CONTRADICTION CONCEPTS IN AAIOFI WITH ISLAMIC BANKING

Running head: CONTRADICTION CONCEPTS IN AAIOFI WITH ISLAMIC BANKING

Contradiction concepts in Islamic Banking in Malaysia Nor Alina bt Abdul Latip International Islamic University Malaysia

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Abstract This study investigates the concepts use in Islamic Banking in Malaysia and compares it with guidelines provide by Islamic teachings. It finds that most Islamic banks in Malaysia offer BBA in home financing and Ijarah in car financing as their products. The findings show that concepts of BBA and Ijarah practise in Islamic Institutions in Malaysia are differ from the actual Islamic teachings. The study also reveals that Islamic banks are restricted to the Malaysian requirements in providing their products.

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Page no Abstract Introduction Literature review Methodology Findings Conclusion 2 4 5 7 7 13

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1.0

INTRODUCTION Financial Accounting Organization for Islamic Banks and Financial Institutions is known

as Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). It was established in 1991 (AAOIFI, 2007, p.8). AAOIFI standards are drawn from Islamic teaching. The standards free from three important concepts that are used in conventional institutions which are interest, ambiguity and gambling. These standards help investors or depositors especially among Muslims to invest or deposit their funds in shariah compliance institutions. AAOIFI standards are the best in terms of Islamic shariah principles. Islamic finance is becoming more popular even with non-Muslim investors. Today, Islamic banks are operating in more than 50 countries for example Bahrain, France, UAE, Malaysia, Japan and many more (Abdullahi, 2010, p.12). There are arguments, made by Paxford (2010) saying that Islamic banks are less competitive compared to conventional banking. It is because Islamic banks have no unified Islamic banking body that would create rules and bind all Islamic institutions. This is supported by Mokni (2010) found most countries do use different type of standards. For example, Malaysia uses International accounting standards and Pakistan has adopted supervisory standards. This is different from what Abou-El-Fotouh (2010) found in his study. He found that it is a common myth among people to say Islamic banking system operates under loose regulatory oversight. The reality is Islamic banking is well-regulated and follow defined standards AAIOFI and International Financial Service Board (IFSB). In researcher humble opinion, it is not wrong to have different standards as long as it does not contradict with Al-Quran and Sunnah. It is because we have different kind of Mazhabs. If we look back at all the Mazhabs, we will notice that even

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if sometimes they have different opinions about something, their opinions are still based on AlQuran and Sunnah. The objective of this paper is to highlight concepts that are contradicting between AAOIFI and Islamic banking in Malaysia as identified in a previous study (Abdul Latiff, 2001). It will help to give a clear picture on the Islamic systems that are practised in Malaysia. 2.0 2.1 LITERATURE REVIEW Malaysian Islamic banking studies A few interesting results were found in the study of issues in financial reporting of Islamic banks, realised by Radziah (2001). She found that a Malaysian requirement in reporting is different from AAOIFIs requirements. One of the reasons why Malaysian requirement differ from AAOIFI is because all banks in Malaysia need to follow the guidelines which are provided by the Central Bank. The findings show that the guidelines are originated from International Auditing Standards. It is supported by Mohamed Ibrahim (2009) that International Auditing Standards does not really comply with Islamic shariah. International Auditing Standards are originated from the West. Therefore, they have different ideologies in developing the standards which are different from Islamic rulings. The Westerns are capitalised economy which focuses on transactions which concentrate wealth in the hands of few, for example interest and gambling. They own more money at the expense of others (Usmani, 2002, p.3). However, Islamic CONTRADICTION CONCEPTS IN AAIOFI AND ISLAMIC BANKING economy is prioritized in clarity and lack of ambiguity. Besides that, Islamic economy also focuses on just, fair treatment and care for the rights of others (Ayub, 2007, p.12). In researcher

