Practices of Islamic Banking in Malaysia

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

INTRODUCTION

An attempt will be made in this paper to discuss about the doctrine or rules of Islamic banking product provided by commercial bank in Malaysia. Besides, this doctrine also can help people in dealing with various transactions and of facilitating them to use certain product or schemes.

Before we discuss deeper about this topic, it is better if we firstly identify what types of products that have been provided by the banks. Of course all of these products are based on Islamic Shariah.

Since there are so many Islamic banking products in our country, to have a better understanding, only some of it that is widely used will be discussed here. Those are Al-Wadiah, Al-Mudharabah, Al-Murabahah, Al-Ijarah, Bay-al-Salam, Bai Bithaman Ajil,Al Musharakah and Bay Al Inah .

In addition, the most important thing is what is the status of these products from the Islamic point of view. This will be clarified by some different scholars. We also will discuss about its characteristics, the terms and conditions and also its applications.

Another element that will be included in this paper is also the recommendations and suggestion for the purpose4 of improvement of the existing practical scenario.

Hence, through this paper, it is do really hope that all the elements given can support the idea that Islamic banking products are able to compete with the traditional banking product and it provides better facilities to the Muslim people.

At the same time, we could differentiate between good and bad and have a better understanding about Islam and able to establish its principle. Therefore, we indirectly will have better understanding of the objective and the purpose of our existence as vicegerent of Allah on earth.

TYPE OF ISLAMIC BANKING PRODUCTS

There are many Islamic banking product introduced in this recent time that can solve the problem of unlawful elements such as riba, gharar, gambling, etc. In Shariah itself has provided the easy way to follow and conducive to interest free based. In this report only will stress on some of the Islamic banking product exist in Malaysia and it facilitating doctrines about each banking products. Below are listed of product and definition that will cover.

PRODUCT DEVELOPMENT

During Prophetic Period

Past Prophetic Period

Present Time

Future Time

FINANCIAL INSTITUTIONS

Even Islamic banking products have rivalry from conventional products offered, specific party such as Shariah Supervisory Council and government emphasized used of Islamic product. In Malaysia was located many banks that apply the Islamic banking product in their transactions to counter the used of interest or riba. Banks that all the product offered related to Islamic also build such Bank Islam Malaysia Berhad and Bank Muamalat Malaysia Berhad. Besides, banks those open Islamic windows of Islamic banking product increase from time to time due to awareness and knowledge about the benefits and advantages that can get not only to earn profit but also to get pleasure from Allah.

Islamic Banks

Commercial Banks

Islamic Malaysian Bank

BANKING PRODUCT

(AL-WADIAH)CURRENT ACCOUNT AND SAVING ACCOUNT

Islamic Banks accept funds from their customer to be administered in the form of current account and saving account with the principle of Al-Wadiah (trust). According to the terms and conditions set out in the application form to open an account, the customers are aware of it and mutually agree with the bank about the management fund of their money by the bank. Then, the big income generated from the fund will be distributed as bonus (halal bonus) to the customers. This kind of bonus is voluntary basis and not an obligatory basis.

Now, we will discuss about the Shariah principle concerning these operation. As mentioned earlier, current and saving account falls under the principle of Wadiah (trust). It is permissible in Islam in order to keep its assets or liquid funds as deposit to an individual or to a bank. Since the funds collected from the depositor will be managed by the bank, and the funds will be invested by the bank, there is view that will clarify the justification whether the bank has the right to invest the customer funds or not. The view comes from a group of scholars. Their opinion is that a trust could not be invested without the prior authorization. Based on their arguments, a trust with prior authorization has been altered and become a loan. Normally, loan has its characteristic, which is if there is any extent from the principle loan, it is considered as usury that has prohibited in Islam. However, this is nit the case for trustee. Unless the trustee mismanages the trust, he is not entitled to pay any indemnity. The trustee is not responsible for any damage causes beyond his control. There is no absolute guarantee required from the trustee and this is the case with commercial bank’s responsibility in this regard.

