Ethics and Social Accounting vs. Islamic Accounting

 by  : Hanan Gabil, Wed Al-Nafie and Wejdan Al-Harbi

In early history of accounting, the first name to describe the system of debits and credits in journals and ledger which in fact still the basics of today’s accounting is called Luca Pacioli, year 1494.

 

Accounting is defined as a valuable knowledge to be performed and it is considered to be the main index for all countries’ economy. Accounting is also an essential part in processing information of business and economy activity into financial statements. In other words, accounting is the universal language of business and economics as well as finance. However, unfortunately, there is still fraudulent and dishonest practices in business and economic activities. Accounting can be divided into 6 categories as follows:

  1. Finance Accounting
  2. Management Accounting

iii.  Auditing Accounting

  1. Taxation
  2. Funds
  3. Forensic Accounting.

 

There is no certain activity that could be possible done without relying on accounting, because accounting deals with information that consists of financial status and profitability of economic enterprises.

 

Islamic accounting has existed since the 1500s and has its own principle that not only can decrease the degree of unexpected activities pertaining to accounting process but also increase the welfare of both internal and external parties of the business. That’s because Islamic accounting has an aspect that has more meaning and value which is a similar aspect of conventional accounting too. It comprises of all values required to the most preferable accounting process. This essay details the differences between Social accounting and Islamic accounting.

 

Ethics

Ethics in accounting has been posed after scandals that had the greatest impact of the recent century such as examining collapse hiding, law breaking, fraud and violating moral standards. This setback drove companies towards a common strategic goal – principles of accounting. Thus, the following four elements of principle are essential in ethics:

  1. Honesty and trustworthiness

This rule requires a complete and honest presentation of relevant financial and non-financial information. Information presented should be adequately transparency and must not be used for an ethical advantage. A high degree of integrity and discretion is essential.

 

 

  1. Objectivity

Objectivity requires all professionals and information to be fair and unbiased. Professional judgment must be free from conflict of interest such as hospitality and family relationship. It is strongly recommended to refrain from personal relationships and accepting gifts on duty.

 

  1. Confidentiality of information

Unless absolutely necessary and required by the relevant accounting and auditing standards, confidential information should not be disclosed or be used to gain any unethical advantage.

 

  1. Professional competence and conduct

Professionals are required to have an appropriate level of academic and work competence, preferably related to their field. Any offers of professional duty for which one does not possess sufficient skills to execute the task effectively should be declined. Professionals must always comply with relevant accounting and auditing standards and perform their duties diligently.

 

According to the ethical code of conduct, having a code does not eliminate fraudulent activities. In fact, it is a guide to accountants which needs to be fully accepted by professionals before it can be effectively adopted into practice. Therefore, there are two additional codes that are incorporated into Islamic accounting:

 

  1. Faith-driven conduct

Under Islamic accounting, self-monitoring is fundamental. Self-monitoring may be defined as being constantly conscious of one’s actions and their accountability before Allah on the day of judgment. It is also important to seek Allah’s satisfaction instead of pleasing people while performing professional duties which are consistent with Islamic values and the Shariah. One must always be diligent and sincere in his work and actions. This also stresses on keeping promises and honouring agreements.

 

  1. Legitimacy

Legitimacy requires all professional duties to be according to the Shariah. Accountability to Allah is given priority over accountability to the management. Professionals must have competent knowledge of the Shariah rules and principles through education and formal training. All business activities and transactions must be Shariah compliant and should be verified for religious legitimacy by professionals who are responsible for executing them.

 

Social Accounting

Social accounting is also coined as Social Responsibility Accounting because of its responsibility to measure and inform the public about the social activities undertaken by the enterprise and their impact on the society. It is the vision of  which a business seeks to make a valuable impact on social operations. In simpler words, social accounting can facilitate the identification and management of social risks.

 

Business is a socio-economic activity and its objective is the welfare of the society. It requires full responsibility for providing solutions for social issues. Therefore, the concept of social accounting is to manage huge amounts of funds at their disposal and invest substantial amounts in social activities so as to nullify the adverse effects of industrialization.

 

 

The benefit of social economy is to act as an evidence of social commitment, fulfill its obligations, and advise the government and the general public to form correct opinions that are just and ethical. However, it does have its limitations. It can be labor intensive if strategic planning has not been set, or also been not useful for benchmarking.

 

Islamic Accounting

In an Islamic society, accounting should establish purposes according to Islamic teachings in relation to contemporary accounting thought. Those which are Shariah-compliant are pursued and those that are not are discarded.

 

Certain Islamic ethical principles have a direct impact on accounting policy and principles.

These principles are derived from the Holy Qur’an and the Sunnah, that stresses on the need for justice, truth, and fairness, and are considered to be a society’s priority and responsibility. This also contains specific standards for accounting practices. In Islamic financing principles, it must follow specific elements which gives it distinctive religious identity. These elements  are:

  • Riba (interest): The payment and taking of interest as occurs in a conventional banking system is explicitly prohibited by the Holy Qur’an.
  • Zakat: The process of repetitive distributions of income and wealth is inherently in Islam to guarantee a fair standard of living for every people especially the poor. Zakat is different from a tax, A tax is an obligation of citizens toward the society, whereas zakat is an obligation of a Muslim not only to society but also to Allah.
  • Haram: Islamic banks cannot finance activities or items forbidden in Islam,

Islamic banks give priority to essential production which caters to the needs of

the majority of the Muslim community.

  • Takaful (joint-guarantee): The only type of insurance that would appear to be lawful according to the Shari’ah insurance.

 

Muslims ought to conduct their business activities according to the requirements of their religion which are moderation, justice, kindness, honesty, spending to meet social obligations. Unfairness and greed should be avoided at all times.

 

Applying Islamic accounting principles leaves a beneficial impact directly and indirectly on the internal and external parties of the business; some of which are highlighted below.

 

  • Less possibilities of unexpected activities by the accountant such as fraud in business and society.
  • The creditor will feel more secure in investing their funds in the business.
  • Financial statement and reporting will facilitate better and more accurate decision making by the users.
  • One of the Islamic accounting purpose is to be concerned about the employees and their families when performing their jobs. It can be useful in reducing poverty and increasing the welfare of the society within the company. This increases the purchasing power of the underprivileged which indirectly contributes to the economic growth.

 

The company also benefits from increased profits, customers’ loyalty, trust, positive brand attitude, combating negative publicity, and having a rightful place in the business world.

 

Conclusion

Overall, accounting is the recording of financial transactions and focuses on presenting the information in financial statements, These reports must be prepared according to accounting principles. Accounting also provides essential information to the management to keep the business financially healthy. It places high importance on ethical values. It is of utmost importance for a business to provide accurate evaluation, truth in operations, clear revenues and expenses.

 

Social accounting differs from Islamic accounting. The general concept of Corporate social responsibility (CSR) is to guarantee sustainability which is forbidden under Islamic accounting Exception is only made if it can be regenerated. CSR activities has a direct impact on the social environment. Therefore, it is required by law for CSR activities and information about its operations to be truthfully disclosed to the general public.

 

Because Islamic accounting obligates businesses to follow the Sharia strictly, it is considered a religious responsibility. Economic responsibility requires financial statements to be viable, profitable and efficient whereas ethical accounting is obliged to respect societal and religious values.

 

Therefore, Islamic accounting is considered to be much more complex than the social CSR concept in terms of providing the economy with accurateness, justice without taking or giving interest.

References:

Lewis, M. K. (2001). Islam and accounting. Accounting Forum,25(2), 103-127. doi:10.1111/1467-6303.00058

 

Yarahmadi, H., & Bohloli, A. (2015). Ethics in Accounting. International Journal of Accounting and Financial Reporting,5(1), 356-360. Retrieved April 27, 2017, from www.macrothink.org/

 

Schneider, B. (2017). Accounting Basics: History Of Accounting. Retrieved April 26, 2017, from http://www.investopedia.com/

 

Mishra, S. (2015). Social Accounting: Concept, Definition, Features and Benefits | Financial Analysis. Retrieved April 27, 2017, from http://www.yourarticlelibrary.com/

 

Islam, M. A. (2015). Social Compliance Accounting Managing Legitimacy in Global Supply Chains. Cham: Springer International Publishing.

 

Asfadillah, C., et al. (2012). The Importance of Islamic Accounting in Modern Era. Cambridge, UK.

 

Comprative analysis of AAOIFI Vs IFSB

Nahlah Aljudaibi, Adwaa S. Melebari and Hanadi Simbawah

Introduction:

Islamic finance has been rapidly grown recent few years nearly 20 percent annual growth in each year (Zeine Zeidane, 2015), The Islamic Financial Services Industry now has assets of over $175billionwith equity of US$15billion. With more than 300 Islamic banks, finance companies, investment banks (Shahul Hameed bin Mohamed IbrahimStandard,2007 )& Poor’s Ratings declare that over all assets held by Islamic financial institutions estimate around $1.8 trillion with probability to increase for double-digit growth over the coming few years to reach about $3 trillion.

Thus the Islamic finance system must adapting a stander accounting system that compliant with sharia rule and has a sharia objective which cares about Din(faith), nafs (life), maal(wealth), nasel(progeny) and aqal (rational). For following these principles and provide stander accounting system to service Islamic finance institutions and  guide the operations of the industry around the world, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was established since 1991 in Bahrain which was issuing accounting, auditing and Sharia standards for financial reporting at Islamic financial institutions. The another institution that considers as issuing supervisory and regulatory standards and guidelines which are governance standards for Islamic institutions is The Islamic Financial Services Board (IFSB) that established in 2002 in Malaysia.

Before elaborate, the two Islamic accounting stander in details must explain the general principles of Islamic accounting.

 

 

General principles of Islamic accounting;

According to the (Muhammad, 2002), there are three general principles in Islamic accounting

  1. Accountability:

The concept of accountability is that everyone is accountable for his actions on the Day of Judgment.  The accounting man is a person who involves in accounting issue which let him responsible with the mandated and also related parties, forming in financial statements.

  1. Justice

Justice in accounting system has a meaning of honest and cares about ethical and moral value regarding the parties are included in the financial transaction.

