A Comparative Analysis of Financial Affordability in Islamic Home Financing Instruments in Malaysia

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A comparative analysis of financial affordability in Islamic home financing

instruments in Malaysia
Article in International Journal of Housing Markets and Analysis · May 2019

DOI: 10.1108/IJHMA-11-2018-0090
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International Journal of Housing Markets and Analysis
A comparative analysis of financial affordability in Islamic home financing
instrumentsin Malaysia
Mohd Zaidi Md Zabri, Razali Haron,
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Financial
A comparative analysis of affordability
financial affordability in Islamic
home financing instruments
in Malaysia
Mohd Zaidi Md Zabri Received 10 November 2018
Revised 22 January 2019
School of Management, Universiti Sains Malaysia, Minden, Accepted 23 January 2019
Penang, Malaysia, and
Razali Haron
IIUM Institute of Islamic Banking and Finance,
Kuala Lumpur, Malaysia
Abstract
Purpose – This study aims to compare and contrast the financial affordability of Islamic home financing
instruments such as bay’ bithaman ajil and musharakah mutanaqisah (MM) offered by various home
financing institutions in Malaysia.
Design/methodology/approach – Mathematical simulations were carried out in examining the
financial affordability (or lack thereof) of various Islamic home financing by both Islamic commercial banks
(ICB) and financial cooperatives (FC).
Findings – This study has shown that MM by FC is a workable, more financially affordable option to
potential homeowners. Unlike ICB, MM by FC uses rental rates as a benchmarking tool because of its inherent
nature of flexibility.
Research limitations/implications – MM by FC has the potential to reduce the cost of home
acquisition (purchase affordability) and the amount of monthly installments (repayment affordability) of
homeowners in Malaysia.
Originality/value – This study shows the financial implication of unaffordable Islamic home financing
instruments may have on the Malaysian households, which were derived from using official data from
various government agencies.
Keywords Housing affordability, Islamic home financing, Musharakah mutanaqisah,
Bay’ bithaman ajil, Financial cooperative, Housing cost burden
Paper type Conceptual paper
1. Introduction
Islamic home financing (IHF) products in Malaysia are typically based on bay bithaman ajil
(sales contract based on deferred payment). It is one of the largest asset classes in the
Malaysian Islamic commercial banking (ICB) and finance industry’s portfolios (Bank
Negara Malaysia, 2018). This product witnesses a sharp increase of 23.43 per cent per
annum, vis-à-vis the 8.88 per cent growth of conventional home loans in a rather short span
of 10 years (2008 to 2018) (Bank Negara Malaysia, 2018). Specifically, from RM18.66bn as at
November 30, 2008, IHF products have reached RM153.09bn as at end November 30, 2018 or International Journal of Housing
Markets and Analysis
a share of 27.56 per cent of the total home financing in Malaysia (Bank Negara Malaysia, © Emerald Publishing Limited
1753-8270
2018). DOI 10.1108/IJHMA-11-2018-0090
IJHMA Despite the rapid progress made and the growing maturity of the ICB industry, several
criticisms have been leveled against the pervasiveness of debt-based IHF products in their
portfolio, which led some scholars such as Mydin Meera and Abdul Razak (2005, p. 4) to
argue for its striking similarities vis-à-vis its conventional home loan counterpart:
[. . .] while the BBA is practised as Shari’ah-compliant in some countries, it is, nonetheless,
converging to the conventional mode where the computational formulas are similar to the
conventional and where the profit rate tracks the market interest rate [. . .].
Official statistics from the Bank Negara Malaysia demonstrate that debt-based IHF modes
such as bay bithaman ajil (BBA) and murabahah (cost-plus financing) are still the preferred
instruments for the largest IHF institution in Malaysian ICB. Figure 1 shows the increasing
trend of ICB’s continued reliance on debt-based instruments during the past decade. In
general, debt-based Islamic financing modes were on the increasing trend, which continues
to account for more than half of the total Islamic financing modes by commercial ICB
institutions in Malaysia. Although the equity-based modes are also on the steadier and
increasing trend, the increase is, however, rather marginal. This phenomenon can be partly
explained by its operational business nature, i.e. a profit-maximizing, commercial entity.
McKillop and Wilson (2011, 2015) for example, argued that ICB might disparate the
customer’s needs to simultaneously satisfy shareholders’ profit expectation.
Scholars have long argued that equity-based, IHF instruments such as musharakah
mutanaqisah (MM) is a superior mode in the preservation of maslahah (public interest) and
the attainment of maqasid al-Shari’ah (objectives of al-Shari’ah) (Chapra, 2007; Mydin Meera
and Abdul Razak (2005, 2009). However, at a glance, although ICB does offer equity home
financing mode, its implementation reveals a departure from the normative form of equity-
based financing, as it still operationally mimics its much-maligned counterpart – bay
bithaman ajil (BBA). Scholars such as Mydin Meera and Abdul Razak (2005, 2009) argue
that the true implementation of MM yields less profit to ICB, as it is operationally tedious.
350,000
300,000
250,000
RM Million
200,000
150,000
100,000
50,000
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Figure 1.
Debt-based (BBA and Murabahah) Equity-based (Musharakah and Mudharabah)
Composition of
Lease-based (Ijarah and AITAB) Others (Istisna' and others)
Islamic financing
instruments by
modes (2007-2017)
Source: Bank Negara Malaysia
Apart from that, ICB in Malaysia still uses base financing rate (BFR) and/or base rate (BR) in Financial
benchmarking its IHF products (Shuib et al., 2011; Mohd Ali et al., 2012; Isamail et al., 2013; affordability
and Shuib et al., 2014) as supposed to using rental rates as an endogenously determined
benchmark. Indeed, the literature shows that equity-based IHF modes have been
successfully implemented within the financial cooperative institutional framework. Prime
examples of such frameworks have been carried out, especially in the North America that
include American Finance House LARIBA in the USA and Ansar Cooperative Housing
Corporation Ltd in Canada (Mydin Meera and Abdul Razak, 2005, 2009).
The main idea of this study is to empirically investigate the existential issues within two,
currently the largest IHF providers and how they are unable to continuously provide
affordable IHF instruments to Malaysians in general. This study also departs from two
studies by Wahab et al. (2016) and Yusof et al. (2017) on housing affordability. At first, both
articles might look somewhat similar to the current study, especially with respect to the
issue of housing affordability. However, both studies focus on investigating the relationship
between factors that may or may not have impact on the housing affordability. Further, this
study also departs from these two studies by investigating not only the purchase
affordability aspect but also the repayment affordability aspect and its impact on the
Malaysian households’ income via official data from Bank Negara Malaysia, Department of
Statistics Malaysia and National Property Information Center.
This paper is divided into seven sections. The current section outlines the background of
the study, as well as delineating the objectives that this study sets to achieve. Section 2
reviews the literature on the basic mechanism of IHF and the inability and unsustainability
of both ICB institutions and government-owned home financing institutions in providing
financially affordable IHF options to the Malaysian homeowners. Sections 3 and 4 describe
the estimation techniques, as well as the data that are used in the study. Sections 5 and 6
present the results and discussion of the study. Finally, Section 7 concludes the study.
2. Literature review
2.1 Islamic home financing: the basic mechanics
IHF is based on Shari’ah (Islamic law), and it stands primarily on the prohibition of riba’
(interest), gharar (uncertainty), maysir (gambling) following the Quran and sunnah (practice
and traditions of the Prophet Muhammad p.b.u.h[1]). There are primarily three types of IHF
contracts in practice today across the world: murabahah (cost-plus or mark-up transaction),
ijarah (lease and “purchase” or “acquisition”) and MM (diminishing partnership) (Saiti et al.,
2016). In the murabahah (cost-plus sales) contract, ICB acquires a house at a price known to
both parties and then sells it to the customer for the original price plus an additional
premium. In the ijarah contract, the customer contracts to buy the usufruct of the house for a
certain period of time with the option to acquire the house (usually via a nominal sale) at the
end of the lease period. Finally, in the MM contract, both parties jointly purchase and co-
own the house, while the customer will simply buy ICB’s share of the house over time until
the customer has bought out ICB’s share and completely owns the house (Mydin Meera and
Abdul Razak, 2009).
2.2 The conflict of interest in Islamic commercial banks: its effects on the affordability of
Islamic home financing instruments
In an efficient housing market, formal forms of home financings, including that of IHF, are
onerous to low-income households (Sukumar, 2001; Jones, 2008; Ebrahim, 2009; Kuen, 2013).
In relation to this, debt-based IHF modes such as BBA and tawarruq (commodity
murabahah) would be so unaffordable that these low-income households would have no
IJHMA access to such an indispensable asset (Ebrahim, 2008). Furthermore, these households’ lack
of collateral and a higher risk of defaulting places them in a weaker position to bargain for
advantageous terms (Griffiths and Howells, 1991; Sukumar, 2001). Therefore, to mitigate
these information asymmetry and default risks, ICB prefers fully collateralized instruments
such as BBA (Khan, 2010). As a result, debt-based IHF modes enable ICB to earn
competitive returns without assuming its proportionate risks. That will, in turn, result in
better profit margin that may be later used to pay out dividends to its shareholders. ICB is,
in fact, a type of an investor-owned firm that is required to simultaneously satisfy
“shareholders’ profit expectations and disparate customer needs” (McKillop and Wilson,
2015, p. 97). As a result, ICB will eventually turn low-income households away from the
formal housing market, as they see little to no financial incentive in offering lower-than-
market rate IHF instruments to these households.

