Shari’ah Issues in Deferred Payments

Unit 4 | 1

Shari’ah Issues in Deferred

Payments (Murabahah, Unit 4
BBA and Istijrar)

Topics in This Unit

4.1- Introduction

4.2- Definition of murabahah

4.3- Shari’ah issues in bay bithaman ajil (BBA)

4.4- Definition of bay bima yanqati bihi sir/bay istijrar

Unit At the end of this unit, you should be able to:

Objective
• Determine the Shari’ah in murabahah in Islamic financing
• Determine the Shari’ah issues in bay bithaman ajil (BBA)
in Islamic financing
• Determine the Shari’ah issues in istijrar in Islamic
financing

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Key Terms

Cost plus Bay bithaman ajil (BBA) Rescheduling

Murabahah Istijrar Deferred payment and

instalment
Rebate Recall the facility

Purchase undertaking Late charges

ISLAMIC FINANCING

There are two types of Islamic financing, debt

based financing and equity based financing; both
applications are used in Islamic banking facilities.
This unit will discuss some Shari’ah issues related to
the debt financing category.

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Unit 4.1 INTRODUCTION

Two types of debt financing which dominates the debt financing of Islamic banks globally, are
murabahah and bay bithaman ajil (BBA). Murabahah is a type of contract, which is considered
as a form of sale, where the seller expressly mentions the cost of the sold commodity he has
incurred, and sells it to another person by adding some profit or mark-up thereon. Indeed,
murabahah financing or cost-plus or mark-up price is one of the financing mechanisms in the
muamalat system and is a simple business transaction.

Bay bithman ajil (BBA) is another important contract used in Islamic finance. The discussion
will focus on the concept of BBA, the differences in application in Malaysia and other places,
some potential Shari’ah and legal issues that might arise from its application as well as a study
of some of the clauses in the documentation of the BBA contract in Malaysia. The discussion
in this unit will focus on the relevant Shari’ah issues in murabahah and BBA in Islamic finance.
The other issue is istijrar as an important contract used in deferred payment transactions.

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Unit 4.2 DEFINITION OF MURABAHAH

Literally, the word murabahah is derived from the word “ribh”, which means profit or gain. As a
technical term, murabahah is generally defined as the sale of a commodity at the price the seller
has purchased it, with the addition of a stated profit known to both the seller and buyer. In
short, it is a cost-plus-profit sale in which the seller expressly discloses the profit. A murabahah
sale in its original Islamic connotation is simply a sale. The only feature distinguishing it from
other kinds of sale is that the seller in murabahah expressly tells the purchaser how much cost
he has incurred and how much profit he is going to charge in addition to the cost. Therefore,
if a person sells a commodity for a lump sum price or instalment basis without referencing it
to the cost, this is not considered as murabahah, even though he is earning some profit on his
cost because the sale is not based on a “cost-plus-profit” concept. In this case, the sale is called
musawamah. Due to the special nature of murabahah, jurists have considered it as a sale based
on trust (amanah). Classical jurists have given several definitions of murabahah as follows:

1. Ibn al-Humam’s definition: “Murabahah is a contract of delivery of traded goods by a

seller to the buyer by offering the buyer the selling cost price plus the total profit.”
2. Ibn Qudamah defines murabahah as: “A form of business transaction whereby the
customer is informed that the goods are sold at a price which includes the cost price
and profit.”
3. Imam Shafi’i describes murabahah as the following: “When someone sells an item with
a contract, for instance, for every ten products the profit is one, the buyer thus, must
pay the cost price, that is 90 dirham, plus the profit of 1 dirham for every ten, which is 9
dirham and therefore, the total financing is 99 dirham.
4. Imam Malik’s explanation: “Murabahah occurs when an item is sold and the profit taken
is one dirham for every dirham of the capital spent (1 cost price + 1 profit rate = 2 (total
financing)), or half dirham for every dirham spent (1 cost price + 0.5 profit margin =1.5
(total financing)), or eleven dirham for every ten dirham capital spent (10 cost price +
11 profit margin = 21 (total financing)). Whether the profit is lower or higher than the
capital, it depends on the agreement between both parties.”

The different definitions given above indicate that murabahah is a trust (amanah) sale, which
comprises both the actual cost price and the margin of profit, and it is only valid for commodities
in which its cost price is known.

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Unit 4.2.1 SHARI’AH ISSUES IN MURABAHAH

There are several Shari’ah issues related to the murabahah contract. Among these issues are:

1. Use of Interest Rate as Benchmark

Many institutions which offer financing by way of murabahah determine their profit or mark-
up on the basis of the current interest rate; mostly using LIBOR (London Interbank Offered
Rate) as the criterion. For example, if the LIBOR is 6%, they determine their mark-up on the
murabahah equal to LIBOR or some percentage above LIBOR. This practice is often criticised
on the grounds that profit based on an interest rate should be as prohibited as interest itself. No
doubt, the use of the interest rate for determining a halal profit cannot be considered desirable.

It certainly makes the transaction resemble an interest-based financing, at least in appearance,

and keeping in view the severity of the prohibition of interest, this apparent resemblance should
be avoided as far as possible. However, one should not ignore the fact that the most important
requirement for the validity of murabahah is that it is a genuine sale with all its requirements
and necessary consequences. If a murabahah transaction fulfils all of its conditions, merely
using the interest rate as a benchmark for determining the profit of murabahah does not render
the transaction as invalid, haram or prohibited, because the deal itself does not contain interest.
The rate of interest has been used only as an indicator or as a benchmark.

