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This article appeared in Forum page of The Edge Malaysia, Issue 902, Mar 19-25, 2012
My Say: Looking at Islamic Banking in its Proper Context
Written by Zahid Aziz March 19 2012

The Muslims Consumers Association of Malaysia (PPIM) in a press statement dated 12 February 2012 criticized banks “who use the name ‘Islam’ in efforts to promote and sell their respective products when in reality they still oppress and use methods contrary to Islamic law.”

The Association of Islamic Banks in Malaysia (AIBIM) countered “All Islamic banking institutions in Malaysia operates in accordance with Syariah values and are well regulated in compliance with high standards…”

I believe that we are today actually guilty of failing to see Islamic banking in its proper context. To put it simply, the true environment of Islamic banking as expected by the Shariah is that it should be operating in a riba free environment, in a riba free economy. In other words it should be a sole single system operating in an Islamic economy, putting aside the wider environment of Islamic law for the moment.

What we find today is an Islamic banking system enveloped and impacted by the riba banking system operating within a riba driven economy. Practitioners of Islamic banking understand these daily pressures imposed on them by riba banking, but often, they are not able to articulate the issues to the general public. Incidentally, this is the voice I tried to give them in a thesis entitled “The negative impact of riba banking on the performance of Islamic banking in a dual system like Malaysia” that I recently submitted to a local university.

The following are a few examples dealt with in the thesis:

     Collection of deposits
Islamic banks use the concept of Mudarabah to collect deposits whereas conventional banks use interest rates. If one understands the concept of Mudarabah one knows that the Islamic bank cannot quote a deposit rate upfront; the return on the deposits will only be known on maturity. In a low-liquidity situation, conventional banks merely hike interest rates, but Islamic banks are helpless to compete.

Inability to sell ethical financing products
Ethical financing products for house financing under parallel Istisna’ (a contract of exchange with deferred delivery), for example, requires the Islamic banks to assume higher risks than conventional housing loans. If the developer abandons a housing project under parallel Istisna the Islamic bank assumes responsibility and will not burden the customer to continue paying for a house they will never own. Under conventional house financing (and incidentally the BBA house financing currently used by Islamic banks) the burden is placed squarely on the customers, who will be forced to continue to pay for a house they will never own.

However, to offer the ethical product, the Islamic banks need to price it higher than a conventional loan as it involves assumption of higher risk. The conventional housing loan is at discounted pricing because the burden of abandoned housing is placed on the customers not the banks. Give the public an option - where riba is not made haram to Muslims - society will choose the cheaper but defective conventional product because everyone believes it is always other people and not them, who will suffer the abandoned housing problem.

They actually take a gamble, willing to sacrifice x% of society who will suffer due to abandoned housing. Under the ethical Parallel Istisna’ financing, 0% of society will suffer because Islamic banks will assume responsibility for abandoned housing. Thus, we see how the dual system, and not making riba haram for Muslims, impacts Islamic banking negatively.

There are many other examples but the above should be enough to illustrate the problem. However I would like to clearly state that the current practise of Islamic banking is in no way absolved of the criticism aimed at it.

Today it is very clear Islamic banking is being practised without reference to Maqasid Shariah or Objectives of Shariah. One wonders whether the Islamic bankers who are in a position to decide are adequately educated of Maqasid Shariah. In an Islamic economy economic units must work towards achieving the objectives of Shariah.

Maqasid Shariah in respect of the economy requires among other things, for wealth to be widely distributed and not confined to the wealthy few. A wide distribution of wealth cannot be achieved in an overly debt financing biased Islamic banking system the world finds itself in today. In debt financing, preferences are always given to Islamic banking customers who can offer collateral and who have high levels of equity to meet debt to equity ratios set by Islamic banks. These debt financing conditions usually marginalise the poor and favour the rich. Thus, we see Islamic banks guilty of making the rich richer and the poor poorer.

Celebration of the poor is a hallmark of the struggle of our Prophet s.a.w. We cannot ignore the poor in economic activities. Islam does not believe in the invisible hand as believed by Western Economists to right economic wrongs. Islam demands proactive actions to uplift the plight of the poor and in the context of Islamic banking this translates into emphasis on Islamic microfinance.

How many Islamic banks today see Islamic microfinance as a responsibility they are willing to shoulder? If Islamic banking management are not motivated to do microfinance we need to ask why, and enquire whether there is a bigger systemic issue at hand.

As for the consumers, they need to understand Islamic banks are not charitable organisations but businesses. Cheap financing may translate to poor returns on deposits; will all consumers deposit their money in Islamic banks in such a scenario?

To conclude, we cannot afford to ignore the environment Islamic banks operate in. The way forward, I believe is to understand the environment, know where we are headed and, last but not least, get the right people to lead Islamic banking.

Muhammad Zahid Abdul Aziz has 20 years of experience in Islamic banking and finance and is a director of Muamalah Financial Consulting, an Islamic capital market consultancy.

The Truth about Money


Written by Zahid Aziz

This article appeared in Forum page of The Edge Malaysia, Issue 889, Dec 19-25, 2011


In 1982 the average fresh graduate’s salary was RM1, 200; the cheapest car, if bought brand new, was RM14, 000; and a house cost RM60,000. Today, a fresh graduate earns just RM1000 more at RM2200 but the cheapest car is RM40,000 and a new house is RM300,000.


This has little to do with increasing steel and building materials prices but more to do with the way nations create money. This has not been explained to the populace.


Happy to get his job the fresh graduate is informed he will be paid RM2200 per month. For the moment we will not even think about the fresh school leaver who earns an average wage of RM1000 per month. The graduate employee believes that one year from now he would be able to buy the same number of goods with his salary as he can today. Nobody informs him the truth about money and he believes that money is just paper currency and coins, and that somehow, governments will always ensure the nation’s total amount of money remains unchanged.


In the early days of banking, banks gives gold receipts to people who deposit gold in their vaults. The gold depositors discovered they can use the gold receipts as money as they were readily accepted for the purchase of goods. These gold receipts became money. The banks then realised they could do the same with land and other assets pledged to them.


If they could get people to deposit cash with them by promise of a receipt of interest, they could lend these deposits to other people at higher interest margins. To the  delight of the banks, the borrowers did not want to receive the loans in cash; they were happy to be given a chequebook with the bank with an accounting entry that said the borrower was entitled to that money.


Initially, the banks ensured the loans do not exceed the amount of cash deposited. Then they realised through experience they needed to only hold a certain amount of cash in their vaults; not all their depositors would come to the bank to withdraw cash at the same time. As that was the case, they had the bright idea that they could lend many times more cash than they actually had. All borrowers wanted were cheque books not actual cash, and if everybody used the cheque books to make payments, then there only need to be a good clearing system, not much cash was required to be available.


This was the birth of fractional reserve banking where a RM1000 deposited in a bank and lent out to a borrower less the statutory reserve can result in a chain of depositing and lending, which could create a figure of , say, RM25,000 out of thin air. If the initial deposit is RM1billion then the money created is RM25billion. Hence the money stock of nations continues to increase and that is why the fresh graduates today have to pay so much more for his car and his house.


Governments also add to a nation’s money stock without the graduate employees realising it. When governments spend more than the revenue they earn, they have to sell government bonds to cover the deficit. In other words they give their IOUs, take cash from bondholders and use it to pay the deficit.


When the bond matures at the end of the year and there is another budget deficit, the governments issue new bonds to pay the existing bondholders as well as another series of bonds to cover the new deficit. If the volume of bonds is too high, they print paper currency to settle some of it. This is called the monetisation of budget deficit, which adds further to the nation’s money stock.


With the double increase in the nation’s money stock from fractional reserve banking and the monetisation of budget deficits, the fresh graduate soon finds his RM2,200 per month buying fewer and fewer things. Shouldn’t we tell him about what is happening to his purchasing power?


There is also much reduction in the quality of products as suppliers have to lower quality standards to keep their products within the price range that wage earners can afford. For example keropok or fish crackers no longer taste as good as more flour replaces fish in its ingredients. In rural Indian Muslim restaurants the delicious bawal curry has been replaced by the cheaper sardine curry. Fresh graduates no longer buy new cars but second hand ones and they no longer buy houses but small apartments. Some continue to stay with their parents after getting married creating the new phenomenon called “sandwiched families” with three generations living under one roof.


We really ought to be thinking about a new money system where there are no such wild increases in the nation’s money stock. A return to gold is the obvious solution. If disbelievers say there is not enough gold to fund world trade, let’s put our thinking hats on; it’s really not beyond our intellect to solve the issue.


What appears lacking is the initiative to overcome the inertia to solve the problem. Maybe, when our grandchildren starts work in 2020,  they would earn ,RM5000 per month but a new car could cost around RM100,000 and a new house RM1 million. Do we apologise to them that we were too busy to solve the problem during our time?


Shouldn’t  we be thinking about indexing wages and salaries? The people followed their government’s advice not to over unionise lest it affected the nation’s economy but shouldn’t the people be helped in return now? 


Yes we are proud of national corporates recording billions of ringgit in retained earnings every year, but we paid for it with an untold amount of sweat and tears through the erosion of our spending power.



Muhammad Zahid has 20 years of experience in Islamic banking and finance. He is a director of Muamalah Financial Consulting, an Islamic capital market consultancy.


The A and B of currencies ( The Edge, Malaysia July 18-23, 2011)

The A and B of currencies

Written by Zahid Aziz

This article appeared in Forum page of The Edge Malaysia, Issue 867, July 18-24, 2011

We have just completed a job and about to be paid for it. We are given an option to be paid A or B. A’s value is stable - there seems to be a basic value which is unchanged.

B has no basic value. If you hold B its value can be taken away by various external forces. It can be changed by the governments; it can be changed by governments creating more and more of it; it can be changed by people losing confidence in it; it can also be changed by outsiders holding large quantities of it and cornering the market for it.

However the worse thing is the theft of its value by governments creating more and more of it. We do not even realise the loss of value until we use B to buy things; what cost three B before now cost six B for example.

But we have no choice, we have to use and accept B otherwise we will be imprisoned. But then again we should be grateful it is just a prison term. In the days of Kublai Khan, we could be executed for refusing to accept B!

So the people just accepted it without any protest. The governments also told the people to ‘just do it’. In Latin this translates to ‘fiat’. Hence B is based on fiat- forced on you by the governments.

In the early days one used A to buy and sell things. However dictatorial governments force its citizens to hand over A and use only B. This trend was started by Kublai Khan and he was not a pleasant personality.

Where A was concerned no one could steal its value but with B such opportunities thrived! Isn’t this opportunity to defraud called gharar in Islamic terms?  And we have not even address the qisas punishment for theft.

Don’t forget that in an Islamic finance system we are trying to remove riba from a system of B, a system of deceptive IOUs to be exact, which is really what B is all about. One should remove riba when A is used for buying and selling. But when deceptive IOUs are used instead of A and we are trying to remove riba from that system, it’s farcical to say the least. However the persistent optimist in us hopes that this is just Phase One. Phase two will be the removal of B to be replaced by A.

Before we address the cries of the non-believer of the deemed impossibility of removing B let us dwell on the deceptive nature of B so that things will be clearer.

Now every month we receive a certain number of B, say 3000 of it, which we use to buy food and things for our family. Our assumption is that the governments have put in place a system where the total number of B in the country is unchanged. An unchanged total number of B means we can retain the value of our B, right?

We understand if there is, for example, a fixed total of one million B in the country available for buying and selling a fixed number of products of say one million C. Then the number of C our 3000 B can buy a month is unchanged! However if the number of B can be increased while C remains unchanged we can see the price of C going up in terms of B, right? That means if our 3000 B used to buy 3000 C it can now only buy 2500 C. So who is stealing the value of our B?

Governments are one of the culprits; they can do that by creating more B and you cannot do anything about it. But did you know that governments allow other groups of people to wantonly create more B? These people accept deposit of your B and lend B to other citizens.

When these citizens deposit B again, it is lent to other people. This system allows B to be created out of thin air. Based on the original amount of money that remains unchanged, both the depositors and the borrowers believed they all owned the same bundle of money. And they all have cheque books to prove they can spend it! And remember more B in the system the less C you are able to buy.

Crazy huh? But you don’t question because you were brought up not to question. Now you recall how when you first started work in the 1980s your salary was 1,800 B. If you wanted to buy a new first car it only costs 14,000 B and if you wanted to buy an ordinary terraced house it will only cost you 60,000 B. Today the young man starts work at a salary of 2000 B but a new car is 40,000 B and a new house is 300,000 B! But you still don’t question the system.

It is bad enough if that is all the effect of B, but an international system of B allows superpowers to manipulate the system at the expense of little countries. And you wonder why nobody believes, that if little countries drop B and instead use A in their international trade this ability to manipulate will end

A is gold and B is paper currency and the deposit-lending system described above is fractional reserve banking. Gold is Sunnah money; Dinar, Dirham and Fulus. Dinar is gold, Dirham is silver and Fulus is small change. Sure, there are technical difficulties down this road but is it really beyond our intellect to solve them? Or just like what riba has done to us down the centuries we are hopelessly zombied to its inequities.

Zahid Aziz has 20 years of experience in Islamic banking and finance and is a director of Muamalah Financial Consulting, an Islamic capital market consultancy.


Written by Zahid Aziz  Monday 14 March 2011

This article appeared in Forum page of The Edge Malaysia, Issue 849, Mar 14-20, 2011


In 2008 for the first time since 1930s the world economic system was on the brink of collapse. The international financial system was a like a train screeching to a halt. Fortunately it did not happen this time, the train hobbled on, a wrong system saved by, in all likelihood, an equally erroneous solution that probably sowed the seeds for an even bigger disaster to come.

Nobody knows the ultimate impact of the crisis of October ‘08 but the causes are now generally understood, within the context of conventional understanding without the benefit of an Islamic worldview. This article will try to provide the Islamic perspective on some of the problem.

US mortgage lenders go bankrupt between early 2007 to October 2008   BNP Paribas freezes funds; Northern Rock UK nationalised, Bear Stearns collapsed, Fannie Mae and Freddie Mac rescued; Lehman Brothers bankrupt; AIG rescued by Federal Reserve; credit market squeezed, Icelandic and many European banks nationalised or recapitalised.

The trigger was a decline in US housing prices which unraveled highly leveraged and unsound lending which has been building up over time specifically in the subprime residential mortgage market. It came in the form of securitisation of housing mortgages.

This is the scenario. Banks gives out mortgages which are then sold to a special purpose company (SPC) which issue securities to investors. The Arrangers are investment banks who get paid a fee and their employees gets paid huge bonuses as more structuring are generated. The housing loan banks were happy because they can continue to extend mortgages without keeping them on their books. The Arrangers are happy for as long as mortgages continue to be generated much demanded mortgage backed securities (MBS) can be repackaged and sold to investors. The Investors are also happy, pensioners in Sweden or Singapore are holding clever US originated securities. The US government are also happy and assisted the saga further by deliberately keeping interest rates low in pursuit of a home owners’ democracy.

Soon the good credits dry up. Prudence would have stopped the securitisation machine however a system without values pays no credence to prudence if players involved find they can get way with it, and got away with it they did, and then some.

They started to get involved in predator lending. They seeked sub prime housing loan borrowers aptly described as NINJA borrowers, i.e. individuals with No Income No Job and Assets. Their objective is to keep the production line churning so that the model can continue to securitise the mortgages and MBS sold to the investors.

A clever idea at the time had the poor credits bundled with the better ones to create more saleable securities. To ensure continued sale they got another party involved to deliver credit enhancers. Thus enter AIG, US’s major insurance corporate with the now infamous credit default swaps or CDS.

What this paper actually does is to take the credit risk away from the Credit Debt Obligations (CDO) which is the official name of the securitised mortgages. AIG gets a fat fee for the CDS, assuming credit risks they have no way of measuring. The investors are lulled into believing they have a truly secured paper, secured by the largest insurance company of America.

However bubbles have to burst. By end 2006 US house prices reached unsustainable levels. As the interest rates was raised to address inflationary concerns weaker borrowers began defaulting on housing loans. New purchasers stopped entering the market triggering downward spiral in house prices.

This process rapidly transmitted itself through the structures of securitisation. Lost in their own structuring in the initial stage they did not know who owned the securities that were becoming impaired; the housing loans being packaged and repackaged into CDOs repeatedly. Since the market did not know who owned the loans they stopped dealing in such securities. Soon their attention turn to the companies active in such instruments and are likely to hold large amounts of such impaired securities. Interbank lending and borrowing stopped and the credit crisis internationalised. The dominoes fell as outlined above.

Western literature does not one touch the underlying world view; it either does not know the significance of world views or does not know what it does not know. When world views are not addressed then existing systems and values or lack thereof are assumed correct so solutions are designed for a fundamentally defective system ; patches on balding tyres when what’s required is a full and complete replacement.

From the Islamic perspective there is nothing wrong in securitisation. What is wrong is in the mechanics, the subject matter, and derivative innovations on the concept of securitisation unfettered by Shariah parameters.

Securitisation according to Shariah has certain basic rules to comply with which limits its growth within the confines of the allowables. Such rules include rules of ownership where if sales are made then ownership must be transferred whole; Shariah does not allow sales where it is not clear whether and to whom ownership has been transferred. Apart from the issues of gharar or uncertainty such incomplete transfers approaches the definition of a batil transaction. Secondly, is the asset being transferred Shariah compliant?  Do the parties trading the securities that represent ownership of the underlying assets understand the assets? If not we are clearly in the realms of gharar. It is worse if the assets are ‘toxic’.

The subprime aspect aside, there are already issues in the securitisation structure. Mortgages are receivables or dayn. Under all mazhabs (Islamic schools of law) other than Shafie securitisation require the purchase of the houses with the attached mortgages.

Some structures are so complex structurers can buy pools of asset to underlie their securities, distancing further the security holders from the house owners. The zenith of the structure are CDO’s of CDO’s. This is what happens when structuring are limited only by the imagination of the structurer without benefit of guidance by revealed Shariah. The asset which the securities represent ownership thereof is gharar of the highest nature. Such instruments will not see the light of day under an Islamic system.

Under Shafie purchase of debt is only acceptable if inter alia, it is dayn mustaqir, a valid and collectible debt, purchased by cash The sub prime MBS is certainly not dayn mustaqir and similar issuance cannot arise in jurisdictions adopting Shafie rules.

An insurance company sells CDS for a fee. This means it will reimburse all credit defaults by individual mortgage borrowers. Islam views whoever sells CDS for a fee as engaging in maysir or gambling. These players do not know whether or not the mortgage borrowers will default and they hope their calculation on the fees is correct. When the property bubble burst their calculations and gamble failed. A takaful company would have been prohibited from issuing CDS because of gharar in the nature of asset purchased and maysir in the transaction.

In this context one cannot avoid discussing moral hazard or the weakness of man to conduct muamalat (economic transaction) in an honest and God fearing way. In the Western problem the only worry is getting caught. Furthermore individual interest always supersedes public interest.

So obviously, the structural problems of subprime were made worse by the dishonesty of the players in pursuit of incentive payments and fat bonuses. Personnel of arrangers and banks were in cahoots in predator lending. Personnel of CDS providers blind themselves to the maysir of CDS.

 The personnels’ lack of world view aggravated a defective structure that delivered a killer blow to the US economy. An Islamic system with God fearing personnel should remove some, if not all, of the moral hazards because in an Islamic system it is not about being caught but about being watched.

My Say : When risk is a four-letter word

Written by Zahid Aziz  Monday 17 January 2011

This article appeared in Forum page of The Edge Malaysia, Issue 841, Jan 17-23, 2011


The objection of Islamic Syariah to riba has never been about the size of the interest charged. It is also not confined to consumption loans; it is prohibited also to investment loans.

Investment loans, isn’t that a misnomer in the first place? How could an investment be a loan, and how could a loan be an investment? That is the objection of Syariah to riba, an investment cannot be a loan, and a loan cannot be an investment. But we have accepted the fraud and spun it that a loan is an investment without question. For how else could we have agreed to a guaranteed return to someone who has lent us capital?

How else could we have agreed to a full undiminished return of his capital at the agreed time without consideration of the underlying success or failure of the business? Someone used to say, tell the lie a thousand times and it will be accepted as the truth. In riba the axiom seems to be, practice it for a hundred million times and people will no longer question its injustice.

It becomes a fact of life that we are numbed to its injustice. We are numbed to its injustice because it is not us who bears the direct brunt of the injustice. The UN sponsored Study by the World Institute for Development Economic Research reported that in the year 2000 there were one billion people living on less than USD1 per day.

The per capita GDP (total national output divided by the population)- the difference in income between the world’s richest countries and the world’s poorest countries - is now 267 times, from 22 times in 1913 1% of the world’s population now own 40% of the planet’s wealth.

"The study emphasised that economic growth is, by itself, no fix: How the gains are distributed is just as important. In China, Romania, Sri Lanka and many Latin American countries, swiftly expanding economies have improved incomes for many, but the benefits have been limited by a simultaneous increase in economic inequality, putting most of the spoils into the hands of the rich and not enough into poor households..."  This is the tragedy of the riba driven economy, delivers economic growth but with much inhumanity.

But it is not our problem because we are not amongst the one billion people mentioned above. And so we continue with our life. We have a form of Islamic banking. Some of us are no longer practicing riba banking; really? As outlined above isn’t the objection to riba based on the risk aspect where all manner of risks are transferred by a lopsided contract to the other party? Isn’t the objection to riba about the owner of money disattaching himself from all manner of risks whilst expecting a guaranteed return at the same time?

How do we measure against this requirement? No measure of akad (contract or agreement) will make a transaction riba free until we address the risk aspect. Risk is indeed a four letter word when we have not yet shed our riba drenched clothes.

Amongst the parameters of an Islamic Economic system is the prohibition by law of riba and an economy driven by qirad or mudarabah. Banks will take deposits on Mudarabah and extend financing in the form of Mudarabah and Musyarakah. Banks will remould themselves as true Investment Banks and bankers remould themselves into equity investment managers.

In order to allow the Banks to operate freely as true equity managers of money, the nation’s payment system will in most likelihood be decoupled from them and run by specialist Debit Banks who will honour cheques much in the way debit cards operate. In other words cheques only for amounts in current accounts and processed by banks who are unable to extend credit. Thus the exposure of the investment banks and any failures in their financing will not collapse the nation’s payment system.

The setting is set now for the banks to extend capital on Mudarabah (trustee profit sharing) and Musyarakah (joint venture profit and loss sharing), thus truly transforming the banks into equity investors and rewriting the risk formula into what is natural for business. No more fixed returns on capital extended, and no more guaranteed full return of capital notwithstanding outcome of business.

Banks extend capital on equity basis and absorb business losses as is only equitable. Things are now back into natural equilibrium and risk is no longer a four letter word. Risk is assumed in the correct proportion by all component parts of the economy and serves its function as the oil that runs the economy.

The only people who will object to this will be the riba financiers who have it their way all this while, and of course some of the professionals they enslaved who can no longer see the woods from the trees.


My Say: Risk-managing in Islamic financial institutions

Written by Zahid Aziz    Monday, 09 August 2010

This article appeared in Forum page of The Edge Malaysia, Issue 818, Aug 9-15, 2010


Surah Ta Ha Verses 115 to 119 of the Holy Quran basically tell us that God created us in an environment of risk. Our Father Adam was created in heaven, given a wife and everything he needed but God also gave him risk — the risk of disobeying His command. Man was made weak and susceptible to risk, hence Verse 115, which says: “We had already, before hand, taken the covenant of Adam but he forgot; and We found on his part no resolve.”

This teaches us at least two things. First, an environment of risk and exposure to risk is a natural state of existence for man, right from his beginnings in the heavens of God. On top of that, man is naturally forgetful and weak, which accentuate his exposure to risk.

If man does not have needs, he is less susceptible to risk. If Adam had not needed Hawa, he only had himself to manage as risk exposure. But his need for a wife extended his responsibility of risk management beyond himself. This teaches man that living in a society of other beings is also a natural state of being for him. He has to accept that fact, recognise the increase in risk exposure and manage it.

Similarly, an Islamic financial institution (IFI) has to accept the fact that risks exist in its business and have to be managed. There is no business that is riskless except perhaps riba or interest-based banking. That is why riba banking is abhorred by syariah. Author Saiful Rosly (Performance of Islamic and Mainstream Banks in Malaysia — Saiful Rosly & Afandi Bakar [2003] International Journal of Social Economics) notes that the riskless nature of riba banking “violates the law of nature in Islam since everything except God must depreciate and money is no exception. When money is not subjected to the law of depreciation, man has put money equal to God. In Islamic law, this amounts to idolatry [shirik]. For this reason, God declared war on Muslims who consume riba”.

Once we acknowledge that there are risks in Islamic banking, we need to identify and learn how to manage them. Islamic banking is a business, so there are risks attached to various aspects of the business. What is Islamic banking? It is a business of collecting monies from the public and investing those funds to give returns to the people who have extended the monies. We then need to know why people give money to Islamic banks. Is it for investment or safekeeping? Truly, there is no such thing as depositing money in an Islamic institution and expecting a return. That presumes there is a price on money and the act can be construed as a rental of money, which is the theme of riba banking and the antithesis of Islamic banking. Monies placed in Islamic banks should never be described as deposits with all their conventional connotations. They should be described as public investments or monies for public safekeeping.

So, what are the risks associated with such monies? The risk of not being able to deliver the cash when required by the bank’s customers because the cash has been invested in profit and loss earning projects is one. The question is, why are investors entitled to withdraw on demand when they agreed their money was an investment that surely has a period of maturity? Allowing withdrawals on demand is then clearly seen as an act of aping conventional banking. If the bank needs to have this feature, then the akad of safekeeping or wadiah yad dhamanah seems the most appropriate. Then there is a legitimate risk for the Islamic bank to manage; it needs to risk-manage the liquidity risk of not having enough cash when customers demand to take out their money. That’s the risk on the sources side.

The funding side entails credit risk when Islamic banks engage in credit finance, which has never been considered “illegal” by Islamic jurists; it is its over-usage and abuse that has drawn much criticism. With debt or credit finance, there will be credit risk or the risk of the counterparty not honouring its commitment. If the nature of the Islamic bank’s funding is equity of mudharabah or musyarakah, then the Islamic banker need only address investment risks.

Of course, all risks are looked at from the point of view of the Islamic bank that is exposed to the risks. If the risks are not managed, then the Islamic bank will suffer losses or in the worst-case scenario, it will have to be closed. All these risks are measured in terms of monetary loss. However, Islamic banks are also exposed to a particular risk that conventional institutions are spared from — the risk of a mukallaf, or not obeying the laws of his Maker.

In Islamic risk-management terminology, this is called syariah non-compliance risk. However, this is usually classified as an operational risk and its loss is measured in monetary terms. The overriding risk faced by an Islamic institution is the risk of incurring the displeasure of his Maker, but who is the mukallaf here? They need to be humans. In a combination of responsibility, we offer that the mukallaf include the regulators, shareholders, directors, management, staff and also customers of the bank. The nature of risk management here is to do all things to comply with the requirements of the Law Giver, be it in action, words or heart.

This teaches IFIs another form of risk management: to be true to the teachings and requirements of syariah in all its business and actions, and God will surely protect the institution. It needs to be said, however, that such institutions have to go beyond adhering to the literal legal rules of syariah and achieve the higher platform of embodying masqaid  al-shariah (objectives of syariah). Again, we quote Saiful Rosly (2003): “Ethics again takes a back seat, making way for legal rules to dominate Islamic banking juristic opinions. As ethics [akhlaq] and law [fiqh] do not seem to mix, the Quranic spirit of justice and mutual aid is compromised to pave way for financing techniques that may look Islamic on the outside only.”

Banks are exposed to four broad categories of risks — financial, operational, business and event. These should now be familiar to most people and are much discussed in literature. I would like to forward one aspect of risk for an Islamic bank that has rarely been discussed or brought to the forefront of public forum, that is the risk of operating in a dual financial environment. Islamic banking has to start in a dual banking environment; it’s not as if we have a choice. But the choice we have is not to ignore the impact of riba banking on Islamic banking. The greatest risk of this dual system is the risk of turning an Islamic bank into a replica of the conventional bank in order for the Islamic bank to survive.

When riba is not haram and Islamic and conventional banks have to compete for the same deposits, the rules Islamic banking have to observe can be an unfair advantage to conventional banks. However, this does not mean that conventional banks produce superior products in spite of not following syariah rules; what this means is that conventional banks are allowed to produce defective products for society which should not have been allowed to leave the production line. Factory rejects which are popular in the market would be an apt similitude for conventional products.

Islamic banks take deposits on mudarabah; they have little leeway to respond to sudden changes in market liquidity. Conventional banks price deposits on interest; they can adapt quickly to liquidity changes. As a result, Islamic banks can be high and dry in times of low liquidity and flooded with unwanted deposits in times of high liquidity. All this forces Islamic banks to replicate the nature of a conventional bank so that they can get economic benefits. These actions will bring them into disrepute, entering the dangerous zone of breaching syariah.

Second, an Islamic bank may wish to extend financing based on the equity concepts of mudharabah and musyarakah. However, such financing needs to be funded by deposits. Because of the rental of money concept introduced by conventional banking, people are used to depositing money for the short term so the majority of deposits are short term in nature. Islamic banks that want to extend financing based on mudarabah and musyarakah will think twice if they are to be funded by short-term deposits. What if the depositors wish to withdraw when the projects are always long term in nature?

So to be safe, Islamic banks will find financing that will deliver to them early returns; hence, they will focus on debt financing — again becoming a replica of conventional banking in order to get economic benefits. It is about time people recognised these particular risks of Islamic banking and addressed them in the manner the Law Giver expects them to.

Islamic economics have crossed the divide. Islamic accounting is on the verge of doing so. Islamic risk management must make the jump soon. A subject is only truly relevant when it crosses the divide to take into account the mukallaf’s fear of the consequences of the hereafter. Islamic economics have extended all time horizons to the hereafter and so their calculation of risks and rewards. We should not confine Islamic risk management to monetary loss lest we lose our grip on the subject. An IFI’s risk management must cater for the biggest risk of all — incurring the wrath of the Law Giver.

The risk management framework of an IFI must have achieved maqasid syariah as its ultimate objective. Otherwise, we will achieve neither protection against monetary loss nor maqasid. Sometimes, what seems disastrous in terms of conventional knowledge may actually be the route we need to take to achieve our true objectives.

Muhammad Zahid Abdul Aziz, who has 20 years of experience in Islamic banking and finance, is a director of Muamalah Financial Consulting, an Islamic capital market consultancy



My Say: Commendable Act but it’s no saviour

The Edge Malaysia.

Written by Muhammad Zahid Abdul Aziz

Monday, 22 February 2010


The Central Bank Act 2009 was gazetted on Sept 3, 2009, to replace the Central Bank of Malaysia Act 1958, which was repealed. The Act created international history as the first central banking legislation anywhere in the world to declare that a nation is operating under a dual financial system, conventional and Islamic. Although Malaysia is acknowledged today as the country with the most advanced and comprehensive Islamic banking and finance legislation, local players will remember how they were thrown into the deep end with a barely adequate Islamic Banking Act in 1983.

