BANK Negara Malaysia (BNM) issued the Shariah Governance Policy Documents (SGPD) in 2019 that could bring Islamic banking to a new level playing field in the environmental, social and governance (ESG) sphere today. As many banks are committed to ESG values, Islamic banks in Malaysia are doing the same under the value-based intermediation (VBI) concept promoted by BNM.
Either way, banks are expected to address issues associated to people, planet and profits in a profound way, so as to achieve balance. More importantly, the social (S) thrust of ESG expects Islamic banks to promote ethical and responsible financing by addressing issues of public interest.
One issue is the compounding of profit for recovery of Islamic debts. Recently, BNM’s Shariah Advisory Council (SAC) issued a resolution of not allowing Islamic banks to use the profit rate compounding system for debt rescheduling and restructuring from the Covid-19 debt moratorium.
Actually, public complaints on the compounding of profit rates have been heard for a long while. The Consumer Association of Penang (CAP) in 2013 complained that Islamic banks were charging an effective profit rate (EPR) of up to 41.7% per annum from the compounding of profit rate. This EPR was generated when the quoted profit per annum was compounded on monthly rest instead of yearly rest.
Further complaints by CAP in 2014 were targeted at the use of the flat rate method (FRM) over the reducing balance method (RBM) on personal and hire purchases, which ran in favour of the banks who enjoy higher profits using the former.
Many more issues are adversely impacting public interests including the use of Rule 78 in loan amortisation, which allows banks to recognise a disproportionately larger portion of debt monthly payments as bank profits. Abandoned housing projects, largely from the 1997 Asian financial crises, did not receive resounding remedies from Islamic banks as the sale and purchase (S&P) contract was executed between the customer and the developer, and not with the banks. Borrowing customers were forced to pay rentals for homes to stay and service Islamic debts at the same time.
The earlier Shariah Governance Framework (SGF) 2010 provides a check-listing approach to Shariah compliance in such a manner that the above ESG issues, namely social trust, has not been not duly attended. Instead, greater focus is given by SGF to contracts, transactions and dealing of Islamic banks, all of which must comply with Shariah principles. Others include profit and loss distribution of investment accounts, derecognition of tainted income, zakat payments and the disclosure of Shariah non-compliance events.
None of these parameters were found to address the issues related to social and ethical trust, which is central in ESG and VBI.
The SGPD 2019 could prove as the deal maker for consumer protection. But it again depends on enforcement by boards of directors (BoDs) and review by bank supervisors. Section 8.1 of the SGPD 2019 states that “the board’s oversight accountability over Shariah governance and compliance must reflect the integration of Shariah governance considerations within the business and risk strategies of the IFI (international financial institution)”.
This is indeed a great milestone for Islamic banking in Malaysia as BNM has elevated the role of Shariah committees (SCs) beyond the check-listing duties. They can now attend Shariah matters associated with the banks’ business and risk strategies (BBRS).
Doing so, SC members are also expected to enhance their capacity to participate effectively in BBRS. The SGPD 2019 reiterates this mandate in Section 10.4 — “The Shariah committee must establish a robust methodology to guide its decision-making process. The Shariah committee must take into account relevant business and risk practices in arriving at a decision or advice.”
The possible tensions from SGPD 2019 may arise from the conception BBRS itself.
Usually, BBRS refers to ways in which banks pursue their corporate objectives, most prominently profitability. For each strategy sought, there are associated risks based on bank’s risk appetite statement.
Take for example Rule 78 which serves both as a risk mitigant as well profit maximisation. As a risk mitigant, it discourages borrowing customers to deliberately make early settlements, which can deprive the bank of its potential earnings. But genuine customers may see Rule 78 to be depriving them of capital savings
much needed in debt settlement. Further, the compounding of profit rate and the use of FRM in profit determination are considered unfair as customers have no negotiating power to prevent banks from charging too much profits on them. Profit compounding may not qualify as a Shariah non-compliance issue based on prevailing Shariah regime in Malaysia, but can be counted as inflicting harm to consumers. For argument’s sake, the profit rate issue is part of pricing in the Murabaha parameter, hence it can qualify as a Shariah
issue to be deliberated by the SC. At the end of the day, civil suits can be made against banks if harm is proven to exist that warrants monetary compensations. Abandoned housings that are prone to bankrupt customers is one example where banks are likely to face dire challenges in the court of law if they litigate the defaulters who can in turn use Shariah as a defence against impending bankruptcy. The problem is that these social and public interest matters are only attended by banks when they are litigated by borrowing customers, which is unlikely. It is then left to the Shariah department to consider tabling the issues in the SC meeting. Usually, the Shariah research unit who monitor the market can make recommendation to have these matters included in the SC meeting agenda. If this is not possible, the SC members themselves can independently raise the issues under matters arising, if they choose to stand up to champion the plight of borrowing customers, which is the right thing to do.
But doing so may run into conflict with BBRS, which SC members may choose not to confront unnecessarily. For this reason, the SGPD 2019 poses a great challenge to the integrity of SC members who are acting as the protector of Shariah in Islamic banking. Not only are they required to decide to make Shariah decisions based on Islamic jurisprudence, but they must do so by taking into account BBRS.
For this reason, the BoDs are expected to effectively integrate Shariah governance within BBRS such that these public interest concerns are appropriated as Shariah issues to be deliberated both at the BoD and SC levels. But it commands a high ethical standing to do so. It will be too late when civil actions by discontented customers will lead to the detection of Shariah non-compliance practices implicating Islamic products. For this, the law of torts will prevail over Shariah non-compliance events that can dramatically change the landscape of Shariah governance.
It is believed that the SGPD 2019 under the VBI mandate is able to redefine the conception of Shariah compliance to include social para-meters direly needed to elevate the ethical standing of Islamic banks. This will be the deal maker for the industry when ethics and morality, hence ESG values, are solidly ingrained in Shariah governance.
- Dr Saiful Azhar Rosly, PhD, is the founder and current president of Sadar Education Society. He was formerly a professor at the International Centre for Education in Islamic Finance (INCEIF) and the International Islamic University Malaysia (IIUM).
- This article first appeared in The Malaysian Reserve weekly print edition