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
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)
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.
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