Is the principle of banking in Islam possible?

The following is my answer to a Quora question: “Is the principle of banking in Islam possible?”

Islamic banking has two primary principles: the equitable sharing of profit and loss in any venture, and the prohibition of riba’, usury. In principle, these are equitable considerations, and praiseworthy. The contentions of Islamic banking is not the principles, per se, but the reinterpretation of their application within the context of conventional financial practices, and the creation of near equivalent financial instruments. This is where is falls short.

Islamic banks make a profit through equity participation, which requires a borrower to give the bank a share in their profits rather than paying interest.

For example, we consider mudharabah, where one party, the bank, provides the capital, and the other party, the business owner, provides the expertise and labour. The problem with most such contracts is that, in reality, the loss is borne by the business owner, while the profits are shared. The bank is still a bank. It is not a conventional business partner, and it would be impractical to consider them a silent partner in every business venture that capital is provided, and still have oversight and manage compliance. That makes the bank another mudharib, and losses are passed on to depositors. This system can also be abused by the business, since profits are shared. The business simply declines to declare a profit. This results in the bank reverting to the practices of conventional banking to get their return.

The other common contract system is musharakah, where both parties contribute capital. A simplified example would be a housing loan with a balanced loan to value ratio. What it does is make the bank a partial owner of the property, which has its own legal complications. This means that the owner does not gain ownership of the property even if he pays it all off, in some contracts, and the bank gets a portion upon sale. In other contracts, the owner gains full ownership upon repayment of principal and interest, which is labelled “profit”. In the case of a loan to company, the capital invested is tied to a floating rate, which are still benchmarked to conventional banking rates such as LIBOR. This means any shari’ah-compliance is cosmetic.

Finally, we consider the problematic definition of any and all forms of interest as riba’, usury, which is illogical. For example, if money is lent out by a bank, we must consider that there is an inherent infrastructure cost involved on the principal lent out. The staff need to be paid, the building needs to be maintained, the utilities need to be paid. The bank has a right to charge some form of interest to cover that cost. That does not inherently make it riba’. One of the conditions of riba’ is zhulm, oppression. For it to be riba’, there should be a financial instrument structured in such a way that the underlying asset has no value, such as what happened during the subprime crisis. Or, in a case where the interest of the loan is well in excess of the principle paid such that the debtor would find it difficult to pay off, and the interest on that loan is well in excess of the principal lent out. An example of the latter would be student loans from the US Federal government.

Islamic banks, just like conventional banks, have the same limitations and considerations. In the case of Islamic banks, they use variations of the same business practices and products as normal banks, but white label them with Arabic phrases. They bend over backwards to “Islamisise” the same financial instruments and transactions. They play musical chairs with the same practises. They then appoint their own shari’ah-compliance boards, which are not independent of these same banks. There is then a cost for two levels of compliance. This makes Islamic banking more costly, and less efficient than conventional banking.

We do not actually need Islamic banking as it is. What we do need is ethical banking, a shared framework which can be utilised by banking in general, for the benefit of all. “Islamic banking” is branding, not a reality.

[Shared with permission from Quora Answer: Is the Principle of Banking in Islam Possible?]


Image for illustrative purpose only. Credit: WordPress/Pexels

More than 10 years in the financial line, and having done my studies in Shariah enough to understand the fundamentals and sciences (not to be an expert, just to be clear), I have to agree with Terence in this regard.

We lack clarity in riba, misunderstood interest, yet we want to champion “Islam has the solution”. It is pretty naive, when we fail to grasp reality of things.

And in that naivety, we make religion and livelihood difficult, and in our defence, we say, “these are the restrictions set in our religion.”

Yes, there are restrictions in religion, but not as restrictive as how you would present it to be.

A paradigm shift is more than necessary, before we can leap forward in progress.

The current reality of ILPs, and why you shouldn’t be naive

[This post is written in response to the article Young Millenial POV: Why I Bought (And Cancelled) Two ILPs]

For an article that’s written in 2022, the writer is out of touch with the reality of ILPs (investment-linked policy).

Image courtesy of The Simple Sum.

There are generally 2 types of ILPs:

  • Traditional ILP
  • 101 ILP

Traditional ILP is the plan which many would feel they’re not making money, for the first 5 years at least. And might be up to 10 years till breakeven.

