Malaysia has the most advanced, liquid and sophisticated market for Islamic banking in the world. Of course, I have had many of the Islamic banks in Malaysia as my clients, and I have met dozens of bankers in Malaysia. The innovation and speed of development is impressive.
Malaysian bankers take great enjoyment in telling me that the Middle East may have more money, but the brains are in Malaysia!
I am a big fan of Malaysia and Islamic banking in Malaysia.
If I want to obtain a snapshot of the activities of a typical Islamic bank (that is very active in domestic and international markets) then it makes great sense to analyse the financial statements of such a bank in Malaysia.
PLEASE NOTE : I have no intention of naming this bank – it really does not matter. My working assumption that its activities are comparable with the activities of a typical Islamic bank in Malaysia is, I believe, sound.
Ok, let’s dive right in.
Financial Statements
This is where the good stuff is. Numbers do not lie! (not often, anyway)
All numbers are in RM ‘000.
So, the bank has over RM 55bn in assets – let’s look at liabilities.
And almost RM 52bn in liabilities. The difference, of course, is the equity, which is comprised of share capital and reserves, and totals RM 4.4bn.
Let’s look deeper at the assets, line by line.
1) Cash and short-term funds
These are invariably priced at interest based on my experience. Note 3 in the financial statements provides some breakdown of this figure:
Cash balances with other banks are always placed at interest, and so are interbank placements. Money at call (depending on the terms and conditions) may be priced at 0% - this is possible, however there is no information to confirm this.
2) Deposits with banks and other financial institutions
These total RM 100mn and will be priced at interest.
3) Financial assets held for trading
I wonder what Malaysian Government Investment Issues are?
I found this useful website : https://www.bixmalaysia.com, “Bond and Sukuk Information Exchange”.
I quote from this website below:
“Islamic Securities Government Investment Issues (GII) GII is long-term non-interest-bearing Government securities based on Islamic principles issued by the Government of Malaysia for funding developmental expenditure. GII are issued through competitive auction by Bank Negara Malaysia on behalf of the Government. Funds are used for development expenditures. GIIs are issued with original maturities of 3-year, 5-year, 7-year, and 10-year.”
Now, this is language I am familiar with. Of course, there are “non-interest-bearing”, but I am concerned with how any return is calculated for buyers. The fact that this refers to maturities of 3, 5, 7 and 10 years implies these may be bond-like instruments. Let us read a little further.
“Effective from 22 July 2013, GII is issued based on Murabahah concept. The GII issued prior to 22 July 2013, is based on Bai Al-Inah contract, is a trust certificate, arising from sell and buy back of asset in Islamic finance.”
Ok, here we have it. All Murabaha contracts (in fact every single Murabaha contract I have ever designed, executed, and seen) are priced at interest. This means that the underlying asset is sold to the buyer, who pays for this asset in the future, either via a lump sum, or in instalments. The final price payable by the seller is a function of the cost price and the mark up. The mark up is itself a function of the cost price plus the duration of delay in repayment. The calculation is no different to a bank offering you a loan and charging you interest. First, you agree how long you want to repay the loan, then the bank calculates the interest rate to be charges, and tells you how much to repay on a monthly basis.
The process with a Murabaha contract is exactly the same, notwithstanding the fact that you are buying an asset.
The reference to Bay Al 'Inah is also interesting – this is another contract used to deliver interest via the buying and selling of assets. This has been made impermissible by AAOIFI (the Accounting and Auditing Organisation of Islamic Financial Institutions, based on Bahrain, and is a global regulator and standard-setting body for Islamic banking). However, Bay al Inah has traditionally been permissible in Malaysia, as it is claimed that the Shafi school of jurisprudence permits such a structure / transaction. Hence the utililisation of this contract is not in contravention of the rules set by the Shaafi school of Islamic law. As such, there is no question of this being impermissible activity in Malaysia, as things currently stand.
The question to be asked, then, is that if Bay al Inah is permissible – why did the Malaysian government change from Bay al Inah to Murabaha. In my view this is part of a general process to try to move away from Bay al Inah contracts. Is this a good thing?
