By: Dr. Mohammad Mahbubi Ali
Head of Economics, Finance, Zakat and Awqaf
International Institute of Advanced Islamic Studies (IAIS) Malaysia
The COVID-19 outbreak was first identified on 31 December 2019, in Wuhan, a city in China with a population of around 11 million, before it escalated into a worldwide pandemic. As of 14 August 2020, 21.33 million people have been infected by the virus around the world with a total death toll of 762,331, whereas 14.12 million people have recovered, representing more than 66% of total infected cases, leaving 6.4 million active cases globally.
As the global health crisis peaked, lockdowns to restrict movement have been the preferred mechanism to reduce the infection rate of the virus. Imposing a lockdown necessitates the closure of economic and business activities, including the restriction of travel between borders.
In Malaysia, the implementation of Movement Control Order (MCO) in Malaysia to curb the COVID-19 pandemic since 18 March 2020 has mandated the closure of all government and private premises, except those involved in essential services. This measure has impacted the cash flow of the general public, and both small and medium-sized enterprises (SMEs), affecting their capability to fulfil bank obligations.
In view of the above, the government on 25 March 2020, announced an automatic six-month moratorium on loan/financing repayments starting 1 April 2020. According to Bank Negara Malaysia, this moratorium on all loan/financing repayments is expected to ease the cash flow of SMEs and individuals that are likely most affected by COVID-19.
Moratorium from Shariah Perspective
In Islam, the creation of indebtedness, within the capability to repay it, be it resulting from a benevolent loan or a deferred sale contract, is permissible. However, a debtor is responsible for making timely payment of his obligations or as demanded by the creditor. The Qur’anic command to ‘fulfil (all) obligations’ clearly urges the practice of honouring commitments, including debt. Failure to fulfil a timely payment by a solvent debtor is deemed a breach of other rights and may be subject to punishments. This is based on the hadith which says that “delay in payment on the part of one who possesses means makes it lawful to dishonour and punish him”, in which according to Ibn al-Mubarak, “dishonour” represents being subject to harsh words and “punish” represents imprisonment. There is also this famous hadith censuring debtors that avoid paying their dues despite being capable: “Procrastination by a solvent debtor is oppression” (HR. Bukhari and Muslim).
However, if a debtor is facing genuine difficulty to pay his obligation in due time, the creditor is advised to grant the debtor a time extension: “And if someone is in hardship, then [let there be] postponement until [a time of] ease. But if you give [from your right as] charity, then it is better for you, if you only knew” (Quran 2:280).
This verse was initially revealed to Bani Tsaqif asking the payment of their receivables from Bani Mughirah, who was insolvent. The latter then requested for an extension of payment to the former until the next harvest.
Muslim jurists are unanimous that a creditor is obliged to provide postponement of payment to an insolvent debtor. Ibn Rushd argued that demanding for payment is only warranted if the debtor is solvent. Otherwise, the debtor is given the repayment moratorium until he is financially capable of doing so.
The verse also implies the prohibition of any increase over and above the outstanding amount of obligation as a result of the given postponement, for this will trigger the issue of riba jahiliyah or nasi’ah. BNM’s press release on 1 May 2020, however, allowed the recognition of accrued profit over the deferment period for hire purchase and fixed-rate Islamic financing. This has invoked various contentions and criticisms on how BNM communicates its policy. However, BNM’s position was later reversed by the Minister of Finance on 6 May 2020 who affirmed that the moratorium would not invoke any extra charges including modification loss.
On the whole, a debtor in Islam is classified into two types: solvent and insolvent. A solvent debtor is compelled to fulfil his timely obligation; thus, he is not entitled to an extension of payment. The debtor’s refusal to make timely payments, while being able to pay it, might be subject to punishment. In some incidents, forced selling of the collateral under a court order is necessary to recover the creditor’s outstanding debt. On the other hand, an insolvent debtor shall be given sufficient extension of time to settle his obligation until he is financially capable of paying.
In view of the above, the three-month targeted moratorium extension announced by the Malaysian government on 29 July had taken into consideration the status of bank clients who either lost their jobs or had pay cuts and are now insolvent as a result of this. The banks are granted the authority to identify their customers’ eligibility for a moratorium which will also ensure the banks’ financial liquidity and business sustainability amid this extraordinarily challenging time.
Repayment moratorium for insolvent customers is also in line with the ultimate objectives of the Shariah on the protection of life and the protection of legally-owned property, which in this case are the people and SMEs affected by COVID-19.
Impact on the Islamic Banking Industry
The World Economic Outlook released by the International Monetary Fund in June 2020 projected that the world would endure a negative economic growth up to -4.9% in 2020; which marks a further 1.9% decline compared to the April 2020 forecast (-3%).
As the global economy braces for an economic downturn and a prolonged recession, Islamic banks are not exempt from the adverse negative impact on their profitability, asset quality, and liquidity.
The S&P Global Ratings forecasted that Islamic banking sectors would suffer from a drastic drop in revenue in 2020, recording only a low-single-digit growth as a result of government measures to contain the COVID-19 pandemic. In Malaysia, for example, Islamic banks are now experiencing lower financing margins resulting from the slashing of BNM’s base rate to 1.75% p.a., lower fee-based income due to lesser demand for certain banking services, slower financing growth, and a drop in investment returns due to a capital market slump. The government’s six-month moratorium on loan and financing repayments, which has been extended for targeted customers, would further deepen the profit decline of the Malaysian Islamic banking industry for the year 2020.
The pandemic has also exposed Islamic banks to an increase in Non-Performing Financing (NPF) and gross impaired financing (GIF) due to a high number of business closures and rising unemployment rate. Many customers worldwide were placed under quarantine, movement controls, and even total lockdown, as part of their government’s containment measures. As a result, many are facing cash flow deteriorations and lose the ability to pay their bank instalments. In Malaysia, the S&P Global Rating estimated that the NPF would elevate up to 1.7-1.8% of the outstanding financing in 2020, compared to 1.5% on 31 December 2019. In support, Moodys’ Investors Service, the US-based credit rating agency, has raised concern on asset deterioration of the banking industry in Malaysia due to the six-month moratorium policy. The moratorium would only soften the negative impact on banks' asset quality in the short run, but if the pandemic is prolonged, the bank’s impaired loan/financing is expected to increase by the end of the moratorium.
Apart from that, the pandemic might also increase the liquidity risk for Islamic banks due to massive withdrawals from depositors. This is especially true since depositors might now have to start withdrawing their savings to sustain their livelihood. Concomitantly, new depositors would prefer to place their funds in safe-haven assets such as gold. On the other hand, the credit default risk might rise significantly due to the increase in business shutdowns and unemployment. Additionally, the delay in cash inflow due to moratorium will also increase the liquidity risk of Islamic banks. Against this backdrop, Bank Negara Malaysia (BNM) has taken a pre-emptive measure to enhance banks’ liquidity capacity via the reduction of the statutory reserve requirement ratio by 100 basis points.
Nevertheless, the coronavirus crisis does offer new opportunities to Islamic banks. As the world reacts to the COVID-19 pandemic and adjusts to the new normal of social distancing, reduced physical interaction has become a priority. The banking industry is now forced to explore new avenues and alternatives to in-person banking and physical exchanges in conducting their daily operations. The World Health Organization (WHO), for instance, recommends the use of contactless payment without physical handling of banknotes. Accordingly, the adoption of digital finance and financial technology (fintech) are becoming indispensable to the industry to move forward post-COVID-19.