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International Journal of MuamalatNovember 2017, Vol. 1, No. 1

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MANAGING CREDIT AND INVESTMENT RISKS OFISLAMIC COOPERATIVES IN THAILAND: A CASE STUDY

OF IBNU AUF COOPERATIVE LIMITED

Mohammadtahir Cheumar1Dr Wan Nazjmi Bin Mohamed Fisol2

Rahayati Binti Ahmed3

Assoc.Prof. Dr Besar Bin Ngoh4

1,2,3 Kulliyyah Muamalat and Management Sciences, Sultan Abdul Halim Mua’dzam ShahInternational Islamic University (UniSHAMS).

4 Faculty of Finance and Administrative sciences, Al-Medinah International University (MEDIU).

Abstract

Cooperative movement in Thailand has a long history with the establishment of Wat ChanCooperative way back in 1916. The objective then was to save Thai farmers from losing most oftheir agriculture land to the middle men and money lenders, resulting from inability to settletheir debts. Today more than 7000 cooperatives exist in Thailand alongside other establishedinstitutions of intermediation such as the commercial banks, Islamic bank and credit companiesforming an important component of the vast landscape of Thailand financial infrastructure.Islamic cooperative on the other hand is a new entry to the financial system, emerged in 1987starting with the establishment of Islamic Savings Cooperative of Pattani Limited by DenTokmena, a former senior government officers and Vice Minister of Health Care and Homeaffairs of Thailand. The existence of Islamic cooperatives, in particular in the southern region isnot without problems. Many contemporary and long-standing issues are haunting the Islamiccooperatives in particular on the unfavourable regulatory and supervisory frameworks thathave not been supportive of their growth and development. Similar to the case of Islamic bankof Thailand (IBank), Islamic cooperatives in Thailand do not have a “level playing field” withtheir conventional counterparts. The issues are worsened with higher risk exposures thatIslamic cooperatives are facing due to the nature of their products and services that have to beShariah compliant. Many Islamic cooperatives are facing problems of inadequate capital andtight liquidity position, together with incompetent staff and poor corporate governance. Thisstudy is an attempt to evaluate the natures and severity of investment risks of their productsand services that have to be Shariah compliant in Islamic cooperatives in southern Thailand:Ibnu Auf Cooperative Ltd., and hence to propose workable strategic mitigation plans.

Keywords: Islamic cooperative, risk management, Islamic investments


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Introduction

There were 7,093 conventional cooperative societies in Thailand as at end of 2014 with a totalmembership of 11,275,804 compared to only 27 Islamic cooperatives with membership of lessthan 100,000, operating mainly around the southern provinces of the Kingdom (COOP Thai,2015). Cooperative societies exist in Thailand alongside other established institutions ofintermediation such as the commercial banks, Islamic bank and credit companies forming animportant component of the vast landscape of Thailand financial infrastructure. Islamiccooperative on the other hand is a new entry to the financial system, emerged in 1987 startingwith the establishment of Islamic Saving Cooperative of Pattani Limited by Den Tokmena, aformer senior government officers and Vice Minister of Health Care and Home affairs ofThailand. In his visit to Manila in 1983, attending Shariah Administrative Conference of Asia,Den Tokmena was very impressed with the establishment of Phillippines Amanah Bank, the firstIslamic bank in Asia. Upon his return to Thailand, Den Tokmena wanted to establish an Islamicbank, but the idea was rejected by the government, and an immediate alternative DenTohmena establish an Islamic cooperative in 1987. By 1988 Islamic Savings Cooperative ofPattani (ISCP) had 360 registered members, and within 10 years (1998) the membership hadincreased to 8,186, with branches in 12 districts in the Provincial Pattani.

