Islamic Finance: A new role for Islamic banks?

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This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Nov 16 - 22, 2015.


Baiza Bain is vice-president at Maybank Asset Management Group


I HAD the opportunity to attend the recent World Islamic Economic Forum. It was a surreal experience as I had the opportunity to interact with a number of international delegates on areas that are outside my realm of Islamic finance. The various conversations I had certainly allowed me to have a different perspective on my area of practice. It made me realise that there are many ways in which Islamic finance could evolve to keep up with the rapidly changing times.

So, in what way has Islamic finance tried to keep up with the times? I remember having a conversation with an old friend who highlighted a unique initiative that is currently being worked on. This initiative was actually announced under Budget 2015. Called the Investment Account Platform (IAP), its aim is to diversify the roles that are currently being played by the Islamic financial institutions by way of adding on the responsibility of being an investment intermediary.

Traditionally, Islamic financial institutions, like their conventional counterparts, have played the role of credit intermediary — assessing the application of those seeking finance, ensuring that their credit meets the required standards and disbursing the funds. The financing is made from a pool of deposits that have been collected by these Islamic financial institutions. 

How will the IAP be different? For starters, it will be a dedicated platform funded by investors rather than depositors. Investors are able to take risks and their investments will not be subject to capital charges, unlike the deposits being utilised by the Islamic financial institutions. This means the IAP investors can fund a larger pool of parties. The government’s aspiration for the IAP is to have the platform fund small and medium enterprises (SMEs) through equity participation by the IAP investors.

The equity participation can be done via one of the following shariah contracts:

1.    Musyarakah is a contract of partnership where two partners go into a profit-making venture. Any gains from this venture could be distributed between the partners in a pre-agreed ratio that may or may not reflect the amount of capital contributed by each partner in the venture. Any losses, however, will be distributed according to the ratio of capital contributed by each of the partner.

2.    Mudarabah is a contract of partnership where one partner is the contributor of capital (Rab al mal) and the other partner is the contributor of the know-how (Mudarib). The gains from the venture will be split according to the pre-agreed ratio by both partners, but any losses will be borne solely by the Rab al mal.

To encourage more investors to participate in the IAP, the government has given a tax exemption on any income earned by the investors. This exemption is subject to the following conditions:

i.    Tax exemptions shall only be accorded for three consecutive years starting from the first year profit is earned;
ii.    The investment is made for a period of three years starting from the operation date of the IAP;
iii.    The tax incentive shall only be accorded for investment activities in Malaysia, in venture companies owned by Malaysian or locally incorporated companies;
iv.    Tax exemption shall only be accorded for investments made in SMEs and venture companies in any sectors; and
v.    The definition of SMEs is as per the latest definition issued by SME Corp Malaysia.

How does the introduction of the IAP benefit the Islamic finance industry? To sum up:

1.    The availability of shariah-compliant equity funding to complement the current shariah-compliant debt funding in the market;

2.    The ability to finance via equity good SMEs that may not be able to qualify for shariah-compliant debt funding from banks due to their small size;

3.    The creation of another income stream for shariah-compliant investors; and

4.    Reducing the dependence on the deposit pool for shariah financing.

In my opinion, the IAP will be an innovative product that provides Islamic banking customers the opportunity to earn investment returns and tax incentives. Between the IAP and the shariah-compliant crowdfunding initiative, Islamic finance appears to be on its way to staying relevant with the changing times. There are exciting times ahead!