33A. Al Bai Bithaman Ajil - Principle & Concepts

What is Al Bai Bithaman Ajil?

Bai Bithman Ajil (sometime spelt as Bay' Bithaman Ajil) or BBA, is an Islamic financing product involving sale of goods where the sale price is payable on instalment basis. This type of transaction is best referred to as "deferred payment sale". However, in layman term, it's just a purchase of good on credit.

Under conventional banking perspective, banks do not engage in the business of selling goods but grant loans repayable by monthly instalment (or depending on the facility type, repayment can also be on demand basis) where interest (in Islam, interest chargeable by Banks is also considered as usury or riba) is charged until the principal portion (or the original loan amount) is fully repaid.

As mentioned many times in this blog, usury (or interest) is strictly prohibited in Islam. This claim is clearly evidenced by Al Quran verse Al Baqarah (2:275) below:

                                          Extract from website Noble Quran

The keywords of surah Al-Baqarah 275 is that "Trade is like usury but Allah had permitted trade and forbidden usury". Thus, instead of offering the joint venture financing product of Musyarakah (known as Shariah base product which is contrary to Shariah compliant product) during the inception of the first Islamic Bank i.e. Bank Islam Malaysia Bhd (BIMB) in Malaysia in 1983, the Islamic financing product of Murabahah was introduced to meet the above Quranic verse interpretation. Before we define what is "Murabahah" it should be noted that BBA is a Murabahah product but the product name of BBA was given by BBMB to differentiate between a short term (below 12 months) and long-term (above 12 months) tenor financing products.

Now, what is Murabahah? 

Murabahah or murabaha (Arabic مرابحة, more accurately transliterated as murābahah) involves a sale where the seller indicate his original cost of purchasing the good/s (in banking perspective - the original financing amount offered by the Bank) and the mark-up amount (agreed profit rate (%) x financing tenor) as the selling price. In most cases, the buyer would have pay certain amount as deposit (normally 5 - 10% of purchase price) while the balance is payable on instalment basis over the agreed deferred payment period (financing tenor) using the bank financing facility.

If we are to analyze the transaction flow, it is a "trade" transaction (Shariah compliant) but if we are to really view the transaction based on Shariah based interpretation, (explained under Section 30 of this blog) we need to evaluate validity of the transaction based on these requirements:-

ISSUE NO.1

i) is it a REAL trade transaction? What is the real intention of the transaction?

ii) was it a pre-arrange sale to validate the "trade" transaction so as to meet the requirement of Surah Al-Baqarah (2:275) i.e. irrespective it is a bi-lateral or tri-partied transaction; and

iii) why there is issue of "time value on money?" i.e. why sale price differs from one deferred payment period to another, for example the sale price for purchase under deferred payment sale of say, one (1) year is different from say, ten (10) years?.

We shall discuss all Shariah related issues (will be numbered accordingly as above) when readers have fully understood basic modus operandi (or transaction flow according to most common prevailing banking practises in Malaysia) of Murabahah/BBA. We shall examine all the issues based on practitioners' point of views versus opinion of Islamic scholars who are in favour and those who are against the princple of "deferred payment contract" product. We are not trying to create confusion among the readers of this blog but seeking consensus among the scholars (who mostly does not have banking experience) but raise issues on validity of product.

Irrespective the above-mentioned issues, conceptually, Murabahah/BBA involves the followings:

• Based on BUYING and SELLING concepts where all these five (5) tenets must be available:

   i.     Seller/Vendor
   ii.   Buyer/Purchaser
   iii.  Goods/Assets
   iv.  Price/Consideration
   v.   Akad/Contract (Offer & Acceptance)

The contract of buying & selling is established upon full completion of all 5 tenets above.

• Sell at FIXED price (principal amount plus fixed profit margin i.e. for whole financing tenor);

• Bank’s PROFIT MARGIN is based on BUYING and SELLING; NOT from money LENT out as loans;

• Sale price is the CEILING AMOUNT (the Writer opine that BBA can be considered a hedge product since its sale price is fixed throughout the financing period vis-a-vis a variable conventional interest rate environment ) that the bank can claim or amount due from the buyer (or customer);

• Goods delivered upfront and must be also be free from all encumbrances (seller has valid title or ownership over the goods)

• Financing tenor can be from short, medium to long term basis.

