Kuliah 3 - Islamic Bank

8/3/2019 Kuliah 3 - Islamic Bank

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Kuliah 3

SHARIAH & LEGAL ISSUES IN ISLAMICCONSUMER BANKING (SALE-BASED

FINANCING)

Universiti Kebangsaan Malaysia

Faculty of Law

Pursuing PHD Program in Law

P58462

Musbri Mohamed

DIL; ADIL ( ITM )

MBL ( UKM )


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The elementary concepts of modern Islamic

banking date back to the mid 1940s. Models for

Islamic banking appeared in the mid-1950s, but

comprehensive and detailed concepts for

interest-free banking only appeared in the late

1960s. The political environment during that

time almost all Muslim countries was hardly

favorable for a change in the entire system of

banking and finance. In fact, the first

experiment in Islamic banking was set up

undercover in Mit Ghamr, Egypt in 1963. The

model for the experiment was the German

Savings bank modified to comply with Islamicprinciples, i.e. it was barred from charging and

paying interest. Nevertheless, the charter of the

Bank did not refer to Shariah.


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The second Islamic Conference of Foreign Ministers in

1973 adopted a document on the "Institution of anIslamic Bank, Economics and Islamic Doctrines". In

1974, the Islamic Development Bank (IDB) was

established as a result of this conference. The member

states of the OIC became members of the IDB. The IDB

helped to establish a number of Islamic banks in various

countries.


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Beginning in 1974, several Islamic banks have been

established which include: Dubai Islamic Bank in 1975,

Faisal Islamic Bank of Sudan in 1977, Faisal Islamic

Egyptian Bank and Islamic Bank of Jordan in 1978, Islamic

Bank of Bahrain in 1979, the International Islamic Bank of

Investment and Development, Luxembourg in 1980 and

BIMB in 1983.

Today, there are more than a hundred financial institutions

which claim to be operating partially or fully on an interest-

free basis in 34 countries.


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Islamic banking has been adopted at the national level in Pakistan, Sudan,

and Iran, and they have decided to Islamize the whole banking system. Iran

enacted a new banking law in August 1983 requiring complete abolition of

interest by March 1985 (M.N. Siddiqi 1988: 48). Sudan opted for a total

change when a presidential decree was issued in 1984, directing all banks to

stop dealing with interest.

The Central Bank of Sudan, on 10 December 1984, directed all commercial

banks to stop dealing with interest with immediate effect, and to negotiate

conversion of existing deposit into investment deposits or any other kind of

deposits in accordance with shariah. All outstanding interest bearing

advances were either to be settled through repayment or they had to be

converted into one of the Islamic modes of financing. Foreign transactions

were to continue on the basis of interest till an alternative way as available.


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Sale Based Financing

BBA

Murabahah

Bay al-Inah

Tawarruq

Bay Salam

Bay IstisnaSale and Lease Back


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Leased Based Financing

AITAB

Operating Lease

Ijarah Mausufah fi Zimmah

Sale and Lease Back

Deposit Services

Wadiah Yad Damanah

Murabahah

Mudarabah

NIDCTawarruq


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Credit/ Charge Card

Bay al-Inah

Tawarruq

Ijarah

Kafalah with Fee

Cash Line Facility

Bay al-Inah

Tawwaruq


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GENERAL PRINCIPLES INBBA ANDMURABAHAH

Both contract are contract of sale and purchase (bay)

Sale and purchase is a contract of exchange (aqd al-muawadah)

The exchange is between the two counter values, i.e., goods and

price

Sale and purchase presupposes the transfer of ownership between

the parties (regardless of any formal registration of transfer).


