Compare and Contrast AITAB and Al-Bai Bithaman Ajil Islamic Financial System and Environment (ECON 6640) Presenters Zakariyah Shamsuddin Azrul Hisham Md Isa Mohd Azmi Jaafar Mohd Hilmi Hithir Nur Asmira

Outline Introduction What is AITAB Purpose and Structure AITAB Salient Requirement AITAB Shariah and Legal Issues in AITAB What is BBA Purpose and Structure of BBA Essential Requirement of BBA Shariah and Legal Issues in BBA Comparative Analysis AITAB vs BBA Features & Mechanism Legal and Shariah Benefits Conclusions and Recommendation

General principle of Ijarah Some basic rules of al-ijarah are as follows: Al-ijarah is valid only with consent of both parties to the contract. That is, to avoid gharar, the contracted usufruct or manfaat has to be absolutely ascertained. The usufruct must be lawful and must have a valuable use. All liabilities arising from ownership shall be borne by the lessor who owns the rental property. The rent, period and the purpose of the lease must be clearly specified (must agreed upfront)

What is AITAB (Al Ijarah-Thumma Al Bai)? Operational Leasing with a promise to sell Lessor made a promise (wa’ad) that he will sell the asset to the lessee if he (i.e lessee) is able to pay all the rental payments as stipulated in the leasing contract. Once the lessee paid all the rents, the lessor is obligated to sell the asset to the lessee. That is, the promise (wa’ad) becomes binding leading to both party to execute the contract of sale (al-bay’). If the lessee fails to pay the rents, the lessor has no obligation to sell the asset to the lessee.

Ijarah Thumma Bai’ Hire-Purchase A transaction which begins with an Ijarah contract for the purpose of renting out the lessor’s asset to the lessee. Consequently, at the end of the lease period, the lessee will purchase the asset at an agreed price from the lessor by executing a purchase (Bai’) contract. Hire-Purchase is the hiring of goods with the option to purchase. You are the hirer and the company financing the goods is the owner Ownership is transferred to the hirer after all the installments have been paid Meanwhile you have possession and use of the goods. Hire-Purchase

ISLAMIC HIRE-PURCHASE AITAB True Leasing 1.Ownership risk 2. No intention to own Ownership risk ISLAMIC HIRE-PURCHASE Conventional Hire-Purchase (financial leasing) 1.No ownership risk 2. Intention to Own Intention to Own

AITAB The Shariah has made lease or rental income lawful by virtue of the ownership risk of the asset taken up by lessor. Hence, in Islamic commercial law, ijarah always implies true or operation lease and its component must always be a true lease.

AITAB : Procedures (i) The Bank (lessee) will sell the Ijarah assets (normally such as plant, equipment, machinery) to the financier (lessor) by executing as asset purchase agreement. (ii) The financier having obtained the ownership of the assets, will then lease the assets back to the issuer by executing an Ijarah contract. (iii) At the end of the lease term the asset will be purchased by the lessee at an agreed price.

Basic Structure of AITAB Bank 2) Purchase 90% of the PP 5) Ownership 4) Pay Rent Customer 1) Quotation and Arbun 10% Car Dealer/ Supplier 3) Delivery Upon completion of Ijarah contract, the Bank will transfer the ownership to Customer

AITAB OPERATION PRACTICED BY ISLAMIC BANK 1. AITAB follows the Syari'ah Principle & the spirit of the HP Act. 2. There are 2 agreements involved under AITAB : (i) Al-Ijarah Contract (hiring agreement); and (ii) Al-Bai' Contract (purchasing agreement) 3. Customer has to sign the 'Aqad Letter (Acceptance Letter) to denote the offer and acceptance of transactions.

Shariah and Legal Issues in AITAB Ownership & Risk  Under Ijarah concept - the ownership lies with the bank/ finance company. Therefore, risk, responsibilities and liability cannot be placed on the hirer/customer for loss caused for factors beyond his control. BUT in practice – liability & risk is borne by the hirer/customer. Although the bank is the lessor and owner of the asset, all risks and liabilities of ownership are effectively transferred to the lessee, for instance, insurance, road tax, and major maintenance. WHY ??? Because leasing is considered as a mode of financing instead of transaction to transfer the usufruct of a property from one person to another for an agreed period against an agreed rental.

