Essay: Mudarabah

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1.2 Background of Study

In the early history of Islam, the injunction relating to the prohibition of riba or interest was strictly observed and adhered to. Gradually the declining of the religion adherence among the Muslims coupled with the spread of Western influence as a result of the long period of colonial domination of Muslim countries by Western power, the financial practices based on interest became solidly entrenched. (Warde, 2000) said that the propaganda somehow gained a certain momentum in aspiring and cultivating awareness among the Muslims, which eventually started to pressure the governments to at least show some positive response and initiative to reform the secular system into an Islamic one. In fact, to a certain event, in some cases as that experienced in Pakistan, Islamic banks is on the platform of every major political party, and for any politician, not endorsing it amounts to political suicide.

The system of Islamic commerce and finance dates back to the early days of the Prophetic era and the system was initiated under the guidance of the Prophet Muhammad SAW, the historical founder of Islam. The basic philosophy is that no one is allowed to exploit the misfortune of another person. Islamic finance focuses on the philosophy of investing in socially responsible businesses. Commerce was central to the Islamic tradition since the emergence of the Prophet Muhammad SAW that was also a merchant involved in commercial activities and established detailed ethical and commercial rules in business transactions.

The shari’ah prohibited interest because it is pure rent on money which is considered immoral. The provider of a fund can only be entitled to a return if he or she undertakes the ownership risk of the business; otherwise, the transaction will be considered an exploitation. Fiqh al-Mu’amalah focuses on how to minimize disputes among traders, a very common issue, particularly in relation to contractual agreements. Islamic financial instruments take the form of contracts, and a number of such tools have been used for hundred years. There were no Islamic financial institutions that served as intermediaries between the providers of funds and the users of funds before the second half of the 20th century, when the revolution in Islamic finance and banking started all over of it.

The contemporary Islamic financial institutions started in the early 1970s because of two important developments in the Islamic world: the rise of pan-Islamism and the oil boom. In the wake of the political association promoting the unity of Muslims under one Islamic state and the rising of oil prices, the Organization of the Islamic Conference (OIC) agreed to create the Islamic Development Bank (IDB) in 1974. Some people argue that the real establishment of modern Islamic finance started with the development of the IDB. During the 1970s and 80s, Pakistan, Sudan and Iran embarked on a full Islamization of its banking sector.

The second experiment at attempting to implement the principles of Islamic banking and finance was in Egypt, from 1963 to 1967 through the establishment of the Mit Ghamr Savings Bank in a rural area of the Nile Delta. The operation of the bank was driven by the fundamental Islamic principle of the prohibition of interest. Unlike the Pakistani Bank, the borrowers had to have deposits in the bank in order to request a loan. The experiment was initially very successful but the savings bank eventually failed and the valiant experiment came to an end in 1967 for political reasons. The bank was taken over by the National Bank of Egypt and the Central Bank of Egypt. Other experiments followed these two experiments. The spirit of the Islamic financial system took roots in most of the Muslim worlds such as Malaysia, Iran, Pakistan, the Emirates, Saudi Arabia and Kuwait all allowed the establishment of Islamic financial institutions.

Islamic banking and financial institutions is not something new in Malaysia currently, however it is only been recognised because of its fast revolution and development in growth of the current products and opportunities adhere with the conventional bank and financial institutions one. Nevertheless, the development of oil prices has also further driven our countries to be involved in Islamic markets. That is why Islamic bank look for the opportunity of the huge petrodollar surplus in the Middle East region, which is estimated at US 250 billion a year (KPMG, 2006). Malaysia also stand to gain because of its progress banking sector and source regulatory body. The year 2003 saw the introduction of an Islamic Hedge Fund that could tap in to the capital of Islamic families with a potential value of trillions of dollars in asset management (Butcher, 2003).

