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ScienceDirect Procedia - Social and Behavioral Sciences 129 (2014) 380 – 387

ICIMTR 2013 International Conference on Innovation, Management and Technology Research, Malaysia, 22 – 23 September, 2013

Developing a Framework of Islamic Student Loan-Backed Securitization Shafinar Ismaila, Mohammed Hariri Bakri b, Rosalan Alic, Azman Mohd Noord a Faculty of Business and Management,Universiti Teknologi MARA, Bandaraya Melaka 75300, Malaysia Faculty of Technology Management And Technopreneurship, Universiti Teknikal Malaysia, Melaka 76100, Malaysia c Arshad Ayub Graduate Business School,Universiti Teknologi MARA, Shah Alam 40450, Malaysia d Kulliyah of Economy,Universiti Islam Antarabangsa, Kuala Lumpur 50728, Malaysia

b

Abstract Research has shown that the default rate is higher for those countries that implement the mortgage-type loans. Many researchers have tried to address this issue, usually by analyzing the repayment collections to reduce the default rate. The introduction of asset-backed securitization (ABS) in Malaysia has benefited the economy. Though only spanning over eight years, the securitization process and its continuous innovation have contributed to resolving and risk managing problems such as lease, auto loans, credit cards receivables and commercial mortgages. This study particularly focuses on the student loan problem, which has not yet been implemented as a securitization process in Malaysia. This work considers the characteristics of Malaysian higher education, suggests a structure for student loan securitization, and studies the potential of the asset-backed securitization conceptual framework in resolving the problem. The expectation is that the new financial instrument will benefit both the students and the government. The main purpose of this research is to investigate the use of Student Loan-Backed Securitization that meets shariah-compliance and can be implemented in Malaysia. It is expected that the Capital Theory may contribute significantly to the positive testimony of Islamic student loan-backed securitization framework. This framework is proposed to create its structure and issue a highly graded and marketable sukuk that complies to global shariah principles, and hence, help the Malaysian government to enhance its National Key Economic Area in meeting its quality global Islamic financial market. © 2014 Authors. Published by Elsevier Ltd. Open and/or access under CC BY-NC-NDunder license. the responsibility of Universiti © 2013The Published by Elsevier Ltd. Selection peer-reviewed Selection and peer-review under responsibility of Universiti Malaysia Kelantan Malaysia Kelantan, Malaysia.

Keywords: student loan-backed securitization; debt financing; default rate; capital theory *

Corresponding author: Fax : +606-2857115 E-mail address: [email protected]

1877-0428 © 2014 The Authors. Published by Elsevier Ltd. Open access under CC BY-NC-ND license. Selection and peer-review under responsibility of Universiti Malaysia Kelantan doi:10.1016/j.sbspro.2014.03.691

Shafinar Ismail et al. / Procedia - Social and Behavioral Sciences 129 (2014) 380 – 387

1. Introduction As of May 2012, National Higher Education Fund Corporation (NHEFC) has approved loans for some 1.98 million students amounting to RM 44.18 billion, with the actual dispersed stood at RM30.44 billion, (The Star, 2012, p. 3). While the total sum owed to NHEFC is RM 6.83 billion from 1.09 million borrowers, the corporation has so far only managed to collect RM 3.31 billion. Further statistics by the Corporation indicated that although many NHEFC borrowers are showing their interest to pay, the actual sum collected still remains low. In fact, 31,606 borrowers owing RM 1.06 billion were allowed to postpone their payment due to factors such as illness or pursuing higher degree. Surprisingly, around 30% of loan distributed went to those enrolled in private higher education institutions (IPTS) but the sum borrowed by those in IPTS represented almost half of the total allocation. As shown in Table 1, out of the total loan disbursed amounting to RM 36 billion, only RM 3 billion get repaid. Table 1. Financial Performance of NHEFC as at Year 2012 Year

