Applied Islamic Banking

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

Introduction

The theoretical and moral impetus behind Islamic finance lies in the teachings of the Shari’;ah, or Islamic law. The marriage of faith and commerce is as old as Islam itself, but the application of Shari’ah principles to modern capitalism only emerged in the second half of the twentieth century.

Islam prohibits the receipt or payment of interest in hire purchase transactions, continuing in the tradition of its sister faiths. The Shariah also ties finance to real goods and services, and rules out investment in harmful industries like alcohol, arms and tobacco among others. Other Shariah requirements reflect the values of mutual consent, justice, fairness, co-operation and the public interest.

To ensure that Islamic financial services meet these criteria, Islamic finance providers usually work under the guidance of Shariah scholars. These Islamic legal experts have played a critical role in the development of the field by applying the principles and instruments of classical commercial law in the Islamic legal tradition to modern financial practices

A study published in 1997 by M. M. Met Wally casts some light differences between Islamic and conventional bank in hire purchase transaction. This study was based on data from 15 interest-free (Islamic) banks and 15 conventional banks in countries where a dual banking system was in operation. The study tested for differences in liquidity, leverage, credit risk, profitability and efficiency. The result shows Islamic financial relied more heavily on their equity than conventional banks. Islamic financial institutions and traditional banks offered their depositors similar returns.

According to Common Law hire purchase means," hire-purchase transaction in a contract whereby the owner lets out goods on hire and agrees that on completion of necessary payments, the hire may either return the goods and terminates the contract or elect to buy the goods. The hirer cannot sell the goods under hire. If this is done, the hirer may be liable to the owner for conversion.” Section 2(1) of the Hire Purchase Act 1967defines hire purchases a agreement includes a letting goods with a option to purchase and an agreement for the purchase of goods by installment.

A hirer is a person who takes the goods from the owner under the hire purchase agreement and includes the person to whom the hirer’s rights under the agreement have passed by assignment or by operation of law. The owner is a person who lets goods to be hirer under the hire purchase agreement and includes a person to whom the owner’s rights under the agreement have passed by assignment or by operation of law.

Section 4 (1) of Hire Purchase Act 1967 provides that the hire purchase agreement must be in writing and must be sign it.
Section 5(1) of Hire Purchase Act 1967 state that “A hire purchase agreement that is not in writing shall not be enforceable by the owner”.
Section 39 of Hire Purchase Act 1967 state that if there is any alteration n the hire purchase agreement, the hirer must sign to show his consent.
Section 4d of Hire Purchase Act 1967 requires a separate hire purchase agreement in respect of every item of goods purchased.
Section 5 (2) of Hire Purchase Act 1967 state that at any time before the final payment is made the owner shall within 14 days give the copy for hirer.
Section 7 (1)(b) of the Hire Purchase Act 1967 provides that the owner has the right to sell the goods before the property is pass to hirer.

Usually Bank may supply implement or equipment or goods on rental basis in hire purchase transaction. The ownership of the implement or equipment or goods will be with the Bank and the client jointly and the portion of the client will remain to the Bank as mortgage until the possessed the equipment for certain period. The client, after completion of the installments, will be the owner of the implements or equipment or goods.

Hire Purchase is a Special type of contract which has been developed through practice. Actually, it is a synthesis of three contracts:

Shirkat means partnership and share in ownership. When two or more persons supply equity, purchase an asset, own the same jointly, and share the benefit as per agreement and bear the loss in proportion to their respective equity, the contract is called Shirkatul Melk contract.

The term Ijarah has been derived from the Arabic works (Air) and (Ujrat) which means consideration, return, wages or rent. This is really the exchange value or consideration, return, wages, rent of service of an asset. Ijarah has been defined as a contract between two parties, the Hire and Hirer where the Hirer enjoys or reaps a specific service or benefit against a specified consideration or rent from the asset owned by the Hire. It is a hire agreement under which a certain asset is hired out by the Hire to a Hirer against fixed rent or rentals for a specified period.
Elements of Ijara

According to the majority of Fuqaha, there are three general and six detailed elements of Ijarah.