  1. Truth:

The measurement and reporting of accounting activity must create justice or fairness for all shareholders and this cannot happen without Truth principle

AAIOIFI:

AAIOIFI is based in Bahrain and operates as an independent international organization with support from some200 institutional members coming from about 45 different countries. Consist of central banks and monetary authorities, financial institutions, accounting and auditing firms, and other institutions that support the international Islamic finance industry.

AAIOFI is a stander for sharia, accounting, auditing, and governance exactly is issued of 88 standers including of 48 Sharia standards, 26 accounting standards, 5 auditing standards, 7governance standards and 2 codes of ethics. The standards are implemented globally even in non-member countries as they are applicable to IFIs worldwide.

The objectives of AAOIFI:

  • To develop accounting and auditing thoughts relevant to Islamic financial institutions
  • To disseminate accounting and auditing thoughts relevant to Islamic financial institutions and its applications through training, seminars, publication of periodical newsletters, carrying out and commissioning of research and other means
  • To prepare, promulgate and interpret accounting and auditing standards for Islamic financial institutions
  • To review and amend accounting and auditing standards for Islamic financial institutions

AAOIFI carries out these objectives in accordance with the precepts of Islamic Shari’a which represents a comprehensive system for all aspects of life, in conformity with the environment in which Islamic financial institutions have developed. This activity is intended both to enhance the confidence of users of the financial statements of Islamic financial institutions in the information that is produced about these institutions, and to encourage these users to invest or deposit their funds in Islamic financial institutions and to use their services.

AAOIFI Standards

Shari’ah Standards

Guidance on Shari’a permissibility and rules for specific Islamic finance products and mechanisms. AAOIFI’s Shari’ah standards are typically issued through a professional and meticulous scholarly methodology (known as the due process). The standards development process follows a number of stages, commencing with the commissioning of consultants to conduct a thorough study on a specific topic or issue that greatly impact the Islamic finance industry. The study involves Shari’ah characterization of the topic in question and the compilation of Fiqh academy fatwas and collective fatwas pertaining to the topic, and it accounts for all relevant practical applications. The exposure draft is then submitted to the respective Shari’ah standards subcommittee which discusses and reviews it. If approved, the consultant will be commissioned to prepare an exposure draft on the same topic or issue. The first exposure draft will then be discussed with the subcommittee prior to submission to the Shari’ah Board for further discussion and elaboration.

Accounting Standards

Guidance on accounting treatment for specific Islamic finance products and mechanisms and guidance on presentation of financial statements for Islamic financial institutions. Accounting standards due to the unique characteristics coupled with the growing demand of IFIs’ products and services so as to facilitate and enhance the credibility and reliability of the financial statements and reports. It is argued that the current standards which are based on conventional framework seem insufficient to guide the IFIs. Currently, the various IFIs apply different accounting standards in their preparation of their accounts due to the absence of Islamic accounting standards (Zaini, 2007). The trend towards the AAOIFI standards has become a pressing issue that has generated heated debate among Organization of Islamic Cooperation countries.

AAOIFI accounting standards have been made part of mandatory regulatory requirement in jurisdictions such as Bahrain, Jordan, Oman, Qatar, Qatar Financial Centre, Sudan, and Syria.

AAOIFI accounting standards have also been adopted by Islamic Development Bank Group, a multilateral institution.

In addition, AAOIFI accounting standards have also been used as basis of national accounting standards in jurisdictions such as Indonesia and Pakistan..

Auditing, Governance and Ethics Standards

AAOIFI auditing, governance and ethics standards are not part of mandatory regulatory requirement for Islamic finance.  Instead, these standards are used voluntarily by leading Islamic financial institutions across all major Islamic finance jurisdictions.

AAOIFI’s Auditing Standards broaden the scope of the external auditor so that s/he is satisfied with reasonable assurance that the Islamic bank’s transactions comply with Shari’a rules and principles. Require the external auditor’s report to clearly state in the auditor’s opinion whether or not the financial statements give a true and fair view in accordance with Islamic Shari’a rules and principles and the financial reporting framework.

AAIOFI’s Governance Standards aim to enhance the role of SSB in corporate governance. Provide guidelines to harmonize the SSB’s structure and process, including: l Its appointment, dismissal, and the format of its report and the information it should contain. l Steps that should be followed by the SSB in its review to form an opinion as to whether or not the bank has complied with Shari’a precepts.

AAOIFI’s code of ethical structure conduct consists of three sections; namely the foundations of accounting ethics, the principles of ethics for accountants, and the rules of ethical conduct for accountants. The foundations of accounting ethics delineate seven basic foundations; namely, integrity, vicegerency, sincerity, piety, righteousness, Allah-fearing, and, accountability to Allah. From these seven foundations, AAOIFI developed six basic ethical principles; namely, trustworthiness, legitimacy, objectivity, professional competence and diligence, faith-driven conduct, and professional conduct and technical standards. Finally, for all six ethical principles, they developed guiding rules for accountants in their professional works.

IFSB:

Islamic Financial Services Board, it’s an international organization that issues guiding principles and standards for association to central bank and monetary authorities and other institutions that are responsible for regulation and supervision of Islamic financial services industry. IFSB was founded in Malaysia 2002 and started operation on 2003. It serves as an International standard-sitting body of regulatory and supervisory agencies to ensure soundness and stability of the Islamic financial services industry in banking, capital market, insurance.

IFSB definesShari’ahgovernance system as a set of institutional and organizational arrangement through which an Islamic financial institution ensures that there is effective independent oversight of Shari’ah compliance over each of the following structures and process:

  1. a) Issuance of relevant Shari’ah pronouncement or resolution. This refers to a juristic opinion on any matter pertaining to Shari’ah issues in Islamic finance given by the appropriately mandated Shari’ah board.
  2. b) Dissemination of information on such Shari’ah pronouncement or resolutions to the operative personnel of the IFIs who monitor the day-to-day compliance with the Shari’ahresolutions vis-à-vis every level of operations and each transaction. However, this task would normally be done by the internal Shari’ah compliance department.
  3. c) An internal Shari’ah compliance review or audit reports that if there is any incident of non-compliance, it should be recorded and addressed and rectified. With regard to this, IFSB-3 sets out that Shari’ah resolution issued by the Shari’ah boards should be strictly adhered to. d) An annual Shari’ah compliance review or audit for verifying that internal Shari’ah compliance review or audit has been appropriately carried out and its findings have been duly noted by the Shari’ah boards.

The IFSB members have increased from 9 in 2003 to 188 members in 2016with 3 membership type:

1)      31 as full members.

2)      22 as associate members.

3)      125 as observer members.

The ISFB consists of:

  • The general assembly, which includes all members of the ISFB
  • The council, which acts as the policy making body of the IFSB and includes the senior executive of each full member of the organization
  • The technical committee, which advises the council on issues and consists of up to 15 persons appointed by the council
  • The working group, which drafts standards and guidelines and reports to the technical committee
  • The secretariat, which acts as the permanent administrative body and is headed by a secretary-general appointed by the council

 

 

The objectives of the IFSB are:

* To promote the development of a prudent and transparent Islamic financial services industry through introducing new, or adapting existing, international standards consistent with Sharî’ah principles, and recommending these for adoption

* To provide guidance on the effective supervision and regulation of institutions offering Islamic financial products and to develop for the Islamic financial services industry the criteria for identifying, measuring, managing and disclosing risks, taking into account international standards for valuation, income and expense calculation, and disclosure.

* To liaise and cooperate with relevant organizations currently setting standards for the stability and the soundness of the international monetary and financial systems and those of the member countries.

* To enhance and coordinate initiatives to develop instruments and procedures for efficient operations and risk management.

* To encourage cooperation amongst member countries in developing the Islamic financial services industry.

* To facilitate training and personnel development in skills in areas relevant to the effective regulation of the Islamic financial services industry and related markets.

* To undertake research into, and publish studies and surveys on, the Islamic financial services industry.

* To establish a database of Islamic banks, financial institutions and industry experts.

IFSB Standards

the IFSB has issued twenty-seven Standards, Guiding Principles and Technical Note for the Islamic financial services industry. The published documents are on the areas of:

  1. Risk Management (IFSB-1)
  2. Capital Adequacy (IFSB-2)
  3. Corporate Governance (IFSB-3)
  4. Transparency and Market Discipline (IFSB-4)
  5. Supervisory Review Process (IFSB-5)
  6. Governance for Collective Investment Schemes (IFSB-6)
  7. Special Issues in Capital Adequacy (IFSB-7)
  8. Guiding Principles on Governance for Islamic Insurance (Takāful) Operations (IFSB-8)
  9. Conduct of Business for Institutions offering Islamic Financial Services (IIFS) (IFSB-9)
  10. Guiding Principles on Sharī`ah Goverance System (IFSB-10)
  11. Standard on Solvency Requirements for Takāful (Islamic Insurance) Undertakings (IFSB-11)
  12. Guiding Principles on Liquidity Risk Management (IFSB-12)
  13. Guiding Principles on Stress Testing (IFSB-13)
  14. Standard on Risk Management for Takāful (Islamic Insurance) Undertakings (IFSB-14)
  15. Revised Capital Adequacy Standard (IFSB-15)
  16. Revised Guidance on Key Elements in the Supervisory Review Process (IFSB-16)
  17. Core Principles for Islamic Finance Regulations (IFSB-17)
  18. Guiding Principles for Retakāful (Islamic Reinsurance) (IFSB-18)
  19. Recognition of Ratings on Sharī`ah-Compliant Financial Instruments (GN-1)
  20. Guidance Note in Connection with the Risk Management and Capital Adequacy Standards: Commodity Murābahah Transactions (GN-2)
  21. Guidance Note on the Practice of Smoothing the Profits Payout to Investment Account Holders (GN -3)
  22. Guidance Note in Connection with the IFSB Capital Adequacy Standard: The Determination of Alpha in the Capital Adequacy Ratio (GN-4)
  23. Guidance Note on the Recognition of Ratings by External Credit Assessment Institutions (ECAIS) on Takāful and ReTakāful Undertakings (GN-5)
  24. Quantitative Measures for Liquidity Risk Management (GN-6)
  25. Development of Islamic Money Markets (TN-1)
  26. Stress Testing (TN-2)
  27. Guiding Principles on Disclosure Requirements for Islamic Capital Market Products (IFSB 19).