Hence, Islamic banking has emerged as one of the fastest developed industries over the past few decades and it has driven tremendously at a rapid speed, posting as a new image since its growth when it first introduced in the 1970s (Bank Negara Malaysia, 2013). It has spread to all corners of the worldwide and received widespread acceptance from both Muslims and non-Muslims at the same (Dusuki and Abdullah, 2007). Also, through Ernst & Young’s World Islamic Banking Competitiveness Report 2013-2014, Islamic banking assets were set to exceed USD 1.7 trillion by the end of 2014, signifying an annual growth rate of 17.6 percent over the last four years (Bank Islam Malaysia Berhad (BIMB), 2014). The Islamic banking industry in Malaysia recently shifting through a new phase of development with the implementation of Islamic Financial Services Act 2013 (IFSA) that merged several separate laws into a single legislative framework with the core objective to promote financial stability and compliance with the Shariah principles (IFSA, 2013).

The IFSA 2013 is the sole legislation in Malaysia that governs all matters in Islamic finance; including banking, the capital market, as well as takaful. It came into effect in June 2013, and it repeals the previous acts of the Islamic Banking Act 1983 and the Takaful Act 1984, in which the latter was formally the standard guideline for takaful operation in Malaysia. Therefore, with the coming of the new IFSA, the Takaful Act 1984 was rescinded and no longer employed as the guideline for takaful operation in Malaysia. The rationale behind the formation of this act is undoubtedly to provide the central bank of Malaysia with the necessary powers to effectively perform both regulatory and supervisory roles in the Malaysian capital and financial market.

1.3 Problem Statement

Mudarabah is a principle most commonly used in Islamic finance and banking. According to this principle, a person who has capital will give his capital to another person whom he trusts to run a business venture. He will not interfere with the business but rather give the partner the independence to run it. In return, the partner will give back the amount of capital plus a share profit at the end of the business period (Ahcene Lahsana, 2014).

In the context of deposit, the depositor provides capital to an Islamic bank to run its banking operations. For allowing the bank to use the deposit, the depositor is entitled to a share of the profits agreed by the depositor and the bank. The share can be a third or half of the profits, depending on the initial agreement between the depositor and the bank. This agreement is set at the beginning of the contract. The bank does not guarantee the depositor that the business will be profitable although the bank will do its best to ensure that it is profitable. In the event of a business failure, the depositor will bear the losses (Ahcene Lahsana, 2014).

Noor Saliza Zainal et al. (2009) in her empirical studies managed to establish the relationship between Mudharabah investment account and set of independent variables consist of Gross Domestic Product (GDP), Unemployment Rate (UER), Income Per Capita (IPC) and Consumer Price Index (CPI). Noor Saliza Zainal et al. (2009) said that GDP, UER, IPC and CPI have significant relationships with Mudharabah investment account. UER was found out as the most dominant factor that effect both investment and Mudharabah accounts. The impact of IFSA 2013 towards Mudharabah-based products have not been reached since it was enacted in 2013. This enhances the author to conduct this research. Kenanga Investment Bank’s annual financial data been the main reference.

Nevertheless, the lack of transparency or disclosure guidelines related to the Mudharabah or Profit Sharing Investment Accounts (PSIAs) was amongst the issue arise in investment type deposit. Information asymmetry and regulatory shortcomings in profit sharing investment accounts are amongst the flaws in investment product. Rashid Ameer et al. (2012) found out that the IFIs were not optimist enough in policies, procedures, product design and structure; profit allocation basis, methodology of calculating profit attributable to investment account holders (IAHs). Therefore, information on Shariah-compliance was adequate. It is attractive that IFI do not provide full disclosure connected to PSIAs because such revelation is not mandatory. Does IFSA overcome information asymmetry effectively? This research in other hands attempt to solve this issue by analysing IFSA and Investment Account Guidelines (Bank Negara Malaysia, 2014).

IFSA had redefined investment deposit (Bank Negara Malaysia, 2014) from guaranteed to non-principal guaranteed feature for investment nature deposit. This has driven to realignment of IFIs deposit structure. Would such realignment affect IFI particularly Kenanga Investment Bank’s products, its funding structure and most importantly its performance? These type of issues influences the author to perform this research.