Total Loan Given

Amounts Repaid

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 TOTAL

206,241,009.99 339,934,818.89 1,732,195,737.57 1,714,812,964.04 1,946,943,725.89 1,850,338,773.27 1,760,516,923.79 2,232,558,806.30 2,729,139,554.40 2,759,046,462.35 1,393,712,458.93 2,294,924,546.60 4,382,707,245.60 5,439,760,091.02 5,093,409,885.78 35,876,243,004.43

51,140.29 2,806,729.29 5,038,062.82 9,368,342.38 34,226,036.40 44,186,636.56 97,391,382.78 192,499,693.05 294,754,233.96 346,682,054.87 553,689,886.03 638,402,260.80 737,591,119.90 2,956,687,579.13

Number of Students Loan Given 11,279 17,223 85,429 86,441 98,940 97,854 108,654 118,114 142,205 130,323 60,585 103,549 166,272 215,539 207,963 1,650,370.00

Source: NHEFC, 2012 Of the 600 IPTS under the Ministry of Higher Education (MOHE), some 434 institutions depend on NHEFC. Since they represent about 70% on NHEFC, on one hand, it could cause them to close down if the loans were abolished. Sources from the Corporation, on the other hand, claim that only around 30% of those paying back their loans are doing so consistently. However, based on the MOHE’s 2011 Graduate Tracking Survey, around 40 000 graduates in the country were still unemployed. In addition, a review of literature on student loans indicates that the problem is not a research priority in Malaysia (Ismail et al., 2011). The majority of investigations have taken place in the United States (Hartung et al., 2005). This paper thus attempts to investigate whether student loan-backed securitization is suitable as an alternative financing in the Malaysian higher education (HE), in order to relieve the pressure currently imposed on the government budget. We will analyse and consider possible effects of introducing student loan securities as a type of asset-backed securitization. Student loan securities have been implemented in other countries; however, it is a new concept for Malaysian HE especially in the

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Islamic student loan-backed securitization which is new and the first in the world (Ismail & Serguieva, 2009). In a particular country, government and private parties have their own system to finance their higher education students (Chapman & Harding, 1993; and Barr, 2003) and each country adopts different way to handle it. Many goverments set up an institution or a corporation to manage student loans (Chapman, 2006) to offer to univerity students who qualify for the loans. According to Khan (2008), main reasons for non-repayment of student loans are their unemployment and desire to continue for higher degree. In Malaysia, government formed NHEFC in 1997 to provide loans for higher education students (NHEFC, 2013). This was for those who qualify to pursue their studies in higher learning institutions but did not have any assistance or scholarship from the governement such as MARA, JPA, Bank Negara Malaysia, Petronas, Telekom, Tenaga, and Khazanah. Federal government through NHEFC offers assistance to the selected students with nominal charges so that it will not burden the students when they want to make repayment, and gives special incentive to write off their educational loans when they obtained their First Class degree. As such, government of Malaysia has provided budget for educational loans with a big amount of money every year. Many countries now, unfortunatley, cannot depend on the government budget due to economic crisis in which they need to reduce their deficit budget. This is a justifiable remark as they have to allocate to other expenditures such as public healthcare, housing and schools (Ziderman, 2004). Likewise, a request by NHEFC in 2007 for RM 2 billion was rejected due to government focus on public infrastructure, healthcare and other social needs for Malaysian citizens. As such, NHEFC has to find other alternative such as borrowing from EPF which is under Ministry of Finance but has limited educational funding. Due to limited fund from government and its agencies, the government plans to allow NHEFC to work with main banks in Malaysia to provide special educational loans for students (Annual Budget, 2013). However,the authors still believe that the students will be not happy as they may have to pay higher interest expenses than they have paid currently about 2% per annum to NHEFC. Therefore, this study intially will offer the alternative source for funding students loans by securitizing student loans through Islamic ABS instrument, reffered to as Islamic student loan backed securitization (i-SLBS). Ultimately, this i-SLBS will attempt to offer interest free source of educational loans to university students and a form of investment to Muslim investors based on Islamic principles. Two types of framework to finance higher education students are implemented in most countries: income-contingent loans and mortgage-type loans (Chapman, 2005; Barr, 2003; Ziderman, 2004; Ismail et al., 2011). The income-contingent loans type is proportionate to income; whereas mortgage-type loan repayments are based on a monthly fixed rate. The latter usually contributes to low repayment collection compared with income-contingent loans (Chapman & Ryan, 2005); this is because the system itself allows the opportunity to default. In the case of the mortgage-type loans, the borrower of the loan has a repayment contract after graduation, which sets the fixed monthly repayment rate and repayment term (Cartwright, 2008). Moreover, income-contingent loan schemes depend on graduate earnings; graduates with lower lifetime earnings pay less (or do not pay at all), whilst those with higher earnings pay higher or in full (Palacios, 2004). As a result, the default rate is low in the case of this scheme (Ismail et al., 2011). In order to implement the income-contingent loan system, it is a requirement that the countries have strong tax system links with the government and organization providing loans (Ismail & Serguieva, 2009). Developed countries, such as the USA, the UK, Australia, and Canada, all use income-contingent loans as a type of repayment collection; however, owing to the weak tax system and coordination problem with the government and loan provider, the system is not very successful in developing countries. Notably, research has shown that the default rate is higher for those countries that implement the mortgage-type loan (Barr, 2003; Chapman, 2006; Ismail et al., 2011).