Islamic bankers, lawyers, and other practitioners were expected to survive on their own, fight for new rules, and generally steer Islamic finance forward, with the condition that it complies both with syariah and every single piece of civil law. One doesn’t need a degree in comparative law to appreciate the enormity of this task.

Islamic banking is supposed to operate as the sole and single system in a riba-free environment, operating within an Islamic economy governed by syariah laws. The Revelations in the Quran certainly do not coincide with an Islamic banking system enveloped and impacted by a well-entrenched riba competitor system, operating within an interest-driven economy, within man-made laws.

Islamic banking law began to be built on case law, which could sometimes steer it into choppy waters. But we always found ourselves back on course, with many mindful of the fact that the boat we were in was being built on questionable specifications in the first place. Into this context was born the Central Bank Act 2009.

Is the Central Bank Act 2009 the long-awaited saviour? Before we analyse the Act, we need to identify the major outstanding issues of Islamic banking practices that cry out to be addressed:
•    Operating in a civil law environment where syariah issues may not be appropriately and adequately addressed, should Islamic banking be taken out of the realm of the civil courts and placed where it rightly belongs, the syariah courts?
•    Procedural laws, such as the Rules of the High Court, that do not accommodate Islamic banking. For example, court forms that require Islamic banks to specify the “principal” and “interest” of their facilities. Or the automatic 8% a year default interest from the date of default to date of judgement awarded by judges to all successful litigants.
•    There is no legislation that makes it compulsory for the courts to refer syariah issues to syariah experts, leaving it to the sole discretion of judges who may or may not consult syariah experts as they see fit.
•    In conflicts of Islamic banking legislation with other legislation, which one rules?
•    The National Syariah Advisory Council at the Central Bank, being the assumed supreme authority to determine Islamic banking laws, being then by wording of the legislation, be made subservient to the supervision and regulation of the Central Bank.

•    The legal treatment of Ibra’ or rebate in an Islamic debt-financing facility which iconises the incompatibility of syariah nuances with certainty as required by civil law.

•    The lack of formal Islamic finance education among judges and litigating and drafting lawyers has been much lamented but not addressed.

•    Consideration for alternative dispute resolution for Islamic banking cases in view of its alien nature to civil courts.
These are just some of the major issues facing Islamic banking practices presently. Let us now examine whether the new Central Bank Act 2009 has accommodated all Islamic banking wishes.

•    The Central Bank Act 2009 (CBA 09) does not touch on the jurisdiction for Islamic banking cases, which remain firmly within the ambit of the civil courts. As a Central Bank Act, it may not be the platform to change federal and state lists in the constitution. But the import of the Act reaffirms that Islamic banking is going to stay firmly on the federal list. This then begs the question on when the syariah capabilities and Islamic banking knowledge of judges and the legal fraternity are going to be addressed. If Islamic banking cases are to be dealt with by civil courts, court officials must be adequately trained. The problem is not going to go away by ignoring it. And when are procedural laws going to be amended to accommodate the existence of Islamic banking?  A lot of judicial time and effort are being wasted on matters that can be easily resolved with long overdue amendments to procedural laws.

•    The previous legislation did not make it compulsory for judges to refer syariah issues to syariah experts. Section 56 of the new CBA 09 appears to have resolved this problem by requiring the Court (and arbitrator) to “take into consideration” any published rulings of the Syariah Advisory Council of Bank Negara. However, a Muslim bred in unspoken respect and obedience to fatwa finds this phrase quite discomforting. Section 56 is an improvement over the previous legislation, but it does not say  the rule is binding on the judge. Religious nuances aside, what if a judge “takes into consideration” an SAC syariah ruling, decides it is not appropriate for his judicial decision, and makes a decision which in terms of the Islamic Banking Act (IBA) is against Islam? Does not the IBA define Islamic banking business as any banking business that does not go against Islam?
Whilst it is all very well to declare in Section 51 that the SAC is the supreme authority over Islamic financial law, Section 55 then goes on to say that the judge is actually the ultimate arbiter. So that fits into the context that Syariah law is not supreme in this country. But how then do you reconcile a judicial decision which is ultra vires a democratically passed Act of Parliament, namely the Islamic Banking Act? The position is, however, a bit clearer on new issues which have not been deliberated on by the SAC — upon making a reference to it under Section 56, the court is then bound by the ruling under Section 57.
•    Conflicts between Islamic banking legislations and other legislations are not addressed by the CBA 2009. Only against the Companies Act does Islamic banking legislation win by virtue of Section 55 of the IBA, which makes the Companies Act subservient to it. Against all other legislation there remains deafening silence. We’d hope that the Islamic Banking Act, as outlined above, would be a comfort of sorts, but a more forthright legislative defence would be the preferred choice.

•    The phrase in the previous legislation putting the National Syariah Advisory Council under the purview of Bank Negara appears to have been left out. In addition to the deletion we have, for what it’s worth, Section 51 (2) which says the SAC may determine its own procedures. Dare we draw comfort from the fact that the SAC is no longer by wording of legislation subservient to a body which should not be, and I daresay would not want to be, its supervisor, Bank Negara?

•    Ibra’ or rebate of an early settled Islamic debt financing facility has always exemplified the uncomfortable juxtaposition of syariah nuances with the certainties as required by civil law. Syariah advisers have always been loathe to approve rebate clauses in Islamic sale and purchase agreements for fear of indicating a multiplicity of prices in an Islamic buy and sell akad which demands the declaration of only one price. This quirk of syariah demand has led to banks demanding defaulters settle the full selling price in mid-term defaults, when it is clearly not due. Islamic banks that know the correct procedure will then make an undertaking in their statement of claim to rebate to the defaulter any amount not due to them. Islamic banks who know that the date of settlement could be years after the date of judgement resort to this, rather than go to court again to ask for an additional sum. It is clearly so much easier to ask for the full selling price, which they are entitled to, and rebate all amounts not due to them. But some court submissions were made without the undertaking to rebate in the statement of claim.

