Key To Successful Development of a Dual Islamic Finance & Takaful Systems Corporate Lecture Series Prof. Dr. Mohd. Ma’sum Billah Asian Business Forum

Key Issues Clear Picture on Dual System. Clear Picture on Dual System. Is it a Combination Or Compromization Or Harmonization Or Segregation? Is it a Combination Or Compromization Or Harmonization Or Segregation? Is It a Product Or a System? Is It a Product Or a System? The Road to Success. The Road to Success. The Mysterious Mechanisms. The Mysterious Mechanisms. The Global Update. The Global Update. The Platinum Tips. The Platinum Tips. Leading Islamic Finance & Takaful Instruments. Leading Islamic Finance & Takaful Instruments.

Clear Picture on Dual System Islamic Financial System is Not By Name But by Action Islamic Financial System is Not By Name But by Action Misconception Misconception A Clear Picture A Clear Picture The Global Reality The Global Reality

Is Dual Islamic Finance a Combination Or Compromization Or Harmonization Or Segregation? It is Neither Compromization Nor a Combination. It is Neither Compromization Nor a Combination. But, A Segregation. But, A Segregation. In Some Situations, It Is with Harmonization by Shari’ah Compliance. In Some Situations, It Is with Harmonization by Shari’ah Compliance.

Is Islamic Finance Or Takaful A Product Or A System? It is Not A product. It is Not A product. But A Sytem With Integration By Shari ’ ah & Divine Spirit. But A Sytem With Integration By Shari ’ ah & Divine Spirit.

The Road to Success Sincerity With Transparence. Sincerity With Transparence. Review (Products & Policies) Exercise Considering the Socio-economic Sensitivity. Review (Products & Policies) Exercise Considering the Socio-economic Sensitivity. PR & Performance With Standard Professionalism. PR & Performance With Standard Professionalism. Sustainable Risk Assessment & Effective Decision Making. Sustainable Risk Assessment & Effective Decision Making. Wisdom, Tolerance & Mutual Respect. Wisdom, Tolerance & Mutual Respect. Plan & Action. Plan & Action. Shari’ah Compliance With Divine Spirit. Shari’ah Compliance With Divine Spirit.

The Mysterious Mechanisms Dynamic Marketing Strategies. Dynamic Marketing Strategies. Sustainable Research & Rediscovery. Sustainable Research & Rediscovery. Ranks & Rewards. Ranks & Rewards. Global Comparison. Global Comparison. Reasonable Less Liability with Added Benefits & Rewards. Reasonable Less Liability with Added Benefits & Rewards. Mutual Corporate Care & Concern. Mutual Corporate Care & Concern. Punctuality with Smartness. Punctuality with Smartness. Settle Before Time. Settle Before Time.

The Global Update Middle Eastern Phenomena. Middle Eastern Phenomena. African Phenomena. African Phenomena. Malaysian & ASEAN Scenario. Malaysian & ASEAN Scenario. Indian Sub-continent. Indian Sub-continent. European Market. European Market. US & Other World’ Condition. US & Other World’ Condition.

Review Excercise With Innovation. Review Excercise With Innovation. Unhealthy Competition. Unhealthy Competition. Dynamic Offerings with Acceptable Standard. Dynamic Offerings with Acceptable Standard. Foreseeable Plan & Acceptable Performance. Foreseeable Plan & Acceptable Performance. The Platinum Tips

Leading Islamic Finance & Takaful Instruments MUDHARABAHMUSHARAKAH MURABAHAH Bai Bi Thaman Ajil WakalahTabarru’ UjrMirath

Contract between two parties: Contract between two parties: An Islamic bank as an investor (rab al-mal) who provides a second party, the entrepreneur (mudarib) with financial resources to finance a particular project. An Islamic bank as an investor (rab al-mal) who provides a second party, the entrepreneur (mudarib) with financial resources to finance a particular project. Profits are shared between the parties in a proportion agreed in advance. Profits are shared between the parties in a proportion agreed in advance. Losses are the liability of the Islamic bank and the mudarib loses only its efforts and his expected share in the profits Losses are the liability of the Islamic bank and the mudarib loses only its efforts and his expected share in the profits MUDHARABAH

The two partners participate in the capital of the venture The two partners participate in the capital of the venture Profits are allocated according to an agreed proportion, allowing for managerial skills to be remunerated Profits are allocated according to an agreed proportion, allowing for managerial skills to be remunerated Losses are borne by the partners in proportion to their contribution to the capital Losses are borne by the partners in proportion to their contribution to the capital MUSYARAKAH (JOINT PARTICIPATION)

Contract available for financing the purchase or import of capital goods, consumable goods or raw materials Contract available for financing the purchase or import of capital goods, consumable goods or raw materials Fundamental principles: Fundamental principles: –Purchase price should be declared to the client –Goods must be classified and clearly identified according to international or commonly accepted standards or classifications MURABAHA (MARK UP ON SALE)

Why more than 80% revenues generated by most of Islamic Banks are from the Murabahah financing?