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ESSENTIAL CONDITIONS FOR SALE CONTRACT

(BBA & MURABAH)

CONTRACTUAL EXPRESSION (Sighah)

Offer Acceptance

Clarity

Consensus at idem

CONTRACTING PARTIES(Aqidan)

Offeror Offeree

Of full contractual capacity

(ahliyyah al-ada al-kamilah)

Legal authority to contract

As owner & in possession of asset

Legal representative (agent, guardian etc)


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SUBJECT MATTER (Mahall al-aqd)

Goods/Asset Price/ consideration

Something of value

Ascertainable

Legal


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SPECIAL FEATURES FOR BBA & MURABAHAH

BBA

Final price should be contractually agreed and known to both

parties

Payments of price is deferred

Time and mode of payment should be ascertained

No need to state the cost price and amount of mark-up

MURABAHAH

It is a sale and purchase contract based on trust (bay al-

amanah)

Full disclosure and transparency between the parties

Cost and amount of mark-up are disclosedPayment of price can be spot or deferred, depending on the

agreement between the parties (if deferred also a BBA)


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OBSERVATIONS

The Islamic banking practice in Malaysia tends to confine BBA to long term

asset financing and Murabahah to short & medium term financing.

This has nothing to do with any Islamic law requirement

BBA in Islamic law is simply a method of repayment, i.e., deferred

payment and thus, it applies to all kinds of sales where the payment is

deferred whether on the basis of instalments or lump sum payment at theend of the tenor.

BBA and Murabahah in practice; does the contract reflect BBA and

Murabahah or some other contract?

The transactions are more reflective of Bay al-Inah, rather than BBA or

Murabahah

Technically, bay al-Inah is also a form of sale and purchase contract

But, it is different from normal BBA and Murabahah because it involves two

subsequent sale and purchase contract, between two parties


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SOME CONTROVERSIES ON BAY AL-INAH

Transactions between two parties only, on the same asset.

Gives rise to the assumption that the apparent sale and purchase transactions arefictitious.

The assumption is : the parties are not interested in the transfer of ownership of the

property, but in the transfer of cash between them to be paid at a later time, with a

mark-up


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OTHER OBSERVATIONS

It is important to note that

Murabahah, as a trust sale (amanah),

requires more strict conditions

compared to other normal or deferredpayment sale.

Therefore, this presentation will first

examine issues peculiar to Murabah,

and alter, issues which are common

to BBA and Murabahah as salecontracts generally.


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SHARIAH AND LEGAL ISSUES IN MURABAHAH

Being an amanah sale, the seller is obliged to disclose the actual cost price or

purchase price of the asset that is intended to be sold to the customer on the basis

of Murabahah.

The failure to disclose, or the disclosure of incorrect cost price will render the

contract voidable.Following this principle, there are many other issues to be considered:+

Murabahah cannot be effect on an asset which cost price is not known or cannot be

known due to the nature of the asset or the contract leading to the acquisition of

that asset.

Cost price includes insurance premium, transportation cost, import duty, etc.

Mark-up formula could be in term of amount or in terms of percentage and this

formula must be disclosed and agreed up-front.Some scholars (Hanafis) have required that the nature of contract in acquiring the

asset must also be disclosed to the buyer under a Murabahah sale.


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COMMON SHARIAH & LEGAL ISSUES FOR BBA/MURABAHAH

Both BBA and Murabahah are always sale and purchase transactions. They are

never intended to become financing instruments in the strict sense.

Therefore, BBA and Murabahah must remain in their original nature and cannot be

made analogous to any financial instrument to the extent that principles of sale and

purchase embodied in them are put aside.Most of the Shariah and legal issues stem from misunderstanding of this fact. The

issues are as follow:

Terminology used:

Payment vs repayment, sale vs loan, customer vs borrower, financier vs. Lender;

What would be the correct term in BBA and Murabahah documentation?

Misconceptions: it is just another form of financing, it is a fixed rate term

loan, interest is substituted with margin of profit


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Both BBA and Murabahah should result in transfer of ownership irrespective

of whether the registration of the transfer is made or otherwise.

Case study :BIMB v. Dato Nik Haji Mahmud

Clause on Right to recall; is it lawful to insert clause allowing the bank or

financier to recall the facility in the events of default?