This is due to low investment allocation in the initial years: only a portion of premium is invested while the rest go to charges. (“Best of both worlds”: you get a decent insurance coverage with potential investment returns.)

All info can be read in the product summary.

It is possible to break even before 10 years, depending on fund choices and allocation. But I get it, sometimes by the 5th year, the agent who sold you the plan is not around, and you wouldn’t know what to do.

Traditional ILPs is meant for long term: at least 15 years, if not 20 years or more.

Image for illustrative purpose: why you should invest for the long term.

101 ILP is the “newer” version, although AXA and Zurich were among the pioneers (as early as 2013 if I recall, when I first learn of it; it could be earlier.) HSBC Insurance had Growth Manager (if I recall the name right), as early as 2011 (when I first joined the industry), if not earlier.

100% premium is invested from day 1. Charges will be deducted backend.

It is called “101 ILP” because it used to be that it would provide that additional 1% insurance coverage or 101% of premiums paid.
(Do note that currently, different 101 ILPs provide varying coverage, ranging from only 1% of premiums paid to 105% of premiums paid or investment value, whichever is higher; do read the product summary or product brochure.)

It is like investing in unit trust (currently, most 101 ILPs do access unit trust funds), with additional insurance, albeit minimal. Hence, it is sometimes called an “insurance wrapper”.

Clients get to see investment performance from first year, but still recommended to hold it for at least 5 years. Most 101 ILPs would cater to 10 year policy term and longer; few cater to as low as 5 years.

So that’s in brief.

It doesn’t pay to be naive. As Cat Steven would sing,

“You’re still young, that’s your fault
There’s so much you have to go through”

When in doubt, seek professional advice.

“Love doesn’t put food on the table.”

Turning 35 this year, I’m appreciating that advice much more. The advice that’s often given to those who intend to get married.

Love doesn’t put food on the table. Prayers and supplications do not put food on the table. “Reliance” on God to provide doesn’t put food on the table.

Effort does.

Being a financial planner for a little more than 10 years, I’ve met various couples and seen the different efforts to put food on the table: to provide for the family, for a better living.

The OTs, the part-time jobs, the delivery job, the side-hustle, the home business.

I used to see couples arguing, even in front of me, that I felt like I’ve to be a counsellor.

Yes, finances can be a delicate topic that can lead to arguments: “I’m paying for this”, “you’re paying for that”, “I’m contributing more to this family financially, you don’t talk..” 😅😢

And over the years, I’ve seen couples not only tide over the years together; some actually sail through almost smoothly.

What worked? Effective delegation of responsibilities and mutual respect and understanding.

To my clients, as much as I’ve been of service to you, I’ve learnt a lot from you. Thank you. 🥰

Image for illustration only.

How do I invest in a volatile market?

The last 2 years since the pandemic outbreak has been interesting for investors. As they say, “In every crisis lies an opportunity.”

High growth in technology sector as well as healthcare (albeit stagnation after 6 months or so) motivated new and young investors to jump onto the bandwagon.

However, it should be noted that the great gains in the last 2 years were the exception rather than the norm.

How should one invest in a volatile market?

We embrace this volatility and adapt to it. What we recognise as volatility is the aggregated result of people being emotional and tied to sentiment, their hopes, their panic, their optimism, moving the market as an overreaction to events and trends.

Terence Nunis, Investing in a Volatile Market

We ride the swells of this volatility by keeping to a few principles. We look for well-run companies, with good market fundamentals.

Terence Nunis, Investing in a Volatile Market

We should bear in mind that the market fluctuates up and down.

Image for illustrative purpose only.

In general, bullish (upward-trending) markets tend to be associated with low volatility, and bearish (downward-trending) markets usually come with unpredictable price swings, which are typically downward.

“This is how it works,” Lineberger says. “And if you can stomach it, you can enjoy outperforming inflation by almost three times per year. My best advice is to embrace volatility and know that it’s normal.”

What Is Market Volatility—And How Should You Manage It?

Terence Nunis offers the following points of advice in investing in volatility:

  1. Identify growth industries.
  2. Identify growth regions.
  3. Consider where the market will be a decade or fifteen years from now.

[Read more: Investing in a Volatile Market]

Image for illustrative purpose only.

Always remember that investing is and should be for the long term.

