Page 3 - Saiful Azhar

 Benchmarking profit rate against interest rate: pricing of Islamic debt instruments is set
by the bank using LIBOR as the benchmark rate on which the credit spread is added to
evidence the risk of the borrower. This shows Islamic banks carry only risks similar to an
interest-bearing loan, namely, credit risks, market risk and operational risks. One
fundamental principle of Islamic transaction is that “profit is accompanied with risk” al-
ghormbilghunm which in a sale (al-bay) constitutes the taking of business risk by the
trader who says, buys goods at cost, say $10 and intends to sell at a profit, say
$15. Business risk suggests that there is no guarantee he can sell it at a profit. In an
economic downturn, he may only sell below cost and thus, make a loss. Business risk or
commercial risk does not exist in tawaruq and other Murabahas, as it is blocked by way
of speedy sequences of sale and resale to nullify any price change of commodity that the
program uses, say palm oil and metals.

 Using Shariah as a defence against default: that more loan structures have appeared in
Islamic debt instruments is evident by the increasing number of legal cases with the
Shariah utilized as a defence mechanism against default. Recent Dana Sukuk default in
2017 shows the use of Shariah by the borrower to invalidate the musharaka contract
entered by contracting parties as it contains a purchase-undertaking agreement that
turns it into a loan. Earlier in 2004 defaulting Beximco Pharmaceuticals argued in court
that the contract utilized in the deal is based on a loan contract as opposed to a sale.
Ironically, in both cases, the Shariah authorities invalidated their own fatwas for some
commercial reasons.

 Asset-based Sukuk: When the Quran promotes al-bay over riba (al-baqarah 275), the
idea is to put capital at risk in trade and commerce as opposed to safety in riba from the
loan covenant commonly dictated by the lender. It also means the passing of ownership
of goods by the seller to the buyer in exchange for the price. The defaulting case for
Investment Dar (2009), Nakheel Sukuk (2008) and KSA Saad Sukuk (2012), however,
revealed that the deals were not based on the asset-backed model in which ownership of
underlying assets is passed to the investors. In these three asset-based sukuks, no
transfer of an asset is evidenced from the SPVs to the investors, making it more like a
conventional interest-bearing bond.

Based on the above observations, Islamic finance practices which are mainly driven by
commercial banks and Shariah regulators must look for more viable options to diversify assets
and funding that can free itself from the dictates of interest rates. As for now, clear evidence on
convergence should not be downplayed as minor glitches and distractions. The move to
introduce investment account (IA) funds in Malaysia in 2014 via IFSA 2014 is a bold policy action
that can help dilute the high intensity of tawaruq utilization in financing and deposit market. When
banking shareholders have now to embrace the environmental, social and governance (ESG)
criteria in banking operations, and it should proceed to address fragility issues as part of its social
concern. It will be a tough agenda indeed as it means a crusade against the system of riba.