The wording: This includes offer and acceptance.
Contracting parties: This includes a Hire, the owner of the property, and a Hirer, the party that benefits from the use of the property.
Subject matter of the contract: This includes the rent and the benefit.

The Hire (Muajjir) - The individual or organization hires or rents out the property of service is called the Hire (muajjir).

The Hirer (Mustajir) - The individual or organization hires or takes the hire of the property or service against the consideration rent or wages or remuneration is called the Hirer (mustajir).

The benefit or asset (Maajur) - The benefit which is hired or rented out is called the benefit (maajur).
The Rent (Aj’r or Ujrat) - The consideration either in monetary terms or in kinds fixing quantity of goods or money to be paid against the benefit of the asset or service of the asset is called the rent or ujrat or aj’r.

This is a sale contract between a buyer and a seller under which the ownership of certain goods or asset is transferred by seller to the buyer against agreed upon price paid or to be paid by the buyer. Thus, in Hire Purchase under Shirkatul Melk mode both the Bank and the Client supply equity in equal or unequal proportion for purchase of an asset like land, building, machinery, transports etc. Purchase the asset with that equity money, own the same jointly, share the benefit as per agreement and bear the loss in proportion to their respective equity.

The share, part or portion of the asset owned by the Bank is hired out to the Client partner for a fixed rent per unit of time for a fixed period. Lastly the Bank sells and transfers the ownership of its share or part or portion to the Client against payment of price fixed for that part either gradually part by part or in lump sum within the hire period or after the expiry of the hire agreement.

As per procedure of transfer of ownership and legal title of the part owned by the Bank is transferred to the other partner, the sale contract may be of various forms, some of the major forms are mentioned below:

Hire Purchase under Shirkatul Melk through gradually transfer (sale) of legal title or ownership of the hired asset or property.

Under this type certain ‘asset or property’ is purchased with equal or unequal equity participation and owned jointly by the two parties, the Bank and the Client. The Bank’s share or portion of the asset is hired out to the Client partner against fixed rent or rentals per unit of time for a fixed period with a promise that the Hire Bank will sell or transfer the ownership of its portion to the Client Hirer gradually part by part in proportion to the consideration paid. So, the Hirer may acquire the full title of the Hire’s portion of the asset on payment of the total price at the end of the hire period.

Under this system the total price of the hired property or asset should be determined and divided over the period of hire contract (per unit of time) so that the Hirer in addition to the payment of fixed rent or rentals may pay gradually the proportionate consideration of the total price of the hired property or asset to acquire proportionate ownership of the same part by part and become full owner of the hired asset at the end of the hire period.

It should be noted that there should be a separate sale contract for payment or acquisition of each share (per unit of time as per hire deal) or part of asset sold to the Hirer and the amount of rent should be decreased proportionately with decrease of Hire’s ownership and increase of Hirer’s ownership on the property or asset.

Whatever reason, the hire contract is revoked prior to the payment or transfer of full title to the Hirer, the Hirer will share that part of the title to the hired property which has been transferred to him against payment made by him and the remaining part will be shared by the Hire Bank. If Bank loss, after the sale of Bank’s share to the property or asset that shall be recouped from the Client or Client’s security. In our Bank, we shall be following this type of Sale Contract in Hire Purchase under Shirkatul Melk.

Hire Purchase under Shirkatul Melk through transfer of legal title by gifts (for no consideration).

Under this type the portion of asset owned by the Hire partner is hired out to the Hirer partner with a prior promise that the Hire, upon settlement of all the rent or rentals or installments by the Hirer, will transfer his ownership or title to the property to the Hirer through gift without any further consideration. After the expiry of the hire period and payment of all the rent or rentals or installments, the title of property may be transferred by a separate gift deed executed by the Hire or, the title may be transferred by issuing a gift deed by the Hire making it conditional on the settlement of all rental installments. In the later case, the legal title is automatically transferred as soon as the hire period expires and the fixed rent installments for rent are settled. The working of the agreement would be: If the agreed upon rental installments are settled within the agreed upon period, ownership of the asset will be transferred to the Hirer as gift.

