Monday, August 01, 2011

Commodity murabaha spreads to deposits

The Indonesian subsidiary of CIMB, CIMB Niaga, is planning on launching a commodity murabaha deposit account, according to Bernama.  A commodity murabaha is a product mostly used between banks to manage liquidity where one bank buys a commodity (like palm oil) in the spot market, sells it to the counterparty with deferred repayment, and the counterparty then sells the commodity in the spot market.  It is as close as you can get to a conventional interest-based loan in Islamic finance.  Its use has been controversial (commodity murabaha is the same thing as tawarruq) but deemed necessary to keep the Islamic finance industry running (and I accept its use where there are no or very few suitable alternatives, like in inter-bank money markets).

However, when it is introduced as a deposit account product, it is an unequivocal statement that 1) Islamic banking is not any different from conventional banking; and, 2) Islamic banking cannot offer anything new to consumers that will fulfill the role of deposits (liquid, safe places to store money and earn a return).

On the first point, the ideal structure (at least from early theoretical models) is that Islamic banks operate as financial intermediaries between depositors and borrowers (as in conventional banks), but introduce a profit-sharing mechanism that somewhat insulates the bank from the maturity mismatch in conventional banking because depositors are theoretically required to bear loss from their deposits.  They provide the bank with capital under mudaraba and the bank provides financing under mudaraba.

The mudaraba model of banking on the asset side is not common.  The asset side of banks balance sheets has always been more debt-based using ijara or murabaha (including tawarruq) to create a predictable stream of income and a financial statement that bank analysts can easily identify with (and which fits into regulations designed for conventional banks).  On the liability side of the balance sheet, Islamic banks have mostly left the mudaraba model intact.  Depositors are typically required to accept the possibility of loss, although in practice, they are protected from losses by surplus profit or profit-equalization reserve accounts, which shift the first loss position to equity holders and also hold the profits that would accrue to depositors in excess of conventional banks' interest payments on deposits.

In addition to the reserve accounts that protect depositors, there are other forms of deposit accounts like amanah, where the bank guarantees the principal of the account but does not pay a return.  There are other deposit structures like wadiah and wakala that are also used that also require the depositors to (mostly theoretically accept losses).  In the UK, the Islamic Bank of Britain was allowed to give customers the option to refuse deposit insurance if a loss in their deposits would occur due to bank insolvency (as far as I know this is not allowed in the US, although consumers could theoretically refuse to withdraw any deposits held in bank accounts of failed institutions which offer Islamic banking, if the FDIC got involved).

The striking thing about the use of commodity murabaha is that it acknowledges that any model where there is a possibility of loss (mudaraba, etc.) or where there is guaranteed principal but no return (amanah) is not enough to attract depositors.  Instead, the conventional deposit account with principal protection and a return on deposits has to be (re-)created.

There is one other alternative that I can think of and that this product is being used to create Islamic certificates of deposit for retail consumers where funds are locked up for a certain period of time with principal guarantee and a fixed profit.  If this were the case with this product, it would make some sense, but it still amounts to the bank managing its balance sheet into a form that is familiar to conventional bankers (and consumers!).

I would imagine that this type of deposit account is used by other Islamic banks, so I don't want to single out CIMB Niaga, but the implications of bringing commodity murabaha into the equation with depositors when so many near-equivalents are possible and already in use are not positive.  It adds one area of the balance sheet to the list of "things the industry does to make it as close as possible to conventional finance".  As much as I support using replicated products to offer new services to consumers in Islamic banking, I try to limit my support to areas where Islamic finance has not yet found a different way to do these things.  Besides equity, deposits stand alone as the area of an Islamic bank's balance sheet where other, less cynical products are available and already in use.

No comments: