Friday 19 August 2016

BNM Fintech Regulatory Sandbox Discussion Paper and Islamic Financial Services

Following the establishment of Bank Negara Malaysia (BNM) Financial Technology Enabler Group (FTEG) on 2nd June 2016, BNM issued a discussion paper on Fintech Regulatory Sandbox on the 29th July 2016. BNM in its Press Statement said that "the Sandbox will allow regulated financial institutions (FIs) and fintech companies looking to do businesses regulated by the Bank to experiment with fintech solutions in a production or live environment, subject to appropriate safeguards and regulatory requirements." BNM invited written comments on the discussion paper to be submitted by 30th August 2016.
 
Clauses specific to Islamic finance are as follows:
  1. Section 1.6 of the discussion paper states that one of the intended outcomes is to ensure innovative solutions for Islamic financial services are consistent with prevailing Shariah standards.
  2. Section 3.2 defines "Islamic Financial Services" as Islamic financial intermediation activities including Islamic banking and takaful services which leverage on technological innovation
In my opinion, the above clauses are not a problem for financial institutions as they should already have Shariah governance to ensure compliance to the prevailing Shariah standards. Collaborative fintech companies that partner with Islamic financial institutions should also not have any problem as they can ride on the Shariah governance of their partners. However, it is a big challenge for competitive fintech companies especially small start-ups which are not familiar with Shariah requirements.
 
I would recommend BNM to have a section on guidelines to comply with "prevailing Shariah standards". The guidelines should clearly differentiate the requirements for Collaborative and Competitive fintech companies. Some of the details to be included are the governance structure and the measures to be taken for ensuring the compliance.
 


Thursday 18 August 2016

Fintech Raya Special on CapitalTV



I had this interview program with a private TV channel, CapitalTV, to talk about Financial Technology (Fintech). CapitalTV made this special program for business news aired on the second day of eidul fitri (Hari Raya Puasa) 2016.

The following are some of the pictures captured during the recording of the programs.



Monday 15 August 2016

Musharakah Mutanaqisah and Its Implementation in Home Financing Products in Malaysia



This is another collaboration effort with my wife. This paper, Musharakah Mutanaqisah, the Contract Elements and its Implementation in Malaysian Home Financing Products was published in the collection of academic articles by Kolej Polytech Mara (KPTM).

The following is the conclusion of the paper:

" Musharakah Mutanaqisah is an Islamic equity financing instrument. It is a form of partnership in which one of the partners promises to buy the equity share of the other partner gradually until the ownership of the subject of the Musharakah is completely transferred to him. However, the buying and selling agreement must be independent of the partnership. Shariah forbids the contract of partnership is entered as a condition for the contract of buying and selling.

Musharakah Mutanaqisah contract is a combination of two (2) contracts, Musharakah and Ijarah which have to be concluded separately. Shariah scholars internationally including Bank Negara Malaysia Shariah Council and AAOIFI, are in consensus of the permissibility of the contract.

From Shariah contract perspective, Musharakah Mutanaqisah is a binding contract. The contract comprises the elements of sale and lease which are binding and create a constructive obligation on the contracting parties. The obligation is created on the party who has agreed to buy the share of his partners and therefore he is required to pay the price of the shares. The financier, on the other hand, is also obliged to sell his share to the customer according to the ratio that has been agreed upon at the beginning of the contract.

Musharakah Mutanaqisah contract and its implementation in Malaysia as a Home Financing instrument is still a long way to go. It only started in 2006 with only seven (7) banks so far are offering this product. Since Musharakah Mutanaqisah is more globally accepted compared to BBA Home Financing which is more prevalent in Malaysia, the motivation for Malaysian banks to offer Musharakah Mutanaqisah based products is very clear. To make Malaysia a global hub in Islamic Finance industry, it is crucial for Malaysia to offer products that are aligned to globally accepted Islamic principles.

However, banks in Malaysia are still quite slow in adopting Musharakah Mutanaqisah. Instead migrating to Musharakah Mutanaqisah based financing, banks in Malaysia seems to be moving towards Commodity Murabahah based financing which is another debt based financing. At least two banks, KFH Malaysia and Citibank Malaysia, have discontinued their Musharakah Mutanaqisah based home financing products. One of the key reasons, there are still a number of unresolved issues if these banks were to strictly follow the rules of Musharakah Mutanaqisah contract. It is not that it is impossible. But, to implement it within the existing banking framework and legal regulations, operationally there are some challenges. Bankers have to change their mindset to be more “landlord” likes.

One of the main considerations for banks to offer Musharakah Mutanaqisah is the risk management aspect. The application of Shariah principles in Musharakah Mutanaqisah contracts creates distinct relationships, rights and obligations of the parties to the contracts. As a result, banking institutions are exposed to both market risk associated with the joint ownership of the underlying asset, as well as credit risk associated with the obligation on the part of the customer to acquire, and on the banking institution to sell, its share of ownership in the asset. Therefore, banks will have to have a more robust risk management system.

