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By
Calvin W. H. Cheong*
&
Jothee Sinnakkannu
Abstract
This paper aims to identify the key factors that have contributed to the existence and the growth of Ar- rahnu (Islamic pawn
broking scheme) in Malaysia. Based on the previous studies and cost of borrowing analysis, this paper found that the need for interest
(riba) free, transparent transaction and low cost short- term cash borrowing scheme is much preferred by the pawning customers.
Besides that the cost of borrowing in this scheme is the lowest compared to the conventional pawn broking scheme. However, the Ar-
rahnu scheme needs to address central issues such as the marketing, public awareness and the locations of this scheme.
Corresponding author:
Calvin W. H. Cheong
Department of Accounting & Finance Monash
University Sunway Campus Jalan Lagoon
Selatan
46150 Bandar Sunway
Selangor D. E. Malaysia
Telephone: +603–55146297
E-mail: calvincheong88@hotmail.com
==============================================================
In its conventional guise, pawn broking is a form of secured money lending provided by pawn shops; representing the simplest and
fastest source of short term cash borrowings. Prior to its introduction, a vast majority of Muslims in Malaysia and around the world had
limited alternatives for low-cost interest-free cash advances. Presently, the situation has improved with the introduction of a pawn
broking system based on the Maqasid al-Shariah, known as Ar-rahnu which is a source of interest-free microcredit. The dual
existence of conventional and Islamic pawn broking services has increased the level of competition in this industry, giving clients a
greater variety of choices in obtaining faster and simpler access to funding as opposed to conventional sources of funds from banks
and other financial institutions. The word Ar-Rahn, in its most literal sense, means a pledge or security for a loan. Under the Ar-rahnu
concept the borrower or Ar-Rahin is required to pledge or produce redeemable collateral or Ar-Rahn in the form of gold or silver as an
instrument of guarantee that the loan will be repaid (collateral redeemed) at the maturity of agreement. If the borrowed sum is not repaid at
maturity then the lender (Al- Murtahin) has the right to sell the collateral to recover the loan. Collateral is an important instrument for the
security of loan by providing a guarantee to the financial institution as it reduces the lenders risk and increases the borrowers cost of
default.
The literature on Islamic pawn broking in Malaysia is limited. However, some research has been conducted that studies the existence
and the operational system of the Ar-rahnu concept. These studies have documented the importance of pawn broking system in our
society (Sanusi and Johari, 2006; Mohammed et al., 2005; Lao, 2005; Ismail and Ahmad, 1997; Rugayah, 1986). The authors explore the
views of the Shariah view regarding the pricing system, assets pledged, customer service and the locality of Islamic pawn broking activity.
Ismail and Sanusi (2005) studied the importance of Shariah rules in the implementation of an Islamic pawn broking system. They
argued that Islamic principles such as wadiah, qardhul hassan and ujra must be given a careful consideration in establishing Islamic pawn
broking system. Similarly Mohammed et al. (2005) argued that wadiah, qardhul hassan and ujra makes Ar-rahnu clearly different from the
conventional pawnshop. Both however, stress that the prohibited elements of riba and gharar must be eliminated in the Ar-rahnu
system.
Mohammed et al., (2005) and Ismail and Ahmad (1997) examine the importance of pricing in the pawn broking transactions.
Mohammed et. al. (2005) found that service charges imposed under Ar-rahnu is relatively cheaper than the conventional pawn
broking system. This would mean that the cost of borrowing cash in an Islamic pawn broking system is lower than conventional
counterpart. Similarly, Ismail and Ahmad (1997) found Islamic pawn shops to charge a relatively lower transaction fee as
compared to conventional pawnshops. In a pawn broking system, the collateral is of paramount importance. Studies such as
Sanusi and Johari (2006), Mohamed et al. (2005) and Ismail and Ahmad (1997) observed the differences in the types of assets
pledged as collateral between Islamic and conventional pawn brokers. Sanusi and Johari (2006) found that Islamic pawn brokers
only accept gold and gold jewelry while conventional pawnshops accept items beyond gold and gold jewelry including Rolex
watches, rare gemstones such as diamonds and sometimes electrical and electronic items. Similarly, Islamic banking institutions
that offer Ar-rahnu schemes such as Bank Rakyat only accept gold as collateral. This finding is similar with studies conducted by
Mohammed et al., (2005) and Ismail and Ahmad (1997).