Under this mode the rentals fixed and agreed upon will be sufficient not only to amortize the capital outlay but also to yield an adequate amount of profit for the Hire. However, the rent or rentals agreed upon shall not be considered as price or part of price of the asset and the full ownership of the asset shall lie with the Hire till final settlement of the rent or rental installments.

Hire Purchase under Shirkatul Melk Through transfer of legal title (sale) at the end of hire period for a token consideration.

Under this contract the possession of the asset owned by the Hire is hired out to the hire for a fixed period against fixed rent or rentals and at the end of the hire period the title to the asset is transferred to the Hirer by a separate sale contract on payment of agreed upon token consideration. The consideration may be equal to the value of the asset or not and it would be sufficient if a mutual agreement is reached on the consideration.

Hire Purchase Under Shirkatul Melk through transfer of legal title (sale) at the end of Hire period for payment of a specified amount to the hire by the hirer

This agreement includes an ijarah or hire contract and a sale contract. Under this agreement a specific asset is hired out for a fixed period against specific rent mentioning a specific consideration to be paid by the Hirer (buyer) after the expiry of the hire period and upon payment of the agreed upon consideration. The hired asset becomes sold and its title transferred to the Hirer (the buyer). Under the agreement, the hire contract becomes effective firstly and the sale contract will be effective only after the expiry of the hire contract.

Hire Purchase Under Shirkatul Melk through transfer of legal title (sale) period to the end of the hire term for a price that is equivalent to the remaining ijarah or rental instruction.

This is an ijarah or hire purchase agreement which includes a promise made by the Hire that he will transfer the title of the hired property to the Hirer at any time during the hire period on payment of the remaining ijarah or rental installments, if the Hirer wishes so. Under this system first, the ijarah or hire contract becomes effective and remains so until the legal title is transferred to the Hirer. As soon as the title to the asset is transferred to the Hirer the ijarah or hire contract lapses for the remaining period, because both the benefit and the hired property become the Hirer’s property. This type of sale should be executed by a separate sale contract at the time of sale.

In case of Hire Purchase under Shirkatul Melk transaction the asset or property involved is jointly purchased by the Hire (Bank) and the Hirer (Client) with specified equity participation under a Shirkatul Melk Contract in which the amount of equity and share in ownership of the asset of each partner (Hire Bank & Hirer Client) are clearly mentioned. Under this agreement, the Hire and the Hirer becomes co-owner of the asset under transaction in proportion to their respective equity participation.

In Hire Purchase under Shirkatul Melk Agreement, the exact ownership of both the Hire (Bank) and Hirer (Client) must be recognized. However, if the partners agree and wish that the asset purchased may be registered in the name of any one of them or in the name of any third party, clearly mentioning the same in the Hire Purchase Shirkatul Melk Agreement. However, in IBBL, no third party registration shall be allowed

The share or part of the purchased asset owned by the Hire (Bank) is put at the disposal or possession of the Hirer (Client) keeping the ownership with him (Bank) for a fixed period under a hire agreement in which the amount of rent per unit of time and the benefit for which rent to be paid along with all other agreed upon stipulations are also to be clearly stated. Under this agreement, the Hirer (Client) becomes the owner of the benefit of the asset but not of the asset itself, in accordance with the specific provisions of the contract which entitles the Hire (Bank) is entitled for the rentals.

As the ownership of hired portion of the asset lies with the Hire (Bank) and re is paid by the Hirer (Client) against the specific benefit, the rent is not considered as price or part of price of the asset.
In the Hire Purchase under Shirkatul Melk Agreement the Hire (Bank) does not sell or the Hirer (Client) does not purchase the asset but the Hire (Bank) promise to sell the asset to the Hirer (Client) part by part only, if the Hirer (Client) pays the cost price / equity or agreed price as fixed for the asset as per stipulations within agreed upon period on which the Hirer also gives undertakings.

The promise to transfer legal title by the Hire and undertakings given by the Hirer to purchase ownership of the hired asset upon payment part by part as per stipulations are effected only when it is actually done by a separate sale contract.

As soon as any part of Hire’s (Bank’s) ownership of the asset is transferred to the Hirer (Client) that becomes the property of the Hirer and hire contract for that share / part and entitlement for rent thereof lapses.