Although there are some issues and challenges for banks to offer Musharakah Mutanaqisah, these should not discourage them. Rather, a more collective efforts needs to be put in place to address these issues/challenges so that the Home Financing Products based on Musharakah Mutanaqisah principle will become more popular especially because the contract is more in line with higher objective of Shariah as proven by global acceptance of Shariah scholars on the permissibility of the contract."

Digital Economy and Islamic Finance - Opportunity or Disruption


Islamic Banking & Investment, Asia - Middle East Congress 2016 was held on the 6th of April 2016 at the Intercontinental Hotel Singapore. I was invited to be a panel member in discussing the topic of Digital Economy and Islamic Finance - Opportunity or Disruption. 

In my view, Digital Economy is both Opportunity and Disruption to Islamic Finance. Fintech companies, which play significant role in the digital economy, have created various opportunities for Islamic finance consumers and Islamic finance industry. At the same time, these fintech companies have disrupted traditional financial services players.

The picture below illustrates the impact of fintech to Islamic finance and digital economy.




Friday 12 August 2016

Shariah-Related Parameters for Islamic Bank IT systems


WHILE going through one recent social media posting, I came across a question: How can we “Islamise” an information technology (IT) system in a bank? Someone with the right qualification and experience in Islamic finance answered it.

I summarise the answer as the system needed to be developed with features and functions that could support Shariah requirements of products and services of an Islamic bank.

This relates to one of my past column entries on whether an IT system can be certified as Shariah-compliant.

My view is that an IT system by itself cannot be certified as Shariah-compliant due to the fact that an IT system is just an enabler to support financial institutions’ products and services. The characteristics of the products and services would dictate the system behaviour.

An IT system of a particular Islamic financial institution (IFI), which has been configured with the requirements of its products and services, could be audited to ensure the behaviour of the system fully complies with the Shariah requirements.

In order to support Shariah requirements of Islamic banks’ products and services, the IT systems must come together with relevant Shariah-related features and functions. I refer to these as Shariah-related parameters.

Allow me to share some of the key parameters which I have gathered over 19 years of my experience providing IT systems to IFIs in Malaysia and abroad.

Top in my list is fund type. IFIs clearly differentiate their sources and uses of funds. The sources of funds can be internal (shareholders’ funds) or external (customer deposits or investments).

The external funds are further segregated into restricted funds and unrestricted funds. Restricted funds can only be used by IFIs for a specific purpose, pre-agreed with the funders whereas the unrestricted funds can be used on a general pool basis to finance banks’ fund-based products. The segregation of funds is important for profit distributions to depositors and investors.

The next important parameter is Islamic concept. An Islamic concept can simply be a single Islamic contract such as Mudharabah and Ijarah, or combinations of a few Islamic contracts such as Musharakah Mutanaqisah and Ijarah Thumma Al-Bai’ (AITAB).

Both Islamic-bank sources-of-fund products (deposit and investment) and uses-of-fund products (financing) are developed based on certain underlying Islamic concepts. These concepts govern the behaviour of the products such as the types of documents to be signed, the profit computations, the exit conditions, etc.

Some products are also designed with additional supporting Islamic concepts. For example, Tawarruq-based products can be with or without Wa’ad.

Different Islamic concepts require different sets of additional parameters. For example, Musharakah- and Mudharabah- based products require a profit-sharing ratio. Ijarah-based products require parameters for rental computations and method of ownership transfers. Tawarruq or Commodity Murabahah products require commodity types and counter parties. Ar-Rahnu products require storage fees calculation options and gold-related parameters.

In addition to parameters that are unique to a particular Islamic concept, there are some common parameters for certain categories of products. For example, common to all “sale-based” Islamic financing such as Bai’ Bithaman Aajil, Murabahah, Tawarruq and Istisna’ concepts, parameters for sale price computations are required. A sale price is as simple as financing amount plus total profit margin.

However, the profit margin needs to take into considerations the period of financing progressive disbursement (for financing of property under construction) and the period after the financing has been fully disbursed.

Rebate options are another set of parameters common for sale-based financing. Due to the progressive disbursement of financing for property under constructions, higher rates used for sale price computations, prepayments of sale price and early settlement of the financing facilities, the actual banks’ profit earning could be lesser than a contracted profit margin. The difference between the upfront profit margin and actual bank earnings will be rebated to customers by offsetting the sale price balance.

Finally, a set of important parameters very unique to IFIs are those related to the rate of return (ROR) calculations.

In Malaysia, the ROR computation is governed by Bank Negara Malaysia Rate of Return Framework. Two main components of the framework is calculation table (CT) and distribution table (DT). CT is to derive banks’ distributable income and DT is to prorate the distributable income into bank’s various types of deposits and investments. The ROR for each deposit and investment product will be derived based on the prorated distributable income for that particular product.

In summary, some parameters are required for overall Islamic banks operations, some are common by Islamic concepts and some are unique to a particular Islamic concept.

Islamic concept is key because all Islamic products and services are backed by certain underlying Islamic concepts. These concepts give rise to options or parameters to govern the behaviour and the operations of the products and services. The specific details above are merely examples. There are many more parameters required to support Islamic-bank products and services of varying degree of complexities.

