Contracts In Islamic Banking
By : Ust Hj Zaharuddin Hj Abd Rahman
Islamic Banking products in recent years have proliferated into a dynamic and popular subject in the banking industry, demonstrating the creative, innovative and enthusiastic works from the Islamic Banking practitioners and Shariah Scholars. In the mean time, the role of Shariah advisors has become crucial to ensure that all the products introduced are Shariah compliant. Approval and verification from the Shariah advisors on the concepts, products structures and applications is deemed compulsory before the products are being released into the market.
One of the vital aspect which, need to be carefully scrutinized is the aqad (contract) and legal documentation of the products. Contract in Islamic business is the measure of transaction validity. It can be equalized to an intention (niyah) put for an action, which differentiate the action whether it is to be considered as a ritual practice or custom, and which will bring either rewards or sins.
A contract can also be regarded as the root of an Islamic business where it determines the components of the business in which if it is void or dubious, it will invalidate the contract and ownership entitlement of subject matter i.e. asset/property in a transaction as well as the profit resulted from the transaction.
Other than the accurate Islamic concept, which is being used in a Banking product, a contract play the main factor in determining the lawfulness of a transaction, whether it is halal or haram. The concepts and structures, which are previously approved by Shariah can suddenly change to haram if there is any flaw in the contract.
Islamic banking today is dealing with a lot of contracts and documentations in daily transactions with regard to the financing, deposit and investment products. In order to ensure that the transactions has been documented in accordance with Shariah, some crucial aspects need to be taken into account, as follows:
- Accurately determining the types of contract (aqad),
It is crucial in order to:
- Justify the business types and also to have a clear picture on the Shariah approved manner when conducting the business transaction.
- Verify full adherence of an Islamic concept (which is used in the product) tenets, conditions and rulings in a contract (aqad). For example, the fund invested in the saving account, which is done on the mudharabah basis, is to observe the mudharabah conditions and rulings accordingly, thus in Mudarabah the capital and profit cannot be guaranteed by the bank, and if these conditions are infringed, the contract is nullified. Following this, OIC Islamic Fiqh Academy in its 9th Conference had decided that a guaranteed capital is only allowed on the third party and must be made separate from the original Mudharabah contract. The same verification applies to other business activities such as Musyarakah (partnership) and Ijarah (leasing) in which each must fulfill the conditions of contract underlies.
Therefore, all contract and legal documents must fulfill all these conditions and rulings. Without delicate inspection into this matters, a contract might turn to be void (fasid) and consequently, all the money invested and all the profits gained are considered as unlawful, thus be regarded as invalid or doubtful.
Therefore, Islamic terminology used in all Islamic products must be made well known to public in order to inculcate the understanding of the concepts employed.
- Contract Content
The contents, terms, and conditions included in a contract, as well as the choice of words or sentence structures must be revised from the Shariah point of view. This is to ensure the conveyance of the right message, which in today common practice does not hold true. This is because, even though a products concept has been approved by Shariah Council, the documentation of the contract, agreement, and regulations are still been outlined by the Bank and lawyers who might not have deep experience in the Shariah concept, resulting in severe mistakes and deviation from actual meaning.
An Islamic name without the exact Islamic content is still not acceptable and invalid in the Shariah view. Other than that, it is also learnt that there are some improper words in current Islamic banking legal documents which could lead to confusions, it is actually cannot be used in Islamic banking document, such as repayment, loan, borrowing, draw down etc. Therefore, all legal documents e.g. Letter of Offer, Sale and Purchase Agreement, and Master Facility Agreement must gone through a meticulous, exhaustive content screening by the internal Shariah officers and external Shariah Advisors.
Contents of Legal documents which invalidate the buying and selling contract are those contravene with the interest (Maslahah) of the contract such as conditions:- the buyer cannot use a certain part of an asset bought, lessee must gain continuous benefits from a leased asset etc. Majority schools of Islamic scholars are in mutual verdict that had any of these kinds of conditions be included in a contract, it will automatically invalidate the contract.
- Sequential Rules in Executing Contracts
Another aspect that unnoticeably can nullify a contract is the setting up of a contract without following the exact sequence of time, place, documents sign-off etc. In Islamic Banks current practices, e.g. Bai Bithaman Ajil contract (BBA) needs a correct sequence on the agreements execution. This means, Letter of Offer (LO), Master Purchase Facility (if any), Asset Purchase Agreement (APA), Asset Sales Agreement (ASA), Power of Attorney (if any) and many more must be executed in a correct order and sequence. If this is not been taken care of, the bank might be mixed up in selling something, which is not yet in its possession.
Regarding this, the Prophet PBUH had said:
Do not sell something, which is not belongs to you. (Narrated by At-Tirmidzi)
Moreover, a more complex structure of products such as Parallel Istisna, Ijarah Muntahiyah Bit Tamleek, Diminishing Musharakah, Islamic Sukuk etc will involve in a much difficult problems arising from sequence matters if it had not been observed from the very first stage.
- Two Contract in A Contract.
The Prophet PBUH had strictly prohibited two sales proposals in one contract. Accordingly, this issue has been the central attention of Muslim scholars since decades. For example, a combination of selling and buying contract together with leasing contract or seller offers two different selling prices and buyer sign-off the purchasing agreement unspecified of the price he/she had chosen. These kinds of matters need critical attention so that one will not transgress the border set up by Allah.
As we know, Islamic Banks deal with a lot of contracts in their products in line with Shariah requirements. In relation to this, a high stamp duty costs had raised some questions to both customers and the Islamic Banking practioners. As a result, the Government has introduced Tax Neutrality clause, which can be benefited in Islamic transactions. It is certainly good for the Islamic Banks but the critical requisite now is how to stir Islamic bankers, lawyers, government tax officers and other related parties to be more alert and aware on the handling of stamp duty and other tax treatment for this Islamic transactions. If the true understanding cannot be attained, Islamic banks will face difficulties to be a major player in the future, and it is definitely contradict with the governments target to be a Global Islamic Banking and Finance Hub.
In conclusion, in order for Malaysia to become the global Islamic banking hub, regulators, Islamic banks, Shariah practitioners and lawyers should jointly make a paradigm shift from a solely adapted conventional banking product, system and mentality to a truly originate Islamic banking base products and system. This therefore indicates that we should not just merely focus on the Islamic names and innovative product structures but to ensure that all contracts and legal documents are valid from the Shariah perspective.
* Writer is a Shariah Compliance Manager, Product Development Division, RHB Islamic Bank Berhad. He holds B.A (Hons) Usuluddin Malaya University and M.A(Hons) Al-Yarmouk, Jordan