Thailand is a multi-religious country with Buddhists being the majority and Islam the minoritywith only around six million followers. Majority of the Muslims occupy and reside around thefive Southern Regions of Thailand. In Southern Thai, the traditional financial institutions mostlyrevolved around the institutions of pawnshop and towards the 80’s the Cooperative Societieswere established by the Muslims in the region. These two main financial intermediaries exist tothese days alongside the existence of modern financial institutions. Long before thesecommercial banks embarked in Islamic banking business, Shariah compliant financial services inThailand were initially made available through Muslim cooperatives in the southern region.Initially there are four of such cooperatives, which are still in active operation until today andthey are Islamic Savings Cooperative of Pattani, Ibnu Affan Saving Cooperative, As_SiddiqSavings Cooperative, Saqaffah Islamic Savings Cooperative, and Al-Islamiah Savings Cooperative(Yamirudeng, K.M. 2013 &Haron, S. &Yamirudeng, K.M., 2009). Cooperative movement inThailand has a long history with the establishment of Wat Chan Cooperative way back in 1916.The objective then was to save Thai farmers from losing most of their agriculture land to themiddle men and money lenders, resulting from inability to settle their debts. Today thousandsof cooperatives exist in Thailand alongside other established institutions of intermediation suchas the commercial banks, Islamic bank and credit companies forming an important componentof the vast landscape of Thailand financial infrastructure.

Islamic cooperative on the other hand is a new entry to the financial system, emerged in 1987starting with the establishment of Islamic Savings Cooperative of Pattani Limited by DenTokmena, a former senior government officers and Vice Minister of Health Care and Homeaffairs of Thailand. The existence of Islamic cooperatives, in particular in the southern region isnot without problems. Many contemporary and long-standing issues are haunting the Islamiccooperatives in particular on the unfavourable regulatory and supervisory frameworks that


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have not been supportive of their growth and development. Islamic cooperatives in Thailand isvery much at their “infancy” stage, being in existence for less than 30 years compared to theconventional cooperatives which existed since 1916, (Thai COOP, 2016). Although the basis ofoperations of Islamic cooperatives is different from their conventional counterparts, they aresubjected to the same laws and regulatory requirements under the Co-Op Act of 1999 (formerlyunder Cooperative Act of 1968). This has created additional burdens of risks to the Islamiccooperatives as the laws of the country do not recognise Islamic contracts (Ngah,B.N, 2016).The scope of services for an Islamic cooperative is very wide and being an institution of financialintermediaries for the members, the cooperative engages in businesses ranging from trading toinvestments, apart from meeting the financial needs of the members.

Types of Cooperatives in Thailand

In 1999, cooperative act as ‘Cooperative Act, B.E. 2542’ was issued and has been enacted sincethen, the cooperatives in Thailand are officially categorized to seven (7) types, namely (i)Agricultural Cooperative, (ii) Land Settlement Cooperative, (iii) Fisheries Cooperative, (iv)Consumer Cooperative, (v) Saving and Credit Cooperative, (vi) Service Cooperative, and(vii)Credit Union Cooperatives. However, by the year 2016, there exist 9 types of cooperativesin Thailand, including Islamic cooperatives as reflected in Table 1.1 below

Table 1.1: Types of Cooperatives in ThailandNo. Name of Types No. Name of Types1 Agricultural Cooperative 6 Service Cooperative2 Land Settlement Cooperative 7 Credit Union Cooperatives3 Fisheries Cooperative 8 Cooperative Banks4 Consumer Cooperative 9 Islamic Cooperatives5 Saving and Credit Cooperative

Structure and Composition of Cooperative Societies in Thailand -2014

Overall composition of cooperative societies in Thailand is reflected in Table 1.2 below.

Table 1.2: Annual Statistics of Cooperatives, AgriculturalGroups and Vocational Groups in Thailand 2014

Cooperatives Number ofActive Cooperative

Number ofMemberships

1.Agricultural 3,712 6,601,4952.Fishery 79 15,3173.Thrift & Credit 1,396 2,771,3514.Land Settlement 90 188,4275.Consumer 174 731,0426.Services 1,134 461,1047.Credit Union 508 710,812All Type 7,093 11,275,804

Source: Co-Op Promotion Department, Thailand, 2016


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As reflected in the above Table 1.2, the biggest cooperatives are the Agriculture cooperativeswith a membership of more than 6.6 million or 58% of the total cooperative membership in theKingdom of Thailand.

Organizational Structure of Cooperative in Thailand

In term of scope of operations, conventional cooperatives tend to be very specific in theiractivities commensurate with their names and objectives of establishment. This is reflected inTable 1.3 below.

