The purpose of an Islamic financial system is to mobilize funds from savings-surplus units and allocate the same among savings-deficit units in the economy and to do this in accordance with the goals of the Shariah. Taking the Malaysian example, one may observe that the contracts/products involved in the process have changed over time. From the wide array of possibilities that Islamic finance offers, the policy maker’s choice has undergone a shift as the system has achieved greater maturity and depth. Malaysia set up its first Islamic Bank in 1983. Its vision for the future is captured in the Islamic Financial Masterplan prepared in the early 2000’s that divides the time line into four distinct phases. Phase 1 (1980s) witnessed laying and building the foundation through dedicated legislation for setting up Islamic banks and takaful companies and legislation enabling the government to tap Shariah-compliant means of funding. Distinct aspect of Shariah compliance in Islamic financial transactions were addressed. Phase 2 (1990s) was characterized by institution building with the key achievements being formulation of specific regulation allowing establishment of Islamic windows formation of Shariah Advisory Council of Bank Negara Malaysia and establishment of Islamic Interbank market. Phase 3 (2000s) was far more eventful and witnessed the development of the dual financial system in the country and a clear mandate to BNM to develop the Islamic financial system, entrance of foreign Islamic banks and Islamic subsidiaries, creation of supporting infrastructure in the form of training and capacity building institutions and finally, the launch of MIFC as a national agenda to promote the Malaysian Islamic finance industry. Phase 4 (2010s) saw the maturing of the regulatory and policy framework with enactment of the Islamic Financial Services Act (IFSA) and a requirement for Islamic financial institutions to observe end-to-end Shariah compliance. It witnessed the birth of the investment account (IA) opening up the possibility of a multitude of Islamic financial products in the risk-return space.
The IFSA 2013 had a major impact on Islamic banking. It clearly differentiated between a “deposit” and an “investment”. According to the new regulation, if a deposit, based on the Islamic contract, guarantees the principal amount to customers upon demand, it is classified as deposit. And if a deposit, based on the Islamic contract, does not guarantee the principal amount to customers upon demand, it is classified as investment.
It may be noted that the preference of the regulator during the initial phases of Islamic banking in Malaysia was to model products for raising funds as deposits. This was done in a manner to ensure that the largely risk-averse customers would receive consistent returns and capital protection similar to what a conventional financial system would offer. The financial system comprised deposit products – current and savings – modeled after qard and wadiah that were essentially free from any contractual stipulation concerning returns. Yet, the depositors on savings (wadiah) deposits would receive returns in the form of gifts (hibah) that were consistent and compared well with returns on their conventional counterparts. Parallel to conventional fixed deposits, the Islamic financial system would offer mudarabah and wakalah deposits. These deposits however, departed significantly from the classical concept of mudarabah and wakalah. A person contributing to a venture under classical mudarabah would be expected to share profits with the entrepreneur but bear all losses himself and in classical wakalah, the investing principal is expected to pay a fee to the party acting as agent regardless of how the investment performs. Clearly, these features create products that are inherently riskier to the accountholder than conventional deposits. The mudarabah and wakalah based products in their modified form incorporated mechanisms (e.g. setting aside reserves and obtaining third party guarantees) to ensure that mudarabah and wakalah accountholders received what they were comfortable with – stable and positive returns. The risk-sharing nature of Islamic finance had to be compromised due to market considerations.
However, as the Islamic financial system in Malaysia moved from its infancy and growth stage to a phase of maturity, the choice of the regulator and policy maker shifted in favor of banks offering mudarabah and wakalah products as Investment Accounts (IA) instead of deposits. From the standpoint of the bank customers, Islamic deposits have their principal guaranteed. There is pooling of funds and there is risk transfer from the customer to the bank. In contrast, in case of IA, there is no guarantee of principal. Funds are specified and not commingled with other bank funds. More importantly, there is risk-sharing between the customer and the bank. Islamic deposits come in three types: current account, savings account and fixed deposits. IAs come in two types – restricted IA and unrestricted IA. In terms of purpose, Islamic deposits primarily provide for the safe custody of funds while IAs are for investment only.
The introduction of the IFSA 2013 led to reclassification of mudarabah and wakalah deposits as investments. This implied for the banks the following: (a) investment type disclosure requirements (b) risk sharing infrastructure (c) not-guaranteed principal or no PIDM cover (d) oversight function on the management of funds and (e) tagging of funds specific assets for performance. Following the IFSA 2013, BNM also issued the Investment Account guidelines and defined the “investment” criteria as follows:
- “Investments” are non-capital protected instruments which is consistent with the mudharabah, wakalah fi isthihmar, and musyarakah deposit contracts.
- “Investments” carries an inherent market / investment risks, and customers must understand the structure as an “investor”.
- As an “investor”, the customer must understand the risks based on their profile. Customer must expressly accept the risks to enter into an investment product.
What are the implications?
It implied that Banks no longer can employ the following Displace Commercial Risk (DCR) techniques to boost returns on the profit:
- Gift (Hibah) from Shareholders Funds
- Waiver of Bank’s profit share / earned fee
- Restricted use of Profit Equalisation Reserves (PER)
|Deposit Accounts||Investment Accounts|
|Type of Shariah Contracts||Wadiah, Qard, Tawarruq||Mudharabah / Musyarakah /Wakalah Fi Isthihmar|
|Profit||Discretionary / Fixed Contracted||Profit Sharing / Earned Fee|
|Loss||Not Applicable||Lower Returns / Loss of Capital|
|Treatment on Balance Sheet||On-balance Sheet||Off-Balance Sheet or On-Balance Sheet|
|Risk Profile||No Risk||Low/Medium Risk|
|Tenure||On Demand||Minimum Investment tenure|
|Disclosure Format||Savings Account / Fixed Deposits||Unit Trust / Structured Investment|
|Investment Assets||General Investment Account (Unrestricted)||Defined Investment Account i.e. Unrestricted Investment Account (URIA) or Restricted Investment Account (RIA)|
|Customer Documents||Terms and Conditions||PDS, Terms and Conditions, Performance Report and Risk Warning Statements|
Further the Investment Accounts may be unrestricted or restricted in nature. A line of distinction between the two types may be drawn as below:
|Unrestricted Investment Accounts||Restricted Investment Accounts|
|General Investment||Specific Investment|
|Unmatched Balance||Matched Tenure & Balance|
|Fixed/Unfixed Tenure||Fixed Tenure|
|Easy exit & Redemption||Penalty on exit & Redemption|
|Mixed Asset Portfolio||Single Asset Utilization|
In a further transformational move, Bank Negara introduced a multi-bank investment account platform (IAP). The IAP was officially launched on 17 February 2016 by the former Governor of BNM, Tan Sri Dr Zeti Akhtar Aziz.
(To be continued)