DOES IFSA 2013 MARGINALIZED MUDARABAH-BASED DEPOSIT? A CASE STUDY OF AMBANK ISLAMIC BERHAD. Mohd Shaifuddin bin Mohd Noor

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1 DOES IFSA 2013 MARGINALIZED MUDARABAH-BASED DEPOSIT? A CASE STUDY OF AMBANK ISLAMIC BERHAD INTRODUCTION Mohd Shaifuddin bin Mohd Noor The Islamic Financial Services Act 2013 ( IFSA ) differentiates investment account from Islamic deposit. Investment account is demarcated by the usage of Shariah contracts. It has non-principal guarantee feature for investment nature deposit. Notwithstanding this, the IFSA offers adequate legal basis to upkeep the further solidification of investment account process that provides proper protection to investment account holders (IAH) whilst safeguarding financial stability of the Islamic banking system. Under the IFSA, the urgency of payment for investment deposit account upon insolvency of the Islamic financial institution (IFI) is treated separately from Islamic deposit, in accordance with the rights and obligations accrued to the IAH. Besides capital contribution, IFI source of financing are largely contributed by its deposits. Would IFSA have negative impact on IFI s deposit growth rate and deposit mix motivates motivate the author to conduct this research. This paper shall use one of the local IFI, AmBank Islamic Berhad ( AmBank Islamic ) as its reference to analyse the impact of IFSA towards its deposits taking behaviour and its performance. This paper shall analyse the behaviour of mudarabah deposit during post IFSA era. Mudarabah contract is considered as a pure Shariah compliant contract whereby it was practiced by Prophet Muhammad s.a.w. and Khadijah a.s. Hence, it could be considered as the superior shariah investment contract. Nevertheless, IFIs encountered great challenges in implementing it as we could see later in this paper. Shariah laws manifested in mudarabah should demonstrate the superiority and alamiyah of Islamic laws. Nevertheless, it encounters extreme challenges in implementing it demonstrates by this study. RESEARCH PROBLEM Noor Saliza Zainal et al. (2009) in her empirical studies managed to establish the relationship between mudarabah investment account and set of independent variables comprised of gross domestic product (GDP), unemployment rate (UER), income per capita (IPC) and consumer price index (CPI). Noor Saliza Zainal et al. (2009) found out that UER, GDP, IPC and CPI have significant relationships with mudarabah investment account. UER was found out as the most dominant factor that influenced both investment and mudarabah accounts. The impact of IFSA towards total deposits of investment and mudarabah accounts have yet to be established since IFSA was recently enacted in This issue motivates the author to conduct this study. AmBank Islamic s financial data shall be the main reference point to fill up this gap. Lack of transparency or disclosure guidelines related to the mudarabah or profit sharing investment accounts (PSIAs) is amongst the problems in investment type deposit. Information asymmetry and regulatory shortcomings in profit sharing investment accounts are amongst the flaws in investment product. Rashid Ameer et al. (2012) found

2 323 out that the IFIs were not transparent enough in policies, procedures, product design and structure; profit allocation basis, methodology of calculating profit attributable to investment account holders (IAHs). Nevertheless, information on Shari ah compliance was satisfactory. It is interesting that IFI do not provide full disclosure connected to PSIAs because such revelation is not mandatory. Does IFSA overcome information asymmetry effectively? This research therefore attempt to solve this issue by analysing IFSA and Investment Account Guidelines (Bank Negara Malaysia 2014). This gap inspires the author to conduct this research by using AmBank Islamic as the main references. Does IFSA marginalized mudarabah deposit at AmBank Islamic through its stringent guidelines and modus-operandi motivates the author to perform this research. IFSA has redefined investment deposit (Bank Negara Malaysia 2014) from guaranteed to non-principal guaranteed feature for investment nature deposit. This has led to realignment of IFI deposit structure. Would such realignment affect IFI particularly AmBank Islamic s deposit taking behaviour, its funding structure and its performance? These issues influences the author to perform this research. Based on the above, the research problem could be summarized as follows: i. Is IFSA have negative impact to AmBank Islamic mudarabah deposit? ii. Does IFSA overcome information asymmetry effectively? iii. How far AmBank Islamic s funding structure and performance were affected post IFSA. PURPOSE OF STUDY This study is designed to examine the impact of IFSA towards AmBank Islamic deposit taking behaviour, its deposit product structure and its financial performance ultimately. RESEARCH OBJECTIVES i. To identify the impact of IFSA towards AmBank Islamic total mudarabah or investment based deposits. ii. To examine how IFSA could overcome information asymmetry effectively. iii. To analyse AmBank Islamic liabilities and/or deposit structure and its profitability post IFSA. LITERATURE REVIEW AmBank Islamic Berhad s ( AmBank Islamic ) Background. i. AmBank Group Ammb Holdings Berhad (2015) declared that AmBank Group is one of Malaysia s premier banking groups with nearly 40 years of legacy in understanding Malaysians and provides a wide range of both conventional and Islamic financial solutions and services, including retail banking, wholesale banking, as well as the underwriting of general insurance, life assurance and family takaful. 323