In order to explain the point, let us ponder the following illustration. A and B are two brothers.
A, trades in liquor which is totally prohibited in Shari‘ah. B, being a practicing Muslim dislikes
the business of A and starts the business of soft drinks, but he wants his business to earn as
much profit as A earns through the trading of liquor. Therefore, he resolves that he will charge
the same rate of profit from his customers as a charges over the sale of liquor. Thus, he has tied
up his rate of profit with the rate used by A in his prohibited business. One may question the
propriety of his approach in determining the rate of his profit, but obviously no one can say that
the profit charged by him in his halal business is haram, because he only used the rate of profit
of the business of liquor as a benchmark. In Malaysia, the rate is based on the base financing
rate (BFR) published by Bank Negara Malaysia.

Similarly, so far as the transaction of murabahah is based on Islamic principles and fulfils all
its necessary requirements, the rate of profit determined on the basis of the rate of interest will
not render the transaction prohibited.

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2. Promise to Purchase
Another important issue in murabahah financing which has been subjected to debate between
contemporary Shari’ah scholars is that the bank/financier cannot enter into an actual sale at the
time the client seeks murabahah financing from him. This is because the required commodity
is not owned by the bank at this stage and the known principle in muamalat is that one cannot
sell a commodity not owned by him nor can he effect a forward sale.

He is, therefore, bound to purchase the commodity from the supplier, and only then can he sell
it to the client (after having its physical or constructive possession). On the other hand, if the
client is not bound to purchase the commodity after the financier has purchased it from the
supplier, the financier may be confronted with a situation in which he has incurred huge expenses
to acquire the commodity, but the client refuses to purchase it. The commodity may be of such
a nature that it has no common demand in the market and is very difficult to dispose of. In this
case, the financier may suffer unbearable loss. The solution to this problem is by asking the
client to sign a promise to purchase the commodity when it is acquired by the financier. Instead
of being a bilateral contract of a forward sale, it becomes a unilateral promise from the client
which binds himself and not the financier. As it is a one-sided promise, it is distinguishable
from the bilateral forward contract. This solution is subjected to the objection that a unilateral
promise creates a moral obligation but it cannot be enforced according to Shari’ah by the courts
of law. This leads to the question of whether a one-sided promise is enforceable in Shari’ah. The
general impression is that it is not, but before accepting this impression at its face value, we will
have to examine it in light of the original sources of Shari’ah.

An in-depth study of the relevant material in the literature of Islamic jurisprudence would
show that the fuqaha (Muslim jurists) have different views on the subject. Their views may be
summarised as follows:

(a) Many of them are of the opinion that “fulfilling a promise” is a noble quality and it
is advisable for the promisor to observe it, and its violation is reproachable but it is
neither mandatory, nor enforceable through courts. This view is attributed to Imam
Abu Hanifah, Imam al-Shafi’i, Imam Ahmad and to some Maliki jurists. However,
there are many Hanafi, Maliki and some Shafi’i jurists who do not subscribe to this
view.
(b) A number of Muslim jurists are of the view that fulfilling a promise is mandatory
and a promisor is under a moral as well as legal obligation to fulfil his promise.
According to them, a promise can be enforced through the courts of law. This view
is ascribed to Samurah Jundub, Umar Abdul Aziz, Hasan al-Basri, Sa’id al-Ashwa’,

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Ishaq Rahwaih, Imam al-Bukhari and Ibn Shubrama. The same view is held by
some Maliki jurists and it is preferred by Ibn-al-‘Arabi and al-Ghazzali, the famous
Shafi’i jurist, who says the promise is binding, if it is made in absolute terms.
(c) Some Maliki jurists present the third view. They say that under normal conditions,
a promise is not binding, but if the promisor has caused the promisee to incur some
expenses or undertake some labour or liability on the basis of that promise, it is
mandatory upon the promisor to fulfil his promise, for which he may be compelled
by the courts.
To conclude, it can be said that if promises are not enforceable in commercial transactions,
it may seriously jeopardise commercial activities. Say, as an example, somebody orders a
trader to bring for him a certain commodity and promises to purchase it from him. The trader
subsequently imports it from abroad, which incurred huge expenses; it will definitely result in a
huge loss to the trader if that person does not purchase it from him. It is on these grounds that
the Islamic Fiqh Academy (Session 1 to 8, Decision No. 2 and 3) has declared promises made in
commercial dealings binding on the promisor with the following conditions:

(i) It should be a one-sided promise.

(ii) The promise must have caused the promisee to incur some liabilities.
(iii) If the promise is to purchase something, the actual sale must take place at the
appointed time by the exchange of offer and acceptance. A mere promise itself
should not be taken as the concluded sale.
(iv) If the promisor backs out of his promise, the court may force him either to purchase
the commodity or pay actual damages to the seller. The actual damages will include
the actual monetary loss suffered by the seller, but will not include the opportunity
cost.
On this basis, the client can make a promise to the financier that he will purchase the commodity
after the latter acquires it from the supplier. This promise will be binding on him and may be
enforced through courts in the manner explained above. This promise does not amount to
actual sale. It will simply be a promise and the actual sale will take place after the commodity
is acquired by the financier for which the exchange of offer and acceptance will be necessary.

