bai sarf

Examining The Concept of Risk and
Islamic Finance
Mohamed Rithuan
4th & 5th June 2014, Mandarin Oriental Hotel, KL
Islamic Finance is based on Shariah principles that are
universal in nature…
KEY ELEMENTS OF ISLAMIC FINANCE
Shariah Concepts in Islamic Finance
Exchange Based
•
•
•
•
•
•
•
•
•
Murabahah
Mark up sale
Musawamah
Negotiated sale without reference to cost
Bai’ Bithaman Ajil
Deferred payment sale
Bai’ Salam
Forward sale
Bai’ al-Sarf
Currency sale
Istisna’
Manufacturing sale
Tawarruq / Commodity Murabahah Monetisation
Bai Inah
Sale and buy back
Bai’ al-Dayn
Debt trading
Partnership Based
• Musyarakah
• Musyarakah Mutanaqisah
• Mudarabah
Joint venture
Diminishing partnership
Profit sharing
Lease Based
• Ijarah
• Al-Ijarah Muntahia Bi al-Tamlik
• Al-Ijarah Thumma al-Bai’
Leasing
Leasing ending with a sale
Leasing ending with a gift
3
Shariah Concepts in Islamic Finance
Charity Based
• Hibah
• Qardul Hasan
Gift
Benevolent loan
Waiving Contracts
• Ibra’
• Muqasah
• Tanazul
Rebate
Set-off
Waiver
Security Contracts
• Kafalah
• Rahn
• Wadiah
Guarantee
Collateralised debt
Safe custody
Services
• Wakalah
• Wa’ad
• Ujr’
Agency
Promise
Fees
Essential Elements in a Contract
The essentials (rukun) under the exchange and lease based concepts, and the
conditions (hukum) of each essential element are as follows :Contracting Parties
Buyer / Seller
Lessor / Lessee
• The Contracting Parties must
be qualified persons under the
law, having complete legal
capacity i.e. :• for individuals, of sound
mind and have reached the
age of majority
• competent to deal with the
contract
• Not prohibited from dealing
with their property i.e. :• not declared bankrupt or
wound up
• not prodigals
• Not under any coercion or
compulsion to transact
Subject Matter
Form of Contract
Goods
Offer and Acceptance (aqad)
• The Goods are permissible
under Shariah
• Not in the form of ribawi item
• The Goods can be possessed
• Has economic value and some
use
• Seller / Lessor / Partner has
ownership of the Goods
• The Goods can be delivered to
the Buyer / Lessee
• The Offer and Acceptance
(aqad) is exercised in words or
by other methods recognised
by Shariah such as conduct,
writing and gesture
• Offer (ijab) and Acceptance
(qabul) must clearly indicate
the intended motive of the
contracting parties
• The subject accepted in the
contract must correspond to
what has been offered
• Executed in a majlis
Islamic banking is based on different contractual
relationship including profit sharing basis …
Islamic Rate of Return Management (Asset Driven)
Return on Assets
Assets
Distinct characteristicownership of assets
Akin to loans but legal
position of lender &
borrower is replaced by
different contractual
relationship
Inventory
Real estates/ Automobiles
Asset-backed Transactions
Murabahah (cost plus) / Ijarah
(leasing) / Istisna’ (manufacture) /
Salam (forward sale) / Sukuk
Profit Sharing Transactions
Investor-entrepreneur
relationship
Investment Returns
Liabilities
Demand Deposits
Wadiah / Commodity Murabahah
General Investment Accounts
Mudarabah / Commodity Murabahah
Mudarabah / Commodity Murabahah
Profit Equalisation Reserves
Fee Based Services
Equity
Cost of borrowings
Akin to Fixed Deposits
but uses profit sharing
basis where return based
on performance of assets
Specific Investment Accounts
Mudarabah (profit sharing & loss
bearing) /Musyarakah (profit & loss
sharing)
e.g. Qardhul Hassan (Benevolent Loan)
Akin to Demand Deposits
but exhibit differently as it
prohibits gifts upfront /
predetermined return
Cost of Funds
Conventional Asset & Liability Management (Liability Driven)
Distinct characteristic as
prudential tool
Funds From Islamic Banking Operations
Basically, funds are obtained from the following sources :Products
Shariah Concepts
Shareholders’ Funds
Share Capital & Reserves
Islamic Deposit
Current Account
Wadiah, Qardhul Hassan
Savings Account
Wadiah, Mudarabah
General Investment Account (GIA)
Mudarabah
Specific Investment Account (SIA)
Mudarabah
Fixed Return Investment Account (FRIA-i)
Commodity Murabahah
Islamic Negotiable Instruments
• Negotiable Islamic Debt Certificate (NIDC)
• Islamic Negotiable Instruments of Deposit (INID)
Bai’ Inah
Mudarabah
Mudarabah Interbank
• Placements (investments)
• Takings (deposits)
Mudarabah
Mudarabah
BNM Wadiah Placement & Tender
Wadiah
Trading of Islamic Financial Instruments
Bai’ al-Dayn
Islamic Interbank
Money Market
For Islamic Window Operations, all Islamic funds are segregated from those related to
conventional banking and a separate accounting system / entries are adopted.