3 324 The Group receives strong support from the Australia and New Zealand Banking Group ( ANZ ) (one of Australia s leading banks) particularly in Board and senior management representations, risk and financial governance, products offering and new business developments. In the general insurance business, the Group has partnered with Insurance Australia Group Ltd ( IAG ). Whilst in the life assurance and family takaful businesses, the Group has a partnership with MetLife International Holdings Inc. ( MetLife ). The Group continues to benefit in terms of expertise transfer from IAG and MetLife. AMMB Holdings Berhad is the holding company of AmBank Islamic Berhad and is a public listed company on the Main Market of Bursa Malaysia. ii. AmBank Islamic Berhad ( AmBank Islamic ) AmBank Islamic Berhad (formerly known as AmIslamic Bank Berhad) is the fullfledged Islamic banking subsidiary of AmBank Group. Established in May 2006, as a wholly owned subsidiary of AMMB Holdings Berhad, AmBank Islamic has built a solid reputation in serving the banking needs of corporates and individuals since its beginnings as AmBank Group s Islamic Banking Division in Being the first-to-market in the region through numerous product innovations, AmBank Islamic provides a wide range of Shariah-compliant retail banking, business banking and related financial services, which also include investment advisory as well as treasury products. Striving to be the premier Islamic bank of choice, AmBank Islamic continues to grow while providing their customers a complete range of innovative Shariah-compliant financial solutions. AmBank Islamic s shariah advisor comprises of competent scholars currently attach to local universities. Refer to Annexure A for details. Islamic banking business: Source: AMMB Holdings Berhad (2015) IFSA (Ifsa 2013) IFSA was mooted from recommendation number of Bank Negara Malaysia (2011), the Financial Sector Blueprint The recommendation is to enact a comprehensive legislative framework for the conventional and Islamic financial systems respectively. The proposed legislation will reinforce a sound, transparent, and accountable system for effective regulation and supervision that is consolidated across the banking, insurance, takaful, financial intermediary and payment system services sectors. Gopal Sundaram (2013) (Who is the leading legal advisor of IFSA and former BNM Assistant Governor, BNM) have inscribed splendidly the history of IFSA. Islamic Banking was formally introduced in Malaysia with the enactment of the Islamic 324

4 325 Banking Act 1983, the Government Investment Act 1983 and the Takaful Act 1984 by the Malaysian Parliament. Islamic finance in Malaysia has enjoyed continuous and stable growth and now constitutes more than 20% of the banking assets of the banking system. After some thirty years of resilient and undisrupted growth of Islamic finance in this country, it has become imperative to review and assess the suitability and appropriateness of the legislative and regulatory framework in which Islamic banking and takaful operates. Following extensive policy research, discussions and consultations, Bank Negara Malaysia issued the Financial Sector Blueprint in December As noted in the Blueprint itself, the 10-year Blueprint is a strategic plan that charts the future direction of the financial system as Malaysia transitions towards becoming a high value-added, high-income economy. The Blueprint notes that A key pillar of financial sector development for this decade is the strengthening of Malaysia s position as an international Islamic financial centre. Given the more challenging international environment, emphasis will increasingly be placed on enhancing the resilience of Islamic finance, including in liquidity and crisis management, to complement the ongoing efforts in strengthening the relevant regulatory and legal framework for Islamic finance and in promoting greater harmonisation in interpretations. IFSA therefore was intended to provide the strengthened regulatory and legal regime to meet the challenges and developments of an increasingly sophisticated and internationalised Islamic finance industry. Surianom MiskamandMuhammad Amrullah Nasrul (2013) and Gopal Sundaram (2013) both recognized that IFSA was intended to pave way for the development of an end-to-end Shariah compliant regulatory framework for the conduct of Islamic financial operation in Malaysia. The new Act provides a comprehensive legal framework that is in full compliance with Shariah in all aspects of regulation and supervision, from licensing to the winding up of the Islamic financial institutions. The legislation specifically provides for the enforcement of Shariah non-compliance risk and imposes statutory duty upon the Islamic financial institutions to ensure that their aims, operations, affairs, businesses and activities are in compliance with Shariah rules. IFSA has the effect of repealing the Islamic Banking Act 1983, the Takaful Act 1984, the Payment System Act 2003 and the Exchange Control Act IFSA is an omnibus legislation for the regulation and supervision of key Islamic financial institutions such as Islamic banks, takaful operators, international Islamic banks, international takaful operators as well as operators of payment systems which the transfer of funds between Islamic bank accounts or which enables payments to be made by means of Islamic payment instruments, issuers of Islamic payment instruments, takaful brokers and Islamic financial advisor. As an omnibus legislation, it also provides for regulation and supervision of payment systems and the oversight of the Islamic money market and Islamic foreign exchange market. The principal regulatory objectives of IFSA is to promote financial stability and compliance with Shariah. The new law commands Bank Negara Malaysia to foster the safety and soundness of Islamic financial institutions, the integrity and orderly functioning of the Islamic money market and the Islamic foreign exchange market as 325

5 326 well as safe, efficient and reliable payment systems and Islamic payment instruments and fair, responsible and professional business conduct of Islamic financial institutions. The Bank is also required to strive to protect the rights and interests of consumers of Islamic financial services and products. Definition of Investment Account & Islamic Deposit {Sect. 2 (1) of (Ifsa 2013)} Ifsa (2013) Section 2(1) defined investment account as an account under which money is paid and accepted for the purposes of investment, including for the provision of finance, in accordance with shariah on terms that there is no express or implied obligation to repay the money in full and (a) either only the profits, or both the profits or losses, thereon shall be shared between the person paying the money and the person accepting the money; or (b) with or without any return. Islamic deposit under Ifsa (2013) Section 2(1) means a sum of money accepted or paid in accordance with Shariah (a) on terms under which it will be repaid in full, with or without any gains, return or any other consideration in money or money s worth, either on demand or at a time or in circumstances agreed by or on behalf of the person making the payment and person accepting it; or (b) under an arrangement, on terms whereby the proceeds under the arrangement to be paid to the person paying the sum of money shall not be less than such sum of money, Based on the above definition, Islamic deposits will now confined to principal guaranteed shariah contract i.e. qard, Murabahah and wadiah whilst funds placed for investment purpose under principal non-guaranteed shariah contracts such as mudarabah and wakalah shall fall within Investment Account. As a result, IFI product offerings had to be re-aligned to meet definition of Islamic deposit and investment account. iii. Mudarabah Investment Account guidelines, Bank Negara Malaysia (2014) defined various investment related terminologies / principals as follows: Investment account holder, refers to a customer with an investment account maintained at an IFI. Mudarabah, means a contract between capital provider (rabbul mal) and an entrepreneur (mudarib) under which the rabbul mal provides capital to be managed by the mudarib based on any profit generated from the capital is shared between the rabbul mal and the mudarib according to mutually agreed profit sharing ratio (PSR) whilst financial losses are borne by the rabbul mal provided that such losses are not due to the mudarib s misconduct (ta adi), negligence (taqsir) or breach of specified terms (mukhafalah al-shurut). Musharakah, means a partnership between two or more parties which may take effect through contractual relationship ( aqd) or by operation of Islamic law, whereby all contracting parties will share the profit and bear loss from partnership. 326