Based on the above statement, the research problem could be summarized as follows:

i. Is IFSA 2013 give negative impact to the Mudharabah-based products of Islamic bank?

ii. Does IFSA 2013 can observed asymmetric information in effective ways?

iii. How far Kenanga Investment Bank’s operation and performance due to the termination of investment account?

iv. Does IFSA affect the fixed return that was promised by the IFIs to the depositors in mudarabah contract?

1.4 Research Question

In order to obtain the objectives, the following research questions are established to guide the overall research process especially data collection, analysis, and interpretation (Mohd Karim, 2010). The study will discuss about the impact of IFSA 2013 to the mudarabah-based products of Islamic banking in Malaysia and the case study was conducted at Kenanga Investment Bank. The research questions are as follows:

1. Who is affected (the customer) by the transition plan of the implementation of IFSA 2013?

2. What products in Kenanga Investment Bank Berhad’s that were affected in the transition plan?

3. What is Kenanga Investment Bank Berhad’s new range of products after the transition?

4. Is IFSA 2013 have negative impact to the products of Kenanga Investment Bank Berhad (KIBB)?

5. Does IFSA 2013 overcome information asymmetry in effective ways with their objective of the implementation?

6. How far Kenanga Investment Bank Berhad’s funding structure and does the performance was affected post IFSA 2013?

7. Does IFSA 2013 affect the fixed return that was promised by the IFIs to the depositors in mudarabah contract?

1.5 Research Objectives

The objectives of this study are as follow:

i. To analyse the impact of IFSA 2013 towards Kenanga Investment Bank Berhad;

ii. To study how IFSA 2013 could verify applicability of information to various categories of the IAH, such as retail, small and medium enterprises and others; and

iii. To examine Kenanga Investment Bank Berhad’s suitability and fair dealing practices in relation to the offering or participating in investment account

1.6 Significance of Study

This study is important because it is an alternative way for the customer more understand about the conversions that have been made to affected products under the Bank’s portfolio. So that, this study examine the effect of Islamic banking products, regulatory and supervisory post IFSA 2013. However, the author highlighted the effect of IFSA 2013 to the Mudharabah-based products as it was the main source of funds.

Besides, this study enables customer to contribute knowledge, especially to enrich the understanding of Islamic banking regulatory and supervisory of Islamic bank particularly after the transition exercise that was currently being carried out by Islamic banks. If compared to the conventional bank which is literally closest to Islamic banking, in fact Islamic bank is full-fledged Shariah compliance that were free from usury (riba’), uncertainty (gharar), gambling (maysir) etc which is implemented in conventional banks. Also, the literature about Islamic banking is very far behind as it have been seen as a trick to avoid riba (usury) that was also been prohibited in Islam because it contained huge uncertainty (gharar fahish) so that the effort to make this literature should be viewed as a major contribution to religion and Islamic bank mainly in Malaysia.

Moreover, this study seeks to explore the impact of IFSA 2013 that was implemented by Kenanga Investment Bank Berhad whether it’s also give negative impact to the Mudharabah-based products or not as the structure and stability of the deposit base is of utmost importance in banking management. Additionally, this study also discover on how IFSA could prevail over information asymmetry in effective ways. Besides being an important variable in determining the direction of monetary policy, bank’s deposits provide the means of multiplying funds through the strong guarantees derived from the element of trust in banks.

1.7 Scope and Limitations of the Study

This study is conducted on the impact of reclassification of Islamic deposits under IFSA 2013 that was implemented by Kenanga Investment Bank Berhad to recipients while focuses on the data collection in the annual finance report of Kenanga Investment Bank Berhad. The data used are from 2015 to 2016 as the effective date and transition shall take effect commencing from 1 June 2015 even though the framework of IFSA 2013 was issued on 3 May 2013. Therefore, 2016 was the year in which the latest annual finance report can be obtained. While the ratio for two years of the implementation has been adequate to support discussions research. Therefore, data for 2014 and previous years are not included in scope of the research.

