Islamic finance players should explore opportunities in equity-based financing in making the industry more attractive.
Making this call, Bank Negara Malaysia's Deputy Governor Datuk Muhammad Ibrahim said through equity-based financing, industry players could move away from mimicking conventional products and operate truly on syariah compliance.
He said in terms of risk assessment, such transactions will necessary inject greater market discipline among industry players.
"This business model is premised on a few fundamental assumptions. The bank and its staff will have to be good at risk assessment, due diligence, assets valuation, good at project financing and management, a good landlord, skillful in project monitoring and have the necessary expertise on specific areas such as construction, agriculture and manufacturing," he said.
He was speaking at the opening ceremony of a conference here today on contemporary issues in Islamic home, personal and auto financing.
Muhammad said the shift from asset based financing to equity-based financing however did not mean Islamic banks would operate without any risks.
Islamic banking should be the conduit for the financing model if the business climate is good.
If the environment in certain sectors decline significantly, it could adversely impact Islamic finance, he said.
Muhammad also said a shift from debt based financing to equity-based financial system would not necessarily lead to a better equitable outcome to society.
If it is not properly implemented it could cause uneven benefits to various stakeholders, he explained.
Equity-based financing in Islamic model is based on the sharing of business risks, as well as rewards by the bank and its client.
Both parties would have to contribute for the basic ingredients of a business venture such as capital, management, know-how, labor, and other related professional attributes.
Profits are distributed based on an agreed profit distribution ratio while losses are prorated to each party’s capital participation.
Equity financing is cemented by entering in either one of two contracts, namely a partnership contract and a trust financing contract.