Table 1.3: Structure of Cooperative Movement in Thailand

Source: Co-Op Promotion Department, Thailand, 2016

Cooperative in Thailand are very vertically organized in a three-tier system; primarycooperatives at district level and federations at provincial and national level. The primarycooperative consists of individual members while members of provincial and nationalfederations are cooperatives. The members elect the board of directors through the generalmeeting with maximum number of 15 persons for cooperative development policiesformulation. The board of directors, then, appoints a manager and staff to run the cooperativebusiness. Five of more cooperatives at primary or provincial level can form a provincial ofnational federation together to undertake joint activities on behalf of their affiliations such asprocessing and trading of agricultural products. At national level, there is the AgriculturalCooperative Federation of Thailand of which all 76 provincial agricultural cooperativefederations are affiliate. There are also the Sugarcane Growers Cooperative Federation ofThailand, Swine Raisers Cooperative Federation of Thailand, Dairy Cooperative Federation ofThailand and Onion Growers Cooperative Federation of Thailand. Thrift and Credit Cooperatives,and Consumer Cooperatives are affiliated in a national federation of their own. All types of


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cooperatives at all levels, according to the Cooperative Act, B.E.2542, have to implicitly beaffiliates of the Cooperative League of Thailand (CLT). The CLT in functioning as an apex body ofthe whole cooperative movement. It does not run as a business enterprise, but acts as afacilitator, coordinator and provides educational support in the promotion of all cooperativeprogress (CPD, 2012). For Islamic cooperatives however, much wider scope of activities, Islamiccooperatives are exposed to a much wider risk spectrum compared to their conventionalcounterparts.

This study is specific to the examination of risk profile of Islamic cooperatives in Thailand basedon their credit and investment activities.

Statement of Problems

Although most Islamic cooperatives in Thailand are profitable but profitability among them iswide ranging from a net profit of 5% to 45%. Past studies on Islamic cooperatives as well asIslamic banking in Thailand revealed similar problems as listed below;

1. Unfavourable regulatory and supervisory frameworks, (Fereydoony, M. 2012).2. Capital inadequacy, (Mahamud, T. 2016).3. Islamic liquidity management, (Mahamud, T. 2016).4. High investment risk, (Ngah, B.N. 2016).5. Incompetence human resources, (Mahamud, T. 2016).6. Poor corporate governance, (Ngah, B.N. 2016).

As Fereydoony (2012) cited incompatible laws as a major obstacle to the development ofIslamic financial institutions in Thailand. Lacking in Islamic financial infrastructure, such asIslamic liquidity market (ILM) to enable Islamic cooperatives to manage their shortages as wellas their liquidity surplus has caused serious inefficiency in liquidity management, (Mahamud, T.2016). Although all cooperatives are free to deposits their funds with any financial institutionsin Thailand but Islamic cooperatives are restricted in accepting “interest” on their deposits, inwhich case “interest” income from conventional banks is to be disposed-off to charitableorganizations. Investment in Government marketable instruments such as government bondsand government securities are forbidden as all government instruments are conventional-basedand interest bearing. Sukuk issuance is still a pending matter in Thailand, for which IBank is stillstruggling with its first Sukuk issue (IBank annual report, 2013).

Islamic cooperatives, unlike their conventional counterparts are not allowed under Shariah lawsto pay fixed return to their depositors and investors while at the same time members areexpecting higher returns on a continuous basis. This has resulted in the cooperativesexperiencing higher cost of funds compared to conventional banks or even the Islamic banks,(Ngah, B.N. 2016). Mudharabah depositors in Islamic cooperatives tend to lose their money as“Rabbul-mal” in the event that the cooperatives incurred losses. In 1998, Muamalat SavingsCooperative of Thailand collapsed due to numerous reasons including investment failures.There is a very high risk of investment as discovered by Ngah (2017) under Islamic contracts ofMusyarakah in project financing as compared to Murabahah or even Ijarah contracts which are


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based on prices marked-up. Islamic cooperatives involved in many joint-venture investmenteither with their members or with corporations outside their membership. Some of the JV’ssuffered losses due to several causes which include lacking in technical competencies amongthe management of most cooperatives, (Mahamud, T. 2016). Lacking in financial prudence andport corporate culture and poor Shariah governance have also been cited as among the majorproblems facing Islamic financial institutions including Islamic cooperatives, (Shodiq, M., 2014).Staff competencies have also been a global issue in Islamic finance, including the Islamiccooperatives and as such the Thailand’s Cooperative Act of 1999 spelt out very clearly of theneeds for all cooperatives to develop the knowledge and competencies of their members andstaff.