Clause on Cross default ; is it permissible to insert and practice this right

in BBA and Murabahah transaction?Clause on consolidation and set off; this can be based on Islamic principle of

al-muqasah.

Incorporation of purpose of financing in the agreement

Disclosure of the rate or formula of margin of profit

Rebate clause i.e. Whether the bank/financier is allowed to incorporate this

clause in the agreement

Case study :Affin bank v. Zulkifli(2005)

Note : rebate oribrais a discretion of the bank/financier


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Compensation clause i.e whether the bank/financier is allowed to

insert the clause that is : in the case of default and delayed payment,the bank/financier is entitled to recover its actual loss from the

customer?

Right of the bank/financier to sell the receivable to a third party for

liquidity purposes

Right to repossess the asset in the case of non payment (e.g. BBA foe

vehicle financing)

Definition of an asset; tangible asset, intangible asst, right, etc.

Definition of ownership to an asset; beneficial interest vs legal interest


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Third party financing:

(joint ownership single applicant)(single ownership joint applicant)

Restructuring or rescheduling the facility

Third party collateral

Istisna (manufacturing contract) for house under construction?

Beneficial ownership for house under construction?

Novation agreement for BBA for houses under construction

Solution in the case of non-completion of the house?


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OTHER CONTENTIOUS ISSUES

Selling something before taking

possession of the asset convert the

Murabahah and BBA into a mere

financing instrument instead of actualbuying and selling

e.g. 1 : the judgement of the Shariah

Supreme Court in Pakistan

Order 83, Rules of High Court

e.g.BIMB vs Adnan bin Omar


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SHARIAH COMPLIANCE GOVERNANCE IN MALAYSIA BANKING

STATUTES

Specific Islamic Banking Laws requires Syariah compliance & mandate Syariah

governance

Sect. 2 IBA 1983

Islamic banking business means banking business whose aims and operations donot involve any element which is not approved by Religion of Islam

Sect. 3 (5) IBA 1983

The Central Bank shall not recommend the grant of a licence unless..

The aims and operations of the banking business which it is desired to carry on will

not involve any element which is not approved by the religion of Islam and

That there is in the articles of association of the bank concerned, provision for the

establishment of the Shariah Advisory Board, as may be approved by the CentralBank, to advise the bank on the operations of its banking business in order to ensure

that they do not involve any element which is not approved by the Religion of Islam


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Sect. 124 BAFIA 1989

Islamic Financial Business any financial business the aims and

operation of which do not involve any element which is not approved by

the Religion of Islam .

COURTS JURISDICTION IN IF CASES

Civil courts have jurisdictionWhy?

Although the term Islamic law in Para 1, List 11 of Ninth Schedule is

wide, its application is limited to persons professing the religion of

Islam.

Only federal legislations on IBF no state legislations on IBF.

Banking & Finance within List 1 (Federal List) of Ninth Schedule


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MALAYSIAN LEGAL FRAMEWORK FOR IF : CONSTRAINS?

Lack of Substantive Law

Law & regulation are procedural not substantive

. Substantive rules in IF derived from rulings from Shariah

Boards/Committees

. In Malaysia centralised Shariah Advisory rulingsJudicial Issues

. Jurisdiction civil courts

. Judges & legal counsels are not trained in Shariah

. Potential conflict with Shariah principles & philosophies courts

decisions may not reflect Shariah principles, or may even contravene

those principles

. Lack of substantive law aggravate the problem


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Other Legal issues

Application of general laws to IF

. General laws are not legislated to facilitate/ support IF

. In the case of contradiction between general laws &

Shariah no clear cut provision on which one will

prevail


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THE STAND OF THE COURT ON IF LITIGATION...

Bank Kerjasama Rakyat Malaysia Berhad v Emcee Corporation

Sdn Bhd,per Dato Abdul Hamid Mohamad:

- as was mentioned at the beginning of this judgement the facility isan Islamic banking facility. But that does not mean that the law

applicable in this application is different from the law that is

applicable if the facility were given under conventional banking...The

procedure is provided by the Code and the Rules of High Court 1980.