2. Success Stories of Students’ Loan Securitization in Chile and South Korea Chile’s higher education system stands out as being one of the most privatized and open to the market in the world. The Chilean Congress passed Law # 20.027 of 2005, which provides the legal framework for the creation of a student loan system guaranteed both by the State and by higher education institutions (HEIs), financed by the private capital market through the securitization of the loans (Ismail & Serguieva, 2009). The system operated for the first time in 2006, in which approximately 21,000 students were able to access financing of their higher education for the remainder of their careers. It is expected that as the system matures, more and better information will be available and this will benefit the students and the HEIs. Additionally, it is highly likely that the current number of financed students could grow significantly in the next few years. The old model does cover for tuition fees only but the new model suggested by Larraın and Zurita (2007) state that the student loan must extend coverage of the loans to include not only registration, but also reasonable cost of living, thus further improving access to higher education. Likewise, in examining the student loan policies in Korea, Hong and Chae (2011) found the presence of evolution, opportunities and challenges that contribute to the success of its student loan securitization. They testify that the role of reforms in its student loan policies has managed to contribute to the expansion of higher education from a historical perspective. Interestingly, they conclude that since 2005, the student loans-backed securities have played a major role in promoting the affordability of higher education for all in Korea. However, they are cautious as there is a growing need to secure its sustainable funding mechanism. It is in this study that researchers attempt to structure student loans-backed securities based on Islamic principle in the Malaysian higher education institutions. 3. Benefits of Securitization ABS can reduce bankruptcy costs for some firms (Ayotte & Gaon, 2005). Moreover, asset securitization can lower firm’s overall cost of financing which can be predicted by this model as introduced by them. In addition, Ali and Jaafar (2012) in their findings, support past studies on benefits of asset securitization and interestingly verify that MBS provides highly rated long term investment to bank institutions, insurance companies and fund managers. Hence, this increases its net assets value for financing government staff housing loans in Malaysia. Lemon, Liu and Mao (2010), show that nonfinancial firms collected from firm’s 10,000 disclosures tested a number of predictions using a large database of asset-backed securitizations. Their finding supports the economic benefits in the form of lower overall financing costs through the use of securitizations to a company and better investment return to market participants as they appear to understand how these transactions affect the firm’s assets and credit risk, and hence, this gap becomes the thrust of this study. 4. Capital Theory Human capital theory posits that individuals treat the commodity of higher education as an investment. According to human and financial theory a notion of formal higher education renders individuals more productive in which employers recognize them and then remunerate based on education qualification and relatively based on higher marginal product. In obtaining job in the formal sector where the salary appears to be higher, that demands for higher education level to be based on knowledge (Sarpong , 2002). One of the factors that derived demand for higher education is economic determinant, such as expected rate of return from the educational investment. A review of the higher education literature should include the analysis of individual’s higher education choices. Robbins Committee in the United

