Islamic banks are said to be already taking steps to convert their existing mudarabah deposits into either

commodity murabahah or wadiah deposits in compliance with the IFSA.

ISLAMIC banks could experience a potential spike in operating costs and see further
pressure on net interest margins (NIM) once they comply with Bank Negaras move to
reclassify Islamic deposits as either principal guaranteed or investment accounts. Islamic
banks or conventional banks with Islamic banking subsidiaries are given until June 30 next
year to comply with this requirement under the Islamic Financial Services Act (IFSA) 2013.
This means that products with mudarabah (profit sharing) or wakalah (agency) features are
considered investment accounts and are not-principal guaranteed and hence not protected by
the Malaysia Deposit Insurance Corp (PIDM). The classification aims to provide greater legal
clarity on the types of syariah financial contracts. Customers will have a choice and will be
able to differentiate between products that are principal guaranteed and those which are not
that provide potentially higher risk returns like mudarabah. Mudarabah is a contract between
a depositor and an entrepreneur (bank), whereby the latter can mobilise funds for its business
activity. Any profits made between the two will be shared according to an agreed ratio while
losses are borne solely by the depositor unless the bank is negligent. Islamic deposits, on the
other hand, like wadiah (custodian), qard (loan) and tawarruq (sale) are principal guaranteed.
Currently, all Islamic deposits are protected by the Malaysia Deposit Insurance Corp (PIDM).

About 50% of Islamic deposits in the banking system falls under the investment account
category. Based on PIDMs latest statistics for the assessment year in 2012, total insured
deposits for the Islamic banking business totalled RM50.2bil, compared with RM40bil the
previous year. Although discussions on the reclassification are still on-going with the central
bank, banking analysts and players feels the likely one would be the conversion of
investment-based mudarabah (profit sharing) accounts to commodity murabahah (cost plus).
This will potentially lead to higher operating cost and further compress NIM for Islamic
banks, according to analysts. Under the commodity murabahah principle, the customer
purchases an asset (commodity) from the vendor on a cost-plus mark-up basis where profit
margin has to be agreed upfront.
In Malaysia under this principle, the banks use the funds received from depositors to buy
commodities either from the London Metal Exchange (LME) or from Bursa Malaysia.
At this stage, banking analysts contacted by StarBizWeek agree that commodity murabahah is
the most viable option. A banking analyst from MIDF Research says Islamic banks in his
view are already taking steps to convert their existing mudarabah deposits into either
commodity murabahah or wadiah (custodian /safekeeping) deposits in compliance with the
IFSA. The conversion, the analyst says, from mudarabah into commodity murabahah would
attract transaction cost, adding that competition for the latter was expected to be more intense
moving forward.



CIMB Research analyst Winson Ng says the reclassification will be detrimental to banks
margins as banks earn smaller spreads from investment accounts than Islamic deposits. At
this juncture, he says the research house is not able to quantify the impact as the percentage
of Islamic deposits that will be reclassified as investment accounts is unclear, since it will be
determined by depositors. This, he notes, will add pressure to Islamic banks cost of funding
and impact their NIM.

Maybank IB Research in a recent note says that in view of the parallel banking system in the
country, the conversion will mean that Islamic banks would have to compete even more
aggressively with conventional banks for funds. As for wadiah accounts, the restrictions on
promotional activity and rate advertising may place Islamic banks at a disadvantage to
conventional banks especially in terms of their current accounts-savings accounts gathering
efforts.

