Subject: Islamic Banking
by Syed Akbar Ali
I recently attended a talk on “Contemporary Islamic Finance”. The speaker was a young man with
a PhD in Islamic Banking and Finance (UK). He was from an outfit linked to INCEIF ( International Center for Education in Islamic Finance).
Islamic banking or Islamic finance exists because the religious folks have succesfully inculcated the idea that bank interest is riba and therefore haram. The Quran states clearly that riba is haram but nowhere can we derive the injunction that bank interest is riba. The two are not the same.
Anyway the religious folks have created ‘islamic finance’ and ‘islamic banking’. To cut a long story short there really is no such thing. Islamic finance and Islamic banking are just arabised versions of conventional banking. There is nothing islamic about it. Neither is there anything un-islamic about conventional banking either.
If you take a housing loan from a conventional “haram” bank you pay a monthly instalment. If you dont pay, the bank will auction your property. If you go to an ‘islamic bank’ you still have to pay monthly instalments which can be more expensive than the conventional bank. If you dont pay your instalment, the islamic bank will still auction your property too. What is so islamic or unislamic about that?
The conventional ‘haram’ bank will charge you interest say 10% a year. The ‘islamic bank’ charges you what they call a ‘profit rate’ which will also be 10% or more a year. Kira-kira semua sama, tapi ini halal, itu haram. This is called pulling the wool over peoples’ eyes.
Talking about the pricing of his Islamic banking products, the young man with the PhD in Islamic banking made no bones about it. He said it quite loudly and clearly ‘we want to be the same as the market’.
I discovered this islamic banking trick years ago when we were handling the earliest stages of Islamic banking in Malaysia . At that time we called it an ‘Islamic window’ – Maybank did not yet have a full fledged Islamic banking license. But three months Islamic Bankers Acceptances (IABs) were priced exactly the same as three months conventional BAs. And so on. Tak ada beza pun.
A colleague who wore a kopiah to work had volunteered to go and work in the Islamic banking part of the bank. After a while he became even more confused. He said the calculations were all the same. In Islamic banking you add an ‘Al’ prefix to everything. Al Wadiah, Al Murabahah, Al Mudharabah, Al this and Al that. Other than the ‘Al’ its all the same.
Then the speaker dropped a bombshell. There is a famous case where an Islamic bank was suing a borrower for non payment of a housing “loan”. According to Islamic banking the bank does not give you a “loan”. The bank first buys the house from you at the market price. Then it sells the house back to you at a higher price over the period of the “loan” say 10 years, 15 years etc. Its just a deferred payment scheme with a ‘profit rate’ factored in.
The Islamic bank determines the selling price by compounding the “profit rate” (say 10% - copycatting the conventional banking system - ‘we want to be the same as the market’) for 10 years or 15 years. For those of you who have financial calculators (and if I still remember my financial computations), this is just the Future Value (FV) of an annuity at 10% starting with Present Value (PV) being the price of the house today and going forward 10 years, 15 years, 20 years etc. The Casio calculator will give you the ‘islamic’ answer in seconds. Does that make Casio ‘islamic’ too?
In a conventional ‘haram’ bank, if you default on your 20 year housing loan say after just three years, the conventional bank will ask you to pay back the principal amount of the loan plus 10% interest compounded for three years. The islamic bank cannot do that. The islamic bank will ask you to pay the full selling price of the house (based on 10% for 20 years) – even though you defaulted only after three years.
This is what the Islamic bank was claiming. However the very wise judge of the High Court Abdul Wahab Patail, the brother of our present AG, made a landmark decision. He ruled that the Islamic bank cannot charge the borrower the full amount for the full tenure of the “loan” when the borrower had defaulted just a few years into the “loan”.
This decision by Justice Abdul Wahab Patail still stands until today and it has not been overturned. It also destroys a huge chunk of Islamic banking because the Judge has essentially ruled that the islamic banking system in Malaysia is actually unjust. It is worse than riba.
So how does INCEIF and the Islamic bankers handle this situation? This is where the speaker dropped the bombshell – and with a great big smile too. He said “the Muslims dont know” about Justice Abdul Wahab Patail’s decision. Well dear Muslims, I hope that now you know. Please do spread the word quickly.
The speaker said that ‘Islamic banking can still go on in our country because the Muslims dont know the decision by Abdul Wahab Patail’. In other words the islamic bankers are not going to tell the Muslim borrowers either. They will keep it quiet. Shhhhh ! ! And this is Islamic?