However, despite the growing appeal of the IHF, there are many ICBs that still refuse to
finance low- to lower-middle income households’ home purchase. It is especially true for
households that are otherwise known as “unbankable” (Dusuki, 2008; Ahmad, 2015;
Mohammad, 2015). Their reluctance may be caused by concerns on the ability to mitigate
the risk profile usually associated with these unbankables’ uncertainty in monthly incomes
and the relatively high cost of making smaller IHFs (Chiquier and Lea, 2009). Apart from
that, ICB also tends to distribute economic returns to shareholders that spread out across a
large economic area or around the world and not necessarily to those who are a part of the
ICB’s immediate community (Azmi, 2011).
2.3 Are government-owned home financing institutions sustainable?

None of the successful home financing systems in existence today developed without some
form of active support by the government. The World Bank Annual Report (2009), for
example, outlined what government-owned home financing institutions generally
represented in an attempt to provide an institutional answer to at least these three issues:
(1) providing financial service to jumpstart the infant market;
(2) catering the needs of segments of the population underserved by the commercial
banking sector, i.e. lower or informal market segments; and
(3) acting as a policy implementation tool, i.e. Cagamas Berhad[2].
However, if the government-owned financing institutions maintain their status quo through
these heavily subsidized programs, they will surely affect the long-term fiscal health of a
given country. It was aptly demonstrated by the wide-ranging spending cuts in the recently
tabled Malaysian Budget 2017 to achieve a target of 3 per cent budget deficit. Malaysia
indeed has been recording consecutive budget deficits since 1998. Table I and Figure 2
further exhibit the fluctuation of home financing provision by government-owned or
government-linked institutions in Malaysia. Apart from the steady increase of home
financing provision by commercial banking institutions, government-owned home
financing institutions are slowly reducing their home financing provision activities. A case
in point, Sabah Credit Corporation, a government-owned home financing institution for civil
servants in Sabah (both federal and state), saw a decrease of almost 50 per cent in home
financing provisions within the past five years alone. This is indeed a worrying trend since
Sabah was recorded as having the highest national house price index (319.9) in 20163. It is
an increase of 141 per cent from 132.5 in 2006 (National Property Information Centre, 2016).
Stated differently, on an average, housing prices in Sabah has increased nearly twofold in a
ten-year span. As a result, this caused government-owned home financing institutions such
as Sabah Credit Corporation to disburse as much as 141 per cent more funds to finance its Financial
home financing applicants as compared to what it used to cost them only a decade ago. affordability
As part of their social financing mandate, government-owned home financing
institutions are often disbursed to the privileged, and sometimes, exclusive vehicles of
rationed subsidies (Chiquier and Lea, 2009). It is especially true in the case of Malaysian civil
servants. According to the official statistics from the Ministry of Human Resources
Financing rate for new home financings

