BNM Fintech Regulatory Sandbox Discussion Paper and Islamic Financial Services

Following the establishment of Bank Negara Malaysia (BNM) Financial Technology Enabler Group (FTEG) on 2nd June 2016, BNM issued a discussion paper on Fintech Regulatory Sandbox on the 29th July 2016. BNM in its Press Statement said that "the Sandbox will allow regulated financial institutions (FIs) and fintech companies looking to do businesses regulated by the Bank to experiment with fintech solutions in a production or live environment, subject to appropriate safeguards and regulatory requirements." BNM invited written comments on the discussion paper to be submitted by 30th August 2016.

 

Clauses specific to Islamic finance are as follows:

1. Section 1.6 of the discussion paper states that one of the intended outcomes is to ensure innovative solutions for Islamic financial services are consistent with prevailing Shariah standards.
2. Section 3.2 defines "Islamic Financial Services" as Islamic financial intermediation activities including Islamic banking and takaful services which leverage on technological innovation

In my opinion, the above clauses are not a problem for financial institutions as they should already have Shariah governance to ensure compliance to the prevailing Shariah standards. Collaborative fintech companies that partner with Islamic financial institutions should also not have any problem as they can ride on the Shariah governance of their partners. However, it is a big challenge for competitive fintech companies especially small start-ups which are not familiar with Shariah requirements.

 

I would recommend BNM to have a section on guidelines to comply with "prevailing Shariah standards". The guidelines should clearly differentiate the requirements for Collaborative and Competitive fintech companies. Some of the details to be included are the governance structure and the measures to be taken for ensuring the compliance.

 



Fintech Raya Special on CapitalTV

I had this interview program with a private TV channel, CapitalTV, to talk about Financial Technology (Fintech). CapitalTV made this special program for business news aired on the second day of eidul fitri (Hari Raya Puasa) 2016.

The following are some of the pictures captured during the recording of the programs.

Musharakah Mutanaqisah and Its Implementation in Home Financing Products in Malaysia

This is another collaboration effort with my wife. This paper, Musharakah Mutanaqisah, the Contract Elements and its Implementation in Malaysian Home Financing Products was published in the collection of academic articles by Kolej Polytech Mara (KPTM).

The following is the conclusion of the paper:

" Musharakah Mutanaqisah is an Islamic equity financing instrument. It is a form of partnership in which one of the partners promises to buy the equity share of the other partner gradually until the ownership of the subject of the Musharakah is completely transferred to him. However, the buying and selling agreement must be independent of the partnership. Shariah forbids the contract of partnership is entered as a condition for the contract of buying and selling.

Musharakah Mutanaqisah contract is a combination of two (2) contracts, Musharakah and Ijarah which have to be concluded separately. Shariah scholars internationally including Bank Negara Malaysia Shariah Council and AAOIFI, are in consensus of the permissibility of the contract.

From Shariah contract perspective, Musharakah Mutanaqisah is a binding contract. The contract comprises the elements of sale and lease which are binding and create a constructive obligation on the contracting parties. The obligation is created on the party who has agreed to buy the share of his partners and therefore he is required to pay the price of the shares. The financier, on the other hand, is also obliged to sell his share to the customer according to the ratio that has been agreed upon at the beginning of the contract.

Musharakah Mutanaqisah contract and its implementation in Malaysia as a Home Financing instrument is still a long way to go. It only started in 2006 with only seven (7) banks so far are offering this product. Since Musharakah Mutanaqisah is more globally accepted compared to BBA Home Financing which is more prevalent in Malaysia, the motivation for Malaysian banks to offer Musharakah Mutanaqisah based products is very clear. To make Malaysia a global hub in Islamic Finance industry, it is crucial for Malaysia to offer products that are aligned to globally accepted Islamic principles.