The key reason behind this strict requirement is to eliminate the element of gharar or uncertainty. Gold and sometimes silver, is a widely
traded commodity whose price information is widely and easily available. On top of that, institutions or specialists that provide testing
services that attest to the purity of the gold or silver are readily available. Hence, the borrower and lender can be assured that the value
placed on the gold or silver pledged is fair and transparent. Should any doubts on the objectivity of the valuation arise, there are many
other specialists who are willing to value the gold or silver for a small fee, thereby eliminating the
This paper aims to identify the factors that contributed the growth of Islamic pawn broking in Malaysia on a conceptual basis. Although
Islamic pawn broking is relatively new in Malaysia, its existence has influenced the end users of short term debt market. This study also
aims to identify the current and potential key challenges and opportunities that Islamic pawn broking has. The rest of the paper is
structured as follows. Section 2 provides a history of pawn broking in Malaysia and around the world. Section 3 describes the
precepts underlying Ar-rahnu and how the Ar-rahnu system works in Malaysia. Section 4 provides a brief analysis between Ar-rahnu
and the conventional pawn broking system and highlights the challenges and future prospects of Ar-rahnu in Malaysia. Section 5
concludes.
Pawn broking services rose to popularity in Medieval Europe. In its initial form, pawn broking was purely benevolent venture; monts
de piete established by the authority of the popes lent money only to the poor, without interest on the sole condition that valuables
pledged covered the amount of money advanced. However, it soon became apparent that the charging of interest was necessary in order
for these ventures to remain profitable (Herbermann, 1913). It was not until the mid-seventeenth century that guidelines to pawn broking
were established, the Bank of England being the pioneer. However, it was only in 1800 when official legislation governing
pawnbroking was passed in the British Parliament, the details of which are considered to be the backbone of all future laws
governing pawn broking services.
In Malaysia, pawn broking is governed by the Pawnbrokers Act 1972. This Act outlines all the necessary guidelines and principles
that have to be adhered by both the pawnbroker and client. The number of conventional pawn broking licenses approved between
1985 and 2006 had increased by 21 percent. In 1985, the number of conventional pawn broking licenses was 194, while in 2006 the
figure has increased to
234. The states that have the greatest number of conventional pawn shops are Perak, Selangor, Johor, Kedah and Penang. The
states with a larger non-Malay population have the tendency of having a larger number of conventional pawn broking services
compared to states with a larger Malay population. As a result of this disparity, there has been a concerted effort to establish
interest-free credit firms for the Muslim community in Malaysia as well as around the globe ( Hamidullah, M. Ma‟ Arif)
3
Consequently the Minister of Finance announced a scheme called “Skim Ar-rahnu” (SAR) on 21st August 1993 through the
collaboration of Bank Negara Malaysia (the central bank of Malaysia), the Malaysian Islamic Economic Development Foundation
and Bank Kerjasama Rakyat Malaysia Berhad. Later during the year (SAR) was launched at six branches of Bank Rakyat Malaysia.
Another interesting turn of events that underlined the development of Islamic pawn broking in Malaysia is the legal barrier
imposed on conventional practice in Kelantan. In 1995, the state government of Kelantan ordered the cessation of all riba or interest
based conventional pawnshops in its jurisdiction. Nonetheless, the conventional pawnshops primarily owned and operated by non-
Muslims may continue to operate if they were to deal in accordance with the Ar-rahnu principles (Shaari and Azlina, 2003).