Another group of scholars are in the opinion that trusts fund may be invested without prior authorization provided the trustee takes care of the security of the trust. Regarding the returns from investment of a trust without prior authorization, there are also different views. Majority of the scholars agree that the return belongs to the trustee considered as makruh (reprehensible). Meanwhile, another group of scholars say that the return on investment belongs to the depositor and not to the trustee and warranty given by the later is related only to the mismanagement and its counterpart. The return from investment with prior authorization is distributed in compliance with terms and conditions of authorization. Therefore, it is fair when banks provide halal bonus on Current and Saving Accounts.

(MUDHARABAH) INVESTMENT ACCOUNT-TIME DEPOSIT

Islamic bank accepts a time deposit from its customers ranging from the period of one month up to 2 years period. There are two issues regarding this matter.

The first one is under existing banking rules, customers fund are refundable on or before maturity. According to Islamic Shariah, this kind of deposit is refundable under the claim. Islamic bank is obliged to give the customers halal bonus, provided that it is not less than what is given to current and saving account.

Second point is while accepting time deposit, the bank may give a promise that the expected return will not be less than what they can expect from commercial bank but such a promise is not compulsory in Islamic Shariah. If there is any loss incurred, the customers will not subject to any loss. This is because based on the policy that funds received by the bank from the public will be put together in a pool for common investment.

Besides, under this account, the customer acts as financiers (capital provider) and a bank as an entrepreneur. The return on direct investment of the bank is distributed between the customer and the bank at a ratio agreed upon by both parties. When the bank acts as an intermediary, the income for the bank is equals to the differences between what it has received from the entrepreneur and what is promised to the depositors. Regarding the loss issue, if there is any loss on investment, the depositor will not be involved since the investment is pooled together and invested in different sectors and units of economics activities. However, there are some justification on this pooling system and will be discussed shortly.

The next element that should be taken into consideration is how does scholars response this product from Islamic angle.

Time deposit is considered an investment with prior authorization. The relationship between the depositor and the deposit taker or the bank can be defined into three categories.

First one is fund deposit is considered as a loan. From Islamic point of view, a borrower has the absolute right to invest it as this is the philosophy of lending scheme. The return from this loan is also the absolute right to the borrower since the loan is under his guarantee and obligations. However, the lender/depositor cannot claim from the borrower anything in excess of principal amount. This is because any excess generated from loan is regarded as usury or riba, which is prohibited in Islam. However, any voluntary bonus and pre-determined service charge is not considered as riba. Therefore, any amount charged by the lender in the form of administrative cost is permissible in Islam.

Second category is the bank which accepts deposit is regarded as entrepreneur or Mudharib and the depositor as financier or capital provider (RAB AL MAL). The return from investment is distributed between the two parties on the mutually agreed ratio basis. In fact an Islamic bank makes a promise to the depositor to give him return which could be higher than the prevailing rate of return in the money market. It can do so because under normal condition a bank always can make profit out of its investment.

Third category is the bank may invest the fund in any project as joint investment. In this situation, the bank and the depositor are regarded as partner (MUSHARAKAH) which will be discussed later.

Regarding the pooling system, there are different views from Islamic scholars. A group of scholars say that pooling system is not allowed. To them, pooling system implies a mixture in responsibility which in return may lead to a confusion of customers’ rights.

Another group of scholars (from Hanafi, Maliki and Hanbali schools) allow the mixture of fund. Modern economics that has been implemented supports the pooling system. There are big project that require a huge capital investment which could be undertaken only if public funds are pooled together. During the time of the Prophet (pbuh) in his young age, was involved in Mudharabah deals in two journeys to Syria (Syam). He was as an entrepreneur and the capital was provided by Khadijah (ra), who later become his wife.

(MUDHARABAH)TRUST PROJECT FINANCING

For project financing, Islamic Bank may implement it in the form of Mudharabah. The former that has been discussed before is for customers’ deposit, which is little bit different with Mudharabah under project financing. Party who manages the project will only under control of the entrepreneur and the bank has no right to interfere in the management. It may supervise and verify that terms and conditions set out in the financing agreement are complied with. If there is any loss in trust financing, the bank as financier will bear with it and not the entrepreneur.

