PROCESS AND PROCEDURESFROM CONVENTIONAL TO ISLAMIC BANKING

AMIR ALFATAKH YUSOFISLAMIC BANKING

SPEAKER PROFILE

1. Started in Conventional Banking Sales for OCBC Bank Retail, Business Banking and Corporate Banking, Kuala Lumpur Main Branch (1997-2003)

2. Grabbed opportunity to become OCBC Bank Islamic Banking Windows (IBW) Product Developer (2003-2005)

3. Led the Islamic Banking Personal Financial Services to build business (2005-2006)

4. Jumped : Kuwait Finance House (2007), ABN AMRO for IBW (2007-2008), Al-KhalijiCommercial Bank Qatar (2009-2011), AmIslamic Bank (2011-2012), Standard Chartered Saadiq (2012-2015)

5. Now Acting Country Head for IBW UOB Bank (2016-Present), recently launched IBW business (July 2016)

6. Committee Member of AIBIM’s Qard WG, Investment Account WG, Tawarruq WG. Industry awareness task-force for BNM. IBFIM trainer (Deposits & Financing products).

7. Maintains a free-to-use website Islamic Bankers Resource Centre (http://islamicbankers.me)

AMIR ALFATAKH

UITM, HULL (UK), IIUM

INTRODUCTION TO ISLAMIC BANKING INDUSTRY

OUTLOOK BEYOND 2017

INTRODUCTION

On ParRecent developments on

Shariah views or Business Practices = on

par with conventional features & global

standards

Islamic Banking to the ForefrontFor some time now, Islamic Banking has been the focus of the

Banking world, arising from greater acceptance and faster growth in the industry than the conventional space. There is

also greater awareness on the structures being offered

Ethical BankingDesire to include Islamic

Banking as “Ethical Banking” in practice puts responsibility to Shariah Committee to re-look at banking rules more carefully

Segment Banking, Not ReligionBetter understanding that Islamic Banking is NOT religion banking,

especially for non-Muslim customers. It is an alternative model or infrastructure, that follows certain rules which complies with the

requirements of the Shariah

THE GLOBAL ARENA

Islamic Assets in 6 core markets (Qatar, Indonesia, Saudi Arabia, Malaysia, UAE, Turkey) set to show double digit growth in 2016. The YOY growth is expected to sustain at 16%-17% growth until 2020.

Malaysia is expected to sustain the 2015 growth of 11% for 2016-2017

Source: World Islamic Banking Competitiveness Report (EY2016)

The Global Profit of Islamic Banks set to TRIPLE and is in line to reach USD$1.6 trillion in Assets by 2020.

OPPORTUNITIES ABOUND • Middle East• North Africa• South East Asia (+Malaysia)

Highest Growth

• Eastern Europe / Turkey• Hong Kong / Singapore• United Kingdom

Emerging Markets

• China• Western Europe• Russia

Untapped Potential

§ Overseas work opportunities for Islamic Banking Specialists (4-6 years background)

§ Active hiring of experienced individuals esp for short-term contracts in Middle East

§ Consultancy work / start-ups

§ Support Areas – Legal / Advisory / ShariahConsultancy / Operations / IT

§ Growth in Islamic Financial Institutions:§ Local Islamic Banks

§ Locally Incorporated Foreign Islamic Banks

§ Islamic Subsidiaries of Local / Foreign Banks

§ Development Financial Institutions (DFI)

§ Islamic Banking Windows of Conventional Banks

§ Islamic Investment Banks

§ Takaful Companies

GROWTH OF ISLAMIC BANKING

BECOMING AN ISLAMIC BANKING HUB

There is an on-going push by BNM to position Malaysia as the foremost leader in Islamic Banking products and services:

ü Clear Guidelines

ü Business-Friendly

ü Close Supervision

ü SAC Oversight

BNM target for the industry : 40% of all Banking Assets to be booked under Islamic Banking by 2020

ISLAMIC BANKING FINANCIAL INSTITUTIONS (MALAYSIA) excluding DFI & IBW

1. Affin Islamic Bank

2. Al Rajhi Banking & Investment Corp

3. Alliance Islamic Bank

4. AmIslamic Bank

5. Asian Finance Bank

6. Bank Islam

7. Bank Muamalat

8. CIMB Islamic

9. HSBC Amanah

10. Hong Leong Islamic Bank

11. Kuwait Finance House

12. Maybank Islamic

13. OCBC Al Amin

14. Public Islamic Bank

15. RHB Islamic Bank

16. Standard Chartered Saadiq

BUT WHY IS ISLAMIC BANKING GROWING?

