A Critical Comparison between Malaysian Islamic Banks and Middle Eastern Islamic Banks

Presented by:Iqbal JusohRAM Ratings Intern (October-December 2007)

Research Report:

Introduction : History of modern Islamic finance

UAE (Dubai Islamic)Kuwait (KFH)

Bahrain (Al-Baraka)Saudi Arabia (Al-Rajhi) & Ors

Egypt (Mit Ghamr)Middle East

Trade-based society

1963 1975 - 1988

Bank MuamalatAmIslamic

RHB IslamicKFH Malaysia & Ors

BankIslam

Tabung HajiMalaysia

1963 1983

Introduced BBA,

Wadiah Yad Dhamanah

The Differences

Malaysian Islamic banks vs.

Middle Eastern Islamic banks

Different school of thought

Different Shariah interpretation

Different product offerings

Different level of funding cost

Different accounting treatments,

disclosures, presentation of financial statements

Different risk exposures

Different way of

liquidity management

Regulatory framework

Malaysian Islamic banks vs.

Middle Eastern Islamic banks

Different school of thought & Shariah interpretation

HANAFI

MALIKI

SHAFI’I

HANBALI

MALAYSIA

UAEKUWAITBAHRAIN

SAUDI ARABIA

GCC

PRAGMATIC

Tawarruq

BBA

Bai’

al-InahBai’ ad-Dayn

Different product offerings

Short-term financingMurabahah

SalamBai’ al-Inah (Malaysia only)

Bai’ ad-Dayn (Malaysia only)Tawarruq

Medium-term financingIjarah

Istisna’

Long-term financing / partnershipsMusyarakahMudharabah

Long-term financingMurabahah

BBA (Malaysia only)Musyarakah Mutanaqisah

Fee-based servicesWakalahKafalah

Saving depositsWadiah Yad Dhamanah (Malaysia only)

Qard

Demand depositsWadiah Yad Dhamanah (Malaysia only)

Qard

Investment accountsMudharabah

Mudharabah + Qard

ReservesEquity capital

ISLAMIC BANK’S BALANCE SHEET

ASSETS LIABILITIES

Murabahah / BBA

Cost

Profit

If disclosed

Murabahah

Spot payment

Deferred payment

Cash

Cashor

Credit

Deferred paymentBBA Murabahah

Middle Eastern’s practice

Short-termLong-term

Malaysian’s practice

Different operation of Murabahah

KFH KUWAITSUPPLIERS

CUSTOMERS

BANK MUAMALATAMISLAMIC

RHB ISLAMICSUPPLIERS

CUSTOMERS(as Islamic bank’s purchasing agent)

Middle Eastern’s practice

Malaysian’s practice

Sell goods

Deliver goods to Islamic bank

Sell goods at cost + profit

Sell goods

Deliver and sell goods at cost + profit

Sometimes warehouse needed

House / real estate financing

BANK MUAMALATAMISLAMIC

RHB ISLAMIC

BBA

KFH MALAYSIA

Musyarakah Mutanaqisah

Istisna’

Ijarah Mausufah Fi Zimmah

Ijarah

Murabahah

Ijarah Muntahiah Bi Tamlik Dubai Islamic

KFH KUWAIT

AL-BARAKA

Ijarah Mausufah Fi Zimmah

Different recognition on Bai’ al-Inah

BBA CUSTOMER’S ASSET

BANK

CUSTOMER

Malaysian’s view

Middle Eastern’s view

Bai’ al-Inah

Bank sel ls back at

cos t + pr ofi tCus

tom

er

sells

at c

ost

Maliki

Hanbali

Hanafi

BANK

BANK’S ASSET

CUSTOMER

Bai’ al-Inah

Shafi’i

Ban

k se

lls a

t cos

t + p

rofit

(d

efer

red

paym

ent)

Bai’ al-Inah is invalid

Bai’ al-Inah is valid

Bank buys back at cos t

( cash)

AAOIFI

Islamic Fiqh Academy

SSB KFH

Car financing

DEALERISLAMIC BANK / OWNER

CUSTOMER/HIRER

DEALER

ISLAMIC BANK / OWNER

Hire-Purchase-i/ AITAB

Bank buys asset

Bank leasesasset

Cus

tom

er p

ays

inst

allm

ents

(r

enta

l)

Customer maintains road tax and insurance for 2nd

year onwardsBank’s responsibility

to maintain

Sometimes buys from dealer CUSTOMER

Given option to purchase upon expire of leasing tenure

Bank leases asset

Customer pays installments (rental)

