My column appeared in THE MALAYSIAN RESERVE, 10 Feb 2014
Monday, 8 August 2016
Evolution of Islamic Term Deposit in Malaysia
The company I work for started getting involved in providing IT system for Islamic banking and finance in Malaysia in 1994. When it comes to system requirements, the Mudharabah general investment account (Islamic term deposit) or fondly known as GIA, demands significant work.
GIA’s conventional counterpart is the fixed deposit (FD). The most distinct feature of GIA when compared to its conventional counterpart is on profit processing.
Here are some key features of GIA profit processing during early days of Islamic banking in Malaysia which was operating undercash basis accounting:
1) Unlike conventional FD, where the amount of interest for the whole tenure of deposit with the bank would be fixed upfront, for the Mudharabah GIA, system had to support recalculation of profit, based on the latest announced rate for the product, on the maturity of GIA. (The process of calculating the latest announced rate is based on GP2-i, the Bank NegaraMalaysia (BNM) framework of rate of return). During the investment placement, only the indicative rate will be printed on the GIA certificate. Upon maturity of the GIA, the system had to recalculate the actual profit to be paid to customer.
2) Interim rate concept had to be introduced for the Mudharabah GIA. Since the actual profit to be paid to customer would only be known on maturity of the GIA, interim profit processing is required to cater for a periodic profit payment depositors during the interim period. For GIA greater than 12 months, interim profit will be paid on a six-monthly basis based on the latest six months GIA profit rate announced by the bank. The final profit payment will be the total actual profit (recalculated on maturity) minus total interim profit paid.
3) For premature GIA closure (withdrawal before maturity), profit will be paid based on the latest announced rate on the product closest to the number of completed months of the account. For example, six months GIA that was prematurely withdrawn on the 4.5th month will be paid with the latest rate of four months GIA for the completed four months that the customer maintained the GIA account with the bank.
When Islamic banking and finance in Malaysia moved towards accrual accounting, additional requirement for GIA profit processing was introduced for the system to cater for “variable rate GIA”. Upon declaration of the latest rates of the GIA products on monthly basis, on the effective date of the new rates, the system had to accrue profit due to customers using the latest rate. This means, by the time the GIA matures, the system would have accrued the actual amount of profit due to GIA depositors. Therefore, upon maturity, the system would just have to credit the accrued profit to depositors’ accounts.
A few years later, another investment account product based on wakalah bi al-istithmar (investment agency) was introduced. The profit processing of Wakalah investment account was also different from conventional FD.
The following excerpt from BNM Shariah resolution highlights the differences:
1) If the Islamic financial institution has breached any terms of agreement or has negligently invested in an instrument which has no potential to generate profit at the minimum rate (for example 5% per annum), the Islamic financial institution will have to pay compensation as much as the principal sum of investment plus the actual profit (if any); and
2) If the Islamic financial institution invested in an instrument that is expected to generate profit at the rate of at least 5% per annum but failed to reach the targeted rate due to problems which are not attributable to the negligent conduct of the Islamic financial institution, such loss shall be borne fully by the customer.
The above conditions mean that upon GIA placement, depositors will be given an indicative rate of 5%. Upon maturity, if the actual rate declared by bank is lower than 5%, let’s say 3%, profit based on 3% will be paid to customer. The 2% loss will be borne by the depositor unless depositor could prove that the loss was due to the banks’ negligence in managing his or her investment.
However, Islamic banking in Malaysia still treats GIA as liability and it is covered under the Perbadanan Insuran Deposits Malaysia or the Malaysia Deposit Insurance Corp. This coverage will soon end when the new framework of investment account takes effect.
BNM has issued a concept paper on the Framework of Investment Account targeted to be effective on June 1, 2015. Among its objectives are “to facilitate the orderly development and operationalisation of investment that is consistent” with Islamic Financial Services Act 2013 (IFSA) and and “to promote compliance with standards on Shariah matters”. IFSA has redefined investment accounts where the return of customer deposit cannot be guaranteed.
During the transition period prior to the commencing of the new framework, Islamic Financial institutions are given options to implement alternative structures of Islamic term deposit products.
As an IT solution provider in the local market, we are now getting requirements to support Murabahah term deposit from almost all banks that we are supporting. Murabahah term deposit is based on the concept of Tawarruq or Commodity Murabahah.
My observation tells me that some Islamic banks in Malaysia are slowly phasing out Mudharabah GIA. It seems there is a trend that Mudharabah and Wakalah investment accounts will be slowly replaced by Murabahah term deposit.