CHAPTER 2: LITERATURE REVIEW
1. Introduction
This chapter has two parts, the first part is a summary of the concept paper of the investment account of Bank Negara Malaysia and the second part is a discussion on the investment account under mudarabah to comply with the regulators requirements.
2. SUMMARY OF THE CONCEPT PAPER OF THE INVESTMENT ACCOUNT UNDER MUDARABAH (BNM/RH/CP 008-10)
2.1. Objective
The Islamic Financial Services Act 2013 (IFSA) distinguishes the definition of two major sources of funding in Islamic banking institutions (IBI), i.e. Islamic deposit and investment account. The formulation of this regulatory framework for investment account (the framework) aims to outline the regulatory requirements on the conduct of investment accounts. The objectives of the Framework are as follows:
a) To facilitate the orderly development and operation of investment accounts consistent with IFSA and to promote compliance with the standards on Shari’ah matters issued by the Bank;

b) To promote the implementation of good governance and sound risk management in the management of investment accounts, thus, safeguarding the interests of investment account holders (IAH) and other stakeholders;

c) To set out the minimum disclosure requirements that will facilitate fair assessment of investment proposals and informed decision made by the IAH; and

d) To outline the prudential regulatory requirements in order to support sound management of investment accounts and sustain financial stability in the dual banking system.

The Framework sets out the regulatory expectations for investment accounts that encompasses the following:
a. Disclosure on product structure and key terms and conditions;

b. Establishment of oversight arrangement over the management of investment accounts and assets funded by the investment accounts;

c. Establishment and implementation of risk management system and internal control system; and

d. Disclosure of information on investment account’s performance and risks exposure

2.2. Investment objectives
KIBB was clearly outline the objectives of the investment account and provide sufficient disclosure in the product disclosure sheet and legal documentations. KIBB also have been identify and set out specific investment strategies and risk management strategies to obtain the investment objectives. In addition, KIBB conduct sound assessment by using reliable information and research methodology to identify the suitability criteria of the IAH that qualify to invest in the particular investment account. Especially the criteria that reflect the IAH’s risk appetite to accept the risks inherent in assets funded by the investment account given the projected return on investment.

The prospective IAH must be adequately informed of the risk and return profile of the investment account. the KIBB ensure that the funds from the IAH are invested in accordance with the established strategies to achieve the desired investment objectives. In the case of KIBB’s restricted investment account, the terms of investment account must clearly stipulate the restriction imposed by the IAH on the KIBB in managing the investment account.

2.3. Effective date and transition arrangement
The Framework was issued on 3 May 2013 and shall take effect commencing from 1 June 2015. The IBI are accorded a two-year period to implement the investment account as outlined in the Framework. Nevertheless, the IBI may adopt and offer investment account as specified in the Framework prior to the specified effective date. The bank acknowledges that the IBI require time and resources to implement and comply with the requirements outlined in the Framework especially to enhance existing human resource systems and other financial infrastructures and facilitate consumer understanding. The bank requires the IBI to undertake immediate initiatives to review their business strategies in the implementation and offering of investment account under the IFSA. In this regard, the IBI are required to:
a. Identify the gaps that exist to satisfy the requirements set out in the Framework;

b. Conduct assessment on the approach to transform existing unrestricted investment account and restricted investment account to comply with the Framework;

c. Determine reasonable timeline for the banks to fully comply with the regulatory requirements; and

d. Institute the development of necessary infrastructures to support the operation of investment accounts prior to the effective date as specified by the Bank.