6 327 Restricted investment account or RIA, refers to a type of investment account where the customers provides a specific investment mandate to the IFI such as purpose, asset class, economic sector and period for investment. Unrestricted investment account or URIA", refers to a type of investment account where the customers provides the IFI with the mandate to make the ultimate investment decision without specifying any particular restrictions or conditions. Wakalah, means a contract in which a party (muwakkil) authorises another party as his agent (wakil) to perform a particular task, in matters that may be delegated, either voluntarily or with imposition of fee. Wakalah bi al-istithmar, means a wakalah contract entered for the purpose of investment. Mudarabah could be used to finance short-and medium-term investment projects too. Nevertheless, it had limited exposure in Malaysia s Islamic banking industry due to high risk and high capital charges or risk weightage as required by the regulator. Mudarabah financing based contract contributed less than 0.02% of total IFI financing for the past 12 months ended April See Annexure B for details Malaysia s mudarabah financing exposure. Bank Negara Malaysia (2012) on Capital adequacy framework for Islamic banks (Risk-weighted assets) has imposed 150% risk weight to mudarabah project financing. In other words, for each RM1.00 million additional mudarabah financing would requires IFI to increase its capital due to higher Risk Weighted Assets by 150% to RM1.5 million and also for IFI to maintain at least 8% Capital Adequacy Ratio (CAR). This CAR was sanctioned by (Bank Negara Malaysia 2012) under the Implementation of Basel III guideline. Refer to Annexure C and Annexure D for Risk Weight and computation of Risk Weighted Assets & CAR respectively. Tatiana et al. (2015) described mudarabah contracts are analogous to trust-based financing in the traditional financial system. The income generated from the invested money is distributed between the financial institution and the entrepreneur in accordance with the agreement, concluded at the moment of signing the contract. Simon ArcherandRifaat Abdel Karim (2009) have identified several regulatory delinquent arising from the use of profit sharing investment accounts (PSIAs). It does not meet the legal definition of deposits. Neither the customers capital nor any return on it is guaranteed by the bank. Hence, PSIAs are not capital certain and are, essentially, investment products. IFIs therefore, do not meet the criteria to be classified as depositary institutions as required by banking regulations in the majority of countries. Nevertheless, in Malaysia this problem has been addressed by IFSA In Jordan, Malaysia and Qatar, the regulators requires IFI not to pass losses to unrestricted PSIAs via smoothing the periodic returns paid to them. These tactic is achieved by a combination of low risks investment strategies and establishment of reserve accounts made out of profits payable to PSIA holders. Reserves in this account would be used to smooth profit payment (known as profit equalisation reserve (PER)) 327

7 328 and to shelter periodic losses (known as investment risk reserve (IRR)). In Malaysia PER is no longer being practice by IFI since the introduction of IFSA. Low return attributable to profit smoothing is common in PSIA. V Sundararajan (2007) deliberated key subjects in the measurement and mechanism of risks in IFI, particularly the effects of profit sharing investment accounts (PSIA) for risk measurement, risk management, capital adequacy and supervision. Cross country data on a sample of banks reveal a considerable smoothing of returns paid to PSIA, despite wide divergences in risk. This suggests that the sharing of risks with PSIA is fairly imperfect in practice, although, in principle, well-designed risk (and return) sharing arrangements with PSIA can serve as a powerful risk mitigant in Islamic finance. Supervisory authorities can provide strong incentives for effective and transparent risk sharing and the associated product innovations, by inking the extent of capital relief on account of PSIA with appropriate supervisory review of the risks borne by the PSIA (equivalently the extent of displaced commercial risk assumed by the shareholders), and by requiring adequate disclosure of these risks. Given the overwhelming use of non-pls financing modes, IFI cannot be said to be risksharing in any meaningful sense. Feisal Khan (2010) declared that IFI transactions mimic conventional, collateralized debt contracts very closely, often right down to actually using current market interest rates as pricing benchmarks. IFSA which has defined Investment account which is PLS in nature as non-guaranteed principal An empirical studies conducted by Saiful Anwar Dadang Romansyah et al. (2010) has successfully managed to predict the mudarabah time deposit return. The research model was capable to predict with 95.22% accuracy for Bank Shariah Mandiri 12 months mudarabah Time Deposit. This model could be used as an adequate tool to help depositors in predicting future return of mudarabah Time Deposit product at Bank Shariah Mandiri. This prediction capability will provide depositors tools to determine the probably highest return investment in the market. This tool may also keep depositor to stay longer in the IFI before flowing the surplus fund to conventional bank. This is an important findings particularly for the customers who love certain and fixed investment return. Based on the above, PSIA which is largely based on mudarabah concept have various inherent issues which restrict its growth rate. The introduction of IFSA which clearly defined it as non-guaranteed principal is expected to further deteriorate its performance. Mudarabah is deemed as the pure Islamic model compared to debt based mode. However, it is not a favourite model amongst the industry players. Mudarabah is less preferable compared to Islamic debt financing instruments such as murabahah and bai bithaman ajil. This is caused by the existence of asymmetric information that continuously presents in mudarabah (profit sharing) contracts and creates problems of adverse selection and moral hazard. Due to this, mudarabah (profit sharing) has declined it importance as a financing or deposits vehicle. RESEARCH METHODOLOGY The present research is based on a deductive approach - strictly qualitative. For analysing all the data the author used the following research methods: comparative 328