In Mudharabah, any loss of commercial risk will be borne by financier (bank). By commercial risk, we mean that the entrepreneur has no hand in the losses such as falling of international and domestic price, the finance regulations introduced by the government, etc.nevertheless, and the entrepreneur is not free from responsibilities on any damages caused to the project due to the mismanagement which is not a commercial nature.

The entrepreneur is a trustee and is responsible to safeguard the interest of trust. When an entrepreneur is breaking the terms and conditions of agreement, he is responsible for such a disruption. In conclusion, the bank in Mudharabah project as a sleeping partner.

For Shariah ruling, this kind of project financing has no difference with customers’ deposits. However, to make it easier to understand, there is a story narrated by Imam Malik. It is about the two sons of Khalifah Umar (ra). Their names are Abdullah and Ubaidallah. There were coming back from an army expedition to Iraq and were receiving a fund trust from the governer of Basrah which belonged to the State Treasury “BAITUL MAL” in Medina. The Governor of Basrah, Abu Musa As-Ashary allowed them to invest it, provided the principal amount is given to BAITUL MAL, when they reached Medina. Khalifah Umar insisted that the funds, its principle and profit given to BAITUL MAL because they were given this facility as they were sons of Khalifah. The Khalifah was asking whether all members of the corps were given the same facilities. The reply was nit.the young brother, Ubaidallah urged that it was under their warranty. So any loss incurred to the trust was to be borne by them. Therefore, it was their proper right to have any profit out of it. One of the audience recommended that the deal to be considered as Mudharabah and such the profit should be distributed between the two brothers in one part and the Treasury on the other part. It was accepted by the Khalifah.

The following are some conditions concerning Mudharabah activity. The main point here is about the capital.

-there is a general consensus among Fuqaha that Mudharabah with Dirhams and Dinars are allowed while other than that is not allowed such as goods or coins. This is because dirhams and dinars does not change in value due to the market value. According to major fuqaha including Malik and Shafie, the Mudharabah with coins and goods, which values will fluctuate if there is in condition which a commodity owner asks the mudharib, to trade with it and, when its concluded to purchase a asimilar commodity from him, balance, if any, to be divided between them.it is shows that the validity of that Mudharabah. Imam Malik added that the commodity owner could have given it to the Mudharib when it was selling well i.e. had a high price. When the Mudharib has to return the commodity, to the owner, he purchases it with the third of its original price, hence adding the difference in price in his share of profit. The same process goes to the coins. In short, capital must be in dirhams or dinars because it is easily traded and their market values seldom change.

-let say a creditor says to a debtor, “consider my debt as a Mudharabah capital and profit yielded is to be divided in half”. This is invalid Mudharaba, because the refund of debt is guaranteed and as such, cannot constitute a capital, whereas the capital for Mudharabah is deposited in trust with the Mudharib. Mudharabah with deposits: all Fuqahas agree on the validity of Mudharabah, using the fund as capital because in this case, capital is belongs to Rab Al Mal and is considered available. Deposits differ from debts in that they remain the property of the depositor even when deposited. Both are in trust basis.

-the capital should be known in terms of it quantity and quality. Meaning to say that both parties should know all the elements regarding the capital.

-in this case the Mudharib should receive the capital in person and be free to use it.

(MUSHARAKAH)PARTNERSHIP

Under Musharakah, a bank may participate in a project by involving in equity participation. Indirectly, the bank will be a shareholder in which it has the right to be represented in the management of the company. The dividends earned by the company will be shared by the bank on the basis of its participation.

The Musharakah model will be able to benefit participants in two ways, namely:

The subject of partnership or Shirkah in the form of individual partnership, legal entity and joint venture company is well known. No question or argumentation is raised against the partnership form.

In one tradition as narrated by Baihaqui, the Prophet (pbuh) says:

I have no relation to a person who betrays a man who has deposited something to him in his custody as a trust which has to be taken care of the fourth Khalifah , Sayyidina Ali narrated in another Hadith that there were 2 partners. One of them needs to spend most of his time praying in the mosque behindthe Prophet (pbuh). The other one used to spend his time on business in the market. On the day of profit distribution, the latter claimed for more profit than what was agreed in view of his efforts in making profit. The case was submitted to the Prophet (pbuh) in which he says, “Be aware that the profit you gained was in fact due to your partner’s active in praying in the mosque”.