The court adjudicating it is the High Court. So, it is the same law that

is applicable, the same order that would be, if made, and the same

principles that should be applied in deciding the application.


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TRENDS IN CASE LAW

Case law on Islamic banking in Malaysia had been

mainly on BBA; and a few on Istisna

BBA had been used right from the start of Islamic

Banking in Malaysia e.g. BIMBs house financing

since 1983BBA is still the main contract for asset financing in

Malaysia though some Islamic banks have started to use

some other contract

Istisna had been used by some Islamic banks to finance

asset/s under construction

A few later cases tend to question some basic features of

BBA arrangement e.g. rebate vs unearned profit,validity of BBA?


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ARAB-MALAYSIAN FINANCE BHD V TMAN IHSAN JAYA SDN

BHD [2008] ARAB-MALAYSIAN FINANCE BHD V TMAN IHSAN

JAYA SDN BHD [2008]

The consolidated judgment of this case & 11 others in July 2008 had caused

shock-waves in the industry

All the 12 cases involve BBA contracts

Main issue validity of BBA contract?Judge recognized a few variation of BBA, and gave the following verdicts

according for each variation:

There is no novation agreement BBA is not valid, just a loan transaction &

bank can only recover principal sum profit portion is interest (riba)

There is novation agreement BBA is valid, and:

Can recover full outstanding sale price (if financing period has expired)

If period has not expired, bank can recover a lesser sum i.e.

outstanding sale price minus unearned profit


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ISSUE : VALIDITY OF BBA?

Validity of Islamic banking contract under s. 2 of IBA 1983

must it be approved by all recognised school of law?

If a facility is to be offered as Islamic to Muslims generally,

regardless of their madhab, then the test is no element not

approved by the Religion of Islam under the interpretation of any

of the recognised madhab. That it is acceptable in the Religion of

Islam when it is not accepted by the other madhabs (per Wahab

Patail at para 5)

This conclusion is fallacious difference of views in matters

subject to ijtihad is allowed

Bay al-Inah is allowed by SAC of BNM and SC, though otherShariah boards may not approve the practice


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ISSUE: FORM V SUBTANCE LEGAL TRICK (HILAH)

Bearing this in mind it is not sufficient that the distinction between

a sale and loan is maintained in form, but it must also be maintained

in substance. It is the reality and not the form and labels that

matter. (per Wahab Patail at para. 29)

Is it wrong to use legal trick (hiyal)Two school of laws:

ShafiI & Hanafi (e.g: al-Sarakshi) generally allow legal tricks as

long as they are in line with Shariah principles & do not deny the

rights of people or involve in wrongfulness

Maliki & Hambali (e.g: Ibn Qayyim) generally disallow legal

tricks. In fact, strongly against the practice consider them as fraudagainst God & Shariah.


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BBA FINANCING WITH NOVATION

ISSUES ?

Novation ? Status under Sharah ?

Amount recoverable full outstanding amount of

selling price or lesser amount ?Issue of rebate on the unearned profit?

Precedents :

BIMB v Adnan Omar

Affin Bank v Zulkifli


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MURABAHA COMMODITY WITH TAWARRUQ FEATURES

Some IFIs use murabahah contract with tawarruq arrangement to

allow for cash financing without resorting to bay al-Inah

Examples are some banks in Saudi Arabia, Kuwait and Bahrain

However, this practice has also been criticized as being a merehilah (legal trick) by some contemporary scholars

e.g. The Majlis Majma al-Fiqh al-Islami in its 17th meeting

Though in an earlier meeting, Majlis Majma al-Fiqh had approved

tawarruq in principle (15th meeting) they considertawarruq

masrafi as not approved (17th meeting)