3. Securities Against Murabahah Price

Another issue regarding murabahah financing is that the murabahah price is payable at a later
date. The seller/financier naturally wants to make sure that the price will be paid at the due
date. For this purpose, he may ask the client to furnish a security to his satisfaction. The security
may be in the form of a mortgage or a hypothecation or some kind of lien or charge. Some basic

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rules about this security must, therefore, be kept in mind. The first is that the security can be
claimed rightfully where the transaction has created a liability or a debt.

No security can be asked from a person who has not incurred a liability or debt. Therefore, the
proper way in a murabahah transaction would be that the financier asks for a security after he
has actually sold the commodity to the client and the price has become due to him, because
at this stage, the client incurs a debt. However, it is also permissible that the client furnishes
a security at an earlier stage, but only after the murabahah price has been determined. In this
case, if the security is possessed by the financier, it will remain at his risk, meaning that if it
is destroyed (without any negligence or misconduct) before the actual sale to the client, he
will have either to pay the market price of the mortgaged asset and cancel the agreement of
murabahah, or sell the commodity required by the client and deduct the market price of the
mortgaged asset from the price of the sold property. The second rule pertaining to securities is
that it is permissible for the sold commodity itself to be given to the seller as a security.

4. Guaranteeing the Murabahah

The seller in a murabahah financing can also ask the purchaser/client to furnish a guarantee
from a third party. In the case of a default in the payment of the price at the due date, the seller
may claim a recourse from the guarantor, who will be liable to pay the amount guaranteed by
him. One of the issues debated by scholars is related to third party guarantee: whether it is
permissible for the guarantor to charge a fee.

The classical scholars unanimously agreed that a guarantee is a voluntary transaction and
no fee can be charged on a guarantee. However, some contemporary Shari’ah scholars adopt
a different approach. They say that the prohibition of the guarantee fee is not based on any
specific injunction of the Al-Qur’an or the Sunnah. It has been deduced from the prohibition
of riba as one of its ancillary consequences. Moreover, guarantees in the past were of a simpler
nature. In the present commercial activities, the guarantor sometimes needs to embark on
some groundwork and a lot of administrative work. Therefore, the guarantor is allowed to
charge a fee to cover expenses incurred in the process of issuing a guarantee.

5. Penalty of Default
Another issue in murabahah financing is that if the client defaults in payment of the price at the
due date, the price cannot be increased. In interest-based loans, the amount of the loan keeps
on increasing according to the period of default. But in murabahah financing, once the price
is fixed, it cannot be increased. This restriction is sometimes exploited by dishonest clients
who deliberately avoid paying the price at its due date, because they know that they will not

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have to pay any additional amount on account of the default. In order to solve this problem,
some contemporary scholars have suggested that the dishonest clients who default in payment
deliberately should be made liable to pay compensation to the Islamic bank for the loss it may
have incurred on account of the default. In Malaysia, the regulator has agreed that the bank
may charge 1% from the total outstanding amount or the actual loss as the compensation for
default of payment and it shall only be charged once and not compounded.

In the Middle East, when entering into a murabahah transaction, the client must understand
that in case he defaults in payment at the due date, he will pay a specified amount to a charitable
fund maintained by the bank. It must be ensured that no part of this amount shall form part of
the income of the bank. However, the bank may establish a charitable fund for this purpose and
all amounts credited therein shall be exclusively used for purely charitable purposes approved
by the Shari’ah. The bank may also advance interest-free loans to the needy from this charitable
fund. This practice is based on a ruling given by some Maliki jurists who say that Shari’ah
does not allow a debtor to pay an additional amount in case of default because it amounts to
charging interest. However, in order to assure the creditor of prompt payment, the debtor may
undertake to give some amount to charity in case of default.

6. Absence of Rollover in Murabahah

Another important issue in murabahah contract is that the transaction cannot be rolled over
for an extended period. In interest-based financing, if a customer of the bank cannot pay at
the due date for any reason, he may request the bank to extend the facility for another term. If
the bank agrees, the facility is rolled- over on the terms and conditions mutually agreed at that
point of time, whereby the newly agreed rate of interest is applied to the new term. It actually
means that another loan of the same amount is re-advanced to the borrower.

Some Islamic banks or financial institutions have misunderstood the concept of murabahah
as merely a mode of financing analogous to an interest-based loan, and started applying the
concept of roll-over to murabahah. If the client requests them to extend the maturity date of
the murabahah, they roll it over and extend the period of payment on an additional mark-up
charged to the client which practically means that another separate murabahah is booked on
the same commodity. This practice is totally against the principles of Shari’ah. It should be
clearly understood that murabahah is not a loan. It is the sale of a commodity where the price is
deferred to a specific date. Once the commodity is sold, its ownership is passed on to the client.

The commodity is no more a property of the seller. What the seller can legitimately claim is the
agreed price, which has become a debt payable by the buyer. Therefore, there is no question

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of effecting another sale on the same commodity between the same parties. The roll-over in
murabahah is nothing but interest because it is an agreement to charge an additional amount
on the debt created by the murabahah sale.

7. Rebate on Early Payment

Sometimes, the debtor wants to pay earlier than the specified date. In this case, he wants to
earn a discount on the agreed deferred price. Is it permissible to allow him a rebate for his early
payment? This question has been discussed by classical jurists in detail. The issue is known in
Islamic legal literature as “da’ wa taajjal” (give discount and receive soon). Some earlier jurists
have held this arrangement as permissible, but the majority of the Muslim jurists, including
those from the four recognised schools of Islamic jurisprudence, do not allow it.