Research Questions

Based on preceding discussion this paper has the following questions that need to be addressed;1. What are the types of investment risks exposed to Islamic cooperatives in Thailand?2. How Islamic cooperatives can mitigate such risks?

Objectives of the Paper

This paper in intends to;1. Explore the types of investment risks exposed to Islamic cooperatives in Thailand.2. Offer probable solutions to mitigate risks for Islamic cooperatives in Thailand.

Research Methodology

This paper employs qualitative methods of analysis based on available literature on Islamiccooperatives in Thailand, Malaysia and Indonesia. Since financial data on performance of mostIslamic cooperatives in Thailand is not available to the author, descriptive analysis will be basedon one cooperative (Ibn Auf Cooperative Ltd.) whose financial data is accessible. Although thequantitative findings may not be representative due to limited data, it is however useful toprovide some empirical indications of the performance and extent of risks exposed to Islamiccooperatives in Thailand. Several theoretical foundations will be examined to support theanalysis made in this study. Denzin (1978) introduces the concept of triangulation to fourelements of research study: data, methodology, investigator, and theory. One of the leastpopular of these four is theoretical triangulation. It is a process whereby an analyst modifiesand integrates multiple theories to build an interpretive account or a “lens” that produces deepinsights and critical questions for further studies than a singular theory would otherwiseprovide. Although theories are useful to organise patterns as well as make sense of aphenomena in an empirical observation, but they are discerning in what they let us see as adirect result of its limitations. A listing of various risks is made on descriptive basis, reflectingthe extent of risk exposure in Islamic cooperatives in Thailand.

Other than the seminal work of Ebrahim (2009) that partly introduces the concept ofcooperative, there is only scattered literature exploring the problems and challenges in


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investment management within Islamic cooperatives including financings to their members.The authors managed to review related literature and identified some of the most relevantchallenges that seem to be hampering Shariah compliant investments by Islamic cooperativesand it is important to highlight that the problems mentioned in the preceding list might affectthe Shariah compliant investment by the Islamic cooperatives. These factors are interconnectedand can be presented in varying degrees; however, together they are seen to inhibit Shariahcompliant intermediation capacities of the cooperatives.

Business Model and Strategy

Some authors have deduced Financial Cooperative (FC) as cost-minimising enterprises (Taylor,1977) in a way similar to government or government-linked enterprises. Nevertheless, thisvision only takes into account of FC’ superficial features, as they are more than mere cosmetics.This in turn, results in consequential differences between FC and investor-owned firms, forexample, Shariah compliant commercial banks. They pursue different goals, possess differentcustomer bases, and pursue different operational strategies. The most fundamental differencebetween Shariah compliant commercial banks and FC lies in two aspects of ownership-commonbond and mutuality. Common bond often results in FC members’ knowledge ofcreditworthiness of other members and allow exercise of moral suasion on membermortgagors as they may feel greater social pressure to repay outstanding instalments.

