The Impact of Ownership Risk in True Sale-Based Financing on Profit Charges: A Structural Equation Modelling (SEM) Approach

Abstract

The fundamental principle of true sale is based on the ownership state of the subject matter of sale where the selling party must own the asset legally and keep full ownership of the goods before making the sale. In the riba-free system, the Islamic bank assumes a role of a trading entity. It undertakes a trading position and exposes itself to business risk as the asset is booked on its balance sheet. It follows that the profit rate it charges the customer will reflect an additional risk-premium to account for the business risk exposure. Due to business risk exposure, this study introduces the financial infrastructural constraints on the use of true sale-based Islamic financing namely 1) economic capital requirement for the on-balance sheet holding of tradable assets and 2) the tax charges by the fiscal authority on the purchase of tradable assets by the bank. Thus, based on this premise, the objective of this study was formulated to empirically investigate the impact of these constructs (cost of fund, overhead, default risk, capital charges, tax burden and profit rate) on profit rate of true sale-based financing. A Survey questionnaire and a semi structured interview were the tools used for data collection. The analysis was done by using Structural Equation Modelling (SEM) technique and the findings revealed that all independent variables except for cost of fund, have positive and significant impacts towards profit rate charged. Given the findings of this study, it is recommended that the true sale-based Islamic financing is to be funded by investment fund rather than deposit fund. Hence, the additional capital and tax charges will be absorbed by the investors. From this study, we hope that future research could be expanded further by investigating cross border Islamic banking practices in terms of the pricing of true sale model and closer comparison can be made between Malaysian Islamic banks and Foreign Islamic banks.