BNM Push

Strong support and incentives given by government to support the BNM vision and desired infrastructure

MarketDemand

There is a sizeable demand for Islamic

products, based on a more ethical & fair adoption of

banking practice

ShariahCompliance

Shariah requirements allow for “compliant” activiteswhich allows for a bigger access to investors.

§ Asset Backed transactions – Not overly-geared as deals are based on real assets

§ Prudent products – the limited range of “sophisticated” products limits the risks

§ Financing of stable activities – real economies

§ Growing Confidence – removal of many contentious conventional and “old skool” Islamic Banking practices

§ Demand by Customers

DEMAND BY THE CUSTOMERS

MUSLIM CUSTOMERS

i. Greater awareness of Shariahrequirements in Banking

ii. Comfort of being involved in Shariah-compliant businesses only

iii. Good measure of fairness

iv. Prefers “simple to use” products

NON-MUSLIM CUSTOMERS

i. Attractive features of Islamic Products (at par)

ii. Reasonable treatment for penalties on their financing

iii. Fair terms and conditions = maximisefinancial benefits

iv. No inclination to religion, just on features and benefits

FUN FACT : ON AVERAGE, NON-MUSLIMS MAKES UP TO 80% OF CUSTOMERS-BASE FOR ISLAMIC BANKING

11%

54%

35%

Non-Muslims

BANK NEGARA MALAYSIA AS THE DRIVER

ISLAMIC FINANCIAL SERVICES ACT 2013 (IFSA)

i. The Islamic Financial Services Act 2013 (IFSA) was introduced to re-align all the existing Acts governing Islamic Banking into a single Act.

ii. The scope of business has been re-defined to encompass all entities offering Islamic product and services

iii. Some contracts nature were also re-defined

iv. The responsibilities of all the stakeholders in an Islamic Banking business is emphasized, especially Shariah Committee

BNM POLICY DOCUMENTS & GUIDELINES

i. Since 2013 when IFSA was introduced, BNM had released multiple Guidelines and Concept Papers to be discussed with the industry players

ii. Comments and feedback on the intended guidelines were received from the various industry players

iii. Shariah Advisory Council (SAC) of BNM is also consulted before the paper is finalised.

iv. The final version : Policy Documents are introduced to Banks to comply

BRIDGING THE GAPCONVERSION TO ISLAMIC BANKS

ROAD TO COMPLIANCE

CONVENTIONAL BANKING STRUCTURE

Customer Deposits

Invest / Utilise

Interest Income

Under the Conventional Banking, the modus operandi is:

1. Shareholders gives capital

2. Bank receives customer deposits & invest

3. interest received are distributed

4. Customer request for loans

5. Bank borrows interbank funds

6. Bank lends the funds at an interest rate

7. Customer pays interest + principal

Interest Income

Customer Lending

Interbank Borrowing

TREASURY FUNCTION

A conventional bank is designed to have 2 main functions i.e. 1) Collect Deposits and 2) Give Loans. As such, income and pricing becomes important when introducing their products.

ISLAMIC BANKING STRUCTURE

In Islamic Banks, while income and pricing remains important, there is also consideration on why a product is launched and the impact it has on customers. Not all fees can be charged, and not all features can be used in Islamic Banking. The Islamic Banking Model itself is not a standalone arrangement.

