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MALAYSIA BERHAD
1.0 INTRODUCTION
Evaluation of bank performance is important for all parties: depositors, the bank
funds from the bank based on the bank performance. From the performance, the bank
management will look up whether to improve its deposit service or loan service or others
Malaysia. The important underlying force that led to the establishment of this Islamic bank in
Malaysia was the elimination of riba that is known as interest. With the increase in Muslim
populations and awareness of Islamic values, there was a greater demand for Islamic bank
BIMB was established in July 1983 to meet these demands and challenges. Since then
BIMB introduced and marketed various interest free products such as Wadiah Yad
Dhamanah, Mudharabah, Musyarakah and others. Bank’s business has expanded over the
years. Its assets and deposits have increased from RM325 mil to RM4, 440 mil in 1997. The
financing of loans and services increased to RM991 mil in 1997. The number of branches
increased to 75 in 1998. However, as time has passed, many new banks had emerged offering
various kinds of financing products, leaving consumers with variety of choices at almost zero
switching cost.
macroeconomic conditions, it is pertinent to look into the performance of BIMB to see where
the bank stands and how it had performed against its competitors. In Islam, business is an
Ibadah (worship) and is recommended whereas riba (interest) is prohibited. From business
point of view, Islamic bank is not only a firm but also a moral trustee of the depositors where
deposits are trust given to banking firm. It is naturally expected that as a custodian of trust for
the depositors’ deposits, Islamic bank is likely to be more liquid and become more solvent
Islamic ethics, is accountable to the depositors in this world and the world hereafter for their
failure to keep the trust entrusted upon them. It is, therefore, expected that the liquidity and
solvency ratio of the Islamic bank will be higher than conventional banks. However, it is also
expected that the liquidity ratio of the Islamic bank may decline during the later periods
compared to its early eras. As the bank grows, it acquires more skill and the art of banking
business, it will keep less liquidity and thus the liquidity ratio may decline.
Malaysia were shaken in 2005 by the news that BIMB reported a loss of RM450
million. This was the first time ever that the bank had gone into the red (NST, 2005) but was
a consequence of the financial crisis in 1998, since when the non-performing loans (NPLs)
had been building up. NPLs can be defined as a loan on which the borrower is not making
interest payments or repaying any principal.1 At what point the loan is classified as non-
performing by the bank, and when it becomes bad debt, depends on local regulations. Banks
normally set aside money to cover potential losses on loans (loan loss provisions) and write
off bad debt in their profit and loss account. In some countries, banks that have accumulated
too many NPLs are able to sell them on - at a discount - to specially established asset
management companies (AMCs), which attempt to recover at least some of the money owed.
Danaharta could not take the loans off BIMB’s books then because it could not take the loans
off BIMB’s books then because it could not take Shari’ah compliant loans. Thus, it was also
reported that the NPLs were close to 21 percent, well above the market average of 8 percent.
1
http://lexicon.ft.com/Term?term=non_performing-loan--NPL
The financial crisis highlighted the vulnerability associated with fragmented financial
systems and also the risk of banks ignoring even basic risk management which in turn
There is broad agreement that a substantial number of bank failures may destabilize
the system of monetary payments and control, and impair the flow of funds to borrowers
lacking access to capital markets. Because of the perceived link between banks’ financial
stability and the performance of the economy, it is therefore not surprising that the amount of
bank risk is readily reflected in the Basle Committee’s constant and ongoing effort to account
Even though risk management in banking is not a new activity, the aforementioned
scenarios show that more emphasis should be given to managing major risks such as market,
credit and operational risks. Effective risk management is critical to sustaining business
growth and continued profitability of the banks either conventional or Islamic. Given today’s
mortgage crisis has though witnessed a number of collapse and near collapse. Credit risk,
high leverage, and liquidity and funding risk are the main factors contributing to the crisis;
hence, lessons should be learned, and prudent risk management should be in place so that
This article review tries to identify the methods and tools used in managing market,
credit and operational risk in BIMB. Studies that are directly directed to risk management of
Islamic banks have been conducted by Khan & Ahmad (2001) and Mohd Ariffin (2005) on
17 Islamic banks on risk management issues. Many issues were highlighhted, with the crux of
the problem the inability to manage risks effectively due to a lack of relevant instruments
available in an Islamic banking context. Where risk is concerned, the study highlights that the
rate of return risk (or benchmark risk as referred to in the study) is considered as the most
critical for Islamic banks. In principle, Islamic banks are different from conventional ones
due to prohibition of riba’ and the need to comply with the Shari’ah. As such the nature and
characteristics of risks that Islamic banks are exposed to should be different from
conventional banks. However in practice, Islamic banks offer products which are quite
similar to the conventional bank and emulate the practices of the conventional banks.
The establishment of Bank Islam Malaysia Berhad (BIMB and nowadays known as Bank
Islam) in 1983 was seen as a major leap forward in the development of Islamic banking in
Malaysia. Bank Islam is the first full-fledged Islamic bank in Malaysia, was set up primarily
to assist the financial needs of the Muslim’s country. However, after two decades served
Malaysians in Islamic banking industry, seems that Bank Islam suddenly found itself in the
red when it reported a loss of RM456 million for the first time since its inception. The bank
had to write off some RM2.3 billion after being mired by financial losses in 2005 and 2006.
