Research Report:

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

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

Introduction : History of modern Islamic finance

1963

1975 - 1988

Middle East
Trade-based society

Egypt (Mit Ghamr)

UAE (Dubai Islamic) Kuwait (KFH) Bahrain (Al-Baraka) Saudi Arabia (Al-Rajhi) & Ors

1963

1983

Malaysia

Tabung Haji

Bank Islam
Introduced BBA, Wadiah Yad Dhamanah

Bank Muamalat AmIslamic RHB Islamic KFH Malaysia & Ors

Malaysian Islamic banks vs. Middle Eastern Islamic banks The Differences

Different school of thought

Different Shariah interpretation

Different product offerings

Different risk exposures

Different way of liquidity management

Different accounting treatments, disclosures, presentation of financial statements

Regulatory framework

Different level of funding cost

Malaysian Islamic banks vs. Middle Eastern Islamic banks Different school of thought & Shariah interpretation

HANAFI

BBA

Bai SHAFII MALAYSIA al-Inah

PRAGMATIC

Bai adDayn

Tawarruq HANBALI SAUDI ARABIA GCC MALIKI UAE KUWAIT BAHRAIN

Different product offerings

ISLAMIC BANKS BALANCE SHEET ASSETS Short-term financing Murabahah Salam Bai al-Inah (Malaysia only) Bai ad-Dayn (Malaysia only) Tawarruq Medium-term financing Ijarah Istisna Long-term financing / partnerships Musyarakah Mudharabah Long-term financing Murabahah BBA (Malaysia only) Musyarakah Mutanaqisah Fee-based services Wakalah Kafalah LIABILITIES

Saving deposits Wadiah Yad Dhamanah (Malaysia only) Qard Demand deposits Wadiah Yad Dhamanah (Malaysia only) Qard Investment accounts Mudharabah Mudharabah + Qard Reserves Equity capital

Murabahah / BBA Middle Easterns practice

Cost

If disclosed

Spot payment

Cash

Profit

Murabahah Cash or Credit

Deferred payment

Long-term

Short-term

Malaysians practice

BBA

Deferred payment

Murabahah

Different operation of Murabahah

Deliver and sell goods at cost + profit KFH KUWAIT Sometimes warehouse needed

SUPPLIERS

Sell goods

Middle Easterns practice

CUSTOMERS

Deliver goods to Islamic bank

SUPPLIERS

Sell goods

CUSTOMERS (as Islamic banks purchasing agent)

BANK MUAMALAT AMISLAMIC RHB ISLAMIC

Malaysians practice

Sell goods at cost + profit

House / real estate financing

BANK MUAMALAT AMISLAMIC RHB ISLAMIC

BBA Istisna

KFH MALAYSIA KFH KUWAIT Murabahah Musyarakah Mutanaqisah

Ijarah Muntahiah Bi Tamlik

Dubai Islamic Ijarah Mausufah Fi Zimmah

Ijarah

Ijarah Mausufah Fi Zimmah

AL-BARAKA

Different recognition on Bai al-Inah Malaysians view

Shafii BANK Bai al-Inah is valid BANK

Bank sells at cost + profit (deferred payment)

Bank buys back at cost (cash)

Bank sells back at cost + profit

Customer sells at cost

BBA

CUSTOMERS ASSET

Bai al-Inah

BANKS ASSET

CUSTOMER

CUSTOMER

Bai al-Inah

Middle Easterns view

Maliki Hanbali Hanafi Bai al-Inah is invalid

AAOIFI Islamic Fiqh Academy SSB KFH

Car financing
HP

DEALER

Bank buys asset

T AC

ISLAMIC BANK / OWNER Bank leases asset Customer pays installments (rental)

Hire-Purchase-i / AITAB

MALAYSIA

CUSTOMER/ HIRER Given option to purchase upon expire of leasing tenure

Banks responsibility to maintain ISLAMIC BANK / OWNER Sometimes buys from dealer DEALER

Customer maintains road tax and insurance for 2nd year onwards

Customer pays installments (rental)