THE MOST SUITABLE APPLICATION IS THE MUDHARABAH

There is linkage between Sources and Application of Funds

Sources of Funds

Pool of Funds

Application of Funds

Islamic Banking Contracts

Income from Activities

Distribution of Income (less Expenses)

TREASURY

• Manage liquidity end to end

• Invest in compliant instruments

• Manage cost of funds

OPERATIONS

• Detailed workstream• Commodity Desk• Sequencing & Aqad

Completion

LEGAL

• Contractual Relationships• Aqad & Transactional

Documents• Islamic Terms &

Conditions

SHARIAH REVIEW & AUDIT

• Execution of documents• Completion of Aqad• Shariah Non-Compliant

Events

SHARIAH COMMITTEE

• Deliberation of New Products & Issues

• Decisions on SNC Events• Approval of Products,

Processes, Structures

CONVERSION TYPES

Infrastructure: Conventional Bank Description: Islamic Banking products offered via Conventional Banking channelsAdvantage: Low cost, existing infrastructureDisadvantage: Dependent on Conventional BankConversion Complexity: Low.

WindowsInfrastructure: Islamic Subsidiary leveraged on Conventional Bank (parent)Description: Islamic Banking products offered via Conventional Banking channels & Standalone BranchesAdvantage: Medium cost, existing infrastructure. Independent ManagementDisadvantage: High cost to set up Islamic BranchesConversion Complexity: High

SubsidiaryInfrastructure: Islamic Bank Description: Islamic Banking products offered via Islamic Banking channelsAdvantage: Standalone Management & Banking Infrastructure. Disadvantage: High Operating costsConversion Complexity: Medium

Full Fledged

ISLAMIC BANKING WINDOWS

• Management Team = ConventionalBanking Structure

• Conventional Core Banking System• Terminologies change + enhancementsSystem

• Document Enhancements to ShariahcontentsDocuments

• Identify Shariah touch-points to enhance processesProcesses

• Design based on Islamic contractsAqad

• Separate Treasury structure to be built and managed independentlyTreasury

• Separate General Ledgers to be built and flow through into different booksAccounting

Conversion into Islamic Banking Windows are mainly the following:

1. New documents

2. New processes

3. New systems

Leverage Structure

Allocated Capital

Shared Balance Sheet

ISLAMIC BANKING SUBSIDIARY

• Management Team = IslamicBanking Structure

• Conventional Core Banking System• Terminologies change + enhancementsSystem

• Document according to Shariah contentsDocuments

• Identify Shariah touch-points to enhance processes (leverage)Processes

• Design based on Islamic contractsAqad

• Separate Treasury structure to be built and managed independentlyTreasury

• Separate General Ledgers to be built and flow through into different booksAccounting

Conversion into Islamic Banking Subsidiary are mainly the following:

1. New documents

2. New processes

3. New systems

4. New governance

5. Migration to Islamic (optional)

6. Vesting Order

Leverage Structure

Capital from Parent

Standalone Balance Sheet

ISLAMIC BANK (FULL FLEDGE)

• Management Team = IslamicBanking Structure

• Islamic Core Banking SystemSystem

• Document according to ShariahcontentsDocuments

• Shariah based processesProcesses

• Design based on Islamic contractsAqad

• Islamic Treasury structureTreasury

• General Ledgers for Islamic transactionsAccounting

Standalone Structure

Standalone Capital

Standalone Balance Sheet

Conversion into Islamic Bank (Full Fledge) are mainly the following:

1. New documents

2. New processes

3. New systems

4. New governance

5. New Capital

6. Migration to Islamic (mandatory)

7. Vesting Order

8. Sell of Conventional Portfolio

EXAMPLES OF KEY DIFFERENCES (PRODUCT)

While most of the features between Islamic Banking and Conventional Banking products are the same, there are differences arising from Shariah requirements that provides better justice and fairness to the customers.

Shariah Committee plays an Important role to regulate the rules against business requirements. Consideration of fair-play and justifiable charges forms part of the decisions made by ShariahCommittee

For each product, Shariah Committee is responsible to assess the features, conditions, operations, and fees & charges.