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Salam contract is suitable for future/forward

contracts in commodities, provided the parties are

willing to pay the price upfront

If both price and goods are deferred, this is not

salam

In Malaysia, SC allows the practice on the basis ofbay al-istijrar(allowed by Ibn Abidin in Hanafi

School) and /orbay bima yanqati bihi al-sir

(allowed by Hanafi school of law)

Note : both practice involve buying and selling

now or continuously, without fixing the price yet,

and the price is payable at the end of the period

agreed according to market price then


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SPECIAL FEATURES FORBAY AL-ISTISNA

This contract is also an exception to the general rule pertaining to the

existence of the subject matter at the time of contract

This contract involves manufacturable goods only (commodities that

cannot be manufactured e.g fruits, grains etc are not suitable)Payment of the price is flexible need not be advanced at the time of

contract only

Proper description of the goods ordered should be made

Time, place and mode of delivery of both the goods and price should

be specified at the time of contract

This contract is suitable to finance the purchase of property which is

still under construction


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ISTISNA IN PRACTICE: SOME LEGAL AND SHARIAH

ISSUES

Originally the istisna contract is not binding on neither party until

the goods are made and accepted by the buyer (majority view in

the Hanafi school)However, in contemporary Islamic banking, it is accepted that

istisna is binding on both parties from the start (minority view in

Hanafi school)

As with other types of sale, parties in Istisna are free to fix the

price as they wish, using e.g, cost-plus or mark up approach

Payments for the price is flexible and can be delayed until

delivery, or even beyond


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However, to make matters easier, a schedule of progress payment may be

agreed between the parties

In contemporary practice, Islamic banks may employ istisna to finance

manufacture and construction contract project financingClassical Islamic law also allows the manufacturing party in an istisna to

sub-contract the manufacturing to a third party through a second istisna

This arrangement is known as back-to-back istisna or parallel istisna

This structure has been used by contemporary Islamic banks to finance the

purchase of major manufactured goods such as ships and airplanes


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The financing aspects ofAl-Bay Bithaman Ajil(BBA) is very

complex as it must represent the buying and selling activities (al-

bay). As such, all the Shariah requirements to constitute a valid

sale contract must be adhered to. In addition to that, it must also

satisfy the civil aspects of a sale contract because Islamic banking

matters fall under the jurisdiction of the civil court by virtue of the

Federal Constitution and Civil Law Act 1956. To sum up, the

practitioners of Islamic financing (bankers and lawyers) must be

conversant with both legal systems as well as rules and procedure

so as to avoid possibility of being challenged in the court of law of

non-conformity or contradiction withShariah and existing civil

law and rules of procedure.


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Legislations for Islamic Banking Business

Although the Islamic Banking Act specifically governs the Islamic banking business,the provisions of the same may not be sufficiently exhaustive to cover all aspects.

Thus, there are several legislations that we refer to in the conduct of Islamic banking

business. These are:

* The Islamic Banking Act 1983

* The Banking and Financial Institutions Act 1989

* The Takaful Act 1984

* The Companies Act 1965

* The Securities Commission Act

* The Stamp Duty Act 1949

* The National Land Code

* The Contracts Act 1950

* The Real Property Gains Tax Act 1967* The Hire Purchase Act 1967

* The Sale of Goods Act 1957

* The Development Financial Institutions Act 2002


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The key issue is understanding the proper application of the above

mentioned legislations in the implementation of Islamic banking business

and in resolving issues or disputes. For example, based on the statutory

provisions, we have to be able to distinguish whether an Islamic banking

product would be liable for ad valorem or minimal stamp duty; or whether

certain aspects of a movable asset transacted under anIjarah facility fall

within the purview of the Hire Purchase Act 1967 or the Sale of GoodsAct 1957.

The main authority that carries out a supervisory and advisory role and at

the same time ensures enforcement of rules and regulations under the

BAFIA and IBA is Bank Negara Malaysia.

Musbri Mohamed

December 2011

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Kuliah 3 - Islamic Bank