Dr. Aznan bin Hasan Ahmad Ibrahim Kulliyyah of Laws, International Islamic University Malaysia,...

Dr. Aznan bin HasanDr. Aznan bin HasanAhmad Ibrahim Kulliyyah of Laws,Ahmad Ibrahim Kulliyyah of Laws,International Islamic University International Islamic University

Malaysia,Malaysia,[email protected]@iiu.edu.my

Presentation OutlineRetail Banking?What are the products offered?Prospect and Challenges for further development

Conclusion

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Section 1: What is Retail Banking?

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Retail BankingTypical mass-market banking where individual customers

use local branches of larger commercial bank.Banking for individual customersCommon services include deposit accounts (demand or

non demand) personal financing, house financing, car financing, cards facilities, etc

This very basic definition has evolve to also cover private banking in which a more holistic approach towards banking, asset and wealth management is provided especially to the HNWI

Beyond just providing financing, retail banking scope has evolved to address the entire financial situation of a client.

Including everything from protecting and growing the client’s asset in the present, to planning retirement andpassing wealth on to future generations

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Cont’dPotential for Islamic retail banking is enormous, especially

in countries which have big Muslim population.This presentation will only cover some Islamic retail

products: Deposits Home finance Car Finance Cards facility

Instead of only focusing on the products, this presentation will try to explore on the future prospect in Islamic retail banking

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Section 2: What are the products offered?

- Deposit Taking Activities

- House Financing - Car Financing - Personal Financing - Credit Cards

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In The Nutshell PRODUCTS SHARIAH

PRINCIPLES(LOCAL)

SHARIAH PRINCIPLES(INTERNATIONAL)

LIABILITIES

Savings / Current Acc

Wadiah/mudharabah Wadiah/qard/mudharabah

GIA / SIA Mudharabah Mudharabah

Deposit Tawarruq / wakalah

ASSETS

House Financing / Refinancing

BBA (Bay’ al-’Inah), Istisna’

Murabahah, AIMAT, MM, Istisna’

Vehicle Financing BBA (Bay’ al-’Inah), AITAB

Murabahah, MM, AIMAT

Cash Line Facility / Personal financing / overdraft

BBA, Bay’ al-Inah Murabahah, Ijarah, tawarruq

Credit Card Bay’ al-Inah, Wadiah, al-Qard al-Hasan

Tawarruq, Ijarah

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1) DEPOSIT TAKING ACTIVITIES

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1) Deposit Taking ActivitiesIn Savings and Current Accounts, the

principles used are WYD (guaranteed safe custody), al-qard or mudharabah

Some banks employ both principles (qard, mudharabah) based on certain percentage.

In WYD and al-qard, no return (in whatever form, including the right to enter into contest) can be promised

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Other Alternatives in Deposit Taking ActivitiesTawarruq based DepositWakalah based Deposit

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ISLAMIC DEPOSIT BASED ON TAWARRUQ

BROKER A BROKER B

Depositors Islamic Bank

1Sells Metal“X”

2Pays the purchase price at cost (RM100) on spot

4Pays the purchase price at cost plus

profit (deferred)

3Sells metal “X” at cost plus profit (deferred)

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Sells metal “X” at cost price(RM10

0)

6Pays purchase price at Metal

“X’ at cost price

Rm100 on spot

Invests

WAKALAH BASED DEPOSIT

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DEPOSITORS

BANK

Leverage using:1- Buying and selling share2-Islamic Call Option

1) Fixed Income Securities

2) Commodities Murabahah

3) EtcDeposit

Bank works as an agent to invest the money in specified investment portfolio

2) HOUSE FINANCING

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House Financing

Almost all banks employ BBA (bay’ al-Inah)Several Shariah & Legal Issues surrounding

the application

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Modus OperandiDeveloper

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Bank

CustomerS & P

PPA

PSA

Is this BBA or Bay’ al-’Inah?

Shariah & Legal IssuesIssue of bay’ al-’InahWhat is the asset sold and bought? House to

be completed? Right over the house to be completed?