The view of Islam concerning partnership is also applicable to any sort of cooperation such as joint venture, profit sharing and placement.

(AL-IJARAH)LEASING AND HIRE PURCHASE

A bank may undertake to finance a project by way of leasing and hire purchase. When a customer needs to use the services of equipment, machineries, vehicles, etc through the soft facilities of rental, the bank will purchase a given asset to be leased to the customer. If so desired, the bank may finance a project under Hire Purchase Scheme. In this scheme, the customer will pay a rent of a given asset along with the installment of principal payment. T the end, the title of the asset right will be transferred to the name of customer after the payment of the last installment of the principal.

About the justification of its operation, leasing and hire purchase is lawful transaction which is permissible in Islamic Shariah and there is no difference of opinions of Islamic scholars on this subject. Therefore, there is no need for further discussion about this issue.

MURABAHAH (MARK UP OR COST PLUS)

Murabahah is a form of financing which relates to sales. Literally means a “profit transaction”. It seems that a “pre-financing sale” is an appropriate expression of this team in English. A major difference between Mudarabah and sale is that the seller is not in the possession of goods under purchase when order is made. The commodity in question will be purchased by the seller (financier) on receipt of confirmed order from the buyer at cost price plus a profit margin. It also defines as “an agreement between two parties in which one party do request the financier to buy upon his request certain goods or commodities with in undertaking for the applicant to buy these goods or commodities at cost-plus a profit margin. It differs from ‘forward purchase’ on two accounts. Firstly, the fund is provided by the seller instead of by the buyer. Secondly, in Murabahah delivery is made instantly rather than with future. It is basically an arrangement where the customer who wishes to purchase certain items or goods, request the bank to purchase the items and sell them to him at cost plus a declared profit.

As for example, a trader who needs a particular commodity which is to be imported or to be dispatched from another region, he may request the bank to purchase the said commodity on his behalf. The sale price is fixed at purchase price plus profit margin and charges if any. The settlement could be in cash, in deferred sale or in installment sale basis. The opinion of Shariah concerning Murabahah is like sale and Murabahah has been defined by the scholars in the following ways:-

Ibnu Qudamah in his book El Muncy 9volume 4, page 199) says:

“The price plus agreed profit margin is the Murabahah price”.

Imam Kasany defines it in BADAI SANAI 9volume 7, page 93):

“The purchase price plus profit margin is the price for Murabahah”.

Sometime it happens that the buyer refuses to take delivery of the commodity after the seller has purchased it on his order. According to the rulling of Islamic scholars he should be forced by the court to fulfill his commitment. To them, order is a legal obligation (zimmah) for which settlement may be made compulsory. However, Imam Shafie differs with them. When a debtor could be brought to the court to pay his debt, so a buyer who promised to buy commodity under Murabahah be forced to fulfill his commitment.

Many people confuse sale for profit Murabahah operations with operations involving interest, but it should be noted that in sale for profit a commodity is sold for money and the operation is not a mere exchange of money for money. It is nothing but a sale operation. This confusion has happened to those people because the profit rate is determined in advance. There is also an element of risk involved in such a sale because the Islamic legal form we use (in accordance with the ruling by the Shariah Supervisory Board) dose not commit the customer to buy the commodity when it is made available to him even if it satisfies all the standards he has asked for. Only once, however, has a customer actually rejected a commodity after its arrival.

Murabahah is a form of sale and purchase (al-bay’) which has been expressly authorized by the Quran, Sunnah and Ijma’ of ummah.

For example, in Surah al-Baqarh : 275 says:

“But Allah has permitted trade and forbidden usury…”

From the Sunnah, It was reported that the Prophet s.a.w had been asked regarding the best occupation. In replying, the Prophet says:

“The work of a man with his own hands, and an honest trade (i.e. which does not involve any fraud or cheating).”