Conclusion:

This paper discusses the important role of AAIOFI and IFSB to ensure that the whole activities of financing activities are in line with the Shari’ah. Also the paper including comparison between AAIOFI and IFSB, the country that host it , objectives, members, standards ,rules and regulation.

 

 

References:

Lumpur, K. (2015). IFRS vs AAOIFI : The Clash of Standards ?, (March 2007). Trokic, A. (n.d.). Islamic Accounting ; History , Development and Prospects, 1–6. \Lumpur, K. (2015). IFRS vs AAOIFI : The Clash of Standards ?, (March 2007).

Kingdom, U. (2012). AAOIFI – Governance and Auditing Standards, (September).http://www.ifsb.org/objectif.php

Nawal Kasim, Sheila Nu NuHtay, S. A. S. (2013). Comparative Analysis on AAOIFI , IFSB and BNM Shari ’ ah Governance Faculty of Accountancy. International Journal of Business and Social Science, 4(15), 220–227. Retrieved from http://ijbssnet.com/journals/Vol_4_No_15_Special_Issue_November_2013/28.pdf

The automobile financing using Islamic contracts

by : Fatima Abalhareth

  1. Introduction

Shop around before you make a decision about buying or leasing. Consider the offers from different dealers and several sources of financing, including banks, credit unions, and finance companies. Comparison shopping is the best way to find both the vehicle and the finance or lease terms that best suit your needs as an example of our project today is a vehicle specifically Islamic Vehicle Financing.

This study will attempt to investigate tow big ideas; first what is the Islamic vehicle financing done with the Saudi Arabia Banks. To achieve the objectives of the study, we shall compare between the conventional finance and Islamic finance, especially on the process of vehicle finance on details. Second, we’ll move to the calculation part which is how Islamic banks in Saudi Arabia provide these services in their contracts to enhance the study.

1.1 The Vehicle financing

The vehicle financing is in direct lending, when get a loan directly from a bank. After the agreement to pay, over a period of time, the amount financed, plus a finance charge. Once enter into a contract with a dealership to buy a vehicle, you use the loan from the direct lender to pay for the vehicle. In Other hand, it is in dealership financing, which is another common type of vehicle financing, getting financing through the dealership, and a dealer, enter into a contract where you buy a vehicle and agree to pay, over a period of time, the amount financed plus a finance charge. The dealer may retain the contract, but typically sells it to a bank, finance company or credit union — called an assignee — that services the account and collects your payments.

Before we buy or lease a vehicle should be attention on these 3 points:

  1. Consider Federal and State Laws. b. Determine How Much You Can Afford. c. Monthly Spending Plan. Also, if we want to lease a vehicle must be considered the monthly payments on a lease usually are lower than monthly finance payments on the same vehicle because you are paying for the vehicle’s expected depreciation during the lease period, plus a rent charge, taxes, and fees. But at the end of a lease, you must return the vehicle unless the lease agreement lets you buy it and you agree to the purchase costs and terms.

However, to determine if leasing fits your situation:

  • Consider the beginning, middle and end of lease costs.
  • Compare different lease offers and terms, including mileage limits.
  • Consider how long you may want to keep the vehicle.

For instant:

Term 3 Years – 36 months 5 Years – 60 Months
Purchase Price $31,000 $31,000
Down Payment (20%) $6,200 $6,200
Amount Financed $24,800 $24,800
Contract Rate (APR) 5.00% 5.00%
Finance Charge $1,958 $3,280
Monthly Payment Amount $743 $468
Total of Payments $26,758 $28,080

 

  1. Difference between Islamic & Conventional Financing

The basic difference between Islamic Banking and conventional banking is the contractual relationship. This fundamental difference posed a totally different outlook on what happens after that. The contract between a customer and a conventional bank is simple; a loan where interest is charged upon. But look at an Islamic contract. The contract defines the relationship, the responsibilities, the subject matter, and the sequencing and ownership requirements for the use in an economic transaction. However, the transaction explains the rewards and returns on the completion of the contractual obligation by the regulators of the Shariah Committee; Cause and effect, risks and compensating return, action and rewards. The deployment of Islamic Banking funds is not for charity. It is still a business that should not charge interest. Moreover, the return on Shareholder capital is also important to ensure that capital is continued to be invested into Islamic Banking for it to grow. With growth comes the ability to continue supporting the ummah, the Muamalat defined within Shariah-compliant transactions. The main difference between Islamic Banking and conventional banking is that the concept of justice to customer is not regulatory driven; it is conceptually driven by the idea of Islamic Banking itself. A lot of conventional banking practices are developed to maximize returns while minimizing risk and risk-transference is a key consideration for conventional banks. Regulators have to be vigilant to ensure conventional banking to the line to protect customer’s interests.

  1. ISLAMIC VEHICLE FINANCING Vs CONVENTIONALVEHICLE FINANCING

With the increasing demands of everyday life, vehicle ownership has shifted from a mere luxury to a vital necessity. Purchasing a car is often the second most expensive, yet important purchase, after buying a home. While doing so, an individual has two options available: either to make a hand on hand (cash) purchase or to go for Vehicle financing. However, due to the exorbitant car prices and lack of the funds available, many individuals prefer the latter option and approach the various financial institutions, which provide this facility at different rates.

Vehicle Ijarah’ has been designed according to the principles of Islam and is completely interest-free. Moreover the Ijarah contract and other documentation also comply with Shariah requirements. On the other hand, a conventional car-financing scheme is actually an Interest based loan given by the financial institution and interest is charged on that loan. Also, in conventional car-leasing arrangements, the lease contract is not in compliance with Islamic Shariah and has Riba and other un-Islamic elements in it.

In ‘Car Ijarah’ the asset remains in the ownership and risk of the bank and the customers only pay the rentals for use of the asset; just like house rent. These basic differences are described in detail as the first term is (leasing or financing) that traditional systems provide financing for purchasing car, i.e. In essence, they are giving loan and earning interest. The Islamic car financing – It is not a financing scheme rather it is a lease contract. Ijarah is based on a lease contract. It is not a mixture contract. IJARAH is an Arabic term with origins in Islamic Fiqah, meaning to give something to rent. Leasing is a contract are transferred from the lessor, to another person is the lessee, at an agreed-upon price called the rent, and for an agreed-upon period of time called the term of the lease that is a second term (rental or installment).

Also, the term of (down payment or security deposit) that is in Ijarah the buyer is required to keep a security deposit at the bank. The minimum requirement for security deposit is 20% of the car value and the maximum is 50%. The requirement is different in the case of conventional car financing is a down payment made by the buyer of the car. The amount required for the down payment is 20% of the price plus the installment for the first year. Both the down payment and the security deposit mentioned above are one-time payments. However, the return in the Islamic mode of financing, the buyer has the right to return the car anytime during or at the end of the lease period, but in a conventional car financing the customer cannot return in any case.

  1. The Contracts used for Islamic Vehicle financing

-Murâbaḥah contract; the seller informs the buyer of his cost of acquiring or producing a specified product. The profit margin is then negotiated between them. The total cost is usually paid in installments.

-Ijārah (Lease, lease purchase); A party leases a particular product for a specific sum and a specific time period. In the case of a lease purchase, each payment includes a portion that goes toward the final purchase and transfer of ownership of the product.

Ijārah and murâbaḥah have many similarities and differences. In both financing modes, the bank is not a natural owner of the asset, but acquires it upon receiving a request from its client. Like murâbaḥah, ijārah rentals are paid in installments over time, and are supposed to cover the cost of the asset or the value of an investment for the bank and to provide a fair rate of return on investment. Thus, both contracts create debt. However, in murâbaḥah, the benefits and risks of ownership of the asset are transferred to the client along with ownership, ijārah rentals can be made flexible to reflect changing vehicle business conditions, especially if the rental period is very long. Murâbaḥah and ijārah are easily understood because of their close similarity to conventional financing (installment sales and leasing). Other contracts as Salam (Prepayment, deferred delivery) the buyer pays the seller the full negotiated price of a product that the seller promises to deliver on a future date.

-Istisna’ (Deferred payment, deferred delivery) A manufacturer (contractor) agrees to produce (build) and to deliver a certain good (or premise) at a given price on a given date in the future. The price does not have to be paid in advance (in contrast to Salam). It may be paid in installments or part may be paid in advance with the balance to be paid later on, based on the preferences of the parties.

-Salam and istisna’ are less frequently used debt-based Islamic financing instruments that do not meet the condition of physical possession of the asset for sale; these are the only two exceptions to the principle that one cannot sell a commodity before it comes into existence.

There are four main differences between istisna’ and salam contracts. (i) istisna’ involves the sale of unique manufactured goods as opposed to salam that can be used in standardized goods. (ii) Unlike salam who requires the payment of the full price up front, istisna’ allows for spot, deferred, or even installment payments. (iii) An istisna’ contract can be cancelled unilaterally until the date that the manufacturer starts working on the goods, while the salam contract can be cancelled only before the contract signature. (iv) The time of delivery is fixed in salam, whereas istisna’ can specify a maximum time for delivery after which the purchaser is no longer bound to accept the vehicles.

  1. Islamic vehicle financing by Five Saudi Arabian banks and their products

— Al Rajahy Bank, Car Ijarah is simply a rental agreement under which the car is given to the customer on rent for a period agreed at the time of the contract. The customer is required to deposit an initial amount (security deposit) with the Bank. Upon completion of the lease period the customer has two options, either to return the car and take away the security deposit or take ownership of the car against his security deposit or any other agreed amount via separate sale transaction.

— Bank Al Riyad, Ijarah means lease, rent or wage. Generally, the Ijarah concept refers to selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipment such as plant, office automation, motor vehicle for a fixed period and price.

— The National Commercial Bank (NCB), Murabaha is a Shariah-compliant form of financing where the Bank, based on requests from its customers, purchases specific commodities and sells them to the customers at an agreed-upon price equal to the Bank’s cost plus a specified profit margin, which is payable on a deferred basis in agreed-upon installments. The main uses of Murabaha are in residential, commercial real estate, and trade finance.