2.4. Related policies
This framework shall be read together with the respective documents but not limited to the following guidelines:
• Shari’ah Standard on Mudarabah (BNM/RH/GL012-4);

• Guidelines on Investor Protection ((BNM/RH/GL018-2);

• Guidelines on Corporate Governance for Licensed Islamic Banks (GP1-i) (BNM/RH/GL/002-1);

• Guidelines on Corporate Governance for Development Financial Institutions (BNM/RH/GL005-14);
• Shari’ah Governance Framework for Islamic Financial Institutions (BNM/RH/GL012-3);

• Framework on Rate of Return (BNM/RH/GL008-4);

• Guidelines on Financial Reporting for Islamic Banking Institutions (BNM/RH/GL008-18);

• Guidelines on Financial Reporting for Development Financial Institutions (BNM/RH/GL005-16);

• Guidelines on the Recognition and Measurement of Profit Sharing Investment Account (PSIA) as Risk Absorbent (BNM/RH/GL007-11);

• Guidelines on Product Transparency and Disclosure (BNM/RH/GL000-3);

• Single Counterparty Exposure Limit (BNM/RH/GL001-38);

• Guidelines on Introduction of New Products (BNM/RH/GL008-3);

• Liquidity Framework for Islamic Banking Institutions (BNM/RH/GL002-12);

2.5. Definition and Interpretation
Definition of Investment Account and Islamic Deposit {Sect.2 (1) of (IFSA 2013)}

IFSA 2013 Section 2(1) defined “investment account” as an account under which money is paid and accepted for the purposes of investment, including for the provision of finance, in accordance with shariah on terms that there is no express or implied obligation to repay the money in full and (a) either only the profits, or both the profits or losses, thereon shall be shared between the person paying the money and the person accepting the money; or (b) with or without any return.

“Islamic deposit” under IFSA 2013 Section 2(1) means a sum of money accepted or paid in accordance with Shariah (a) on terms under which it will be repaid in full, with or without any gains, return or any consideration in money or money’s worth, either on demand or at a time or in circumstances agreed by or on behalf of the person making the payment and person accepting it; or (b) under an arrangement, on terms whereby the proceeds under the arrangement to be paid to the person paying the sum of money shall not be less than such sum of money.

Based on the above definitions, we can verify that the main issue arising from the use of PSIAs is that they do not meet the legal definition of deposits. Neither the customers’ capital nor any return on it is guaranteed by the bank. Hence, PSIAs are not ‘capital certain’ and are, essentially, investment products. Therefore, Islamic bank do not meet the criteria to be classified as depositary institutions as required by banking regulations in the majority of countries include Malaysia. So that, IFI should take an action to clarify the major differences between deposit product and investment account in order to meet the true definition of both applicable contracts.

2.6 Shari’ah compliant investment account

Pursuant to Section 28(1) of the IFSA (2013), the IBI are responsible for ensuring that the overall operations of investment account are in compliance with Shari’ah requirements. The IBI shall be guided by the Shari’ah standards of respective contracts issued by Bank Negara Malaysia and the rulings of the IBI’s own respective Shari’ah committees in structuring and offering investment accounts. The opinion of the Shari’ah Advisory Council (SAC) of the Bank shall be sought to resolve issues pertaining to Shari’ah matters as outlined in the Shari’ah Governance Framework for Islamic Financial Institutions (IFI).

In order to meet the objective of business venture or sharing outcome of the investment, the investment account must be aligned based on mudarabah, musharakah or wakalah bil istithmar (wakalah) contract. The investment account structure, strategies, terms of agreement and asset portfolio must be supervised by the Shari’ah Committee of KIBB in order to ensure the operation was comply with Shari’ah.

IFSA

IFSA was introduced from recommendation number 4.1.1 of Bank Negara Malaysia (2011), the Financial Sector Blueprint 2011-2020. The recommendation is to enact a comprehensive legislative framework for the conventional and Islamic financial system respectively. The proposed legislation will reinforce a sound, transparent and accountable system for effective regulation and supervision that is amalgamated across the banking, insurance, takaful, financial intermediary and payment system services sectors.

Gopal Sundram (2013) (Who is the leading legal advisor of IFSA and former BNM Assistant Governor, BNM) have engraved splendidly the history of IFSA. Islamic banking was formally been introduced in Malaysia with the enactment of the Islamic Banking Act 1983, the Government Investment Act 1983 and the Takaful Act 1984 by the Malaysian Parliament.

