Shari’ah Instruments Applicable In Business Realities

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

INTRODUCTION

This piece will be discussing the instruments applicable in Islamic business. More accurately, it will talk about financial instruments that are applicable in an Islamic transaction, especially in the Malaysian context since it is becoming the international hub for Islamic banking and finance.

In the Prophet saw’s time, Islamic banking was in the form of a simple savings account. During the Middle Ages, it is claimed that many concepts and practices of Islamic banking and finance were adopted by European businessmen and bankers. Only until recently that Islamic banking and finance is being utilized and assimilated into modern needs, becoming one of the world major players. At the Organisation of Islamic Conference in Jeddah 1973, discussion regarding the Islamisation of banking system was carried out, which resulted in some banks to switch to profit and loss sharing system from of the interest system.

However then, they were still technically commercial banks with no-interest policy. Fortunately modern Islamic banks have gone a long way since then. It has gone through three phases of development since it was called for in the 70’s. Its emergence was marked by a period of profitability from oil, resurgence of Islam and the establishment of the OIC. In the 1976, it began to expand further outwards from the Arab countries. However, after reaching its maturity in 1983 onwards, Islamic banking in the Arab countries faced setbacks such as declining price of oil, relative increased interest rate and strength of dollar in the US and the capital outflow of the OPEC (Organisation of Petroleum Exporting countries). In the positive side, Arab banks started to open up branches in the US, spreading the practice of Islamic banking to the non-Muslim areas. Now, Islamic finance is able to be a tool for competitive advantage. Islamic banking and finance has gain popularity again when Muslims desire a system that is ethical and is according to Islam. There is a call for more equitable system.

So exactly what is Islamic banking? Islamic banking is an element under Islamic economic order, thus its features also applicable to Islamic banking. To summarise from an article from The Institute of Islamic Banking and Finance’s website, there are 6 features of economic order. Islam discourages exploitations, encourages Muslims to spend his wealth judiciously, reduce surplus and give charity, discourages wealth to accumulate in few hands and aiming for social justice without depriving individuals of their hard earned money.

It’s underlying basis for being is much unlike the one being practice worldwide, the conventional banking system. The most important element of Islamic banking is that it is not about gaining without going through pain. That is, we cannot earn without having a little bit of risk and effort. Interest, usury or riba’ is strictly prohibited in Islam. The literal definition of riba’ is to increase or add to anything. Technically, it varies among the Islamic schools of thought; however they are not too far out from each other. The Hanafis says that “Riba’ is the extra or the increment of wealth without any return in the exchange of wealth according to Sharie legal measurement”. The Hambalis says that “Riba’ is the extra or the increment of something which is defined according to the Sharie legal measurement”. The Shafies and the Malikis say that “Riba’ is a contract which is without equal return or something defines according to the legal sharie measurement during the contract or with lapse of time in the exchange”. Only Riba’ relevant to debt will be discussed here. Riba’ Al-Duyun is an increase rising from debt that is repayment which is charged with some percentage amount. It furthers into two dimensions. The first one is Riba’ Qardh “where the increase (interest) on the principal sum of the loan is agreed upon at the point of contract”. The second one is Riba’Jahilliyah which “refers to the increase levied on the borrower for late repayment or failure to repay the loan”. A delay between lending and repayment is called Riba’ al Nasiah. In Surah Al Baqarah verse 275 stated:

“Those who live on usury shall rise up before Allah like men whom Satan has demented by this touch: for they claim that usury is like trading. But Allah has permitted trading and forbidden usury.”

Here Allah swt have clearly stated that riba’ is wrong and that trading is good and that we shouldn’t mix the two together.

Also in verse 279 stated: “if you do it not, take notice from Allah and His messenger. But if ye turn ye back, ye shall have your capital sums. Deal not unjustly and ye shall not be deal with unjustly.”

In this verse, God have specifically announced that to charge interest is an act of injustice. Islam is against anything that oppresses people and interest has many ways of exploiting others, namely the depositors and borrowers. Also, profitability is not seen as the soul target for performing business. Rather Islamic banking is responsible for social objectives also, such as equal distribution of wealth. Social goals are not to be ignored in any part of Islam.