— Arabi N Bank, Istisna’a is a contract for the acquisition of assets to be manufactured in accordance with the specifications of the one who requests the assets to be manufactured / procured. In this product the Bank can either be the manufacturer/ procurer (Saani) or the party who is seeking the assets to be manufactured/procured (Mustasni). In project finance, the Bank takes the role of Mustasni and agrees with the customer to deliver specified assets for an agreed upon price. The Bank pays for the asset in staged payments. At the same time, the Bank enters into a forward Ijara and leases the assets to be created to the customer with promise to transfer ownership.  The main use of Istisna’a is in project finance combined with forward Ijara to finance the construction of new projects.

–Bank Al Balad, All the above Shariah-compliant financing products are accounted for in conformity with the accounting policies described in these financial statements. They are included in the financing and advances.

  1. Case Study

All banks apply the simple interest formula to calculate the total amount of the loan, then divide the total amount by the number of months. Example: Loan amount is 100000. The profit margin percentage rate is 2%. Number of financing years is 5. The total loan with profit margin is 100000* (1+2%*5) =110000. Monthly installments equals 110000/60=1833.33

Risk Management; in addition to facing common risks with conventional financial institutions, Islamic banks also face their own unique risks. The Shari’ah-compliant nature of assets and liabilities distinguishes them from conventional banks while at the same time exposing them to similar market, credit, liquidity, operational, and legal risks. Notably, differences in opinion among equity risk arise when Islamic banks enter into musharakah and mudârabah partnerships, as providers of funds and they share in the business risk of the activity being financed.  The mark-up risk tends to rank highly for Islamic banks. However, All in all, profit-sharing investment accounts (PSIA), diminishing musharakah, mudârabah, Salam, and istisna’ tend to be considered riskier than murahabah and ijārah. To mitigate risks, Islamic banks use a variety of prudential reserves.

For example, trade-based contracts (murabaha, Salam and istisnaa) and leasing are exposed to both credit and market risks. For example, during the transaction period of a salam contract, the bank is exposed to credit risk and at the conclusion of the contract it is exposed to commodity price risk. However, the unique nature of Islamic financing, with a diverse set of instruments used as sources and uses of funds, calls for the development of new techniques, processes, institutional setup, and procedures to further improve risk management practices and challenge Islamic finance–specific risks.

Further standardization for Shari’ah compliance would benefit Islamic financial institutions. Unlike conventional banking where a unified set of international standards help agents to identify risks associated with the bank’s activities, Islamic financial institutions often face difficulties presenting internationally accepted Islamic instruments to their customers, while it seems challenging to standardize different interpretations of certain religious matters across jurisdictions and Shari’ah scholars.

For example, if a customer is interested in a new car costing Rs. 300,000 for a tenure of five years and is willing to pay a 50% security deposit, the monthly rental would be Rs. 300,000 × 0.014067 = Rs. 4220 per month for five years.

If a customer wants to buy a second hand car, is interested in a car costing Rs.300, 000 for tenure of five years and is willing to pay a 50% security deposit, the monthly rental can be calculated from Table 1.2. The monthly rental would be Rs. 300,000×0.014230 = Rs. 4261 per month for five years. Table 1.3 demonstrates the difference between a Car Ijara and a conventional car lease.

Table 1.1 Rental calculations for new cars

15 0.030399 0.024789 0.021590
20 0.028821 0.023533 0.020515
25 0.027242 0.022277 0.019440
20 0.025664 0.021021 0.018366
35 0.024085 0.019765 0.017291
30 0.022507 0.018508 0.016216
45 0.020929 0.017252 0.015142
40 0.019350 0.015996 0.014067

Security deposit (%)                           3 years                          4 years                                5 years

 

Table 1.2 Rental calculations for used cars

Security deposit (%) 3 years 4 years 5 years
20 0.029412 0.023940 0.020726
25 0.027799 0.022660 0.019639
30 0.026186 0.021379 0.018552
35 0.024572 0.020099 0.017465
40 0.022959 0.018819 0.016378
45 0.021346 0.017539 0.015290
50 0.019732 0.016259 0.014230
 

The Ijara contract is binding under the Sharia’a and does not contain any conditions that make the contract void.

  1. Conclusion

Islamic finance has expanded rapidly and is spreading across many regions. Islamic financial assets grew, on average, about 20 percent annually over the past decade. Despite this growth, Islamic finance still represents a very small share of global financial assets. To this end, several factors still constrain the realization of the full potential of Islamic finance. A few are discussed in this paper, such as lack of liquidity management instruments and underdevelopment of appropriate safety nets, notably Shari’ah-compliant deposit insurance scheme and lender of last resort facilities.

Islamic banks operating in many conventional systems do not have access to Shari’ah compliant tradable short-term treasury instruments to channel excess funds to other Islamic financial institutions. The absence of such instruments restricts growth, forces banks to hold excessive reserves, and also curtails the central bank’s ability to conduct monetary policy operations.

 

 

 

 

 

 

 

  1. Reference list

 

  • Krasicka and Nowak (2012) for more discussion on actions taken by Malaysia to ensure level playing field for the Islamic finance industry.
  • AAOIFI – Accounting and Auditing Organization for Islamic Financial Institutions (1999), Statement on the Purpose and Calculation of the Capital Adequacy Ratio for Islamic Banks, Bahrain: AAOIFI.
  • The National Commercial Bank, Annual Report 2014.
  • Ahmad, Ausaf and Khan, Tariqullah (1997). Islamic Financial Instruments for Public Sector Resource Mobilization, Jeddah, Saudi Arabia: IDB, IRTI.
  • Ahmad, Ausaf and Khan, Tariqullah (eds) (1998). Islamic Financial Instruments for Public Sector Resource Mobilization, Jeddah, Saudi Arabia: IRTI.
  • Sole, Juan, 2007, “Introducing Islamic Banks into Conventional Banking Systems,” IMF Working Paper 07/175 (Washington: International Monetary Fund).
  • Abedifar, P., P. Molyneux, and A. Tarazi. 2013, “Risk in Islamic Banking.” Review of Finance, No. 6 Vol. 17, pp. 2035–2096.
  • Ahmad,Ausaf (1993),‘Contemporary practices of Islamic financing techniques’,research paper no.20,Islamic Research and Training Institute, Islamic Development Bank, Jeddah.
  1. Introduction

Shop around before you make a decision about buying or leasing. Consider the offers from different dealers and several sources of financing, including banks, credit unions, and finance companies. Comparison shopping is the best way to find both the vehicle and the finance or lease terms that best suit your needs as an example of our project today is a vehicle specifically Islamic Vehicle Financing.

This study will attempt to investigate tow big ideas; first what is the Islamic vehicle financing done with the Saudi Arabia Banks. To achieve the objectives of the study, we shall compare between the conventional finance and Islamic finance, especially on the process of vehicle finance on details. Second, we’ll move to the calculation part which is how Islamic banks in Saudi Arabia provide these services in their contracts to enhance the study.

1.1 The Vehicle financing

The vehicle financing is in direct lending, when get a loan directly from a bank. After the agreement to pay, over a period of time, the amount financed, plus a finance charge. Once enter into a contract with a dealership to buy a vehicle, you use the loan from the direct lender to pay for the vehicle. In Other hand, it is in dealership financing, which is another common type of vehicle financing, getting financing through the dealership, and a dealer, enter into a contract where you buy a vehicle and agree to pay, over a period of time, the amount financed plus a finance charge. The dealer may retain the contract, but typically sells it to a bank, finance company or credit union — called an assignee — that services the account and collects your payments.

Before we buy or lease a vehicle should be attention on these 3 points:

  1. Consider Federal and State Laws. b. Determine How Much You Can Afford. c. Monthly Spending Plan. Also, if we want to lease a vehicle must be considered the monthly payments on a lease usually are lower than monthly finance payments on the same vehicle because you are paying for the vehicle’s expected depreciation during the lease period, plus a rent charge, taxes, and fees. But at the end of a lease, you must return the vehicle unless the lease agreement lets you buy it and you agree to the purchase costs and terms.

However, to determine if leasing fits your situation:

  • Consider the beginning, middle and end of lease costs.
  • Compare different lease offers and terms, including mileage limits.
  • Consider how long you may want to keep the vehicle.

For instant:

Term 3 Years – 36 months 5 Years – 60 Months
Purchase Price $31,000 $31,000
Down Payment (20%) $6,200 $6,200
Amount Financed $24,800 $24,800
Contract Rate (APR) 5.00% 5.00%
Finance Charge $1,958 $3,280
Monthly Payment Amount $743 $468
Total of Payments $26,758 $28,080

 

  1. Difference between Islamic & Conventional Financing

The basic difference between Islamic Banking and conventional banking is the contractual relationship. This fundamental difference posed a totally different outlook on what happens after that. The contract between a customer and a conventional bank is simple; a loan where interest is charged upon. But look at an Islamic contract. The contract defines the relationship, the responsibilities, the subject matter, and the sequencing and ownership requirements for the use in an economic transaction. However, the transaction explains the rewards and returns on the completion of the contractual obligation by the regulators of the Shariah Committee; Cause and effect, risks and compensating return, action and rewards. The deployment of Islamic Banking funds is not for charity. It is still a business that should not charge interest. Moreover, the return on Shareholder capital is also important to ensure that capital is continued to be invested into Islamic Banking for it to grow. With growth comes the ability to continue supporting the ummah, the Muamalat defined within Shariah-compliant transactions. The main difference between Islamic Banking and conventional banking is that the concept of justice to customer is not regulatory driven; it is conceptually driven by the idea of Islamic Banking itself. A lot of conventional banking practices are developed to maximize returns while minimizing risk and risk-transference is a key consideration for conventional banks. Regulators have to be vigilant to ensure conventional banking to the line to protect customer’s interests.

  1. ISLAMIC VEHICLE FINANCING Vs CONVENTIONALVEHICLE FINANCING

With the increasing demands of everyday life, vehicle ownership has shifted from a mere luxury to a vital necessity. Purchasing a car is often the second most expensive, yet important purchase, after buying a home. While doing so, an individual has two options available: either to make a hand on hand (cash) purchase or to go for Vehicle financing. However, due to the exorbitant car prices and lack of the funds available, many individuals prefer the latter option and approach the various financial institutions, which provide this facility at different rates.