Moreover, FC management usually has access to inside information about the financial positionand job security of Shariah compliant mortgage financing applicants, which is not generallyavailable to other types of financial intermediaries. A consequence of this informationadvantage is that, these FCs may be more efficient, either because they hold fewer bad Shariahcompliant mortgages in their portfolio, or are able to spend less time and cost in processingapplications and monitoring outstanding defaults. The tight bond restriction however, comesat the cost of a less diversified Shariah compliant mortgage financing portfolio, potentiallynegating the peer monitoring advantage (Esho, 2001). In the past, FC’ common bond andmutuality organisational structure have addressed asymmetric information problems byrequiring that these institutions to extend mortgage finances only to members. Membermortgagors’ personal financial information regarding size and share account balances is oftensupplemented by the personal knowledge of the member-mortgagor. Prior to the generalavailability of online credit reports, this common bond and mutuality arrangement reducedcosts of extending and monitoring Shariah compliant mortgage financing to member-mortgagorwhose financial statements and financing records had been difficult to acquire (Srinivasan andKing, 1998). Today, on the other hand, apart from few institutions that still specialise in specificcustomer groups, FCs have no restrictions with respect to their clients. They have since evolvedinto larger firms, which transact with many mortgagors who are not members and which arerun by professional managers. In other words, members are usually customers, but not allcustomers are members (Gorton and Schmid, 1999). Additionally, in an economy where peoplechange jobs and locations regularly, the inter-temporal and inter-personal commitment thatdefines the ‘common bond’ may be even harder to preserve (AlMuharrami and Hardy, 2013).


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Currently, these firms resemble conventional investor-owned firms, yet their ownershipstructure is not able to adjust accordingly. One important institutional restriction is that FCshares can only be traded with the FC itself and then only at face value (Gorton and Schmid,1999). As a result, there can be no hostile or reverse takeovers of FC. Another importantrestriction is that shares cannot be accumulated into blocks. Thus, irrespective of the amount ofstock owned, each person receives one vote and block holders in FC are unable to exert theirvoting power. These distinctions are common to a financial cooperative. A second reason forthis inflexibility is that the degree of separation between ownership and control is easilymeasured as it was indexed by the number of FC’ members. As a result, the degree ofseparation of ownership and control, which affects firms’ performance in cross-section, can beanalysed. The size of agency costs can be quantified as a function of free-riding. Because of therestrictions on ownership structure, as the number of FC’ members rise, the size of agency costshould increase. In other words, the more dispersed the equity ownership of an FC, themembers will be more likely to free-ride on each other’s efforts to monitor the FC management(Gorton and Schmid, 1999). FC redistributes their profits through price subsidies-i.e., throughlower profit rates on Shariah compliant mortgage financing and higher profit rate on savings(Hart and Moore, 1998; Reichert and Rubens, 1994). Although this may be perceived asdistorting the ‘invisible hand’ in the market by distorting prices, but conversely, it helps FC torealise their objective of maximising members’ surplus.

However, such objective may lead to potential conflicts among members. This is particularly sosince member-depositors and member-mortgagors have not only different, but oftenconflicting objectives. Hence, individual utility may be at the cost of another’s. Even thoughboth types of members (savers and mortgagors) may gain from better profit rates compared tonon-members, this might prompt potential internal conflict concerning the benefit distributionas the amount of resources to be redistributed is limited. The conflict resolution is based on thedominance of one type of member over the other (Willian R. Emmons and Schmid, 2002; Smithet al., 1981). When members are asked to vote in the annual general meeting (AGM), if themedian voter shifts from member-savers to member-mortgagors, the consequential benefitreallocation choice could change accordingly, and vice versa. Thus, the choice between keepinglow profit rate on the Shariah compliant mortgage or raising rate of return on saving dependson the alignment of the voting members in the AGM (William R Emmons and Mueller, 1997). Inthe National Cooperative Policy (NCP) 2010-2020, the ministry in charge of cooperatives,Minister of Domestic Trade, Cooperatives and Consumerism (KPDNKK) contends that themajority of the cooperatives are small in size and most importantly—capital.

Most cooperatives are dependent on the internal resources of capital (i.e., share capital,member’s fees, and retained earnings). Since FC’ asset and liability holding defines its size; itshould be positively related to its willingness to extend Shariah compliant mortgage financing.One would expect small FC to be less willing to offer Shariah compliant mortgage financing toits members. A small FC must either commit a relatively large portion of its portfolio to Shariahcompliant mortgage in order to spread the highly specialised overhead costs thinly, diversifiedinto other types of banking activities or else, completely stay out of the Shariah compliantmortgage market (Peterson and Kidwell, 1983). On the other hand, larger FCs are in a position


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to spread overhead costs over a larger volume of financing and can obtain portfoliodiversification more easily. Thus, they may be more willing to make Shariah compliantmortgage financings.