The Bai Bithaman Ajil/Murabahah facility can be graphically explained according to the following chart :
 
Chart 1
 

The property purchase transaction has to undergo the normal legal documentation prior release of the funds to the developer/vendor but in short, the transaction flow (acceptable in Malaysia) process based on the above graphical chart is as follows:-

1. Buyer (customer) identified an asset to be sold by a vendor, where the asset can be either:

• a property under construction (where bank will release the amount financed progressively according to architect's claims), or
• a completed house (e.g. house for sale by first owner);

ISSUES NO.2

i). Are we using the right contract or Islamic principle? i.e. BBA to purchase house under construction? Some scholars said that the Banks should be selling tangible asset instead of selling "a non existence asset" since the house is yet to be constructed;

ii). Should the right contract for house under contruction be "istis'na or Sale by Order?"

2. Buyer will sign the Sale & Purchase (S&P) Agreement with the developer/vendor and pay certain agreed down-payment (or just a booking fee first) to indicate Buyer's commitment to purchase the house;

3. Buyer cannot afford to pay cash for the purchase thus, Buyer will approach an Islamic Bank to finance the purchase;

4. Based on the Buyer's S&P Agreement with developer/vendor, Bank will sign a Novation Agreement (some banks, discard this practice) and the Property Purchase Agreement (PPA) with the Buyer. When the Bank signed the PPA, the Bank become the beneficiary owner of the house;

5. Upon completion of the normal legal requirement processes, the Bank will pay the vendor in full (or progressively) to complete the sale transaction. Prior releasing the funds, the Bank will sign the Property Sale Agreement (PSA) with the Customer indicating that it has sold the property to the Customer.

6. The Customer will pay the deferred installment amount on monthly basis until full settlement.

POINT TO NOTE

i. Murabaha/BBA is a Shariah CONTRACT/MODE OF PAYMENT. If the transaction is on bi-lateral basis (involves only 2 party), then the contract is known as Bai Al-Inah.

ii. The buying and selling transaction between the Bank and customer does not involve legal transfer of ownership. However under Shariah (Malaysian view), the buy and sell transaction is considered genuine sale where the rights over the property is transferred although on paper the house is not registered in Bank's name;

iii. Real Property Gain Tax (RPGT) that should have been derived from the buy and sell transaction (if any), is exempted.

iv. The principal financing document is Asset Sale Agreement.

v. Stamping is on “ad valorem” basis (RM5 per RM1,000 financing amount) but on the Bank’s Purchase Price (Amount Financed).

vi. The underlying asset for transaction not necessary be charged as Collateral since collateral is considered administrative matter. However in practice, the owner's name will be registered as the owner in the land office registry while the Bank will have a charge over the property;

vii. Stamp duties for re-financing from conventional to Islamic, is exempted. Facility in excess of original financing amount, stamp duties chargeable only on additional amount. Will also enjoy 20% stamp duty remission for new facility (this remission may be one day be retracted by the Government to ensure level playing field with the conventional bank);

Before we close this section, the Writer would like to show other verses in the Quran ( Surah Al-Baqarah) that explains Muslims must keep away from usury or riba.

Surah Al Baqarah (2:276) - Allah deprive usury from ALL BLESSING.

Surah Al Baqarah (2:278) and (2:279). More importantly is surah 279 since Allah and the prophet declares WAR to those who deal in usury or riba.

Allah knows best.

33. Al Baithaman Ajil/Murabahah

We shall discuss above-mentioned topic under five (5) sections, namely

A. Product principle/concepts;
B. Practical application (including simple accounting entries);
C. Comparative analysis;
D. Legal issues (Malaysia law);
E. Shariah issues and resolution.

We shall not discuss all the above in detail but the Writer's approach is to provide enough information for readers of this blog to understand the about the product. Similar approach will also be used in discussing other Syariah compliant products as mentioned under section 32.

Allah knows best.