Issues 2 Governing Law  Despite AITAB has Syariah dimension, AITAB is still governed by civil law, i.e. Hire Purchase Act, 1967. Based on the above, AITAB under the HP Act 1967 has put together the contract of sale together with the contract of leasing. The former is granted on the basis of the option clause. According to which Al-ijarah thumma al-bay’(AITAB) is a contract of leasing with a promise (wa’ad) to sell. It must not be understood as a mixture or combination of the al-ijarah dan al-bay’ contracts. It is not a leasing contract with a condition to sell (al-bay’)

Issues 3 In the event of late payment, can the Bank levy late payment charges?  Some agreements of financial leases imposes a late payment charges at 1.00% if there is delay in the payment of rental after the due date. This is not permissible in Shariah. A monetary charge from a debtor for late payment is exactly the Riba prohibited by Al-Quran. Therefore the bank cannot charge an additional amount in case the hirer delays payment of the rent. However, in practice – ruling by BNM 1.00% is imposed to serve as a deterrent to customers & to cover part of admin cost.

Issues 4 Absence of the element of ‘iwad in the bank’s profit. The bank does not undertake any market risk as a true lessor, it merely provides financing. There is also no value-added effort as it is the customer who identifies the asset and merely sources financing from the bank.

BAI BITHAMAN AJIL - BBA INTRODUCTION Bai Bithaman Ajil is basically a trade deal in which the seller allows the buyer to pay the price of a commodity at a future date in lump sum or in installment. An agreement that refers to the sale and purchase transaction for the financing of an asset on a deferred payment basis with a pre-agreed payment period. The sale will include a profit margin. The subject of sale also must come into the possession of the bank before being handed over to the other party There are now two distinct sale contracts that occur at different points of time. The first contract is between the vendor and the bank and second contract is between the bank and its client

BAI BITHAMAN AJIL - BBA Bai Bithaman Ajil is not a loan. It is the sale of a commodity the price of which is deferred to a specific date. Thus, it is a condition for Bai Bithaman Ajil transaction to comply with the basic rule of sale. Basic rule with regards to sale. The subject of sale must exist at the time of sale. The subject of sale must be in the ownership of the seller at the time of sale. The subject of sale must be in the physical or constructive possession of the seller when he sells it. The sale must be instant and absolute. The subject of sale must be a property of value. The subject of sale must be specifically known and identified to the buyer. The certainty of price is a necessary condition for the validity of a sale. The sale must be unconditional.

General Principle of BBA BBA is a defined as an instalment sale. It is a contract whereby the commodity is delivered immediately and the price is paid by instalments. The payment is delayed to a fixed and stipulated period of time. The selling price includes the cost price plus an agreed profit margin which will increase depending on the length of period over which the deferment is agreed upon. Nevertheless the selling price is known from the time the contract is made. According to some writers BBA occurs when the payment of Murabahah is deferred to a certain date agreed upon by the parties. It is also possible to say that while in Murabahah the original cost is disclosed it may not be necessary under BBA. In the Malaysian context the selling price both in Murabahah and BBA is based on the cost price. However, Murabahah is used for short-term transactions while BBA is used for longer term transactions.

Its profits are fully justified by the risk it assumes as a vendor and there is no suspicion of riba.

BBA : Procedures Benefits Identifies the asset and the value of the asset must relate to the amount of financing Purchaser will enter to an Asset Purchase Agreement with the Bank Immediately, Bank will enter Asset Sale Agreement with the issuer. Bank sells back the asset at a sale price with element of profit ( to be paid deferred basis) Payment from the purchaser to the Bank will be based on staggered basis. Benefits (i) Long Term Financing

Essential Condition for Bai Bithaman Ajil (BBA) Meaning – a trade deal which bank allows customer to pay the price of the property at a future date in lump sump or installment Concept – borrower asks bank to purchase an asset from the supplier and then sells it to customer. Conditions (in accordance with Fiqhi Murabaha) Bank must hold and own the goods before selling it to customer The 1st sale between the bank and the supplier must be made known by the bank to customer Bank should give customer the option (Khiyar) whether to buy or refuse the goods Bank should bear the risk in the trade Bank should not take deposit in advance from customer

SHARIAH & LEGAL ISSUES ON BBA MODES OF FINANCING Controversies with regards to permissibility Different opinion among Muslim scholars whether the price charged by the seller can be higher than spot price Open the back door towards interest based transaction Hanafi, Shafii, Jumhur of Fuqaha permit the charge with certain condition : Bank should have possession over the object before handed over the customer No late payment/default penalties Customer in financial difficulty – allow for reschedule Two sales in One Sales Based on the interpretation of the hadith which reads. “The prophet s.a.w prohibited two sales in one single sale. The interpretation: One transaction with two different price (spot price and future price) is prohibited. Selling subject matter that yet to exist Interest as benchmark

ISSUES ON BBA FINANCING IN MALAYSIA Bai Bithaman Ajil is not a loan. It is the sale of a commodity the price of which is deferred to a specific date. Thus, it is a condition for Bai Bithaman Ajil transaction to comply with the basic rule of sale. Financing of incomplete/defect properties Khiyar al-Ayb or option of defect is a legal right whereby the customer does not need to stipulate a special clause or reservation of the option at the time of contracting. Option in its absolute sense is a right given to both parties or to either one to accept or rescind the contract. If anything appears in the subject of the contract which does not match its original use or decreases its conventional market value or makes it unfit to meet requirements expected of it, then the buyer have the right to exercise option of defect.

