Islamic Deposits and Investment Accounts in Income Smoothing in Post-Reclassification of the Islamic Financial Service Act 2013

This study attempts to determine the impact of the reclassification on income smoothing practices by Islamic banks in Malaysia through loss provisions. It is well acknowledged that Islamic banks set up an allowance for loss provisions in order to absorb any future losses. However, alternative mechanisms, such as Profit Equalization Reserve (PER) and Investment Risk Reserve (IRR) instead of loss provisions, are used to smooth income. This study determines whether the exercise by Islamic banks in Malaysia to reclassify Islamic deposits to investment accounts after the enacted Islamic Financial Service Act (2013), may have caused unintended consequences in less profit payout to investment account holders. The results do not indicate any unintended consequences of less profit payout to investment account holders from the present exercise by the Islamic banks in Malaysia to distinguish Islamic deposits from investment accounts.
JEL Classification G21, G32
Full Article
  1. Ahmed, J. and Kohli, H.S., 2011. Islamic Finance. Writings of V. Sundararajan, SAGE Publications
  2. Archer, S. and Karim, R.A.A., 2006. On capital structure, risk sharing and capital adequacy in Islamic banks. International Journal of Theoretical and Applied Finance, 9(3), pp.269-280
  3. Archer, S., Karim, R.A.A. and Sundararajan, V. (2010). Supervisory, regulatory and capital adequacy implications of profit-sharing investment accounts in Islamic finance. Journal of Islamic Accounting & Business Research, 1(1), pp.10-31
  4. Bushman, R. M. and Williams, C.D., 2012. Accounting discretion, loan loss provisioning, and discipline of banks’ risk-taking. Journal of Accounting and Economics, 54, pp.1-18
  5. Dechow, P.M., Ge, W., and Schrand, C., 2010. Understanding earnings quality: a review of the proxies, their determinants and their consequences. Journal of Accounting and Economics, 50, pp.344-401
  6. Central Bank of Malaysia., Accessed at August 13, 2014
  7. Fonseca, A.R. and Gonzalez, F., 2008. Cross country determinants of bank income smoothing by managing loan loss provisions. Journal of Banking & Economics, 32, pp. 217-228
  8. Frait, J. and Komarkova, Z., 2013. Loan Loss Provisioning in Selected European Banking Sectors: Do Banks Really Behave in a Procyclical Way? Finance a uver-Czech Journal of Economics and Finance, 63(4), pp.308-326
  9. Jacob, J., 2014 Reclassifying Islamic banking deposits. Available online at business-news/28167-recla, Accessed at August 13, 2014
  10. Huizinga, H. and Laeven, L., 2009. Accounting discretion of banks during a financial crisis. Working paper International Monetary Policy (IMF) no. 207, pp.1-41
  11. Kanagaretnam, K., Krishnan, G.V. and Lobo, G.J., 2008. Is the market valuation of bank’s loss provision conditional on auditor reputation? Journal of Banking & Finance, 33, pp.1039-1042
  12. Khan, T. and Ahmed, H., 2001. Risk Management an analysis of Issues in Islamic Development Bank, Occasional Paper no. 9, Islamic Development Bank, Jeddah
  13. Kilic, E., Lobo, G.J., Ranasinghe, T. and Sivaramakrishnan, K., 2013. The impact of SFAS 133 on Income Smoothing by Banks through Loan Loss Provisions. The Accounting Review, 88(1), pp.233-260
  14. La Porta, R., Lopez-de Silanes, F., Shleifer, A., Vishny, R.W., 1998. Law and finance. Journal of Political Economy 106, pp.1113-1155
  15. La Porta, R., Lopez-de Silanes, F., Shleifer, A., 1999. Corporate ownership around the world. Journal of Finance, 52, pp.471-517
  16. La Porta, R., Lopez-de Silanes, F., Shleifer, A., Vishny, R.W., 2002. Investor protection and corporate valuation. Journal of Finance, 52, pp.1147-1170
  17. New Straits Times, 2013. “Islamic finance depositors get even more protection”, New Straits Times, July 13, 2013, p. B5
  18. Sundararajan, V., 2005. Risk measurement and disclosure in Islamic finance and the implications of profit sharing investment accounts. Paper prepared at the Sixth International Conference on Islamic Economics, Banking and Finance, Jakarta, Indonesia, November 22-24, 2005
  19. Taktak, N.B., 2011. The nature of smoothing returns practices: the case of Islamic banks. Journal of Islamic Accounting and Business Research, 2(1), pp.142-152
  20. Taktak, N.B., Zouari, Sarra, B.S. and Boudriga, A., 2010. Do Islamic banks use loan loss provisions to smooth their results? Journal of Islamic Accounting and Business Research, 1(2), pp.114-127
  21. Vyas, D., 2011. The timeliness of accounting write-down by U.S. financial institutions during the financial crises of 2007-2008. Journal of Accounting and Research, 49, pp.823-860
  22. Zoubi, T.A. and Al-Khazali, O., 2007. Empirical testing of the loss provisions of banks in the Gulf Cooperation Council (GCC) region. Managerial Finance, 33(7), pp.500-511

Article Rights and License
© 2014 The Authors. Published by Sprint Investify. ISSN 2359-7712. This article is licensed under a Creative Commons Attribution 4.0 International License. Creative Commons License
Corresponding Author
Mohd Yaziz Mohd Isa, Universiti Tun Abdul Razak, Bank Rakyat School of Business and Entrepreneurship, Kuala Lumpur, Malaysia
Download PDF


Mohd Yaziz MOHD ISA
Universiti Tun Abdul Razak, Kuala Lumpur, Malaysia

Universiti Tun Abdul Razak, Kuala Lumpur, Malaysia