Remember the  infamous case of Affin Bank vs Zulkifli Abdullah (2005), where the plaintiff bank did not make the undertaking to rebate, leading the judge to declare Islamic banking exorbitant, and subsequently, for the same judge to declare that all such Islamic debt financing facilities non-syariah compliant. The decision was overturned by the Court of Appeal, leading to a collective sigh of relief for the embattled Islamic banking industry. The SAC in 2002 approved the inclusion of such an Ibra’ or rebate clause, in sales agreements based on the objective of maslahah and the analogy or qiyas of dha’ wa taajjal. Perhaps via Section 56 and 57 of the CBA 2009, when syariah rulings of the SAC may no longer be ignored by the courts, this issue will be put to rest once and for all.

•    Lastly, although arbitration is mentioned under Section 56 and 57, no declared bias is made in its favour as compared to settlements via court. Perhaps this is not entirely unacceptable as only through court battles can case law be built and precedent Islamic banking law be established.

The CBA 2009 is clearly not the knight in shining armour expected by some. Clearly, the authorities have decided to postpone all major battles. However, its hand is shown in the manner of testing of waters. We commend the law makers for the bold declaration of a dual financial system and the legislative requirement that the judiciary may no longer ignore SAC rulings. Apart from that, the CBA 2009 can hardly be said to have resolved all outstanding issues in Islamic banking practices. With the baton of leadership in their hands, we sincerely hope the authorities are mindful of the landscape of the battlefield we find ourselves in, for no war can ever be won without such vision. We need generals who see the battlefields clearly and an army that is well trained, disciplined and committed. For did not Allah say we are at war with riba?

Muhammad Zahid Abdul Aziz has almost 20 years of experience in Islamic banking and finance. Starting with Bank Islam Malaysia Bhd in 1990, he made  his mark as a sukuk pioneer. He left Bank Islam in 2000 to form an Islamic capital market consultancy in Kuala Lumpur called Muamalah Financial Consulting.

Korean Daily News 16th March 2010

Korea sukuk Law order to help bring funds from the Middle East

Say selfless representative Abdul Aziz Islamic Financial Consulting

Islamic finance funding and long-term investment brings much potential of rich business opportunities in the Middle East, etc. There are many advantages says Malaysia's Islamic financial consulting firm, Muamalah Financial Consulting’s  Muhammad Abdul Aziz,  He spoke with representatives of the Korean Development Bank who acted as co-host to the 17 th Islamic Finance  Seminar at which he was invited speaker.

Aziz said the "global Islamic financial markets since the crisis amounts to 50 percent annual growth rate" and "based on assets, particularly thorough sukuk has been hailed as safe investments," he explained.

As excessive leverage and high risk credit default swaps (CDS) learnt by global investors, they are increasing their investments will sukuk. Sukuk are beginning to be attractive to investment funds in the U.S., the UK and global funds, he said.

Aziz said sukuk  investments is also expanding in  the Middle East. Oil money is a rich pool for invesments," he said. Diversify the portfolio in terms of these funds have not yet entered fully the market looking for investment and it is very likely they will do so soon. " For  AAA credit rated sukuk  in Malaysia, the cost of financing is  10 ~ 20bp (0.1 ~ 0.2%-point) lower than bonds now," he said. Yes the reality is different in Korea, but "if South Korea enabled Islamic finance borrowing costs wil be lowered," he predicted.

Another advantage of Islamic finance long-term investment is that you prefer.

Aziz said tenor of Sukuk depends on company size, smaller companies ususll commands 5 years, large companies perhaps up to 20 years over the long term," he explained. State-owned petrochemical company in Saudi Arabia, SABIC has even issued a 20-year sukuk.

When companies take advantage of Korea sukuk issuance capabilities similar advantages can be obtained.

The Saudis are planning sukuk for IWPP Desalination , learning from Malaysian experience in issuing Sukuk for IWPs. The Islamic investors are expected to strongly support the sukuk

Unfortunately, corporate taxes are still issues in Korea because the Sukuk law is not yet passed.

[Imsanggyun News]

Daily News &,  



My Say: Differences in sukuk jurisdiction

By Zahid Aziz

Email us your feedback at ( The Edge Daily 19 Nov 2007)

While Islam has declared war on riba (usury), many Muslims interpret that as allowing them to practise and develop Islamic banking gradually — letting it coexist with conventional banking so that its beauty and advantages will shine through better understanding of the system. Hence, it will allow more people to use it and perhaps later, opt for the Islamic way of doing banking.

That's what we assumed as acceptable under syariah. However, to equally as many Muslims, a clear interpretation of syariah does not support such a notion; what is haram (forbidden) is haram and cannot be condoned in any manner. But many Muslims, being seasoned apologists for their religion, condone riba banking and allow it to exist side by side with Islamic banking. As a result of setting up a competitor with many rules, to compete with one which doesn't have to observe such rules, we see a mutated version of Islamic banking appearing everywhere, moulded not so much by the demand of syariah but that of unfair competition.

Therefore, what we see everywhere is Islamic banking in the sense of a wolf in sheep's clothing. No doubt, the wolf's claws are somewhat trimmed and manicured but that aside, it's still very much a wolf. There are many who fail to see much difference between what is called Islamic banking and its conventional alternative.

Righteously, the illiterate ummah or Muslim community are being criticised for not seeing the difference between a transaction with a syariah akad (solemnisation/agreement) and one without, but deep down I sympathise with their confusion because true Islamic banking is not allowed to flourish. Many wise men tell some of us that mudharabah (profit sharing) and musyarakah (joint venture), which are considered the true proponents of Islamic banking, are impractical and only for the dreamers.

Let's us not fail to see the wood from the trees. The banking industry has never known any other form of banking until Islamic banking started making its appearance. Conventional banking flourished unperturbed and has developed into a university of knowledge that holds sway as the only practical way to do banking. Subjects, such as derivatives and risk management, derive from this body of knowledge.

Against this background, let me begin to compare the merits of Islamic banking by using the following analogy. During my university days, I remember my English mate who told me he did not like curry very much. His version of the curry was this: you cut the apples into small pieces, boil them with raisins, throw in some curry powder and then give it a good stir until it all seems cooked. I then invited him for a meal at a local Indian restaurant and purposely ordered some curry and rice for my friend. He polished his plate and told me he was so wrong about the curry and it was actually very nice.

Now, Islamic banking in a dual banking environment is your curry with apple and raisins boiled in curry powder water. Islamic banking on its own, without the existence of conventional banking, is your home-cooked curry your mother makes.

