LONDON, 19 December 2005 — Bank Islam Malaysia, for over two decades the flagship Islamic bank in Malaysia, is steeped in a financial scandal which saw the Bank recently declare losses for the year ending June 30, 2005, totaling RM457 million mainly due to provisioning totaling RM774 million as a result of bad loans and investments incurred by its Labuan branch. Cumulatively, Bank Islam has a gross non-performing loan (NPL) portfolio of RM2.2 billion.
The scandal is not only of mismanagement and poor internal controls, but also of years of regulatory indifference fueled by the misconceived notion of an untouchable Bank Islam because it was a favorite child of the Malaysian government being the first and model Islamic bank in the country and region.
While it may be tempting to liken the Bank Islam saga to that of Dubai Islamic Bank a few years ago when the Gulf bank suffered a near $300 million fraud only to be baled out by the Dubai government underwriting the losses and taking out a substantial debt-for-equity stake, the Bank Islam situation is much different both in the type of losses and the response.
Bank Islam shareholders, in an effort to restructure the institution, are in negotiations with various entities — both local and international. First Bank Negara, the Malaysian central bank, gave it permission to start negotiations with the Bahrain-based Unicorn Investment Bank for the possible acquisition of a stake in the bank. Foreign investors can own a maximum 49 percent stake in Malaysian-incorporated banks.
Then Bank Commerce Tijari, one of the top three anchor banks in Malaysia, reportedly started negotiations for the possible merger of Bank Islam with the group, which already has a stand-alone Islamic commercial banking license and arguable has the most proactive Islamic investment banking franchise CIMB Islamic, which heads the structuring and lead arranging tables for both domestic and international Shariah-compliant capital markets issuances in 2005.
Despite the losses and provisioning, Bank Islam remains a financially sound financial group. It has one of the most powerful brands in the global Islamic banking business. And its debt restructuring will not cost the Malaysian taxpayer a single ringgit, because the mechanism is one of the most innovative in the world and is proven.
No sooner did the new Managing Director Datuk Noorazman Aziz, who was drafted in April 2005 to sort out the Bank’s finances, announce the record losses and provisioning, and Bank Islam together with Bank Negara announced the formation of a special purpose vehicle (SPVs) to manage and restructure the debt and loan portfolio.
During the Malaysian financial crisis in 1998 the government set up two such SPVs — Danaharta and Danamodal. The former was to handle the restructuring of financial sector debt, and the latter the restructuring of corporate debt. Today, both entities have been successfully liquidated, following the successful restructuring of the country’s bank and corporate sectors debt portfolios. This unique approach, compared to other countries in the region, attracted the praise of the International Monetary Fund. The then Malaysian Premier Mahathir Mohamad refused to go to the Fund for help.
Of the RM2.2 billion gross NPL, the SPV will ring-fence and bundle RM1.6 billion, and the remainder will continue to be processed by the bank on its books since they comprise mainly current Islamic home financing loans.
The restructuring could turn out to be a blessing in disguise. While the losses are being blamed on the Labuan branch, which was converted from an offshore branch in December 2004, this sort of crisis was on the cards for some time now. Bank Islam had a reputation in the market for being the spoilt child of the Malaysian Ministry of Finance; and the perception of the bank was more of a Muslim financial fraternity or government development financial institution. In reality Bank Islam had a commercial banking license.
Bank Islam was losing key managers over the last 15 years because of the sheer inertia, lack of ambition and internal controls at the institution for many years. The seasoned Malaysian banking elder, Dato Mohammad Yusoff Haji Nasir, was brought in by Bank Negara as chairman in December 2000 to go in and have a look at the situation.
“I was surprised at what I found. The composition of the board was not appropriate in the sense that there were no bankers or board members who were familiar with banking. I am not criticizing the past chairman because he was also put there by the authorities. He is not a banker. Bank Islam at the time was not run as a commercial bank. In the public perception, Bank Islam was just like Bank Industri or Bank Penbangunan — a government development bank,” he stressed in an interview last year.
According to Mohammad Yusoff, the corporate image of Bank Islam was suffering because the branches were old and dilapidated. He found a bank not only with a bad NPL (non-performing loan) account, but also with a near non-existent credit and debt collection policy. “If the credit policy is not there the NPL will just balloon. I mentioned this to the management of Bank Islam, but somehow the reception was not there. They somehow were not reporting to their Board what was happening. I immediately changed this and instituted a reporting system to the Board, which is very important,”
Mohammad Yusoff explained.
While things did start to change for the better in the last two years, the real extent of the mismanagement came to the fore when the experienced Datuk Noorazman, formerly a senior executive of Citibank in Malaysia and the Director General of the Labuan Offshore Financial Services Authority, came on board.
The Bank Islam saga is a timely reminder for governments not to interfere in the financial services or any other business sector for emotional and sentimental reasons. Yes, new entities and sectors may need a bit of handholding initially. But not at the expense of management and market best practice, and certainly not at the expense of the taxpayer and the small shareholders.