Vehicle Ijarah’ has been designed according to the principles of Islam and is completely interest-free. Moreover the Ijarah contract and other documentation also comply with Shariah requirements. On the other hand, a conventional car-financing scheme is actually an Interest based loan given by the financial institution and interest is charged on that loan. Also, in conventional car-leasing arrangements, the lease contract is not in compliance with Islamic Shariah and has Riba and other un-Islamic elements in it.

In ‘Car Ijarah’ the asset remains in the ownership and risk of the bank and the customers only pay the rentals for use of the asset; just like house rent. These basic differences are described in detail as the first term is (leasing or financing) that traditional systems provide financing for purchasing car, i.e. In essence, they are giving loan and earning interest. The Islamic car financing – It is not a financing scheme rather it is a lease contract. Ijarah is based on a lease contract. It is not a mixture contract. IJARAH is an Arabic term with origins in Islamic Fiqah, meaning to give something to rent. Leasing is a contract are transferred from the lessor, to another person is the lessee, at an agreed-upon price called the rent, and for an agreed-upon period of time called the term of the lease that is a second term (rental or installment).

Also, the term of (down payment or security deposit) that is in Ijarah the buyer is required to keep a security deposit at the bank. The minimum requirement for security deposit is 20% of the car value and the maximum is 50%. The requirement is different in the case of conventional car financing is a down payment made by the buyer of the car. The amount required for the down payment is 20% of the price plus the installment for the first year. Both the down payment and the security deposit mentioned above are one-time payments. However, the return in the Islamic mode of financing, the buyer has the right to return the car anytime during or at the end of the lease period, but in a conventional car financing the customer cannot return in any case.

  1. The Contracts used for Islamic Vehicle financing

-Murâbaḥah contract; the seller informs the buyer of his cost of acquiring or producing a specified product. The profit margin is then negotiated between them. The total cost is usually paid in installments.

-Ijārah (Lease, lease purchase); A party leases a particular product for a specific sum and a specific time period. In the case of a lease purchase, each payment includes a portion that goes toward the final purchase and transfer of ownership of the product.

Ijārah and murâbaḥah have many similarities and differences. In both financing modes, the bank is not a natural owner of the asset, but acquires it upon receiving a request from its client. Like murâbaḥah, ijārah rentals are paid in installments over time, and are supposed to cover the cost of the asset or the value of an investment for the bank and to provide a fair rate of return on investment. Thus, both contracts create debt. However, in murâbaḥah, the benefits and risks of ownership of the asset are transferred to the client along with ownership, ijārah rentals can be made flexible to reflect changing vehicle business conditions, especially if the rental period is very long. Murâbaḥah and ijārah are easily understood because of their close similarity to conventional financing (installment sales and leasing). Other contracts as Salam (Prepayment, deferred delivery) the buyer pays the seller the full negotiated price of a product that the seller promises to deliver on a future date.

-Istisna’ (Deferred payment, deferred delivery) A manufacturer (contractor) agrees to produce (build) and to deliver a certain good (or premise) at a given price on a given date in the future. The price does not have to be paid in advance (in contrast to Salam). It may be paid in installments or part may be paid in advance with the balance to be paid later on, based on the preferences of the parties.

-Salam and istisna’ are less frequently used debt-based Islamic financing instruments that do not meet the condition of physical possession of the asset for sale; these are the only two exceptions to the principle that one cannot sell a commodity before it comes into existence.

There are four main differences between istisna’ and salam contracts. (i) istisna’ involves the sale of unique manufactured goods as opposed to salam that can be used in standardized goods. (ii) Unlike salam who requires the payment of the full price up front, istisna’ allows for spot, deferred, or even installment payments. (iii) An istisna’ contract can be cancelled unilaterally until the date that the manufacturer starts working on the goods, while the salam contract can be cancelled only before the contract signature. (iv) The time of delivery is fixed in salam, whereas istisna’ can specify a maximum time for delivery after which the purchaser is no longer bound to accept the vehicles.

  1. Islamic vehicle financing by Five Saudi Arabian banks and their products

— Al Rajahy Bank, Car Ijarah is simply a rental agreement under which the car is given to the customer on rent for a period agreed at the time of the contract. The customer is required to deposit an initial amount (security deposit) with the Bank. Upon completion of the lease period the customer has two options, either to return the car and take away the security deposit or take ownership of the car against his security deposit or any other agreed amount via separate sale transaction.

— Bank Al Riyad, Ijarah means lease, rent or wage. Generally, the Ijarah concept refers to selling the benefit of use or service for a fixed price or wage. Under this concept, the Bank makes available to the customer the use of service of assets / equipment such as plant, office automation, motor vehicle for a fixed period and price.

— The National Commercial Bank (NCB), Murabaha is a Shariah-compliant form of financing where the Bank, based on requests from its customers, purchases specific commodities and sells them to the customers at an agreed-upon price equal to the Bank’s cost plus a specified profit margin, which is payable on a deferred basis in agreed-upon installments. The main uses of Murabaha are in residential, commercial real estate, and trade finance.

— Arabi N Bank, Istisna’a is a contract for the acquisition of assets to be manufactured in accordance with the specifications of the one who requests the assets to be manufactured / procured. In this product the Bank can either be the manufacturer/ procurer (Saani) or the party who is seeking the assets to be manufactured/procured (Mustasni). In project finance, the Bank takes the role of Mustasni and agrees with the customer to deliver specified assets for an agreed upon price. The Bank pays for the asset in staged payments. At the same time, the Bank enters into a forward Ijara and leases the assets to be created to the customer with promise to transfer ownership.  The main use of Istisna’a is in project finance combined with forward Ijara to finance the construction of new projects.

–Bank Al Balad, All the above Shariah-compliant financing products are accounted for in conformity with the accounting policies described in these financial statements. They are included in the financing and advances.

  1. Case Study

All banks apply the simple interest formula to calculate the total amount of the loan, then divide the total amount by the number of months. Example: Loan amount is 100000. The profit margin percentage rate is 2%. Number of financing years is 5. The total loan with profit margin is 100000* (1+2%*5) =110000. Monthly installments equals 110000/60=1833.33

Risk Management; in addition to facing common risks with conventional financial institutions, Islamic banks also face their own unique risks. The Shari’ah-compliant nature of assets and liabilities distinguishes them from conventional banks while at the same time exposing them to similar market, credit, liquidity, operational, and legal risks. Notably, differences in opinion among equity risk arise when Islamic banks enter into musharakah and mudârabah partnerships, as providers of funds and they share in the business risk of the activity being financed.  The mark-up risk tends to rank highly for Islamic banks. However, All in all, profit-sharing investment accounts (PSIA), diminishing musharakah, mudârabah, Salam, and istisna’ tend to be considered riskier than murahabah and ijārah. To mitigate risks, Islamic banks use a variety of prudential reserves.

For example, trade-based contracts (murabaha, Salam and istisnaa) and leasing are exposed to both credit and market risks. For example, during the transaction period of a salam contract, the bank is exposed to credit risk and at the conclusion of the contract it is exposed to commodity price risk. However, the unique nature of Islamic financing, with a diverse set of instruments used as sources and uses of funds, calls for the development of new techniques, processes, institutional setup, and procedures to further improve risk management practices and challenge Islamic finance–specific risks.

Further standardization for Shari’ah compliance would benefit Islamic financial institutions. Unlike conventional banking where a unified set of international standards help agents to identify risks associated with the bank’s activities, Islamic financial institutions often face difficulties presenting internationally accepted Islamic instruments to their customers, while it seems challenging to standardize different interpretations of certain religious matters across jurisdictions and Shari’ah scholars.

For example, if a customer is interested in a new car costing Rs. 300,000 for a tenure of five years and is willing to pay a 50% security deposit, the monthly rental would be Rs. 300,000 × 0.014067 = Rs. 4220 per month for five years.

If a customer wants to buy a second hand car, is interested in a car costing Rs.300, 000 for tenure of five years and is willing to pay a 50% security deposit, the monthly rental can be calculated from Table 1.2. The monthly rental would be Rs. 300,000×0.014230 = Rs. 4261 per month for five years. Table 1.3 demonstrates the difference between a Car Ijara and a conventional car lease.

Table 1.1 Rental calculations for new cars

15 0.030399 0.024789 0.021590
20 0.028821 0.023533 0.020515
25 0.027242 0.022277 0.019440
20 0.025664 0.021021 0.018366
35 0.024085 0.019765 0.017291
30 0.022507 0.018508 0.016216
45 0.020929 0.017252 0.015142
40 0.019350 0.015996 0.014067

Security deposit (%)                           3 years                          4 years                                5 years

 

Table 1.2 Rental calculations for used cars

Security deposit (%) 3 years 4 years 5 years
20 0.029412 0.023940 0.020726
25 0.027799 0.022660 0.019639
30 0.026186 0.021379 0.018552
35 0.024572 0.020099 0.017465
40 0.022959 0.018819 0.016378
45 0.021346 0.017539 0.015290
50 0.019732 0.016259 0.014230
 

The Ijara contract is binding under the Sharia’a and does not contain any conditions that make the contract void.

  1. Conclusion

Islamic finance has expanded rapidly and is spreading across many regions. Islamic financial assets grew, on average, about 20 percent annually over the past decade. Despite this growth, Islamic finance still represents a very small share of global financial assets. To this end, several factors still constrain the realization of the full potential of Islamic finance. A few are discussed in this paper, such as lack of liquidity management instruments and underdevelopment of appropriate safety nets, notably Shari’ah-compliant deposit insurance scheme and lender of last resort facilities.

Islamic banks operating in many conventional systems do not have access to Shari’ah compliant tradable short-term treasury instruments to channel excess funds to other Islamic financial institutions. The absence of such instruments restricts growth, forces banks to hold excessive reserves, and also curtails the central bank’s ability to conduct monetary policy operations.