Full right? Beneficial Ownership? NLC on beneficial & Legal rights?

Is this right saleable? Gharar is excessive. The rate of non

completion is high?

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Suggestions:Real Murabahah (BBA)Istisna’Extended AITABMM

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“Real” Murabahah

What about 10% S & P requirement?Only suitable for completed house.Are the banks and the developers wiling to do

this?

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CLIENT

DEVELOPER

BANK

1 2

5

4

3

Parallel Istisna’

For House under constructionPerformance risk. The bank will be more

selective?Are the banks and the developers wiling to do

this?The practice of Bank Muamalat

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CLIENT

DEVELOPER

BANK

1 4

2

5

3

AITAB / AIMAT

Suitable for both (house under construction and completed)

Forward lease is needed for house under construction

Performance risk. The bank will be more selective?Are the banks and the developers wiling to do this?

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CLIENT

DEVELOPER

BANK

1 4

2

5

3: Bay’ or Istisna’

MM

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CLIENT CLIENT

110

904. Co 0r joint

ownershipDEVELOPE

R

5

2

6

•Suitable for both (house under construction and completed house)•Forward lease must be employed for house under construction•Performance risk in house under construction

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ISLAMIC REFINANCING Sell and buy back (‘Inah Contract)

Notesa) The client will refinance his “asset” to get more money/cash for his

other financial needsb) Part of the amount proceeds (PP) will be used to redeem the

outstanding balance of previous House financing (if there is any)c) New facility will be createdd) Sale transaction has been used to avoid dealing in “money for

money” (compare with conventional personal financing (refinancing)

Client Financier

1. sells asset “x” at RM 1000 on spot (PP)

2. Resells asset “X” at RM 1200 on deferred payment basis (SP)

3) CAR FINANCING

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Car Financing: An OverviewTo purchase car on credit. Two options:

1) Get a financing from the bank 2) Sometimes, dealers have their own

package of car financing.

In conv., the main contact used is either loan given or hire purchase

And all in all, the repayment is based on IR (principal & interest).

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The Islamic AlternativesIn general, the same effect of auto loan in

conventional can be achieved in Islamic finance.

However, various Islamic contracts have been utilised by Islamic banks in their offering of car financing.

Among the most important contracts: - Murabahah / BBA - AITAB / AIMAT / Ijarah wa Iqtina’ - MM

BBA / MurabahahBBA in Malaysia is, in fact, bay al-’nah.In Middle East, some banks use murabahah

as a basis for auto financing, e.g KFH, Commercial bank’s al-Safa Islamic banking (vehicle murabaha)

Simply said, the bank will purchase the car from the developer on cash basis and then sell the car to the client on deferred term basis

The client is not allowed to pay a deposit to the car dealer at all

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AITAB

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It is combination of various contracts.

The bank purchases the car from the car dealer

The bank then lease the car to the customer at agreed consideration (fixed or floating).

Undertaking to sell by the bankTransfer of the asset to the client

Modus Operandi

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CAR DEALER

BANK CLIENT

1. Client identifies the vehicle and pays deposit

2. Client approaches the bank and obtain AITAB

financing facility

3. The Bank purchases the car and pay the remaining purchase price of the car (90%)

4. The bank leases the car to the client at certain rental price (pp + profit) with an option to purchase at the ned of the financing period

©Copyrights reserved Amanie 2006 29

TRANSFER THE ASSET TO THE CLIENT It can be done in various ways.

1) The bank unilaterally promise to make a gift of the asset to the client at the end of the period. (ijarah al-muntahiyah bi al-Tamlik).

2) A promise upon the payment of the remaining installments. (ijarah walqtina)

3) The final payment is considered the price of the car 4) A promise to sell for a token or other consideration

(AITAB). All these contracts must be documented in a way that

shows that they are different contracts all together


Put and Call Option 2 Situations:

Call Option (the right of the client to purchase): Unilateral promise by the bank to sell / give the leased object to the customer.