To replace the element of interest which is not permissible in Islam, Islamic banks had introduced the Financing and Profit Loss Sharing system, whereby banks are in partnership with its customers, thus expose them to certain amount of risk. Furthermore, the only debt product that these banks are allowed to sell is the Qardhul Hassan, the interest-free loan which is permissible in Islam.

In Malaysia, Islamic finance begun in 1963 when the Pilgrims Fund Board or Lembaga Tabung Haji was established. This was aimed at Muslims who wanted to save for Makkah. It provides returns that did not involve riba’. The proper Islamic bank was set up in 1983 – the Bank Islam Malaysia Berhad which provides not only savings products, but also products comparable to the conventional banks, and in line with the teaching of Islam. In the next section, different Islamic financial instruments will be discussed to give a better view of the current Islamic banking in Malaysia.

THE ISLAMIC BANKING INSTRUMENTS

There are a number of Islamic banking concepts that are being used to sell the financial products. Only for basic products such as savings and current accounts that single concepts are used on. For others, bankers have proved themselves to be creative combining two or more concepts to form the products.

The basic concepts outlined by the Bank Negara Malaysia (BNM) are thirteen. Brief explanations are given.

This refers to goods or money which is given to the bank with trust for safe keeping. In return for using the bank as a depository, it may give some returns to the depositor.

This involves an entrepreneur who wants to go into a business but have no capital and a financier who has money and would like a share of profit from the business. The bank can be either entrepreneur (when it invests into businesses with depositor’s money) or the financier (where it contributes the money). The profit-sharing ratio is predetermined.

This is when sale of goods comes with deferred payment solution in the form of installments. The bank buys the commodity on behalf of the buyer, and sells it to him at a cost-plus price.

It is similar to BBA; however the buyer pays either in installments or in lump sum, at a later date.

According to BNM’s definition, Bai’ al Inah is when “ the financier sells an asset to the customer on a deferred payment and then the financier immediately repurchases the asset for cash at a discoun t”.

This is equivalent to the conventional leasing.

This is equivalent to the conventional hire-purchase.

Collaterised borrowing.

This is a partnership where profit ratio is predetermined, and any loss is borne by both parties.

This is mentioned in the introduction. It is an interest-free loan product where the borrower is not obligated to pay interest, but he may give a little as a small gesture of thanks to the bank.

Is a guarantee procedure, where a third party guarantees that one of the contracting parties will comply with the contract.

When a person nominates another person to act in his behalf.

Commission or fees charged on service given.

These are the basic Islamic financial instruments. To encourage the market penetration of Islamic banking products, besides the setting up of Bank Islam Malaysia Berhad and Bank Muamalat Malaysia Berhad, BNM had also allowed conventional banks to open Islamic windows. This has resulted in a diverse range of products, from savings account and current deposits, to credit card services and Umrah financing. What are the products resulted from these concepts? Here are some scenarios which hopefully are better and more interesting to pore over. The products mentioned are actual products available in Islamic banks and Islamic windows in Malaysia.

Say that you are a young man with lots of money. You are worried for its safety under your pillows so you decided to put it in a bank. However, the conventional ones have values that are not in line with yours, (i.e. they pay interest). So you go to an Islamic bank to open a savings account, or usually known as al-Wadiah. Worry no more about clashed values. The concepts involved in a savings account are wadiah and mudharabah, which means that you will have your money in the hands of the bank, assured that you will get your money back anytime you want it. Also, at the same time you are providing cash for the bank to invest it in projects. Any profit it gains; it will share by the stated returns percentage. Any loss however, will not be borne by you because the bank was entrusted to safe keep your money in the first place.