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Kingdom in 1963 as cited by Menon (1998) has attempted to isolate and determine the main influence on the private demand of higher education. The results shows that certain variables that influence such as family background and economic and qualification are needed, and are based on level of education in prospective employers, as well as cost of tuition (Hsing & Chang 1996 and Li & Min 2001), family income (Mueller & Rockerbie, 2004), and financial aid for students (Michael, 1999). One of the alternative ways to solve the demand for higher education is to give loan to students. According to the OECD's Education Clance 2011 as cited by Willet (2011), 14 out of 25 countries (for which data is available) have reformed tuition fees and support for students since 1995. Tuition fees, as expected, have been increasing in Australia, Austria, Japan, the Netherlands, New Zealand, Portugal, and the U.S.. Interestingly, the U.S. ranks ninth worldwide in the proportion of young adults (age 25-34) who completed a four-year college degree, at some 41 percent, according to Peter McPherson and David Shulenberger (The Wall Street Journal, June 20, 2009). As tuition fee rises, therefore, more U.S. students (and their parents) simply will not be able to afford college (Mcpherson & Shulenberger, 2010). In both industrialized and developing countries, since student loans are increasingly demanded, it is viewed important to have a method of financing higher education as it can transfer parents’ and students’ financial burden to the government (Woodhall, 1987; Johnstone, 1986). This remark is notable as one of the basic premises of student loans and that is “study now and pay later”, which is a deferred payment. The absence of collateral makes human capital investment indeed more risky than any other forms of investments. For instance, Friedman (1955) raised the presence of risk and uncertainty in human and financial investment, notably financing student loans. In order to reduce this notable risk, student loan securitization was introduced, with reference to student loan backed bonds (Lazzaro, 2008) in raising educational funds. For this view, Fan, Sing, Ong and Sirmans, (2004) define the raising of fund through a process of issuing asset-backed securities (ABS) that are backed from revenue producing asset which generates future cash flows. Asset securitization, however, differs from collateralized debt or traditional asset-based lending in that the loans or other financial claims are assigned or sold to a third party, typically a special-purpose vehicle (SPV) or trust. According to Giddy (2000), interest and principal payments are dependent on the cash flows coming from the underlying assets, in which SPV issues one or more debt instruments, referred as asset-backed securities (ABS). 5. Proposed Conceptual Framework of Islamic Student Loan-Backed Securitization (i_SLBS) In view of this, as a creative debt financing that acts as risk management tool, Sukuk ABS can appeal investors from the Middle-East countries. In fact, according to IIFF Europe that was held in Geneva in November 2006, it was estimated that Arab investors have more than US$ 800 billion on deposit in overseas banks, much of which is secured in Swiss banks. Likewise, calls for Arab investors to repatriate their wealth in the wake of 9/11, sluggish western stock markets and attractive Middle-East property investment opportunities, have seen many hundreds of millions of dollars return to the Middle East. Nevertheless, this is reiterated by the launching of Malaysia Sukuk ABS in 2005 as its global acceptance can be an evidence for Malaysian companies to undertake the issuance as a creative and cheaper debt financing option for the future. To reflect the global credit crisis, Islamic bond market was without exception when its issuances in 2008 dropped to US$7.3 billion or 54% decline of UD$15.7 billion in 2007. However, it makes a strong comeback in 2010 with a whopping value of US$51.5 billion, representing a superb rise of 54% compared to 2009. Likewise, it is interesting to note that Malaysia still maintains number one issuer for Islamic global bond by dominating about 54% in 2008, 60% in 2009 and superbly at 78% in 2010 with a whopping value of US$40 billion as monitored by Zawya (2011). Since Islamic securitization is part of Islamic bonds or sukuk in Malaysia, the study is strongly motivated to propose the framework for Islamic Student Loan Securitization as follows.