In case of event of default, the bank has two options:

1) call back the facility and repossess the car2) Put option (the right of the bank to sell). By

requiring the client to purchase the car at an agreed price.


Cont’dPresently, there is no specific Act regulating

Islamic Hire Purchase transaction. Instead all HP transactions are governed by HP Act 1967

New amendment to the HP is now under review. Should surface in the near future.

This amendment is very important as the present HPA does not only allow interest, but also to a certain extent make provisions to HP: Sec 4c. Contents of HP agreement Sec 34. Avoidance of certain provisions


Cont’dPresently, the legal doc for IHP are drafted to suit the

HPA in the following mannerterms charges clause in the 2nd schedule is defined as

rental payment rather than interest chargeslate payment interest – late payment charges. But the

amount?So far, the AITAB financing in Malaysia is in fixed rate

financing.Amendments to the law are made to allow for a floating

rate AITABSome banks have already had their model of floating rate

AITAB


Cont’d

Some have added flavour to the AITAB. E.g. Hong Leong HP Reward Financing-I, where one-time Cash reward of 0.5% of the financing amount is paid to the qualified customer on the 7th month from the funding date.


Musharakah MutanaqisahSCB (Pakistan) Islamic Auto Financing:

MusharaCarIt is a partnership whereby a financier and

his client participate in the joint ownership of a car. It is understood that the client will purchase the share of the financier gradually over the life of the transaction, thus increasing his own share until all the share of the financier is purchased by him so as to make him the sole owner of the property.

Modus Operandi

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CAR DEALER

BANK CLIENT

1. Client identifies the vehicle and pays 10% contribution

2. Client approaches the bank and obtain MM

financing facility

3. The Bank pays the remaining purchase price of the car (90%) as its contribution

4. The bank leases the car to the client at certain rental price . The client will also purchase the bank’s share gradually according to agreed method. At the end of the period, the car belongs solely to the client

4) PERSONAL FINANCING

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Personal Financing

The nature of personal financing liquidity.Though it may be used for acquiring asset, it

is largely considered for cash purposes.As such, the financing mode to be used must

have the ability to provide cash.For the time being, the most suitable principles

to provide the facility are bay’ al-’inah & tawarruq

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TAWARRUQ FOR PERSONAL FINANCING

Bank

Client Com. Broker B

Com. Broker A

Sells commodity

Pay cash

Sells

com

m. P

ay d

efe

rred

Sells com

Pay cash

Explanation:1) Bank obtains promise to buy from clien2) Bank buys commodities from broker A and pays cash3) Bank sells the commodities to client on deferred basis.4) The client authorises the bank as his agent to sells the commodities to commodities broker B on cash. 5) The amount will be deposited into client’s account. Client obtains liquidity and has liability to pay bank on deferred basis.6) Client will pay the bank on deferred basis, according to their agreement• This model has been used by Islamic bank in

Middle East to provide personal financing (personal loan) to their clients.

• E.g. al-tawaruq al-mubarak finance (Arab National Bank –Saudi Arabia), al-Khair financing (Abu Dhabi Islamic Bank- UAE), Amanah Personal Financing (HSBC Amanah), tasaheel (al-Manar – Kuwait)

Cash Line FacilityThe principle use is bay’ al-Inah and the

procedure is the same like personal financing.The cash proceeds, however, is not disbursed

directly to the client, rather it will be deposited into client’s account as cash line facility.

Client can utilise the line for cash facility.Profit is only charged on the utilised amount and

the remaining will be rebated.Repayment of the facility can be on lump sum

payment at the end of financing or on yearly reduction limit, or any time frame agreed between the client and the bank

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5) CREDIT CARD

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Credit Card FacilityBIMB, Ambank and BSN use combination of

bay’ al-’Inah, wadiah and qard in providing the facility.