Bank promises to sell upon expire of leasing tenure

Ijarah Muntahiah Bi Tamlik

MALAYSIA

MIDDLE EAST

HP ACT

Different operation of Ijarah

AL-BARAKA

KFH KUWAIT

AL-RAJHI

KFH MALAYSIA

OPERATING LEASE

FINANCIAL LEASE / IJARAH

THUMMA AL-BAI’

AL-BARAKA

Islamic banks maintain assets of a high degree of marketability

Showrooms or warehouses needed by Islamic banks

Not practised by Malaysian local Islamic banks

Different recognition on Bai’ ad-Dayn

BANK MUAMALAT

AMISLAMIC

RHB ISLAMIC

KFH MALAYSIA

MIDDLE EASTERN ISLAMIC BANKS

SALE OF DEBT AT DISCOUNT

SALE OF DEBT AT DISCOUNT

SAC BNM & SAC SC

BANKER’S ACCEPTANCE-i

CUSTOMER

IMPORTER

ISLAMIC BANK

Credit sale

Sells debt at discount

Gets instant cash

Collect payment on bank’s behalf upon maturity

Different operation of Istisna’

ISLAMIC BANK CUSTOMER

CONTRACTOR / CUSTOMER

Malaysian way: Parallel Istisna’

4. Bank delivers Istisna’ asset

1. Customer requests bank to construct Istisna’ asset

2. B

ank

agre

es a

nd re

ques

ts c

ontra

ctor

to

con

stru

ct Is

tisna

’ ass

et

3. Upon completion, contractor delivers Istisna’ asset to the bank

Different operation of Istisna’

ISLAMIC BANK CUSTOMER

CONTRACTOR (OTHER THAN

CUSTOMER)

Middle Eastern way: Direct Istisna’

4. Bank delivers Istisna’ asset

1. Customer requests bank to construct Istisna’ asset

2. B

ank

agre

es a

nd re

ques

ts c

ontra

ctor

to

con

stru

ct Is

tisna

’ ass

et

3. Upon completion, contractor delivers Istisna’ asset to the bank

ISLAMIC BANK CUSTOMER

1. Customer requests bank to construct Istisna’ asset and pays progress billings

2. Bank delivers Istisna’ asset upon full settlement of progress billings

Middle Eastern way: Parallel Istisna’

Different deposit structures

BANK MUAMALAT

AMISLAMIC

RHB ISLAMIC

WADIAH YAD DHAMANAH

DUBAI ISLAMIC

AL RAJHI

KFH KUWAIT KFH MALAYSIA

AL-BARAKA

QARD

MUDHARABAH

MUDHARABAH

Deposit as custodian asset

Bank guarantees the custody

Bank is free to mobilize the deposit

Bank pays return as hibah (gift)

Deposit as loan

Bank is bound to return the loan

Bank is free to mobilize the loaned money

Bank pays back just the loaned money with no return

Customer deposits money as capital provider (Rabb-al-Mal) in the bank’s business

Bank acts as entrepreneur (Mudharib)

Banks distributes profit (if any)

If loss, will be absorbed by Customer (unless due to Bank’s misconduct / negligence

Some practise PER, some does notAl-Baraka practices PER & IRR

Obliged to practise PER (including KFH Malaysia)

Implication of such differences

Different level of

funding costHigher

funding cost

Lower Funding cost

WADIAH YAD

DHAMANAH

QARD

MALAYSIAN LOCAL ISLAMIC BANKS

MIDDLE EASTERN ISLAMIC BANKS

Different accounting treatments

Accounting and Financial Reporting Standards Applied By Islamic Banks

Bank Accounting and Financial Reporting Standard(s)

Al Rajhi Bank International Financial Reporting Standard (IFRS)

KFH Kuwait IFRS, with some local amendments

Dubai Islamic IFRS

AlBaraka AAOIFI standards

Bank Muamalat MASB standards and BNM/GP8-i Guidelines

AmIslamic MASB standards and BNM/GP8-i Guidelines

RHB Islamic MASB standards and BNM/GP8-i Guidelines

KFH Malaysia MASB standards and BNM/GP8-i Guidelines

Implication of such differences

Different accounting treatments

AAOIFI MASBFRS i-1 2004 BNM / GP8-i

MALAYSIAN ISLAMIC BANKSBBA & WADIAH YAD DHAMANAH

AL-BARAKA & ALL BAHRAIN-BASED ISLAMIC BANKS

Issues:

1. Reporting investment accounts as liabilities on the balance sheet (Appendixes 4-A, 4-B, 4-C)

2. Reporting investment accounts off-balance sheet (Appendix 4-D)

3. Requirement for specific financial statements i.e. statements of changes in restricted investments and statement of sources and uses of Qard fund (Appendix 4-E)