Home financing institutions 2014 2015
Commercial banks 4.38 4.54

Treasury Housing Loans Division 4.00 4.00
Bank Kerjasama Rakyat Malaysia 4.76 7.00
Malaysia Building Society Berhad 7.43 7.54 7.40 7.61
Borneo Housing Mortgage Finance Berhad 6.75 7.50 6.75 7.50
Bank Simpanan Nasional 4.93 4.96
Table I.
Sabah Credit Corporation 3.00 7.50 3.00 7.50 Home financing
institutions and its
Source: Bank Negara Malaysia financing rates
100%
90%
Percentage of share
80%
70%
60%
50%
2015 2014 2013 2012 2011
Sabah Credit Corporation 0.00% 0.00% 0.00% 0.00% 0.00%
Bank Simpanan Nasional 1.60% 1.50% 1.30% 1.10% 1.10%
Borneo Housing Mortgage Finance Berhad 0.20% 0.20% 0.20% 0.20% 0.20%
Malaysia Building Society Berhad 1.10% 1.20% 1.40% 1.60% 1.70%
Bank Kerjasama Rakyat Malaysia Berhad 0.50% 0.60% 0.70% 0.90% 1.10%
Treasury Housing Loans Division 10.50% 10.30% 9.70% 9.90% 10.40%
Commercial Banking Institutions 86.00% 86.20% 86.70% 86.30% 85.40%
Commercial Banking Institutions Treasury Housing Loans Division Bank Kerjasama Rakyat Malaysia Berhad
Malaysia Building Society Berhad Borneo Housing Mortgage Finance Berhad Bank Simpanan Nasional
Sabah Credit Corporation Figure 2.
Home financing
Sourse: Bank Nagara Malaysia provision
outstanding
(2010-2015)
IJHMA Malaysia (2015), civil servants in Malaysia constitutes merely 1.6 million out of the 12.46
million workers in Malaysia. These civil servants are entitled to IHF facilities offered by the
Malaysian government’s Public Sector Housing Financing Board (LPPSA)4 at an affordable
rate of 4 per cent. Barring the 3 per cent rate offered by Sabah Credit Cooperation that is
exclusive to civil servants who are serving in the Sabah state, the LPPSA’s rate is
considered as the lowest rate offered among all home financing institutions. However, this
presents a dilemma for the rest of the Malaysian labor. Where can they acquire such an
affordable rate? Table I below shows the alternative home financing institutions, together
with their financing rates, which the rest of the Malaysian workforces have to rely upon for
their IHF needs.
Both Table II and Figure 2 illustrate the home financing origination trend for the past
five years in Malaysia, and it points to the market share consolidation by ICB. While the
total home financing disbursed by LPPSA in terms of absolute value increased at around 10
per cent over these terms, it remains a marginal provider as compared to the ICB. This
increase in the IHF origination by the ICB is at the expense of other government-owned or
government-linked home financing institutions such as Sabah Credit Corporation and
Borneo Housing Mortgage Finance Berhad, which either reducing or merely maintaining its
status quo in their home financing disbursements. It is also interesting to note that Bank
Kerjasama Rakyat Malaysia Berhad, a cooperative banking entity, is gradually moving
away from the home financing market, as illustrated by their declining market share over
the past five years (1.4 per cent in 2010 to 0.50 per cent in 2015).
In view of the above, globally, there is an emerging trend of privatization of government
home financing institutions in Argentina, Australia, France, South Korea and Spain. The
nature of government intervention has, therefore, evolved into support of securitization
conduits such that of Cagamas Berhad, specific and targeted subsidies and preferential
regulatory treatment of home financing instruments (Chiquier and Lea, 2009). For example,
the Malaysian government has been providing tax rebates on interest/profit payments on
home loans/IHF. Nevertheless, the current trend is to gradually do away with government-
owned home financing institutions, because of their poor performance as inefficient
financiers and failure to meet housing policy objectives (Chiquier and Lea, 2009). This
discounts the possibility of the government-owned IHF providers to sustainably offer
affordable IHF products to the Malaysians.
3. The estimation techniques: purchase and repayment affordability of Islamic

home financing modes
The purchase and repayment affordability estimation techniques are used in this study to
estimate the role (or lack thereof) that IHF plays in the financially affordable home financing
provision among Malaysians and its overall impact on the Malaysian households’ monthly
income.
Purchase affordability considers whether a household is able to finance enough funds to
purchase a house (Gan and Hill, 2009). Repayment affordability, on the other hand, considers
the burden imposed on a household for repaying the IHF without falling below the poverty
line (Hancock, 1993; Gan and Hill, 2009; McCord et al., 2011). Both purchase affordability and
repayment affordability include additional parameters that describe the down payment
ratio, monthly installments payment-to-income ratio, the financing duration and the IHF
profit rate. All these parameters are fixed for repayment affordability, with the exception of
the IHF profit rate (Gan and Hill, 2009). In relation to purchase and repayment affordability,
Schwartz and Wilson (2008) propose a “Housing Cost Burden” approach to measure the
housing cost overburdened. This approach, which was introduced by the US Department of
RMm Annual change (%)

