BBA, Justice Abdul Wahab and the Court of Appeal

In July 2008, High Court judge Datuk Abdul Wahab Patail had ruled that the application of the BBA contracts in Arab Malaysian Finance Berhad v Taman Ihsan Jaya & Others (2008) was contrary to the Islamic Banking Act 1983 (IBA).

On March 31, the Court of Appeal unanimously overturned Abdul Wahab's much-debated judgment in the Bank Islam Malaysia Bhd v Ghazali Shamsuddin & Two Others, and nine other cases.

Abdul Wahab Patail ruled that BBA is a loan transaction and not a trade based financing. This is because there is no transfer of title from the customer to the bank during the PPA and hence the bank has no legal or beneficial capacity/right to make a valid sale under the subsequent PSA. This was why there was a fear of default under BBA contracts because the contract itself is deemed not enforceable.

Therefore, the BBA is deemed a conventional loan with an Arabic name, the form changes but in substance it is still a plain conventional loan and the profits charged under a BBA transaction are therefore deemed to be interest.

On 31st March (the report in the Malaysian Reserve is 6 months late), the 3 member CoA ruled that Abdul Wahab had erred in making his judgement and reversed the ruling, re-establishing BBA as a bona fide sale transaction and upholding to sanctity of the BBA contracts. The 3 member bench rules that “civil courts should not decide whether a matter is in accordance with the religion of Islam”. Such issues need to be solved in consultation with Islamic scholars. And since BNM’s SAC has endorsed BBA as an approved product, civil court judges should not dispute it.

My opinion – the BBA was created in 1983 based on the conventional loan platform to enable Islamic finance to break into the market while operating on the existing platforms. It was true 26 years ago when awareness on Islamic finance was low and such products were necessary to avoid “cultural shocks”. But as knowledge on Islamic finance grew, such Inah based products are not necessary anymore; the market has more understanding of the Islamic financial system and is ready to accept the structural differences.

Abdul Wahab was arguing on valid grounds, he is merely exposing the “loan behind the façade of a trade” element of the BBA.

It is about time the market, the regulators and the judiciary accept the fact that BBA is a product designed to ease the entry of Islamic finance into the market. It has outlived its purpose and should be phased out completely.

Shariah Compliant vs. Shariah Based

The difference is quite obvious; a Shariah compliant product is one that meets all compliance criteria, it may not necessarily be Shariah based (like “Shariah compliant derivatives” for example) but it is sufficient that it does not contravene any Shariah ruling. A Shariah based product on the other hand is already compliant; it is after all based on Shariah perimeters which makes compliance automatic.

Shariah compliant products may have its origins in conventional banking. To make a financial instrument Shariah compliant, all that needs to be done is to remove those elements or components which contradict with Shariah and replace them with a Shariah acceptable concept. Multiple contracts may be used to facilitate and complete the transaction and inevitably some form of legal trickery could be involved. I would agree with the definition of a Shariah compliant product being a conventional product which has been “Islamised”. An example of a Shariah compliant product is an Ijarah transaction where only the beneficial ownership is transferred and not the legal ownership.

A Shariah based product is a financial instrument which is derived from the laws of Shariah. It may share some similarities with existing conventional products but it did not originate form any conventional products. Structuring Shariah based financial solutions is easier because there is no need to find ways to circumvent Shariah prohibitions in order to achieve Shariah compliance. A Mudharabah venture capital model is an example of a Shariah based product.

Making existing financial products Shariah complaint is an easy, short term approach. It will satisfy the market’s need for Shariah compliant products but it will not distinguish Islamic finance as an alternative model to conventional banking. Merely Islamising and making existing conventional products Shariah compliant will cause the Islamic finance sector to converge with the conventional sector. Convergence means being one and the same and since Islamic finance is not the same as conventional finance; convergence should not be allowed to happen.

BBA is an example of a Shariah compliant financial product whose roots can be traced to conventional debt based lending. As a consequence, the mechanics and pricing of a Bai Bithaman Ajil financing is identical to that of a conventional loan.

Being different products running on different concepts and platforms, convergence cannot happen even on pricing. An Ijarah based mortgage carries different risks compared to a collateralised debt based mortgage. Therefore, given the different risk elements of the two similar products, the pricing cannot be identical; it should reflect the underlying risks involved.

Islamic finance is an alternative to conventional finance and hence convergence should not happen.

Tawarruq – a Tripartite Inah?

The OIC Fiqh Academy rules that organised Tawarruq is unacceptable (Resolution 179 (19/5) 26 – 30 April 2009). In particular they ruled that it came into conflict with Maqasid Shariah (the basic principles underlying Shariah).

Tawarruq is widely used as a liquidity management tool and most scholars sanction the structure. However, some scholars argue it involves legal trickery and contains elements of interest based lending. Tawarruq does not create any enonomic activity but instead it creates debts.

What is Tawarruq? To me, it is basically an Inah with an additional contracting party. The whole process of buying and selling metals/commodities is merely a charade, a legal trick as the main purpose is to transfer cash from one party to another. I commented on the issue previously (http://shariah-finance.blogspot.com/2009/05/commodity-trading.html) and I sort of feel vindicated by OIC’s declaration.

It has always been argued by some that niyah (intention) is secondary when undertaking such contracts. I do not agree. If we exclude niyah, everything will be permissible. A lot of observers have urged Islamic finance practitioners to look at the substance behind the form when structuring Shariah based solutions, the on going debate on substance over form of Islamic banking products and services.