Then I learned something else too. While the speaker was talking about murabahah (one method of islamic financing), the Chairman at the talk was getting quite agitated. The Chairman was a foreigner from the Middle East and is an internationally acclaimed Islamic scholar himself. Suddenly he interrupted the speaker and made a clarification. He said that according to the Hanafi madhab (I think he is a Hanafi) murabahah was riba. Meaning murabahah was haram.
He then said that the Islamic banking practised in Malaysia was according to the Shafie madhab. Madhab means sect. Only then did it dawn upon me that in Malaysia we dont have generic islamic banking. It is “Shafie banking”, according to the Shafie madhab.
A Muslim friend with a PhD from Cambridge later explained that this is partly the reason why there cannot be an “international Islamic capital market”. One madhab’s murabahah is another madhab’s riba. One madhab’s al bai al bithaman ajil is another madhab’s riba also.
When a borrower defaults (or prepays) a 20 year housing “loan” say after just three years, the islamic bank can do what is called ‘ibrar’. (In the old days they called it muqassa – I dont know why the change). ‘Ibrar’ means to refund the balance owing but not yet due. In other words ‘buah belum masak lu jangan kira lah’. But there is no fixed or detailed idea about ‘ibrar’ among the islamic bankers.
So defaulting borrowers have no choice but to fight it out in the Courts with the Islamic banks. The speaker said that todate there are 3,500 unresolved cases of islamic banking BBA housing loans (Al Bai Al Bithaman Ajil) being disputed at the Courts in KL. And one judge, a Dato Rohana, has been assigned to handle all these cases. Well good luck Justice Dato Rohana. She will become an expert in Al Bai Al Bithaman Ajil calculations – maybe faster than Casio.
If it is a conventional housing loan, all these 3500 cases can be resolved by a Casio calculator. (Ya Allah, why do the Muslims like to create all these strange things and end up tying themselves in knots?)
During the talk, the speaker put up a slide that had the arabic word ‘zulm’. Zulm in Malay is zalim, meaning oppressive. The meaning was that Islamic banking should not be zalim or oppressive like the ‘conventional’ banking system with its interest based practises.
But how is the islamic bank less oppressive than the conventional bank? You charge the same rates – quite unashamedly saying ‘want to be the same as the market’. The terms and conditions are the same except when the ‘loan’ turns bad. Then the islamic bank can become worse than Shylock the Jewish moneylender. They want their pound of flesh. And the conventional bank is still ‘haram’?
There is another danger lurking. Talk is some ignorant do gooders are thinking of legislation where Muslims will be barred from using the conventional banking system. They can only go to the Islamic banking system. That is how we end up in the Club of Doom.
Note: If a loan is defaulted in Islamic banking, the outsanding amount you have to pay is far worse than borrowing from a chettiar.
I do not know very much this chap Syed Akbar Ali. He is either addressing a very secular audience or his outlook on Islam could well be termed 'liberal'. On other issues at least that I have read him before, he sounds like a 'Liberal Islamist' , a new animal on the block. I define 'Liberal Islam' as fashionable,populist and playing to the gallery but empty up there 'spiritually', not steeped in 'tradition' and the 'hukum hakam' of things. But yet, here Syed Akbar Ali has got some truth: for sometime now the perception is that 'Islamic banking is not Islamic'.
Personally I got the wrong end of the stick from Islamic banking some 10 years back. I took a' business loan' from Bank Islam under the 'Al Bai Al Bathiman Ajil' concept to buy a shoplot for investment. The investment turned sour and after 7 years for diligently paying the 'loan' I could not sustain the property. I sold the shoplot at cost price[ economy was bad then]. And Bank Islam , after 7 years of payment the residual was still about 80 % of the initial loan that I took. I was not aware at that time there were a backlog of court cases contesting the validity and fairness of the system.Otherwise I would have easily be persuaded to joining the bandwagon of 'defaulters'. I gentlemanly paid Bank Islam the sum asked.....Now that Akbar Ali has brought up the issue of court cases pending, that has left a 'lump' in my throat......
I could have join the bandwagon of people looking for justice from an 'unjust' situation... I assume wrongly that Bank Islam had done their sum from the perspective of 'fairness and justice' diligently!
retired Islamic banker with Standard Chartered
old MCKK form mate to yours truly.