My column as appeared in The Malaysian Reserves on 8 August 2016

Islamic Finance Conference 2016



I was invited to speak on Fintech during Islamic Finance Conference 2016 jointly organized by Islamic Banking and Finance Institute Malaysia (IBFIM) and Malaysian Institute of Accountants (MIA). The conference was held at Istana Hotel, Kuala Lumpur on 23rd March 2016.


I spoke about the impact of Financial Technology (Fintech) on Islamic Finance. The following were the observations and recommendations that I shared with the audience:

Observations:

Fintech Penetration into Islamic Finance is still at infancy stage with small number of participants

“Islamic Fintech” are mainly in the area of crowdfunding and P2P Lending

Emergence of Fintech in Islamic Finance space is a blessing as it provides more choices for the consumers as well as providing platform for a more “genuine” Islamic financing

Recommendations:

1.For Fintech entrepreneur wannabe, it is a huge untapped industry. Consider beyond P2P and crowdfunding.

2.For traditional providers, adopt Fintech innovation. Embark into digital banking journey by collaborating with Fintech companies


Other speakers were as depicted in the picture below.



Factors Affecting the Pricing of Islamic Home Financing in Malaysia


This paper, a collaboration with my academician wife,  was published in The Malaysian Corporate Secretary Journal.

Below is the conclusion of the paper.

" The overall price of an Islamic home financing includes upfront cost, total profit (BBA financing), total rental (MM financing) and incidental fee charges.  The upfront cost are processing fee, disbursement fee, legal fee, stamp duty and MRTA and incidental fee charges are late payment penalty fee, capital prepayment fee and early settlement fee.

While BBA profit and MM rental are conceptually different, the mechanism applied to compute the profit or rental is the same.  Both BBA and MM financings make use of annuity concept and standard mathematical amortization model.

There are many factors affecting the total home financings such as amount of financing, tenor, rate(s), age of customer, banks’ policies on advance or early payment or extra payment, instalment amount, payment pattern, profit during construction, late payment fee, capital prepayment fee, early settlement fee, banks’ incentives and government incentives"

Thursday 11 August 2016

An Analytical Study on The Pricing of Islamic Home Financing and Conventional Home Loan

 
For my MSc. in Islamic Banking and Finance thesis, I decided to research on the pricing of Islamic Home Financing and compare it with conventional home loan. The motivation was to verify my belief that being an Islamic banking product does not make it cheaper or expensive although there were claims made that Islamic financing are more expensive than conventional loan.

Below is an excerpt from my Thesis abstract.

" This research paper attempts to analytically study the pricing of Islamic home financing versus conventional home loan to examine the competitiveness of the pricing of conventional home loan and Islamic home financing.  Specifically, this research will identify the components of loan and financing prices, the formula used in calculating the various price components and the factors that affect the price calculations.  This research will also gather available pricing related data and finally make comparisons of the various pricing components of conventional home loan and Islamic home financing.  The finding of this research shows that the pricing formula for conventional loan and Islamic financing are the same.  If all factors affecting pricing calculation are the same, the price of a conventional home loan and Islamic will be exactly the same.  What makes a loan or a financing more expensive than the other is the product feature and other terms and conditions imposed by the loan or financing providers.  There was some truth that product feature wise, Islamic BBA home financing appeared to be more expensive in the past.  Now that Islamic banking products have evolved, the pricing of floating rates BBA and MM financing have become very competitive with conventional home loan products. "

Wednesday 10 August 2016

Post Grad Diploma in Islamic Banking and Finance from IIUM


I started off my formal study in Islamic Finance by registering into IIUM Post Grad Diploma in Islamic Banking and Finance at the International Islamic University Malaysia. It was a two year program for part time students. The classes were conducted on Saturdays and most students took two subjects per semester.

We were given basic exposures of Islamic Economics and Islamic Jurisprudence before taking Islamic Finance courses. One of the concepts that I learned and still remember very well is Islam, its Worldview and Economics.

We had to take 8 subjects to complete the program. The subjects that I took are as follows:

1. Islamic Economics
2. Introduction to Principles of Islamic Jurisprudence
3. Islamic Financial System
4. Transactions in Islamic Banking and Finance
5. Islamic Banking Products and Services
6. Accounting for Islamic Financial Institutions
7. Fund & Exposure Management
8. Ethics and Governance of Islamic Financial Institutions

I started the program in 2008 and completed in 2010. I was awarded Best Student (Academic)!

 
 

Tuesday 9 August 2016

Graduation Ceremony for Msc. in Islamic Banking and Finance from IIUM with Datuk Muhammad Ibrahim

After 10 years of on the job exposure in Islamic Banking and  Finance, I decided to get formal qualification on the subject. I enrolled as part time student at International Islamic University of Malaysia. I was very lucky to have course mates from various background and specializations as well as from various parts of the world. There were lawyers, bankers, central bankers, academicians, and many more.

I was very lucky to have Datuk Muhammad Ibrahim (at that time still a Bank Negara Malaysia Assistant Governor) as one of my course mates. We graduated on the same day in October 2012.