32-List of Islamic financing products

List of financing concept/products that we shall discuss in detail are listed below:

Debt Financing

Al-Bai' Bithaman Ajil/Bai' Muajjal (Deferred Payment Sale)
Al-Murabahah (Cost Plus)
Tawarruq (Commodity Murabahah)
Al-Qard (benevolent loan)
Bai’ as-Salam (future delivery)
Bai’ Al-Istijrar (supply contract)
Ar-Rahnu (collateralised borrowing/Pawn Broking)
Bai' al 'inah (sale and buy-back agreement/Credit Card/personal financing)


Lease Financing

Al-Ijarah Thumma al-Bai’ (leasing and subsequently purchase)
Al-Ijarah (leasing)
Al-Istis'na Ijarah

Debt Trading
Bai’ al-Dayn (debt trading/block discounting)

Equity Financing
Al-Mudharabah (profit-sharing)
Musyarakah Muntanaqisah (Diminishing Musyarakah)
Al-Musyarakah (joint venture)

Trade Finance

Letter of Credit (Wakalah/Musharakah/Murabahah)
Trust Receipts (Murabahah)
Al-Kafalah (Bank Guarantee)
Export Credit Refinancing (Murabahah/Al-Dayn)
Accepted Bill (Murabahah/Al-Dayn)

Fee/Commission

Al-Hiwalah (remittance)
As-Sarf (foreign exchange)
Al-Ujr (fee)
Al-Hibah (gift)

Capital Market
Sukuk (Debt/Lease/Wakalah)
Islamic Unit Trust
Islamic REITS
Islamic Derivatives
Structured Products

All the above products have been offered by Islamic Financial Institutions (including widow operators in Malaysia). My approach in describing these products shall be towards practical aspects, including highlighting some of the constraints in implementing the products and also some legal issues relating to it (Malaysian legal aspects).

From Writer's own experience, most of the Islamic banking products are well documented but sometimes, the products can be rendered as non-shariah compliant (whether the users are aware of it, is a challenge), when it comes to implementation. Examples (to highlight a few) on how the products can be rendered as non-Shariah compliant are as follows:

a) using conventional accounting entries instead of Islamic accounting entries;
b) signing of sale agreement first instead of purchase agreement when signing legal documents of debt (trade) related products;
c) using wrong terminology in legal documents etc.

Of course, these products are not spared from critics thus the Writer shall highlight some of the differences in term of opinion (basically, not to confuse the reader but to analyse what are the differences and what consensus can be reached for better understanding and offering of the products). In addition, the Writer shall also provide comparative analysis vis-a-vis conventional banking products.

To ensure, Islamic banking income are not tainted due to wrong processes (basically due to lack of experience and sometime due to staff working attitude etc), those responsible (in Malaysia now, it's the responsibility of Shariah audit and Shariah review staff in the Islamic banks) must be able to trace these discrepancies so that tainted income will not be mixed with "halal income" where unknowingly we are depriving income from Islamic banks of Allah's blessing according to surah Al-Baqarah (276) that reads as follows:

"Allah does not bless usury, and He causes charitable deeds to prosper, and Allah does not love any ungrateful sinner" ( سورة البقرة , Al-Baqarah).

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ALLAH KNOWS BEST.

31- Brief Development on Islamic Finance in Malaysia

This brief update was extracted from the Economic Report (Star Special, Saturday 8 October 2011) and Bloomberg (7 October 2011)


July 1, 2011

The Shariah Governance Framework was implemented to further strengthen the oversight role, authority, accountability, independence and competency of the Board of Directors, the Shariah Committee and the Management of the Islamic Financial Institutions on Shariah matters.

First half of 2011

Two Islamic indexes were launched namely:

a) the Bloomberg Malaysian Foreign Currency Sukuk Index (a non-Ringgit denomination index developed to provide global benchmark for the performance of Sukuk and the avability to track movement of foreign currency); and

b) Bloomberg-AIBIM-Bursa Malaysia Sovereign Shariah Index - collaboration between Bloomberg.