The view of those who allow this arrangement is based on a hadith in which
Abdullah ibn Masud is reported to have said that when the Jews belonging to the tribe of Banu
Nadir were banished from Madinah (because of their conspiracies), a few people came to the
Prophet (p.b.u.h.) and said, “You have ordered them to be expelled, but some people owe them
debts which have not yet matured.” Thereupon, the Prophet (p.b.u.h.) said to them (the Jews
who were the creditors): “Give discount and receive (your debts) soon”. The majority of the
Muslim jurists, however, do not accept this hadith as authentic. Even if the hadith is held to be
authentic, the exile of Banu Nadir was in the second year after Hijrah, when riba was not yet
prohibited.

For these reasons, the majority of the jurists held that if the earlier payment is conditioned
with a discount, it is not permissible. However, if this is not taken to be a condition for earlier
payment, and the creditor gives a rebate voluntarily, it is permissible.

The Islamic Fiqh Academy takes the same view in its annual session.
It means that in a murabahah transaction effected by an Islamic bank or financial institution, no
such rebate can be stipulated in the agreement, nor can the client claim it as his right. However,
if the bank or a financial institution gives him a rebate on its own, it is not objectionable.

8. Rescheduling of Payments in Murabahah

If the purchaser/client in a murabahah financing is unable to pay according to the dates agreed
upon in the murabahah agreement, he sometimes requests the seller/the bank for a reschedule
of the instalments. In conventional banks, the loans are normally rescheduled based on
additional interest. This is not possible in murabahah. If the instalments are rescheduled, no

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additional amount can be charged for the rescheduling. The amount of the murabahah price
will remain the same and in the same currency.

Some Islamic banks proposed rescheduling the murabahah price in a hard currency different
from the one in which the original sale took place. This was proposed to compensate the bank
through appreciation of the value of the hard currency. Since this benefit was proposed to be
drawn from the rescheduling, it is not permissible. Rescheduling must always be based on the
same amount in the same currency. At the time of payment, however, the purchaser may pay,
with the consent of the seller, in a different currency based on the exchange rate of that day (the
day of payment) and not the rate at the date of transaction.

Unit 4.2.2 PROHIBITED ELEMENTS IN MURABAHAH

After examining the concept of murabahah and its relevant issues, it is important to highlight
some basic mistakes often committed by financial institutions in the practical implementation
of the concept. Among these mistakes are:

1. To assume that murabahah is a universal instrument which can be used for all types of
financing offered by conventional interest-based banks. Under this wrong assumption,
some financial institutions are using murabahah for financing overhead expenses of a
firm or company such as paying salaries of their staff, paying the bills of electricity and
setting off their debts payable to other parties. These practices are totally unacceptable
because murabahah can be used only where a commodity is intended to be purchased
by the customer. If funds are required for other purposes, murabahah cannot be applied.
Other suitable modes of financing like musharakah, leasing, and so on can be used
according to the nature of the requirement.
2. The clients sign the murabahah documents merely to obtain funds though they do not
intend to use these funds to purchase a specific commodity but to use them for some
other unspecified purpose. In order to satisfy the requirement of the formal documents,
they name a fictitious commodity. Obviously, this is a fabricated deal and it is the duty
of the financier to make sure that the client really intends to purchase a commodity
which may be subjected to murabahah.
3. Sale of a commodity to the client is effected before the commodity is acquired from the
supplier. This mistake is invariably committed in transactions where all the documents
of murabahah are signed at one time without taking into account the various stages
of the murabahah. Some institutions have only one murabahah agreement, which

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is signed at the time of the disbursement of money, or in some cases, at the time of
approval of the facility. This is totally against the basic principles of murabahah. In
the earlier discussion on the concept of murabahah financing, it has been elaborated
that the murabahah arrangement practiced by banks is a package of different contracts,
which come into play one after another at their respective stages. Without observing
this basic feature of murabahah financing, the whole transaction turns into an interest-
bearing loan. Merely changing the nomenclature does not make it lawful in the eyes of
Shari’ah.
4. Entering into a murabahah contract on commodities already purchased by their clients
from a third party. This practice is unacceptable in Shari’ah. Once the commodity is
purchased by the client himself, it cannot be purchased again from the same supplier.
If it is purchased by the bank from the client himself and is sold to him, it is a buy-back
technique, which is disputed in Shari’ah, especially in murabahah. In fact, if the client
has already purchased a commodity and he approaches the bank for funds, he either
wants to set-off his liability towards his supplier or wants to use the funds for some
other purposes. In both cases, an Islamic bank should not finance the client based on
murabahah because a murabahah contract can only be effected on commodities which
have not been purchased by the client yet.

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Unit 4.3 SHARI’AH ISSUES IN BAY BITHAMAN AJIL (BBA)

The most popular type of financing used by almost every Islamic bank in Malaysia is bay
bithaman ajil (BBA).

Unit 4.3.1 DEFINITION OF BAY BITHAMAN AJIL(BBA)

The Majallah al-Ahkam al-‘Adliyyah which is mainly a Hanafi-based codification, refers to BBA
as bay al-muajjal. The latter term has also been employed in Pakistan. It is only expected that
the term is more preferable to the government of Pakistan as the Hanafi school of law is also the
official mazhab in Pakistan. In Bangladesh, it is known as bay muazzal. This is not new, only
different names connoting the same practice. In the Middle East, however, the same practice
of BBA is used under the term murabahah. This may lead to some confusion in Malaysia, as the
practice in Malaysia is to employ both terms to two different products. This will be dealt with
later in this unit.