Datuk Seri Abdullah Ahmad Badawi (Prime Minister at that time) directed BIMB to take
immediate action against those who could have led the bank to record the financial loss. Bank
Islam which is the country’s pioneer in Islamic financial institution seems to be like from
leader to laggard.
To turnaround Bank Islam as the flag bearer of the country’s Islamic financial
institution, a new Managing Director was appointed and a new management team was put in
place to stop the damages and turn around the bank’s fortune. After a year struggling to rise
up the image of Bank Islam, it looks like the bank made an impressive recovery to chart
strong growth and return to profit. After four decades of evolution and expansion, Bank Islam
continues to make history and lift Islamic banking into the high level.
3.0 ISSUES
Based on the case study, we can see the downfalls of Bank Islam are contributed by
i. Financial Debacle
As we can see, Bank Islam had reported losses for two (2) consecutive years as
(Profit / (Loss) Before Zakat and Tax) of the case study. It was heavy provision
for bad financings totaling RM2.3 billion in those two (2) years. Upon the
provision, the losses are from its corporate financing from the Labuan
subsidiary which the bank had realised converting the subsidiary into a branch
In 2006, the capital deficits to RM278 million based on the Statistical Review as
stated in Balance Sheet as at 30th June 2006 in item Shareholders’ Fund (shown
Statements in Annual Report 2006 of Bank Islam, the core capital ratio showed
-2.78% and the risk-weighted capital ratio is -2.84% (shown in Figure 3.0). The
core capital defined the financial strength of the bank normally based on the
sum of its equity capital and disclosed reserves. While the function of the risk
weighted capital is to show that all the assets of the bank holds that are
systematically weights for credit risk. Technically, what we can see is Bank
from the automobile financing. The roots cause are from the weak underwriting
standards and the quality of the business as we can see poor asset quality was
the direct result of the poor credit evaluation, insufficient depth and breadth in
be seen in Figure 4.0 as below that shows the provision of the NFP.
It was a big mess in how the bank runs the business. It can show by the lack of
services provided by the bank and the weakness in marketing. From the human
capital development’s view the turnover of staff is very high and also the work
culture of the staff which very much like a public sector organisation.
they want to stay competitive if the core banking system is outdated? They have
no proper system especially in risk management and collection which shows the
absence of key IT Enablers. The products and services provided also did not
much different from the conventional financial institution. They are lack of
delivery. As we knew Bank Islam has limited branch networks and Auto-teller
Machines (ATMs), the location of the premises which is not strategic, the
physical condition of the premises is in poor quality and the bank’s operation
4.1 Profitability
position of BIMB has not changed over ten years as the data collected by using
income statements and balance sheets from their annual reports start from 2000 until
2009 (10 years). All three measures of profitability, i.e Return on Asset (ROA),
Return on Equity (ROE) and Profit Expense Ratio (PER), are not statistically
2005-2009 due to the losses made by BIMB in 2005 and 2006. There are various
reasons for lower profitability performance of BIMB. First, BIMB does not have wide
scope for investment in any stock or security because of religious constraints. It can
only invest in Shari’ah approved projects. It cannot invest beyond the Shari’ah Board
approved investments even if it can earn higher rate of returns. In Malaysia, Shari’ah
major source of earnings for BIMB. The rate of return of government bond is lower
conventional banks.
4.2 Liquidity
From the study (year 2000 – 2009), also showed that BIMB maintained its liquid
position. As highlighted earlier, this may be due to the mandate of the bank in
providing guarantee for depositors’ deposits and trust (amanah). BIMB’s investment
is limited by the Shari’ah i.e the Islamic law. Islamic banks are not permitted to invest
although these investments may be highly profitable. The restricted set of investment
opportunities helps Islamic banks, in particular BIMB, to hold higher liquid assets.
Second, most loans and investments of Islamic banks are of short-term nature.
Murabahah constitutes a shorter term and a lower risk investment for a bank. There is
the asset. On the other hand, mudarabah and musyarakah financing are of longer term
investment that constitutes only a small percentage of the bank’s total financing.
Thirdly, as a fairly new player in the market as compared to the conventional ones,
the bank cannot afford to incur losses and undermine the general reputation of Islamic
banking system.
The bank’s performance of risk and solvency between 2000-2004 and 2005-2009
revealed that BIMB’s involvement in risky business measured in Debt Equity Ratio (DER),
Debt to Total Asset Ratio (DTA), Equity Multiplier (EM) and Loan Deposit Ratio (LDR)
decreased over years. The reason for the low risk of BIMB can be seen from few angles.
Firstly, BIMB’s investments in government securities are much larger than the conventional
banks. Secondly, it has more equity capital compared to assets shown by its EM. Larger
equity capital indicates a higher shock absorbing capacity for the Islamic bank. It can
withstand more assets or loan losses as opposed to bank(s) which has (have) less capital.
Islamic banks face certain risks that are associated with specific business models and
Islamic contracts. The unique risks arising from compliance with Shari’ah rules and
principles need to be addressed by Islamic banks and included in their assessment or risk
management systems.