The Islamic Financial Services Act (IFSA) 2013 was introduced to streamline the Islamic banking definitions and practices. With the introduction of this Act, we can clarify many matters but not all of it is in our favour. From the Act, we viewed a significant re-defining of the deposit product. Needless to say, the Islamic banking industry is at arms on this new definition. But to classify it as a new definition is also not entirely accurate. We have been taking in mudarabah-based deposits as our main method of accumulating deposits in the bank. Mudharabah by nature is profit sharing investment arrangement for the purpose of gaining return. Any profit obtained from this investment will be shared among the entrepreneur and the capital provider based on mutually agreed ratio while any losses will be borne solely by the capital provider unless the entrepreneur is proven negligent. In all intent and purposes, this is an investment rather than deposits.

Following extensive policy research, discussions and consultations, Bank Negara Malaysia issued the Financial Sector Blueprint 2011-2020 in December 2011. As noted in the Blueprint itself, “the 10-year Blueprint is a strategic plan that charts the future direction of the financial system as Malaysia transitions towards becoming a high value-added, high-income economy”. The Blueprint notes that “A key pillar of financial sector development for this decade is the strengthening of Malaysia’s position as an international Islamic financial centre. Given the more challenging international environment, emphasis will increasingly be placed on enhancing the resilience of Islamic finance, including in liquidity and crisis management, to complement the ongoing efforts in strengthening the relevant regulatory and legal framework for Islamic finance and in promoting greater harmonisation in interpretations.”

IFSA have been made to enhance continuous development of Shariah-compliance product and services of Islamic banking that have been existed for over many decades in order to make high profitability and at the same time to overcome challenges that have been faced by Islamic bank in Malaysia. Surianom Miskam and Muhammad Amrullah Nasrul (2013) and Gopal Sundaram (2013) both recognized that IFSA was intended to pave way for the development of an end-to-end Shariah compliant regulatory framework that is in full compliance with Shariah in all aspects of regulation and supervision, from licensing to the winding up of the Islamic financial institutions. The legislation particularly provides for the enforcement of Shariah non-compliance risk and imposes statutory duty upon the Islamic financial institutions to ensure that their aims, operations, affairs, businesses and activities are in compliance with Shariah rules. IFSA has the effect of repealing the Islamic Banking Act 1983, the Takaful Act 1984, the Payment System Act 2003 and the Exchange Control Act 1953.

The IFSA is a new legal order for Islamic finance structure in Malaysia. It provides for the regulation and supervision of Islamic financial institutions, payment systems and other relevant entities. Furthermore, IFSA work it places guidelines on the oversight of the Islamic money market and Islamic foreign exchange market to enhance financial stability and sustainability while complying with Shariah standards for related, consequential or incidental matters.

The investment objectives of IFSA is to conduct sound assessment by using reliable information and research methodology to identify the suitability criteria of the IAH that qualify to invest in the particular investment account. In addition, the criteria that reflect the IAH’s risk appetite to accept the risks inherent in assets funded by the investment account given the projected return on investment. In the modus operandi of restricted investment account, the terms of investment account must clearly stipulate the restriction imposed by the IAH on the IBI in managing the investment account.

Mudharabah

Investment Account guidelines, Bank Negara Malaysia (2014) defined various investment related terminologies/principals as follows:

“Investment account holder” refers to the investors who invest funds or capital in the investment account with the IBI” (BNM, 2014).

Mudarabah is a form of partnership between one who contributes capital (rabb al-mal/capital provider) and the other who contributes efforts in the form of managerial skills (mudarib/manager). Profit from the outcome of the partnership is shared between the capital provider and manager according to a mutually agreed profit sharing ratio while the losses are borne solely by the capital provider, provided that such loss is not due to the manager’s negligence or violation of specified conditions (BNM, 2014).