Doc Nik, under the al-bai' bithaman ajil concept the bank buys the prop from the seller/developer on your behalf, say RM100k and sells to you at a price, cost plus profit (as in a trading transaction as trading is allowed in Islam). The profit that the bank makes in selling the prop to you takes into account the period u take to pay back the bank in monthly instalments. If the prevailing housing loan rate is 10%, the bank would sell at RM110k if you take 1 year loan.The transaction is sealed in an akad whereby u agree to buy the prop from the bank at rm110k . Jadi kalau u decide to settle your loan in full 1 month after u take the loan the bank kata u kene bayar ikut akad yang u dah buat, rm110k
I was specifically asked on this issue by a potential customer, a non-Muslim, (at that time there was a pending court case involving BI). I asked the customer, if I insist on full selling price, withoit giving rebate, if u decide for early settlement, am I fair to you? He said .'No'. I told him Muslims decide to introduce Islamic banking because there is no fairness in conventional banking which incorporates riba. Islam demands fairness in all dealings. So, if I insist on something not fair and worse than conventional banking then I am not adhering to Islamic teachings apart from my religion being viewed as devoid of fairness. The customer straight away decided to take our loan but what I couldnt assure him was what would happen if I was no loner in the bank. I used to argue with my mat salleh bosses who obviously expected me to 'lebih kurang' in order to maximise profit for the bank. I told them I would be accountable in the world hereafter and hence could not expect me to compromise.
I think BI put more emphasis on fulfilment of the akad (perhaps with opportunity for higher profit), instead of the fundamental Islamic teaching that we must be fair in our dealings with human beings. Macam mana nak kata Islam itu adil?
Dr Nik Isahak
Zahar, despite the bitter experience, I will still do Islamic banking, if I have to borrow. Hanya terkilan saja that 'they did not do proper due diligence' to safeguard ignoramus like me who just play by the rules! Thinking that there is more justice and fairness and compassion in anything Islamic...
That is a lot of money, at my level, I lost due to 'poor due diligence on their part with respect to people wanting to sell or settle midway'. I went in blindly and in good faith.
My lawyer friend did inform me at that time of the avenue for a lawsuit, but the sale had already gone thru and I could no longer stand the excessive 'bleeding' monthly as a result of holding the property which did not bring any income. I did ask the bank to share 'in the loss'. They say they will go bankrupt if they subscribe to that. They only share in the profit not loss! Mashaallah!
Rasa pedih lagi hati di bulan puasa ini. To be let down by a system which appear Islamic and just.....Dulu benda ini dah lupa but when Tuan Syed brought it up, I am now having some heartburn...
But let us hear what Dr Rosli, a one time Senior Bank Negara specialist on the subject, has to say, to be fair.We have to start somewhere, I am sure with time and experience Islamic banking will improve, and all the groans and complaint we have now we have to put aside as necessary price or 'tuition fees' as we fine tune Islamic banking.The whole world will warm to it in due time....we just have to give time
Dr Rosli Yaakob
One time Senior Bank Negara specialist on Islamic banking
Currently 'Tabung Haji Chairman', Bangladesh
[ He introduced the concept of TH to Bangladesh.]
??? Future Finance Minister, If the present NTR Government got displaced in the next 'Erection'
Yang Berbahagia Dr. Nik Isahak. Your comments on Islamic banking lures me into giving you some response.
First, it must be known that in a secular system of government where Islamic law is not practiced and in the absence of Islamic currency system (Gold Dinar and Silver Dirham), there can never be a true Islamic banking. We have only "Semi-Islamic Banking" at best. For full Islamic banking, we shall have to wait for the day when Islamic State is reestablished and Islamic currency system restored. That could be in the era of Imam Mahdi. Who can tell? Only Allah knows.
Islam requires us Muslims, first, to ensure that not only activities we carry out are halal but the financing modes used to finance those activities are also halal. Second, Islam requires an Islamic bank and its clients to share risks and rewards (profit and loss). Hence, a case where a client puts his money in the bank and earns a fixed income on that money regardless of whether the bank is making profit or incurring loss is unthinkable in Islamic banking and finance. The reverse also holds – an Islamic bank cannot expect to earn a fixed income from the financing facility it extended to a client regardless of whether that client is making profit or not. Third, an Islamic banker ought to be a practicing Muslim. For example, it is unthinkable that a Muslim is an Islamic banker during the day but a drinker during the night.
Many Islamic banks and their clients were already guilty for not willing to share losses. They were only willing to share profits. This is the main flaw of Islamic banking today.
Second, those who say that Islam does not allow one to do business by borrowing money are misguided. Allah allows borrowing for any legitimate purpose so long as no interest (additional money, predetermined, that is, in percentage or in absolute amount) is added to the principal at the time the lending-borrowing agreement was made.