Investing is a long-haul game, and a well-balanced, diversified portfolio was actually built with periods like this in mind. If you need your funds in the near future, they shouldn’t be in the market, where volatility can affect your ability to get them out in a hurry. But for long-term goals, volatility is part of the ride to significant growth.

What Is Market Volatility—And How Should You Manage It?

Relevant reads:

And from myself:

Staying invested with a flexible fixed income approach..

Staying invested with a flexible fixed income approach as inflation bites, an article on JP Morgan’s Income Strategy in navigating the current market environment.

Source: US Bureau of Labor Statistics, FactSet, Federal Reserve, J.P. Morgan Asset Management. Real 10-year Treasury yields are calculated as the daily Treasury yield less year-over-year core CPI inflation for that month. For the current month, we use the prior month’s core CPI figures until the latest data is available. Guide to the Markets – U.S. Data are as of Dec 31, 2021.
The Straits Times.

While it is a sponsored content, it is a good read.

A flexible fixed income approach, to me, would also include a multi-asset fund(s) or portfolio.

The key is to stay invested amidst market fluctuations, for at least 3 to 5 years. For a potentially decent returns.

Why should you have a concentrated portfolio versus a diversified one?

The following is my answer to a Quora question: “Why should you have a concentrated portfolio versus a diversified one?”

A concentrated portfolio consists of a few specific equities and derivatives for the sole purpose of surpassing the benchmark. It maximises potential gain at the expense of very high risk. It works when you make the right call on the underlying assets and companies. But when you miss, and you will eventually miss, the losses are great. A concentrated portfolio generally takes advantage of a bubble, requires significant management, and for a short investment horizon.

The opposite of it is a diversified, where the assets and investments are diversified across asset classes, industries, geographic regions and more. The idea is to spread the risk since the chances of the entire market crashing is miniscule. Such a portfolio generally minimises leveraging as well. A good diversified portfolio is normally passively managed, has an extended investment horizon, and tends to outperform a concentrated portfolio over that extended investment horizon due to compounding.

In summary, for most people, I would advocate a diversified portfolio. Concentrated portfolios are for accredited investors with access to the latest market information and the best market analysis.

Terence K. J. Nunis

[Shared with permission from Quora Answer: Why Should You Have a Concentrated Portfolio Versus a Diversified One?]


Image for illustrative purpose only.

I agree with Terence that for most people, a diversified portfolio should be advocated. Especially for new investors.

One can have a little exposure to concentrated portfolios or selected AI funds (which are accessible to retail investors on some platforms) with professional advice.

While new investors can also consider multi-asset funds along with a diversified portfolio.

Should new investors have bonds in their portfolio?

The following is my answer to a Quora question: “Should new investors, in their 20s, have bonds in their portfolio?”

It is a good practice to have bonds in your portfolio. Debt instruments lower the overall risk of your portfolio, and stabilise it in the event that equities drop. Equities have the potential to earn well, but they are more volatile. Debt instruments, such as bonds, do not have as high a yield, but the value is stable because the yields are stable – they are fixed payments over specific periods of time.

Generally, for someone just building their portfolio, they need a balanced spread of investments. I would recommend a 40% weightage to debt instruments, and 60% to equity instruments. As they gain a measure of familiarity with the market, they can adjust the weightage according to the anticipated market conditions.

Terence K. J. Nunis

[Shared with permission from: Quora Answer: Should New Investors in Their 20s Have Bonds in Their Portfolio?]


Image for illustrative purpose only.

It boils down to balancing your portfolio in accordance to your risk profile. This would apply to all age groups.

Personally, I would recommend a multi-asset fund to kickstart your investment. Or 40:60 ratio of debt to equity as recommended by Terence, if you are a little more savvy to investment and a balanced risk profile.

What is the Difference between a Bond Mutual Fund versus a Bond ETF?

The following is my answer to a Quora question: “What is the difference between a bond mutual fund versus a bond ETF, and which is a better investment?”

A bond fund, also known as a debt fund, is simply a fund that invests in bonds, or other debt securities. Bond ETFs are simply exchange-traded funds that invest exclusively in bonds. They are like bond mutual funds because they hold a portfolio of debt instruments.

Bond funds have a pool of capital, raised from investors. The fund manager allocates the capital to various securities. In contrast, a bond ETF tracks an index of bonds in order to match the returns from the underlying index. Bond funds may buy from the issuer, over the counter, or from an exchange. ETFs, as their name suggests, buy exclusively from an exchange.