Meanwhile, Musharakah means a form of partnership between two or more parties(partners) contributing equal or varying amount of capital and jointly managing the venture. Profit from the outcome of the partnership is shared between all partners according to mutually agreed profit sharing ratio while losses incurred are proportional to the partners’ capital contribution. (BNM, 2014).

“Wakalah” under BNM (2014) guidelines means a contract in which a party (muwakkil) authorises another party as his agent (wakil) to perform a particular task, in matters that may be delegated either voluntarily or with imposition of fee.

BNM (2014) guidelines defined “Wakalah bi al-istithmar” as an investment agency contract in which the capital provider (muwakkil) mandates his agent (wakil) to perform a particular mu’amalah transaction or investment and in return the agent will receive a fee (ujr) for the service.”

“Restricted investment account” from BNM (2014) means a type of investment account where the IAH authorise IBI to invest their funds in Shari’ah compliant assets with specific restrictions or conditions such as purpose, asset classes, economic sector and period for investment or others.”

Under BNM (2014) guidelines of “Unrestricted investment account” can be defined as a type of investment account where the IAH authorises IBI to invest their funds in Shari’ah compliant assets without specifying any restrictions or conditions on the management of the funds.

Mudharabah could be used to finance short-and medium-term investment projects. Nevertheless, it had limited exposure in Malaysia’s Islamic banking industry due to high risk and high capital charges or risk weightage as required by the regulator. Mudharabah financing based contract contributed less than 0.02% of total IFI financing for the past 12 months ended April 2016. See Annexure B for details Malaysia’s Mudharabah financing exposure. Bank Negara Malaysia (2012) on Capital adequacy framework for Islamic banks (Risk-weighted assets) has imposed 150% risk weight to Mudharabah project financing. In other words, for each RM 1.00 million additional Mudharabah financing would requires IFI to increase its capital due to higher Risk Weighted Assets by 150% to RM 1.5 million and also for IFI to maintain at least 8% Capital Adequacy Ratio (CAR). This CAR was sanctioned by (Bank Negara Malaysia 2012) under the Implementation of Basel III guidelines. Refer to Annexure C and Annexure D for Risk Weight and computation of Risk Weighted Assets & CAR respectively.

Tatiana et al. (2015) described Mudharabah contracts are analogous to trust-based financing in the traditional financing system. The income generated from the invested money is distributed between the financial institution and the entrepreneur in accordance with the agreement, concluded at the moment of signing the contract bind.

Simon Archer and Rifaat Abdel Karim (2009) have identified several regulatory delinquent arising from the use of profit sharing investment accounts (PSIAs). It does not meet the legal definition of deposits. Neither the customer’s capital nor any return on it is guaranteed by the bank. Hence, PSIAs are not ‘capital certain’ and are, essentially, investment products. IFIs therefore do not meet the criteria to be classified as depositary institutions as required by banking regulations in the majority of countries. Nevertheless, in Malaysia this issue has been allocated by IFSA 2013.

In Malaysia, Islamic banks prefer to invest a significant part of unremunerated accounts in assets with certain return and lower risk (short term maturity) which generates additional returns for shareholders in the same time can provide high profit taken by Islamic bank. They can obtain smooth return by using a combination of reserves retained from the profits attributed to both investment account holders and shareholders which is profit equalisation reserve (PER) that is not being applied by IFI after the implementation of IFSA 2013.

The low return attributable to profit smoothing is familiar in PSIA. V Sundararajan (2007) conscious key subjects in the measurement and mechanism of risks in IFI, particularly the effects of profit sharing investment account (PSIA) for risk measurement, risk management, capital adequacy and supervision. Cross country data on a sample of banks reveal a considerable smoothing of returns paid to PSIA, despite wide divergences in risk. This suggests that the sharing of risks with PSIA is fairly imperfect in practice, although, in principle, well-designed risk (and return) sharing arrangements with PSIA can serve as a powerful risk mitigants in Islamic finance. Supervisory authorities can provide strong incentives for effective and clear risk sharing and the associated product innovations, by inking the extent of capital relief on account of PSIA with appropriate supervisory review of the risks borne by the PSIA (equivalently the extent of displaced commercial risk assumed by the shareholders), and by requiring sufficient disclosure of these risks.