My answer is … maybe!
To illustrate what I mean when I say these securities are priced at interest – the same website provides a very useful search function. We can search for all government securities that have been listed (both Islamic and non-Islamic / conventional).
I chose one conventional security (that pays interest coupons) and one Islamic security, that pays profit instead of interest.
Conventional Security
Islamic Security
The conventional security has an interest coupon of 3.88% and the Islamic security (based on a Murabaha contract) has a profit rate of 3.73%.
This is what I mean when I say the rate on the Murabaha contract is an interest rate, but it illustrates the profit made on the Murabaha transaction, and not simply interest payments.
However, the fact remains that the calculation of this rate is made by reference to interest rates, and is calculated by reference to the relevant interest rate, and simply the final presentation of these cash flows is via Shariah compliant Murabaha contracts.
Back to the financial statements – let us now look at the Sukuk component.
All Sukuks are priced at interest – it does not matter whether it is a fixed profit rate, or a floating profit rate. It is priced at interest.
Now, the final item, which is Unit Trusts, at an amount of RM 5m, I cannot give an opinion. This is because it all depends on what these unit trusts are. There are unit trusts that are priced at interest (for example, a fixed income unit trust that invests in bank deposits, and fixed income securities such as Sukuk), and there are also unit trusts that invest in non-interest-bearing securities such as equities and shares. There is no further information provided here – so this element is inconclusive.
4) Derivative Financial Assets
These total almost Rm 4bn (based on the notional amount) and, the majority of these are forward contracts.
Now, forward contracts are, generally, instruments to hedge risk. Of course, forward transactions, per se, are impermissble in Islamic commercial law. You can not agree to buy and asset in the future and also pay for it in the future.
However, certain exemptions are made for instruments which hedge the risk of a bank. How does this risk arise?
The risk arises from the general commercial activities of the bank. There are two major commercial risk that these forward contracts hedge:
1) Interest rate risk (called Profit Rate Risk for Islamic banks). This means the banks have an exposure to movements in interest rates. In simple terms, if the bank gives you a loan and you pay a fixed rate of 7% annually, then the bank is taking on a risk, and so are you. If the interest rates rise, the the bank can be said have suffered somewhat. The interest rates have risen, but the bank can still only charge you 7%, because that is what you and the bank agreed. The bank cannot charge you more because the interest rates have risen. This is the risks the banks take.
As a consumer, you may well prefer to take out a fixed rate loan, because you expect interest rates to rise.
In order to hedge the bank’s position, it often enters into derivative contracts to reduce it’s potential losses in case interest rates move in a non-favourable way. This is via forwards and swaps (and also via options, but options are not mentioned here).
The same applies to profit rate swaps. They are a little more complicated, but their function is the same – they provide protection to the bank in case the interest rates move in such a manner to reduce the value of its loan portfolio.
2) Foreign Currency Risk
If the bank has to make or receive payments in a currency other than RM, and these payments occur in the future, then the bank as exposure to movements in the exchange rates. These exposures can be hedge by currency forwards and swaps.
This risk hedging is normal for a bank – indeed a bank that gives loans at fixed rates of interest and does not hedge this risk, would give me concern from a risk management and governance perspective.
Now, the amounts above represent notional amounts, but the bank does not reflect this total of almost RM 4bn on the face of the balance sheet. Instead and amount of Rm 125mn is reflected. Where does this come from?
Here we see a valuation of assets at RM 124mn and liabilities of RM (111mn). These are the numbers on the balance sheet.
So – to summarise, both these forwards and profit rate swaps are priced at interest.
5) Financial assets available for sale
The top portion is clearly priced at interest – we have already looked at Malaysian Government Investment Issues. Debt instruments are, by definition, priced at interest. We already know that all Sukuk are priced at interest.
The bottom section –these are shares and unit trusts. Shares, of course, are not priced at interest. And, again, I am comfortable in agreeing, without access to further information, that these unit trusts are potentially not priced at interest.
6) Financial assets held to maturity
We already know all Sukuk are priced at interest.