Normally, the asset used for bay’ al-’Inah is the shares certificate of a land belongs to the Bank

Most Middle Eastern Banks use tawarruq for the facility

KFH uses AIMAT for its credit cards. But this can only be use to purchase asset which are leaseable

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Credit Card based on Bay’ al-inah

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Credit Card Account

BANK CLIENT

4. Client utilises the facility.

1. Client approaches the bank for credit card. The bank sells

the bank’s asset at selling price (PP + p)

3. The purchase price will be deposited into the client’s wadiah account, to be utilised as credit limit.

2. The bank purchase back the asset at purchase price)

Credit Card based on Tawarruq

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Bank

Broker A

Client

Broker B

1. Bank purchases

commodity at pp2. Bank sells the commodity at sp (pp

+ p)

3. Client sells the commodity at pp.

4. The proceeds will be deposited into the client’s credit card account to be utilised as his credit limit

Credit Card Account4. Manage the

facility

Credit Card Based on Ijarah

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Bank

Client

Merchant

1. Bank identifies suitable merchant

2. Bank appoints client as agent to purchase the durable goods from the merchant

3. Client purchases goods as an agent for the bank

4. Bank rents the durable goods to the client on AIMAT basis and the client will pay rental accordingly

Credit Card based on Ujrah

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Bank

Credit Card Account

Merchant

Client

1. Bank opens the account

and determines credit limit

2. Client purchase goods from merchant and pays using credit card

1. Credit card facility

Pays fees (ujrah)

6) FINANCIAL CONSOLIDATION

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Financial Consolidation Offered by some banks.Utilises bay’ al-’Inah conceptSpecially targeted to individual clients who

are facing very tight cashflow due to excessive financial obligation.

In normal circumstances, the maximum obligation should not be more than 75% of monthly gross income.

This facility will try to consolidate all the financial obligation of the client (like HF, CF, PF,CC etc) into less financial obligations.

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Cont’dTwo methods are normally employed:

1) Refinancing the client’s asset, e.g. house to get cash to pay other financial obligation.

2)Getting new personal financing. By doing this, the client will be able to reduce

the amount of monthly installment, though extending the period

Depending on situation, financial consolidation will make client’s cash flow more liquid, healthy and affordable.

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SECTION 3: PROSPECT AND CHALLENGES FOR FURTHER DEVELOPMENT

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1) Challenges In Offering Deposit Products The nature of loan in wadiah yad al-dhamanah & qard:

The practice of hibah, it is really indicative?The nature of the term deposit in certain jurisdiction,

e.gUK: “Art. 5 (Paragraph 2) of the Financial Services

and Market Act 2000 (Regulated Activities) Order 2001 (as amended):

…. ‘deposit’ means a sum of money.. Paid on terms-A) under which it will be repaid, with or without interest or premium, and either on demand or at a time or in circumstances agreed by or on behalf of the person making the payment and the person receiving it…”

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Case Study: UKIBB’s terms for deposit accounts (para. 6) try to

bridge this issue:“…..6.3: As a matter of English Law (which applies

to these special conditions ) and in accordance with our Memorandum and Articles of Association, in the event that your capital suffers a loss, we shall seek to mitigate the loss in the following manner:

6.3.1. We may forego some or all of the fees chargeable by us in respect of the investment of the pooled funds for the calculation period relevant to your account(s).

6.3.2: We shall draw upon any available balance in the profit stabilisation reserve account administrated by us to make good as much of your capital loss as the available balance permits us to do so

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Cont’d

6.3.3: In accordance with our Memorandum and Articles of Association, our directors are prevented from declaring any distribution to our shareholders unless they are satisfied that there is no shortfall in meeting your claim (s)

6.4: If the pooled funds referable to your capital return a loss, we shall make an offer to you to make good the amount of any shortfall that you may have suffered. We are required by current UK bank regulations and policy to make this offer to you. If you choose to accept this offer, you shall be entitled to receive payment from us of the full amount that you had previously deposited with us. You are entitled to refuse this offer from us.

6.5: We would like to draw your attention to the guidance offered by our Shari’a Supervisory Committee. Their guidance is that if you accept our offer to make good the amount of any shortfall (set out in special condition 6.4), you will not be complying with Shari’ah principles.