Maybank Islamic, in responding to queries, says it will continue to offer mudharabah deposits
alongside wadiah and commodity murabahah until June 2015. In line with IFSA, by June
2015, the bank says it will be introducing an investment account based on mudharabah
structure that targets to give a more competitive rate to customers. Meanwhile, Maybank IB
research analyst Desmond Chng says the most viable alternative at this stage after having
spoken to several industry players was the conversion of mudarabah accounts to commodity
murabahah.
Chng in his recent report said the downside to commodity murabahah was that it was a
slightly more expensive alternative to mudarabah as it involves a transaction fee of RM15
that would be levied on every RM1mil transaction on both the buy and sell side. This, he
says, would increase the operating costs to a bank that decides to pursue this route, noting
that this transaction fee would be treated as an operating expense.
Additional operating costs could include issuing investment prospectuses and preparing
regular updates on the performance of the assets if mudarabah accounts are converted to
investment accounts. At the same time, IT systems may have to be upgraded to ensure the
proper tagging of assets to liabilities, and additional personnel may have to be employed to
cope with the increase in transactional activity, Chng says. Industry observers concur that
there will be opportunity costs if depositors decide to opt for conventional banks.
He says the financial impact would vary from bank to bank depending on the strategy
adopted and frequency of deposit churned. Based on general parameters, he says he expects
the additional transaction costs would average just about 5% of pre-tax profit for Islamic
banks. Since these banks account for less than 16% of their respective financial groups
earnings, the impact at group level is even more marginal, at below 1%. However, he says the
impact to BIMB Holdings would be larger since bank Islam accounts for 81% of group pre-
tax profit. Even so, Chng RIA refers to a type of investment account where the investment
account holder provides a specific investment mandate to the bank with regard to the
purpose, asset class, economic sector and period of investment. Whereas, URIA refers to a
type of investment account where the investment account holder allows the bank to make the
ultimate investment decision without specifying any particular restriction or condition. Feels
the impact would still be manageable at just minus 4%. Many analysts, however, feel that
besides seeing NIM compression and hike in operating costs due to the reclassification and
conversion, also agree that it could see a reduction in the size of bank balance sheet.
Commenting on this point, Chng says if mudarabah/wakalah accounts are taken off-balance
sheet, banks asset size will contract as these accounts makes up about 43% of total assets of
Islamic banks. However, he feels the impact is likely to be marginal if only restricted
investment accounts (RIA) are taken off-balance sheet, for these make up a much smaller
proportion of deposits. He says whether an investment account has to be taken off-balance
sheet or not has not been clearly spelt out yet by the central bank, adding that it could
eventually depend on whether the account is a restricted investment account (RIA) or
unrestricted investment account (URIA).







Differences between Wadiah,
Mudarabah and Murabahah
Al-Wadiah Deposits (Savings & Current Account)
Shariah principles applicable to savings account are Al-Wadiah, Mudharabah and Al-Qard.
However, Al-Qard is commonly offered by Islamic banks in the Middle East. Let's us
examine the principle/concept and brief operation aspects of each type of deposits.
Al-Wadiah is a contract (akad) between the Owners of good and the Custodian of the goods.
The role of the Custodian (in banking perspective, the bank) is to protect the goods from
damaged, destroyed, stolen etc. Basically, the contract is entered between both parties to
ensure safe custody.
In Malaysia, SAVINGS ACCOUNT offered by Islamic banks is under the contract of Al-
Wadiah Yad Dhamanah (Guaranteed Custody). The core of this arrangement is that the bank
has authority to use the depositors' money and guarantee to return the same when the
depositors need it. Most Islamic banks (particularly in Malaysia) require the depositors to
give their consent for the bank to use the depositors' money but for some Islamic banks, they
kept it silent i.e. no consent is required.
As trustee under this Guaranteed Custody contract, the bank is not allowed to mention or
promise any rewards in the form of profits or gifts (hibah) on the deposits it received.
Similarly, the depositors too cannot demand any reward or return from the Bank on their
savings placement.
It seems, BNM National Shariah Council (NSC) had made decision disallowing payment of
profit or "hibah" for Al-Wadiah deposits. However, in practise, Islamic banks in Malaysia
(except the International Islamic banks or IIB) are giving "hibah" in monetary form (as
gesture of appreciation by the bank to the Depositors) and somehow, the Shariah Committee
(SC) of the individual Islamic bank does not prevent but kept silent about this "hibah" issue.
Perhaps, the SCs allow payment of "hibah" due to "maslahah" (public interest) in order for
Islamic banks to compete as alternative to the conventional savings deposit account where
paying "interest" is standard for all types of savings deposit accounts.
The Writer opines that as long as the Islamic banks maintain this view, we may not be able to
clearly differentiate between the Islamic from the conventional savings deposit. We have to
make a stand when it comes to Shariah compliant issue. Anyhow this is just the personal
view of the Writer. Perhaps, Shariah scholars can share their views to clarify this issue.
What are the differences between Islamic from conventional savings account. In summary,
the differences are as follows:-
Chart 1;