7) Financing, advances and others
This totals RM 39bn
This note in the financial statements is too large to copy here. However, I can copy here the breakdown in terms of the contracts used.
These are all priced at interest. I do not have the inclination (or the time, currently) to explain exactly why this is the case, but it certainly is the case.
Of the major items that total to the RM 39mn, we can see House financing is RM 14bn, Personal financing is RM 11bn, and other term financing is Rm 10bn. When we see the word “financing”, it is a safe assumption that these are priced at interest.
To confirm this (if we needed confirmation – I certainly do not, but readers may prefer it) we see the following in the notes:
This confirms that of the RM 40bn in this section, over RM 5bn relates to fixed rate financing, and the balance to floating rate financing. Typically, it is this fixed rate financing that results in the need for this bank to hedge this exposure via the forward contracts and profit rate swaps we saw earlier.
8) Other assets
These total RM 99mn
There is not enough information here to analyse any further, but I am comfortable to exclude these assets from being priced at interest.
9) Statutory deposits with Bank Negara Malaysia
These total RM 1.3bn.
This confirms these balances are non-interest bearing.
The remaining assets are insignificant, and I will exclude them from my analysis.
Let us now look at the liabilities.
Liabilities
A reminder of this bank’s total liabilities:
Let us go line by line.
1) Deposits from customers
These are priced at interest.
We see a breakdown by contract type:
Let’s look at the bank’s website for further information on these products:
We see the following types of deposit and savings products:
a) iGain
b) Al-Awfar
c) Qard Savings Account
d) Basic Savings and Current Account
e) Wafiyah Investment Account
f) Qard Current Account
g) Term Deposit-I (Tawarruq)
h) Savings and Investment Zakat
Ok, let’s take a deep breath and analyse each one of these in turn
a) iGain
“iGain is a transactional investment account whereby customer still can opt for the banking facilities such as Mobile Banking, Debit Card, Standing Instruction and etc.”
We are informed this is based on a Mudarabah contract.
From the Product Disclosure Sheet:
“For the purpose of this iGain and based on the Shariah contract of Mudarabah, the IAH and the Bank will share any profits deriving from the investment activities managed by the Bank whilst financial losses will be borne by the IAH solely except for losses which are due to or arising from any act of misconduct, negligence or breach of specific terms by the Bank.”
This is standard for a Mudarabah agreement. You can read further about these contracts in other articles on my site.
Here are the profit sharing ratios:
Again, these are quite standard.
The profit that is made by the use of funds is referred to as Gross Rate.
There is reference to a Campain for this product, and here are the indicated rates for this period:
These indicative rates are interest rates, stated as profit rates. How is this profit created?
“The fund is categorized as low risk investment where the funds will be invested in House & Fixed Asset (HFA) portfolio of the Bank to generate stable income for the IAH. “
So the funds are “invested” into a portfolio comprising the house loan portfolio of the bank, and the fixed asset portfolio. We have already see above the home finance assets of the bank (the loans they have given out) and they are priced at interest. Fixed income assets are also by definition priced at interest.
Hence the investment into these products is an investment into assets that are priced at interest. And thus any profit share of the account holder is a profit share of profits generated from activities priced at interest. Hence these profits are also priced at interest.
This is all quite logical, and as expected.
I could continue and do this same analysis for every deposit product the bank has, however that is quite tedious and we would not learn anything interesting or new.
Rather, we can look at the contract types specified in the notes to the financial statements.
Wadiah
This is a principle of custody or safe-keeping. The customer appoints the bank to look after the deposit funds.
“I / We hereby agree that the money deposited into my/our Savings Account is for the purpose of safe keeping based on the Islamic principles of al-Wadiah ( safe custody) and I / we hereby give my/our consent to the Bank to utilise use or invest the whole or part of any monies standing to the credit of my/our account in the manner that the Bank shall deem fit.The Bank guarantees payment of the whole of such or any part there of standing to the credit of my/our account upon demand. “
So the bank is utilising these funds, and also guarantees to repay the whole of the deposit amount back. This type of guarantee is not permissible with Mudarabah contracts.