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opinion, the Islamic institutions need to have additional requirement in addition to the existence standards. The standards that they use now are not enough to fully cover the Islamic requirements. Home financing for Islamic banking in Malaysia uses the concept of Bai Bithaman Ajil (BBA). There are arguments whether Islam permits this concept or not since it is still a new concept. Through the study done by Siti Salwani (2008), she found that there is principle of gharar (uncertainty) in Bai Bithaman Ajil. The study finds that the gharar involves for the house under construction since the subject matter is not exist when conclude the contract. Likewise, Kameel and Dzuljastri supported that BBA concept is contradicting to Shariah teaching. One of the reasons is because Central Bank has allowed a floating-rate in calculating customers monthly instalment. The floating-rate is usually based on conventional interest rate. If the conventional banks charge lower interest rate than Islamic banks will also lower their profit charge and vice versa. Conversely, from the study found by Talib (2000) the profit charge by Islamic Bank is merely the difference the cash price and deferred payment price. It is actually depend on the bank how much they want to mark up from the original cost of the asset since it is based on sales contract. On the other hand, the researcher finds that it is not enough just to depend on what the Islamic Bank wants to charge the customers. In order to be fair and just to customers, the bank should disclose on how they calculate their profit margin. By doing so, it is actually promote transparency which is required by Islamic teachings. Most of Islamic banks in Malaysia apply al-Ijarah Thumma al-Bay (AITAB) for car financing. The main issue with AITAB is the limitation of Islamic bank to fully use the concept. Malaysian requirement has imposed condition on all banks to follow Hire-Purchase Act 1967 for car financing (Abdullah & Dusuki). The Act is suitable for conventional banks not Islamic

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institutions since the Act involves calculation of interest in the instalments. The researcher strongly agrees with the prior study since it is the serious problem of why Islamic banks in Malaysia cannot fully follow Islamic requirements. The Malaysian government has imposed many restrictions to banks regardless whether in is Islamic banks or not. The restrictions are good to standardize the banks, however the restrictions should be adjusted accordingly in order to be practically use in Islamic banks. 3.0 METHODOLOGY For this study, the researcher managed to conduct face-to-face interview with AmIslamics bank officer to find out more on how they actually practise Islamic products and become a primary resources for this paper. Using this method, the researcher is free to ask questions which seem appropriate to this topic. From the interview, useful insights and suggestions were obtained. The interview session had taken roughly 1 hour. It was recorded on audio thumb recorder and was then transcribed into words to further support the analysis. As for the secondary resources, the researcher focused on library research as a method of collecting data. There were number of journals, books, and internet articles used as references. 4.0 4.1 DATA ANALYSIS Al-Bay Bitahaman Ajil (BBA) operation When a customer wants to acquire a house but does not have the fund, he has the option to take conventional home financing loan or Islamic BBA. BBA is different from conventional home financing loan because BBA is a trading contract while conventional loan merely give out money and in the future they get back their money with extra amount. The BBA contract works between the buyer (customer) and the seller (bank). Before any trading can happen, the bank

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needs to buy the house first, then only can sell it to the buyer at cost plus profit margin (Talib, 2000). The house is delivered immediately but the price of the asset is paid over an agreed period by instalments (Meera & Abdul Razak). For example, Ahmad wants to buy a house. Ahmad then approaches Islamic financial institution and identify the house. The bank needs to buy the house since the shariah requires the bank to obtain the ownership over the house before it can sell to Ahmad. After the bank possesses the ownership of that house, it then sells the house to Ahmad at a cost plus profit margin by instalments. Meera & Abdul Razak, also opined in Malaysia context, on the situation happened in 1996, if the customer wishes to buy a house, he must put a downpayment of 10 percent of the overall price. The bank then enter BBA contract with customer for another 90 percent. The bank pays the developer based on 90 percent of the price and sells back the asset to the customer. From the researcher findings, the scenario is still applied in Malaysia. The customer is required to pay the deposit of 10% to the developer. For example, if the price of the house is RM300,000. The customer needs to pay RM30,000 to the developer and the remaining balance the bank pays it first. The bank percentage of the ownership is transferred to the customer based on the accumulated amount the he pays. For example, for the first year the bank owns 90% of the house and 10% belongs to the customer. During the second year, 80% belongs to the bank and 20% to the customer. It continues until the house is transferred to the customer 100%. This is one of the issues regarding Islamic practise in Malaysia. The house is not belong to the bank since the bank only hold 90% ownership of that house. Other issue also arises when it involves house under construction or house is not exist yet during the conclusion of the contract (Razali, 2008). In relation to the house under construction, it is involves the element of uncertainty. Any products offer by Islamic banking should free from riba (usury), gharar (ambiguity) and maisir (gambling) (Mohamed Ibrahim, 2009). These are the