8 Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10 Q11 Q12 Q13 Q14 Q15 Q16 Q17 Q18 Q19 Q20 Q21 Q22 Q23 Q24 Q25 Q26 Q27 Q28 Q29 Q30 Q31 Q32 Q33 Q34 Q35 Q36 Q method, document analysis, external observation. Qualitative method of research and descriptive approach to research were applied in this study as they were appropriate in looking into the research issue understudied. Library research was adopted because IFSA was recently launched in June Data post IFSA therefore is limited. As this is a case study over AmBank Islamic Berhad, hence AmBank Islamic s audited accounts for 9 financial years ended March 2007 to 2015, 3 rd quarter interim financial statement as at and Bank Negara Malaysia data would be the main source of information for this research. These information are derived from the public domain and hence confidentiality issue does not arise at all. RESEARCH FINDINGS i. IFSA s impact to Islamic Banking s deposit Figure 1 revealed that contribution of Investment deposit (mudarabah) against total deposit declined significantly from 37.5% in Dec to 0.4% in March In March 2007, it contributed 58.1% of total deposit. However, it has registered a declining trend since then. Sharp declined was registered since Dec. 2013, immediately after the introduction of IFSA. Figure 1: Industry Investment Deposit Contribution for the past 37 Quarters ended March % 60.0% 50.0% 40.0% 30.0% 58.1% in March % in Dec % in Dec % 10.0% 0.0% 0.5% & 0.4% in Dec & March respectively Source: Bank Negara Malaysia Under IFSA all Investment deposit which is pre-dominantly governed under Mudarabah contract the principal and profit are not guaranteed. Principal and profit payments are purely subject to the performance of the investment. Investment deposit is therefore subject to capital reduction. Fears of depositors losing its investment which may led to market instability and a run over the bank are the major contributory factors for IFI to near total shut down of its mudarabah based deposit to other type of deposits. Figure 1 above exhibited that total deposit continued to grow for the past 37 quarters ended March However, Investment deposit has depleted to 0.4% of total deposit in March IFSA does not affect deposit growth rate. However deposit mixed are 329

9 330 moving away from Investment deposit which are pre-dominantly under mudarabah contract. 450, , , , , , , , , Figure 2: Total Deposit vs Investment Deposit for the past 37 Quarters ended March 2016 (In RM Million) Q1 Q3 Q5 Q7 Q9 Q11 Q13 Q15 Q17 Q19 Q21 Q23 Q25 Q27 Q29 Q31 Q33 Q35 Q37 Total Deposit Total Investment Deposit Source: Bank Negara Malaysia Figures 1 & 2 portrayed that Investment Deposit based on mudarabah is less preferable by the industry players beginning Dec 2013 or at Quarter 28, 6 months after IFSA effective date, 30 June As at March 2016, mudarabah based deposit or Investment deposit has depleted to 0.4% of total IFI deposits. These data showed that IFSA has indirectly marginalised mudarabah deposit in the Islamic banking industry. The industry has adopted Murabahah Tawarruq ( MTQ ) as the principal contract for its deposits products. MTQ contract currently dominating IFIs deposits marginalising mudarabah based deposit to the wall. Declining trend on Investment deposit is very obvious at industry level as portrayed out in Annexure E. i. IFSA impact to AmBank Islamic. Mudarabah deposit. On 14 March 2014, Bank Negara Malaysia ( BNM ) had issued a policy document on Investment Account ("IA") aimed at outlining the regulatory requirements on the conduct of investment accounts that are consistent with the IFSA and that comply with standards on Shariah issued by BNM. This policy document comes into effect on 14 March 2014 (Bank Negara Malaysia 2014). On 14 February 2014, BNM had issued the Transition Policy under IFSA ( transition policy"), allowing Islamic financial institutions a transition period until 30 June 2015 to comply with IFSA and BNM standards on Shariah and policy document on Investment Account. Pursuant to the application of the policy document on Investment Account and the transition policy, as reported in Ambank Islamic Berhad (2015), the Bank has adopted the followings: 330

10 331 (i) (ii) Segregated investment deposit products from deposit accounts and presented these separately as investment accounts in the financial statements; Discontinued with the application of profit equalisation reserve ("PER"). The available amounts in PER had been distributed to the remaining account holders in the form of hibah. As a result, Investment Account was introduced by AmBank Islamic as a new product offering. The accounting policy adopted for Investment account pursuant to IFSA and Bank Negara Malaysia (2014) are as follows: Unrestricted Investment Account AmBank Islamic Unrestricted Investment Account is based on the Shariah concept of Wakalah bil Istithmar. It refers to an arrangement whereby the Investment Account Holder ("IAH") (as the principal or muwakkil) appoints AmBank Islamic as an agent (the "wakil") for the purpose of investment. AmBank Islamic as wakil shall not be liable to compensate losses except losses due to its own misconduct, negligence or breach of specified terms. The amount invested by the IAH aims to provide the IAH with steady flow of income by investing in low risk investments which AmBank Islamic deems appropriate. For current financial period, AmBank Islamic did not impose Wakalah fees to the IAH. Restricted Investment Account ( RIA ) AmBank Islamic s RIA is based on mudarabah concept where IAH agree to participate in the specific financial/investment activities undertaken by AmBank Islamic and share the profit generated from financing and/or investment activities based on an agreed profit-sharing ratio. The IAH shall bear the losses arising from the assets funded under the mudarabah concept except in cases of misconduct, negligence or breach of contracted terms by AmBank Islamic. Therefore, any allowances for impairment and capital charge will be transferred to the IAH to reflect the potential losses to the IAH. Currently, the existing RIA arrangement is between the AmBank Islamic and AmBank Berhad only. RIA is not offered to the public yet. Distribution of profit between the unrestricted IAH and AmBank Islamic. The unrestricted IAH place funds with AmBank Islamic in exchange for an expected rate of return ( ERR ) for the agreed period of the investment. AmBank Islamic mobilises the investment account funds in accordance with its investment strategy to generate returns. In the event that the actual rate of return ( ARR ) is higher than the ERR, the IAH agree that this difference shall be retained by AmBank Islamic as a performance incentive. On the contrary, if the ARR is lower than the ERR, AmBank Islamic is obliged to distribute the ARR to the IAH. AmBank Islamic adopts the standard methodology in calculating the rate of return and profit distribution to the IAH consistent with Rate of Return framework issued by 331