Decisions are coloured by what the ummah know and don't know. Do we know that mudharabah and musharakah have macro objectives? Do we know that mudharabah is a tool in the Islamic economic system meant to rope in idle capital into the economic machine? Do we know that musharakah is the Islamic economics answer to a world free of economic recessions? More pertinently at the individual level, do we care?

For many within the community, they apparently don't care. So, who should take heed if the individuals don't care? Obviously, the answer is the authorities.

The next question is: are our policymakers aware of the philosophy and hikmah (wisdom) of Islamic banking? In my view, an honest answer is a sad no. How many times did we not see central bankers govern Islamic banking with little understanding or sympathy of its hikmah and objectives? Is it the vogue now for central bankers to impose strict risk-management practices on Islamic banks with exactly the same rules for conventional banks?

Do they think that conventional banking is a "this is my money, pay me back at all costs" system, compared with Islamic banking which tries to implement economic justice between contracting parties and shoulders macro objectives for the bigger economy? Where do mudharabah and musyarakah rank in the context of risk management? Are they not the conventional risk managers' nightmare? So, is it right to insist that Islamic banks adopt the same risk management rules as conventional banks? Are the present captains of Islamic banking appointed to run Islamic banks today fully aware and conversant with the philosophy of Islamic banking?

To extend the argument further: do we acknowledge that an Islamic banking system is merely part of a larger Islamic economic system operating within the confines of hudud and syariah law and meant to govern people to whom the akhirah (hereafter) — many times more important than the world we live in today — is the key objective? Until we see Islamic banking within this perspective, we will not do justice in any of our judgements on it.

The dilemma faced by Islamic banking today is well illustrated in sukuk developments in three jurisdictions — Malaysia, the Gulf countries and Saudi Arabia. Sukuk, for the uninitiated, is your Islamic bonds, which are the flavour of the century in financing mega projects in the world today. They are so popular now that even a state in Germany has used them to raise funds.

Malaysia started the ball rolling with the issuance of sukuk. The Kuala Lumpur International Airport Islamic bond issue of RM2.2 billion in 1996, of which this writer pleads guilty to be principally responsible for, is said to be the one that kick-started the sukuk industry in Malaysia. The Guthrie sukuk, pioneered by Bank Islam (Labuan) a little later, became the precedent used by sukuk arrangers throughout the world. The trading of debt in Malaysia is objected to by some, although supported by the Shafie Islamic school of law (Malaysian Muslim Sunnis are from this school of thought) provided it is dayn mustaqir, that is, valid and collectible debt.

I do not wish to enter a debate here but what I would like to highlight is the existence of a particular group in the Malaysian Islamic finance industry which exerts an exceptionally strong influence. When a particular Islamic finance product or syariah interpretation seems quite unwieldy, the Islamic bankers or scholars usually get the blame. Little blame is ever put on the legal advisers.

However, in Malaysia, the legal advisers have a big say in the shaping of the final version of Islamic finance products. Their final decision as to what is or is not acceptable has stunted many Islamic products. When Islamic banking emerged in 1983, the government basically said: "Here is the Islamic Banking Act, but we are not going to amend any other law. You have to work that out yourselves. Any disputes in Islamic banking go to the civil courts, not the Syariah Courts."

That set the tone for Islamic banking in Malaysia. The players not only have to comply with syariah but also with every civil law. Scholars or Islamic bankers will never allow any clear contradictions with syariah, but the legal advisers have the talent to drive things into no man's land, with the aim of complying with civil law and syariah. What results is usually an Islamic product that is not "pristine" and one that does not blatantly contradict syariah or offend civil law.

Now, how do they fare in the Gulf? In sukuk, they have steered clear of the objections to Malaysian debt sukuk by some clever structuring using the principle of musyarakah. But they make an about-turn in some features, turning the musyarakah sukuk into just another debt sukuk. I am referring to the purchase undertaking by the clients and the profit tanazul by the sukukholders/musyarakah partners.

Under the purchase undertaking, the clients give the sukukholders a guarantee that the musyarakah investment is profitable. If it ever makes a loss, they undertake to buy the sukukholders' share. Now, any beginner in Islamic banking fiqh (jurisprudence) will know that one simply cannot guarantee profits in a musyarakah venture; it goes against the basic principles of musyarakah.

The musyarakah partners agree on a profit-sharing ratio. Every six months, profits are shared according to this ratio. However, in return for the purchase undertaking, the sukukholders reciprocate by a tanazul or "rebate" of profits in excess of an agreed amount, usually Libor (London inter bank offered rate) plus an agreed percentage. Many people find it strange for one partner to give away its share of the profits to another in a musyarakah. Why do they do these things: purchase undertaking and tanazul of profits?

Many people who invest in sukuk are conventional bond market investors or Muslim investors who leave the decision making to conventional advisers. These people tell the sukuk arrangers and issuers, "Call it what you like, but make sure your sukuk have these two conventional requirements and we will invest in it." Thus, we see another example of those from conventional banking dictating the terms of Islamic instruments.

For as long as monied Muslim individuals or institutions leave investment decisions to conventional advisers, we will not see truly syariah-compliant instruments coming to the market. Like most things in Islam, things do begin with the ummah. Allah says in the Quran: "We will not change the destiny of a people until they begin to change themselves."

Let's now turn to Saudi Arabia which started later than most in Islamic banking and sukuk. But to its credit, it had no pretensions: it was willing to learn from whomever has more experience. But it tolerated no short-cuts in syariah interpretation. In this country, courts and judges decide based only on syariah and syariah law is supreme. It will not compromise on syariah in implementing Islamic finance.

So, forget about the Malaysian sukuk and the Gulf sukuk; neither is acceptable in Saudi Arabia. It objects to the Malaysian interpretation based on the issue of "inah or reflection of riba" and the Gulf sukuk for the reasons above. The battle lines are drawn between the Saudi scholars and the conventional bond market. The Saudi scholars will not budge. There is a stalemate, although some breaches in the defence were seen recently over two major sukuk issues, which conservative Saudi scholars are not happy with. Alas, in Saudi Arabia, Islamic bankers have found a fort where conventional pressures hold no sway.

Muhammad Zahid Abdul Aziz has more than 17 years' experience in Islamic banking and capital market. He started with Bank Islam Malaysia Bhd, later managed ICM Consultancy and syariah advisory company, Muamalah Financial Consulting. Now based in Riyadh, he is a full-time sukuk and Islamic investment banking consultant to Saudi Arabia's Bank AlBilad.



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