In Hire Purchase under Shirkatul Melk Agreement, the Shirkatul Melk contract is affected from the day the equity of both parties deposited and the asset is purchased and continues upto the day on which the full title of Hire (Bank) is transferred to the Hirer (Client).

The hire contract becomes effective from the day on which the Hire transfers the possession of the hired asset in good order and usable condition to the Hirer, so that the Hirer may make use of the same as per provisions of the agreement.

Effectiveness of the sale contract depends on the actual sale and transfer of ownership of the asset by the Hire to the Hirer. It is sold and transferred part by part, it will become effective part by part and with the sale and transfer of ownership of every share / part. The hire contract for that share / part will lapse and the rent will be reduced proportionately. At the end of the hire period when the full title of the asset will be sold out and transferred to the Hirer (Client), the Hirer will become the owner of both the benefit and the asset consequently the hire contract will fully end.

Hire Purchase under Shirkatul Melk is a binding contract for the parties to it - the Bank and the Client who are committed to fulfill or meet their undertakings or obligations in accordance with the relevant agreement.

Under this agreement the Bank acts as a partner, as a Hire and at last as a seller ;on the other hand the Client acts as a partner, as a Hirer and lastly as a purchaser. Ownership risk is borne by both the Hire and Hirer in proportion to their retained ownership / equity.

Under this agreement the role of Hirer is one that of a trustee, the hired asset being a trust property in his hands; he will manage, maintain the asset in favour of the interest of the Hire at his own cost as the exact subject of hirer except in cases of any accident due to any event entirely beyond control of the hirer and natural calamity or disaster (acts of Allah) to be determined by the Bank after proper investigation within the knowledge of the hirer.

The Hirer is responsible for keeping the hired asset(s) in good condition throughout the whole period of hire and if the asset is damaged or destroyed due to mismanagement, corruption, negligence, transgressions, default, etc. of the Hirer, he shall be responsible to compensate the Hire (Bank) for that. Of course, such mismanagement, corruption, negligence, transgressions, default, etc. Of the hirer shall be determined by the Hire (Bank) after proper investigation within the knowledge of the hirer.

The Hirer cannot, without obtaining prior written permission of the Hire (Bank) make any changes in the exact item of the hire, or remove it from its place of installation and transfer it to another location. In a Hire Purchase under Shirkatul Melk agreement any stipulation may be made, provided it is not against the nature and requirements of the contract itself, nor does it violate the /this may be the last one divine laws of Islam and is also acceptable to both the parties.

Hire Purchase under Shirkatul Melk facilities may be for medium-term or long-term period hich may be utilized for the expansion of production and services, as well as housing activities. The duration of Hire Purchase under Shirkatul Melk contract shall not exceed the useful life of the subject or asset of the transaction. The Bank should not normally enter a Hire Purchase under Shirkatul Melk transaction for items with useful life of less than two years.

Hire Purchase under Shirkatul Melk transaction facilitates the Client (Hirer) to get benefit from the hired asset in exchange of rental and also to become full owner of the asset by purchasing it part by part.

If, for any reason, the hire contract is revoked prior to the transfer of full title of the asset to the Hirer, then the title of the asset will be shared by both Hire and Hirer – the Hirer will share that part of title which has been transferred to him against payment and the Hire will share the remaining part,

This is the example of the case that involves riba. For the detailed reasons recorded in the three separate judgments authored by Khalil-ur-Rehman Khan, J., Wajihuddin Ahmed, J., and Muhammad Taqi Usmani, J., it is hereby held that any amount, big or small, over the principal, in a contract of loan or debt is "riba" prohibited by the Holy Quran, regardless of whether the loan is taken for the purpose of consumption or for some production activity. The Holy Prophet (PBUH) has also termed the following transactions as riba:

A transaction of money for money of the same denomination where the quality on both sides is not equal, either in a spot transaction or in a transaction based on deferred payment.
A barter transaction between two weighable or measurable commodities of the same kind, where the quantity on both sides is not equal, or where the delivery from any one side is deferred.
A barter transaction between two different weighable or measurable commodities where delivery from one side is deferred.

