Applied Islamic Banking

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

In this paper we have chosen to give deep discussion about one kind of popular transaction nowadays which is hire purchase. Additionally, we will focus more on its procedures and mechanisms in the real world situation. As to give a clear picture of what it is all about, let us give the definition of hire purchase. It is actually obtaining the benefit of the possession and use of goods before one has paid fully for them. In Malaysia, many major companies especially commercial banks like Bank Islam, Bank Muamalat, Bank Industri etc have offered this kind of service to their customers. In the first schedule of Hire Purchase Act (HPA) 1967, it lists the goods that can be used in applying hire purchase which are:

All consumer goods; in S.2 (1) of HPA defines consumer goods as goods purchased for personal, family and household purposes.
Motor vehicles namely invalid carriages, motorcycles, automobiles including taxi cabs and hired-cars, goods vehicles also buses including stage buses.

“A hire purchase transaction is a contract whereby the owner lets out goods on hire and agrees that on completion of the necessary payments, the hirer may either return the goods and terminate 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.”

In this hire purchase, there are some parties that involved in this application which are:

Dealer means a person, not being the hirer or the owner or a servant of the owner, by whom or on whose behalf negotiations leading to the making of a hire purchase agreement with the owner were carried out or by whom or on whose behalf the transaction leading to a hire purchase agreement with the owner was arranged.
Goods include any replacements or renewals by the hirer of any part or parts thereof and any accessories added or additions made thereto by the hirer during the period of the hiring.
Hire purchase agreement includes a letting of goods with an option to purchase and an agreement for the purchase of goods by installments (whether the agreement describes the installments as rent or hire or otherwise), but does not include any agreement:

whereby the property in the goods comprised therein passes at the time of the agreement or upon or at any time before delivery of the goods or
under which the person by whom the goods are being hired or purchased is a person who is engaged in the trade or business of selling goods of the same nature or description as the goods comprised in the agreement

Hire purchase price means the total sum payable by the hirer under a hire purchase agreement in order to complete the purchase of goods to which the agreement relates, exclusive of any sum payable as a penalty or as compensation or damages for a breach of the agreement.
Hirer means the person who takes or has taken goods from an owner under a hire purchase agreement and includes a person to whom the hirer’s rights or liabilities under the agreement have passed by assignment or by operation of law.
Minister means unless otherwise stated, the Minister for the time being charged with the responsibility for consumers affairs.
Owner means a person who lets or has let goods to a hirer under a hire purchase agreement and includes a person to whom the owner’s rights or liabilities under the agreement have passed by assignment or by operation of law.
Third-party insurance means any insurance in relation to liability in respect of death or bodily injury caused by or arising out of the use of a motor vehicle being insurance required by law.
Vehicle registration fees means any amount to be provided under a hire purchase agreement by the owner for payment by or on behalf of the hirer under this Act in connection with the registration and use of a motor vehicle including any amount payable for third-party insurance.

This hire purchase service can be practiced either in the conventional way or in the Islamic way whereby we decide to focus on Islamic hire purchase. In essence, the features of both products are quite similar. The differences between the two are as noted below:

AITAB Car Financing follows the Shariah principle as well as the spirit of the HPA while conventional hire purchase follows only the HPA.
The financing for AITAB is sourced from permissible (Halal) funds while the conventional hire purchase has no limitation of its sources funds.
Different usage of terms such as:

*Conventional*	*Islamic*
Loan	Financing
Interest Rate	Profit Rate
Hiring Charges	Mark-up
Late Payment Interest	Late Payment Charges

There are two agreements involved under AITAB namely:

(i) Al-Ijarah Contract (hiring agreement); and
(ii) Al-Bai' Contract (purchasing agreement)

A minimal late payment fee of 1.00% p.a. of the installment due will be imposed for customer who did not pay promptly while conventional hire purchase charged a fee of 8.00% p.a. of the installment due. However, some finance companies do not impose this condition. They charged administrative charges for all the fees incurred to normalize from accounts in arrears. In addition, some finance company imposed both fees to mirror the actual losses when hirers failed in their obligation to pay the monthly installments.
Under AITAB, customer has to sign the 'Aqad Letter (Acceptance Letter) to denote the offer and acceptance of transactions while conventional hire purchase does not have such agreement.

An Islamic Hire Purchase Financing scheme is a car financing facility, which adopts the Shariah concept of Al-Ijarah Thumma Al-Bai' (AITAB). The term "Al-Ijarah" means hire, lease or rent whereas "Al-Bai'" means purchase. Under the Shariah principle, Al-Ijarah Thumma Al-Bai' (AITAB) refers to 2 contracts undertaken separately which are Al-Ijarah (hiring contract) and Al-Bai’ (purchase contract). Dealer or seller sells the goods to the finance company, which becomes the owner, in return for payment, which is cash price less deposit paid by hirer for the goods under AITAB agreement. Upon settlement of the hire rentals, the Purchase Agreement will be executed automatically, thus transferring the ownership of the vehicle from the finance company to the hirer.

It is designed to cater for the needs of both Muslim as well as non-Muslim customers. AITAB financing enables Muslims to perform their financial transaction according to the principle of Shariah and in line with their religious beliefs. In addition, the late payment charge is slightly lower compared to conventional hire purchase. Other than that, the features and benefits of AITAB are as good as what are available under conventional hire purchase. As such, customers do not lose out when taking up AITAB Car Financing scheme.

Modus operandi in this Islamic hire purchase is when under the Al-Ijarah contract, the hirer (customer) hires the goods from the owner (finance company) at an agreed rental over a specified period. Upon expiry of the hiring period, the hirer enters into the Al-Bai' contract to purchase the goods from the owner at an agreed price. During the period of the agreement, the finance company owns the vehicle. Upon settlement of the hire rentals, the purchase agreement will be executed automatically, thus transferring the ownership of the vehicle from the finance company to the hirer. However, in the event of the customer failing to perform his obligation to service the hire rental or performs otherwise from the terms and conditions stated in the agreement, the finance company has the right to exercise reasonable actions to mitigate its losses.

Under AITAB Financing the purpose of financing is of paramount importance and it must be clearly stated and revealed to ensure customer whose income or nature of business derived from a forbidden source under the eyes of the Shariah does not take up the facility, such as:

Customer will be entitled for a rebate for any early settlement cases. The calculation of rebate follows the standard formula accorded under the HPA. The rebate is not given in cash but it will reduce the balance outstanding. The settlement amount is the net figure after deducting the rebate. A minimal late payment fee of 1.00% p.a. of the installment due will be imposed for customer who did not pay promptly while conventional hire purchase charged a fee of 8.00% p.a. of the installment due. However, some finance companies did not impose this condition. They charged administrative charges for all the fees incurred to normalize from accounts in arrears. In addition, some finance company imposed both fees to mirror the actual losses when hirers failed in their obligation to pay the monthly installments.

Normally, the minimum period of financing is 1 year (12 months) and a maximum financing is 7 years (84 months). However, period of financing used by finance companies is determined based on various factors such as:

Type of cars i.e. new or second-hand
Age of vehicle
Customer profiles
Income exposure
Market Condition

Since AITAB follows the spirit of HPA, the maximum margin of financing allowed is 90%. Again, various factors are being used to determine the maximum margin of financing such as:

Type of cars i.e. new or second-hand
Age of vehicle
Customer profiles
Income exposure
Market Condition

The HPA stipulates the specific course of actions available for owner of the vehicle (finance company) to take for certain scenarios. Under AITAB Financing, the same recourse will be taken, like issuing out repossession order, repossessing the car, auctioning the car or taking legal action against the hirer. These actions are allowed under Shariah principle.