It is interesting to note that although payment of "hibah" is somehow practise in Malaysia,
NSC decision that NO free gifts or inducement items (e.g. free umbrella, coin box etc) should
be given to new depositors is being strictly adhered by Islamic banks. So, unlike conventional
banks where new savings depositors are given free gift such as an "umbrella with the bank's
logo", new Al-Wadiah savings depositor normally do not enjoy such gift.
There is a Shariah opinion allowing Islamic banks to give gifts to loyal depositors whom
have maintain their accounts with the bank for example, more than 6 months. If such gifts are
given, it should be given without any differentiation or category such as special gift to those
whom maintain deposit amount of more than RM10,000 and the like. It should be given to all
depositors whom meet the same criteria irrespective the balances in their accounts.
As for CURRENT ACCOUNT, it is also offered under the principle of Al-Wadiah Yad
Dhamanah. Unlike savings account holders whom are given passbooks, Current Account
depositors are given cheque books where it can be issued to pay 3rd parties or withdraw cash
for own use.
Technology has changed the operations of banks in Malaysia where previously banking
counters/banking halls are the busiest place in a bank, nowadays withdrawal of cash, transfer
of funds, bills payment etc can be done through the Automatic Teller Machine (ATM) or
deposit cash via the Cash Deposit Machine (CDM). Banking transactions can also be done
on-line through Internet banking services and now fund transfer can also be done via mobile
phone. To-date there is no Shariah issue relating to services using technology but it would be
interesting to observe what Islamic banks will do when one day, conventional bank grant
loans such as overdraft without requiring the customer to sign any agreement or go to the
bank, suffice with just an application via the Internet.
Al Mudharabah Savings.
Another popular savings account offered by Islamic Bank is Al-Mudharabah savings
accounts. Under this concept, the depositors shall entrust the bank to utilize the deposits for
its financing and investment activities without any interference from the depositors.
Profit earned from the banks investment will be shared between the Bank and depositors in
accordance with the agreed profit sharing ratio (PSR). It is interesting to note that under
Mudharabah savings, the profit-sharing-ratio (PSR) is only valid for one (1) day. At end of
the day, whatever PSR during the day is terminated but it will be automatically renewed the
next day. To operate in this manner, the Bank need to seek consent from the Depositors on
this automatic profit sharing renewal arrangement on condition the PSR remained unchanged.
If the Bank decides to change the PSR, it still need to advise the depositors in writing by
giving sufficient time such as 14 days to object the change in the PSR. Without any objection,
the bank can change the PSR without any written acknowledgment or consent from the
depositors. If the depositor objected to the change in the PSR, the bank reserves right to
request the depositor to withdraw the money.
This type of arrangement must be clearly explained to depositors to ensure transparency. So
when a new depositor intends to open a Mudharabah savings account, the depositor MUST
BE VERBALLY advise by the counter staff of this arrangement before opening the account
instead of just asking the depositors to read the fine line (most depositors do not read the
standard terms) in the application form.
Since this savings account uses Al-Mudharabah principle, the depositors are exposed to risk
i.e. losses (if any) is to be borne by the depositors. Likewise, this possibility must also be
highlighted to the depositors. To match risks with rewards, profit rates payable to
Mudharabah savings account holders are normally higher than conventional savings deposits
rates.
Looking at the above conditions, what is so attractive about Al-Mudharabah savings
deposits? Compare to Al-Wadiah Savings where granting of "hibah" is an issue, there are no
profit payment issue under Mudharabah Savings products. In addition, depositors under
Mudharabah savings account enjoy MULTI-TIER profit sharing ratios normally structured as
per Chart 2 below:-