11 332 BNM. AmBank Islamic neither adopt profit smoothing practices nor employ displaced commercial risk technique in the calculation of the ARR to the IAH. As a result, AmBank Islamic s deposit composition has changed drastically as shown in Figure 3 herein. Total deposit continue to grow and was not affected by IFSA. However, mudarabah based deposit has extinct from the bank s book. 35,000,000 30,000,000 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 0 Figure 3: AmBank Islamic deposit for the past 10 years ended 3rd Quarter FYE 3/2016 (In RM'000) Q 2016 Non-Mudharabah Mudharabah Total Deposits Source: AmBank Islamic audited accounts. AmBank Islamic depositors are divided into two i.e. Non-Financial Institution and Financial Institution customer. Deposits are divided into two models i.e. mudarabah and non-mudarabah models. AmBank Islamic s deposit continued to grow steadily for the past 10 years ended 3 rd quarter of FYE 3/2016. Nevertheless, the outstanding mudarabah based deposit was ground zero as at December 2015 (or 3 rd quarter of FYE 3/2016) since all have been transferred to other type of deposit, particularly Murabahah Tawarruq (See Annexure F for details). IFSA therefore has marginalized mudarabah deposit at AmBank Islamic and the industry too. Deposit mix, profitability & financing deposit ratio. AmBank Islamic has developed Commodity Murabahah Term Deposit to replace the mudarabah investment deposit. Commodity Murabahah is a Shariah principle based on Tawarruq and Murabahah concept (See Annexure G for details of Murabahah Tawarruq model). In July 2014, AmBank Islamic had officially communicated to all mudarabah Depositors that all existing investment deposits shall be converted into Commodity Murabahah deposit. AmBank Islamic claimed in their communication that this exercise is to comply with IFSA, It is also to allow customer to enjoy principal guaranteed deposit and fixed profit rate. The conversion was scheduled to commence in August The communication to the customers were also serves as a tool to obtain customers consent for the conversion of the existing mudarabah deposit. Customers mudarabah existing deposit will be automatically converted into Commodity Murabahah deposit upon its renewal if AmBank Islamic do not hear anything from the customers by 15 August Auto conversion shall take place upon maturity of each 332

12 333 mudarabah deposit commenced on 15 August Details of the conversion exercise is summarized at Annexure H. Appointment of AmBank Islamic as the customers agent to sale & purchase the commodity on behalf of the customers are secured simply by customers decision to continue maintaining their deposit with AmBank Islamic after the conversion. Such continuation shall also constitute customers consent and agreeable to the Specific Terms and Conditions for Commodity Murabahah-based Term Deposit and it shall automatically be binding on the customers. These auto conversion and appointment as customers agent are shariah compliant. IFSA has led to change in AmBank s funding structure via the creation of Investment Account in its balance sheet. Ambank Islamic Berhad (2015), declared RM1.3 Billion outstanding RIA. This RIA is a contract between AmBank Islamic as mudarib and AmBank Berhad as the rabbul mal. It is used for certain financing activities conducted by AmBank Islamic. Profit to be distributed to AmBank Berhad s investment therefore now will subject to the profit generated from financing and/or investment activities based on an agreed profit-sharing ratio. AmBank Islamic prepared to accept such investment by AmBank Berhad since both are having common shareholder / management team and common investment / credit risk policies. RIA as of today is not offered by AmIslamic Bank to external customers. Ambank Islamic Berhad (2015)Deposit mix however remained unchanged whereby low cost deposit CASA (Curent & Saving Accounts) continued to contribute less than 20% of AmBank Islamic total deposit during pre & post IFSA (See Annexure I). As a result of high cost of fund due to low contribution of CASA, AmBank Islamic profitability continue to decline during pre and post IFSA. AmBank Islamic pre-tax profit, net margin, ROA and ROE were all on declining trend prior to IFSA as depicted at Annexure J and Annexure K. We therefore may conclude that IFSA has no significant impact towards AmBank Islamic s profitability. Both IFSA and AmBank Islamic s profitability has no direct relationship at all. AmBank Islamic financing ratios remain stable. Deposit to Asset, Financing Deposit and Financing to Total Funding ratios during pre & post IFSA remain unchanged at an average of 81%, 84% and 78% respectively. See Annexure L for details. Hence, we may conclude that IFSA has no impact on AmBank Islamic funding structure. Information asymmetry. Bank Negara Malaysia (2014) has effectively and successfully managed information asymmetry. Non-transparency inherent to mudarabah based product is now become history with the introduction of IFSA. Bank Negara Malaysia (2014) is an Investment Deposit policy. This policy document sets out: (a) specific requirements on the structuring, risk management and market conduct of investment accounts; (b) oversight requirement over the management of investment account funds and investment assets; and (c) transparency and disclosure requirements including minimum information to be disclosed in product disclosure sheet, key terms and conditions to be included in primary documents, investment account performance report to the investors and additional disclosures in the IFI s financial statements; and (d) prudential requirements relating to investment accounts. 333