Calculation of Installment and Profit

Calculation based on Base Rate + Margin Calculation based on Base Rate + Margin, capped to the Maximum Ceiling Rate

Facility Amount Over Financing Period

Increases as amount is compounded and capitalised as new Principal Amount

Capped at the Maximum Selling Price agreed in the Aqad

Early Settlement Charges

Based on Lock-in period, ES charges = 1.0% of the Amount Settled

Not Allowed (unless to recover actual costs incurred)

Penalty Rate (Punitive) on Non Performing Accounts

Pre-Judg: Up to BR+3.5% x new PrincipalPost-Judg: Up to 8.0% x new Principal

In-Ten: Up to BR+3.5% or CR x O/S PrincOff-Ten : IIMM Rate x O/S Balance

Late Payment Charges

1.0% on the amount in arrears compounding into new Principal

1.0% on the amount in arrears non-compounding into Principal

SHARIAH AS THE ULTIMATE LINE OF DEFENSE

WITH GREAT POWERS COMES GREAT RESPONSIBILITIES

i. IFSA 2013 outlined the roles and responsibilities of bank’s Shariah Committee

ii. Shariah Committee are required to discuss, deliberate and decide on all matters pertaining Islamic Banking in the bank

iii. Responsibility is on the Shariah Committee to make quality decisions, backed by proper research and robust deliberations

iv. Stiff penalties for negligence : RM25 million fine and/or 8 years jail

SHARIAH GOVERNANCE FRAMEWORK (SGF)

i. One of the important requirements by BNM on the operations of Islamic Banking business is the establishment of the ShariahGovernance Framework (SGF)

ii. SGF governs the operations of the Islamic Banking business including all review and oversight functions in the bank

iii. SGF outlines the roles and responsibilities of Shariah Committee and all other internal committees for Islamic Banking

iv. Detailed requirements to be set by bank.

CHALLENGES AND ISSUES MAKING THINGS WORK WITHOUT COMPROMISE

DECISION CONSIDERATION

VIABLE ISLAMIC FINANCIAL INSTITUTION

Expenses

ShariahCompliance

Profitability

• How much capital do we need?

• How much system enhancement must we do?

• What do we do with existing customers who do not want to convert?

• Can we legally auto convert existing customers?

• How do we treat Shariah non-compliant income?

• What products should we develop?

• How do we sustain profitability?

• How do we create awareness on Shariah?

EVOLUTION OF ISLAMICBANKING

Since the introduction of Islamic Banking Act in 1983, the industry has slowly evolved in terms of the following:

v Guiding principles of Islamic contracts by BNM

v Suitability of products towards customers needs

v Operational efficiency of Islamic products and services

v Shariah increased depth and quality of decision making

Principles discussed with industry

DraftRobust discussion on structure

ConceptDetailed and specific instructions

Policy

Looking at Market Needs for design

IdeaBased on principles and competition

DevelopCatering for specific needs via new design

Enhance

Shariah looks at existing regulations

GuidedQuestions the status quo and directs compliance

DiscussProvides solutions based on specific research

Research

OPERATIONALISING REQUIREMENTS

EXTERNAL

• BNM Policy Documents• IFSA• Laws of Malaysia• Best Practices

INTERNAL

• Shariah Rules• Internal Guidelines• Custom (Urf)• Customer Needs

UN

DER

STAN

DIN

G

REQ

UIR

EMEN

TS

Policy & SOP

Product Design

Processes & Controls

Documents

Operations

System

Accounting & Finance

Ensuring the requirements are captured into the products and processes

OPERATIONAL CHALLENGES IN ISLAMIC BANKING

vThe key challenge in Islamic Banking is the BALANCE between Shariah Requirements & Business Needs

vAdditional Shariah Requirements becomes a RISK for the Bank if fail to be observed

vInadequate Controls, Human Error and Wrong Understanding of Requirements often leads to SHARIAH NON COMPLIANT EVENTS (SNCE)

vWith IFSA 2013, Banks do not have a choice but to comply

Shariah Business

SUMMARY Strong push from BNM for Islamic Hub

Demand for Islamic Banks = consistent

Various Options Available for Conversions

Islamic Banking Windows : Small but Efficient

Islamic Banking Subsidiary : Teenage Participant

Islamic Bank : Independent Entity

Decision on which Model = careful thinking

There is a lot of opportunities for the development of Islamic Banks over conventional banks.

Due to the interest in Islamic financial institutions (especially from Middle East), Malaysian Financial Institutions find ways to offer an alternative structure under Islamic Finance.

However, the Shariah Compliant requirements must remain valid to attract investors.

THANK YOU FOR LISTENING QUESTIONS AND ANSWERS