Justifying the Need for Smoothing Tools by Islamic Banks

  • Mohammad Bilal Khan International Islamic University, Malaysia https://orcid.org/0000-0001-6273-9642
  • Seedy Conteh International Islamic University, Malaysia
  • Shaiq Ahmad Ghafoorzai International Islamic University, Malaysia
  • Mohammed Meeran Jasir Mohtashem International Islamic University, Malaysia
  • Abdul Hai International Islamic University, Malaysia
Abstract views: 751 , PDF downloads: 417
Manuscript submission template downloads: 0
Keywords: Smoothing Tools, Islamic Investment Account, Profit Equalization Reserve PER, Investment Risk Reserve IRR

Abstract

This paper focuses on the positive impacts of using smoothing tools such as Profit Equalisation Reserve or PER and Investment Risk Reserve or IRR to smoothen the rate of return or profit on investments to investment account holders (IAH) of Islamic financial institutions (IFIs). Since the goal of introducing PER and IRR into Islamic banks is to compete with the conventional banking industry, it is a shield used by Islamic banks to protect their risks such as displaced commercial risk (DCR), withdrawal risk (WR), and reputation risk. This is a qualitative review of the positive impacts of using smoothing tools in Islamic financial institutions. One of the major issues highlighted is Islamic banks' sensitivity to the conventional interest rate changes because many Islamic banking products are benchmarked against the conventional interest rate. Moreover, the limited techniques and instruments available to mitigate the rate of return risk also need the regulators' serious attention. Before the use of smoothing tools was restricted by BNM, Islamic banks were allowed to save up until 15% from profit gain. However, in certain circumstances, BNM has allowed IB’s to save up to 30% from profit gains. Hence, smoothing tools like PER and IRR enabled Islamic banks to be competitive and manage their unique risks. This research is focused on the positive aspects of using smoothing tools (STs) and does not cover the negative aspects from the Shari’ah, legal or corporate governance point of view. Since the abandonment of smoothing tools by IFI’s after the instructions of Bank Negara Malaysia (BNM) in 2014, there has not been much debate about the benefits of using STs. Therefore, this paper might provide a spark required to re-ignite the whole debate once again. 

 

Penelitian ini berfokus pada dampak positif dari penggunaan alat pemulusan seperti Profit Equalization Reserve (PER) dan Investment Risk Reserve (IRR) untuk memperlancar tingkat pengembalian atau keuntungan investasi kepada investment account holders (IAH) dari Islamic financial institutions (IFIs). Karena tujuan memperkenalkan PER dan IRR ke bank syariah adalah untuk bersaing dengan industri perbankan konvensional, itu adalah perisai yang digunakan oleh bank syariah untuk melindungi risiko mereka seperti displaced commercial risk (DCR), withdrawal risk (WR), dan reputation risk. Penelitian Ini menggunakan tinjauan kualitatif tentang dampak positif penggunaan alat pemulusan di lembaga keuangan Islam. Salah satu isu utama yang disoroti adalah sensitivitas bank syariah terhadap perubahan suku bunga konvensional karena banyak produk perbankan syariah yang dibandingkan dengan suku bunga konvensional. Selain itu, keterbatasan teknik dan instrumen yang tersedia untuk memitigasi risiko tingkat pengembalian juga perlu mendapat perhatian serius dari regulator. Sebelum penggunaan alat pemulusan dibatasi oleh BNM, bank syariah diperbolehkan menabung hingga 15% dari perolehan keuntungan. Namun, dalam keadaan tertentu, BNM mengizinkan IB untuk menghemat hingga 30% dari perolehan keuntungan. Oleh karena itu, alat pemulusan seperti PER dan IRR memungkinkan bank syariah menjadi kompetitif dan mengelola risiko unik mereka. Penelitian ini difokuskan pada aspek positif dari penggunaan smoothing tools (STs) dan tidak mencakup aspek negatif dari sudut pandang syari'ah, hukum atau tata kelola perusahaan. Sejak ditinggalkannya alat pemulusan oleh IFI setelah instruksi Bank Negara Malaysia (BNM) pada tahun 2014, tidak banyak perdebatan tentang manfaat penggunaan STs. Oleh karena itu, tulisan ini mungkin memberikan percikan yang diperlukan untuk menyalakan kembali seluruh perdebatan sekali lagi.

Author Biography

Mohammad Bilal Khan, International Islamic University, Malaysia
Final year student of MSc. Islamic Banking and Finance, studying at International Institute of ISlamic banking and finance, the world's no.1 IBF institute in research, a part of IIUM, Gombak, Malaysia.

References

AAOIFI. (2012). Consultation Paper on Financial Accounting Standard. Manama, Bharain: Accounting and Auditing Organisation for Islamic Financial Institutions.

Academy, O. f. (2000). Resolutions of OIC fiqh academy. jeddah: OIC fiqh academy.

Amin, H. (5th June, 2017). Understanding PER and IRR in Islamic Invest Accounts. Th Borneo Post (Sabah).

Bank Negara Malaysia. (2010). Syariah Resolution in Islamic Finance. kuala lumpur: Bank Negara 2nd Edition.

Bank Negara Malaysia. (2014, March 14). Investment Account. Kuala Lumpur, Malaysia.

F. &. (2013). Perspectives of Earnings Management in Islamic Banking Institutions. International Journal of Business and Management Invention, ISSN (Online): 2319 – 8028, ISSN.

IFSB. (2010). Guidance note on the practice of smoothing the profits pay out to investment account holders. IFSB.

IFSB. (December 2010). Guidance note on the practice of smoothing the profits payout to investment account holders. Islamic Financial Services Board, Malaysia.

Iqbal, Z. a. (2007). An Introduction to Islamic Finance: Theory and Practice. Published by John Wiley & Sons, Pte. Ltd. .

Ismail, A. &. (2006). An empirical analysis of profit equalization reserve decisions. Retrieved 27 November 2015 from http://pkukmweb.ukm.my/~ekonis.

Juliza, F. &. (20th March 2019). Profit Equalisation Reserve and Income Smoothing Practices in Malaysian Islamic Banks: Robust Statistical Analysis. Asian Academy of Management Journal, Vol. 24, Supp. 1, 79–92.

Karim, S. A. (2009). Profit-sharing investment accounts in Islamic. Palgrave Macmillan 1745-6452 Journal of Banking Regulation Vol. 10, 4, 300–306.

Nurdianawati, A. &. (2006). Why do Malaysian customers patronise Islamic banks. International Journal of Bank Marketing, Vol. 25 No. 3, 2007 pp. 142-160.

OIC Fiqh Academey. (2000). Resolutions of OIC fiqh academy. jeddah: OIC fiqh academy.

S. &. (2013). Practice of profit equalization reserve investment risk reserve by Islamic banks. International Journal of Research in Social Sciences, ISSN 2307-227X.

Salman S. & Htay, S. (2013). Practice of Profit Equalization Reserve and Investment Risk Reserve by Islamic Banks. International Journal of Research In Social Sciences, 1-5.

Sundararajan, V. (2005). Risk measurement and disclosure in Islamic finance and the implications of profit sharing investment accounts. Proceedings of the 6th International Conference on Islamic Economics and Finance, Jakarta, Indonesia, 23-24 November, Vol. 2.

PlumX Metrics

Published
2021-06-09
Section
Articles