Seen in this pic right to left is yours truly, Datuk Muhamad Ibrahim (BNM Governor), brother Yono from central bank of Indonesia and brother Zahid (one of Islamic banking pioneers in Malaysia).

Chairman of New Zealand Rugby Union at Global Islamic Finance Forum

Knowing that the company that I work for has connection with Mr. Brent Impey, the Chairman of New Zealand Rugby Union, the organizing committee of Global Islamic Finance Forum (GIFF) 5.0 had requested for my assistance to bring him to speak at GIFF 5.0. We were lucky to get Brent to agree to honour the request.


This picture was taken during lunch specially hosted by Dato' Redza (CEO of Bank Muamalat Malaysia, also Chairman of Associations of Islamic Banking Institutions Malaysia) for Mr Brent Impey. Also seen in this pic is Tan Sri Munir (Chairman of Bank Muamalat), Mr. Goh Peng Ooi (Silverlake Executive Chairman), Dr. Raymond Kwong (Silverlake Axis CEO).


With Brent and Dr. Raymond at my company's booth at GIFF 5.0. Rugby and Islamic Finance, it has never happened before!

The Need for Digital Islamic Banking


IN OCTOBER 2001, education consultant Marc Prensky coined the terms Digital Native and Digital Immigrant. Digital Native refers to a person born or brought up during the age of digital technology, hence familiar with computers and the Internet from an early age.

Digital Natives spend “their entire lives surrounded by and using computers, video games, digital music players, video cams, cell-phones and all other toys and tools of the digital age”. Growing up with digital gadgets and the sheer volume of their interactions with these gadgets have changed the way they think and process information.

On the other hand, Digital Immigrant refers to a person not born into the digital world but at some point later on in his/her life picks up digital technology. Just like other types of immigrants, while some may blend well with the new environment, most would retain their “accent” or their foot in the past.

In a paper entitled “Digital Natives, Digital Immigrants”, Prensky discussed the conf lict facing education in which Digital Immigrant instructors, who speak an outdated language (that of the pre-digital age), are struggling to teach a population that speaks an entirely new language.

Now this population of Digital Natives have entered the workforce and some have become successful entrepreneurs. In more advanced countries, Digital Natives are slightly older than in some less developed ones. They are commonly Millennials (born 1982-2002) or Generation Z (born 1996-2009). It has been estimated that Millennials will form 75% of the workforce by 2030.

Accenture estimated their spending power in the US alone was US$600 billion (RM2.4 trillion) in 2013 and forecast that it would go up to US$1.4 trillion by 2020.

It is apparent that the population size and the spending power are significant enough not to be ignored by the financial services players. In my view, the conflict of Digital Immigrants and Digital Natives is also happening within the banking and Islamic banking industry today.

Most of the current banking products and services as well as the distribution channels were developed or designed by Digital Immigrants under the constraints of policy and regulatory compliance requirements prepared by yet another group of Digital Immigrants.

As a result, Digital Natives find these products and services less appealing and the distribution channels not sufficiently customer friendly. Digital Natives tend to fancy the alternatives provided by fintech companies.

Indeed, fintech companies offering more convenient and more cost effective alternative digital financial services are mushrooming.

This phenomenon is great for consumer empowerment but a threat to traditional financial services providers. To compete with fintech companies in addressing Digital Native consumers’ needs and behaviours, traditional banks have to embark on a digital banking journey.

Digital banking is not just about having digital distribut ion channels such as online and mobile (app and web) banking. Digital banking is customer oriented and offers the customer the service of his/her choice through the access of his/her choice.

It focuses on being relevant to the customer in his/her daily life through digital outreach but still recognises the importance of customer engagement via human contact.

A digital bank also has an innate knowledge of the customer.

A particular customer may visit a branch, call the contact centre, make a comment through social media such as Twitter or Facebook, and a digital bank would be aware of all these accesses and interactions and would respond promptly and consistently.

It would leverage on the customer’s single view data as a competitive differentiation and will proactively offer services required by the customer. This “personalised” service of digital banking appeals to Digital Natives.

Islamic finance players must have a digital Islamic banking strategy in order to survive.

Digital Islamic banking is a Shariah-compliant version of digital banking. At the very basic, digital Islamic banking capabilities need to match the capabilities offered by conventional counterparts.

This is necessary to cater for the needs of Muslim Digital Natives.

To further compete with conventional providers and the fast-growing fintech companies, digital Islamic banking has to be more innovative. With superior customer experience innovations, digital Islamic banking could also capture the non-Muslim Digital Natives market.

In summary, digital technology has changed customer behaviours.

Digital Natives now represent a sizeable portion of our workforce population and they have significant spending power.

Their demand for digital services drives the needs for digital banking.

For Shariah compliance, Muslim Digital Natives need digital Islamic banking. It is also possible for digital Islamic banking to attract the overall Digital Native market segment with digital services offering superior customer experience.