Bank leases asset

CUSTOMER

Bank promises to sell upon expire of leasing tenure

Ijarah Muntahiah Bi Tamlik

MIDDLE EAST

Different operation of Ijarah

AL-BARAKA

OPERATING LEASE

Islamic banks maintain assets of a high degree of marketability AL-BARAKA

KFH KUWAIT FINANCIAL LEASE / IJARAH THUMMA AL-BAI

AL-RAJHI

Showrooms or warehouses needed by Islamic banks

KFH MALAYSIA

Not practised by Malaysian local Islamic banks

Different recognition on Bai ad-Dayn

BANK MUAMALAT SALE OF DEBT AT DISCOUNT AMISLAMIC BANKERS ACCEPTANCE-i

SAC BNM & SAC SC Sells debt at discount MIDDLE EASTERN ISLAMIC BANKS SALE OF DEBT AT DISCOUNT Credit sale IMPORTER KFH MALAYSIA Gets instant cash

ISLAMIC BANK

CUSTOMER

RHB ISLAMIC

Collect payment on banks behalf upon maturity

Different operation of Istisna

2. Bank agrees and requests contractor to construct Istisna asset

CONTRACTOR / CUSTOMER

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

4. Bank delivers Istisna asset ISLAMIC BANK 1. Customer requests bank to construct Istisna asset CUSTOMER

Malaysian way: Parallel Istisna

Different operation of Istisna

CONTRACTOR (OTHER THAN CUSTOMER)

2. Bank agrees and requests contractor to construct Istisna asset

Middle Eastern way: Parallel Istisna

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

4. Bank delivers Istisna asset ISLAMIC BANK 1. Customer requests bank to construct Istisna asset CUSTOMER

ISLAMIC BANK

2. Bank delivers Istisna asset upon full settlement of progress billings 1. Customer requests bank to construct Istisna asset and pays progress billings

CUSTOMER

Middle Eastern way: Direct Istisna

Different deposit structures

Obliged to practise PER (including KFH Malaysia)
BANK MUAMALAT

MUDHARABAH AMISLAMIC WADIAH YAD DHAMANAH Customer deposits money as capital provider (Rabb-al-Mal) in the banks business Bank acts as entrepreneur (Mudharib) Banks distributes profit (if any) If loss, will be absorbed by Customer (unless due to Banks misconduct / negligence DUBAI ISLAMIC QARD MUDHARABAH AL RAJHI AL-BARAKA Deposit as loan Bank is bound to return the loan Bank is free to mobilize the loaned money KFH KUWAIT KFH MALAYSIA Bank pays back just the loaned money with no return

Deposit as custodian asset RHB ISLAMIC Bank guarantees the custody Bank is free to mobilize the deposit Bank pays return as hibah (gift)

Some practise PER, some does not Al-Baraka practices PER & IRR

Implication of such differences

MIDDLE EASTERN ISLAMIC BANKS QARD

Lower Funding cost

Different level of funding cost

MALAYSIAN LOCAL ISLAMIC BANKS WADIAH YAD DHAMANAH

Higher funding cost

Accounting and Financial Reporting Standards Applied By Islamic Banks

Bank Al Rajhi Bank Accounting and Financial Reporting Standard(s) International Financial Reporting Standard (IFRS) IFRS, with some local amendments IFRS AAOIFI standards MASB standards and BNM/GP8-i Guidelines MASB standards and BNM/GP8-i Guidelines MASB standards and BNM/GP8-i Guidelines MASB standards and BNM/GP8-i Guidelines

Different accounting treatments

KFH Kuwait Dubai Islamic AlBaraka Bank Muamalat AmIslamic RHB Islamic KFH Malaysia

Implication of such differences

Different accounting treatments Issues: 1. 2. 3. 4. 5. 6. 7. 8. 9. Reporting investment accounts as liabilities on the balance sheet (Appendixes 4-A, 4-B, 4-C) Reporting investment accounts off-balance sheet (Appendix 4-D) 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) Unrestricted investment accounts not as liabilities, but to be placed under equity of unrestricted investment account holders (Appendix 4-F) Distributions to PSIA deduct distribution from operating revenues to calculate operating income (Appendix 4-G) Distributions to PSIA compute operating income first, deduct distribution, to get net profit (Appendixes 4-H, 4-I) Jargon lacks of explanation (Appendix 4-J) Practice of PER for PSIA, with PER parked under other liabilities (Appendix 4-K) Practice of PER and IRR (Appendix 4-L)
MALAYSIAN ISLAMIC BANKS BBA & WADIAH YAD DHAMANAH AL-BARAKA & ALL BAHRAINBASED ISLAMIC BANKS