Home financing institutions 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015
*
Commercial banks 226,963 255,842 288,501 325,232 367,950 411,280 12.9 12.7 12.8 12.7 13.1 11.8
Treasury housing loans division 26,007 31,208 32,982 36,318 43,898 50,225 –2.7 20.00 –1.6 –0.3 20.9 14.4
Bank Kerjasama Rakyat Malaysia Berhad 3,837 3,382 2,978 2,569 2,361 2,599 –8.4 –11.9 –11.9 –13.7 2.5 10.1
Malaysia Building Society Berhad 5354 4,947 5,409 5,377 5,303 5,467 1.5 –3.6 –0.3 –0.6 –1.4 3.1
Borneo Housing Mortgage Finance Berhad 682 641 641 660 714 755 –4.8 –4.4 2.8 2.8 8.3 5.7
Bank Simpanan Nasional 3,132 3,806 3,806 5,003 6,430 7,794 3.2 5.3 33.3 31.5 24.6 21.2
Sabah Credit Corporation 141 96 96 81 69 58 –13.1 –17.3 –15.8 –15.8 –14.7 –16.3
Total 266,116 299,660 334,413 375,239 426,725 478,177 10.3 12.6 11.6 11.1 13.7 12.1
Note: *Includes ICBs

Source: Bank Negara Malaysia
Home financing
(2010-2015)
outstanding
Financial
Table II.
affordability
IJHMA Housing and Urban Development, considers households paying more than 30 per cent of
their income on home financing as housing cost overburdened. The approach categorizes
purchase and repayment affordability according to – no burden (under 30 per cent of
income), moderate burden (30 to 49 per cent of income) and severe burden (over 50 per cent
of income).
Apart from that, these approaches are also aligned with Bank Negara Malaysia’s (the
central bank) context of housing affordability. In its Guidelines on Responsible Financing
(Bank Negara Malaysia, 2012) an IHF instrument is deemed to be affordable if the amount
and terms allow the customer to reasonably meet the repayment obligations in full
throughout the course of financing, without recourse to debt relief or substantial hardship.
In general, financing policies of home financing institutions typically require a customer’s
total debt service ratio to be below 60 per cent of monthly disposable income (Bank Negara
Malaysia, 2016).
4. The data
Base rates and indicative effective financing rates of ICBs used in this study are sourced
from the Guide to Consumer on Reference Rate and Base Rates and Indicative Effective
Lending Rates of Financial Institutions and Annual Report 2016 by Bank Negara Malaysia.
The house prices and the average rental prices used in the same section were collected from
the National Property Information Center (NAPIC)’s Annual Property Market Reports 2016.
Median household incomes (national and state level) used for mathematical simulations in
Section 6 were collected from the Household Income and Basic Amenities Survey 2014 by
Department of Statistics, Malaysia.
5. Islamic home financing modes and their compounding effect on the purchase
affordability of Malaysians
Scholars have long argued that debt-based IHF mode such as the BBA that is offered by ICB
is more expensive than the conventional home loans (Mydin Meera and Abdul Razak, 2005;
Ebrahim, 2009; Smolo and Hassan, 2011) which puts considerable strain on the Malaysian
households’ repayment affordability. The following examples will further elucidate the
aforementioned statement.
5.1 BBA by Islamic commercial banks

Consider a single-story, terraced house that is selling at RM350,000 (US$83,577; exchange
rate of RM1 = US$0.24). The customer makes a down payment of 10 per cent and requests
from an ICB to finance the remaining 90 per cent, i.e. RM315, 000 using the BBA home
financing instrument. Assuming the indicative effective financing rate (IEFR) charged by an
ICB is 4.65 per cent 5 per annum for 30 years payment period. However, it can range
between 4.20 per cent, which is the lowest IEFR in the market as currently offered by Bank
Islam Malaysia Berhad, and the highest at 5.10 per cent by the Asian Finance Bank and the
Alliance Islamic Bank (Bank Negara Malaysia, 2018). Table III below details the BR and its
IEFR by ICB that offers IHF.
First, the ICB would buy the house for RM315,000 and then sell the house to the customer
at a profit, with deferred payments over the 30-year period. The monthly installments
amount is RM1,624.26, payable for 360 months. The total financing is RM584,733 with a
total profit for the ICB equals RM 269,733 (equivalent to RM51,304 after adjusting to
inflation)6. This profit is almost double the original selling price of RM315,000. Figure 3
below summarizes the transactions in BBA home financing.
However, bear in mind that the above illustration does not account for IHF instruments Financial
that were offered prior to the introduction of the BR. In fact, prior the introduction of BR, IHF affordability
modes, including that of the BBA, is usually pegged to the BFR. For instance, using the
above example, IHFs that used the BFR (without any ibra’ or rebate) will have to pay as high
as RM1,839.17 per month (the latest BFR prior the introduction of BR was 6.85 per cent).
Although IHFs with the BR seems like a cheaper alternative to the much-maligned BFR, it is
No. Islamic financial institutions BR (%) IEFR (%)
1 Affin Islamic Bank Berhad 3.74 4.65

2 Al Rajhi Banking and Investment Corporation (Malaysia) Berhad 4.10 4.70

3 Alliance Islamic Bank Berhad 3.82 4.75
4 AmIslamic Bank Berhad 3.80 4.50
5 Asian Finance Bank Berhad 3.77 5.10
6 Bank Islam Malaysia Berhad 3.65 4.20
7 Bank Muamalat Malaysia Berhad 3.75 5.05
8 CIMB Islamic Bank Berhad 3.90 4.65
9 Hong Leong Islamic Bank Berhad 3.69 4.60
10 HSBC Amanah Malaysia Berhad 3.50 4.85
11 Kuwait Finance House (Malaysia) Berhad 3.10 4.59
12 Maybank Islamic Berhad 3.00 4.35
13 OCBC Al-Amin Bank Berhad 3.72 4.91
14 Public Islamic Bank Berhad 3.52 4.35
15 RHB Islamic Bank Berhad 3.65 4.65
16 Standard Chartered Saadiq Berhad 3.52 4.52 Table III.
BRs and IEFR of
Source: Bank Negara Malaysia ICBs
Figure 3.
BBA home financing
by ICBs
IJHMA still subject to changes by the individual ICB, as they need to reflect their cost structure.
Therefore, if the cost structure of an individual bank increases, there is always a possibility
to see further increases in the BR that will, in turn, result in much pricier IHF instruments.
5.2 MM by Islamic commercial banks