A bond fund is not superior or inferior to a bond ETF. They may invest in the same category of assets, but there are fundamentally different, to serve different investor needs. People put money in a bond fund because they want their investment to be actively managed. Bond funds offer more such options. However, if you have a high volume of movement, then an ETF is better because it works through an exchange,

Bond ETFs are also more transparent, since you can see the holdings at any time. For a bond fund, you will likely have to wait for the fund report to be released. However, a bond fund works better for someone with a lower risk profile since there is always a secondary market for the fund. You can sell the fund back to the fund issuer. In the case of an ETF, you can only sell it on the market, and if there is no buyer, you are stuck with it.

Terence K. J. Nunis

[Shared with permission from: Quora Answer: What is the Difference between a Bond Mutual Fund versus a Bond ETF?]

Image for illustrative purpose only.

Your Guide to ILPs and a peak into “New ILPs”

The Simple Sum recently posted an article, “Your Guide to ILPs: What You’re Paying for When You Buy Investment-Linked Insurance Policies”.

Image courtesy of The Simple Sum.

It is a good read, especially for policyholders who may not be aware of the investment allocation or how the policy actually works.

It should be noted though that the article is based on traditional ILPs.

“New ILPs”, sometimes known as “101 ILP”, offers minimal insurance coverage and focuses more on investment. Premium is 100% invested before charges are deducted later on.

This “New ILP” offers a different kind of investment opportunity similar to that of unit trust investing, with added benefits and advantage by virtue of being an insurance policy, particularly in respect to estate planning.

It is an alternative that customers can consider, especially if to utilise its status as an insurance policy while maximising premiums (from first premium payment) for investments.

Will Agribusiness Bonds do well amidst pandemic?

Climate change will cause a profound impact on our food security. Agricultural areas are at risk from the effects of temperature changes. Changes in ocean currents and temperatures will affect fishing and fisheries. Desertification is a risk for many areas. This means the price of putting food on the table will rise, even as quality may be inconsistent. In the meantime, agriculture commodity markets are expected to do well, because the price of the product will rise.

In 2020, there was a bull run in agriculture commodities which defied expectations and proved immune to Covid-19’s economic and social consequences. People still need to eat, even amidst an epidemic. And people stuck at home tend to eat more. It is true that coffee and cocoa suffered, but grains and oilseeds reached multi-year highs. Even commodities associated with the energy complex, and GDP growth, palm oil and sugar, performed well.

This is easily explained, on hindsight. We know that speculators bought record amounts of agricultural commodity futures in 2020, feeding that price upside. The fiscal and monetary stimulus created a flow of funds out of sovereign bonds, since yields dropped. Investors were looking for alternatives, and agricultural commodities were attractive investment assets. Speculation is part of the reason prices are expected to drive up.

We also owe these prices to the resilient demand of many markets, most especially China, which was stocking up on corn and soybeans. This demand will slowly decline in the coming year, which will lead to some surplus, dampening prices in the near term.

That being said, this surplus will not last long because climate change, and a worsening La Niña and will continue to be a major challenge for farmers around the globe, negatively impacting the availability of agricultural commodities in general. Countries, in order to secure their food security, will continue to drive prices up as they seek to secure adequate supply of these commodities, particularly wheat, corn. and soybeans.

Food security is the key point here. There will continue to be a scramble for all sorts of agricultural commodities, and this is expected to exacerbate in time. Speculation will feed that rise, but speculation creates temporary bubbles. In the long term, the trend is towards scarcity, meaning rising yields.

Terence K. J. Nunis, Consultant

Image courtesy of Terence.
Image courtesy of Terence.

[Shared with permission from AgriBonds Will Continue to Do Well in the Near Term.]

Commentary:

This is an interesting news and market development, amidst much talk of a bullish equity market, particularly technology and healthcare funds.

Sometimes we get carried away with the news of bullish equity market, that we neglect bonds.

While I understand the enthusiasm, a little caution is necessary. Not every wave that we see should be ridden upon.

Always understand our position, risk tolerance as well as time horizon.

While it may be a good time to go into technology funds and even AgriBonds, always remember the golden advice: do not keep all eggs in one basket.

It is thus recommended to engage a professional financial planner for advice.

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