Performance of Islamic Cooperatives in Thailand

Based on limited data available Performance of Islamic Cooperatives in Thailand in term of ROAand ROE are presented below:

Table 1.4: Ibnu Auf Cooperative Ltd. 2009-2013

Financial Year

#

ITEMS Growth2009 2010 2011 2012 2013 5 Years

%1 Number of

Membership22,668 25,193 26,156 27,650 28,160 23.80%

2 Reserve Capital(TBT)

10,009,639 11,715,455 14,646,022 19,829,138 24,422,385 140%

3 Share Capital(TBT)

220,946,570 290,426,050 450,014,500 568,129,300 634,510,100 188%

4 Total Co-opFunds (TBT)

248,670,141 330,028,737 509,190,226 633,800,908 697,245,775 181%

5 Financing &Investments(TBT)

451,674,806 654,384,801 986,474,409 984,782,620 981,081,771 177%

6 Total Assets(TBT)

700,344,948 984,413,539 1,495,664,637 1,618,583,528 1,678,327,546 139%

7 Members Loans(TBT)

141,788,641 249,828,382 504,803,410 415,589,131 326,067,906 129%

8 Total Deposits(TBT)

320,354,614 472,181,491 680,525,672 633,665,173 621,492,390 94%

9 Total Revenue(TBT)

28,588,246 44,263,465 77,101,201 73,166,431 73,966,480 155%

10 Total Expenses(TBT)

12,435,767 17,632,490 33,018,604 27,333,961 36,112,681

11 Net Profit (TBT) 16,152,479 26,630,974 44,082,596 45,832,470 37,853,798 137%12 Net Profit

Margin %57 59 57 61 51

13 Return onCapital (ROE %)

7 9 9.7 8 5.9

14 Return onAssets (ROA %)

2.3 2.7 2.9 2.8 2.3

15 Zakat Co-op 553,563 835,708 1,559,506 1,975,558 1,200,000 117%

Source: Ibnu Auf Annual Report


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Chart 1.1: Financing & Investment, Members loans, Net profit and Total deposit of Ibnu AufCooperative Ltd. 2009-2013Source: Ibnu Auf Annual Report

Risk Management

Prudence, responsiveness, empathy, and transparency are some of the imperative valuesstrongly linked to risk management. FC on the other hand, tend to lean on the moreconservative side of risk management as their business model flows from their underlyingprinciples of maximising members’ surplus (Goglio and Alexopoulos, 2014). By involving itself inthe Shariah compliant mortgage financing intermediation however, FC will be investing in thereal economy and create spill over effects to all stakeholders. In the following sub-sections, weexplore the types of risks faced by FC in offering Shariah compliant mortgage financing. Inparticular, we examine default risk, profit rate risk, and liquidity risk (Md. Zabri et al., 2015).

a) Default Risk

Default risk is the most significant risk associated with FC. A mortgagor’s ability to repay theinstalments can be seriously affected by various factors, some of which are not directly underthe mortgagor’s control. Default risk is simply defined as the potential that a borrower will failto pay their instalments in accordance with the stipulated terms. The goal of default riskmanagement is to maximise the FC’s risk-adjusted rate of return from the Shariah compliant


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mortgage financing by maintaining its exposure within acceptable Shariah compliantparameters. Additionally, FC needs to manage the default risk inherent in the entire financingportfolio as well as the risk in individual Shariah compliant mortgage financing. Highermortgage finances-to-share ratio is negatively related to efficiency, suggesting that highermortgage finance ratios are accompanied by substantially greater operating costs. It would notbe a viable business model for a smaller FC to diversify its entire credit risk and hence, they willbe unable to benefit from economies of scale (Ory and Lemzeri 2012). Further, FC’s willingnessto offer Shariah compliant mortgage financings would likely be increased if the FC were betterable to collect outstanding Shariah compliant mortgage financing obligations either because ofgreater Shariah compliant mortgage lending expertise or through automatic payroll deductionplans. In general, the automatic payroll deduction plans serve to simplify collection proceduresand its associated costs (Peterson and Kidwell, 1983). FC in the U.S have therefore, devotedconsiderable attention to developing fee-based services to mitigate mortgage financing defaultrisks (Reichert and Rubens, 1994). However, FCs in Malaysia, are able to mitigate default riskthrough the automatic payroll deduction plans, which is administered by BPA.