These three categories are termed in the Islamic jurisprudence as riba-al-sunnah because their prohibition is established by the Sunnah of the Holy Prophet (PBUH). Along with the riba-al-Quran, are four types of transactions termed as ‘riba’ in the literature of Islamic fiqh based on the Holy Quran and Sunnah.

Out of these four transactions, the last two ones mentioned above as 2 and 3 have not much relevance to the context of modern business, the barter business being a rare phenomenon in the modern trade. However, the riba-al-Quran and transaction of money mentioned above as 1 are more relevant to modern business.

In the light of the detailed discussion above, there is no difference between types of loan, so far as the prohibition of riba is concerned. It also does not make any difference whether the additional amount stipulated over the principal loan or debt is small or large. It is, therefore, held that all the prevailing forms of interest, either in the banking transactions or in private transactions do fall within the definition of riba. Similarly, any interest stipulated in the government borrowings, acquired from domestic or foreign sources, is riba and clearly prohibited by the Holy Quran.

The present financial system, based on interest, is against the injunctions of Islam as laid down by the Holy Quran and Sunnah, and in order to bring it in conformity with Shariah, it has to be subjected to radical changes.

A variety of Islamic modes of financing has been developed by Islamic scholars, economists and bankers that may serve as a better alternative to interest. These modes are being practiced by about 200 Islamic financial institutions in different parts of the world.

These alternatives being available, the transactions of interest cannot be allowed to continue for ever on the basis of necessity. Many experienced bankers, to name a few, such as Dr Ahmad Muhammad Ali, President Islamic Development Bank, Jeddah, are the bankers who have long experience of banking in different parts of the world, appeared before us. All of them were unanimous on the point that Islamic modes of financing are not only feasible, but are also more beneficial to bring about a balanced and stable economy and in support of this view material containing facts and figures was

This enactment confers power on the court to allow interest to the creditor, upon all debts or ascertained sum payable which the court gets recovered. The Federal Shariat Court has declared the Act repugnant to Injunctions of Islam as even the Council of Islamic Ideology had recommended its repeal in its session held on 11th November 1981.

The question of allowing interest by the court while granting decree has been exhaustively dealt with by the Negotiable Instruments Act 1881 and the Civil Procedure Code 1908 as amended from time to time and as such there is no need to retain the Interest Act 1839 on the Statute Book, so the same for this reason alone needs to be repealed. Even otherwise an undefined, naked and generalized power to allow interest on a debt is repugnant to injunctions of Islam for the reasons already discussed above. We would, therefore, hold that Interest Act, 1839 being repugnant to injunctions of Islam was rightly directed to be repealed.

"Another term used in this provision is hire purchase. Under this system banks may finance the purchase of these items under a joint ownership arrangement with or without security. They would receive, in addition to repayment of the principal a share in the net rental value."

"A hire purchase agreement may be defined as an agreement under which an owner lets chattels of any description out on hire an further agrees that the hirer may either return the goods and terminate the hiring or elect of purchase the goods when the payments for hire have reached a sum equal to the amount of the purchase price stated in the agreement or upon payment of a stated sum. The essence of the transaction is therefore (i) bailment of goods by the owner to the hirer, and (ii) an agreement by which the hirer has the option to return or purchase the goods at some time or another."

This transaction, as practiced in the market, has different forms, some of which any have elements not conforming to Shariah, but it is not the right place to go into these details. Even if the hire purchase is adopted as mentioned by Chitty in its purest form, with no violation of a principle of Shariah, the question in the clause under discussion is not of the validity of the transaction in itself. The question here is one of payment of a ‘return’ on the promissory note or a bill evidencing he obligation to pay rent in a hire purchase agreement. There fore, it is subject to the same finding as recorded in the case of lease.

As we know Al-Quran and Sunnah are our first references. Whatever we did we must follow that rules, especially when we conducted business. Every transaction must be avoided from the riba or interest. Riba is prohibited in Islam. Hire Purchase transaction is allowed in Islam as long as the parties fulfill the conditions that is state in Hire Purchase Act 1967.

The reason of these acts is to protect the right of both parties. Islam is equal to everyone. We are advice to live in harmony community. Whatever product Islam created is to give tha accommodation for their ummah .