  1. Reference list

 Krasicka and Nowak (2012) for more discussion on actions taken by Malaysia to ensure level playing field for the Islamic finance industry.

  • AAOIFI – Accounting and Auditing Organization for Islamic Financial Institutions (1999), Statement on the Purpose and Calculation of the Capital Adequacy Ratio for Islamic Banks, Bahrain: AAOIFI.
  • The National Commercial Bank, Annual Report 2014.
  • Ahmad, Ausaf and Khan, Tariqullah (1997). Islamic Financial Instruments for Public Sector Resource Mobilization, Jeddah, Saudi Arabia: IDB, IRTI.
  • Ahmad, Ausaf and Khan, Tariqullah (eds) (1998). Islamic Financial Instruments for Public Sector Resource Mobilization, Jeddah, Saudi Arabia: IRTI.
  • Sole, Juan, 2007, “Introducing Islamic Banks into Conventional Banking Systems,” IMF Working Paper 07/175 (Washington: International Monetary Fund).
  • Abedifar, P., P. Molyneux, and A. Tarazi. 2013, “Risk in Islamic Banking.” Review of Finance, No. 6 Vol. 17, pp. 2035–2096.
  • Ahmad,Ausaf (1993),‘Contemporary practices of Islamic financing techniques’,research paper no.20,Islamic Research and Training Institute, Islamic Development Bank, Jeddah.

 

Islamic Home Finaning – Case study based on KSA banks

by Maryam Hammad

1- Introduction:

 Most of people haven’t the financial affordability to build or purchase a house while only a few people own the resources that enable them to purchase their own house. So, they move towards the banks to request house mortgage for the long term repayment from their personal income.

 

2- What is home finance/mortgages?

 One of the most common forms of the debt is a home mortgage .Also, a home mortgage is one of the most advised. The consumer will has the lowest interest rate in a home mortgage loans than other type of debt.

 

 Home mortgages is a loan given by mortgage company , bank and other financial institution for residence purchasing or investment. The owner of the property ( borrower) transfers this property to the lender under the condition that the ownership of this property will be transferred back to the owner when the all payment has been made and after satisfying all terms and condition of home mortgage. 

 A home mortgage has fixed or floating interest rate and this rate is paid on monthly basis with a part of the amount of the loan principal. This interest will be decrease over time as paying down the principal by the owner.

 

3-Difference between Islamic finance and conventional finance:

·         Conventional Financing Principles

·         The essential part of the source of revenue in conventional institution is  the interest that charged on the money lending to the corporations and individuals. In addition, Interest is the main runner of conventional banks operations. Charging fee on international trade facilities, safety of wealth, guarantees and transfer of funds are other sources of income.

·         The Payment over a tenure  is made by installments in which  the part of  the payment of this installment goes towards servicing the interest and the remainder for down the principal.  Many facilities are provided by loan contract and it is known as a loan Facility agreement

·         Islamic Financing Principles

·         The system of Islamic finance operates according to the principle of Sharia and it promotes social justice.  Islamic finance concerns with moralities and values. so, immoral actions such as fraud, injustice gambling and ambiguity, are prohibited by Islam.  The transactions of interest-based (riba) are avoided by Islamic finance and it introduces the concept of buying something on the borrower’s behalf, and  then selling it back to the borrower at profit instead of interest-based transaction.  Profit and loss sharing in Islamic bank is based on Islamic mode of financing, Mudarabah and Musharka which is exclusive structured for Islamic institutions. Because Islamic institutions share the risk with the depositors, the risk in the Islamic institutions is lower than traditional institutions. 

 

4-Difference between Islamic home finance and conventional mortgages:

Conventional home financing is a common form around the world to purchase house where the customer signs a contract with the bank which contains schedule payment to be paid by the customer over specified period of time. The mortgage loans that provided by commercial banks offer this product for two groups of customer. The first is for commercial purpose and the second is for the residential purpose. The mortgage loan of commercial real estate is used for the purposes of business: building or purchasing shopping malls, restaurants and hotels and corporate offices while the residential loans are for general public usage to purchase or construct a house. 

Home financing according to Shariah-compliant is a financing a home form, in a way that the principles of Islamic law and its ruled do not violated. Also, the program of Islamic home financing does not involve  Riba (usury / interest), Maysir (gambling) and Gharar (speculation or contractual uncertainty).Generally, it is based on equity partnership between the bank and the customer  In Islamic home financing the customer pay monthly rent of the home purchased to the bank on the portion of funds supplied to purchase the home and this portion diminishes as the home purchaser pays to the bank to purchase the portion of the bank.  The wealth and income of conventional mortgage financing is not distributed equally and it create insecurity, stress and conflicts. In contrary, the shared equity financing which is in Islamic finance reduce the conflict, insecurity, and stress and make equitable society. 

 

5-Contracts used for Islamic home financing with process and details:

Islamic banks offer interest free products. The most common home financing products and structure are:

A- Murabaha or Bay’ Bithaman Ajil (BBA , deferred payment sale)

B- Diminishing Musharkah which is the most common product for home financing around the world

C- Parallel istisna (construction-required sale).

D- Ijarah (leasing).

 

A- Bay’ Bithaman Ajil Home Financing

 The Bay’ Bithaman Ajil ( commonly referred as ‘BBA”) home financing is based on deferred payment of shari’ah concept. It is a modification in the Murabaha (cost plus) contract, the product is received instantly while the price and the profit is paid in installments over long period of time.BBA term generally used in Malaysia and Brunei and it is known as bay mu’ajjal in the region of South Asia while in the middle eastern countries is known as bay murabaha. The facility of BBA is provided by Islamic bank to enable the home purchaser to pay the cost of financing. The bank purchases the assets  cash from vendor and sell is on credit basis to the customer. The selling price (The cost plus the profit) must be agreed upon concluding the contract between the customer and the bank. The bank is liable for liabilities and all defects until ownership is transferred to the customer.

The modus operandi of Bay’ Bithaman Ajil home financing:

1- The customer who want to purchase a house approach the bank for financing.

2- The bank  assesses the creditworthiness of the customer and approves the request.

3- The bank purchase the house from the developer and pay full amount on cash.

4- The bank sell the house to the customer at a markup price.

5- The customer pay the sales amount on an installment basis.

 

B- Diminishing Musharkah Home Financing 

 The diminishing Musharka (musharakah Mutanaqisa) is based on partnership equity. The customer and the bank (financer) create a contract to purchase a house jointly. The bank gives the option to the  customer (buyer) to purchase the portion of the bank in this house over the contract period. So, step by step the portion of the bank in this house will decline gradually till the end of the contract and the customer own the whole equity. This done by the customer who pays the schedule payment and monthly rent to buy the portion of the house that owned by bank. The rent that the customer pay is paid on the outstanding portion that owned by the bank. The contract can terminate at any point when the all remaining payment is paid by customer. 

The modus operandi of Diminishing Musharka home financing:

— 1- Musharaka contract is signed by both Islamic banks and customer in order to purchase the house. Jointly they will be the partners or owners of this house.  

— 2- At the beginning, the customer pay for example 20% as initial margin and the bank pay the remaining of 80%. 

— 3- The house will be rent to the customer after purchasing it, portion of the payment of the rent will go to the contract of Musharaka.

— 4- The ownership portion of the islamic bank will decline gradually from the payment of the rent.

— 5- The customer will have the full ownership of the house at the end of this contract.

C- Parallel Istisna Home Financing

 Istisna’ is an assets purchasing contract in which the purchaser place an order to purchase the assets that will deliver in the future according to the specification which is in contract. The purchase price, sale, and the installment will be decided by both parties. Parallel Istisna include two contract. The first contract is between the customer and the bank as a manufacturer, builder or supplier. The second contract between the bank as purchaser with a manufacturer, builder or supplier to meet the obligations of the first contract. The profit is realized from the difference of two contract.  

The modus operandi of Parallel Istisna Home Financing:

1- The customer request from the bank to construct a specified house (the specification include the type, nature, quantity, and the date of delivering). The price of the contract contain the cost to the bank plus the margin profit (e.g:250000). The customer will pay in deferred basis.

2- Islamic bank enter into another contract of parallel istisna’ contract with a subcontractor to develop the house (e.g;180000) as specified in the first istisna’ contract. The two istisna’ contract must remain independent .So, any problems arise of nonperformance of the one of the contracts should not  affect the other contract. 

3- The completed house will be delivered to the Islamic bank by the developer.

4- The Islamic bank will deliver the house to the customer and the installment must paid by the customer.  

D- Ijarah (leasing) Home Financing:

 Ijara is lease based contract used  by the Islamic banks under the principle of Ijara wa Iqtina,. The customer identifies a home and request the Islamic bank for financing. After analyzing the customer and the home by the bank, the bank purchases this  home and leases to the customer based on monthly schedule rent payment. Rizwanullah et al., (2012) argued that the customer contributes to the account to purchase the home  in addition of paying the rent. The bank will be responsible for all expenses that related  to this home. buyer equity of the home will increases with the payment. At the end of this contract the bank will transfer the  ownership of this home to the customer.

 

6- Islamic home financing instruments used by Saudi  banks ( example from Saudi Arabian banks and their products(:

Riyad Bank Islamic Home Financing :

 Riyad Bank provides financing of real estate host to its customers whose concern is to own a property. It provides to the customer all around the Kingdom of Saudi Arabia both a complete and incomplete property or a part of land and The mortgage advisors of Riyad Bank guide the customer to choose among this financing. The products of Riyad bank that based on islamic home financing are according to Shari’a compliant and are provided with competitive rates of profit margin and flexible payment plan. This products include:

·         Purchasing of Readymade Properties: Riyad Bank provides purchase of readymade property finance solutions and  providing the stability that its customers need. This product is provided with a high financing amount.

·         Purchasing Incomplete Property :Riyad Bank Home Financing assists the customer with purchase formalities and  it allows to pay regular installments based on the progress of construction with maximum finance amount.

·          Home Equity Readymade PropertyThe program of Riyad Bank’s Home Equity for readymade properties is offering to the customer with funds which support  in addressing the several needs of finance.

·         Home Equity Incomplete Property: Riyad Bank provides in this program for the customer the facility for making payments towards the completion of construction with financing up to SAR 5 million and terms of payment up to 240 month.

