Bai’ Bithaman Ajil (BBA) - Financing

Introduction

Bai Baithaman Ajil (BBA) is one of the common instrument practiced in modern Islamic banking & finance. (in Malaysia, Brunei and Indonesia at least)

The BBA is a deferred instalment sale whereby bank capitalizes its profit up front in the sale of the property to the customer who in turn is required to pay a fixed sum until the tenure ends.

BBA is an extension of the Murabahah (cost plus) contract, mainly used for Medium and long-term financing.

It is important to know the difference between Murabahah Sale and BBA for further clarification.

Special features of BBA & Murabahah

BBA

• Final Price should be

contractually agreed and

known to both parties

• Payment of price is deferred

• Time and mode of payment

should be ascertained

• No need to state the cost

price & amount of mark-up

• Long-term financing

Murabahah

• Sale & Purchase based on

trust (aqd al-amanah)

• Requires full disclosure &

transparency between parties

• Cost and mark-up must be

disclosed

• Payment of price either spot

or deferred (if deferred

should be defined as in BBA)

• Short term financing

History & Development

The BBA is widely practiced in countries like Malaysia, Indonesia and Brunei. It has been launched by almost all financial institutions in Malaysia since it was implemented by Bank Islam Malaysia Berhad (BIMB) in 1983.

According to the statistics in BIMB granted 77.6% of its total financing under BBA and 9.7% under Murabahah in 1984.

In 1997, BIMB used BBA and Murabahah as its main income generating products of up to 90.5% of its total assets.

Other banks also reported similar percentages as compared to BIMB.

• On the contrary, It is a highly controversial subject among

Fuqahas’ worldwide and widely being debated with

regards to its permissibility and majority of the Middle

Eastern Shariah Scholars have disapproved it.

• Even though some Shariah councils have agreed on its

permissibility, a guideline from the Council of Islamic

Ideology (Pakistan) in its report on the elimination of

interest states that:

“However, although this mode of financing is understood to be permissible under the Shariah, it would not be advisable to

use it widely or indiscriminately in view of the danger attached to it of opening a back door for dealing on the basis of interest”

Source: The Council of Islamic Ideology Pakistan, (1977), Elimination of Interest from the Economy: Government of Pakistan

Bai Bithaman Ajil structure

Murabahah

• Means a sale contract which selling price is equal to cost price plus profit margin (or mark-up sale).

• Two types of murabahah:▫ Cash murabahah : the purchase settled in cash.▫ Credit murabahah : a credit sale with the purchase

settled by installment payments. • In a credit sale involving assets & properties, one will

use the long-term credit murabahah contract or BBA.

Source: Saiful Azhar Rosly (2005)

The BBA in the Market

The Property Sale Agreement (PSA) : the bank sells the house to the customer at BBA price.

The Deeds of Assignment / Charge : the bank holds the house as collateral.

The Property Purchase Agreement (PPA) : the bank buys the house from the customer.

The Property Sale Agreement (PSA) :the bank sells the house to the customer at BBA price.

The Deeds of Assignment / Charge :the bank holds the house as collateral.

The contracts involved

Pricing Mechanism of BBA

The Property Sale

Fixed Rate BBA Financing

• Monthly installment is calculated based fixed profit rate as shown in the above illustration

• Normally the profit rate charged would be higher than the conventional mortgage rate by 2% to 3% depending on various factors such as short to middle term monetary environment; the pricing and cost of funds of each financier

• Ibra would be given at the discretion of the financier if the customer redeem the financing earlier than the contracted tenure.

Example on Calculation of Monthly Installment

Profit Margin = Profit rate X Purchase price X financing tenure

Selling Price = Purchase price + Profit margin

Monthly Installment = Selling Price / Financing tenure (months)

Eg :

Purchase price or Financing amount = RM 100,000

Profit rate = 9% p.a.

Financing tenure = 10 years

Profit margin = RM100,000 X 9% X 10 years = RM 90,000

Selling Price = RM 100,000 + RM 90,000 = RM190,000

Monthly installment = RM 190,000 / 120 months = RM 1584

Profit

Rate

Tenure

Floating Rate BBA Financing• Monthly installment is calculated based on Effective Profit Rate( EPR) at the time of the application for the financing facility.