My column as appeared in THE MALAYSIAN RESERVE 11 July 2016

Of Fintech and Disruption in Banking


On April 11, 2016, The Malaysian Reserve ran my column in which I wrote about fintech. One month later, I’m seated at Sasana Kijang Auditorium in Kuala Lumpur. Datuk Muhammad Ibrahim, the new governor of Bank Negara Malaysia (BNM), is delivering the keynote address at the Global Islamic Finance Forum (GIFF) 5.0. 

One of his key messages was for Islamic financial institutions (IFIs) to adopt fintech innovations because “the potential impact of such technological disruptions is significant”. 

The governor said an estimated 10% to 40% of overall banking revenues could be at risk by 2025 due to fintech innovations outside banking institutions that are able to achieve a significant pricing advantage. 
It was also pleasing to hear from the governor that the central bank has been actively engaging with fintech firms to better understand their activities and provide guidance on the regulations that may apply to them. BNM has also commenced a review on the regulatory framework to remain appropriate while encouraging productive innovation.


Subsequent to the keynote address, a few speakers also talked about fintech and disruptions. In fact, the word disruption was frequently mentioned throughout the three-day forum. Someone actually counted. It seems the word “disruption” was mentioned 593 times.

Naturally, it will surface every time we engage in fintech conversation. 
Allow me to share some observations on the disruptions that have taken place in the financial industry. According to Brett King in his book Bank 3.0 published in 2013, there are four phases of disruption within financial services. Each phase is disruptive enough that it becomes a game changer.

The first phase of disruption occurred with the arrival of the internet. With the internet came internet banking. It has changed the way customers perform banking transactions. As internet banking facilities become better and more reliable, customers’ visits to branches become fewer. Social media has amplified the disruption by Internet banking. In this social media age, financial institutions may be subjected to public pressure from the social network influence.
The second phase of disruption is the emergence of smart device or phone applications. With this comes portable or mobile banking, which allows customers to perform banking transactions on the move. Except for cash deposit and withdrawal, everything that previously could only be done via the ATM machines can now be done through mobile-phones.

The third phase is when we move to mobile payments on a broad scale. In this phase, we see the convergence of debit/credit cards with our mobile-phones. 
With this, we do not need as much cash or a plastic card anymore. In fact, with our need for physical cash reduced rapidly, the disruption will be far-reaching. As we do not need to go to the ATM machines and physical branches as much anymore, a large part of the reason for their existence disappears. 

In addition, as the usage of debit cards and mobile payment becomes more widespread, the legacy payment method such as the cheque becomes less relevant. This phase is not just about the accelerating demise of cash and cheques, but also the loss of physicality, where we need much fewer physical interactions with a bank for basic day-to-day banking.
The fourth phase is about banking no longer being somewhere we go, but something we just do. There will be a fundamental split between banking as a distribution business and banking as a product manufacturing or credit provisioning capability. 

Banks are losing the basic day-to-day bank account to the mobile-phone or commodity value store. Now, you do not need to be a bank to provide banking services. Customers will go about their daily lives with banking embedded into processes that require financial products or transactional support. Home-buying will integrate with mortgage sale, travel websites will integrate with travel insurance and financing options, a retailer will give line of credit for furniture purchases, etc. 
In summary, the disruptions in the financial industry is real. Once upon a time, we all had to visit bank branches for any kind of banking activity. As time goes by and with the help of technology sophistication, we can do banking anytime anywhere. 

Now, another technology revolution is taking place. Fintech companies are offering alternative banking products that are cheaper and more convenient. As advised by the governor, IFIs have to adopt fintech innovations to remain relevant.
My column as appeared in THE MALAYSIAN RESERVE 23 May 2016

