Islamic Financing

Islamic banking only deals with “halal” products. Talking about “halal” food that Muslims consume, the terminology “halal” does not necessarily mean that the food is “pork free” but basically the slaughtering of the animal must also be undertaken in the manner approved by Shariah. Likewise, all banking transactions (including services) and operations must comply with Shariah principles. In banking, a loan which is normally offered by conventional banks is priced by adding interest at an agreed interest rate on top of the principal loan amount and the bank can continue charging interest on a monthly basis until the loan is fully paid for.

Under Islamic banking, however, no profit or fee can be charged on top of the loan amount granted. The word loan commonly used by conventional bank carries a different meaning under Islamic banking. Under Islamic banking, when a loan is granted, it has to be a benevolent loan (al-Qhad Hassan) which is free from any interest or fee. Thus, when a Islamic bank grants a loan of RM100,000 to a customer under al-Qhard Hassan, the bank can only collect RM100,000 (truly interest free).

In order for an Islamic bank to generate income from its banking activities, it has to structure its financing contracts based on a buy and sell contract, which is trade related. It can also grant financing by using leasing contracts, which is very popular in the Middle East or a partnership contract where the bank and the customer, both agree to a profit and loss sharing arrangement. In Malaysia, the buy and sell contract is more popular where debt is created and the settlement of the sale price (financing amount plus total profit margin due on whole financing tenure) is on a deferred payment basis. Although there are arguments that the buy and sell contract is a modified term loan at a fixed price, the transaction is in accordance with the requirements of buy and sell transactions stipulated in the Al Quran (verse Al Baqarah 275) where in short, it is translated as “Trade is like usury”, but God had permitted trade but forbids usury. This is the basis for trading transaction for deferred payment financing facilities like Al Bai Bithaman Ajil and Murabahah. However, there are also arguments that the buy and sell transaction must be a genuine sale, which means that one must own the asset before it can be sold. This will be discussed in further detail in an article on financing.

Based on the explanation above, reporters when writing about Islamic banking should avoid using the word “Islamic loan” but replace it with “Islamic financing” instead. The earlier refers to benevolent loan whereas the latter, refers to business transaction the bank normally undertakes when granting financing facilities to its customers. Thus, Islamic bank relationship with its customer is regarded as “Financier – Customer” rather than “Lender – Borrower”.

For a buy and sell contract to be considered as “halal,” each transaction must subscribe to these five (5) tenets;-

1. There is a Seller, capable of taking responsibility, sound mind, has attained the age of puberty and not restricted in dealing with business transaction i.e. not a bankrupt;
2. There is a buyer, of similar criteria to as (1);
3. There is a merchandise (asset), exists, pure substance (halal/lawful), of some use therefore of some value, seller must be the real owner, can be delivered to buyer and specification is known to both parties;
4. Price, known by both parties in amount and type of currency (ensure transparency);
5. Offer and acceptance, absolute, indefinite, acceptance must be consistent with the offer and acceptance conditions.

In addition to the above five tenets, Islamic banks must avoid offering financing or invest in four (4) main related activities forbidden (“haram”) under Shariah law, namely

1. gambling and chance-based games (Qimar),
2. alcohol based, particularly intoxicated drinks, including production, distribution and retailing
3. usury or in other words, bank interest charge by conventional banking and or the more serious business type of usury is loan from “loan shark, and
4. Non beneficial items such as entertainment related equipment, cigarette manufacturing plant and the likes of it.

On placement of deposits, most Islamic banks accept deposits under the principle of Al-Mudharabah (profit & loss sharing) which defer from conventional banking fixed deposit where interest is determined at the front-end of placement. For this reason, Islamic deposit rates are higher for depositors who place funds for longer tenure as they are willing to share the risk with the bank by placing funds at a longer tenure.

Before we move on to financing products, we would like to talk about the various types of deposit available in the market, how profits are shared and distributed to customers, and the benefits as compared to the conventional deposits. We shall highlight the comparative aspects of deposits in our next article.

Source: money3.com.my