• In most cases, the monthly installment would remain the same for the whole financing tenure. Depending on the benchmark profit rate, IFR (Islamic Financing Rate) which is normally referenced to the BLR (Base Lending Rate) or the KLIBOR (Kuala Lumpur Interbank Offered Rate), the EPR would be adjusted accordingly based on the formula shown in the illustration below

EPR = IFR minus 2.0% ; OR EPR = KLIBOR plus 0.2%

• Normally the contracted profit rate (CPR) is calculated based on the following formula :

CPR = IFR plus 4.0%; which is also benchmarked against the movement in IFR.

• In the event that the EPR exceeds the CPR (like in the example below at T1), the EPR charged will equivalent to CPR. In here, the CPR served its purpose as a maximum ceiling profit rate chargeProfit

Rate

Tenure

CPR = IFR + 4.0%

T1(12) (6 )T2T0

EPR = IFR - spread

Floating Rate BBA Financing

Example on Calculation of Monthly Installment and Selling Price

Eg : Purchase price or Financing amount = RM 100,000 CPR (Contracted Profit Rate) = 10% p.a. Financing tenure = 10 yearsProfit margin = RM100,000 X 10% X 10 years = RM 100,000Selling Price = RM 100,000 + RM 100,000 = RM100,000

Monthly installment is calculated differently where it is based on the EPREPR = IFR minus spread i.e. EPR = 6.0% - 2.0% = 4.0% Using the financial calculator, the month installment is RM 1013 per month.

Example on Calculation of Ibra based on difference between EPR and CPR

Eg. At the point T2, EPR = 6%, CPR = 10%. The Ibra = CPR – EPR (10%-6%) = 4%

At the point T1, EPR = 12%, CPR = 10%. The Ibra = CPR – EPR (10%-12%) = -2% (No rebate) and the effective profit rate charged = CPR

Comparison at a glanceFixed Rate BBA

• Fixed monthly installments for whole financing period based on fixed profit rate charged

• Profit calculated on monthly rest basis

• Selling price is determined by CPR

• No advantage on pre-payment or extra payment made by customer

• Ibra or rebate would be given in the case of early settlement of financing

• Beneficial to the bank in event of deflationary interest environment

• Beneficial to the customer in event of inflationary interest rate environment

Floating Rate BBA

• Fixed monthly installments for whole financing period based on Effective Profit Rate (EPR) which is similar to conventional pricing calculation

• Profit calculated on daily rest basis

• Selling price is determined by CPR

• There is advantage on pre-payment or extra payment made by customer – less profit charged by the financier

• Ibra or rebate would be given in case early settlement of financing; extra payment and also for the differences between Effective Profit Rate (EPR) and the CPR on daily basis

• Beneficial to the bank as it reduces the asset – liabilities mismatch

• Beneficial to the customer as they can reduce the profit charged by bank

Critical Evaluation• Fixed rate BBA financing is no longer offered in the Malaysian Islamic

financial market as at today. Almost all the Islamic banks have moved to offer the alternative floating rate BBA financing to compete with the conventional banks mortgages products.

• However, all Islamic banks in Malaysia still have the fixed BBA financing in their assets portfolio base.

• Unique product innovation to resolved the issues stated earlier by financier: asset-liability mismatch; creation of competitive level playing field with conventional banks in terms of product flexibility and pricing; risk mitigation arising from this mismatching.

• New issue with this new product : issue of pricing benchmarking against conventional benchmark based on interest rate (BLR = Base Lending Rate)

• While the customer is ascertained to get ibra or rebate from the financier, the Shariah requirement that the financier cannot fixed the amount of ibra upfront and the amount of ibra payable would be at the discretion of the bank, leaves the customer at the whim and fancy of the financier

• Other earlier issues with fixed rate BBA financing remain unresolved.

Issues Relating to BBA

Issues highlighted in the High Court and the Court of Appeal 

•  High Court (Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors [2009] 1 CLJ 419) 

• Apply the concept of ‘equitable interpretation’

 • Use the case of Affin Bank

Bhd v Zulkifli Abdullah (2006) 1 CLJ 438  

• BBA contracts were contrary to basic principles of Islam

•  Court of Appeal (BIMB v Lim Kok Hoe and Ors (Unreported )  

• The issues raised by the learned judge is not novel and has been decided in 2 cases; Adnan v BIMB (unreported) and Datuk Hj. Nik Mahmud v BIMB [1998] 3 CLJ 605

 

• High Court judgment is set aside and the cases need to be sent back to the High Court to be heard on their merits.