ISSUES ON BBA FINANCING IN MALAYSIA PPA & PSA Malaysia practice on ownership and delivery of asset financed under BBA: (a) Property Purchase Agreement (PPA) (b) Property Sale Agreement (PSA) Both PPA and PSA seem to resemble a legal device that serve to provide an evidence that act of buying and selling is actually taking place as required by Shariah. In practice, these two agreements are merely to disguise the bank as intermediary status i.e.. As the financier and not the seller. Islamic bank are responsible in ensuring that sequence of the contract are followed properly. Mistake is invariably committed in transactions where all the documents of BBA are signed at one time without taking into account various stages of the sale. Some Islamic bank have only one contract which is signed at the time of approving the facility.

Extraction of the provision : PSA Agreements “The bank, not being the developer of the property, shall not liable for any claims in respect of any defects, shrinkage or other faults affecting the property which are due to defective workmanship or materials or any other cases whatsoever of the property are not having been constructed in accordance with the specifications and plans approved by the appropriate authority. (underline is ours/emphasis added). However, the customer can make any claims against the vendor/proprietor.” PSA has added more responsibilities on the customer to the extent that the bank is free from all risks whatsoever. The bank is fully covered and in a very secured position.

Comparative Table BBA vs AITAB in Malaysia Scope BBA AITAB Purpose Property Financing Equipment and Vehicle Financing Ownership Customer Bank Regulation IBA 1983 BNM HP Act 1967 Mechanism Murabahah Sales and Al Bai Ijarah / Al-Bai Documentation PPA,PSA and D.O.A Acceptance Letter (Aqd)

Comparative Table BBA vs AITAB in Malaysia Scope BBA AITAB Event of Default -Ownership lies to the Customer - Bank will pursuit legal action for the debt -Repossession of the goods by the bank - Bank will pursuit legal action Early Termination /Settlement? Yes, customer is not required to give advance notice to the Bank for the early settlement.There is no early settlement penalty fees/charges imposed on customer. Yes, customer will also be entitled for a rebate for any early settlement cases. Potential to be securitised Yes Maturity Profile Long term basis:- Within 2-30 years Short term basis: Maximum 9 year Financing Mode Monthly Rest / Reducing Balance Flat Late Payment Penalty 1% flat Existence of Asset Completed/incomplete Exist

Summary : Comparative Issues BBA vs AITAB Aspect BBA AITAB Shariah Different opinion among Muslim scholars whether the price charged by the seller can be higher than spot price Missing elements of Iwad According to Shariah - Ownership lies with the owner/bank. Therefore, liability cannot be placed on the hirer for loss caused for factors beyond his control. BUT in practice – liability & risk is borne by the hirer/customer. Missing element of Iwad Practical Bank should have possession over the object before handed over the customer PBR- The Ijarah period shall commence from the date on which the leased asset has been delivered to the hirer/customer, thus rent should start to be payable when the leased asset has been delivered to the hirer/customer

Comparative Benefits: BBA vs AITAB BBA vs Conventional Financing AITAB vs Conventional HP The total cost of the property purchased is determined at the time of contract or 'aqad. There is no additional or "hidden" cost that will change the price of the property purchased The transaction is transparent. Customers will know exactly when the financing will end. There will be no compounding of arrears and outstanding penalty charges. Repayment is not subjected to fluctuation of BLR AITAB financing enables Muslims to perform their financial transaction according to the principle of Syari'ah and in line with their religious beliefs. In addition, the late payment charge is slightly lower compared to Conventional HP. Other than that, the features and benefits of AITAB are as good as what are available under Conventional HP. As such, customers do not lose out when taking up AITAB Car Financing scheme.

RECOMMENDATION -AITAB Should have statute on AITAB (based on HPA 1967 as not all provisions contradict Shariah) Improve jurisdiction of Shariah court in handling Islamic finance matters Need to standardize the procedures & documentation for all Financial Institutions offering AITAB. Market AITAB rigorously – awareness amongst Muslims and non-Muslims. Ownership to be ascertained 1.

RECOMMENDATION -BBA Based on the given rules on Khiyar ‘Ayb, it is apparent that an Islamic bank as a selling party must hold all liability arising from all defective goods sold. As indicated in the PSA has already excluded all the liabilities on the part of the bank as it i.e. the bank should be seen as merely the financier and not the seller or vendor. Doing so has discounted the principle of “al-Kharaj bil Daman” (in any benefit lies a liability). in current lslamic banking operations and Therefore putting the risk of implicating riba in the profit created from the al-bay bithaman ajil financing.

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