As its first definition, BBA is a sale contract in which the payment of the price is deferred and
payable at a particular time in the future. In fact, it can be implicated in any sale contract,
including musawamah and murabahah. It is however, inapplicable for a salam contract, as
the payment of salam must be settled in full on the outset of the contract. From this, it is
obvious that BBA is not a kind of sale; rather it refers to the manner of the payment via a
deferred payment basis, be it a lump sum payment or instalments. However, modern practices
in banking and finance have somewhat modified this situation. BBA has been referred to as the
sale and purchase transaction for the financing of an asset on a deferred and instalment basis
with a pre-agreed payment period. With this limitation, other contracts such as istisna’ would
be excluded from the ambit of BBA, though more often than not, the payment of istisna’ price
is also deferred.

Unit 4.3.2 SHARI’AH ISSUES RELATED TO BAY BITHAMAN

AJIL (BBA)

Besides the issues mentioned earlier s there are also several other issues that need some
attention. Some of these issues are discussed below.

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Clause on the Right to Recall the Facility

In the legal documentation of a conventional loan agreement, it is stated that the bank has the
right to recall the facility, repossess the property and terminate the facility. In a BBA financing,
the situation is different. This is due to the fact that the ownership of the house (the property)
has been transferred to the client by virtue of the S&P. sale & purchase agreement Hence,
the bank has no right whatsoever to repossess the house. What the bank is entitled to is the
payment price of the property. Therefore, the conventional clause on the “right to recall” is not
appropriate for the BBA facility. However, this clause can be included in the BBA financing
facility with certain modifications. The right to recall the BBA financing facility means that the
bank has all the right to terminate the facility and claim for the unpaid amount, but not the
right to repossess the house (property). However, if the property is used as collateral, the bank
can sell the property and claim on the unpaid amount and release the balance to the client.

Unit 4.3.3 THIRD PARTY FINANCING

Third party financing can occur in two situations. Firstly, the property is owned in a joint
ownership, but the application for financing is made by only one applicant. Secondly, the
property is owned by one person only, but the application is made by joint applicants (the
owner and the other person). In both circumstances, a letter of gift will be executed. In the
former, the joint owner of the house will execute a letter of gift on his portion of the property in
favour of the applicant before the facility can be processed, whilst in the latter, the owner will
execute the letter of gift in favour of the other applicant before the facility can be processed.

Third Party Collateral

Under certain circumstances, a person who requests for a facility is required to provide the
bank with extra collateral. If the person has some other property, then he can create a legal
charge over that property in favour of the bank in lieu of the facility requested. If the person
has no other property, he can also create a legal charge over a property that belongs to someone
else. However, before this charge can be created, a letter of gift must be executed, in which the
third party will execute a letter of gift in favour of the applicant. The client will then charge the
property in favour of the bank.

Right to Sell the Receivables to a Third party

Once the BBA contract has been successfully completed, the client is responsible for paying the
selling price to the bank. The right to receive the payment is indisputably the sole right of the

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bank. Hence, it is the right of the bank to sell the receivable that it will acquire from the client,
without having to request any permission from the client, because the right over the receivable
belongs totally to the bank. Normally these receivables will be sold to a third party who will
then issue a bond to finance the purchase of these receivables.

Example of this bond is the Mudarabah Cagamas Bond. This bond was issued by Cagamas
Bhd. Under this facility, BIMB sold its Islamic housing financing facilities (BBA receivables)
to Cagamas Bhd based on the concept of sale of debt at a discount. Following this transaction,
all rights of BIMB with regard to the debt are transferred to Cagamas Bhd. It means that the
right to receive debt from the BBA instalment will be transferred to Cagamas. Therefore, the
institution would transmit to Cagamas all the instalments received from the clients under
the BBA on a monthly basis. Cagamas, on the other hand, would issue mudarabah bonds to
raise the necessary funds to finance the purchase of these receivables. Through this, the bond
holders become investors to this business and Cagamas becomes the entrepreneur. They will
benefit from the cash flow stream derived from the house financing portfolio.

Following the rules of mudarabah, any profit derived from this business would be shared on a
pre-agreed ratio between Cagamas Bhd and the bond holders and any losses or diminution of
the amount invested will be fully borne by the bond holders.

BBA Financing: Selling of the Non-Existent

As has been elaborated before, the BBA financing facility in Malaysia is applied for property
undergoing construction as well as completed property. Though no problem arises from the
latter practice, a leading Shari’ah issue might arise from the former. This is because, in BBA
financing for a house under construction, the property that is transacted is not yet in existence.
This might contradict the ruling on the existence of subject matter in a sale contract. If the
opinion of the majority of jurists is to be applied, the BBA facility on property under construction
is not allowed. Even though the opinions of Ibn Taymiyyah and Ibn al-Qayyim allowing the sale
of non-existent subject matters is to be followed, one central issue still remains; their opinion
in allowing the sale of non-existent subject matter is based on the near certainty of delivery.
Hence, they maintain that even though the subject matter does not exist during the time of
conclusion, the contract is still valid provided that the parties to the contract are confident
that the delivery is possible at the future agreed time. If the opinions of Ibn Taymiyyah and
Ibn al-Qayyim were to be taken into consideration, would the application of BBA financing in
Malaysia pass the test of certainty of delivery? With the rate of non-completion being so high,
can we say that the parties are certain that delivery is possible at the agreed time? What about
the delay in delivery which has caused a lot of trouble to house buyers? With all these questions

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remaining unanswered, the practice of BBA is said to defy the rule of certainty in delivery as
prescribed by the two scholars.

