Friday, 12 August 2016

Shariah-Related Parameters for Islamic Bank IT systems

WHILE going through one recent social media posting, I came across a question: How can we “Islamise” an information technology (IT) system in a bank? Someone with the right qualification and experience in Islamic finance answered it.

I summarise the answer as the system needed to be developed with features and functions that could support Shariah requirements of products and services of an Islamic bank.

This relates to one of my past column entries on whether an IT system can be certified as Shariah-compliant.

My view is that an IT system by itself cannot be certified as Shariah-compliant due to the fact that an IT system is just an enabler to support financial institutions’ products and services. The characteristics of the products and services would dictate the system behaviour.

An IT system of a particular Islamic financial institution (IFI), which has been configured with the requirements of its products and services, could be audited to ensure the behaviour of the system fully complies with the Shariah requirements.

In order to support Shariah requirements of Islamic banks’ products and services, the IT systems must come together with relevant Shariah-related features and functions. I refer to these as Shariah-related parameters.

Allow me to share some of the key parameters which I have gathered over 19 years of my experience providing IT systems to IFIs in Malaysia and abroad.

Top in my list is fund type. IFIs clearly differentiate their sources and uses of funds. The sources of funds can be internal (shareholders’ funds) or external (customer deposits or investments).

The external funds are further segregated into restricted funds and unrestricted funds. Restricted funds can only be used by IFIs for a specific purpose, pre-agreed with the funders whereas the unrestricted funds can be used on a general pool basis to finance banks’ fund-based products. The segregation of funds is important for profit distributions to depositors and investors.

The next important parameter is Islamic concept. An Islamic concept can simply be a single Islamic contract such as Mudharabah and Ijarah, or combinations of a few Islamic contracts such as Musharakah Mutanaqisah and Ijarah Thumma Al-Bai’ (AITAB).

Both Islamic-bank sources-of-fund products (deposit and investment) and uses-of-fund products (financing) are developed based on certain underlying Islamic concepts. These concepts govern the behaviour of the products such as the types of documents to be signed, the profit computations, the exit conditions, etc.

Some products are also designed with additional supporting Islamic concepts. For example, Tawarruq-based products can be with or without Wa’ad.

Different Islamic concepts require different sets of additional parameters. For example, Musharakah- and Mudharabah- based products require a profit-sharing ratio. Ijarah-based products require parameters for rental computations and method of ownership transfers. Tawarruq or Commodity Murabahah products require commodity types and counter parties. Ar-Rahnu products require storage fees calculation options and gold-related parameters.

In addition to parameters that are unique to a particular Islamic concept, there are some common parameters for certain categories of products. For example, common to all “sale-based” Islamic financing such as Bai’ Bithaman Aajil, Murabahah, Tawarruq and Istisna’ concepts, parameters for sale price computations are required. A sale price is as simple as financing amount plus total profit margin.

However, the profit margin needs to take into considerations the period of financing progressive disbursement (for financing of property under construction) and the period after the financing has been fully disbursed.

Rebate options are another set of parameters common for sale-based financing. Due to the progressive disbursement of financing for property under constructions, higher rates used for sale price computations, prepayments of sale price and early settlement of the financing facilities, the actual banks’ profit earning could be lesser than a contracted profit margin. The difference between the upfront profit margin and actual bank earnings will be rebated to customers by offsetting the sale price balance.

Finally, a set of important parameters very unique to IFIs are those related to the rate of return (ROR) calculations.

In Malaysia, the ROR computation is governed by Bank Negara Malaysia Rate of Return Framework. Two main components of the framework is calculation table (CT) and distribution table (DT). CT is to derive banks’ distributable income and DT is to prorate the distributable income into bank’s various types of deposits and investments. The ROR for each deposit and investment product will be derived based on the prorated distributable income for that particular product.

In summary, some parameters are required for overall Islamic banks operations, some are common by Islamic concepts and some are unique to a particular Islamic concept.

Islamic concept is key because all Islamic products and services are backed by certain underlying Islamic concepts. These concepts give rise to options or parameters to govern the behaviour and the operations of the products and services. The specific details above are merely examples. There are many more parameters required to support Islamic-bank products and services of varying degree of complexities.

My column as appeared in The Malaysian Reserves on 8 August 2016

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