The paper that has been studied by Tafri F.H et al. (2014) showed that in the case of
the Islamic banks, market risk VaR is not extensively used. Although most of the
Islamic banks have used VaR to some degree in calculating the market risk of these
instruments, some are still in the planning stage. Since Islamic finance is either asset-
The Islamic Financial Services Board (IFSB) defines market risk as “the risk of losses
in on- and off- balance sheet positions arising from movements in market prices”.
adding the risk premium to the benchmark rate (such as the LIBOR2). The nature of
2
London Interbank Offered Rate: is a benchmark rate that some of the world’s leading banks charge each
other for short-term loans.
fixed income assets is such that the mark up is fixed for the duration of the contract.
As such, if the benchmark rate changes, the mark up rates on these fixed income
Credit risk is defined as the risk that counter-party fails to meet its obligation in
accordance with agreed terms. Credit risk would take the form of settlement/payment
risk arising when one party to a deal pays money or delivers assets before receiving
its own assets or cash, thereby exposing it to potential loss. The BCBS’s (2004)
proposes two broad methodologies for calculating banks’ capital requirements for
credit risk. One of the alternatives would be to measure credit risk in the standardized
manner, supported by external credit assessments3 while the other alternative is to use
central bank approval. All conventional and Islamic banking windows adopt the
standardized approach while the Islamic banks about 70% use the standardized
approach while other using the foundation approach and advanced internal rating-
based approach (Tafri, Abdul Rahman, & Omar, 2011). Owing to the risk sharing
nature of the modes of financing and a need to separate the capital of current and
conventional banks. Thus, Islamic banks are better off using the internal rating-based
approach to derive capital adequacy. Among the many advantages of using this
approach are that: it allows the risk profile of each asset to be mapped individually as
the Islamic modes of financing are diverse; it aligns the actual risk exposure of the
banks with their capital requirement; and it is expected to generate reliable data
3
Such as Standard and Poor’s or Rating Agency of Malaysia or Malaysian Rating Agency Corporation.
through the integration of external and internal informatin since external credit
assessments need to be used as benchmarks (Chapra & Khan, 2000). The result of
Tafri, Abdul Rahman & Omar (2011) imply that Islamic banks are still low in terms
The IFSB uses the definition of the BCBS in defining operational risk as “risks arising
from inadequate or failed internal processes, people, and systems, or from external
events”. Due to the fact that Islamic banks are relatively new, operational risk in terms
of personal risk can be acute in these institutions. Operational risk in this respect
particularly, arises as the banks may not have enough qualified professionals (capacity
and capability) to conduct the Islamic financial operations. A study has been
conducted by Tafri F.H et al. (2011) said that the tools and techniques that are mostly
used by the Islamic banks are risk and self-assessment techniques, internal audit
results/scores, internal loss event database, risk mapping, risk indicators, causal event
The findings of Tafri F.H et al. (2014), suggesting that the tools and systems for risk
management practies are barely inadequate for Islamic banks. The three most critical
areas are the lack of “IT professionals with relevant expertise in the process
integration and risk analytics”, “IT systems to cater for each Islamic instrument” and
also the “capactity of human capital in the highly technical areas of risk
measurement.”
6.0 CONCLUSION
Islamic and conventional banks are financial intermediaries that offer similar services to the
public and private sectors. However, in principle, Islamic banks are different from
conventional banks due to the prohibition of riba and the need to comply with the Shari’ah. It
can be concluded that the risk management tools and systems for Islamic banking are seen as
inadequate, particularly in the critical areas of: “IT professionals with relevant expertise in
the process integration and risk analytics”, “IT systems to cater for each Islamic instrument”
and also the “capactity of human capital in the highly technical areas of risk measurement.”
Thus, the Islamic banks should innovate or develop more tools which are Shari’ah compliant
to cater for the sector’s needs, but sufficient expertise in the relevant areas will be essential.
Islamic bank itself must put serious effort in training and educating human resources
that are well versed in Islamic principles as well as the technical disciplines. It may be
difficult, but the integration of this knowledge is important in order to preserve the Islamic
banking industry specifically – and the Islamic financial system generally – from degradation
References
Abdul Hamid, M., & S.M, A. (2011). The Performance of Banking During 2000 - 2009:
Chapra, U., & Khan, T. (2000). Regulation and supervision of Islamic banks. Occasional
Paper No. 3, Islamic Research and Training Institute, Islamic Development Bank,
Jeddah.
Dasuki, A. (2002). Risk exposure of Islamic banks: An application of the AAOIFI standards.
Loughborough, Leicester.
Khan, T., & Ahmad, H. (2001). Risk Management: An analysis of issues in Islamic financial
Mohd Ariffin, N. (2005). Enhancing Transparency and Risk Reporting in Islamic Banks.
Samad, A., & Hassan, K. (1999). The performance of Malaysian Islamic Bank During 1984-
1997: An Explatory Study. International Journal of Islamic Financial Services Vol. 1 No.3 .
Tafri, F., Abdul Rahman, R., & Omar, N. (2011). Empirical evidence on the risk management