To avoid any conflicting issues that might arise, it has been recommended that banks use other
types of financing for properties under construction. For instance, banks can use the contract
of parallel istisna’ as it relates to the financing of an asset involving future delivery. In istisna’,
the object of istisna’ (mustasna’) is not available on the outset of the contract but to be made
available later by the manufacturer or developer. Therefore, it is the most suitable contract
to be used as a financing tool involving properties under construction or properties yet to be
constructed.

BBA Facility: The Dilemma on the Transfer of Ownership

As the BBA contract is actually a sale contract, it calls for the transfer of ownership pertaining to
both legs of the transaction (the cash and the deferred). This leads to another issue, the issue of
possession (al-qabd). It is argued that since BBA is actually a kind of sale contract, the transfer
of ownership and taking of possession must truly happen. The possession of the assets by the
parties, however, could be construed according to the custom and it can take place in different
forms depending on the type asset. In terms of the practice of BBA in Malaysia, the execution
of PPA and PSA in the facility should result in transfer of ownership, irrespective of whether the
registration of the transfer is made or otherwise. It should be noted here that BBA is not a loan
given on interest. It is the sale of a property for a deferred price, which includes an agreed profit
added to the cost. This is among the most important features of BBA financing.

In the case of Dato’ Haji Nik Mahmud bin Daud v. Bank Islam ([1996] CLJ at. p. 582), in order
to facilitate the granting of the BBA facility to Dato’ Nik, who is the registered owner of 25
pieces of land in Kelantan executed a PSA and PPA in favour of BIMB. It was then argued that
the parties transgressed the Kelantan Malay Reserve Land (MRE) as the execution of PPA and
PSA was tantamount to transferring the right and interest of such land to a “person” who is
neither a Malay nor a native of Kelantan. The issue that has arisen is whether the execution
of the PSA and PPA amounts to defeats the purpose and intention of the Malay Reservations
Enactment 1930 of Kelantan (the Enactment), which prevents the transfer or transmission of
Malay Reservation Land in Kelantan to any person who is not a Malay. It was ruled in this case
that the execution of the PSA and PPA did not amount to any transfer of ownership from Dato’
Nik to BIMB. The High Court judge explained:

“ …… In the instance of this case, it was never the intention of the parties, in as much as it
can be said to be within their contemplation, to involve any transfer of proprietorship. It so

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happened that the execution of the property purchase agreement and property sale agreement
constituted part of the process required by Islamic banking procedure before a party can avail
itself of the financial facilities provided by the defendant’s execution of the two agreements,
and in fact, it would be observed that the property agreements would be rendered otiose
and bereft of any consequential value the moment the property sale agreement was signed…
Accordingly, the execution of the property purchase agreement had not transgressed the
provisions of the Enactment since there was no dealing or attempt to deal with the said lands
contrary to the provisions thereof.”

The Court of Appeal also upheld the decision of the trial judge ([1998] 3 MLJ at pp 393-394):

It is clear that s 7 (i) of the Enactment prohibits any transfer or transmission or vesting of any
right or interest of a Malay reservation land to any person not being a Malay. In this case, the
trial judge had found that the appellant was all along the registered proprietor of the properties;
in short, no transfer was being effected. Moreover, it was never the intention of the parties
to involve any transfer of proprietorship. Accordingly, the execution of the property purchase
agreement had not transgressed the provisions ss 7 and 12 of the Enactment since there was no
dealing or attempt to deal in the lands contrary to the provisions thereof. There was no reason
to disagree with the findings of the trial judge.

One may observe that even though justice has been carried out in this landmark case on Islamic
banking, the reasons given by the learned judge may be argued to be contrary in relation to the
nature of the BBA facility and has inadvertently caused serious conflict with the concept of
the BBA contract, whereby, the contract should, from an Islamic law point of view, result in
the transfer of the ownership of the property from one party to another even only for a second.
The judgement has somehow equated the BBA facility with the conventional loan given with
interest. This is said to be in contradiction with the Shari’ah requirement on the transfer of
ownership. Although both seem to have similar characteristics, in which both created a debt
to be paid over time through instalments and this debt is over and above the capital given, the
way the debt is created is the core difference between the two. It seems that the judgement has
not succeeded in appreciating this fact.

Floating-Rate BBA

As mentioned in the previous discussion, BBA financing facilities is structured to be a fixed

rate financing. -Some people are convinced that a fixed-rate mechanism such as this is more
preferable as it provides more financial stability. The nature of fixed-rate financing would
enable people to plan their cash flow since the monthly payments are fixed throughout the

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Legal Documentation
of BBA facility in
Malaysia

A. Sale and Purchase B. Property Purchase C. Property Sale

Agreement Agreement Agreement

Figure 4.1 Components of BBA home financing legal documentation

Sale and Purchase Agreement BBA

This is an agreement made

Accordingly, the client would have to pay 10% of the price of between the client and the
the property. developer.

The signing of this agreement is compulsory, as the customer

must provide the bank with this agreement before the It is the most important agreements
application for financing can proceed. in obtaining such a facility from the
banks. The Sale and Purchase
Agreement (Principal Agreement) will
It has been argued that the developer/seller refused to be a party be signed between two parties.
to the agreement because they did not want to be responsible for
rights and liabilities that might be attached to it.

It is not the concern of the developer/seller as

from whom and how the client acquires the
It is his right then to do whatever
money to purchase the house.
he wants with the house.