Some conditions of Al-Murabahah are as follows:

BAY BITHAMIN AJIL (BBA) OR BAY AL MUAJJAL (DEFERRED INSTALLMENT SALE)

This mode of financing basically is a trade-deal in which the seller allows the buyer to pay the price of a commodity at a future date in lump sum or installment. In the classical fiqh literature it refers to a sale against deferred payment (either in lump sum or installment). BBa need not to have a reference to the profit margin that the supplier may eearn. Its essential element which distinguishes it from a normal sale is the deferred payment. The reason from this mode of financing is to facilitate those buyers that unable to pay cash in buying commodity.

With regard to the question of whether the deferred price can be charged more than the spot price in BBA, the Hanafis, Shafiis, Zaid bin Ali, Al Muayyad Billah and jumhur of the fuqaha’ permit such additional charge. Majority of the Muslim jurists allow the selling price in deferred sale to be set higher than the cash sale. However, this permission does not go without any condition that the object of the sale must come into the possession of the bank before being handed over to the other party. Also in case of default or delay of the payment by the customer, the price can no longer be raised. If the customer is in financial difficulty, respite should be given to him, and another date be fixed for the payment of the balance of the price.

In deferred sale it is necessary that the time for payment of the price be fixed and known by both parties.BBa is considered to be bad (fasid) if the bargain is made for a time not fixed, such as, when it has rained.

BAY AS SALAM (FUTURE DELIVERY)

The system makes payment in advance for the goods to be delivered in some future time. The deal is closed far before a delivery takes place. Salam is defines as “contracting for the purchase or sale of commodities or products on the basis of immediate payment of the price with a future delivery at an agreed upon date and quantity. It is a condition in salam contract that price, time of delivery and specifications of commodities or products (quantity, quality,etc.) are known at the time of concluding the deal.

Bay al-Salam is a contract agreement that involves buy and sell the goods which payment made in advance and delivery of good in future on specific time. For example, a bank customer request to buy a car and the bank agrees to supply a car within two month. Both parties involve in contract of Salam where the customer give money on price car to bank. The bank needs to deliver the car within specific period stated in contract. The reason behind this activities or Salam contract is to facilitate people especially businesspersons that not only depend on cash payment purchase (pay and deliver goods at the same time). It is because the seller may not already prepare the good. Salam also can be called buy goods through order which customer order goods from supplier with cash payment and the supplier will deliver the goods on certain time promised.

Two issues to be considered in the light of Islamic Shariah:

1.1 In Islam a deal is prohibited if there is any ambiguity concerning the specifications or quantities of the commodity involved. Once the specifications and quantities are known there is no harm to have a deal by paying cash before delivery of goods takes place.

1.2 Forward Purchase is supported by a hadith narrated by Ibnu Abbas from the Prophet of Islam:

"When the Prophet migrated to Al Munawwarah, he discovered that people were doing transaction with delivery of goods deferred by one, two or three years. The Prophet (phuh) gives his opinion concerning this transaction saying that whoever makes a deal on future obligation, it should be in specific measurement, specific weight and specific period".

Forward purchase is a deal on future obligation. Therefore, it is recommended that it should be recorded or written as said in the Holy Quran in Surah Al-Baqara verse 282.

"O believers, when you deal each other in transaction involving future obligation s in a fixed period of times, reduce them to writing".

2.1 The view of Shariah on discount price on Forward Purchase needs some clarifications. Although the ruling of the Prophet (phuh) was relating to debt may apply it on analogy basis to the price discount on future delivery. It is agreed quasi unanimously by scholar that analogy is one source of Islamic law. Therefore, Forward Purchase at discount price is unanimously approved by all scholars as permissible and lawful (Jaiz Bil Ijma')

2.2 The Islamic Jurisprudence permits the deal on commodity exchange provided such deals are tightened with delivery of goods and that the substance of sale "payment and delivery" is completed. This provision does not to be fully respected at the existing commodity exchange market. There is a consensus of the Islamic Bankers that deals on the existing commodity exchange do not fulfill the Shariah criterion because obligations (zimma) are traded in the market resembles interest base trading. Shariah may accommodate the Forward Purcahse but has a reservation on commodity exchange as practiced now-a-days in the market.