Impact of Fintech to Islamic Finance


Fintech has been a favourite topic at Islamic finance forums lately. It was the focus at the World Islamic Banking Conference 2015 held in Manama, Bahrain, in December 2015. 
The topic also made its rounds at the Euromoney Islamic Finance and Investment Conference (February 2016, London, UK), Islamic Finance Conference 2016 (March 2016, Kuala Lumpur, Malaysia) and Islamic Banking & Investment Asia/Middle East Congress 2016 (April 2016, Singapore). I happened to be a speaker at the latter two of these events.
What is Fintech?
Fintech, the contraction of the words finance and technology, broadly refers to the application of technology within the financial industry. It covers a wide range of activities including financing, payments and infrastructure, operation and risk management, data security and monetisation, and customer interface. 
Fintech applies to the segment of the technology start-up that is disrupting sectors such as mobile payments, money transfers, loans, fundraising and asset management.
The fintech revolution started post 2007-2008 financial crisis. At that time, policymakers were busy supposedly making finance safer while financial institutions were investing heavily in the solutions for the newly introduced compliance requirements. In between, information technology “geeks” partnered with venture capitalists to introduce a solution that was set to disrupt traditional financial services. The financial solution was technology-based, more convenient, more accessible and more cost effective.
Since then, fintech has been growing rapidly with a global investment reported to be US$12 billion (RM46.92 billion) in 2014 compared to only US$4 billion the year before.
The main types of fintech services are peer-to-peer (P2P) lending, crowdfunding, money transfer, mobile payments and trading platforms. There are also fintech services for other sub-sectors such as wealth management, insurance, etc. Some names involved in fintech are Funding Circle, FundedByMe, TransferWise, TradeCrowd and Kantox.
Fintech has also penetrated the Islamic finance space. A few prominent fintech companies that offer Shariah-compliant financial solutions are Dubai-based Beehive, Jakarta-based Blossom Finance, and Singapore-based KapitalBoost and ClubEthis. These fintechs are in the segments of P2P lending and crowdfunding.
Fintech’s penetration into Islamic finance is still in its infancy with a relatively small number of participants. However, the potential disruptions to traditional Islamic finance should not be underestimated. The disruptions can swing both ways.
From the Islamic finance consumer perspective, fintech disruptions are largely positive. Fintech innovation provides choices which are more aligned to individual needs. With more options, consumers enjoy more competitive financial services cost. 
Latest technology embraced by fintech leveraging on Internet, mobile devices and social media integrations make financial transactions more automated, user-friendly and more convenient, thus a superior customer experience.
Crowdfunding and P2P financing options from fintechs are also a blessing for individuals or SMEs (small and medium enterprises) that require financing but do not qualify for financing from traditional Islamic financial institutions (IFIs). Investors are also entitled to higher potential returns by investing directly into the business ventures that they finance via the online financing marketplace. 
Furthermore, one of the best things that has happened with fintech is that it is able to provide access to financial solutions for the roughly two billion adults who are currently unbanked, as reported by World Bank.
On the flip side, traditional Islamic finance providers face more intensified competition with fintech sharing their pies. In order to remain competitive, they have to reduce financing profit margins and service fees. 
With consumer options to invest through the online P2P and crowdfunding marketplace, IFIs may end up with reduced deposit and investment portfolios. 
With customers spoilt by the fintech innovations of convenient online services anytime, anywhere, integrated and automated, IFIs are facing demands for digital channels to perform transactions. 
The impact is not all negative for traditional IFIs. It is worth noting that fintech is not about to kill traditional players. There are still sizeable customer segments that are only comfortable dealing with brick and mortar banks. 
However, over time, traditional IFIs may face significant reduction in their customer base when digital natives (those who have grown up using the Internet and mobile devices) form the majority of the population unless the traditional IFIs embark on the digital banking journey. 
Traditional IFIs need to consider collaborating with fintech players and leverage on their technology partners. At the same time, IFIs can focus on specialisations in the business segments that cannot be easily replicated by non-traditional players.
On the overall Islamic finance scene, fintech in the Islamic finance space positively contributes to the evolution of the Islamic finance products and services offering. Elimination of credit intermediaries results in lower prices and/or higher potential returns. 
Last but not least, crowdfunding and P2P financing provides the platform for Musharakah- and Mudharabah-based equity financing, which have not been very successful in the traditional IFI environment.
My column as appeared in THE MALAYSIAN RESERVE 11 April 2016

Rebates in Sale Based Islamic Financing


Most of the Islamic financing products in the market are “Sale Based” financing. The products are structured based on Islamic concepts such as Murabahah, Bai Bithaman Ajil (BBA), Bai Inah, and Tawarruq which involve buying and selling aqad of an underlying asset between banks and customers. Upon completing a buy and sell aqad with an Islamic bank, a customer’s debt will be created. The debt amount that the customer has to pay to the bank on a deferred payment basis is known as Bank Selling Price.

A Bank Selling Price comprises of financing amount plus the profit margin that a bank books upfront when a financing facility is provided to a customer. For example, the Selling Price of a 5 year financing of RM 100,000 with a fixed rate of 6% comes out to be RM 115,996.80. In this case, the profit margin is RM 15,996.80. Banks will gradually earn the profit margin as banks’ incomes. The earning process will commence on the first day the financing amount is disbursed to the customer and will last until the day the account matures. The maturity date depends on the tenure of the financing. The balance of the profit margin at any point in time which the bank has not earned as income yet is known as Unearned Profit.

When a customer wants to early settle his/her sale based financing debt, a discount will be given to the customer. The discount is known as Ibra’ (rebate). The maximum rebate amount equals to the Unearned Profit amount at the point of the debt settlement. During early days of Islamic Banking in Malaysia, the rebate depends on bank’s discretion. However, Bank Negara Malaysia has issued a Guidelines on Ibra’ (Rebate) for Sale-Based Financing, effective 1st November 2011, which makes it mandatory for banks to grant rebate to customers who settle their financing before the end of the financing tenure.

While rebate on early settlement is probably the most widely discussed and best understood by many, it is actually only one types of rebates applicable to sale based Islamic financing. There are other types of rebates which are related to Grace Period Profit (GPP), Variable Rates Financing and Staff Financing. IT System for Islamic financing products will have to cater for all these rebate types.