However, banks in Malaysia are still quite slow in adopting Musharakah Mutanaqisah. Instead migrating to Musharakah Mutanaqisah based financing, banks in Malaysia seems to be moving towards Commodity Murabahah based financing which is another debt based financing. At least two banks, KFH Malaysia and Citibank Malaysia, have discontinued their Musharakah Mutanaqisah based home financing products. One of the key reasons, there are still a number of unresolved issues if these banks were to strictly follow the rules of Musharakah Mutanaqisah contract. It is not that it is impossible. But, to implement it within the existing banking framework and legal regulations, operationally there are some challenges. Bankers have to change their mindset to be more “landlord” likes.

One of the main considerations for banks to offer Musharakah Mutanaqisah is the risk management aspect. The application of Shariah principles in Musharakah Mutanaqisah contracts creates distinct relationships, rights and obligations of the parties to the contracts. As a result, banking institutions are exposed to both market risk associated with the joint ownership of the underlying asset, as well as credit risk associated with the obligation on the part of the customer to acquire, and on the banking institution to sell, its share of ownership in the asset. Therefore, banks will have to have a more robust risk management system.

Although there are some issues and challenges for banks to offer Musharakah Mutanaqisah, these should not discourage them. Rather, a more collective efforts needs to be put in place to address these issues/challenges so that the Home Financing Products based on Musharakah Mutanaqisah principle will become more popular especially because the contract is more in line with higher objective of Shariah as proven by global acceptance of Shariah scholars on the permissibility of the contract."

Digital Economy and Islamic Finance - Opportunity or Disruption

Islamic Banking & Investment, Asia - Middle East Congress 2016 was held on the 6th of April 2016 at the Intercontinental Hotel Singapore. I was invited to be a panel member in discussing the topic of Digital Economy and Islamic Finance - Opportunity or Disruption. 

In my view, Digital Economy is both Opportunity and Disruption to Islamic Finance. Fintech companies, which play significant role in the digital economy, have created various opportunities for Islamic finance consumers and Islamic finance industry. At the same time, these fintech companies have disrupted traditional financial services players.

The picture below illustrates the impact of fintech to Islamic finance and digital economy.

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

Islamic Finance Conference 2016

I was invited to speak on Fintech during Islamic Finance Conference 2016 jointly organized by Islamic Banking and Finance Institute Malaysia (IBFIM) and Malaysian Institute of Accountants (MIA). The conference was held at Istana Hotel, Kuala Lumpur on 23rd March 2016.


I spoke about the impact of Financial Technology (Fintech) on Islamic Finance. The following were the observations and recommendations that I shared with the audience:

Observations:

•Fintech Penetration into Islamic Finance is still at infancy stage with small number of participants

•“Islamic Fintech” are mainly in the area of crowdfunding and P2P Lending

•Emergence of Fintech in Islamic Finance space is a blessing as it provides more choices for the consumers as well as providing platform for a more “genuine” Islamic financing

Recommendations:

1.For Fintech entrepreneur wannabe, it is a huge untapped industry. Consider beyond P2P and crowdfunding.

2.For traditional providers, adopt Fintech innovation. Embark into digital banking journey by collaborating with Fintech companies

Other speakers were as depicted in the picture below.

Factors Affecting the Pricing of Islamic Home Financing in Malaysia

This paper, a collaboration with my academician wife,  was published in The Malaysian Corporate Secretary Journal.

Below is the conclusion of the paper.

" The overall price of an Islamic home financing includes upfront cost, total profit (BBA financing), total rental (MM financing) and incidental fee charges.  The upfront cost are processing fee, disbursement fee, legal fee, stamp duty and MRTA and incidental fee charges are late payment penalty fee, capital prepayment fee and early settlement fee.

While BBA profit and MM rental are conceptually different, the mechanism applied to compute the profit or rental is the same.  Both BBA and MM financings make use of annuity concept and standard mathematical amortization model.

There are many factors affecting the total home financings such as amount of financing, tenor, rate(s), age of customer, banks’ policies on advance or early payment or extra payment, instalment amount, payment pattern, profit during construction, late payment fee, capital prepayment fee, early settlement fee, banks’ incentives and government incentives. "