IB1005
DEPOSITS AND FINANCING PRACTICES
OF ISLAMIC FINANCIAL INSTITUTIONS
CHAPTER 8 : INTEREST-FREE PERSONAL
FINANCING
COMPILED BY
HAMDAN HJ IDRIS, BSc Econs, MBA (Islamic Banking & Finance)
Certified Professional Trainer (MIM)
Industry Expert
INCEIF
PRESENTED BY
HJ MAHMUD HJ BUNTAT, MBA (AUOL, UK), DBM (Swansea Inst., UK), CIL (UIA)
Part-time Lecturer (INCEIF)
Former Head of Islamic Banking Division, OCBC Bank (Malaysia) Bhd
Chapter 8 : Interest-free Personal
Financing

In this chapter, the concept of Islamic loan is first
examined.

Then, it looks at existing personal financing
facilities offered by many Islamic banks such as
bay al-‘inah, tawarruq and ar-rahn personal
financing.
Qardu Hassan

In Islam, qardhu hasan or benevolent loan is not
a loan for commercial use.

It is strictly a loan for personal use.

Qard means loan while hasan implies good or
benevolent.
A qardhu hasan loan, therefore, expresses the
spirit of cooperation (ta’awun) and brotherhood
(ukuwah) between debtors and creditors.

This is because the creditor expects nothing in
return for the use of the loan

All he needs is the repayment of the loan in full.

The debtor holds obligation to return the
principle loan.

The debtor can also place a collateral (rahn) to
support the loan.
•
When there exists severe reminders against loan
defaulters, Prophet Muhammad S.A.W.
encouraged borrowers to pay more than the
principal loan.

The addition sum, however, are not contractually
mentioned in the loan agreement
•
Narrated Jabir bin 'Abdullah: I went to the
Prophet S.A.W. while he was in the mosque.
After the Prophet S.A.W. told me to pray two
Raka'at, he repayed me the debt he owed me
and gave me an extra amount.

On another occasion, the Prophet s.a.w. says,
”the best amongst you is he who repays his debts
in the most handsome manner’’ (al-Bukhari).
•
The extra payment was not made contractually
binding but released according to the paying
capacity of the borrowing party and most
important his willingness to give more.



In a society that upholds sadeqah as a virtue and
noble action, a debtor is expected to give the
creditor a hibah for the following reasons:1. The debtor is thankful for the loan given by
the public.
2. The debtor is concern that inflation may cut
real value of principle loan.
3. The debtor understands that the creditor
suffers loss of opportunity to earn alternative
income if monies are invested elsewhere.
4. The debtor is an individual with iman and
taqwa.
BAY AL-’INAH
•
Bay al-‘inah is a sale with a repurchase or buy-back
agreement between two parties,

Usually, bay al-‘inah is applied to provide cash advances to
customers. It is deemed valid by some jurists since the
cash advances were made possible by virtue of a sale
agreement and not a loan.

In this manner, bay’ al-‘inah is sometimes viewed as a
legal device (hilah) to circumvent the prohibition of riba.
TAWARUQQ
•
Tawaruq is a three party contract whose
objective is to provide cash advances to the
customer (mutawariqq) while providing profits to
the financier, usually an Islamic bank.

It is a sale and resale contract involving a third
party. It is used by some Middle-east Islamic
banks.
The transactions are explain as follows:
Mr. Ismail is looking for $50,000 cash to pay off
his debt. He saw an on-line advertisement of alSafa bank offering the tawarruq facilities. He
sent the application documents to the bank for
approval processing. Let’s assume that his
application has been successful with full amount
at 10 per cent profit rate per annum payable in 3
years.

To expedite the transaction, al-Safa Bank sells
Asset Y to Mr. Ismail for ($50,000 + [0.1 x
$50,000 x 3] = $65,000 with payment on
deferred basis. Mr. Ismail pays the bank
$65,000/36 a month for 36 months. This is the
murabaha contract. We call it the asset purchase
agreement (APA) between Mr. Ismail and the
bank.

To acquire the $50,000 cash, Mr. Ismail has to
sell Asset Y to company ABC. Usually the
company ABC has business relation with al-Safa
Bank where the former will buy Asset Y from alSafa Bank’s tawarruq customers.

Here, company ABC pays Mr. Ismail $50,000 in
cash in return for Asset Y. This is the asset sale
agreement (ASA) between Mr. Ismail and
company ABC (i.e the third party).