Malaysian Trustees Berhad (Trustee)

Federal Government/MOHE

Merchant Bank Prepares transaction reports and document

,

Kafalah/Rihn (Investors)

Hawalah (Assignment of debt)

NHEFC (Originator/ Servicer) Administrator

SPV (Wakeef)

Transfer with recourse

Sukuk issued to investor

SukukWakalah (51% Tangible Asset, 49%Financing/ Commodity Murabahah)

Proceed from Sukuk

Student Financing Insurer

Student Monthly deductions

Provide takaful to cover student loan

Post office, BSN, Commercial Banks Collection channels

AKPK, BNM, KWSP, Angkasa, SSM, JPJ, LHDN, JPN Government agencies link to NHEFC in controlling and enforcing student database

Figure 1. Proposed Conceptual Framework of i-SLBS MOHE - Ministry of Higher Education

AKPK – Counselling Credit

BNM – Central Bank

KWSP – Employees Provident Fund

Angkasa–National Cooperative Society in Malaysia

SSM –Registrar of Malaysian Companies

JPJ –National Road Transport Department

LHDN – Inland Revenue Board

JPN – National Registration Office

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6. Conclusion and Recommendations With the success stories of Malaysian sukuk in international bond market, the launching of student loans-backed securities based on Islamic principle will appeal Muslim investors, not only in Malaysia but also overseas, notably Middle-East countries. This is supported by the fact that Malaysia still maintains number one issuer for Islamic global bond by dominating about 54% in 2008, 60% in 2009 and superbly at 78% in 2010 with a whopping value of US$40 billion. Likewise, calls for Arab investors to repatriate their wealth in the wake sub-prime crisis in USA and Euro-Debt Zone crisis have seen many hundreds of billions of dollars return to the Middle East. In fact, the global economy is currently facing sovereign debt crisis that is spreading quickly across European region that led to uncertainty among banks particularly towards the credit worthiness of their counterparts since they had invested very much and charged overpriced financial products. As such, Islamic finance has got a wide attention as an alternative form of global financing and investment, particularly asset-backed securities. Therefore, the successful launchings of Malaysian Sukuk ABS in 2005 for its global Shariah acceptance will become a strong testimony for big Malaysian companies to issue it as a creative and cheaper debt financing in the near future. Since Islamic securitization is part of Islamic bonds in Malaysia, the study is strongly motivated to propose the framework for Islamic Student Loan Securitization in Malaysia, for both markets. Acknowledgement This research has been presented in a conference and was supported and funded by Ministry of Higher Education and Universiti Teknologi MARA. References Ayote, K. and Stav, G. (2005). "Asset-Backed Securities: Costs and Benefits of Bankruptcy Remoteness", Texas Finance Festival. Barr, N. (2003). Financing higher education: Comparing the options, UK: London School of Economics and Political Science. Chapman, B. (2005). Income Contingent Loans for Higher Education: International Reform, Centre for Economic Policy Research, DP No 491, Australian National University. Chapman, B. (2006). Government Managing Risk: Income contingent loans for social and economic progress, Routledge, London. Chapman, B. &Harding A. (1993). Australian Student Loans, The Australian Economic Review. Chapman, B., & Ryan, C. (2005). The access implications of income-contingent charges for higher education: lessons from Australia. Economics of Education Review, 24(5), 491–512. Fan G-Z., Sing T. F., Ong S. E. and Sirmans C.F. (2004). Governance And Optimal Finance For Asset-Backed Securitization, Journal of Property Investment & Finance. Volume 2 (5), 414-434 Hartung, D. D., Laterza, R. D. and McGarvey, S. (2006). Methodology FFELP Student Loan ABS Criteria, DBRS. Hsing, Y. and Chang, H.S. (1996). Testing Increasing Sensitivity of Enrolment at Private Institutions to Tuition and Other Costs. American Economist, 40 (1), p.40-45.


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