Dr Nikan Firoozye (http://islamic-finance-resources.blogspot.com/) opines that we should categorize products by their Shariah-risk, with hiyal (legal trick) the most risky. I wish to add that if such measure is used, the higher the Shariah-risk is, the less compliant the product is.

Dr Mohammad Akram Laldin, a respected Malaysian religious scholar, disagreed with OIC's ruling, saying organised tawarruq does not violate Islamic law principles. “From the point of view of Islamic law, there is nothing wrong with the transaction itself.” (http://islamicfinanceupdates.wordpress.com/2009/06/04/islam-allows-organised-tawarruq-asset-sales-scholar/)

I do not see this declaration as a hindrance to the growth or development of Shariah based finance. I see it as moving out and away from the conventional norms and in the long run will bode well for Islamic banking and finance. BBA and Inah based products are being gradually phased out in Malaysia and with the latest declaration, expect to see more products being out of favour. My guess is Commodity Murabahah will be next.

Anyone Got Guts?

What does it take to succeed? What does it take to make a breakthrough? Guts, perseverance and belief. IMHO, none of that is presently present in the Islamic banking and finance industry. No, I’m not putting those hardworking Islamic finance professionals down. All I’m saying is the guts to develop a product which is not based on the conventional platform is absent. All the products from the BBA mortgages to the Inah based personal financing and even the Sukuk Musharakah is tailored to run on the conventional platform especially from the pricing aspect. Granted that different prices for identical products cannot happen in efficient markets but one must remember that a Shariah based mortgage and a conventional based one albeit having the same objective (i.e. home ownership) is drawn upon different principles and hence cannot be priced identically.

What we need is the courage to come up with a product or solution that is not only Shariah compliant in form but also in substance. Can we have an Ijarah based mortgage whose pricing is directly tied to the prevailing rental rates regardless of the base financing (lending) rates? It is after all a lease based mortgage. A Sukuk Musharakah in my opinion should not be priced and traded like a debt based bond; it should be priced and traded like an equity based instrument.Shariah based financial solutions are tied to real assets and actual economic activity and hence should be priced and traded accordingly. We have to breakaway from doing things based on the conventional norms and platforms if we are serious about promoting Islamic banking and finance.

Concepts Used in Islamic Trade (and Banking)

Some of the common contracts and concepts used to facilitate trade the Islamic way. These contracts are also used in Islamic banking and finance to facilitate financing transactions.

• "Bai-al-Dayn" - Debt-trading.
• "Bai-Bithaman Ajil (BBA)" - Deferred payment sales. Where goods are sold on a deferred payment basis at a price which includes a profit agreed by both the buyer and seller.
• "Bai Inah" - A buy and sell contract between two parties where one party sells his asset to the other (price is marked up, payment is deferred) and subsequently buys it back at the cost price paid on the spot. This is often considered a hilah to facilitate the transfer of money under the pretext of trading.
• "Bai Salam" - A contract where payment is made spot while the goods are delivered at an agreed later date. A form of advance payment trade but the goods may not necessarily be in existence.
• "Hibah"Voluntary, unilateral gift.
• "Hiwalah" - Transfer of debt.
• "Ijarah" - Lease contract. A lessor (owner) leases out an asset or equipment to its client at an agreed rental fee and pre-determined lease period. The ownership of the leased asset remains in the hands of the lessor for the duration of the lease.
• "Ijarah Muntahiah Bittamlik" - Lease and subsequent purchase. Muntahiah Bittamlik describes the transfer of the title of the leased asset to the lessee at the end of the lease tenure.
• "Istisna" - A contract to manufacture according to given specifications. The payment terms can either be spot, deferred or in instalments.
• "Kafalah" - Guarantee or surety given by one party who agrees to discharge the liability of another party, as stipulated in the terms of the guarantee.
• "Mudharabah" - Profit sharing and loss absorbing agreement between two parties, one the capital provider (Rab-al-mal) and the other, the entrepreneur (mudahrib). The profit-sharing ratio is agreed upon upfront while losses are borne solely by the financier.
• "Murabahah" - Cost plus sale where goods are sold at a profit and the profit margin is known to the buyer.
• "Musawamah" - Bargaining sale where the seller need not disclose the cost"Musyarakah"Limited liability partnership. All partners share profits on a pre-agreed ratio but losses are shared on the basis of equity participation.
• "Qardhul Hassan" - Interest-free loan or benevolent loan without a specified repayment terms or tenure.
• "Rahn" - Collateral. Where a valuable asset is placed as collateral for a debt, he collateral may be disposed in the event of default.
• "Sarf" - Currency exchange, i.e. buying and selling of foreign currencies.
• “Tawarruq” - Used in “Commodity Murabahah” transactions where an agent is appointed by the bank to purchase certain goods (usually metals other than gold and silver) which are sold to the customer at cost price with payment made spot. The customer then appoints the bank to sell the goods to another agent at a marked up price but payment is deferred.
• "Ujr" - Commission or fee charged for services rendered.
• "Urbun" (Arboon) - Earnest money which forms part payment of the price of goods or services paid in advance.
• "Wadiah Yad Dhamanah" - Savings with guarantee. It refers to a contract between the owner of the funds (depositor) and the Bank for safe-keeping purposes and the bank, as trustee, guarantees the repayment of the whole amount of deposits, or any part thereof, upon request.
• "Wakalah" - Agency contract. It refers to the appointment of an agent who is authorised to act according to the term of the agency.