Bai’ Bithmana Ajil
Murabahah
Istina’
Bai’ Inah
Al-Ijarah Thumma al-Bai
Ijarah
Qardhul Hassan
Ar Rahnu
Musyarakah
Types of Short Term Facilities
Generally, trade finance products are short term and can be classified as follows:
Non-Funded (non-Cash) Facilities
(to facilitate business)
Letter of Credit-i
Bank Guarantee-i
Shipping Guarantee-i
Sales Financing
- Export Credit Refinancing-i
- Bills of Exchange Purchased
Short Term
Facilities
Funded (Cash) Facilities
(to finance business)
Purchase Financing
- Trust Receipt-i
- Accepted Bills-i
General Financing
- Islamic Cashline/Overdraft
- Trade Working Capital Financing-i
Islamic Financial Instruments Investment Products
Product
Shariah Concept
Bank Negara Monetary Notes-i (BNMN-i)
Bai’ Inah
Bank Negara Monetary Notes-Murabahah (BNMN-Murabahah)
Murabahah
Bank Negara Monetary Notes-Bai’ Bithaman Ajil (BNMN-BBA)
BBA
Bank Negara Monetary Notes-Istithmar (BNMN-Istithmar)
Ijarah & Murabahah
Malaysian Islamic Treasury Bills (MITB)
Bai’ Inah
Accepted Bills-i (AB-i)
 Purchases / Imports
 Sales / Exports
Murabahah
Bai’ al-Dayn
Islamic Commercial Papers
 Murabahah Notes Issuance Facility (MUNIF)
 Islamic Revolving Underwritten Facility (IRUF)
 Guaranteed Revolving MUNIF (GRUNIF)
Murabahah
Murabahah
Murabahah
Sukuk BNM Ijarah (SBNMI)
Ijarah
Cagamas Islamic Bond
 Cagamas Mudharabah Bond (CMB) or Sanadat Mudharabah Cagamas
(SMC)
 Cagamas Bai Bithaman Ajil Islamic Securities (BAIS)
 Cagamas Islamic Residential Mortgage Backed Securities (RMBS-i)
Housing Debts-i - BBA
Hire Purchase-i - AITAB
Bai’ Inah
Musyarakah
Islamic Bond (IB) / Islamic Debt Securities (IDS)
BBA, Ijarah, Mudarabah,
Musyarakah
Government Investment Issues
Bai’ Inah
10
Islamic Forex Swap (IFS)
IFS is a unilateral agreement between two counterparties consisting :1. A Bai’ al-Sarf (currency exchange) between an Interbank Counterparty and an Islamic bank at the
beginning of the transaction, followed by a Wa’d (undertaking) by the Interbank Counterparty to
enter into a Bai’ al-Sarf at a future date at today’s exchange rate; and
2. Another Bai’ al-Sarf takes place on the future date at the rate that was agreed earlier
1. (a)
Bai’ al-Sarf
USD
MYR
Counerparty
1. (b)
Bank
Wa’d
Wa’ad to buy USD/MYR at today’s rate
Counerparty
2. Bai’ al-Sarf on the future (maturity) date
Bank
MYR
USD
Counerparty
Bank
Quote
Hoping for something positive..
is NOT a Strategy..!
Concept of Risk Management in Islam
Further he said: "O my sons! enter not (capital of Egypt) all
by one gate: enter ye by different gates. Not that I can profit
you aught against Allah (with my advice): None can
command except Allah. On Him do I put my trust: and let
all that trust put their trust on Him."
(Surah Yusuf: Verse 67)
Hadith from Prophet Muhammad s.a.w
Prophet Muhammad (PBUH) once asked a Bedouin who
had left his camel untied, “Why do you not tie your
camel?” The Bedouin answered, “I put my trust in
God”. The Prophet (PBUH) then said, “Tie up you
camel first then put your trust in God”.