Grace Period Profit (GPP) Rebate

Sale based Islamic financing for property under construction will have GPP factored into the Selling Price. The GPP is the upfront profit margin for the progressive disbursement period. The GPP amount is calculated based on full financing amount. Typically, for financing of a property under construction, banks will disburse the financing amount to developers progressively based on claims by the developer which is tied to the percentage completion of the property. Banks will then accrue the GPP to be charged to customer based on actual disbursed amount. Since GPP that is booked upfront is based on full financing amount but the GPP that is charged to customer is based on actual disbursed amount, there will be unutilized GPP amount when the financing is fully disbursed. The unutilized GPP amount will also be given as discount to customer as a GPP rebate.

 
Variable Rates Financing Rebate

Some of the sale based Islamic financing products are based on variable rates. In this case, Selling Price will be computed based on a Contracted Profit Rate (CPR) but accrual of profit to be charged to customer is based on variable rates (base financing rate plus or minus some spread). The actual rate that is used to accrue profit for bank earning at any point in time is known as Effective Profit Rate (EPR). Throughout the tenure of the financing, EPR can fluctuate following the base rate changes. This means, EPR can be lower than, equal to or higher than CPR. When EPR is higher than CPR, bank can only charge customer the CPR. However, when EPR is lower than CPR which is normally the case, there will be a difference between profit contracted upfront and the actual profit charged. The difference in the contracted profit and actual profit charged will be discounted from customer’s payment to bank. This discount is known as variable rate financing rebate.

Staff Financing Rebate

One of the benefits working in banks is staff financing facility which normally charges discounted rate compared to what normal customers have to pay. In the event the staffs no longer work in the bank, they will have to pay the same rates which other customers have to pay. In order to avoid having to deal with another set of legal documents when staffs’ resign from a bank, banks could compute Selling Price based on normal customer profit rate, similar to the case of contracted profit rate in the variable rate financing. For as long as the staffs work with the bank, bank could set the EPR as the staff rate. The difference between bank earning calculated based on CPR and EPR is known as staff financing rebate.

In summary, based on the various scenario above, rebate or ibra’ plays an important role in structuring sale based Islamic financing. Likewise, an IT system to support sale based Islamic financing must provide flexibility to handle all types of rebates.

My column as appeared in THE MALAYSIAN RESERVE 14 July 2014

The Profit Distribition Process


Islamic financial Institutions (IFIs) act as financial intermediaries between sources of funds (deposits) and applications of funds (financing and investment). Profit generated from the application of funds will be shared with the funds’ providers. A significant portion of IFIs’ sources of funds come from General Investment Account (GIA) that has been structured based on mudharabah (profit sharing) contract.
The contractual relationship between IFIs and depositors under the Islamic mudharabah gives rise to the need of a mechanism to distribute IFIs’ Income to their GIA depositors.


I was first exposed to the methodology of profit distribution in year 2000 when I attended a training in Brunei that was conducted by Bank Islam Research Institute (BIRT). I learnt that the process involved two main steps:


  1. Calculating of the amount of income to be distributed to depositors (termed as distributable income)
  2. Calculating the rates of returns by proportionating the distributable income into various types of deposits that an IFI offers to its customers
Few years later, when I was implementing an IT system in one of the banks in Malaysia, during requirement study process, I got hold of Bank Negara Malaysia(BNM) Framework Rate of Return that was issued on Oct 16, 2001, and to be implemented by Oct 1, 2004. BNM issued the framework as part of an “effort to standardise the method on the calculation of rate of return for the Islamic banking industry (IBI)”.
The framework has been further revised with the latest update issued on March 13, 2013.


Consistent with the steps stated above, the framework comprises two main tables and the guidelines, with formula and examples, on how to derive the tables. The two tables and the objectives are as follow:
  1. Calculation Table (CT) — To guide the IBIs in deriving the net distributable income to the depositors and the bank by incorporating the income generated from the assets, the relevant shared expenses and allowances between the bank and the depositors, and income attributable to the various types of depositors.
  2.  
  3. Distribution Table (DT) — To guide the bank on the proper distribution of the net distributable income posted from the CT, IFIs are required to maintain separate CTs and DTs if they manage multiple funds.
CT is quite straight forward to work on as the information required is normally readily available from the finance department. However, it requires finalisation of income and expenses for the month before distributable income amount can be fixed. In order to avoid too significant fluctuation of distributable income from month to month and to maintain competitiveness with conventional banks.


 
IFIs practice income smoothing using Profit Equalisation Reserve (PER) following BNM Guidelines on PER. PER is a provision of income where during profitable periods some income is put aside to be reserved for not so profitable periods.
DT requires more effort


 
Every month, IFIs are required to keep track of the average daily amount of their deposits segregated by types of deposits. Different types of deposits will have to be defined for mudharabah and non-mudharabah products. For mudharabah, the types of deposits will be further segregated based on various profit sharing ratios (PSRs) offered to depositors.
 
Based on general practice by Malaysian local IFIs, new rates will be declared every 16th of the month and will be effective until 15th of the following month. The process to arrive at the rates will start on the 1st of previous month.


 
For example, for the rates to be declared on Feb 16, 2014, the process to accumulate deposit average daily amount would start from Jan 1, 2014 until Jan 31, 2014. From Feb 1 to 15, 2014, IFIs will be finalising their income and expenses so that they could also work on their CTs to determine the net distributable income (NDI).


