Abdou Diaw and Abdoulaye Mbow (International Centre for Education in Islamic Finance (INCEIF), Kuala Lumpur, Malaysia
Journal / Article Review:
This write is trying to review
and analyze a research paper on “A Comparative study of the returns on
Mudharabah deposit and on equity in Islamic banks”. The article is co-written
by Abdou Diaw and Abduulaye Mbow of the International Centre for Education in
Islamic Finance (INCEIF), Kuala Lumpur, Malaysia. As the paper title
specifically mentioned, the aim of the authors are to compare the return on
investment in the both type of instruments that are mudharabah deposit and
equity in the Islamic banks.
The research was conducted based
on samples collected from nine Islamic banks of seven countries. The source of
samples although seems very small but actually represents a significant portion
of the total global Islamic banking institutions as they are the major players
in their own countries. The chosen countries where the banks operate are the
early adopters and leading players of Islamic finance and banking systems.
The authors highlighted that
mudharabah contract and equity share same profile in terms of risk but are
different on how they are rewarded. This is very true if we look at the actual
return rate Islamic banks give to its mudharabah account holders. This has raised
a question of fairness and transparency to those depositors who bear the risk
of losing their capital investment. They also tried to discover how the
adoption of the Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI) accounting treatment for mudharabah deposit affects on
this account.
In finding the comparative
results, the authors employed the risk-return framework and regression analysis
method on a set of data from selected Islamic banks. The methodologies employed
are suitable in testifying the theory of risk-return on Islamic investment
products by using the regression analysis. The calculations obtained were used
to compare the percentage of Return between the Mudharabah Deposit (ROMD) and Return
on Equity (ROE).
The authors have a clear
understanding on the relationship between risk and return which has a positive
relationship. For example, an investment in mudharabah account exposes the
investors to either profit or loss depending on the performance of the business
ventures. The same principle applies to equity investment. The investment with
similar risk profile should yield comparable return. Thus, both types of
investments should receive same treatment in terms of the return on investment.
They also made the understanding on the study easier for those who do not have
fundamental knowledge in Islamic finance by relating the risk profile in
investment from pure finance viewpoint. That is to justify reasonable
expectations from depositors for similar returns on Mudharabah deposit and
equity.
But the authors did not find any
proof in their research that the Islamic banks upheld this principle. They found
out that the average returns on Mudharabah deposit are corresponding with the
local interest rates. As generally practiced, the normal conventional deposit
receives interest based on local interest rate as the benchmark. The finding
has caused a great concern especially for those who expect a higher return for
their mudharabah deposit whereas the conventional saving accounts are riskless
since the offering banks guarantee both return and principle. Consequently,
this situation may affect the attractiveness of mudharabah deposit in Islamic
banks as compared to conventional deposits.
As the writers pointed out the
similarities in terms of risk profile between mudharabah deposits and equity from
the finance theory’s on risk return did not applicable at Islamic banks in this
research. Two investments were rewarded differently. The ROE behaved in as
similar fashion of the theory but the ROMD seemed to mirror the local interest
rates.
There is an interesting
observation by the writers on the effect of lower return from mudharabah
investment that could cause large fluctuations and frequent movement of the
funds in the banking system namely the Islamic banks and consequently give a
negative effect on economy where fund stability is crucial for country’s
payment system. A deep thought will be more plausible for Islamic banking to
offer Wadiah type deposits rather than mudharabah if the lower return persist
which is unfair to mudharabah account holders.
The authors’ study on comparison
of return on investment in mudharabah and equity was actually not new. There
were some other empirical works conducted that compare the return on these two
types funds. Rosly and Zaini (2008) compared ROMD and ROE for six Malaysian
Islamic banks in 2005 which found that ROE was higher than ROMD that exhibits a
behavior similar to that of conventional-fixed deposit. Fixed deposit also used
local interest rate as the benchmark to determine the return rate.
Sundarajan (2005) went a step
further by examining the relationship among the returns on investment accounts,
the returns on bank deposits generally in the banking system, the return on
assets (ROA) and equity, and the level of risks. His analysis showed that in
practice there is a considerable smoothing of returns on investment account
despite wide divergences in risk, and hence very little risk sharing with
investment. The “smoothing element” of return seems validated by the research
paper authors when they found some Islamic banks have established two types of
reserve namely the profit equalization reserve (PER) and the investment risk
reserve (IRR). These two reserves could be the contributing factors why returns
on mudharabah deposit are always lower than equity.
The result of the research showed
that the ROE in the sample tend to be at least two times higher than the ROMD,
even though the risk is similar in many aspects. There was also no signicant
difference, in respect to the return on mudharabah and equity, between those
banks following AAOIFI standards and those who do not.
This research should be followed
by a more deep study on creation of an Islamic investment product other than
mudharabah deposit that meet the risk and return theory and at the same time
practiced as well as observed by Islamic banks. If an investment portfolio is
exposed to higher risks, then it should be given higher returns. This is
because there are portion of investment communities who are willing to put in
their money for more return as long as the investment is Shariah compliant, free
from usury and permissible.
Reviewed by: saupee
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