Managing Displaced Commercial Risk in Dual Banking System: A Challenge Ahead

By Mastura Mohd Shafie, Mat Noor Mat Zain and Nik Abdul Rahim Nik Abdul Ghani

Abstract

The encouraging growth momentum in Islamic banking in Malaysia has made it the first country to adopt dual banking system wherein Islamic banking exists side by side with the conventional counterparts. The positive developments, via several stages started with a stand-alone Islamic bank in 1983 to the emergence of Islamic banking windows within the conventional banking system, through to the presence of foreign Islamic banks and up to the full-blown appearance of Islamic subsidiaries both for domestic and foreign entities, has led to not only expanded opportunities within the system but also contributed to increasing risk profile of the institutions. Several studies suggested that Islamic banks that operate in dual banking system are exposed to interest rate risk despite operating on interest free basis. The crux of the problem is attributed to the practice of replicating the products to be offered by Islamic banks as used in the existing conventional banking products. The objective of this paper is to discuss the management of displaced commercial risk, a type of risk that arises as an implication from operating in parallel with conventional banks that inevitably exposes the Islamic banks to the rate of return risk. In discussing the challenge in managing displaced commercial risk, the impact of enactment of the new Islamic Financial Services Act 2013 (IFSA) is considered as the profit equalisation reserve (PER) that is commonly practiced in the industry as a mechanism to manage and mitigate such risk and which are no longer allowed under the new regulatory regime. The empirical studies showed changes in the Islamic financial landscape subsequent to the enactment of the new act whereby the Islamic banks’ deposit products offering is skewed towards commodity based murabahah/tawarruq and has migrated from their investment-based shariah contract products. This among others, is meant to manage displaced commercial risk.