BNM / GP8-i

MASB FRS i-1 2004

AAOIFI

Implication of such differences

Different risk exposures Middle Eastern Islamic Banks Malaysian local Islamic Banks

APPENDIX 6

HIGHER EXPOSURES TO CREDIT, MARKET AND OPERATIONAL RISK

LOWER EXPOSURES TO CREDIT, MARKET AND OPERATIONAL RISK

LOWER EXPOSURE TO DISPLACED COMMERCIAL RISK

HIGHER EXPOSURE TO DISPLACED COMMERCIAL RISK

Mutajara Middle Eastern Islamic banks

Bahrain Short-term Sukuk al-Ijarah Bahrain Short-term Salam govt bills Commodity Murabahah - Metal Commodity Murabahah - CPO GII Bai al-Inah Bai ad-Dayn instruments

Different way of liquidity management

Malaysian local Islamic banks BNM Short-term Sukuk al-Ijarah

Impact of Basel II, AAOIFI proposal and IFSBs standards

Basel II AAOIFI Proposal

RWCAR not lower than 8%

Tier 2 capital does not include hybrid capital instruments / subordinated bonds

Tier 2 capital includes hybrid capital instruments / subordinated sukuk

Malaysia (BNM/GP8-i) and (BNM Capital Adequacy Framework for Islamic Banks)

RWCAR Calculation Impact of Basel II, AAOIFI proposal and IFSBs standards
AAOIFI Proposal
RWAK&CA = average risk-weighted assets financed by banks capital + depositors current account CAR: Total Capital RWAK&CA + 50% (RWAUIA) RWAUIA = average risk-weighted assets financed by unrestricted depositors investment accounts

IFSBs Capital Adequacy standard

STANDARD FORMULA CAR: Tier 1 + Tier 2 RWA (Credit risk + Market risk + Operational risk) - RWA funded by PSIA (Credit risk + Market risk)

SUPERVISORY DISCRETION FORMULA CAR: Eligible Capital Total RWA (Credit risk + Market risk + Operational risk) - RWA funded by restricted PSIA (Credit risk + Market risk) - (1-) [RWA funded by restricted PSIA (Credit risk + Market risk)] - (1-) [RWA funded by PER and IRR of unrestricted PSIA (Credit risk + Market risk)]

PSIA = restricted + unrestricted investment account holders

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

RWCAR Calculation Impact of Basel II, AAOIFI proposal and IFSBs standards
Malaysia (BNM/GP8-i) and (BNM Capital Adequacy Framework for Islamic Banks)

CAR:

Capital Base Total RWA (Credit risk + Market risk + Operational risk) - (1-) [RWA funded by PSIA (Credit risk + Market risk)] - (1-) [RWA funded by PER of PSIA (Credit risk + Market risk)]

No differentiation between restricted and restricted PSIA

= 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

PSIA not risk absorbent for banks operational risk

Direction of Islamic banks from other jurisdictions

MALAYSIAN ISLAMIC BANKS GCC MARKET

BBA Bai al-Inah Bai ad-Dayn

CIMB

YOUSUF AHMED KANOO HOLDING

CIMB-KANOO

GCC MARKET

BBA Bai al-Inah Bai ad-Dayn Wadiah Yad Dhamanah

CITIBANK MALAYSIA-i
Musyarakah Mutanaqisah

HSBC AMANAH MALAYSIA

BBA

Conclusion 1.
Different school of thought Different Shariah interpretation Different product offerings

Different risk exposures

Different way of liquidity management

Different accounting treatments, disclosures, presentation of financial statements

Regulatory framework

Different level of funding cost

Eligible regulatory capital: 2. AAOFI vs. Malaysian Islamic banks 3. IFSBs Capital Adequacy standards do not represent the diverse Shariah practices among Islamic banks