End of July 2011

# 847 Shariah compliant securities were hosted on Bursa Malaysia, representing 89% of the total listed securities with a market capitalisation of RM826 billion or 61.7% of total market capitalisation (end 2010: RM756.1 billion or 59.3%);

# Malaysia remained a leader in global sukuk market outstanding and Bursa Malaysia is also the top sukuk listing destination, with 19 sukuk totalling RM88.3 billion (USD29.6 billion);

# Fully fledged Islamic fund management companies is 16 and 160 unit trust funds with total net asset value RM26.4 billion (end 2010 : 152 funds:RM24 bil)

# Islamic wholesale funds launched stood at 24 (end 2010: 19 funds) with size in terms of net asset value (NAV) of RM7 billion (end 2010: RM4.2 Billion);

# One (1) Islamic exchange traded fund is listed with NAV of RM579 million and Islamic real estate investment funds (REITs) stood at 3 with market capitalisation of RM2.5 billion as end of June 2011;

# Asset of Takaful industry grew 16.8% to RM16.3 billion, accounting to 8.7% of total assets in the insurance and takaful sectors. Market penetration rate of family takaful improved to 12.1% (end 2010: 10.9%). For General takaful sector, gross direct contribution increased 18.1% to RM917.5 million (Jan-July 2010: 27.6% or RM776,7 mill, due to higher contribution from motor and medical business

# Malaysia's Islamic banking assets rose 15 percent to RM389.3 billion, strengthening the country's position as the global hub of Shariah compliant financing. Based on total banking system. Financing asset increased to 17 percent (RM246.8 billion) and make up 23 percent of total loans and financing, while deposits grew 14 percent to RM299.1 billion;

# Islamic insurance, or takaful, assets rose 17 percent to 16.3 billion ringgit at the end of July from the same period last year, according to the report. The sector accounted for 8.7 percent of Malaysia’s total insurance industry as of July 31, up from 8.3 percent a year earlier.

 
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30 - FINANCING PRODUCTS

Assalamu alaikum and good day


For those who have been following Islamicbankway twitter, the Writer did mentioned that he has decided to write about Islamic financing product hereon instead of Treasury products due to numerous emails that he received asking to focus on the financing product. So, not to disappoint such requests, effective immediately, the Writer shall focus on Islamic financing first.

Before writing about the financing concept in Islamic Finance, the Writer would like remind all Readers about the frequent wrong terminologies or choice of words used by the media, writers, some Islamic scholars and also some Islamic bankers (especially those from conventional banking background and just joined Islamic banks). The Writer has written on this issue under Session 3 of this blog in 2009 but before we move on to discuss the various Islamic financing products available in the market today, the Writer would like to recap what was deliberated in Session 3.

Correct choice of words must be used to ensure the Islamic finance transactions are not only Shariah compliant but also comply the basic rules under fiqh muamalat and in addition, all ambiguities (gharar' ) must be avoided.

One important factor that we need to know is the difference between Shariah Compliant and Shariah Based financing products. When we say Shariah Compliant financing products, most of the financing products are offered or originated from conventional banks such as bond, structured products, term loan etc but the transactions flows of the products are structured to meet Shariah rules, for example, using 'buy' and 'sell' to validate (requirement under Quranic Al-Baqarah 275) the financing product of Al-Bai Bithaman Ajil (Murabahah). Most Shariah scholars are of the opinion that such transactions are permissible but of course, there are also scholars who do not agree with the structure and said such transactions as disguised usury ('riba').

On the other hand, Shariah based products are said to be approved by Prophet Muhammad S.A.W. (PBUP) and used by traders during the Prophet's time. Examples of these products are Qard (benevolent loan), Musyarakah (equity joint venture), Mudharabah (trustee profit sharing) and Ijarah (leasing).

Important element to distinguish between Shariah based and Shariah compliant financial products is for example, under lease financing, the lessor must be a true (real) owner of the asset or when it involves a sale transaction under murabahah, the sale is a 'true sale' and not a sale to validate a transaction such as using Commodity Murabahah where oil palm or metal is used as the underlying asset to validate the 'buy and sell' requirement. Quite often, commodity murabahah is used to validate ' unsecured' term financing facility offered to customer.