As MM by ICB operationally mimics the BBA, especially in the use of the BR as a
benchmarking tool, this results in the same number of monthly installments as the BBA
mode. Conceptually, MM home financing instrument is inherently different from the BBA
home financing instrument. As a result, in terms of purchase affordability, MM home
financing as currently practised by ICB will not be able to offer affordable IHF solution to
Malaysian homeowners. Figure 4 below provides a detailed modus operandi of MM home
financing by ICB.
5.3 MM by financial cooperatives: the way forward

The increasing withdrawal by the government home financing institutions, coupled with
the increasing role played by the ICB in the home financing market, is forcing most
Malaysian workforce out of the affordable IHF option. The above examples have empirically
illustrated that, within the current institutional framework, homeowners are unable to
affordably purchase their homes via IHF instruments. In fact, from a purely mathematical
standpoint, they are better off using conventional home loans instead. Consider the
following comparison (Table IV) between conventional home loans and both BBA/MM
home financing by ICB.
From Table IV, it is evident that as long as the average profit rates (APR) between the
above financing are the same, the total interest in the conventional home loan will always
equal to the total profit in the IHF instruments. However, should the customer opt for early
settlement, without any ibra’ or rebate from the ICB (which subjects to bank’s sole
Figure 4.
MM home financing
by ICBs
discretion), e.g. after 15 years, the remaining balance under the BBA/MM is always higher Financial
than under the conventional home loans. However, the balance of the conventional home affordability
loan is much lower as the balance is calculated at the present value of the remaining 180
payments. Under the BBA/MM, on the other hand, it is simply the monthly payment times
180 as the total profit for the 30 years is capitalized upfront.
Therefore, there are increasing calls among the scholars of Islamic economics and
finance for the “third sector” institution to address this affordability issue of IHF
instruments (Mydin Meera and Abdul Razak, 2009; Ebrahim, 2009; Al-Muharrami and
Hardy, 2014). In fact, these scholars have even underscored the potential of organizing
financial cooperatives to offer IHF along credit union7 lines as such structure would enhance
mutuality in business dealings. For financial cooperatives in North America, for example,
they offer a slightly different version of MM compared to the ICB. A member-customer will
first have to accumulate shares in the financial cooperative, usually for at least six months,
up to a certain portion of the house price. The financial cooperative will then buy the house
and register it in its name. The member-customer will then enter into a contract where the
member-customer will pay rent on the share of the financial cooperatives. The member-
customer will also get a dividend from the shares in the house. However, to speed up the
member-customers equity acquisition, he/she usually foregoes this dividend and uses it to
pay off the financial cooperative’s shares in the house. The member-customer will continue
to acquire the financial cooperative’s shares until they match the value of the house. Finally,
the title of the house will be transferred to the member-customer either through hibah (gift)
or bay’ (sale).
Consider the same example used for the BBA/MM home financing instruments by the
ICB. In this case, a financial cooperative’s member-customer wishes to buy a house priced at
RM350,000 and saves up to 10 per cent of the price, i.e. RM35,000. The financial cooperative
finances the remaining 90 per cent, i.e. RM315,000. Now, assume that the average rental for
similar homes in the locality is agreed upon between the two parties to be RM1,000 per
month. According to the MM formula, however, if the member-customer pays only RM1,000
per month, it would take more than 30 years (exactly 67 years and three months)8 to fully
own the house. Therefore, some additional amount is necessary to redeem within 30 years.
Here, the rental rate is, x ¼ RP ¼ 350000
1000
¼ 0:003 and the additional monthly amount needed is:
n

x P ð1 þ xÞ C 0
A¼
ð1 þ xÞn 1
MM by Islamic
Conventional home loan BBA commercial bank
Table IV.
Monthly payment RM1,624.26 RM1,624.26 RM1,624.26 Comparison between
Total payment in 30 years RM584,733 RM584,733 RM584,733 conventional home
Total interest/profit RM269,733 RM269,733 RM269,733 loan by conventional
APR 4.65% 4.65% 4.65%
bank and BBA and
Balance after 15 years RM210,210.24 RM292,366 RM292,366
MM home financing
Notes: Price of house: RM350,000; down payment: RM35,000; total loan/financing: RM315,000; monthly by Islamic
rental: RM1,000 commercial bank
h i
IJHMA 360
0:003 350; 000 ð1 þ 0:003Þ 35; 000
A¼
ð1 þ 0:003Þ360 1
A ¼ RM 401:96
Therefore, the total payment equals to RM1,000 þ RM401.96 = RM1,401.96. Table V