It was reported that in 2004 the number of Ar-rahnu clients stood at 1.22 million with an accumulated loan amounting to RM1.17 billion
(ABAC Malaysia, 2008). Also, since its establishment, the MGIT has seen its number of clients double from 12,732 in 1992 to
26,632 in 2005. The value of items pledged too has increased from RM9.85 million in 1992 to RM28.9 million in 2005.
4
precautionary measure such as providing security and insurance to ensure the asset‟s safe return once the client has cleared his
debt.
Table 1 illustrates the margin of credit facility and the maximum allowable loan amount in Islamic pawn broking in Malaysia. Table
2 illustrates the loan period and the maximum extended period allowed by Islamic pawn broking system in Malaysia. Based on table
2, generally the Ar-rahnu system allows 6 months period to redeem any collateral on money borrowed. This time period is similar to the
conventional pawn broking system.
Table 1: Percentage of Available Loan to Collateral Value and Maximum Allowable Loan
Amount offered by Islamic Pawn Broking Institutions
Institution Total Available Loan asa Maximum Loan Amount
% of total collateral value
Muassasah Gadaian Islam 75% RM 1,500.00
Terengganu (MGIT)
Bank Kerjasama Rakyat ( 60% RM 5,000.00 per day or not more than RM
Bank Rakyat) 25,000 of accumulated loan
amount.
Kedai Al-Rahn Kelantan 50% RM 5,000.00 per Receipt
Bank Islam Malaysia Berhad 60% RM 5,000.00 per day or not more than
RM 25,000 of accumulated loan
amount.
Kedai Al-Rahn Perlis 70% RM 5,000.00 per day or not more than
RM 25,000 of accumulated loan
amount.
5
Table 2: Loan Period and Extended Period by Islamic Pawn Broking Institutions in Malaysia
Institution Loan Period Extended Loan Period
Muassasah Gadaian Islam 3 Months 3 Months
Terengganu (MGIT)
Bank Kerjasama Rakyat 6 months 4 Months
( Bank Rakyat)
Kedai Al-Rahn Kelantan 6 months 3 Months
Bank Islam Malaysia Berhad 6 months 3 Months
Kedai Al-Rahn Perlis 6 months 2 Months
Table 3 and 4 provides the summary of monthly safekeeping charges by the Ar-rahnu division of Bank Islam Malaysia Berhad and
Kedai Ar-rahnu Kelantan respectively. It can be observed that the safekeeping charges vary according to the value of the collateral item
pledged. It should be noted that the safekeeping charges are imposed based on the collateral items value and not based on the loan
amount.
If the borrower defaults to redeem the collateral by the maximum period allowed or did not extend the period, a notice informing
the borrower that the pawned item will be auctioned will be sent. If there is no response then the pawned asset will be auctioned off to
recover the amount outstanding and any surplus will be given back to the owner of the asset. In the event the borrower‟s where
about cannot be traced then it is Islamic institutions responsibility to put aside the fund in the Baitulmal account for future savings for if
any claims be made for the surplus by the owner or his heir, which is contrarian to the conventional pawn broking. Functioning of
Muslim funds and their activities could also be found in the work of Khatkhatay (1997), and Bagsiraj (2003).
Section 4 - Discussion
6
Ar-rahnu scheme while the CPB interest rate is fixed at two percent per month as was found by Ismail and Ahmad (1997).
Figure 1 shows the annual cost of borrowing under the Ar-rahnu and the CPB scheme. It can be observed that loans under Ar-rahnu
incur a lower cost of borrowing relative to the loan amount as compared to the CPB scheme. The annual cost of borrowing in the
Ar-rahnu scheme is about half the cost of the CPB scheme which has a flat rate of 24 percent per annum. It is also evident that the
cost of borrowing under Ar-rahnu is about 11 percent per annum when the collateral value is RM500.00, rising only as the value of
collateral increases. Nevertheless, even when RM10,000.00 worth of collateral is pledged, the cost of borrowing is only 15
percent per annum.