I wonder if these accounts pay any profit rate to the account holders?
There is reference to a “profit sharing ratio” in a document explaining this account. It is not clear to me exactly how this fund operates.
However, we do see on the website, a clear presentation of the effective profit rate payable on the Term Deposit-i product:
This makes it clear this is an interest rate, but, in this case, a profit rate for a Tawarruq transaction.
(Tawarruq involves the buying and selling of assets for profit – it follows the same structure as commodity Murabaha which I have written about in some detail on my site).
Some Good News!
I managed to find a list of the profit rates attached to the various deposit accounts on the bank’s website:
Ok, so this is some confirmation of the fact that all profit rates for these accounts are in fact priced at interest, and delivered in a manner consistent with the underlying Shariah compliant contract.
Finally, we can move on to the next item in liabilities.
Investment accounts of customers
In the case on investment accounts, a Mudarabah contract is widely used. The pricing copied above, from the bank’s website, includes both the investment accounts as well as deposit accounts. These are all priced at interest.
We will also find that the investment of customer funds is into the bank’s assets (this has to be the case, where else can the bank use this money if not in it’s main business?).
These assets are of course, priced at interest.
In fact, this is confirmed in the notes to the financial statements. We see that the total Mudarabah investment accounts above are RM 1,516,844,000 and that the Wakala investment accounts are RM 2,295,417,000 all of these are “invested” into the house financing and personal financing assets of the bank:
Deposits and placements of banks and other financial institutions
No further explanation is provided, however it is not possible to conclude that these will be priced at anything other than interest.
Derivative financial liabilities
These have been described above, and this amount of RM 111mn presents the liabilities section of the bank’s exposure. These derivatives are all priced at interest.
Bills and acceptance payable
These total Rm 46mn and no further information is provided. We can say these are not priced at interest.
Subordinated Sukuk Murabaha
We already know, with the use of terms such as Murabaha, and Sukuk, that these liabilities are priced at interest. We can see the “profit” rates of 5.75% and 5.50% in the diagram above.
Other liabilities
These total RM 602mn.
These are detailed as payables and accruals, which are normal for any business. We can say these are not priced at interest.
Zakat and Taxation
Again, we can say these are not priced at interest.
Where does all of this leave us?
Summary
Assets Analysis
97% of all assets of the bank are priced at interest.
Liabilities Analysis
99% of all liabilities of the bank are priced at interest.
Conclusion
What does this mean?
It simply means what it says – 97% of the bank’s assets are priced at interest, and 98% of the liabilities are priced at interest.
So, is this haram?
No, I would not say that. But it shows us a few things. If interest is harmful, then how is something that replicates interest in every meaningful way less harmful?
We are doing Shariah compliant transactions and pricing them at interest. Interest is the price for one thing only – and that is debt and lending money. If you lend money, you price it at interest. If you charge interest, that means you are lending money. It really is that simple.
The fact that we are buying assets, selling assets, making investments - all this is secondary to the fact that the intention of the parties is to transact at interest. And there is only one thing that has a price of interest – debt.
So, when we are forced to introduce assets, it means we can never have a real entrepreneurial or trading relationship with these assets.
How does this materialise?
It means we buy assets we never want. It means, when we buy these assets, we sell them to someone who cares even less than we do about this asset. What is most important is the price, the cash flow, and when this is paid. These are all the elements of debt. And this means there must be interest.
Interest drives what we do, interest makes us create artificial buying and selling. It makes us do transactions that nobody cares about (apart the very specific cash flows?).
How else can Islamic banks buy and sell metal for two years without realising this metal does not exist (see my article on the Curious Case of the Missing Metal).
This is why scholars have called Islamic banking contracts deceptive.
But listen to the language used by participants in Islamic banking –
“Transparent”
“Fair”
“Justice”
“Riba is sinful, wrong and harmful”
and so on.
Personally, I find all this very unsettling. I find it very uncomfortable that we are using the rules of our Creator to derive contracts that are fictitious and artificial.
This makes me feel very uncomfortable indeed.