Profit Equalization Reserve (PER) was allowed to be used by Islamic banks probably about 11 years ago. It was approved by BNM National Shariah Council (NSC) with recommendation by AIBIM to mitigate deposit profit / interest rate disparities between the Islamic banks / window operators and Conventional banks.
For the last 17 years (especially within the first 5 years after 1997 financial crisis) of banking history in Malaysia, we have seen movement of deposits from Islamic banks to conventional banks and vice versa. For those who truly believe that usury (“riba”) is "haram" (prohibited) in Islam, they would continued to place their deposits in Islamic banks irrespective whether the deposit rates offered by conventional banks; but for others (particularly non-Muslims), its natural for them to place their deposits in banks that offer highest deposit rates to maximize return. Thus, for an investor who have no concern whether the banking system is "halal" or "non-halal", when a Islamic bank offers higher deposit rate than the conventional banks, he will move his deposits to the Islamic bank. On the other hand, when a conventional bank offers higher deposit interest rates, he will move out his deposits from the said Islamic bank. Of course, we cannot deny that there are investors who are contented with a bank due to its services thus, irrespective the deposit rate offered in the market, they remained loyal to their existing banks.
Looking at above scenario, for a conventional banks with Islamic subsidiary or Islamic window operation, it does not make sense to pay higher return in one system at the expense of another within its own group. As a result, AIBIM proposed PER (if I could recalled sometime year 2000 or perhaps earlier) which was subsequently approved by BNM-NSC. If the Writer remembered a comment was made when PER was approved (let's not worry by who) proposing that PER should be discontinued once the total Islamic banking assets reach about 40-50% of the total conventional banking assets to ensure level playing field for both systems.
Looking at above scenario, for a conventional banks with Islamic subsidiary or Islamic window operation, it does not make sense to pay higher return in one system at the expense of another within its own group. As a result, AIBIM proposed PER (if I could recalled sometime year 2000 or perhaps earlier) which was subsequently approved by BNM-NSC. If the Writer remembered a comment was made when PER was approved (let's not worry by who) proposing that PER should be discontinued once the total Islamic banking assets reach about 40-50% of the total conventional banking assets to ensure level playing field for both systems.
How is PER calculated?
The Writer is not sure whether there is recent revision in the PER Guideline (issued by BNM) but based on the Writer's best knowledge on subject matter, PER can be utilized and recouped under the following conditions:
#1 Maximum accumulation of PER is not exceeding 30% of shareholders' funds;
#2 Maximum monthly transfer is not exceeding 15% of gross profits before distribution during the month. Thus, in a particular month when there is a large recovery, profit rates may be higher than usual.
#3 Unlimited utilisation to support profit rates due to low income for the month; probably due to high general provision, additional specific provision or to match conventional rate due to sudden hike in overnight policy rate (OPR) which directly affects the conventional base lending rate etc.
As mentioned under Topic (Chart 3 and 4), for transparency reasons, depositors’ consent should be obtained (the Writer is not sure whether Shariah Advisors have consensus on this issue) for the use of PER (please read Topic 21 to understand this requirement). The Writer is also not sure how many Islamic banks are strictly adopting this requirement.
IMPACT – Transfer of profits to PER
When extra profits (supposed to be shared between the bank and customers) are transferred to PER i.e. basically to avoid paying high profit rates (or to reduce cost of MGIA deposits) so as not to be higher than conventional bank, the impact to the Islamic Bank would be as follows:
#1 PBT for the month will be reduced;
#2 “R” rate (benchmark for IIMM) will also be reduced. This means, Islamic banks that placed money with another bank under IIMM, will be paid lower IIMM profit rate than the indicative rate at the time of placement.
Example:
Bank X placed funds in an Islamic bank at indicative rate (to determine the PSR) of 3.5% p.a. Assume the “r” rate on placement was 6.40% p.a. but on maturity (assume today), the “r” rate is reduced to 6.25% p.a (reduction by 0.15% p.a.).
On placement, the profit sharing ratio ( PSR) was (3.5 /6.40 ) = 54.68 : 45.32 (Bank X : IIMM bank); but on maturity, Bank X will be paid at (6.25 x 54.68%) = 3.42% p.a. (lower by 0.08%). Result , is (+) positive carry to the Bank X.
On placement, the profit sharing ratio ( PSR) was (3.5 /6.40 ) = 54.68 : 45.32 (Bank X : IIMM bank); but on maturity, Bank X will be paid at (6.25 x 54.68%) = 3.42% p.a. (lower by 0.08%). Result , is (+) positive carry to the Bank X.
When we choose NOT to increase the PSR but utilize PER to support profit rates to match conventional interest rates, impact to the Bank shall be as follows:-
#1 PBT for the month will increase;
#2 “R” rate (benchmark for IIMM) will also increase. This means, IIMM banks that placed money with Bank X will be paid higher than the indicative rate when placement was originally made.
Example:
Bank Y placed funds in Bank X at indicative rate of 3.5% p.a. Assume the "r" rate on placement was 6.40% p.a. but on maturity, the “r” rate increased to 6.65% p.a. Original PSR on placement was (3.5 / 6.40%) = 54.68: 45.32 (Bank Y: Bank X) but on maturity, Bank Y will be paid (6.65 x 54.68%) = 3.63% p.a. (higher by 0.13%). Result is (-) negative carry to the Bank X.
IMPACT – Payment of “Hibah” (Gift) to MGIA depositors
Payment of “hibah” (this amount is paid from bank’s portion of the profits i.e. profit after distribution) may be necessary, to avoid overall higher cost to the Bank or to support certain deposit tenor profit rates or in situation where there is no PER balance available. Impact to the bank shall be as follows:-
#1 Higher cost to the bank, due to:
a) When the bank's Treasury department carry too much IIMM placements (or "borrowings" in conventional terminology), cost to the bank MAY be higher if we are to utilize PER because utilization of PER will increase “r” rate thus indirectly we are paying more profits to IIMM banks.
b) Due to the use of fixed weightage (or WAR Method) for profit distribution instead of variable PSR for each deposit tenor, the profits to all placement/deposit tenors shall also be equally distributed. This means, longer deposit tenor will be proportionately distributed with higher return. In this situation, its not surprising for an MGIA 60-month deposit tenor profit rate is higher by more than 1.0% compared to a similar tenor for conventional bank (this issue has been discussed in earlier topics on profit distribution table)
c) Depending on the Islamic bank's strategy, it may pay slightly higher profit rate for certain deposit tenor instead of distributing equally as in (b). Under this strategy, "hibah" will be paid to increase the profit rate for certain placement tenor just to match conventional FD rate for similar tenor. This situation normally occur when banks are expecting certain hike in OPR thus, it would increase the deposit rate for say, 6 months deposit tenor so when the OPR actually moves-up, they already locked in certain targeted deposit volume at interest rate which is usually lower when the OPR hiked.
I think the above topic concluded our session on profit distribution. In our next session, which shall talk about the various instruments used by Treasury Department in an Islamic bank, particularly in relation to Islamic Interbank Money market (IIMM) transactions.
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