4. Unrestricted investment accounts not as liabilities, but to be placed under ‘equity of unrestricted investment account holders’ (Appendix 4-F)

5. Distributions to PSIA – deduct distribution from operating revenues to calculate operating income (Appendix 4-G)

6. Distributions to PSIA –compute operating income first, deduct distribution, to get net profit(Appendixes 4-H, 4-I)

7. Jargon lacks of explanation (Appendix 4-J)

8. Practice of PER for PSIA, with PER parked under ‘other liabilities’ (Appendix 4-K)

9. Practice of PER and IRR (Appendix 4-L)

Implication of such differences

Different risk exposures

Middle Eastern Islamic Banks

Malaysian local Islamic Banks

HIGHER EXPOSURES TO CREDIT, MARKET AND

OPERATIONAL RISK

LOWER EXPOSURES TO CREDIT, MARKET AND

OPERATIONAL RISKAPPENDIX 6

LOWER EXPOSURE TO DISPLACED COMMERCIAL RISK

HIGHER EXPOSURE TO DISPLACED COMMERCIAL RISK

Different way of

liquidity management

Middle Eastern Islamic banks

Malaysian local Islamic banks

Bahrain Short-term Salam govt bills

Commodity Murabahah - Metal

Commodity Murabahah - CPO

GII – Bai’ al-Inah

Bai’ ad-Dayn instrumentsBNM Short-term Sukuk al-Ijarah

Bahrain Short-term Sukuk al-IjarahMutajara

Impact of Basel II, AAOIFI proposal and IFSB’s standards

Basel II AAOIFI Proposal

Tier 2 capital does not include hybrid capital instruments /

subordinated bonds

RWCAR not lower than 8%

Tier 2 capital includes hybrid capital instruments /

subordinated sukuk

Malaysia (BNM/GP8-i)

and

(BNM Capital Adequacy

Framework for Islamic Banks)

Impact of Basel II, AAOIFI proposal and IFSB’s standards

AAOIFI Proposal

IFSB’s Capital

Adequacystandard

RWCAR Calculation

CAR: Total Capital

RWAK&CA + 50% (RWAUIA)

CAR: Tier 1 + Tier 2

RWA (Credit risk + Market risk + Operational risk)

- RWA funded by PSIA (Credit risk + Market risk)

RWAK&CA = average risk-weighted assets financed by bank’s capital + depositors’ current account

RWAUIA = average risk-weighted assets financed by unrestricted depositors’ investment accounts

PSIA = restricted + unrestricted investment account holders

STANDARD FORMULA

SUPERVISORY DISCRETION FORMULA

CAR: Eligible Capital

Total RWA (Credit risk + Market risk + Operational risk)

- RWA funded by restricted PSIA (Credit risk + Market risk)

- (1-α) [RWA funded by restricted PSIA (Credit risk + Market risk)]

- (1-α) [RWA funded by PER and IRR of unrestricted PSIA (Credit risk

+ Market risk)]

α = proportion assets funded by unrestricted PSIA which is to be determined by the supervisory authorities

Impact of Basel II, AAOIFI proposal and IFSB’s standards

RWCAR Calculation

CAR: Capital Base

Total RWA (Credit risk + Market risk + Operational risk)

- (1-α) [RWA funded by PSIA (Credit risk + Market risk)]

- (1-α) [RWA funded by PER of PSIA (Credit risk + Market risk)]

α= proportion of losses from credit and market risk exposures borne by Islamic bank, as a result of displaced commercial risk

arising from income smoothing practices (PER) for PSIA holders

Malaysia (BNM/GP8-i)

and

(BNM Capital Adequacy

Framework for Islamic Banks)

No differentiation between restricted and restricted PSIA

PSIA not risk absorbent for bank’s operational risk

Direction of Islamic banks from other jurisdictions

MALAYSIANISLAMIC BANKS

GCC MARKET BBA

Bai’ al-InahBai’ ad-Dayn

CIMB

YOUSUF AHMED KANOO

HOLDING

CIMB-KANOO GCC MARKET

BBABai’ al-Inah

Bai’ ad-Dayn

CITIBANK MALAYSIA-i

HSBC AMANAH

MALAYSIA

Wadiah Yad Dhamanah

Musyarakah Mutanaqisah

BBA

Conclusion

Different school of thought

Different Shariah interpretation

Different product offerings

Different accounting treatments,

disclosures, presentation of financial statements

Different way of

liquidity management

Regulatory framework

Different risk exposures

Different level of funding cost

1.

2. Eligible regulatory capital: AAOFI vs. Malaysian Islamic banks

3. IFSB’s Capital Adequacy standards do not represent the diverse Shariah practices among Islamic banks