The above structure is known as tawaruq munazzam
(ie organized tawarruq). This form of tawaruqq is
found unlawful by the Fiqh Academy of Mecca. It says
that tawaruqq is only permissible when the third
party is independent from the 1st party (ie the bank).
This is important to avoid any form of guarantees
that Mr. Ismail can sell Asset Y for $50,000.

In trading, price is set by market forces, Tawarruq
munazzam shows that there is some form of price
rigging to secure the $50,000 sale price.
(AL-RAHN)
PAWN-BROKING BUSINESS

What then is Islam’s alternative to interest-based
pawnbroking? Islamic law offers a commercial
contract known as Ar-Rahn Scheme (Islamic
Pawn Broking).

A customer can place an amount of gold with the
bank for safe-keeping (wadiah yad dhamanah)
and receive an interest free margin of advance
(qardul hassan) with the gold being held as
collateral (ar-Rahn) for a tenor of up to 6
months, with 2-month extensions thereafter.
WORKFLOW OF AL-RAHN
Qardhu Hassan
$4,000
Borrower
Pledge
$4,000
Islamic
Pawn-Broking
(Lender)
Rahn
$5,000
Al-Wadiah Amanah
Custodial Fee
($4,000/$100) x 2% x 5 = $40
A pawn-broking operation is relatively straight
forward:
The borrower simply needs to place a pledge or
security for the amount of debt needed.

For example, the pledged asset is a gold ring
valued at $2,000.

Should the customer not redeem the facility on
maturity including the fees (ujrah) charged for
safe-keeping, then the gold will be retained by
the bank.

Thus, for gold valued at RM2,000 the margin of
advance is RM1,000 and the relevant fees are 50
cents per RM100 in the value of the gold – this
RM 2,000 / 100 x 0.5 = RM10 per month.

Given that interest (riba) is not implicated in the
rahn pawn-broking business, how would a
company running an Islamic pawn business
(murtahin) make money?

The answer is simple. Profits take the form of
storage fees charged on the pledged property.
There is a standard formula how these fees are
determined. For example, in the case of a
pledge valued at $1,000, the pledger (rahin) is
required to pay a storage fee, say a percentage
of the total value of the pledge.

According to Bank Rakyat, a pledge valued at
less than $1,000 will cost the rahin (1,000/100)
x 40 sen or $4 a month. Normally, only about
half of the pledge value is given to the rahin as
an interest-free loan. Thus, a $500 loan payable
in 6 months will incur a storage cost of $4 x 6 =
$24.

On failure to pay the loan after a prolonged reminder,
the operator holds the right to put the collateral on
auction.. The rahn company will claim loan plus
storage fees due to them. The surplus therein will be
returned back to the rahin.

In case he cannot be located, the proceeds will be
forwarded to the bait-ul-mal from which the rahin is
entitled to make future claims.

At the end of the term, the rahin will pay the
murtahin $524. The rahin can ask for periodic loan
extension provided he pays an additional storage fee.

In case he cannot be located, the proceeds will
be forwarded to the bait-ul-mal from which the
rahin is entitled to make future claims.

In fact, al-rahn can be a better alternative to
finance stocks purchases compared to credit
cards and share-financing loans. At least the
money an individual obtains via al-rahn is backed
by productive assets.

The pawnee (murtahin) is not entitled to use the
collateral (rahn), for his right is only in the
possession of the pledge and not in its use. If
the company uses the pledge for its own benefit
without informing the debtor and then incurs a
loss, it takes full liability for the loss incurred.
SHARE PURCHASE FINANCING

Share margin Financing-i is an alternative to
conventional Share Trading Financing based on
Murabahah.

Under this contract, IFI agrees to finance the
customer’s share trading activities in approved
Shariah counters listed in Bursa Malaysia

Murahbaha share purchase involves a fixed
return, whereby the shares are acquired by the
bank and re-sold to the customer for deferred
credit price.

Additionally, stocks deemed Shariah compliant
involve a qualitative and quantitative analysis,
which necessitate financial screening.

For share margin financing, the Selling Price rate
is capped at the murabahah profit rate, so that
customers avoid fluctuating rates over period of
the financing.

The financing tenure is typically between 1 and 5
years, with a minimum of RM 50,000.
 Have
a good day 
 May God bless you
 Thank you and Wassalam