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key points that differentiate Islamic banking from conventional banks. According to Razali (2008), a contract for under construction is ambiguity because the subject matter does not exist. The sale contract is considered valid once the subject matter exists at the time of the sale and owned by the seller (Saleem, 2010). For example, if a person wants to buy a house, the house must already exist. The house is what referred to as subject matter. The reason behind why existence of subject matter is important because the purchaser can see, touch and evaluate the house. Islam wants every transaction free from gharar and fraud. When the house is under construction, it creates uncertainty since the buyer does not know when it can be completed. Another issue regarding house under construction is that the purchaser needs to pay some amount of money for the year the house is under construction. From the interview, the researcher is informed that the customer needs to pay 4% annually for a period the house is under construction. For example, a customer enters BBA contract to finance a house which is under construction. Based on the agreement, the house is expected to be completed in 2 years and the amount the customer needs to pay is RM300,000 by instalments of RM2,000 monthly. For the first 2 years before the house is completed, the customer is required by the bank to pay 4% as a profit charge to the bank. The charge for the first 2 years impose by Islamic banks in Malaysia is the same concept used in conventional banks. The only different is that conventional banks identify the charge as interest while Islamic banks recognize it as profit charge. It is definitely contradicting to Islamic teachings as Islam does not recognize the profit charge to the customer. Since Islamic banks in Malaysia provides BBA contract for a house which still under construction, another issue can arise. What happen if the construction is not able to complete in 2 years? The bank officer informs the researcher, the customer still needs to make payment as if

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the house is already completed. From the above illustration, Ahmad needs to pay RM2000 even though the house is not able to complete after 2 years. He explains further the reason why this situation happens is because the customer is abided by the contract. Since the agreement mentions the customer needs to pay the instalment after second year, the customer is obliged to pay although the house is not completed. It is clearly shown that Islamic banks in Malaysia do not actually follow the Islamic requirements since the banks charges 4% to the customer for number of years the house is under construction. This situation creates controversy because the Islamic banks function more like a lending channel. The Islamic banks still get back their money at the expense of the customer. If something happens to the project, for example, the construction company run away and abandons the project, the bank leaves the problems between the constructor and customer. This issue can be avoided if Islamic banks in Malaysia restricted the BBA contract to completed house only. Al-Rajhi Bank, for example only provides house financing to a complete house. The concept the Al-Rajhi Bank uses able to eliminate all negative issue regarding Islamic home financing.

4.2

Al-Ijarah operation Conventional banks do use hire-purchase as one of their products. However, conventional

hire-purchase is not in line with Islamic teachings since it is involves element of riba in calculation of term charges. As a solution, Islamic principles have already developed Islamic guidelines for Islamic hire-purchase known as Ijarah. In Islamic banking, Ijarah refers to a leasing contract of properties, equipments and extra (Mohamed Ibrahim, 2009). Islam recognizes Ijarah as a trading contract. It is considered trading because the buyer buys from the seller the usufruct of a thing in return for compensation (Saleem, 2010). In Islamic perspective, Ijarah