·         Land Finance: The Bank offers this product to support its customer to buy a land with various payment plans and maximum financing amount.

·         Subsidized Home Finance and Al-Moyassar Home Mortgage Programs: this is an innovative finance offered by Riyad Bank in cooperation with The programs of  Real Estate Development Fund and the Ministry of Housing in order to help the customer to own their dream house.

 

SABB Bank (The Saudi British Bank) Islamic Home Financing : 

 

·         SABB offers to its customer many options that enable them to own their dream house with the competitive rates of profit, high quality service for its customer and simple financing solutions. A wide range of products of Shariah compliant Home Finance are offered by SABB using:  The concept of Ijarah: SAAB buy property and leases this property to its customer. The financing period up to 25 years with a promise from the bank to transfer the ownership at the end of the period  to the customer. The lease rentals will be paid by the customer and the balance will be payable  to the bank over the period of financing in monthly installments. The properties that SAAB offers under the concept of Ijarah include: Completed villa, apartment or residential building, duplex, uncompleted house and land for building a home in future.

·         Istisna’a and Ijarah Mausoofa Fi-Dhimah: This is based on Construction + forward lease Structure concept and with the promise from the bank to  transfer the ownership to the customer at the end of the lease period. The period of flexible financing up to 25 years period , SAR 5 million financing amount and in which the bank is financing the customer who own the land to build his house. The value of the land will paid by the customer as a part of lease rentals in advance and the remaining balance is payable to SAAB over the period of financing in monthly installment basis. This product has quick approval and easy process.

The Saudi Investment Bank (SAIB) Islamic Home Financing

·          The Saudi investment bank is also provide Islamic home finance products.

·          ALASALAH Murabaha Home Finance: This is a product of an Islamic home financing that offered by the Saudi Investment Bank and this product is according to Shariah compliant and it is Murabaha based contract. The bank purchase the property based on the customer request and the process of evaluation. Then, the Saudi Investment Bank sells this property to the customer based on monthly payments for specified and a greed period of time. The time period can be from 5 years to 25 years with financing amount up to SAR 5 million.  At the end of the period and when the all installment are paid by the customer, the bank transfers the ownership of the property to the customer. Al ASALAH home finance is available for apartments, villas, land and the rate of profit is fixed over the financing period.

 

Al Rajhi Bnk Islamic Home Financing

Al Rajhi Bnk provides many solution for its customer who want to own a house, villa or apartment by purchasing or building. Also, it is providing opportunity to  purchasing a piece of land. Moreover, Al Rajhi Bnk helps the customer in purchasing an investment property and collecting the from the rent. The solutions that the bank provides based on Islamic home financing are:

·         Buy a home: this is for the customer who want to buy ready villa or apartment with finance period up to 20 or 30 years.

·         Buy a Land: this type for the customer who want to buy a land to build his house with finance period up to 20 years.

·         Real Estate Development Fund (REDF) additional finance: This is a program of  real estate financing that based on  the principle of Murabaha and it offers for the customer that satisfied the credit conditions of Al Rajhi Bank. The property  will be purchased  by Al Rajhi Bank on behalf of the customer based on full amount payment  to the seller on the basis that the development fund on behalf of the customer will pay an amount of 500 thousand Riyals towards the bank as an advance payment of the purchase amount. 

·         Home and More: here the bank provides in one package both home and personal at the same time.

·         National Commercial Bank (NCB) Islamic Home Financing: 

·         NCB provides Islamic home finance compatible with the provisions of sharia’ on the basis of Murabaha and Ijara. The bank require 30% down payment for this home finance  and the amount of finance up to 3 SAR million for payroll customers and 7 million for affluent customers with the possibility of early settlement and SAR 3000 is the minimum required  salary.

 

 

7- Case study – (Products, how do the bank calculates the rates and rentals, risk management, agreement, calculations based on Islamic bank):

In Al Rajhi Bank and under Islamic home financing the bank provides services of Home and More in which the bank provides in one package both home and personal at the same time. In the case of monthly salary is SR 10,000  the customer can get the following finances a according to Al Rajhi Bank terms and condition:

 

Personal  Home

Finance Amount (SR) 183,468 Finance Amount (SR)

888,451

Term Cost % 3.50% * Finance Rate % 2.95% *

Annual Percentage Rate (APR) % 4.01% * Effective Rate % 5.05% *

Finance Period (Years) 5 Finance Period (Years)

Total Monthly Installment (SR) 6,000

Number of Installments ( Months) 240

* source: Al Rajhi Bank.

 

·         Parallel Istsina’ home financing case study of one of  Malaysia Islamic bank:

·         The customer identifies a house to purchase and approach the bank for  financing. Then, the customer and the bank will agrees on financing using alistisna’. The bank will enter on parallel al-istisna’ contract with housing  developer to deliver the house as specified in the first istisna’ contract for say SAR 500,000 and now the bank is the owner of this house. After that , the customer will pays as agreed payment schedule over the period of  al-istisna’.

·         For Example; If the purchase price of  the house is SAR 600,000, profit rate is 10% and the customer down payment is 10% (SAR 60000). A financing tenure is 30 years and the installment will be paid on monthly basis. The bank enter parallel istisna’ with the developer which cost 530000 .The computation is as below;

– Annual installments = i((1+i)^n)PV/((1+i)^n)-1

 

= .10 ((1+.10)^30)(600000-60000)/ ((1+.10)^30)-1

 

=SAR 52,282.87

 

– Monthly installments= Annual installments/12 months

 

= 52,282.8/12 

 

= SAR 4,356.90 per month

 

=4,356.90 x 30 years x 12 months

 

= SAR 1,568,486.10

 

   So, the total payment is SAR 1,568,486.10 and SAR 4,356.90 is the monthly payment for the period of 30 years.

 

The risk management of Parallel Istsina’ home financing

 

– Credit risk Management:  1- the probability of  the expected loses and default are assessed carefully by the bank. 

 

2- Generally , band al-Jazaa ( penalty clause) frequently used by bank to ensure that the manufacturer are produce or construct as specification in the contract.

 

3- The delivery of the fund can be agreed on the different phases of the construction. So, the payments will be aligned with milestones.

 

– Market risk Management:

1- The property or the commodity is sold before the date of delivery through parallel Istisna’. by bank.

2-Basid on the different scenarios of market the future market price will be valued.  

3- VAR analysis was used to the market risk management and to the future market price evaluation.

– Liquidity risk Management:

1- Several quantitative models are used by the bank to identify the risk and the price of its product will determine according to that risk.

– Operational risk Management: 

1- The bank ensure that there was not any misappropriation in the distributed fund by ensure that the payment to the supplier with the inspection and ensure the property take place.

2- Ensure that appropriate quality is followed by the manufacturer by taken guarantees from the manufacture.

   

8- Conclusion:

 The system of Islamic finance operates according to the principle of sharia and it is promote social justice. Also, Islamic finance concerns with moralities and values. Islamic bank offer  for its customer many options that enable them to own their dream house with the competitive rates of profit, high quality service for its customer and simple financing solutions. A wide range of products of Shariah compliant Home finance are offered by several Islamic bank.

 Islamic home financing products is more beneficial for the customer than conventional home financing. Also, because Islamic institutions share the risk with the depositors, the risk in the Islamic institutions is lower than traditional institutions.

 

9-  References:

 1. 10 Common Guidance Residential Islamic Home Financing Questions. (n.d.). Retrieved May 08, 2017, from https://www.guidanceresidential.com/blog/10common-guidance-residential-islamic-home-financing-questions/

2. Al ASALAH Murabaha Home Finance. (n.d.). Retrieved May 08, 2017, from https://www.saib.com.sa/en/content/al-asalah-murabaha-home-finance

3. Alrajhibank. (n.d.). Retrieved May 08, 2017, from http://www.alrajhibank.com.sa/en/personal/home-finance/pages/default.aspx

4. Asian Institute of Finance. (2013). Risk Management In Islamic Banks

5. Staff, I. (2017, March 07). Home Mortgage. Retrieved May 08, 2017, from http://www.investopedia.com/terms/h/home-mortgage.asp

6. Home Finance. (n.d.). Retrieved May 08, 2017, from http://www.sabb.com/en/financing/home-finance/

7. Home Financing. (2017, March 07). Retrieved May 08, 2017, from http://www.myuif.com/financing/shariah-compliant-home-financing/

8. Home Loans – Best Housing Loan & Finance. (n.d.). Retrieved May 08, 2017, from https://www.riyadbank.com/en/personal-banking/homeloan?gclid=Cj0KEQjw6LXIBRCUqIjXmdKBxZUBEiQA_f50PhWHyANzD 9Vr7bhrTN-poBL8jYYUzQkh7kKg5VuFc4UaArZB8P8HAQ&gclsrc=aw.ds

9. Ibrahim, M., & Kamarudin, R. (2014). THE ISLAMIC HOME FINANCING IN MALAYSIA ISTISNA’ BASE ON DEBT: QUALITATIVE APPROACH. Labuan e-Journal of Muamalat and Society,,8.

10. L. (2016, May 23). Islamic vs Conventional Financing. Retrieved May 08, 2017, from https://loanstreet.com.my/learning-centre/islamic-vs-conventionalfinancing

11. {{meta.title}}. (n.d.). Retrieved May 08, 2017, from https://www.souqalmal.com/sa-en/home-loans/ncb-home-finance

Diploma in Islamic Finance Course 2017

The following list of courses were prepared from the relevant institutions website. Please contact the institutions for further detail. islamic finance courses-1

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Islamic banking will benefit Kenyans of all faith  Read more

 

Islamic Credit Cards – An Introduction

Authors

  • Silwan Qurabn (MIFM Graduate Student, Effat University, KSA)
  • Mona Alansari (MIFM Graduate Student, Effat University, KSA)

 

Introduction

1) A Credit card is a revolving credit facility within the credit limit and credit period is determined by the issuer of the card. It is also a mean of payment.

2) The holder of the credit card is able to pay for purchases of goods and services and to withdraw cash, within the approve credit limit determined by the card issuer bank.