provides the schedule for the above MM contract.
Table VI shows the possible range of monthly installments that can be paid by the
member-customer. While the amount to be paid monthly was between RM1,540 and
RM1,710 (using the lowest and highest IEFR of 4.20 and 5.10 per cent, respectively) under
the BBA home financing, the monthly amount needed under MM, on the other hand, is only
RM1,401.96. If the member-customer pays RM1,624.26 for the MM mode as in the BBA in
Section 5.1, then the member-customer can own the home in 23 years seven months, i.e.
saving about a year of monthly installments. On the other hand, should the member-
customer can afford the higher installments of say, RM1,710, which is the identical monthly
installments offered by Asian Finance Bank at IEFR of 5.10 per cent, the member-customer
will acquire the house in just under 22 years of monthly installments (21 years and nine
months). Unlike the BBA mode, there is a greater flexibility in terms of monthly installments
for the financial cooperative’s member-customer. For example, member-customer may
choose to rent the house for as low as RM800 and still able to own the house by the 360th
installments. Apart from that, the rental payments can be adjusted according to the locality,
types of houses and proximity to public transportation modes. Figure 5 summarizes the MM
home financing arrangement by the financial cooperative.
Financial cooperative in Malaysia is a cooperative society registered under the
Suruhanjaya Koperasi Malaysia or Malaysian Cooperatives Commissions (SKM) whose
main activity is to finance their members’ needs. These financial cooperatives give out
financings to its members from their capital fees, which are contributed by its members
monthly. It is obligatory for the members of financial cooperative to pay membership fees
besides accumulating the minimum required capital shares to be eligible for financing (i.e.
IHF) from the financial cooperative. Upon the approval of the cooperative board member, a
certain amount of processing fee and takaful (Islamic insurance) payment will be deducted
from the total financing amount. The repayment will be managed through an automated
salary deduction system administered by the credit and banking services (formerly known
as Bahagian Perhidmatan Awam or BPA), ANGKASA.
Cooperative societies in Malaysia consist of mainly finance based, and at 82.53 per cent,
they almost single-handedly contributed to the total revenues generated by cooperative
societies in Malaysia (Suruhanjaya Koperasi Malaysia, 2016). The yearly directories of the
Top 100 Cooperatives in Malaysia by SKM also highlight the importance of financial
cooperative to the cooperative movement in Malaysia as almost half (43 per cent) of those
cooperatives are financial cooperative (Suruhanjaya Koperasi Malaysia, 2016). Even though
financial cooperatives made up the largest numbers as SKM-registered cooperative societies
(41 per cent), as of December 31, 2015, they are almost synonymously equated with personal
financing, which is a core, and lucrative business of financial cooperative (Suruhanjaya
Koperasi Malaysia, 2016).
Based on the above report, it shows that most financial cooperatives that made it into the
list were concentrated on the Islamic personal and/or consumption financing instruments as
their core business operational model. It was also seen that only a handful offered IHF
instruments such as Koperasi Wawasan Malaysia Berhad (KOWAMAS), Koperasi Polis
A B C=AþB D E F G H
Rental division
Monthly Monthly Total Member-customer’s Member-customer’s FC’s FC’s
Month rent (RM) redemption (RM) payment ratio Member-customer FC equity (RM) equity (RM) cash flow (RM)
0 0.10000 35,000 315,000 (315,000)

1 1,000 401.96 1,401.96 0.10000 100.00 900.00 35,501.96 314,498.04 1,401.96
2 1,000 401.96 1,401.96 0.10143 101.43 898.57 36,005.35 313,994.65 1,401.96
3 1,000 401.96 1,401.96 0.10287 102.87 897.13 36,510.19 313,489.81 1,401.96
4 1,000 401.96 1,401.96 0.10431 104.31 895.69 37,016.46 312,983.54 1,401.96
5 1,000 401.96 1,401.96 0.10576 105.76 894.24 37,524.18 312,475.82 1,401.96
. – – – – – – – – –
. – – – – – – – – –
. – – – – – – – – –
. – – – – – – – – –
360 1,000 401.96 1,401.96 0.99600 996.00 4.00 349,999.38 0.62 1,401.96
Table V.
Payment schedule
for MM
Financial
affordability
IJHMA Installment/
median
Monthly Total Period to income
Monthly rent redemption installment acquire the IRR (RM4,585) Housing cost
(RM) (RM) (RM) house (%) (%) burden
800.00 484.77 1,284.77 30 years 3.05 28.02 No burden

900.00 442.66 1,342.66 30 years 3.43 29.28 No burden
1,000.00 401.96 1,401.96 30 years 3.81 30.58 Moderate burden

1,185.04 401.96 1,587.00 27 years and 4.51 34.61 Moderate burden
5 months
6 months
8 months
Table VI. Notes: (a) No burden (under 30 per cent), moderate burden (30 to 49 per cent), severe burden (over 50 per
Possible monthly cent) (Schwartz and Wilson, 2008); (b) median income of RM4,585 is based on 2014 data, the latest median
installments range data available from the Department of Statistic Malaysia
Figure 5.
MM home financing
by financial
cooperative
Diraja Malaysia Berhad, Koperasi Koswip Malaysia Berhad, Koperasi Pembiayaan Syariah Financial
ANGKASA Berhad (KOPSYA), Koperasi Muslimin Malaysia Berhad, Koperasi Kospeta affordability
Malaysia Berhad, Koperasi AIM Berhad, Koperasi Serbaguna MAS Berhad9. Moreover,
barring the likes of cooperative banking institutions such as Bank Kerjasama Rakyat
Berhad and Koperasi Bank Persatuan, these financial cooperatives are still using debt-based
IHF modes, i.e. the BBA, bay al-inah with financing amount that rarely surpasses
RM100,000 and with profit rates that are usually higher than the ones that are offered by the
ICB. Unlike their counterparts in the USA and the UK, whose financial cooperatives are
active in IHF intermediation activities that ultimately help its member-customers to
affordably acquire their dream homes, a major paradigm shift is needed if they were to enter
the IHF market.
6. Islamic home financing modes and its impact on the repayment affordability
From Table VII, the total monthly installments and financing balances are the lowest in the
MM by financial cooperatives (FC) among the four financing methods. The mathematical
derivation for MM home financing by Mydin Meera and Abdul Razak (2005) also shows that
at 3.43 per cent per annum, the rental rate solely determines the return of MM home
financing. Interestingly, this return is independent of the initial capital provided by the
financial cooperative nor the duration of the contract, which is usually the case under BBA
financing.
By translating the IEFR into practical examples, Table VIII highlights the wide extent of
unaffordable IHF instruments may have on Malaysian households, as none of the
instruments by ICB (IEFR that ranges from 4.20 to 5.10 per cent) is affordable to the
Malaysian households. At the lowest IEFR continuum, the LPPSA’s rate of 4 per cent
provides the “softest” impact on the Malaysian households. For example, IHF installments
constitute 16.87 and 22.88 per cent of the bottom 40 per cent (B40) and Malaysian median’s
household incomes. This puts into question again on the limited availability of the LPPSA’s
affordable IHF profit rate to the rest of the Malaysian masses.
However, for Malaysia’s rural, urban and middle 40 per cent (M40) households, they are
definitely better off with the true implementation of MM home financing by financial
cooperatives. In fact, if we were to opt for the “Housing Cost Burden” approach (Schwartz
and Wilson, 2008), both urban and M40 households’ home financing commitments are
considered as moderately burdened, as they ranges between 30.43 per cent and as high as
42.03 per cent of their total income. As a result, MM by financial cooperatives is the best
option for both of these households that mostly reside in towns and cities (Embong, 2011).
As the housing prices for the latter two cases increase, pegging the internal rate of return
(IRR) against the rental rates as supposed to the BR proves that MM home financing
Monthly installments and Conventional MM by Islamic