 
The NDI is then fed into DTs to run simulation of rates calculations. Normally IFIs would run few simulations before IFIs can finalise the rates of returns for the month.


Based on my observations, Malaysian local IFIs normally already have an idea on what rates are to be declared. They will work backwards using PER to adjust their Distributable Income in order to arrive at their desirable rates.
 
My column appeared in THE MALAYSIAN RESERVE, 10 March 2014

Monday 8 August 2016

Evolution of Islamic Term Deposit in Malaysia


The company I work for started getting involved in providing IT system for Islamic banking and finance in Malaysia in 1994. When it comes to system requirements, the Mudharabah general investment account (Islamic term deposit) or fondly known as GIA, demands significant work.



GIA’s conventional counterpart is the fixed deposit (FD). The most distinct feature of GIA when compared to its conventional counterpart is on profit processing.

Here are some key features of GIA profit processing during early days of Islamic banking in Malaysia which was operating undercash basis accounting:

1) Unlike conventional FD, where the amount of interest for the whole tenure of deposit with the bank would be fixed upfront, for the Mudharabah GIA, system had to support recalculation of profit, based on the latest announced rate for the product, on the maturity of GIA. (The process of calculating the latest announced rate is based on GP2-i, the Bank NegaraMalaysia (BNM) framework of rate of return). During the investment placement, only the indicative rate will be printed on the GIA certificate. Upon maturity of the GIA, the system had to recalculate the actual profit to be paid to customer.

2)  Interim rate concept had to be introduced for the Mudharabah GIA. Since the actual profit to be paid to customer would only be known on maturity of the GIA, interim profit processing is required to cater for a periodic profit payment depositors during the interim period.

For GIA greater than 12 months, interim profit will be paid on a six-monthly basis based on the latest six months GIA profit rate announced by the bank. The final profit payment will be the total actual profit (recalculated on maturity) minus total interim profit paid.

3) For premature GIA closure (withdrawal before maturity), profit will be paid based on the latest announced rate on the product closest to the number of completed months of the account.

For example, six months GIA that was prematurely withdrawn on the 4.5th month will be paid with the latest rate of four months GIA for the completed four months that the customer maintained the GIA account with the bank.

When Islamic banking and finance in Malaysia moved towards accrual accounting, additional requirement for GIA profit processing was introduced for the system to cater for “variable rate GIA”.

 Upon declaration of the latest rates of the GIA products on monthly basis, on the effective date of the new rates, the system had to accrue profit due to customers using the latest rate. This means, by the time the GIA matures, the system would have accrued the actual amount of profit due to GIA depositors. Therefore, upon maturity, the system would just have to credit the accrued profit to depositors’ accounts.

A few years later, another investment account product based on wakalah bi al-istithmar (investment agency) was introduced. The profit processing of Wakalah investment account was also different from conventional FD.

The following excerpt from BNM Shariah resolution highlights the differences:

1) If the Islamic financial institution has breached any terms of agreement or has negligently invested in an instrument which has no potential to generate profit at the minimum rate (for example 5% per annum), the Islamic financial institution will have to pay compensation as much as the principal sum of investment plus the actual profit (if any); and

2) If the Islamic financial institution invested in an instrument that is expected to generate profit at the rate of at least 5% per annum but failed to reach the targeted rate due to problems which are not attributable to the negligent conduct of the Islamic financial institution, such loss shall be borne fully by the customer.

The above conditions mean that upon GIA placement, depositors will be given an indicative rate of 5%. Upon maturity, if the actual rate declared by bank is lower than 5%, let’s say 3%, profit based on 3% will be paid to customer. The 2% loss will be borne by the depositor unless depositor could prove that the loss was due to the banks’ negligence in managing his or her investment.

However, Islamic banking in Malaysia still treats GIA as liability and it is covered under the Perbadanan Insuran Deposits Malaysia or the Malaysia Deposit Insurance Corp. This coverage will soon end when the new framework of investment account takes effect.

BNM has issued a concept paper on the Framework of Investment Account targeted to be effective on June 1, 2015. Among its objectives are “to facilitate the orderly development and operationalisation of investment that is consistent” with Islamic Financial Services Act 2013 (IFSA) and and “to promote compliance with standards on Shariah matters”. 

IFSA has redefined investment accounts where the return of customer deposit cannot be guaranteed.

During the transition period prior to the commencing of the new framework, Islamic Financial institutions are given options to implement alternative structures of Islamic term deposit products.

As an IT solution provider in the local market, we are now getting requirements to support Murabahah term deposit from almost all banks that we are supporting. Murabahah term deposit is based on the concept of Tawarruq or Commodity Murabahah.

My observation tells me that some Islamic banks in Malaysia are slowly phasing out Mudharabah GIA. It seems there is a trend that Mudharabah and Wakalah investment accounts will be slowly replaced by Murabahah term deposit.
 
My column appeared in THE MALAYSIAN RESERVE, 10 Feb 2014