13 334 Information asymmetry where no comprehensive disclosure inherent to mudarabah based investment account as identified by Rashid Ameer et al. (2012) has now been resolved via Investment Account policy declared by Bank Negara Malaysia (2014). This policy document covers wide area of transparency and disclosure covering various subjects such as product structuring, management of investment account, oversight arrangement, risk & management control, business & market conditions, transparency & disclosure and prudential requirement. Stringent information regularity requires costly infrastructure to be in place. Yet it continue to pose high risk to AmBank Islamic and the industry players as a whole as in the event of capital loss may lead to a run over the Bank. This is due to the misconception and/or lack of product knowledge by the the public on each and every banking products, particularly the investment account. IFSA therefore has led to marginalizing of mudarabah products largely due to non-guarantee principal, high setup cost and continue to pose high risk to the AmBank Islamic despite availability of transparency and disclosure elements. Based on the findings we therefore can accept on the hypothesis that IFSA has severely affected AmBank Islamic deposit taking behaviour. Mudarabah based deposit has depleted to ground zero and now being replaced with Murabahah Tawarruq Deposit. AmBank Islamic no longer offer mudarabah deposit to the public. It is only restricted to sister company, AmBank Berhad. It was offered as a tool to raise additional funding from related or friendly party. CONCLUSION i. Implication to policy. Strict definition of mudarabah by IFSA and paved further by Bank Negara Malaysia (2014) has made the industry jittery on Islamic banking. The industry reacted negatively by switching all investment account into debt based product. It shown that the Islamic banking industry is not ready to embrace with pure Islamic concepts. The industry continued to be dominated by interest based concept which is prohibited by Islam. As we are aware that debt based financing is a contentious concept because it is deemed as a back door to interest bearing instrument. Mudarabah is a Sunnah of Prophet Muhammad s.a.w. when He conducted the trade on behalf of Khadijah a.s. It appears that this Sunnah has various inherent weaknesses leading to dry respond from the industry players. As a Muslim scholars, industry experts, academicians and muamalat graduates must play a major role in promoting and uphold this Sunnah. Information symmetry is a symbol of honesty and trustworthy. These element therefore must be indoctrinated in each and every players involve in mudarabah in order to avoid misconception of this concept. ii. Proposal The author recommends further investigation on the subject why there is strong rejection on mudarabah still exist despite information symmetry. Does risk and return 334

14 335 elements are the stumbling block for the success implementation of mudarabah based model? This is the gap to be covered by future research. iii. Summary This paper has managed to resolve the research problem statement. IFSA have negative impact on investment account which are based on mudarabah model. Policy on investment account issued by Bank Negara Malaysia have managed to mitigate information asymmetry effectively. Earlier findings on lack of disclosure guidelines related to profit sharing investment account has been addressed herein via introduction Investment Account policy by Bank Negara Malaysia. This policy is very comprehensive to protect the investors particularly. However, the author believed that the high infrastructure set-up cost become major constraint for IFI and AmBank Islamic in particular to implement it. IFSA has no effect at all on IFI s performance and profitability. Over dependence on high costs funding instrument has affected AmBank Islamic earnings. Overall, well integrated and strategized plan need to be established in order to educate, promote and convinced the industry players to subscribe for mudarabah based investment account. BIBLIOGRAPHY Ambank Islamic Berhad Audited Financial Statements for Financial Year Ended March Ambank Islamic Berhad Interim Financial Statements for the Period 1 April 2015 to 31 Dec 2015 AmBank Islamic Berhad. Ammb Holdings Berhad Audited Annual Report. Kuala Lumpur AmBank Goup. Bank Negara Malaysia Financial Sector Blueprint Kuala Lumpur, Bank Negara Malaysia. Bank Negara Malaysia Capital Adequacy Framework for Islamic Banks (Risk- Weighted Assets). Kuala Lumpur, Bank Negara Malaysia. Bank Negara Malaysia Implementation of Basel Iii. Prudential Financial Policy Department Islamic Banking and Takaful Department. Kuala Lumpur, Bank Negara Malaysia. Bank Negara Malaysia Investment Account Guidelines. Kuala Lumpur, Bank Negara Malaysia. Feisal Khan How Islamic Is Islamic Banking? Journal of Economic Behavior & Organization 76(3): Gopal Sundaram The Islamic Financial Services Bill Kuala Lumpur: Abdullah Chan Advocates & Solicitors Ifsa Islamic Financial Services Act Kuala Lumpur: Malaysia. Noor Saliza Zainal, Zulkafli Mohd Yusof & Kamaruzaman Jusoff Influence of Economic Factors on Performance of Investment and Mudharabah Accounts in Maybank, Malaysia. International Journal of Economics and Finance 1(2): 221. Rashid Ameer, Radiah Abdul Kader & Nurmazilah Mahzan Information Asymmetry and Regulatory Shortcomings in Profit Sharing Investment Accounts. International Journal of Islamic and Middle Eastern Finance and Management 5(4):

15 336 Saiful Anwar Dadang Romansyah, Sigit Pramono & Kenji Watanabe Treating Return of Mudharabah Time Deposit as Investment Instrument: A Utilization of Artificial Neural Networks (Anns). Humanomics 26(4): Simon Archer & Rifaat Abdel Karim Profit-Sharing Investment Accounts in Islamic Banks: Regulatory Problems and Possible Solutions. Journal of Banking Regulation 10(4): Surianom Miskam & Muhammad Amrullah Nasrul Shariah Governance in Islamic Finance: The Effects of the Islamic Financial Services Act Proceeding of the World Conference on Integration of Knowledge (WCIK 2013), Langkawi, Malaysia, hlm Tatiana, N., Igor, K. & Liliya, S Principles and Instruments of Islamic Financial Institutions. Procedia Economics and Finance 24( V Sundararajan Risk Measurement and Disclosure in Islamic Finance and the Implications of Profit Sharing Investment Accounts. ISLAMIC ECONOMICS AND FINANCE