Figure 1: Annual cost of borrowing in Ar-rahnu (Bank Rakyat) and Conventional Pawn Broking
(CPB)
Annual Cost of Borrowing
30.00
25.00
20.00
Percent
Ar-rahnu
15.00
CPB
10.00
5.00
0.00
1000.00
1500.00
2000.00
2500.00
3000.00
3500.00
4000.00
4500.00
5000.00
5500.00
6000.00
6500.00
7000.00
7500.00
8000.00
8500.00
9000.00
9500.00
10000.00
500.00
Gold Value
7
We repeat the same hypothetical example using the safekeeping charges of Bank Islam Malaysia Berhad and Kedai Ar-rahnu Kelantan.
The results are displayed in Figures 2 and 3 respectively.
Figure 2: Annual cost of borrowing in Ar-rahnu (Bank Islam) and Conventional Pawn Broking
(CPB)
15.00
10.00 Ar-Rahnu
5.00 CPB
0.00
500.00
10000.00
1000.00
1500.00
2000.00
2500.00
3000.00
3500.00
4000.00
4500.00
5000.00
5500.00
6000.00
6500.00
7000.00
7500.00
8000.00
8500.00
9000.00
9500.00
Gold Value
Figure 3: Annual cost of borrowing in Ar-rahnu (Kedai Ar-rahnu Kelantan) and Conventional Pawn
Broking (CPB)
15.00
10.00 ACB
5.00 CPB
0.00
1000.00
1500.00
2000.00
2500.00
3000.00
3500.00
4000.00
4500.00
5000.00
5500.00
6000.00
6500.00
7000.00
7500.00
8000.00
8500.00
9000.00
9500.00
200.00
400.00
500.00
10000.00
Gold Value
As can be seen from Figures 2 and 3, loans under Ar-rahnu incur a lower cost of borrowing relative to the loan amount as compared to
the CPB scheme. The annual cost of borrowing in the Ar-rahnu scheme is still about half the cost of the CPB scheme. It is also evident
that the cost of borrowing under Ar-rahnu is about 12 percent per annum when the collateral value is RM500.00, rising only as the value of
collateral increases. Even when RM10,000.00 worth of collateral is pledged, the cost of borrowing rises to 16 percent per annum.
Moreover, when we used Kedai Ar-rahnu Kelantan‟s safekeeping charges, which is the highest
8
among the three financial institutions for values up to RM10,000.00, the annual cost of borrowing is still lower than that of the
CPB.
Although the cost of borrowing rises as the value of collateral increases, it seems fair compensation for the lender for proper
safeguarding of the asset(s) pledged as collateral as the lender bears the risk and the responsibility in the event of any untoward
incidents. Despite this, our hypothetical example has shown that, ceteris paribus, the Ar-rahnu system has a significantly lower cost
of borrowing as opposed to the conventional pawnbroking system. Furthermore, it is safe to say that the Ar-rahnu system is more
beneficial, especially to individuals from the lower income group. Normally, such borrowers will be looking towards financing for
amounts below RM5,000.00. Under the conventional system, these borrowers will be looking at a cost of borrowing of 24 percent per
annum or sometimes higher. Under the Ar-rahnu system, the cost of borrowing such a sum would be at most 19 percent per annum; a
significant amount of savings for such folk.
This illegal activity has grown over the years, forming large syndicates that prey on borrowers who are desperately in need of cash
(gamblers for example) but do not possess any assets. These circumstances are particularly challenging for the Ar-rahnu system to
gain foothold because even borrowers who have sufficient assets that can be pledged as collateral choose not to utilize Ar-rahnu but
instead patronize the loan sharks as they can borrow up to a 90 percent margin, sometimes even 100 percent without collateral.