financing balances home loan BBA commercial bank MM by FC
Monthly installment RM1,624.26 RM1,624.26 RM1,624.26 RM1,401.96 Table VII.

Total payment in 30 years RM584,733 RM584,733 RM584,733 RM504,705.60 Comparison between
Total interest/profit RM269,733 RM269,733 RM269,733 RM189,705.60 conventional home
APR 4.65% 4.65% 4.65% 3.43%
loan, BBA/MM by
Balance after 15 years RM210,210.24 RM292,366 RM292,366 RM196,237.59
Islamic commercial
Note: Price of house: RM350,000; down payment: RM35,000; total loan/financing: RM315,000; monthly bank and MM by
rental: RM1,000 financial cooperative
IJHMA Monthly
Monthly Monthly Monthly Monthly installments
installments installments installments installments using MM
@ 4% p.a. @ 4.20% p.a. @ 4.65% p.a. @ 5.10% p.a. by FCs (30
Housing prices (30 years)a (30 years) b (30 years)c (30 years)d years)e
Bottom 40% RM601.54 RM616.16 RM649.70 RM684.12 RM622.48

(RM2, 629 per month) (22.88%) (23.43%) (24.71%) (26.02%) (23.68%)
@ RM140, 000 (Kedah)
Rural RM730.45 RM748.20 RM788.92 RM830.71 RM677.53
(RM3, 123 per month) (23.39%) (23.96%) (25.26%) (26.60%) (23.52%)
@ RM170, 000 (Kelantan)
Malaysia Median RM773.41 RM792.21 RM835.33 RM879.58 RM902.95

(RM4, 585 per month) (16.87%) (17.28%) (18.22%) (19.18%) (19.69%)
@ RM180, 000 (Melaka)
Urban RM1,589.79 RM1,628.43 RM1,717.07 RM1,808.02 RM1,569.11
(RM5, 156 per month) (30.83%) (31.58%) (33.30%) (35.07%) (30.43%)
@ RM370, 000 (Johor)
Middle 40% RM2,019.47 RM2,068.54 RM2,181.14 RM2,296.68 RM1,857.01
(RM5, 465 per month) (36.96%) (37.85%) (39.91%) (42.03%) (33.98%)
@ RM470, 000 (Wilayah
Persekutuan Labuan)
Notes: athe IEFR for home IFH instrument by Lembaga Pembiayaan Perumahan Sektor Awam (LPPSA);
b
the lowest IEFR offered by ICBs, i.e., Bank Islam Malaysia Berhad, with a down payment of 10 per cent;
c
Table VIII. the median IEFR offered by ICBs among others; Affin Islamic Bank Berhad, CIMB Islamic Bank Berhad
d
Housing affordability and RHB Islamic Bank Berhad with a down payment ofe 10 per cent; the highest IEFR offered by Asian
Finance Bank with a down payment of 10 per cent; and the authors used a single story, terraced house’s
of Malaysians by rental rate in state municipalities that are the closest to median incomes as proxies, i.e., Kelantan (RM480
median incomes in per month), Kedah (RM500 per month), Melaka (RM800), Johor (RM1, 200) and Wilayah Persekutuan
2014 Labuan (RM1, 300) (National Property Information Centre, 2016)
instrument is indeed a superior instrument vis-à-vis the BBA home financing instrument. It
is also interesting to note that, despite opting for rental rates that are on the near-premium
continuum as in this study, it still provides among the softest cushions against the impact
that it can have on these households’ monthly incomes. The flexibility of MM can also
enable the member-customer to redeem the financial cooperative’s principal sum, without
the need to compute rebates as in BBA (Mydin Meera and Abdul Razak, 2005). On the other
hand, should a member-customer finds him/herself in a financial difficulty in servicing the
monthly installments, he/she may negotiate for lower rental rates, or buying his/her house at
a comparatively cheaper location, they might be able to enjoy lower monthly IHF
installments. Table VIII also shows that financial cooperative is usually geographically
focused (Azmi, 2011) and, therefore, will respond better to the specificities of MM home
financing’s operationalization.
7. Conclusion
This study offers insights into the unsustainability of the current IHF framework, which are
being dominated by the ICBs and government-owned and government-linked home
financing providers. This study then presented a comparative, financial affordability
analysis between debt- and equity-based IHF instruments by participating institutions in
Malaysia through statistical evidence from the Department of Statistics, Valuation and
Property Services Department and Bank Negara Malaysia. The empirical results Financial
reconfirmed some of the literature’s argument for MM home financing by the financial affordability
cooperative as a better alternative to the ones offered by commercial banking institutions –
both conventional home and IHF instruments that of BBA and MM.
Another interesting point in the study is the apparent affordable nature of conventional
home loan vis-à-vis the IHF products by the ICB. However, Malaysia being a Muslim-
majority nation, the elements of Shari’ah and its underlying business ethics continue to be
an integral part of affective commitment dimension as it was outlined in most of the
literature on IHF’s selection criteria. Specifically, it includes among others, emphasis on
Shari’ah principles in the IHF instruments and services, transparent and unambiguous
commercial transactions and avoidance of riba’-based (usury) business dealings (Amin,
2008; Amin et al., 2009; Ismail et al., 2014).