Another issue comes up when you wanted to further into tertiary level study but not having enough money in the al-Wadiah account to sustain yourself for the duration of your study. Your grades are too inferior to obtain a scholarship and apparently you are too rich to receive PTPTN (just because your father earns a lot, but obviously they overlooked the 10 mouths he has to feed). A loan from conventional bank means paying the principal and the interest later on. Not when you visit the Islamic bank! There, the bank ‘buys’ the education fees and ‘sells’ it to you on a deferred term at a higher price. Here the concept of Bai’ Bithaman Ajil applies. BBA is also applicable when you want to purchase a car or other high-priced goods that take ages to repay.

Four years later and you have just graduated from university. You decided to go into business and still have some savings from al-Wadiah account. The business is to provide basic services such as photocopying, laundering and car renting. But you still need more capital to start, thus off you go to the Islamic bank to form a joint venture with the bank. There are many forms of al-Musyarakah, but the basic form is the sharing of capital, profit and loss. There is also a small amount of intervention from the bank, because they have a share in it too, so they would like to see it make profit. The distribution of profit will be apportioned according to an agreed ratio. However losses also have to be borne by both parties.

But what if you cleaned out you account ages ago during your studies to buy cool new mobile phones to keep up with the crowd? Worry not, the bank also provides al- Mudharabah, allowing you to be in partnership with the bank. Here the bank provides the capital while you as the entrepreneur will work towards doing the business profitably, the returns are agreed upon in ratios. If you are successful in doing so, both you and the bank will get your returns. However if you make a loss, only the bank – the provider of funds – will bear the loss. This concept can also be applied the other way round, where you are the provider of fund and the bank as the entrepreneur. When you put your money in an investment account, the money will be utilized by the bank to invest in projects. The profit sharing ratio for you will probably be higher than normal al-Wadiah.

So now that you are in a business equipped with enough capital, you have to buy the equipment to operate the business. One way to cut the cost of maintaining and also keeping up with acceptable technology advances in photocopiers and washing machines, is through al Ijarah, also known as leasing. You are only required to pay the monthly rent of the machines and the leasing company will provide maintenance. You can also trade newer and better models without losing money.

Another concept is al-Ijarah Thumma al Bai’, hire purchase concept where you lease something for a while then when you decide to buy it, the leasing company will sell it to you. For example the Kancils you have to buy for the rental service. Because you know you probably would not need to trade up the Kancils for Mercedes Benzes, you decide to lease it, and when you have more money, you can opt to buy them. An element of BBA is involved when you decide to buy. The bank will buy the cars from the leasing company, and sell it to you at a higher price to be paid later.

So far no loan product in sight. But wait until you apply for a charge card, otherwise known as a debit card. Qardhul Hasan, benevolent loan concept applies here where you are only required to pay the principal. Not satisfied? You can apply for the credit cards (now that you are a successful businessman). The concept of Bai’ al Inah applies, where the bank ‘sells’ a commodity to you at a higher price and expects you to repay back using the money gained from selling the commodity to another buyer, in installments. However the idea behind this is too vague to explain further. Only the Shafie mazdhab allows the complete use of this concept because others insist that there is element of exploitation at work.

CONCLUSION

Although in practice the Islamic products are much like the conventional ones, with some critics saying that the profit charged on the products are actually interest in disguised, we have to remember that in Islam, everything starts with intention. If we have good intentions, we will be rewarded for it, however if we have bad intentions and actually put it into practice, we will face the consequences later in al Akhirah. One FIE lecturer responded to a question regarding higher percentage being charge by Islamic banks than the conventional banks by saying that it’s a choice that will determined where we will end up.

Here also implies that it is important for an economy to have not just one Islamic bank, but many that will compete and work together to establish good reputation. Malaysia aims at having dual-banking system and has succeeded to be the first nation to have a full-fledged Islamic system side by side with the conventional banking system. Furthermore, BNM targets to fulfill the requirements in order for Islamic banks to be viable, that is by having a large number of player, offering a broad range of instruments and finally having an Islamic money market. This was done by introducing the Skim Perbankan Islam (SPI) in March 1993 to encourage many players to come into Islamic banking in the shortest time possible. Currently the industry has all the elements required and is continuing to advance further.