Syariah Complaint Investment Accounts

The growth of syariah-compliant investment accounts at Malaysian banks will remain strong over the next three to five years, carrying over the trend started in July 2015, as a result of active promotion by the regulator and banks themselves, according to Moody's Investors Service today.

In a statement here, its vice president/senior analyst, Simon Chen, said Malaysian banks have strong incentives to promote the growth of such  investment accounts because they provide capital benefits and an additional source of funding to grow their assets.

"At the same time, concerns exist over the untested state of loss-sharing  mechanisms in the accounts, although the regulators have instituted  safeguards to protect the banks," said Chen.

Moody's conclusions are contained in its just-released report on Islamic  banks in Malaysia, "Strong Growth of Investment Accounts Supports Bank  Capital and Funding, But Risk-Sharing Mechanism Remains Untested".

The robust growth of syariah-compliant investment accounts in Malaysia began in July 2015 following the implementation of the Islamic Financial Services Act 2013, it said.

It said such accounts are defined in the Act as those under which money is paid and accepted for investment in accordance with syariah principles and on terms that state there is no express or implied obligation to repay the money in full.

Moody's noted that by February 2017, these accounts had grown to RM74.2bil, or 13%, of total banking system liabilities, and they will become an increasingly important tool in managing business and income growth, as well as capital adequacy.

On the question of risk, Moody's said, a key issue is whether and to what extent loss-sharing mechanisms in the accounts between the banks and investors will be honoured in case of actual losses. A significant loss event to test the resilience of this regime has yet to occur, it said.

Moody's concerns is underpinned by its observation that Islamic banks in other Islamic jurisdictions, notably some Gulf Cooperation Council countries, in practice do not exercise the contractual loss-absorbing nature of investment accounts.

This situation is perhaps because of customer expectations and out of fear of reputational damage, and can result in Islamic banks bearing much, or all, of the assets risk on behalf of investment account holders, it said.

However, Moody's said, a mitigating feature for Malaysia is that the regulators have put in place safeguards to protect the banks, such as the segregation of the investment accounts from deposits.

Such safeguards will put Malaysian banks on a strong legal footing for upholding the risk-sharing principle behind these investment products when actual losses arise, it said.