UNIQUE
Risks Profile of Islamic Banks
EQUITY INVESTMENT
RISK
N Compliance
Rate of Return
GENERIC
DISPLACED
COMMERCIAL
RISK
Islamic finance is relatively new. Risks inherent in the instruments used are not well comprehended.
Risk in Islamic Banking is not significantly different from conventional banking but there are
additional risks that are unique to Islamic Banking due to their compliance with Shariah rules and
principles.
GENERIC RISKS FOR BANKS
Types of Risks
Definition
Credit Risk
The risk of loss or decline in value due to a counterparty failing to
meet its obligation in accordance with agreed terms and conditions of
a credit related contract or to a change in his / her credit quality.
Market Risk
The risk of losses in on- and off-balance sheet positions arising from
adverse price movements such as benchmark rates, foreign exchange
rates, equity prices on the economic value of an asset.
Liquidity Risk
The potential loss arising from the IFI's inability to unwind a position
in a timely / cost effective manner, either to meet its obligations
(including to meet an unexpected spike in customers’ demand for
cash withdrawals) or to fund increases in assets as they fall due.
Operational Risk
The potential loss resulting from inadequate or failed internal
processes, people and system or fom external events. For IFIs, it
includes Shariah non-compliance risk.
UNIQUE RISKS FOR ISLAMIC BANKS
Types of Risks
Definition
Shariah NonCompliance Risk
Risk arising from the failure to comply with Shariah rules and
principles.
Rate of Return Risk
The potential impact on the IFI’s returns as a result of an
unexpected change in the rate of return.
Displaced Commercial The risk of an IFI facing commercial pressure to pay returns that
Risk
exceed the rate that has been earned on its assets financed by
Mudarabah investment account holders. As a result, the IFI may
have to forego part or its entire share of profit in order to retain
the fund providers and dissuade them from withdrawing their
funds.
Equity Investment
Risk
The risk arising from entering into a partnership for the purpose
of undertaking or participating in a particular financing or general
business activity as described in the contract, and in which the
provider of finance shares in the business risk. This risk is
relevant under Mudarabah and Musyarakah contracts.
Risks in Islamic Modes of Financing
Murabahah
Beginning of Transaction
• The IFI buys the asset based on a promise from the buyer to purchase the asset from the IFI. If
the promise is not binding, the IFI may be stuck with the asset and be exposed to market risk.
• Any loss arising from damage to the asset before delivery to the buyer has to be borne by the
Bank.
• To eliminate the market risk, the promise has to be made binding on the buyer.
Transaction Period
• Once the asset is delivered to the buyer, the IFI faces a credit risk regarding the payment that is
due in the future. To mitigate this risk, the IFI should ask for collateral.
Conclusion of Transaction
• If the payment due is paid, then there is no further risk.
Risks in Islamic Modes of Financing
.… Cont’d
Mudarabah
Beginning of Transaction
• An IFI’s existing competencies in project evaluation and related techniques are limited. IFI’s
can hire the services of experts for the job.
Transaction Period
• As the capital provider cannot intervene in the management of funds, the counter-party risk
includes misreporting of profit by the mudarib (manager).
• If the conditions of the mudarabah is violated, the manager will be responsible for any loss
arising from it, as it constitutes failing the fiduciary duties.
Conclusion of Transaction
• The counter-party risk of untruthful reporting of profit by the mudarib (manager).
Guiding Principles on Risk Management
• BASEL Committee on Banking Supervision
• Islamic Financial Services Board (IFSB)
• Bank Negara Malaysia (BNM)
IFSB-1 Specific Requirements
Principle 2.3 : IIFS shall have in place appropriate methodologies for measuring and
reporting the credit risk exposures arising under each Islamic financing instrument.
IIFS shall develop and implement appropriate risk management and reporting
methodologies relevant to each Islamic financing instrument in respect of managing
their counterparty risks, which may arise at different contract stages (including
counterparty performance risk in Salam and Istisna’ contracts).
Shariah Governance Framework Model for IFI
Should you have any further questions, please
send them by 9 June 2014 to:
[email protected]
Facebook.com/ierp.erm
twitter.com/ierp_institute
linkd.in/QPlbnH
plus.google.com/+Insterperm
22
Facebook.com/ierp.erm
twitter.com/ierp_institute
linkd.in/QPlbnH
plus.google.com/+Insterperm
[email protected]
www.insterp.com