16 337 Annexure A AmBank Islamic Berhad : Shariah Advisors Profile Professor Dr. Amir Husin Mohd Nor Prof. Dr. Amir Husin is currently a Professor at the Faculty of Syariah & Law, University Sains Islam Malaysia (USIM). He obtained his first degree (Hons) in Shariah from Academy of Islamic Studies, University of Malaya. He then successfully completed his Master in Law (LL.M) from University of London and subsequently achieved his Ph.D in Islamic Studies from University of Edinburgh. His areas of specialisation are Islamic Jurisprudence (usul fiqh) and Law. Associate Professor Datin Dr. Noor Naemah Abd. Rahman Dr. Noor Naemah Abd. Rahman is currently a lecturer and Associate Professor at the Fiqh and Usul Department for Academy of Islamic Studies, University of Malaya. She obtained her first degree in Shariah from University of Malaya, a Master degree in Shariah from University of Jordan and a Ph.D from University of Malaya. Her areas of specialisation are Islamic Jurisprudence (usul fiqh) and fatwa. Assistant Professor Dr. Tajul Aris Ahmad Bustami Assistant Prof. Dr. Tajul Aris Ahmad Bustami is currently a lecturer and Assistant Professor at Department of Islamic Law, Ahmad Ibrahim Kulliyyah of Laws, International Islamic University Malaysia (IIUM). He received his first Degree in Law (LL.B (Hons) & LL.B (Shariah)(Hons)) from IIUM and a Master degree in Law (LL.M) from University of London. He then successfully obtained a Diploma in Shariah Law and Practice (DSLP) a professional post-graduate programme from IIUM. Later, he received his Ph.D in Law from IIUM. His areas of specialisation are Islamic Banking Law and Takaful, Muslim Law of Succession & Waqf and Administration of Estates. Dr. Asmak Ab Rahman Dr. Asmak Ab Rahman is currently a senior lecturer at Department of Syariah and Economics, Academy of Islamic Studies, University of Malaya where she received her first Degree and Master in Shariah followed by Ph.D in Islamic Economics. Her areas of specialisation are Comparative Economic Development, Takaful, Islamic Banking, Islamic Economics and Economics of Waqf. Associate Professor Dr. Adnan Yusoff Dr. Adnan Yusoff is currently a senior lecturer at Institute of Liberal Studies, Universiti Tenaga Nasional (UNITEN), Kajang, Selangor. He received his first degree in Shariah (Hons) from University Al-Azhar, Cairo, Egypt. He then obtained a Master of Comparative Law (MCL) from International Islamic University Malaysia, Kuala Lumpur and received his Ph.D in Islamic Muamalat at University of Malaya. His areas of specialisation are Islamic Commercial Law, Islamic Law of Transactions, Islamic Jurisprudence (usul fiqh), Islamic Family Law and Islamic Criminal Law. 337

17 ,000.0 Annexure B Mudarabah Financing Contribution in the Islamic Banking industry. Mudarabah Financing Contribution for the past 12 months ended April 2016 (In RM'000) % 400, , , , , , , , % % % % % % Mudarabah Total Financing Mudarabah Contribution Source: Bank Negara Malaysia Mudarabah financing contributed less than 0.02% of total Islamic Banking industry financing. 338

18 339 Annexure C Risk Weight No Exposure / financing to various type of customer & types of Islamic contracts. Risk Weight 1 Malaysia- Federal government and Bank Negara Sukuk in 0% ringgit. 2 Guaranteed by federal government. 0% 3 Another sovereign of central bank in ringgit. 0% - 20% 4 Guaranteed by sovereign or central bank 0% - 20% 5 Rating of sovereign 5.1 AAA to AA 0% 5.2 A+ to A- 20% 5.3 BBB+ to BBB- 50% 5.4 BB+ to B- 100% 5.5 CCC+ to D 150% 5.6 Unrated 100% 6 Non-federal government public sector. 20% 7 Multilateral development banking (e.g. Asia 0% Development Bank / Islamic Development Bank) 8 Banking institutions & Corporations Rating on short term exposures (commercial paper) 8.1 A-1 20% 8.2 A-2 50% 8.3 A-3 100% 8.4 Others 150% 9 Rating on long term exposures to banking institutions. 9.1 AAA to AA 20% 9.2 A+ to A- 50% 9.3 BBB+ to BBB- 50% 9.4 BB+ to B- 100% No Exposure / financing to various type of customer & types of Islamic contracts. Risk Weight 9.5 CCC to D 150% 9.6 Unrated 50% 10 Rating of corporates, takaful companies, securities firms and fund manager AAA to AA 20% 10.2 A+ to A- 50% 10.3 BBB+ to BB 100% 10.4 B+ to D 150% 10.5 Unrated 100% 11 Exposure to Retail Portfolio (individual or SME) via credit cards, cashline, personal financing, hire purchase 75% and term financing based on murabahah / inah / BBA / ijarah contracts. 339

19 Term financing to retail portfolio over 5 years 100% tenor. 12 Financing secured by Residential Real Estates (RRE) Property based on murabahah / ijarah / BBA / Inah contracts Financing to value ratio (FTV) less 80% 35% 12.2 FTV over 80% to 90% 50% 12.3 FTV more than 90% 100% 12.4 RRE to priority sector FTV less than 80% 35% 12.5 RRE to priority sector FTV 80% to 90% 50% 12.6 RRE to priority sector FTV over 90% 75% 13 Exposures secured by Commercial Real Estate (CRE) The risk weight is based on No. 1 to 11 above (refer no. 1 to 11) No Exposure / financing to various type of customer & types of Islamic contracts. Risk Weight 14 Higher risk assets : musharakah / mudarabah contracts, financing abandoned 150% projects and venture capital. 15 Cash / gold 0% 16 Guaranteed by CGC and financing to local stock 0% exchange 17 Clearing house 20% 18 Unit trust / property trust / publicly traded equity 100% investment. 19 Equity investment by federal government / BNM 100% 20 Others not specified in 1 to 19 above. 100% 21 Islamic Contracts Murabahah / BBA / Ijarah / inah / Salam (refer to 1 to 20 above) 22 Musharakah publicly traded equity 100% 23 Musharakah non-publicly traded equity 150% 24 Musharakah project financing 150% 25 Mudarabah project financing based on rating (refer to 5 to 10 above) 26 Mudarabah project financing. 150% 27 Sukuk rated - based on rating (refer to 5 to 10 above) 28 Sukuk unrated - based on underlying contracts (refer to 21 to 26 above) Source: Bank Negara Malaysia (2012) 340