By virtue of the client paying 10% of the price, he has acquired

the beneficial ownership of the house.

Figure 4.2 Sale and purchase agreement BBA

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Property Purchase Agreement

This is an agreement made

between the client and the
bank
It should be noted that most of the time, the purchase price
consists of the remaining balance of the price of the house (say
90%), and some other costs such as lawyer’s fees etc.
The most significant wording
of this agreement normally
reads :
This will certainly, increase the financing amount to be more than
“The customer has applied to
the remaining price of the house.
the Bank for a financing and
the Bank has approved the
said application and the
The financing amount that the bank is able or willing to finance is customer has agreed to enter
negotiable between the client and the bank. into this agreement with the
bank, whereby the bank, at
the customer’s request
purchases from the customer
Creditworthiness of the client etc. would be among the factors to the Property at the purchase
determine the financing amount to be eventually granted to the price.... ”
client.

Figure 4.3 Property purchase agreement

Again, this agreement is signed Propery Sale Agreement

between the client and the bank

The most significant

The Property Sale Agreement shall be signed after the wording of the agreement
signing of the Propery Purchase Agreement so as to allow normally reads : “ The Bank
the bank to sell back the asset to the client herebly agrees to sell and
the customer hereby
agrees to purchase the
Property at the Sale Price
upon the terms and
subject to conditions
The manner, in which the payment of the price to be herein contained ... ”
made will be detailed, based on the agreement reached
between the bank and the client

Figure 4.4 Property sale agreement

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financing period. Thus, some customers might prefer to have this kind of facility, instead of
having the equivalent conventional products, which are floating-rate in nature. This is because
the payment of the selling price (purchase price together with a profit of the bank) will be
fixed and settled by instalments over a long term period. So, if the client, who is a government
servant, is granted a financing facility to buy a house, he will know the amount that he has to
pay monthly, and this amount will be fixed no matter how the base financing rate (BFR) of
the bank fluctuates. With that, he can plan his payment properly without affecting his other
monthly budgets.

However, it is argued by some that fixed-rate methods of financing might affect the
competitiveness as well as the viability of Islamic banks, and sometimes it is not a preferred
mode of financing to some clients. It is submitted that the clients of Islamic banks have different
preference. Some of them are Muslims who deal with Islamic banking for religious purposes.
For this kind of people, no matter how interest rates move, they will remain with Islamic banks
as they believe that having a loan with interest from a conventional banking amounts to riba.
However, there are clients who prefer Islamic banks due to other considerations. For them, they
will stay with Islamic banks as long as the rates of payment are competitive compared to that
of conventional banks. Once the rate of payment from conventional banking is higher, these
clients will shift to conventional banking. In this case, the fluctuation of interest rate matters
a lot and will definitely affect their preference. If interest rates are climbing, these clients
would choose the fixed-rate financing facility, in which BBA (and also istisna’) is prominent, to
lock the payment price in order to protect themselves against the increasing trend of interest
rates. When the interest rates fall, they will convert their financing to interest-based financing
facilities for a relatively lower payment. So, the fluctuation of interest rates in the market will
definitely affect the demand for BBA and other Islamic fixed-rate modes of financing.

Besides the above, fixed-rate modes of financing have also resulted in a funding mismatch to
the Islamic financial institutions because their long term financing was funded by short term
bank deposits which can give variable returns. It is a disadvantage to Islamic banks as they have
locked their financing profit rates over a long period, while at the same time they “have to give”
a competitive rate of return to their depositors, or risk having these shifting their deposit to
conventional banks that can offer a better rate of return. So, Islamic banks are placed in a very
difficult situation. They have to maintain a competitive rate of return and at the same time
cannot change the profit rate of the concluded fixed-rate contracts.

It is argued that this fixed-rate and price-rigidity factor has rendered Islamic banks to be very
vulnerable to economic and interest-rate volatility. To counter this, Bank Negara Malaysia via
its working group, comprising representatives from Bank Negara Malaysia and the industry has

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come out with the first variable rate financing product based on the concept of BBA. Under this
BBA financing (with ibra’ (rebate) features), the selling price of the asset sold to the customer
on deferred terms would be fixed at a profit rate known as the ceiling profit rate. However,
contrary to the BBA fixed rate, the periodical instalments of this financing will fluctuate and
vary depending on certain benchmarks and the spread of the customer for a particular period.
Say, for instance, if the original monthly instalment is RM 1,000, but the financing payment
plus profit rate of that month (calculated based on certain benchmarks such as the BLR plus
margin) is lower, certain ibra’amount will be given to the client, in order to reduce the monthly
instalments to match that of the current market level. However, if the interest rate increases
beyond the monthly instalment payment (BLR plus margin), the effective profit rate will remain
at the ceiling rate. This means that the client will only have to pay the instalment at not more
than the ceiling price that has been agreed upon upfront.

It means that the ibra’ will be given on a monthly basis and the amount will differ from one
month to another. Upon the maturity of the financing, the total instalments are calculated and
should not exceed the original selling price. Any shortfall will be treated as an ibra’ given to the
client.

It is hoped that such variable rate financing products will be able to reduce the vulnerabilities
of Islamic banks, especially in a dual banking environment where the Islamic banking system
operates in parallel with a conventional financial system. The flexibility of this financial
instrument has also highlighted the compatibility of the Shari’ah in providing a necessary
mechanism to manage and mitigate risk in the modern financial setting.