b) Profit Rate Risk

The general practice in FC seems to be to offer higher profit rate on savings and charge profitrate on financing products that sometimes below the comparable market rate. As a result, thesupply of FC Shariah compliant mortgage financing should be positively related to the profitrate that can be obtained on the product, and negatively related to the rate of return that canbe earned on alternative investment opportunities (Peterson and Kidwell, 1983). Due to theirexcess liquidity, larger and more efficient FC are able to offer: 1) higher finance-to-value ratioon finances, 2) report lower finance-to-share ratios, 3) obtain higher level of capital to financenew products and acquire modern technology, and 4) make greater use of more sophisticatedmortgage finance services, such as adjustable rate mortgage (ARM), which carry a reduced levelof profit rate risk (Reichert and Rubens, 1994). Larger FC would also make greater use of profitrate management techniques such as maturity and duration gap strategies (Reichert andRubens, 1994). To offset the problem of capitalisation, FC needs greater reliance on Shariahcompliant fee-based income as it will enable them to more effectively hedge against profit raterisk and reduce their over-dependence on external financing as a major source of funds(Reichert and Rubens, 1994).

c) Liquidity Risk

FCs are another organisational form that usually utilise local information and peer monitoring.Few FC receive external financings from Shariah compliant commercial banks and/or from thegovernment and then distribute the funds among their members as Shariah compliantmortgage financing. This external form of financing complements internal fundraising frommember deposits and fees, capital shares, and retained earnings (Besley, 1995; Cornforth andThomas, 1990). The minimum down payment required on Shariah compliant mortgagefinancing, if high enough, should mitigate the risk associated with making Shariah compliantmortgage financing and, therefore, increases FC’s willingness to supply Shariah compliant


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mortgages. Reichert and Rubens (1994) claims that sizes of FC have a large impact upon theway FC are managed. Larger FC for example, are less dependent upon Shariah compliantmortgage financing products for generating income and markedly more sophisticated in theway in which they manage default, profit rate, and liquidity risks.

Thus, an FC with small portfolios might need to ration the amount of Shariah compliantmortgage financings to its members. An Analytical Framework to Examine Shariah compliantMortgage Financing Longer maturity Shariah compliant mortgage financings reduce FC liquidityand increases risk, and therefore may negatively influenced FC’s willingness to supply Shariahcompliant mortgage financing. If an FC has a large stock of liquid assets, it may be more willingto commit a larger portion of its portfolio to Shariah compliant mortgages because therelatively long maturity of Shariah compliant mortgages is less likely to place FC in an illiquidposition (Peterson and Kidwell, 1983). Net returns on a Shariah compliant mortgage financingare higher when overhead costs of Shariah compliant mortgage financing can be extended overa larger volume of instalments and a larger amount of Shariah compliant mortgage financingcharges. On the other hand, larger average size Shariah compliant mortgage financings wouldconcentrate risk in fewer obligations by reducing diversification for a given size portfolio.However, the aggregate effect on liquidity and overall portfolio risk would not be large unless asubstantial amount of an FC’s portfolio was committed to Shariah compliant mortgages. Thus,the cumulative effects of changes in Shariah compliant mortgage sizes and maturities on FCShariah compliant mortgage supplies probably vary widely among FC (Peterson and Kidwell,1983).

Human Resource Management

The old pattern of running an FC, with straightforward management schemes through relativelysimple administrative practices is no longer adequate. To ensure growth, FC needs to hiresophisticated, professional management in order to deal with the increasingly complex,specialised and unique Shariah compliant financial situations (Huppi, 1990). For example, thereis a need for additional education and training regarding Shariah compliant financing products,sound asset/liability, and various risks management techniques. Management training,instilling cooperative values and the foundation of markets for cooperative managers are vitalcomponents that ensure the endurance and growth of cooperatives (Basterretxea and Albizu,2011). In the case of FC, it is generally argued that lack of good managers makes it difficult forthese types of businesses to survive (Basterretxea and Albizu, 2011). In general, FC are facing anuphill battle to attract and retain valuable managers as the salary limitations such as thematerial incentives or career structure is incomparable to the investor-owned firms’ (Abell,1990; Cornforth and Thomas, 1990; K. Davis, 2001). Notwithstanding, managerial factors mayalso create incentives for FC to grow by adding new membership groups. An FC’s board ofdirectors trying to attract high calibre, professional managers may find it easier to do so if theFC large enough or has future growth potentials.