This is evident as the Ar-rahnu concept has been introduced in many Islamic banks and state owned banks such as the Agro Bank in
Malaysia. The Islamic pawn broking division in Bank Rakyat started with only 5 outlets in 1993; by 2003 it has grown to 106 outlets
operating successfully in all over the country. Since the introduction of Ar-rahnu scheme in 1993, Bank Rakyat alone has
advanced RM844 millions up to September 2002 involving nearly 888,000 Ar- Rahnu account holders. By December 2001,
the total accumulative safekeeping earned was RM44.37 million (since inception). (Mohd Sharif, 2002)
The average annual income derived from Ar-rahnu scheme alone was more than RM10 million for Bank Rakyat. The annual
reports of 2001 and 2002 revealed that the Ar-rahnu financing and advances were RM81.165 millions and RM119.805 millions
respectively. The deposits from Ar-rahnu fund in 2001 and 2002 were amounting to RM38.223 millions and RM35.223 millions
respectively. The total expenditure with regards to the scheme was RM3.330 millions and RM3.324 millions respectively (Annual
Report of Bank Rakyat, 2001 & 2002). Despite the increased competition from so many financial institutions and conventional
pawn brokers, the growth of Islamic pawn broking seems to grow consistently since its inception. We have identified a number of
reasons for the achievements of the Ar-rahnu system:
9
1. There is scarcity for credit especially for consumption purposes. Islamic pawn broking adheres to Shariah principles. This
attracts the Muslim community to place their collateral items in exchange for credit facilities.
2. Unlike financial institutions, pawnbrokers do not question the purpose for which credit is sought. Financial institutions
requires pages of information, business projection income statement (if for business purpose), guarantor and many other
strict requirements
3. Islamic pawn broking (like the conventional pawn broking) do not set restrictions or stipulations on the manner in which
the fund has to be used
4. There are no extra fees or charges like stamp duty or legal fees
5. The process is immediate because as soon as the collateral items are verified, money is granted to the borrower. The normal
waiting period is less than 30 minutes
6. In comparison to other sources of informal credit, example money lenders and conventional pawn brokers who may charge
interest from 2 – 20% per month, Islamic pawn brokers are relatively very cheap where the charges are usually about
1percent per month
7. No other financial institutions (other than conventional pawn brokers) will provide credit for the type of collateral held by
the customers
8. The credit can be used for long term purpose, since as long as the safekeeping fees are fully paid, the duration of the credit
can be extended indefinitely.
Section 5- Conclusion
It is a fact that Islamic pawn broking system has the capacity and capability to fill the gap in the short-term credit structure of the
country. Islamic pawn broking is not a competition to the conventional pawn broking but it is compensating the rising demand.
Ever since the introduction of Islamic pawn broking service, the demand for it is increasing continuously. Customers prefer Islamic
pawn broking services to conventional pawn broking services because the former provide fast, hassle-free, riba-free and transparent
micro credit facilities.
As a catalyst for further growth of Islamic pawn broking in Malaysia, it is necessary for the operators to take aggressive measures
especially in view of creating awareness among prospective customers. The operators (pawn brokers) should take initiatives to
disseminate the information about its operations, principles, and schemes through media, brochures and online FAQs. Malaysia has
great opportunities and expertise to develop Islamic pawn broking business in this region. The government should encourage those who
are in dire need for fast cash to approach Islamic pawn brokers rather than resort to illegal money lenders who charge exorbitant
interest rates and unfair recovery practices. More Islamic pawnshops should be opened in rural and over populated areas to avoid
monopolization and control by a few pawn brokers.
10
References
Bank Negara Malaysia website -
http://www.bnm.gov.my/index.php?ch=174&pg=469&ac=387
Bagsiraj, M. I., (2003), in Javed A. Khan (editor), Islamic Banking in India: Scope and challenges, „Islamic Financial
Institutions in India: Economic Policies, Perceptions and perspective‟,pp. 133-163.
Bala Shanmugam (1991). „The business of pawn broking in West Malaysia‟, Journal of Southeast Asia Business.
Volume 7, Number 2
Herbermann, Charles, ed. (1913). Catholic Encyclopedia. Robert Appleton Company). Ismail, A.G., & Ahmad, N.Z.
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Toronto, Canada (Mimeo).
Lao, J.J. (2005). “Unexplained pawn pricing behavior: A study of Las Vegas pawnshops”.
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