 

Shariah and Legislation on BBA  

• Hadith of Jabir that the Prophet (p.b.u.h) bought a camel outside the City of Medina and the payment was settled later.

• In Hidaya;

“ A sale is valid either for ready money or for a future payment provided the period be fixed because of the word of the Holy Quran; Trading is lawful and also because there is a tradition of the Holy Prophet p.b.u.h who purchased a garment from a Jew, and promised to pay the price at a fixed future date by

pledging his iron breast-coat”

• Islamic Banking Act 1983

• Central Bank of Malaysia Act 1958

Current Issues vis-à-vis BBA in Malaysia

• The structure of Bay’ I’nah is used;

• Liability of the owner (maintenance, repair, takaful, etc;

• Non-existence (in case of house under construction or to be constructed);

• Inability of the customer to pay (default in payment);

• Two situations must be differentiated;

With valid excuse ( in constraint circumstances)

Should be indulged with some leniencies

“And if he (the debtor) is in constraint, then he must be given respite until he is well of” (al-Baqarah: 280)

Dishonest clients who deliberately avoid to pay. The jurists differ:

• No, any extra charge is riba’

• Yes, but this amount must be channeled to charity. Penalty only to deter the client from further default. The well-off person who delays the payment of his debt, subjects himself to punishment and disgrace.

• In Malaysia, it is considered as ta’widh (compensation) to the bank. (SAC of BNM & SC)

• compared the delay in paying off a debt with ghasb (usurpation) for both of them are an act of obstructing the use of property and exploiting it in a tyrannical way.

• 1% only allowed and cannot be compounded.

• Back door to interest based transactions

Those who disallow the practice of BBA argue that BBA opens the back door to interest based transactions. They argue that if the difference between spot and deferred prices of a commodity is to be recognized, logically we can not reject interest, which in fact is based on the difference in value of money between spot and deferred.

Outstanding Issues on BBA

Outstanding Issues on BBA

• The Hadith:

“The Prophet prohibited two sales in one.”

One of the interpretations of the Hadith deduced that it is a sale contract with two different prices, that is one price in spot payment and the other deferred.

Counter argument: The different prices are only mentioned to the client during the negotiation period. Once the client is settled to a certain period of payment, only one quotation of price is offered to the client.

Outstanding Issues on BBA

• Selling of the Non-existent

BBA in Malaysia is applied over property under construction as well as completed property. This might contradict the ruling on the existence of subject matter in a sale contract. If the opinion of the majority of jurists is to be applied, the BBA facility on property under construction is not allowed. To avoid any conflicting issues that might arise, it has been recommended that banks use other types of financing for property under construction. For instance, banks can use the contract of parallel istisna’ as it relates to the financing of asset involving future delivery.

Outstanding Issues on BBA

• Transfer of Ownership

It is argued that since BBA is actually a kind of sale contract, the transfer of ownership and the taking of possession must truly happen.

In terms of the practice of BBA in Malaysia, the execution of PPA and PSA in the facility should result in transfer of ownership, irrespective of whether the registration of the transfer is made or otherwise.

The Property Sale

Conclusion

• Issues of BBA

• Impact of BBA court cases to the industry in Malaysia

▫ Industry's development and innovation

• The industry moving forward

▫ Musharakah Muthanaqisah Partnership (MMP)

Consensus by Sharia’ah Scholars on the permissibility of

MMP

Musharakah and Ijarah concepts

Beneficial to Customers rather than Financiers

The Property Sale

Conclusion

• Comparison Between MMP and BBA Contracts

BBA MMP

Uses buying and selling concepts.

Practices Musharakah and Ijarah concepts.

Selling price does not reflect the market price but rather uses interest rate as benchmark.

Rental income reflects the market price as the rental value is determined by the market.

Fixed selling price for fixed rate BBA. Financier manage better liquidity rate by adjustable rental income.

Fixed amount to be paid by customers. Rebate decided by the financier.

Total price paid for property can be lower.

The Property Sale

The End.

Thank You.

“One step at a time always works both ways..”