Allah however, allows the borrower, when he returns the money to the lender, to add whatever he likes to the principal sum without the lender asking for it. This voluntarily given additional sum is called hiba (voluntary gift). It is perfectly legitimate. Our Prophet SAW, as reported in many Traditions, always returned things that he borrowed with gifts added. He encouraged others to do the same. It must also be known that he strongly discouraged borrowing. In his supplications, he always asked Allah to free him of debts.
In reality, as banks are profit-seeking entity, lending money on hope that people will give them gift can never be their core business. If this is the case, the banks “will open today and close tomorrow.” But, a bank that is established solely for welfare purposes can do this. Such a bank is called in Islam Qardul Hasan Bank. Those who borrow money from this bank must return the principal at the agreed upon time with or without hiba. Majority of scholars agreed that a reasonable service charge can be imposed on Qardul Hasan loans. Profit-motivated Islamic banks can always set aside part of their resources for extension of Qardul hasan loans to deserving clients.
Third, though musharaka should be on the top of the list of Islamic financing modes, Islam does allow trade-based modes of financing such as ijarah or lease transaction. If for example, a businessman needs a machine for his food processing factory, he can enter into an agreement with a bank whereby the bank buys the machine and leases it to that businessman for an agreed rent (in percentage or in absolute amount) over an agreed period. At the end of the period, the machine is returned to the bank.
If the businessman is also interested to own the machine at the end of the period, he can pay the purchase price of the machine in installment. In this case, his monthly repayment will comprise two elements - rent and payment for gradual ownership transfer. This is called in Islam as Ijarah wa Iqtina and it is perfectly legitimate. Alternatively, he can also pay the market price of the machine at the end of the tenure to own the machine. This is the oldest Islamic banking instrument history ever recorded and because of its simplicity, it is widely used by Islamic banks all over the world today.
Fourth, Islam allows Bai Murabaha or cost-plus sale, that is, seller adds a profit mark-up to the cost of the good he sells. This is also a trade-based mode of financing. A seller can disclose the true cost of the product and additional sum he adds to it to the buyer. If the buyer agrees, then a selling-buying transaction is concluded and payment settled on the spot. This is a perfectly legitimate transaction.
There is no necessity for the seller to disclose the true cost of his product. He just discloses the final price (cost and profit added) and it is up to the buyer to buy it or not. This is a common practice these days. Shops display their products with price tags and it is entirely up to the buyers’ choice to buy or not to buy.
There is also a practice where shops display their products without price tags. When a buyer comes to buy a particular product, the shopkeeper offers an opening price. After some bargaining, they agreed on a certain price and a selling-buying transaction is concluded. Only the shopkeeper and Allah know the true cost of the product sold and the profit portion thereof charged by the seller. The profit, big or small, is perfectly legitimate. When our Prophet SAW was assigned by Hazrat Khadijah to sell products on her behalf in faraway market places, we were told by many Traditions that he always returned with hefty profits, more than she herself or her other traders earned. He SAW disclosed the price and after some bargaining (or perhaps, buyers did not bargain at all), the products were all sold. Hefty profit means at least a double-digit profit and it is perfectly legitimate.
Bai Murabaha is a cash transaction, that is, payment is settled on the spot. Or, even if deferred payment is allowed, the spot and deferred prices are the same as the deferred period is normally short, never goes beyond one year. This mode of Shariah financing is mostly applicable for purchase of small items. Purchase of big-ticket items such as houses, cars, trucks, ships, airplanes and so on normally requires installment payments over a much longer period. How does an Islamic bank handle this? In this case, modes of financing such as Ijarah and Musharaka Mutanaqisa are more appropriate.
Fifth, Islam allows Bai Muajjal mode of financing, that is, deferred payment transaction – “buy now pay later” either in installments (monthly, quarterly or yearly) over an agreed upon period of time or in one bullet payment at an agreedupon date in future. This mode of financing can be best explained by way of an example.
A client (a doctor) comes to an Islamic bank to apply for financing to buy a brand-new E200 Mercedes Benz. The price is RM250,000. After doing the necessary credit evaluation (financing evaluation), the bank agrees to finance the purchase and let say, for simplicity, 100% of the purchase price for a tenure of 3 years. The banks adds a profit mark-up of RM50,000 to the cost price and the client agrees to it. The bank and client also agree that the repayment of the principal amount and profit shall be in 36 equal monthly installments, that is RM8, 333 per month. This is a perfectly legitimate transaction. The issue here is: How do we fix the profit rate? This is where scholars have different views. Some say, in calculating the profit, we can be guided by the prevailing rental rates charged by car rental companies while some others allow reference to be made to prevailing interest rates such as London Inter-bank Offered Rates (LIBOR) or Kuala Lumpur Inter-bank Offered Rate (KLIBOR) or any other interest rate indicators. However, it must be pointed out here that majority of scholars, either rejected the latter outright or strongly discouraged it. It is always better to use car rental rates if data on such is available.