At the very start of 20th century people used to pay cash for all the goods and services they buy, In 1920, Oil companies and department stores started offering courtesy cards which were metal charge plates, which holder can use to make purchase but such cards were mainly accepted only by the merchant who has issued them, such card were more like the modern days store cards.

There is famous story of McNamara’s dinner at Major’s Cabin Grill New York restaurant, next to the Empire State building, when McNamara finished his Dinner with his friends and reached into his pocket to pay money for meal and shocked when discovered that he forgot his wallet home, immediately called his wife to bring wallet and he paid bill with embarrassment, but from that Dinner he came up with new idea of credit cards which can be used at multiple locations. Mc Namara and his lunch friends Bloomingdale and Sneider all three pooled money together and created a new credit card company in 50’s named it as Diners Club.

At the very beginning Diners club credit card were given to 200 people mainly the friends, such card were initially accepted only on 14 new York restaurants and such cards were not made up of plastic instead of paper and accepted merchants were printed on the back of paper, just in second year profit was more than $60,000.

Diner’s club card first started as mass acceptance, which enabled the cardholder to spend more than no cardholders, and diners club charged 7% fee on each transaction, which also required holder to payback all amount at the end of each month. Just after one year it has 42,000 members and by 1953 it was the first internationally accepted charge card company, within just 40 years its position was challenged by the other major competing companies such as American Express which first issued the plastic card.

Among the other the most innovative one was bankAmericard started from California, and spread, it was most accepted in California, in later years Interbank card association emerged to smooth the transaction between merchant, bank and cardholder, BankAmericard eventually became Visa, while the inter bank card association letter became MasterCard. Both card got acceptance almost everywhere and later on issuer’s starts adding perks to attract more customers, the entry of discover card further enhanced competition. Up till late 1960 there were no concrete regulation in credit card industry although millions of people were now using this facility, and because of lack of regulation different issuers were charging much different interest rate and there were number of frauds in practices, the first major legal and regulation process started with “The Truth in lending Act and consumer credit protection act, with such acts standardize method of calculating interest introduced. More regulation were added for the consumer protection through the consumer credit protection act. After the 2008 financial crisis, more regulation were added in “the truth in lending act” through the card act of 2009.

 

How Does Credit Cards Work In Conventional Banking?

Conventional credit card system evolved after the Diners Club inc, and American Express. Under the conventional credit card banking system, merchants account is credited by the bank and money is immediately paid to the merchant, while charges are assembled to the credit card holder at the end of billing period, which the credit card holder pays to bank either entirely or in installment with the interest rate also called as Carrying charges.

Credit card is a financial product which is issued by your bank or other financial institution which allows you to make purchase and take cash advance. The main difference between the charge card and credit card is that charge card required you to make full balance payment at the end of month, which credit card allows you to carry balance indefinitely as long as you can make minimum payment at the end of each month.

Credit cards let you to spend money on credit, you can spend up to a limit which is preset when the card is issued, Once you use the credit card, you are required to make a minimum payment every month before the due date and if you are unable and failed to make that minimum payment, then the interest charges will be applied usually charges are applied to backdated when the goods or services is purchased. The best way to avoid any extra charges and using card wisely is to make sure that you are able to make monthly payment, and we can avoid any fiancé charges if we can make full payment back before the 30 days or end of month.

In normal credit card transaction there are three parties involve, 1) card issuer, 2) payment network 3) merchant. Whereas card issuer is your bank, payment network are normally widely accepted, Visa or MasterCard , normally logo are marked on our credit cards, and merchant is the place from where we make purchase, normally merchant has specially bank called acquiring bank which handle the transactions.

For example you finished your dinner in a bank, and swipe your card in a little machine to pay your bill, that machine transfer your information to merchant (Restaurant’s bank), merchant bank use the Visa or Mastercard payment network, receive authorization from the card issuer bank, once card issuer bank accept the transaction it transfer funds to network (Visa, MasterCard) which then sends funds to your restaurant’s or merchant bank’s account. Later on you pay the balance wither as whole or as in monthly installments.

 

How Does Credit Cards Are Structured In Islamic Baking?

In terms of functions and definition, the Islamic Credit Cards are same like the conventional credit cards, the only thing that is avoided and prohibited is Usury or interest rate, and Islamic credit cards are compliant with Shariah and Islamic principle especially regarding the payment of credit cards.

According to Islamic laws, hadiths and Quran, it is prohibited to pay interest on the money which is withdrawn in advance, like this all the additional interest charges of delaying payment is also prohibited, but if credit card are only served as charge card where you pay the principle amount plus the services charges then its allowed and permitted.

Tawarruq, Murabaha, Bay al Inah and Ujrah are widely used in recent Islamic banking, whereas Bal Al Inah means selling goods with immediate purchase, and Ujrah means service charges or charges against the rendering service.

Bay Al Inah involves selling and buy back transaction of assets by the seller, where seller sales asset to buyer at cash and then buy back on deferred payment basis at higher price,  so Bay al Inah is a two parties contract where a person sells commodity on credit at specific price, and then buy back at lesser price for cash, and the difference between that specified price and lesser price is called profit, modern Islamic banking refer that profit as the credit limits.

Islamic credit card are used and allowed only to buy halal goods and services, Islamic credit card cannot be used to purchase anything that is declared haram by the Shariah. The main different between the Islamic credit cards and conventional credit cards are Riba (interest) and Gharar (Overcharging) both are prohibited in Islamic.

Another famous financial instrument concept used in Islamic credit cards is Tawarruq, where the buyer buys a commodity from seller on deferred payment basis, and the sells same commodity to another party at cash or on the spot payment basis. Basically in this way initially buyer is borrowing cash from the bank via initially purchase, like this way in Islamic credit card use customer buy goods or services from bank on cost plus profit basis and then customer resale it on cash basis, so Tawarruq is basically transfer of ownership process and allowed by the shariah.

Ujrah is another concept used in Islamic credit, it’s the fee that Islamic banks charged against the services they render to its customers, so Ujrah is service fee.

 

Islamic Credit Cards Used In KSA

In Saudi Arabia, AlAhli Islamic Credit Card use the Taqarruq as a financial Instrument for making credit transaction, according to this concept as mentioned above customer buys the good or service from Islamic bank at a marked up price to be paid latter then quickly sales the goods for cash, but it is also necessary tangible assets should underlie all the transaction, for example buying a precious metal from bank at $1000 and then selling it to market at $900 cash.

SABB another bank in Saudi Arabia uses Tawarruq (Mal) and Murabah (SAHM) financial instrument for credit lending, where you can get credit up to SAR 1,500,000 with 5 years of repayment period, but the card holder mush be above 21 years and should have minimum salary above SAR 3000.

According to Tawarruq contact you buy a metal from SABB bank at higher price (bank keeps its profit) on deferred payment, and sale it into market for cash at lower price.

According to Murabaha concept SABB bank purchase Shariah compliant share from local stock market and sale you at known fix profit, after buying share from SABB bank you have the option either to invest share in halal investment portfolio or Sale share to generate cash.

Saudi Investment bank is another Islamic bank which issue Silver, Gold and platinum credit cards to its customers, SAIB and SAMBA credit card also works on Tawarruq principle basis as we discuss earlier.

AL Rajhi credit card works on Murahaha finance basis and offers customer flexibility where you buy now and pay later.  Here bank purchase goods such as car, furniture, electronics or any other goods on behalf of customer and then sell it to customer at a profit, and intermediary retain the ownership of the goods until the loan is fully paid.

 

Case Study – An Islamic Credit Of A Bank

United Arab Bank UAE

United Arab Bank in UAE functions on the basis of personal Murabaha Finance solutions which is a contract between the bank and its client, where bank purchase the goods and sell them to client at cost plus profit on deferred payment basis, and client is required to make payment to bank on installment basis, in this way bank can avoid the charging interest rate forbidden in Islam.

An example of Murabah finance is owning a car, for example you have a favorite car and you want to buy it but you don’t have money to pay it off at once, under United Arab bank Vehicle murabaha scheme bank will purchase the car for you can sell it to you at purchase price plus profit margin, and you will pay back money in installment, the benefit of this credit is that you know the profit and total amount which you have to pay to the bank.

 

MayBank Malaysia

Maybank is based in Malaysia and their credit card products are variety of Visa and MasterCards under the name of MAybankIkhwan.

The concept if MayBank Islamic credit card is based on the Bay Al Inah and Ujrah,  Bay al inah is buy back contract , where seller sale goods on credit at higher price and buy back on cash bases at lower price, different between two prices is profit and it’s also the credit limit.

But the problem with such method is that, buying and selling is pre-specified with no risk, which is haram in Islam, plus most of the cases this is only on the paper buy and sale and no actual physical asset is moved.

Because of the above mentioned problems bank also uses the Ujrah as financial instrument, which is basically charges for rendering services.

Like the conventional bank MayBank also has grace period of 20 days. And Maybank Islamic card requires 5% of the outstanding loan as the minimum payment. In case of failure to make minimum payment 1% of the outstanding loan is charges as a fee and then used to help needy people to perform Umrah trip.

References

Tsosie, Claire. “The History Of The Credit Card – Nerdwallet“. NerdWallet. N.p., 2017. Web. 26 Apr. 2017.

“The Incredible True Story Of The Very First Credit Card”. ThoughtCo. N.p., 2017. Web. 26 Apr. 2017.

ZAID, FATIMAH. “The Difference Between Conventional And Islamic Credit Card”. Academia.edu. N.p., 2017. Web. 1 May 2017.

Erol, C., Kaynak, E. and Radi, E.B., 1990. Conventional and Islamic banks: patronage behaviour of Jordanian customers. International Journal of Bank Marketing8(4), pp.25-35.

Jamshidi, D. and Hussin, N., 2012. A conceptual framework for adoption of Islamic Credit Card in Malaysia. Kuwait Chapter of the Arabian Journal of Business and Management Review2(3), p.102.

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http://www.maybank2u.com.my/mbb_info/m2u/public/personalDetail04.do?channelId=CRD-Cards&cntTypeId=0&cntKey=CRD01.34&programId=CRD01-CreditCards&chCatId=/mbb/Personal/CRD-Cards