Promising discernibility of tawarruq deposit product

TAWARRUQ is as two sale and purchase contracts. The first sale consists of the sale of an article by a seller to a buyer on a deferred basis. The second sale occurs as the buyer of the first sale resells the same article to a third party for liquidity purposes.

One of the significant products emanated from tawarruq is deposit product. The deposit product is of two types. One is a transaction that involves a transfer of funds to another party for safekeeping while the second is a portion of funds which is employed as security or collateral for the delivery of an article. The focus, however, is the former.

Like many banks, Bank Muamalat Malaysia Berhad (BMMB) considers tawarruq deposit as an important customer segment for liquidity purposes. In 2015 alone, the deposit volume amounted to RM9,528,069,000 and increased to RM11,114,518,000 in 2016. On another note, Bank Islam Malaysia Berhad (BIMB) also reported the same trend as the volume of deposit reported in 2015 was amounted to RM24,413,289,000 and increased to RM28, 215,220,000 in 2016. This exponential growth indicates its significance.

This week, I intend to explain tawarruq principle in the context of Islamic deposit products. Three questions are addressed. Question #1 – What are the features of tawarruq deposit? Question #2 – Is the modus operandi of the product similar to tawarruq home financing? Question #3 – What are the impending issues related to tawarruq deposit?

Tawarruq deposit has four features,butwhicharenotconfined to: Firstly, tawarruq deposit is also known as term deposit or fixed deposit where the principal and the profit are guaranteed. In this case, the profit rate is made known to the customer upfront, that is cost plus profit.

Secondly, the outgoing product line like al-wadiah savings account only provides “indicatives rate” or “historical hibah” while tawaruq provides the upfront disclosure of profit rates because it is a sale contract.

Thirdly, the latter is somehow not only fully compliant with the Islamic Financial Services Act (IFSA) 2013 as an Islamic deposit, but also qualifies for coverage under the Malaysia Deposit Insurance Corporation (MDIC) with a deposit insurance protection limit of RM250,000. The MDIC was brought into effect in September 2005.

Fourthly, the product involves flexible profit payment options such as monthly, quarterly, semi-annually, annually or upon maturity.

There are at least five legs involved in tawarruq deposit. Firstly, the customer approaches the bank to make a deposit placement of RM10,000 and then in the second stage, the bank buys the commodity (on behalf of the customer) worth RM10,000 from a commodity trader A. The commodity is “given” to the customer.

Thirdly, the customer sells the commodity to the bank at markup, say RM10,300, to be paid in six months. Fourthly, the bank sells the commodity to a commodity trader B, and earns RM10,000 cash to be invested. Lastly, the bank pays the customer RM10,300.

Comparatively, tawarruq home financing involves at least six stages. Firstly, the customer needs to sign a sale and purchase agreement (SPA) with the house developer. The customer pays 10% of the deposit of RM200,000, equal to RM20,000. Secondly, the customer asks financing from the bank for RM180,000.

Thirdly, the bank buys the commodity from a third party (say Broker A). Fourthly, the bank sells the commodity to the customer on credit basis at cost plus profit margin (at 10% p.a for 20 years @ 240 years). Bank selling price is at RM416,889.60.

Fifthly, the customer repays the commodity purchased on deferred payment basis typically done on a monthly basis, viz., RM1,737.04. Sixthly, the customer intends to appoint the bank as a sales agent to sell the said commodity. The bank sells the said commodity to a Broker B at cost of RM180,000. In the last stage, the proceeds from the sale will be used for settlement of the house bought by the customer.

There is a clear discrepancy as to the customer having “money” in the case of tawarruq deposit while that is not the case in tawarruq home financing. The customer sells the commodity for profit in the former case while the bank sells the commodity in the latter case for the same purpose. The “proceeds” earned in the former case are used by the bank to make an investment for profit, while the latter case makes the payment to the property developer.

It is of the opinion that the term tawarruq breeds confusion among laymen. Laymen view the product as similar to any kinds of deposit products available in the industry. This fallacy becomes nasty as they also assert implicitly that it has a complex modus operandi out of ignorance. Their clarity pertinent to the gaps between Islamic fixed deposit and Islamic investment account is also questionable.

Today, however, the problem is compounded by new researchers in the area of Islamic banking and finance who have cogent banking background but poor soul in appreciating the Islamic banking business philosophy profoundly. I believe it is related to the conventional conception of “publish or perish”.

What is worth mentioning is that the bank cannot sell commodities on behalf of the customer without the latter taking physical ownership of the said articles. As such, does physical ownership take place?

My assertion is based on a perceptual perspective claiming that the bank is typically selling warrants representing the commodities and not the actual commodities. As this implies, the bank does not take possession when purchasing the commodities from the broker. After all, the following issues follow. Do brokers really exist? Does the commodity market exist? Does complete tawaruq transaction really take place? All in all, the transparency of the transactions is of vital importance. Research is needed to simplify this issue.

Furthermore, the customer indeed has some access to his money once it is deposited in the bank. In reality, however, the bank is controlling the funds sprung from the former regardless of the subject matter of the contract or whether the actual sale had occurred or not. Asymmetric information is somehow of occurrence. Those issues mentioned theoretically warrant empirical studies to manage them in an Islamic way for better practice of the product.

In a nutshell, the vista for tawarruq deposit in Malaysia is rather colossal. Given an enhanced savings culture among local folks and an improved innovation by Islamic banks, making tawarruq deposit is one of the preferred innovative products by customers at large.

I also believe that out of the diverse needs of existing and prospective customers, the tawarruq product offerings should be Shariah compliant, competitive and customised according to the customers’ income level, banking preference and investment motive.

Lastly, the purpose of tawarruq deposit for the sake of liquidity by banks tends to be balanced when the interest of customers is highlighted where their receptivity and loyalty are brought into play, at least.

*The author is an Associate Professor/Dean at the Labuan Faculty of International Finance, Universiti Malaysia Sabah, Labuan International Campus. He has a PhD from the International Islamic University Malaysia (IIUM) in Islamic Banking and Finance (PG310163). He can be contacted at hanudin@ums.edu.my