Based on the overwhelming use of non-PLS financing modes, IFI cannot be said to be risk-sharing in any meaningful sense. Feisal Khan (2010) declared that IFI transactions imitate conventional, collateralized debt contracts very similarly, often right down to actually using current market interest rates as pricing benchmarks. IFSA which has defined Investment account which is PLS in nature as non-guaranteed principal.

An empirical studies conducted by Saiful Anwar Dadang Romansyah et al. (2010) has successfully performed to predict the Mudharabah time deposit return. The research model was able to predict with 95.22% accuracy for Bank Shariah Mandiri 12 months Mudharabah Time Deposit. This model could be applied as an adequate tool to help depositors in predicting future return of Mudharabah Time Deposit product at Bank Shariah Mandiri. This prediction capability will provide depositors tools to determine the probability of the highest return investment in the market. Additionally, this tool may also keep depositor to stay longer in the IFI before flowing the surplus fund to conventional bank. This is an important findings particularly for the customers who love certain and fixed investment return.

Based on the above statement, we can conclude that post IFSA, a deposit where the principal (equity) of the depositors are not guaranteed by the nature of the contract will be classified as investments. This mean if a contract by nature carries some risks of loss in principal in its activities, it must be classified as investments. At any point of redemption, there is a possibility that principal is lost due to market conditions (market price). Mudharabah is the model of applicable profit loss sharing (PLS) that been mostly used in Islamic banks which does not used interest-bearing contracts, however, it is less preferable among industry players compared to debt-based financing such as Bai’ Bithaman Ajil and murabahah financing. Hence, Mudharabah has reduced its’ variation of being utmost importance in banking management.

Kenanga Investment Bank Berhad (KIBB) Background.

Kenanga Investment Bank Berhad is a Malaysian financial services company which provides investment banking, stock broking and investment management services. The company was founded in 1973 by Tengku Noor Zakiah Tengku Ismail, the first Bumiputera female stockbroker in Malaysia, with her business partner and is one of the first stockbroking houses in Malaysia. It was listed on the Kuala Lumpur Stock Exchange in 1996. The company\’s key subsidiary, Kenanga Investment Bank, is the largest independent investment bank by equity trading and volume, has the largest network of stockbrokers in the country, and is one of the top three Malaysian stockbrokers by market share. In 2012, Kenanga IB acquired ECM Libra\’s investment banking and stockbroking business. The group further expanded by purchasing ING Group\’s local fund management unit in 2014 (Wikipedia, 2017).

Significant stakes in the company have changed hands throughout its history. It received a 30% equity investment from the U.S. financial group John Hancock in 1989. John Hancock sold its holding to Deutsche Bank in 1991. Deutsche remained a significant shareholder until 2015 to when it disposed part of its interest to Tokai Tokyo. Through a series of merger transactions in 2001, the company\’s largest shareholder (with a 21 percent interest) is the Cahya Mata Sarawak, an investment holding company linked to the family of former Sarawak chief minister Abdul Taib Mahmud (Wikipedia, 2017).

Kenanga Investment Bank Berhad (Kenanga IB) is a Malaysia-based investment bank, which is the holding company of Kenanga Group. Kenanga Group\’s major business activities are categorized into six segments: Its Investment Banking segment, including investment banking, treasury and related financial services; its Stock broking segment, comprised of securities brokering, dealing and investment-related services; its Futures broking segment, pertaining to futures broker businesses; its Money lending and Financing segment, referring to licensed money lending and sales financing services; its Investment segment, including the management of funds and unit trusts, and its Corporate and Others segment, comprised of investment holding and management services. Kenanga IB became the holding company of Kenanga Group as it assumed the listing status of K & N Kenanga Holdings Berhad, which then became Kenanga IB\’s wholly-owned subsidiary, with effect from November 2, 2016.

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