POTENTIAL ISSUES IN MUSYARAKAH Third party guarantee Third party guarantee Shared liability Shared liability Restriction on joint-ownership of capital Restriction on joint-ownership of capital Classification of non-performing financing Classification of non-performing financing Source of funds Source of funds Staff competency and efficiency Staff competency and efficiency Control mechanism Control mechanism

Third Party Guarantee No security / collateral is allowed No security / collateral is allowed Negligence or misuse of funds Negligence or misuse of funds Jordan – Government guarantee Jordan – Government guarantee Sudanese Islamic Bank – Property as collateral Sudanese Islamic Bank – Property as collateral To allow third-party guarantee on Musyarakah financing To allow third-party guarantee on Musyarakah financing To assess Takaful role as third-party guarantee To assess Takaful role as third-party guarantee Both parties contribute to the appointment Both parties contribute to the appointment

Shared Liability JV – both parties share the liability JV – both parties share the liability Indemnity Letter can be requested but Syariah disallows financier to absolve its liability to the project Indemnity Letter can be requested but Syariah disallows financier to absolve its liability to the project To limit the liability under Syariah due to the financier’s non-involvement in the normal management of the project is to be obtained To limit the liability under Syariah due to the financier’s non-involvement in the normal management of the project is to be obtained

Restriction on Joint- Ownership of Capital Syariah: Capital contributed by the partners will belong to the partnership Syariah: Capital contributed by the partners will belong to the partnership Title should be under the name of partnership Title should be under the name of partnership Issues in JV-based Musyarakah Issues in JV-based Musyarakah Section 66 of BAFIA, FIs are not allowed to acquire or hold more than 5% equity in any corporation except by way of credit security Section 66 of BAFIA, FIs are not allowed to acquire or hold more than 5% equity in any corporation except by way of credit security

Assets which are contributed by partners as capital must be clearly differentiated from assets which are lent for specific functions and period by the partners Assets which are contributed by partners as capital must be clearly differentiated from assets which are lent for specific functions and period by the partners Appointment of trustee – economical for small financing? Appointment of trustee – economical for small financing? Alternative: Issue Trust Declaration – need to be registered with ROC Alternative: Issue Trust Declaration – need to be registered with ROC A private caveat can also be lodged if the assets is land A private caveat can also be lodged if the assets is land Still need to amendment BAFIA Still need to amendment BAFIA

Classification of Non- Performing Financing Does not have fixed payment schedule Does not have fixed payment schedule Tenure can be specific or perpetual Tenure can be specific or perpetual It is difficult to classify Musyarakah as non performing based on current Non Performing Loan Guideline by BNM GP3 It is difficult to classify Musyarakah as non performing based on current Non Performing Loan Guideline by BNM GP3 To amend the BNM GP3 To amend the BNM GP3 Perpetual should be exempted from the NPF classification Perpetual should be exempted from the NPF classification To divide it into 2 categories – Specific Maturity Musyarakah and Perpetual Musyarakah To divide it into 2 categories – Specific Maturity Musyarakah and Perpetual Musyarakah

Source of funds  Where the funds should be tapped from? Who are depositors? Specific accounts holder – risk takers?  Gapping issues – short term deposit versus long term lending  Limited shareholder’s fund – worst still - risky

Staff Competency and Efficiency To ensure that proper and structure training and practical are given to the parties involved To ensure that proper and structure training and practical are given to the parties involved

Control Mechanism Difficult to monitor and control especially JV-type Difficult to monitor and control especially JV-type Selective customers only Selective customers only

Recommendations to promote Musyarakah Financing Musyarakah Financing

Other recommendations BE SELECTIVE IN PROJECT SCALE: SMALL TO MEDIUM In a project whereby capital investment is very huge, like construction of dam, gas and oil production plant, musyarakah and mudharabah structure may not be recommended due to the shortfalls of this structure. In practice the financing structure are more toward debt structure, ijarah, rahn and etc.

GO FOR MORE SECURED PROJECT CASH FLOW For relatively small project like a secured infrastructure government award project, bank can adapt the musyarakah and mudharabah structure replacing the murabahah or BBA in trade financing that are widely use in current practice For relatively small project like a secured infrastructure government award project, bank can adapt the musyarakah and mudharabah structure replacing the murabahah or BBA in trade financing that are widely use in current practice In practice Islamic Bank use Murabahah Working Capital Financing facilities in order to facilitate trade finance of particular company that being awarded with government project. In Malaysia, infra project are booming and the need for such financing is huge In practice Islamic Bank use Murabahah Working Capital Financing facilities in order to facilitate trade finance of particular company that being awarded with government project. In Malaysia, infra project are booming and the need for such financing is huge In MWCF bank will get profit out of mark up sale that they charges to its clients of more less like % p.m. and if the bank can participate directly into the project by way of mudharabah or musyarakah the return is far beyond the current margin. In MWCF bank will get profit out of mark up sale that they charges to its clients of more less like % p.m. and if the bank can participate directly into the project by way of mudharabah or musyarakah the return is far beyond the current margin.

For example, government awarded a project to an ABC Co. to construct a RM50 million hospital for a period of 18 months in Gua Musang For example, government awarded a project to an ABC Co. to construct a RM50 million hospital for a period of 18 months in Gua Musang Since the project is guaranteed by the government in term of progressive cash flow payment, bank can use Musyarakah or Mudharabah as a tool to participate in the project for a better return Since the project is guaranteed by the government in term of progressive cash flow payment, bank can use Musyarakah or Mudharabah as a tool to participate in the project for a better return

How this recommendation can solve the shortfalls GO FOR SHORT TERM PROJECT FINANCING Liquidity problem can be resolved as the project undertake is only for short term period Bank can use depositor’s fund instead of limited shareholders’ to capitalize the project in order to give better return to depositors Problems of gaping can be eliminated, since cash in flow will be paid in progress payment. In a typical government project, payment made progressively in monthly payment according to

Direct involvement from the agents Mudharib & Rabbul Maal are the board of executives directors Risk scorecard must be in place and reviewed periodically Appointed independent project/account manager/consultant to assess the performance and detect warning signals for pre-emptive measure

Thank You Wassalam