If the client concerned feels that the profit charged by the bank is more or less similar the amount of rent that he has to pay to a car rental company if he were to rent the car for three years, then there no injustice inflicted on him from the transaction. Further, if he were to wait for his saving to accumulate, perhaps, he will only be able to buy the car after three years. By then, the price of the same car could have gone up, by how much, one can only guess. He could also save some money if he can settle the financing earlier as most Islamic banks normally give rebate for early settlements.
Another issue normally associated with Bai Muajjal mode of financing is: Can the amount of profit charged by Islamic banks vary with time? Put it differently: Can the profit be higher the longer the tenure of the financing? Majority of scholars view that relating profit to time is riba. Hence, a more careful Islamic banker would normally limit Bai Muajjal financing to tenure not longer than one year so that spot price and deferred price of the transaction can remain the same. If Islamic bank buys a television set from a dealer at RM1, 000 and sells the same to a client at RM1200, this price will not change whether the client settles the purchase price on the spot or in one bullet payment after one year or in twelve equal monthly installments. The practice in Malaysia is Islamic banks allow profit to increase with increase in tenure. That is why the Malaysian version of Bai Muajjal (Al Bai Bithaman Ajil it is called) is not accepted in the Middle East.
For financing facilities which require longer term settlement, other modes of financing such as Ijarah wa Iqtina (as explained earlier) and Musharahaka Mutanaqisa (explained below) are more appropriate.
Sixth, Islam allows financing under the mode of Musharaka Mutanaqisa or decreasing ownership, that is, over time, the ownership of the financier of the financed item become less and less while that of the client more and more. Again, we explain this with an example.
A client comes to apply for a financing to purchase a brand-new RM300, 000 condominium. After being satisfied with his creditworthiness, the bank agrees to grant him a Musharaka Mutanaqisa facility to finance, for simplicity, 100% of the purchase price of the condominium on the condition that the client must pay back the financing in five equal installments, that is, RM60,000 per installment.
As the acceptable rental rate for this particular condominium is RM3,000 per month, the client and bank agree that the monthly rental rate of RM3,000 be fixed for the property over the tenure of the facility. Of course, rent may increase or decrease during the period but it is agreed that the rental rate so fixed will remain over the period.
As the ownership of the client over the financed property increases over the period and that of the bank decreases, the portion of the rental income going to client also increases over time and that of the bank increases. The following Table shows this clearly.
Example: Musharaka Mutanaqisa Financing
Financing Balance Ownership of Bank (%)
Ownership of Client (%) Monthly Rent due to Bank (RM) Monthly Rent due to Client (RM) Total Monthly Repayment by Client (RM)
Period 0 300,000 100 0 3,000 0 63,000
Period 1 240,000 80 20 2,400 600 62,400
Period 2 180,000 60 40 1,800 1,200 61,800
Period 3 120,000 40 60 1,200 1,800 61,200
Period 4 60,000 20 80 600 2,400 60,600
Period 5 0 0 100 0 3,000
1. Repayment of Purchase Price of the condominium is RM60,000 per period (RM300,000/5 = RM60,000).
2. Client pays less and less every period as his ownership of the property increases, portion of the rent due to bank decreases.
Scholars are in agreement on this mode of Shariah financing. However, disagreement still exists on how the rental rate can be best fixed. The difficulty arises in fixing the rental rates due to lack of reliable statistics on rents and in some Islamic countries the authorities do not collect such statistics on consistent basis. Further, rental rates are variable from location to location. For example, in Kuala Lumpur alone, rents are different from place to place. Let alone rents for the whole country.
If the client concerned feels that the rent charged by the bank is more or less the amount of rent that he has to pay to the owner of the condominium if he were to rent the condominium, then there is no injustice inflicted on him from the transaction. Further, if he were to wait for his saving to accumulate, perhaps, he will not be able to buy the condominium in a foreseeable future. By then, the price of the same condominium could have gone up, by how much, one can only guess. He could also save some money if he can settle the financing earlier as mostly Islamic banks normally give rebate for early settlements.
Islamic scholars are unanimous in saying that Islamic banking should be a musharaka banking. But, given the state of akhlak of the Muslims today, the implementation of musharaka banking will have to wait. For the time being, Islamic banks focus on those simpler modes of financing and ensure that the practice is in total adherence to the Shariah.
Dr Rosli Yaakub
Gulshan 1, Dhaka,
Sunday, 14 August 2010