Now, let's recap some of the choice of words that should be used when we talk about Islamic finance products:-

1. Islamic loan - financing concept which are sale related (under contract of buy and sell) like Murabahah (deferred payment sale) or Al-Bai Bithaman Ajil (actually a murabahah product but was given special product name by Bank Islam to denote deferred payment sale facility with shorter financing tenor e..g not exceeding 12 months), Al-Mua'jjal (or any other names given by Islamic banks) is NOT A LOAN. The only Islamic loan product available is Al-Qard or benevolent loan which is 100% profit (interest) free. What it means here, under Qard financing facility, when a Bank grant a customer a RM100,000 loan payable over say, 1 year, the maximum amount that the customer need to pay-back to the bank is RM100,000 (only the principal amount). "Trade is like riba but Allah permitted trade and prohibited riba". Thus, due to the fine line between trade and riba, the correct word to describe Islamic banking sale contract such as Murabahah should be "financing or pembiayaan" instead of the "loan or pinjaman";



2. The word "borrower" which actually meant for Qard borrower, should be termed as "customer" under a sale transaction. When the word borrower is used, technically it means someone who need to repay a loan. Since Murabahah is not a loan but a sale contract, the term "Customer" should be the right word to describe the transactors i.e. seller (the bank) and customer (buyer).



3. Term like "repayment" means, to repay a loan. To avoid gharar', the best choice of word should be "payment" for example, "payment of monthly installment" or "payment of sale price". Surprisingly, I have seen Islamic bank using words such as "longer repayment period" in the personal financing brochure.



4. The word "interest" instead of 'profit' is also commonly used?! In a sale transaction, the Bank need to sell higher than the original purchase price to make profit. Without profit, no nobody in his right mind would want to engage in trading business. Likewise, when a bank purchase a property (with intention to resell for a profit) at RM100,000 and then sold it for RM120,000 to the customer (buyer), it means the Bank makes profit of RM20,000 upon full settlement of the sale price. Under the contract of buy and sell, the sale price is the CEILING PRICE that the customer will pay or the bank will charge!

This means, if the customer defaults, the maximum amount that the bank can claim from the customer is only RM120,000 (one of the important advantage in Islamic financing product). Under conventional bank, the bank shall continue to charge interest on compounding basis i.e. interest upon interest, until the loan is repaid.

However, in reality, to avoid customers from taking advantage on Islamic banks, National Shariah Advisory Council of Bank Negara Malaysia (BNM-NSAC) has allowed Islamic banks do charge compensation charges (akin to penalty fee) on late payment but whatever compensation charges collected by the bank, are normally given to charitable organisations. In this respect, compensation charges should not be a source of income to the Islamic bank but as a deterrent mechanism to avoid customers taking advantage on the Islamic banking system by delaying their instalment payment to the bank. It is interesting to note that banks in South Korea charge penalty interest at 12% per annum (much higher than the normal lending rate of between 6-8% per annum) to ensure borrowers pay promptly. If we are to examine their rationale, it would be cheaper to pay promptly rather than delaying payment.



5. Another term wrongly used is "to recall the facility". This term is commonly use by Islamic banks to take action on defaulting customers i.e. to demand full payment of the facility. To avoid gharar', the correct term that the bank should use is "the bank reserve the rights to accelerate the monthly installments or accelerate the payment of the sale price" instead of recalling the facility.

The wrong terminologies used by Islamic bank may not be a concern now but we never know one day where recovery of default Islamic account has to go through the Shariah court, the wrong choice of words may render the sale transaction as non-Shariah compliant. In such situation, the customer may end up just paying the principal amount WITHOUT any profits.

With the recent revision of Shariah Governance Framework where banks are required to ensure they have qualified people in Shariah risk management, Shariah audit, Shariah Review and Shariah research and advisory, we can see that Bank Negara is starting get tough with the Islamic Banks to ensure all transactions are truly Shariah compliant. Sad to say, from Writer's own experience, Islamic products are usually compliant on paper but quite often, product can be classified as Shariah non-compliant due to failure in its operational side, such as these three (3) examples (there are actually more):

a) signing sale legal document first instead of signing purchase legal document (to reflect we need to purchase first before selling it) under Al-Bai Bithaman Ajil transaction;

b) Using conventional accounting entries i.e. the accounting entries only show sale transaction but there are no entries to show the purchases;

c) More serious error still being practise by an Islamic Bank is "compounding of profit" akin to conventional bank "interest upon interest" calculation for overdue installment. This happen when the Islamic bank staff of an Islamic subsidiary or Islamic window do not take ownership of the " Islamic system specifications" and left it to the conventional bank's IT staff, when leveraging on the conventional bank IT system instead of having its own seperate system;

We shall learn more about the proper terminology to be used for other products as we engage the various Islamic banking topics in this blog.





