MALAYSIAN ISLAMIC FINANCE Issuers and Investors Forum 2006

Islamic Mortgages in Malaysia

By Noor Ashikin Ismail

Overview of Islamic mortgages in Malaysia
The demand for Islamic mortgages in Malaysia emerged due to the resurgence of religious awareness among the Muslims of Malaysia to organize their way of life increasingly in accordance with the teachings of Islam. This aspiration became a reality in March 1983 when Bank Islam Malaysia (BIMB) was established to offer Islamic products and services to cater to the demand of Muslims. The financing facilities granted by BIMB included the financing of Islamic mortgages. Today, Islamic mortgages in Malaysia have broadened their appeal to not only devoted Muslims, but also to non-Muslims, due to their competitive pricing as compared to conventional, interest-based financing.

In 1993, conventional banking institutions were permitted to offer Islamic banking products and services through Islamic windows, subject to the specific guidelines issued by Bank Negara Malaysia (BNM), the Central Bank. In 1994, the secondary mortgage market for Islamic mortgages was created by Cagamas, the national mortgage corporation, when it purchased Islamic mortgages from Islamic banking institutions (IBIs). This has resulted in the growth of Islamic mortgages over the years.

The primary market for Islamic mortgages
As at the 30th June 2006, there were 22 IBIs in Malaysia, including foreign banks, that were offering Islamic mortgages. At the same time, Islamic mortgages accounted for US$4.38 billion (RM16.1 billion) or 21.6% of IBIs’ total financing, and 12.3% in terms of total housing loans outstanding in the banking system, as shown in the chart below.

The financing of Islamic mortgages in Malaysia was first made available to individuals under the principle of Bai Bithaman Ajil (deferred payment sale). Today, Islamic finance is moving towards the floating rate market. BNM has allowed a floating rate Bai Bithaman Ajil where customers are required to make higher monthly payments and are given rebates depending on the prevailing market rate.

Islamic mortgages in Malaysia evolved further in March 2006 when Kuwait Finance House (Malaysia), Malaysia’s first foreign Islamic bank, received approval from BNM to introduce a home financing product called Musharakah Mutanaqisah (diminishing partnership) and leasing services. This concept is widely practised in the Middle East, USA, Canada, UK and Australia, but has yet to dominate the Malaysian market.

The secondary market for Islamic mortgages
The secondary mortgage market in Malaysia became a reality with the establishment of Cagamas in 1986 to perform the function of an intermediary between the originators of housing loans and the investors of long-term funds. Cagamas’ specific role was to:

(a) Encourage home ownership by:

(i) providing financial resources to enable originators to grant more loans; and
(ii) providing liquidity by narrowing the gap between the maturity structure of the housing loans and the source of funds.

(b) Develop the private debt securities (PDS) market by:

(i) providing additional instruments for investing surplus funds;
(ii) providing an opportunity for bond dealers to undertake transactions in PDS on a large scale; and
(iii) paving the way for other corporations to raise funds in the domestic market.

From its initial product of purchasing conventional housing loans on a fixed rate basis, over the years Cagamas has extended its range of products that can be purchased on with and without recourse basis. The range of products includes those offered under Islamic principles. From financial institutions, the company has also widened its client base to include the Government of Malaysia, selected corporations, and non-financial institutions.

The benefits that can be obtained by an IBI by selling its Islamic mortgages to Cagamas include:

(a) hedging of profit rate risks;
(b) alternative funding to grow assets;
(c) ability to price financing products competitively; and
(d) deduction of proceeds of the sale from Eligible Liability Base calculation.

The diagram above illustrates the process of converting the Islamic mortgages purchased by Cagamas into debt securities (investible instruments) at the secondary level.

In addition, Cagamas is also instrumental in encouraging and promoting the securitization of Islamic mortgages or purchase on without recourse basis (securitization). One of the objectives of securitization is to sever the risk of the originator’s insolvency from the risk of non-performance of the assets. The originator is not required to repurchase the Islamic mortgages that are in default unless they are found not to be in compliance with the specific eligibility criteria or in breach of the specific warranties provided by the selling institutions. This allows the investors to rely on the asset quality rather than the credit standing of the originator.

The benefits that can be obtained by the IBI from securitizing their Islamic mortgages include:

(a) Off-balance sheet financing

(i) reduce gearing and improve return on assets (ROA);
(ii) improve risk weighted capital adequacy ratio (RWCR);
(iii) relieve pressure on balance sheet growth and re-deploy capital; and
(iv) diversification of funding base.

(b) Attractive funding costs

(i) funding cost based on structure/asset quality;
(ii) not limited by sovereign or corporate rating;
(iii) credit risk transferred to investors; and
(iv) no buy-back except for non-compliance of representations and warranties.

The following diagram illustrates the structure for the securitization of Islamic mortgages.

The way forward for Islamic mortgages
Until early in 2006, most if not all of the Islamic mortgages originated by IBIs in Malaysia were under the principle of Bai Bithaman Ajil. In the future, perhaps the domestic market will witness greater financing of Islamic mortgages under the principle of Musharakah Mutanaqisah or Ijarah, which offer greater value prepositions to both the primary and secondary markets.

As consumers are becoming increasingly demanding and financially sophisticated, IBIs have to anticipate and rapidly respond to new demands and expectations. Going forward, IBIs should consider other alternatives in offering products that have attractive and innovative features at competitive prices. In line with the Government’s effort to position Malaysia as an integrated international Islamic financial hub, IBIs should also be offering products that are as competitive as those offered in other countries such as Bahrain, Dubai and Saudi Arabia.

The availability of Islamic mortgages at competitive costs will continue to play an important role in encouraging home ownership in the country. Therefore, Cagamas is committed to intensify and upscale its role as the national mortgage corporation through providing more innovative products at a competitive price to ensure easy access to affordable Islamic mortgages.

The author is Noor Ashikin Ismail, AVP, Corporate Planning and Strategy, Cagamas, 19th Floor, Menara Maybank, 100 Jalan Tun Perak, 50050 Kuala Lumpur, tel: +603 2078 3688, fax: +603 2078 7867, email: ashie@cagamas.com.my.

The views expressed in this article are those of the author and do not necessarily represent those of Cagamas.

References are available on request from the author.