15 - Interesting Argument on Debt Financing

A friend of mine sent me this article by email last week. A very interesting article about Al-Bai Bithaman Ajil (or deferred payment financing). Before I write about Diminishing Musharakah, I feel it is best for me to clarify some of the issues raised in the article first. Let's read what the article said:

QUOTE:

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 (translation - the calculation is the same but this is halal, the other is 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 (translation - no different)

A colleague who wore a kopiah (transalation - cap normally use by a Malay) 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’(translation - you should not count an unripe fruit). 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.

UNQUOTE

The above article showed that there are still arguments among the Muslim scholars on some of the Islamic banking products. I'm not going to indicate who is right here(let the Shariah Scholars resolve this issue...) but what I plan to do (at this juncture) is to list down the various arguments based on practical issues raised by the article writer above. To do this, I will classify the arguments based on two sides i.e. those who support BBA (Murabahah) and those who are against it.

Supporter of Al-Bai Bithaman Ajil (BBA)

# Surah Al-Baqarah verse 275 in summary, Allah permitted trade and forbidden usury (riba)

# Thus, to validate the above, BBA is structured as a "trade transaction" where the Bank buys the asset and then sells the asset at an agreed price on deferred payment. Technically, it is not a loan (Al Qhad or benevelent loan) transaction so, we cannot classify the customer as a borrower. It is suppose to be a trading transaction.

#Another issue is about the buy and sell transactions. To ensure it is Shariah compliant, the transactions should be done on tripartie basis ("B" buys from "A" and the sell to "C") instead of bi-lateral ("B" by from "A" and then sell back to "A" at original price + mark up). A bi-lateral transaction is considered Bai Al-Enah. Most scholars argued that Bai Al-Enah is not shariah compliant. Again, I would like to stress.... let's the Shariah Scholars argue on this...

# Another issue raised in the article is "the price" Using Casio calculator, profit is pre-calculated based on agreed "profit rate" times (X) the agreed payment period. The monthly instalment and total payable (sale price) is lower if the payment period is one year but the sale price is higher if the payment period is two years. So, the sale price defer based on the deferred payment period agreed by both parties.

# Under BBA transaction, THE PROFIT RATE IS FIXED and is definitely calculated based on NON-COMPOUNDING basis compared to conventional compounding interest calculation. Bank Negara Shariah Council had forbidden "compounding profit calculation" during inception of Islamic banks in Malaysia (so the article writer was wrong on this issue). If we re-examine the profit issue, there is nothing in the Al-Quran or Hadiths that specifically indicate "profit formula" in sale transaction. So, why are we arguing on the profit formula? Of course, there are scholars that said, a Muslim cannot charge more than 30% profit over the original price of the goods. In my over 16 years experience in Islamic banking, I'm yet to find this hadith. Maybe someone out there can help me on this i.e. if there is such hadith, I stand to be guided. I assume the main argument is why higher profit is charged if the deferred payment period is longer (money over time). So, for those who support BBA transaction, their argument is that as long as there is proper purchase and sale agreement (trade transaction), BBA is acceptable by Shariah as a "halal' transaction.

#In the Middle East, most of the deposit are accepted under Al-Qardh (benevolent loan to the Bank) so there is no issue on profit payment (...they don't pay any profit or hibah to the account holders). But in Malaysia, due to the entrenched conventional savings system, deposits are collected under the principle of Al-Wadiah and Mudharabah. There is no issue on Mudharabah deposits (profit is distributed based on agreed profit sharing ratio) but for Al-Wadiah, some banks are still giving "hibah" although Bank Negara's Shariah Council decision forbids payment of "hibah" on Al-Wadiah deposits. Somehow, there is no strict enforcement on this decision due to maslahah issue..(I think so..) Without "hibah',the Islamic banks are scared that they may not be able to collect cheap source of savings deposits.

#Talking about Justice Abdul Wahab Patail decision, it has been overturned. When you examined the case carefully, the Judge decided the case based on "conventional decision" so whatever court awards was definitely 100% "riba". If the decision was based on Shariah decision, the original agreement stands thus, the customer only need to pay based on the original agreement signed between the Bank and the Customer (based on staff profit rate) because the second agreement was signed not according to Shariah Law which resulted the transaction having one (1) Purchase Agreement and two (2) Sale Agreements. The Judge actually awarded extra RM200k more to the Bank (considered as "riba"). Under Shariah decision, the Bank should only be awarded whatever outstanding sale price (...I think it was about RM400k)of the original agreement. In addition, one cannot say the process is unIslamic if the bank has to auction the property to recover their money. Islamic bank is also a business entity...

#In addition, the reason why Islamic Bank has to claim the whole outstanding sale price in a legal process is because the Bank is not able to determine when the legal case can be resolved. But once the case is resolved (..assume the customer settle the outstanding balance), the Bank may give some discount (..usually using similar formula adopted by conventional Bank). Although Shariah wise discount or rebate should not be mentioned in the Agreement (latest practise in Malaysia....this can done by Wa'ad or unileral promise)...morally, the Bank should give a rebate if the Customer settle prior the financing maturity date. In situation where the case drags on...and exceeded the maturity period of the account, the original sale price shall remained unchanged (..fixed) unlike conventional banks where outstanding loan balance shall continued to be compounded until fully settled. I will write full detail (including it's calculation) on this issue once we touch the subject of BBA in later session.

Those who said BBA is haram

Some of the arguments:

# Extra profit over time is not acceptable. Under a true Murabahah transaction, we should not calculate the profit based on time. So, if the profits is say, 20% + original price, the sale price shall shall remained fixed irrespective the deferred payment period i.e. 1 year, 2 years or longer.

# Most BBA transaction in Malaysia is based on bi-lateral transaction instead of tripartie.

As I mentioned in my earlier articles, all these issues can be resolved if the Islamic banks start exploring other better contracts such as Diminishing Musharakah. I'm not particularly worry about BBA as based 25 year interest rate trend (Islamic profit rate tends to be benchmarked by prevailing conventional interest rate), fixed rate financing is very much cheaper than conventional variable rate loan, if the payment period is long. In default situation, conventional bank will claim every single sen on compounding basis. Under Shariah decision in Malaysia, in case of default, the Bank can only claim maximum outstanding sale price. Any compensation charges (...akin to penalty interest in conventional bank) obtained as a deterent measure, has to be given to charity.

I hope the above explanations have answered some of the issues raised in the article but as I mentioned above, full detail on this issue will be examined once we touch on BBA in later session.


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