IslamicBankingWay.Com

ALLAH KNOWS BEST

29 - Free IslamicBankingWay e-Book

Islamicbankingway will be giving a free e-book comprising contents of this blog up to Article 27. However, this free e-book shall only be given away to those who contribute (charity) for the development of the proposed Al-Mustaqim mosque.

Originally a mussolah known as Surau Al-Islamiah (in Taman Nirwana Phase II, Ampang Selangor, Malaysia), the Selangor Islamic Religious Department (JAIS) had on 28th February 2011 approved the upgrading proposal from a surau to a modern mosque to be known as Al-Mustaqim Mosque.




Source: Alislamiah blog

The proposed Al-Mustaqim Mosque will comprise the prayer hall, area for qurban activity, religious centre for understanding Al-Quran, budget hotel for musafir (traveller), shops, offices, staff quarters and Hall square.

The development of the new mosque shall be funded by charity and contribution from the public. Overall cost is estimated at MYR 15 million of which MYR 6 million shall be allocated for the new mosque building while the balance MYR 9 million shall be for other buildings under the whole development.

For more details please visit the following website:  http://surau-alislamiah.blogspot.com/

Just email to ismail.aminuddin@gmail.com confirming that you have contributed to the mosque fund (Allah shall be your witness) with the following details :-

Your name (optional)

Your email address
Country of origin
Your profession

The free e-book shall be emailed to you within 24 hours or if the Writer is outstation or overseas, the e-book shall be emailed immediately upon availability of Internet line. The Writer shall inform via twitter on his plans for overseas travel.

Please make your contribution to :

Name of Account :    Masjid Al-Mustaqim Ampang

Bank :   CIMB Bank Berhad, Malaysia

Account No. 1276-0000585-10-6


Credit should be given to En. Syamsurizal Musa of Key Tech Resources who helped the Writer to convert IslamicBankingWay blog contents into an e-book.

Lastest progress on mosque development. In progress of constructing building framework (15 May 2012)

Completed  (Phase 1) in early February 2013, Al Mustaqim mosque will hold its first Friday prayer tomorrow 1st March 2013. Construction of Phase 2 shall commence soon. We still need your donation...

ALLAH KNOWS BEST & THANK YOU FOR YOUR KIND CONTRIBUTION. MAY ALLAH BLESS YOU.

28 - Treasury Operations in Islamic Banks

Treasury department play an important role in managing the bank’s funds. Two (2) important funds that the Treasury department normally manage are (a) the shareholders’ funds, and (b) the depositors’ deposits such as current account deposits, saving account deposits, general or unrestricted (special) investment deposits and specific or restricted investment deposit, Wakalah deposits and Commodity Murabahah deposits. Excess funds not use for financing activities purposes will be re-invested by the Treasury department in various Shariah compliant instruments that can yield additional income to the Bank.

What are the functions of Treasury Department?

In banking, two very important requirements that the Treasury Department must observes is the maintenance of the minimum statutory reserve imposed by Central Bank (Bank Negara Malaysia) and the Bank’s liquidity requirements. If the Bank failed to observe the above requirements (especially statutory reserve), it will be reprimand and fine by the Central Bank.

Other equally important functions of the Treasury Department is monitoring and controlling risks relating to overall short and long term return to the Bank thus it is important that the Treasury Department able to advise on the type of deposits that the Bank should market and the type of financing assets (including type of pricing) that the Bank should focus to avoid unexpected impact to the Bank’s income especially when Islamic banks are operating in business environment where 80% of the banking assets comprised conventional assets where “interest rate” play very important tools in determining the country monetary policy. In Malaysia, particularly since most of the Islamic banks’ assets (more than 80%) are fixed profit rate, the Islamic banks shall be exposed to commercial displacement risk due to movements of deposits from Islamic banks to the conventional banks or vice versa. Somehow, in Malaysia, most of the public and corporations are still indifference when it comes to “riba” investment instruments. To maximize return, depositors will move their money from one bank to another or move from conventional to Islamic system and vice versa. To reduce the impact of commercial displacement risk, maintenance of profit equalisation reserve was allowed in Islamic banks. Why this is allowed has been explained under Topic 27 on Profit Equalisation Reserve.