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Cont’d6.6: In certain circumstances, we may not be able to pay back to

you the amount that we are obliged under these terms and conditions to pay back to you. If the terms of the Financial Services Compensation Scheme (FSC) apply in these circumstances, you may be able to apply to the FSC for payment of compensation

6.7: If you have suffered a loss in respect of which we have made an offer to you which you have accepted (see special condition 6.4), you may be able to apply successfully to the FSCS for payment of compensation if we fail to make payment to you in respect of that loss, If you have refuse such an offer from us, you may not be able to apply successfully to the FSCS for payment of compensation in respect of the amount that was previously refused by you

6.8: Should you suffer a capital loss due to fraud, gross misconduct or gross negligence committed by us, then we may be obliged, in accordance with Shari’a principles, to make good to you any such capital loss on your savings or term deposit account out of money held by us on behalf of our shareholders

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2) House Financing FacilitiesMost suitable alternatives are MM and Ijarah

Muntahiyah bi al-tamlik.Easy even for refinanceAt present, most banks have the product or in

the course of getting approval for the products.

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3) Finding Alternatives for Personal Financing The nature of personal financing: To obtain cash

instead of acquiring certain assetIn certain circumstances, acquisition of asset

cannot be effected using other instrument rather than bay’ al-inah, simply because the asset is not financeable due to restriction by law, e.g. financing the acquisition of land / construction of house, without individual title to the land.

In some banks, personal financing is offered indirectly, e.g al-Rajhi in Car Financing

Should tawarruq be considered as an alternative?Tawarruq is another controversial principle?

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SuggestionDetermine the needs of the clients. Cash money,

commodities, services, etc.Decide on the structure based on the needsFor asset to be acquired, various structures can be

used like murabahah (BBA), AITAB, MM, Salam, Istisna’

For services, we can use ijarahFor cash money, Tawarruq? Since the resolution of “muzakarah Ulama Nusantara”

organisec by Bank Negara resolve that the two contracts should only be utilised when no modes of financing are available, then their use should be limited to the situation where cash is the purpose

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Case Study: Dubai Islamic BankDubai Islamic Bank has offered Islamic

personal financing The product structure is based on Islamic

financing principles of Ijarah (for services) and Murabaha (for automobiles and goods

Focus here is only on services Products offered under the category of services are: House Rent in Advance Medical Treatment Education and Training Travel Services (Tickets and Travel Packages, Haj and Umrah) Event Hall Services (Marriages and other functions) Hiring of Professional Service

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Modus Operandi

Case Study: Education financeClient selects the UniversityApplication for financing from the bankThe Bank will buy the education service from the

schoolThe Bank then leases the service to the clientThe client will pay back to the bank in monthly

installment basis. Q: Can we use murabahah for this

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Client BankService Provider

Pay rent

Hire Service

Provide Service

Buy service


4) USING NON-CONVENTIONAL BENCHMARKLARIBA Retail Financing, applied in house and

Auto FinancingUsing the concept of lease to purchase. However,

the concept used is actually MM. Reference to the payment is not interest-based.Rather it is marked to market. How?In case of car financing: calling around to find the

monthly rental rate of a similar auto at the car dealer or or the rent-a-car agency utility value of the vehicle

May be difficult to be implemented due to variation in rental, even in one country or state.

ConclusionThe prospect for retail financing is very huge.Studies have shown that in difficult situation, the retail

banking is the last segment of banking that will be effected.The purpose of retail financing is basically to meet the needs

of clients.As the needs of clients are different, depending on various

factors, such as standard of living, age, life styles, purposes etc, the range of retail financing offered must be wide and competitive.

The first and foremost, all the products must comply with the Shariah and this poses another challenges as the determination of Shariah compliance is also different in certain products.

So, offering products that are acceptable globally should be one of the priority in product structuring and enhancement

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THANK YOUWASSALAM

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Dr. Aznan bin Hasan Ahmad Ibrahim Kulliyyah of Laws, International Islamic University Malaysia,...

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