This study has several implications, one of which is the theoretical nature where it has
mathematically proven that it is indeed better to revive the ta’awun (cooperative) spirit
within the Islamic gift economic framework. We are also hopeful that this study will
encourage more financial cooperatives to participate in the IHF provision and subsequently
promotes “positive partnership instead of negative indebtedness” among its member-
customers (Mydin Meera and Abdul Razak, 2005, p. 20). Furthermore, as reported by
Khazanah Research Institute in its 2015 report, there are warning signs that housing
affordability, particularly for lower-income households in Malaysia, will worsen if left
unchecked.
One of the major challenges facing MM by FC is the willingness (or lack thereof) of its
members to continually contribute and help other members to acquire their homes and be
paid below-market returns on their deposits. However, to operationalize such model, we are
of the opinion that we need to go back to the basic Islamic financial literacy to be taught at
schools. Moreover, the spirit of ta’awun is to be endogenously inculcated from home. Further
avenue for research is to investigate on the possibility, viability and perhaps to a certain
extent, the sustainability to operationalize this model (MM by FC) at a smaller scale first
before scaling up at a district, state or national level – by harnessing the “common bond”
(McKillop and Wilson, 2011, 2015) that is usually associated with the success of cooperative
societies in other parts of the world.
Notes
1. It is highly recommended to invoke the salutation of ‘peace be upon him’ whenever a Muslim
hears Prophet Muhammad’s name. It is hereinafter referred to as “pbuh”.
2. Cagamas Berhad is a national corporation that securitizes home financing in order to channel
funds at lower cost to financial institutions. The Kuala Lumpur: corporation achieves the
objective by buying amongst others, Islamic home financings from primary financiers i.e. ICB
through issuance of sukuk (Islamic bonds).
3. The index’s comparative base is 100 and uses the year 2000 as its base year.
4. LPPSA is a statutory body under the public sector Home Financing Board Act 2015. It was
previously known as Bahagian Pinjaman Perumahan (Treasury Housing Loan Division) that
was established in 1971 with an initial fund of RM20 million to provide housing loans to eligible
civil servants in Malaysia. Currently, the interest/financing rate charged on all housing loans/
financings granted to all categories of civil servants is fixed at 4% per annum. It is considered as
one of the lowest interest/financing rates in Malaysia.
5. It is the median IEFR amongst all Islamic commercial banks.
IJHMA 6. The total profit is calculated using a nominal profit rate of 4.65%. However, using the Fischer
equation formula, the real profit rate is calculated as r ¼ ðð1þ1þiÞ
pÞ
1, where r: real profit rate, i:
nominal profit rate, and p : inflation rate. Assuming the inflation rate to be 3.58% (the average
inflation rate in Malaysia from 1973 to 2018), the real profit rate is 1.03%.
7. Credit union consists of a group of people who shares a common bond. It can be a shared bond
through their profession, social interest, political inclination, and religious affiliation. They will
pool their capital together on a regular basis. These savings are then used to provide home
financing to its members. As their ultimate goal is to help other members (and themselves) in
obtaining affordable home financing, they are willing to settle with a usually lower return on
their deposits. They primarily rely on voluntary effort to manage the pooled fund or otherwise
known as ‘shares’.
8. PV = 315,000 IRR/i = 5.143% (RM1, 500 x 12/RM350, 000) PMT = 1,500

9. This list of financial cooperatives that offer Islamic home financing instruments is by no mean
exhaustive. The information has been compiled from the authors’ field work and these
cooperatives’ individual websites.
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Corresponding author
Razali Haron can be contacted at: hrazali@iium.edu.my
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Mohd Zaidi Md Zabri Razali Haron

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market rate IHF instruments to these households.

2.3 Are government-owned home ﬁnancing institutions sustainable?

Financing rate for new home financings

Commercial banks 4.38 4.54

3. The estimation techniques: purchase and repayment aﬀordability of Islamic

RMm Annual change (%)

Note: *Includes ICBs

5.1 BBA by Islamic commercial banks

No. Islamic financial institutions BR (%) IEFR (%)

1 Afﬁn Islamic Bank Berhad 3.74 4.65

2 Al Rajhi Banking and Investment Corporation (Malaysia) Berhad 4.10 4.70

5.2 MM by Islamic commercial banks

5.3 MM by ﬁnancial cooperatives: the way forward

Therefore, the total payment equals to RM1,000 þ RM401.96 = RM1,401.96. Table V

0 0.10000 35,000 315,000 (315,000)

800.00 484.77 1,284.77 30 years 3.05 28.02 No burden

1,400.00 252.70 1,652.70 30 years 5.33 36.05 Moderate burden

Monthly installments and Conventional MM by Islamic

Monthly installment RM1,624.26 RM1,624.26 RM1,624.26 RM1,401.96 Table VII.

Bottom 40% RM601.54 RM616.16 RM649.70 RM684.12 RM622.48

Malaysia Median RM773.41 RM792.21 RM835.33 RM879.58 RM902.95

2008; Amin et al., 2009; Ismail et al., 2014).

8. PV = 315,000 IRR/i = 5.143% (RM1, 500 x 12/RM350, 000) PMT = 1,500

ﬁnancing issues: an analysis of musharakah mutanaqisah- and conventional-based products]”,

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