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Islamic Banking: Diverse Products And Services To Meet All Your Financial Needs

Over the last few months, we have written a series of articles relating to some of the various products and services offered under Islamic banking. The Islamic banking system provides a comprehensive range of offerings, clearly a robust alternative to the conventional banking system. Its many value propositions highlighted should be amongst the main considerations by customers when selecting products and services suitable for their individual financial planning needs.
 
Islamic banking caters to the needs of all individuals and businesses irrespective of race, colour or creed. This is one of the main reasons behind Islamic banking’s burgeoning growth in popularity. Basic products like deposits and financing are already widely subscribed by the public and customers are beginning to venture into more complicated services like Islamic financial planning products. This trend is expected to continue with the widening of consumer awareness.
 
A practical example of how Islamic banking’s value-added proposition transforms into real and tangible benefits to the customer was during the recent Overnight Policy Rate (OPR) revision by BNM on 30th November 2005. Conventional fixed deposit rates are predetermined during placement; any upward review (increase) in the interest rate during the placement tenure would not benefit existing fixed deposit accountholders.
 
For Islamic accounts on the other hand, since profits are reviewed and distributed on a month-to-month basis in accordance to the profit-sharing ratio, General Investment Account-i (GIA-i) customers would enjoy increased returns during an interest rate hike. How this works is that Islamic banking depositors would have agreed on their profit sharing ratio at the outset before funds are placed in the GIA-i. Since returns on the GIA-i are based on revenues generated by the Islamic bank’s business (inclusive of all fee-related services), monthly profit will be distributed according to the pre-agreed profit sharing ratio.

It is worthwhile to note that this is based on one of the two methods of profit payment currently adopted by Islamic banks – the “maturity method” and the “actual method”. The former requires profit payable to be based on the final profit rate determined at maturity e.g. for a 12-month GIA-i, the deposit rate in the final month (i.e. the 12th month’s rate) will be applied to the funds. The latter is the more commonly used approach; it involves paying a profit based on the month-to-month profits declared. Using the same example (for a 12-month GIA-i), the customer will be paid according to 12 different rates throughout the year.
 
Each method has its own advantage and disadvantages. In a situation of rising interest (and consequently rising profit rates), maturity method 12-month GIA-i depositors would enjoy a distinctly higher return for the whole year despite a lower initial indicative profit rate at time of placement. Conversely, in a trend of declining interest rates (lower profit rates), profits paid at maturity could be substantially lower than the initial indicative rate at time of placement
 
Another benefit of which not many customers are aware of is the fact that there are no penalties for the premature withdrawal of Islamic deposits. Islamic banks will typically pay profits based on the “actual” rate for the lower tenure. Conventional banks would generally be inclined to penalise the customer by paying only half of the contracted interest rate. Furthermore for GIA-i deposits, longer tenure depositors are usually rewarded with higher rates of return over those holding deposits of a shorter tenure. Islamic banks strive to incorporate the “principle of fairness” in all dealings (a condition imposed by the Shariah); therefore it makes sense for valued customers who place their funds with the bank for a longer period to enjoy a higher return.
 
An important point of focus for Islamic banking now is the growing consensus around getting more of our domestic product offerings to be universally compliant and globally accepted. Innovative products like the Musharakah (equity joint-venture) and Ijarah (leasing) contract will be an increasingly dominant contributor to the growth of financing products. These sophisticated joint venture agreements between investors and banks hold great promise and potential for success if effectively explored. These arrangements will allow Islamic banks to expand beyond their role as mere financiers to capital-intensive ventures and allow them to be actively involved in investment projects through equity participation.
 
Having a stalwart financial institution as partner in a joint venture will not only provide valuable access to readily-available capital, but also in situations of cash flow inadequacies, equity participation may be adjusted accordingly as the bank is a highly cash-liquid partner. Also, profits and losses will be shared accordingly as per agreement; thus, risks are shared with the participating institution.
 
In a Musharakah partnership, the bank may appoint a professional and experienced executive project manager to manage the project on their behalf as they may not be experienced enough to manage the project on their own. For depositors, when a bank enters into a high-risk project, this does not mean to say that the bank is placing their funds at risk! For a Musharakah project, the bank will typically use a specially designated fund (e.g. “specific investment deposit”) or funds that have been placed by certain party willing to absorb the risks inherent within the particular project.

 
A summary of the main benefits derived by Islamic banking customers:

 Indirect participation in the business and investment activities of the bank and the possibility of generating a higher return through profit sharing.
Ability to hedge against uncertainty and the fluctuation of interest rates through the fixed-rate mechanism as well as the imposition of a ceiling / cap rate.
A high degree of transparency with the bank’s selling price pre-determined upfront (financing contracts).
Ability to mitigate various risks factors like interest rate risk, liquidity risk, etc.
Enhance the capacity for effective cash flow management since deferred payment scheme is clearly stipulated in the terms
Equitable as installment cannot exceed Bank’s selling price
No additional costs as profit cannot be capitalised

So what lies ahead for the Islamic banking industry? Indeed, the same market forces driving advancement of the conventional banking sector will have major impact on the progress of Islamic banking industry. Focus in Islamic banking is gradually moving towards what analysts have identified as new key growth areas. One of them is the wealth management services sector and the development of innovative and new customer-centric products e.g. Takaful (Islamic insurance), Shariah-compliant unit trusts and will writing services. This new emphasis on diversifying the existing product range will hopefully build on efforts to elevate the comprehensiveness of the Islamic financial services industry. In addition, the Government’s pursuit and commitment to establishing Malaysia as the foremost regional centre for Islamic finance will undoubtedly pave the way for more exciting developments in the coming years.

 

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