Conditions of Salam are:

 QARDHUL HASSAN (BENEVOLENT LOAN)

This is made available to the bank's partners (as an interest free overdraft) if they are faced with difficulties or unexpected needs. It is to be noted that the return from the original operation will improve and thereby improve the profitability of the partnership in the end. For example, of the semi-governmental corporations, we do business with deal in huge amounts, which we cannot finance wholly and so we give them benevolent loans without profit and we benefit only from part of the hard currency repayment of these loans in the form of export documents for the operations which the loan was used to finance. These hard currencies we invest in imports in partnership or sale for profit operations which produce a profit for our customers and the bank.

This product is a loan without interest profit and gives reward or gifts to those give loan when the borrowers pay back the loan. For example, Ahmad make a loan without any condition to pay more or other benefit within the contract or outside, but when he pays the loan back accompany with gift or reward to show appreciation and thank for the help. The reason for this activity is to help the poor people or needy in financial. This is to guarantee people can fulfill their needs without any difficulties to pay with interest and dissatisfaction. The concept of the loan is welfare between rich and poor people to cultivate feel of love and care each other. In Qardhul Hassan there is no riba because when settle the loan the borrower in pleasure to give reward to lender. Prophet (phuh) says it:

"Whosoever made righteousness to you, you must to pay back if you unable to give reward just pray for their success and goodness".

Qardhul Hassan is a benevolent debt-financing contract that differs from other contracts. The borrower is not obliged but has the opinion to reward the lender for his generous deed. The benevolent nature of this contract is suitable for lending by the country's citizens to their government for financing its operation and development of social projects.

CONCLUSION

Islamic banks are here to stay and there are signs that they will continue to grow and expand. Even if one does not subscribe to the Islamic injunction against the institution of interest, one may find in Islamic banking some innovative ideas which could add more variety to the existing financial network. One of the main selling points of Islamic banking, at least in theory, is that, unlike conventional banking, it is concerned about the viability of the project and the profitability of the operation but not the size of the collateral. Good project which might me turned down by the conventional banks for lack of collateral would be financed by Islamic banks on a profit sharing basis. It is sometime suggested that Islamic banks are rather complacent. They tend to behave as though they had a captive market in the Muslim masses that will come to them on religious grounds. This complacency seems more pronounced in countries with only one Islamic bank. Many Muslim find it more convenience to deal with conventional banks and have no qualms about shifting their deposits between Islamic banks and conventional ones depending on which bank offers a better return. This might suggest a case for more Islamic banks in those countries as it would force the banks to be more innovative and competitive. Another solution would be to allow the conventional banks to undertake equity financing or to operate Islamic ‘counter’ or ‘windows’, subject to strict compliance with the Shariah rules. It is perhaps not too wild a proposition to suggest that there is a need for specialized Islamic financial institutions such as Mudarabah banks, Murabahah Banks and Musharakah Banks which would compete with one another to provide the best possible services.

In the earlier sections that Islamic Bank can operate and undertake all banking operation except lendind operation with interest. Islamic banks may exist with other traditional banks within the prevailing financial systems. Islamic banks are already exist not only in many Islamic countries but also in some non-muslim countries having offices such as London Luxembourg and Geneva. A common misunderstanding is that the only difference between Islamic banking and secular banking is absence of Riba. The sattus of the Islamic banking in relation to its clients is that of a partner, investor and trader, whereas in secular banking the relationship is of a Creditor and Investor. Islamic banks are thus equity-based whereas the western banks are loan-based. Islamic banking is different in nature and scope as it is equity and investment based rather than loan- based. This makes unique demands on both the management and professionals banks. Islamic bankers are not banker in the usual sense of the word.

As mentioned before, in Islamic banking offer many financial product such as Mudarabah, Musharakah, Murabahah and Bay Bithamin Ajil. All product offers has their own uniqueness in operating transaction activities based on interest free.