but if the “New Economy” moves faster than the speed where regulations are being formalised, there will be a lot of speculative and arbitrage opportunities for the market to gain.

This also means the New Economy brings new risks that the consumers are not aware off. While the banks have been fine-tuning its risks that it takes over the past half-century or so, the fintech companies may not see the elements of risks other than technology risks or systemic risks. Almost all the risks faced by banks are also prevalent in fintech companies or non-banks, plus the specific risks by fintech companies. They might be great at integration of technology, but banks are still masters when it comes to understanding financial risks.

WHAT NEEDS TO BE DONE?

As I mentioned, banks understand risks better than a tech company. A tech company understand speed, efficiency and channels better than any banks can have. At the moment, banks are developing “fintech” on their own which is mostly a process improvement project. Tech companies are developing “banking services” on their own as well, where it linked investor’s money and economic entrepreneurs via technology. The question is really, “why not a bank consume or enter into a partnership with tech companies to provide a solution beyond traditional banking?” We have started to see this trend where banks attempt to purchase outright a tech company and use the company as an incubator for new products and services. It should look into having a different operating structure which encourages new ideas, innovation, internet-based solutions, as well as delivering to a larger segment of consumers (including the Unbanked segment).

The end-result might not look like what we recognise as banks we see today. This could be a separate line of business for banks, where the element of technology integrated into the wider economy is more dominant than its traditional banking products and services. You could have Bank A offering the traditional products and services, and Bank A-Tech offering fintech solutions to a new generation. The same bank catering to 2 business lines, employing different delivery channels.

But breaking away from such traditional infrastructure may take time, and the greatest fear is that the market cannot wait. Fintech companies may be able to offer similar proposition in half the time required, and this will not motivate fintech companies to join-venture with a financial institution. In an environment where new opportunities arise at the blink of an eye and regulations have yet to be formalised, the temptation to go on its own will drive innovation by the fintech companies, leaving behind banks. Fintech companies have the capability to look at consumer needs and develop the solutions from the bottom, and flow the linkages to the top. Connect the dots where the solutions provider are linked together in a platform.

Will fintech companies be the next driver in providing financial solution? I know my answer to that question. It is perhaps just a matter of time where future banking is done outside of a bank. Perhaps the model of banking needs to be re-imagined.

Wishing all my readers a Happy New Year in 2018. I appreciate the support I have received so far. But the new world beckons and hopefully we can do enough to ensure the continuation of the banking industry. I hope Islamic Banking can play a bigger role in taking the industry into this exciting online generation.

The Tawarruq Dilemma

Posted on December 25, 2017 by Amir Alfatakh

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

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

BUT CAN TAWARRUQ ALWAYS BE THE ANSWER?

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

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

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

THE UNANSWERED QUESTIONS ON TAWARRUQ

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

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

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

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

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

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

THE REAL QUESTION IS WHETHER THE ABOVE CAN REALLY BE RESOLVED

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

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

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

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