20 341 Annexure D Computation of Risk Weight Assets and CAR Additional capital required due to high Risk Weight of 150% on Mudarabah Financing RM '000 Capital Adequacy Ratio (CAR) Assumptions: Total Capital (TC) 3,909, TC0 Risk Weighted Assets (RWA) 48,863, RWA0 CAR = (TC / RWA) 8.00% CAR0 Projected additional Mudarabah financing (AF) 100, Risk Weight 150% New Capital required to maintain 8% CAR0 Additional RWA = 150% x AF 150, RWA1 TC1 to maintain 8% CAR : TC1 / (RWA0 + RWA1) Additional Capital to finance additional RWA1 : 8%= TC1 / RWA2 8%= TC1 / 49,013, TC1 = 8% (49,013,743.56) TC1 = 3,921, TC1 - TC0 12, # New CAR1= (TC1 / RWA2) 3,921, % 49,013, Source: Author s illustration 341

21 342 Annexure E Islamic Banking industry deposit growth by type for the past 37 quarters ended March 2016 (In RM '000) 300, , , , , , Q1 Q3 Q5 Q7 Q9 Q11 Q13 Q15 Q17 Q19 Q21 Q23 Q25 Q27 Q29 Q31 Q33 Q35 Q37 Total Investment Deposit Demand Deposit Saving Deposit NID Others Deposit Source: Bank Negara Malaysia. 342

22 343 Annexure F AmBank Islamic Deposit growth & composition for the past 10 years ended 3 rd Quarter of FYE March RM'000 Customers Deposit Q 2016 Non-Mudharabah 1,028,298 1,328,145 1,858,800 2,230,498 2,537,485 4,608,505 7,644,587 7,980,250 15,851,758 29,521,478 Mudharabah 3,642,756 4,118,186 8,296,270 13,398,040 12,712,170 13,663,353 15,566,655 17,482,251 13,903, ,671,054 5,446,331 10,155,070 15,628,538 15,249,655 18,271,858 23,211,242 25,462,501 29,754,876 29,521,478 Financial Institutions Deposit Q 2016 Non-Mudharabah 1,590,343 1,600, , ,331 1,099,067 1,121, , , ,720 1,442,792 Mudharabah 963, ,339 1,445,052 1,485, , ,840 1,974,135 2,323,453 2,433, ,553,567 2,508,781 2,324,476 2,400,081 1,467,556 1,481,305 2,504,721 3,261,358 2,714,064 1,442,792 Total Deposits Q 2016 Non-Mudharabah 2,618,641 2,928,587 2,738,224 3,144,829 3,636,552 5,729,970 8,175,173 8,918,155 16,132,478 30,964,270 Mudharabah 4,605,980 5,026,525 9,741,322 14,883,790 13,080,659 14,023,193 17,540,790 19,805,704 16,336,462 0 Total Deposits 7,224,621 7,955,112 12,479,546 18,028,619 16,717,211 19,753,163 25,715,963 28,723,859 32,468,940 30,964,270 Total Deposits Q 2016 Non-Mudharabah 36.2% 36.8% 21.9% 17.4% 21.8% 29.0% 31.8% 31.0% 49.7% 100.0% Mudharabah 63.8% 63.2% 78.1% 82.6% 78.2% 71.0% 68.2% 69.0% 50.3% 0.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 35,000,000 30,000,000 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 0 AmBank Islamic : Mudarabah deposit trend for the past 10 years ended 3rd quarter FYE March 2016 (In RM '000) Q 2016 Non-Mudharabah Mudharabah Total Deposits 1 Based on AmBank Islamic Audited accounts for the past 9 years and 3r quarter interim financial statements as at 31 Dec

23 344 Annexure G Modus operandi of Murabahah Tawarruq. Transaction sequence. Steps Action Activities 1 Customer Place deposit (RM100,000 for 6 months). Appoint AmBank Islamic as Customer s Commodity Purchasing Agent ( CPA ) and as Customer s Commodity Sale Agent ( CSA ) 2 AmBank Islamic. (Purchase commodity on behalf of Customer) Pursuant to CPA executed with the Customer, AmBank Islamic shall purchase the Commodity on behalf of the Customer. AmBank used Customer s deposits to purchase commodity. Value of the commodity is equivalent to the value of deposit made by the Customer (RM100,000-00) 3 AmBank Islamic. (Customer sell the commodity to AmBank Islamic) Pursuant to CSA, AmBank Islamic shall sell the commodity to AmBank Islamic itself. The Selling Price is (assumed) at cost plus profit payable in 180 days at 3.50% profit rate. Customer s Selling Price to AmBank Islamic: Cost : RM100, Profit {RM100,000 x 3.5% x (180/365)} :RM 1, Customer s Selling Price RM101, AmBank Islamic. (AmBank Islamic sell the commodity to 3 rd party) The Selling Price is payable to the Customer upon maturity 180 days later. AmBank Islamic sell the commodity for RM100,000 on CASH TERM to a 3 rd party. The proceeds shall be used to pay the Customer together with RM1, profit upon maturity, i.e. 180 days after Customer placed the deposit at AmBank Islamic. Commodity Murabahah refers to a sale and purchase of an asset where the acquisition cost and the mark-up are disclosed to the purchaser. Tawarruq consist of two sale and purchase contract. The first involves the sale of an asset by seller (customer) to a buyer (bank) on a deferred basis. Subsequently, the buyer (bank) will sell the same asset to a third party on a cash and spot basis. 344