Moreover, instead of the conventional compensation package based on profit or stockperformance, FC management compensation often reflects an FC’s size and product offerings.


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Managers may therefore have an incentive to increase the FC’s memberships (Srinivasan andKing, 1998). By doing so, it is relatively easier for the management to accommodate the desireof both its member-mortgagors and member-savers (Smith, 1971). As FC’s size become largeror more adept at niche marketing of its Shariah compliant mortgage financings products, soundfinancial management will become increasingly important. The rapid Malaysian bankingindustry consolidation that has characterised the industry in the recent past will undoubtedlycontinue as FC seek to acquire the financial resources, organisational flexibility, andsophisticated managerial skills needed to compete effectively in an increasingly competitivederegulated environment. The resulting trend will be the implementation of increasinglysophisticated financial information databases and reporting systems (Reichert and Rubens,1994).

Therefore, one would expect FC to extend more Shariah compliant mortgage financings if theyhad the expertise necessary to offer such finances. Shariah compliant mortgage lendingexpertise differs from that required to make conventional home loan because lenders mustappraise the value of Shariah compliant mortgage property, handle the legal problemsassociated with the Shariah compliant mortgage and comply with the disclosure requirementsinherent in Shariah compliant mortgage financing (Peterson and Kidwell, 1983). The effort toprovide training and education to the cooperative movement in Malaysia is done by the oneand only cooperative education institution in Malaysia—Cooperative College of Malaysia (CCM).The Cooperative Education Trust Fund Group provides a major component of the CCMadministrative funding, which is pooled from the required 2% contribution of the cooperatives’total profit. Nevertheless, since knowledge regarding Shariah compliant mortgage financing andShariah compliant finance in general is highly specialised, CCM might be able to harnesssynergistic relationships with Shariah compliant specialised institutions such as IIUM Institute ofIslamic Banking and Finance (IIiBF) (Md. Zabri et al.,2015) and International Centre forEducation in Islamic Finance (INCEIF) in organising seminars, workshops, in house trainings, andshort-term courses related to Shariah compliant finance.

Conclusion

By way of final reflection, the review of literature allows the authors to identify these five issues,which seem to inhibit the ability of FC to take part in Shariah compliant mortgage financingintermediation. These issues are by no means exhaustive. In addition, the issues are not seen asstatic but as dynamic and interconnected within and around FC, which may be present indiffering ways and degrees. From the literature, there was little evidence on how these factorsinteract with each other, which this research sought to investigate in the future. Within thecurrent climate of lack of access to a more affordable, Shariah compliant home financing, FC isseen as an alternative provider of Shariah compliant mortgage financing, besides the traditionalplayers of Shariah compliant commercial banks. Through an AF, this paper has demonstratedthat the supply side of Shariah compliant mortgage financing by FC has various issues andchallenges to address within the current Shariah compliant mortgage financing intermediationframeworks. Claims of FC’s ability to sustain such business models can be little more thanrhetoric as there is a need for closer examination by asking a few critical questions, among


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others: how to increase the funds? To what end in sacrificing the basic cooperative’s principles?It is through answering these questions that greater transparency and accountability of Shariahcompliant mortgage financing by FC in Malaysia can be achieved and this type of product cangenuinely make a contribution toward helping low to middle-income Malaysians own a house.

Corresponding Author:

1,2 &3 Kulliyyah Muamalat and Management Sciences, Sultan Abdul Halim Mua’dzam ShahInternational Islamic University (UniSHAMS), Malaysia, ([email protected]),([email protected]), ([email protected]).

4Faculty of Finance and Administrative sciences, Al-Medinah International University (MEDIU),Malaysia ([email protected])

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