RM Profit Rate
(%)

Ceiling Rate Monthly

2,000 10 rebate
Unearned granted
profit
1,700 8
Actual total
Contractual 1,500 4 payments
Agreement = purchase cost +
earned profit

Bank’s
purchase
cost Financing tenure (e.g. months )
End of Tenure

Monthly rebate given at each installment

Effective monthly installments

Figure 4.5 BBA floating rate financing

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Unit 4.4 DEFINITION OF BAY BIMA YANQATI BIHI SIR/ BAY

ISTIJRAR

BBYBS, as defined by Ibnu Qayyim is the practice of taking a certain amount of goods, such
as bread, meat and oil from the seller every day and the buyer pays for them at market price at
year-end or month-end without fixing the price upon the inception of the ‘aqad. This practice
will not give rise to any dispute between the buyer and the seller because they have agreed on
the method of payment and price determination.

Unit 4.4.1 ARGUMENTS THAT SUPPORT THE

PERMISSIBILITY

The application of this principle in buying and selling is not something new. Past Islamic jurists
had determined its status based on Shari’ah principles. The following paragraph sums up their
opinions.

There were two opinions on buying and selling using this principle. The first opinion came
from the majority of Islamic jurists, who rejected it. This was based on the existence of the
element of jahalah (ignorance) in the price of the contract that rendered it invalid.

The second opinion came from some Islamic jurists, such as Imam Ahmad bin Hanbal, Ibnu
Taymiyyah, Ibnu al-Qayyim and the Hanbali school of law, who permitted this principle. Ibnu
‘Abidin of the Hanafi school of law also accepted it through a contract known as bay istijrar.
They permitted it because the price fixing method prevented any jahalah (ignorance) or dispute.

The Hanbali school of law uses qiyas in permitting BBYBS. According to them, this kind of
buying and selling was similar to fixing the price according to mithl or market price which was
already permitted by Shari’ah. Many existing business transactions are permitted based on the
thaman al mithl (market price) concept. This was further strengthened by the fact that there is
no clear prohibition in the Al-Qur’an, Sunnah, ijma or the practices of the Companions of the
Prophet (p.b.u.h.). against this type of buying and selling. It is also a social practice that has
been unanimously accepted as a facility.

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Unit 4.4.2 ARGUMENTS THAT SUPPORT THE

PERMISSIBILITY OF BAY BIMA YANQATI BIHI SIR

The application of this principle in buying and selling is not something new.

Past Islamic jurists had determined its status based on the Shari’ah principles.

The following sums up their opinions:

1. The first opinion came from the majority of Islamic jurists, who rejected it. This was
based on the existence of the element of jahalah (ignorance) in the price of the contract
that rendered it invalid.
2. The second opinion came from some Islamic jurists, such as Imam Ahmad bin Hanbal,
Ibnu Taymiyyah, Ibnu al-Qayyim and the Hanbali school of law, who permitted this
principle.
3. Ibnu ‘Abidin of the Hanafi school of law also accepted it through a contract known as
bay istijrar. He permitted it because the price fixing method prevented any jahalah
(ignorance) or dispute.
4. The Hanbali school of law used qiyas in permitting BBMBS. According to them, this
kind of buying and selling was similar to fixing the price according to mithl or market
price which was already permitted by Shari’ah.
5. Many existing business transactions are permitted based on the thaman al mithl
(market price) concept. This was further strengthened by the fact that there is no clear
prohibition in the Al-Qur’an, the Sunnah, or ijma or the practices of the Companions of
the Prophet (p.b.u.h.) against this type of buying and selling. It is also a social practice
that has been unanimously accepted as a facility.

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SUMMARY

• For a murabahah contract to be valid, the scholars have outlined several conditions
that needs to be fulfilled including knowledge of the initial price by the buyer and
knowledge of the profit margin. One of the important features of a murabahah
contract is that it is not a loan given on interest. However, it is the sale of a commodity
for a deferred price which includes an agreed profit added to the cost.

• Murabahah is one of the popular contracts use in debt financing by Islamic banks.

• In the documentation of murabahah, there are several important clauses that should
be written carefully to ensure a proper meaning and concept to safeguard the interest
of the contracting parties.

• It should be stressed again that BBA is a type of sale contract. As such, it has to carry
all the necessary features of a sale contract, including its essential elements (arkan),
conditions (syurut) as well as the legal effect of the contract. Among the most important
legal effects that must be fully appreciated are the transfer of ownership and the rule
of taking possession.

• Beside this issue, the practice of BBA in Malaysia inherits other issues such as the issue
of qabd, selling of non-existent property, certain clauses in legal documentation and
so on. Lately, BNM has taken the lead to initiate alternatives to the practice of BBA,
namely musharakah mutanaqisah (diminishing partnership) and al-ijarah thumma
al-bay (AITAB).

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QUESTIONS AND PROBLEMS

Question 1.
Define murabahah and show its importance in Islamic banking.

Question 2.
What are the issues of murabahah in Islamic finance?

Question 3.
Define BBA and where it is mostly applied in Islamic finance.

Question 4.
Elaborate on the issues of BBA.

Question 5.
What is bay istijrar?

Question 6.
Discuss the views of the scholars on istijrar.

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• AAOIFI Shari’ah standards.

• Shari’ah Advisory Council Resolution. Bank Negara

Malaysia. Second edition. /

• Ahmad Ibrahim Biq, The Shari’ah financial transaction.

• Al mawsoua al fiqhiyyah al kuwaitiayyah.

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