If you review Chart 2, higher PSR is given to depositors with high deposit amount. Thus,
generally the profit rates for Mudharabah savings are higher than conventional savings
"interest" rates.
One important aspect of Mudharabah savings deposits is that all depositors MUST SIGN A
WAIVER FORM FOR THE CREATION OF PROFIT EQUALISATION RESERVES
(PER) account by the Bank. PER is a reserve account (allowed by BNM and an important
item in the Islamic accounting ) where the bank places undeclared profit amount i.e. this
amount is deducted from the gross profit before distribution and placed in a reserve account
i.e. PER, to support the Al-Mudharabah profit rates in conventional bank interest hike
situation, to avoid Islamic banks from exposing to what is known as "deposit displacement
risk" due to outward movement of deposits from the Islamic banks to conventional banks due
to sudden hike in conventional deposit rates. Under such situation, in order to remain
competitive, Islamic banks may need to match the conventional savings rate.
We have to admit that there are three (3) types of depositors in our banking system as
follows:
a) those who seek high return and can switch from Islamic to Conventional or vise verse
(basically non-Muslims);
b) those who only want to deal with Islamic bank; and
c) Muslims who are still indifferent on the type of banking system (still does not
understand the implication of "riba" to a Muslim) as long as they can get high return
on their investment. This type of Muslims behave like (a) above. They are among the
group who accuses Islamic banking financing products as expensive and prefers to
take "riba" product to enjoy lower pricing. As mentioned in this blog banner, the
Writer will provide examples in later session to prove that conventional bank loans
are more expensive than Islamic financing products.
Murabahah
Murabahah is a particular kind of sale where the seller expressly mentions the cost of the
sold commodity he has incurred, and sells it to another person by adding some profit or
mark-up thereon.
The profit in Murabahah can be determined by mutual consent, either in lump sum or
through an agreed ratio of profit to be charged over the cost.
All the expenses incurred by the seller in acquiring the commodity like freight, custom
duty etc. shall be included in the cost price and the mark-up can be applied on the
aggregate cost. However, recurring expenses of the business like salaries of the staff, the
rent of the premises etc. cannot be included in the cost of an individual transaction. In
fact, the profit claimed over the cost takes care of these expenses.
Murabahah is valid only where the exact cost of a commodity can be ascertained. If the
exact cost cannot be ascertained, the commodity cannot be sold on murabahah basis. In
this case the commodity must be sold on musawamah (bargaining) basis i.e. without any
reference to the cost or to the ratio of profit / mark-up. The price of the commodity in
such cases shall be determined in lump sum by mutual consent.



















Comodity Murabahah Programme in
Malaysia
As a part of Bank Negara Malaysias initiative to support Islamic Finance development
in Malaysia, Commodity Murabahah Programme (CMP) was introduced to facilitate
liquidity management and investment purposes. CMP is a cash deposit product which is
based on a globally acceptable Islamic concept. It is an efficient instrument for
mobilisation of funds between surplus and deficit units.
CMP is designed to be the first ever commodity-based transaction that utilises the Crude
Palm Oil based contracts as the underlying assets. CMP transaction with BNM was first
auctioned competitively in the Islamic Interbank Money Market (IIMM) via the Fully
Automated System for Issuing/Tendering (FAST) on 14 March 2007 and it marked an
extensive effort by the country to become a significant player in Islamic Financial
Market globally. CMP may also be transacted bilaterally amongst IIMM participants
including BNM. The introduction and usage of CMP as liquidity management tool will
contribute to realising the vision of making Malaysia as an International Islamic
Financial Centre (MIFC).

PRODUCT FEATURES
Background
The introduction of CMP as a domestic Islamic money market instrument has already
been endorsed by the National Shariah Advisory Council.
Purpose
To offer Islamic financial institutions a new instrument in managing liquidity in the
IIMM.
Fixed Return
CMP provides certainty of returns as it is undertaken based on pre-agreed margin or
mark-up from the sale and purchase of the underlying asset.
BENEFITS
1. Efficient allocation of resources
2. Effective liquidity management tool
3. Platform for monetary policy implementation
4. Portfolio diversification
5. Risk management facility
6. Global acceptance