The actual level of involvement of a treasury department in profit rate risk management varies by institution, but generally speaking, the department would forecast net profit income and measure the sensitivity of the potential income to changes in profit rates and particularly, which we cannot deny, using conventional interest rate as benchmark. Typically the department would employ a variety of standard and proprietary models to measure this risk.

Result from their analysis will be reported to ALCO (Asset & Liability Management Committee) responsible for overseeing a variety of asset and liability (ALM) activities including the establishment of guidelines for the bank's risk tolerance levels.

The treasury department may further be tasked with ensuring risk management is within the guidelines set by ALCO by entering into a variety of financial transactions, such as profit rate swaps and so on.

Note: It should be noted that there are Shariah issues relating to profit rate swaps (one of our topics for discussion later) but as the Writer mentioned earlier, we shall discuss all the various Islamic banking products first and perhaps later once all the topics have been discussed, then only we shall revisit the Shariah issues (inclusive international arguments) and hopefully, we can derive one standard features which are acceptable by all Shariah Committee in the world. Probably by then, we may move away from certain products that are not acceptable internationally.

Internally within the various divisions in the banks, when each Division or Department is measured as whether it is a cost or profit centre, the Treasury also handles funds transfer pricing (FTP). At a high-level, the FTP process centrally manages the funding requirements of the entire bank in lieu of having each division fund its own balance sheet.

How effective is the Treasury Department would depend a lot on the Treasury Management System. If the Bank is operating under a window or Islamic subsidiary, the treasury management system need to support both the Conventional and Islamic treasury but importantly the transactions are not comingled (this might be one of the many reasons why Qatar Central Bank instructed conventional banks operating window operations to close down or sell-off their Islamic banking businesses) to ensure its meets strict Shariah requirement. The system should provide straight through, end-to-end processing, parameter-driven system to allow users to configure any money market, capital market and foreign exchange products that are currently traded in the marketplace.

The Treasury Management System should have the following modules:

1. The Front Office applications should have suitable tools for managing the trading desk activities. Treasury dealers can monitor daily the trading activities from their respective deal blotter. Generally, the system provides real time information on dealer positions, currency exchange positions, and nostro positions as well as their daily profitability. Other tools that would help the Treasury dealers in analysing their position is that the system should have online calculators, a real time mark-to-market revaluations and the ability to provide "what-if" simulations on profit and exchange rate sensitivities enable dealers to better monitor and control their positions.
2. The Middle Office module also provides real time compliances on the bank's credit, market and liquidity risks. During deal capture, positions and exposures created are validated and checked against the limits parameters set. Limits exceeded will be highlighted instantly and override commands are required to approve such breaches.
3. The Back Office module performs all back office related functions of the Treasury department ranging from deal confirmation, settlement, deal maintenance and cancellation. Outward confirmations through various media such as SWIFT, Fax, Telex and e-mail are generated upon confirmation of the deal. Payment messages through SWIFT, direct debit/ credit and payment advices can be generated as well.
   (Source on treasury management system: www.silverlakegroup.com/2nd/solution5.html)

Asset Liability management (ALM) is a strategic management tool to manage profit rate risk, credit risk and liquidity risk faced by the banks. Banks manage the risks of asset liability mismatch by matching the assets and liabilities according to the maturity pattern or by matching the duration, or by hedging and securitization.

The activities related to sales and trading encompass dealing in money markets (to generate and invest liquidity) and in other controversial activities such as foreign exchange markets (to trade in currency) and derivative markets (to hedge). The later two activities are still subject to arguments by Shariah’ scholars but let’s not argue on these issues first but to understand how these activities are been offered and practised in Malaysia.

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