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transactions can only take place when the seller is the owner of that thing. In theoretically, if a customer wants to buy a car, he can go to the Islamic bank and engages Ijarah contract. The bank buys the car from a car dealer and acquires possession over the car. The dealer can deliver the car to customer after the bank concludes the Ijarah contract with the customer. The customer then must pay to the bank the rentals for an agreed period of time. Most of Islamic banks in Malaysia use Al-Ijarah Thumma al-Bay (AITAB) as one of their Islamic products. AITAB is a new contemporary innovative product and the principles are based on the normal Ijarah. In this context, al-Ijarah means lease while al-bay means sale. Therefore, AITAB is a product that involves 2 contracts. It involves leasing contract for a period of time and upon expiry the rental, the bank and the customer enter into second agreement to purchase the goods. Normally, the purchaser (customer) pays nominal amount of RM1 to the seller (bank) as indication the sale contract has taken place. This is when the ownership is transferred from the bank to customer. Today, instead of the customer asks the bank buys the car, the customer deals directly with the car dealer. The car dealer then prepares all documents relating to AITAB financing. The car dealer is now functioning as a middleman between a financial institution and a customer (Abdullah & Dusuki). When the contract is concluded between the bank and the customer, the dealer then delivers the car to the customer. The issue arise here is when the customer deals directly with the dealer and not with the bank. Initially, the customer must go to the financial institution and the bank handles everything starts from possession over the car until the car is delivered to the customer. It is clear that the customer does not know the car dealer until the car is delivered to the customer. The contradiction concept involves here is when they practise the

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other way round. The customer definitely knows the car dealer and on top of that, the car dealer is the one who prepare the documents. According to Abdullah and Dusuki, this situation happens because hire-purchase transaction in Malaysia is governed by Hire-Purchase Act 1967. This Act covers both conventional and Islamic hire-purchase. Hire-Purchase Act is an Act that protects the hirer and guarantor against dealers who handle directly the transaction. However, the Hire-Purchase Act stills not fully fulfill the shariah requirements. Hire-purchase Act is suitable for conventional financial institutions since it contains element of interest in the rentals charge. It is not suitable for Islamic financial institution to rely only on the hire-purchase Act. When Islamic banks follow the same Act as conventional banks, the customers may perceive as if the Islamic banks are the same as conventional banks. However, this does not happen to Islamic banks in other countries. According to Mohamed Ibrahim (2009), Kuwait Finance House, for example has own warehouse where they buy and keep their cars. If a customer wants to engage Ijarah contract with them, the customer can go directly to the warehouse, choose a car and financing package. This is much easier because it is free from uncertainties.

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5.0

CONCLUSION From the above findings, it is shown that there are Islamic products in Malaysia which

contradicting to the Islamic teachings. Two products are able to be highlighted by the researcher which is BBA and Ijarah. The Malaysian scholars should evaluate each product critically in order to come up with products which follow Islamic principles. The Islamic financial institutions put themselves in jeopardise if they just accept products without carefully evaluate. People without Islamic banking knowledge will perceive Islamic Financial Institutions same as conventional banks. As a result, if the Islamic financial institutions fail to differentiate themselves from existence banks, it can simply mean that they are not fully success in implementing Islamic principles as their products.

Besides that, the Islamic financial institutions in Malaysia cannot fully follow Islamic teachings if they do not get support from the Bank Negara. Until today, there is no endorsement from the Bank Negara that make compulsory for the Islamic Banks in Malaysia to follow AAIOFI. As a result, each Islamic bank in Malaysia has their own shariah committee to monitor the products that they want to offer. The Bank Negara does impose rules and regulations which are based on conventional transactions to Islamic banks in order to standardize the banks. However, the issue here is when they use conventional act for Islamic products. The rules and regulations impose so far are still not enough to cover the Islamic products. The Bank Negara shariah committees should develop appropriate acts in order for Islamic banks to provide facilities which are in line with Islamic rulings.

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REFERENCES Abdullahi, K. & Molly, J. (2010), Where are Islamic private banking and wealth management headed and why?, Islamic Finance News,7(49), 12-14, Retrieved from www.islamicfinancenews.com Abdullah, N.I & Dusuki, A.W (November), A critical appraisal of al-Ijarah al-Bay (AITAB) operation: Issues and prospects, Paper presented at 4th International Islamic Banking and Finance Conference of the Monash University, Kuala Lumpur. Abdul Latiff, R. (2001), Issues in financial reporting of Islamic banks: A comparison between AAOIFIs standards and the Malaysian requirement, Accounting, Commerce & Finance: The Islamic Perspective Journal, 5(2), 98-120. Abou-El-Fotouh, H. (2010, January-March), Keeping clean, New Horizon-Islamic Banking, 4244. Accounting, Auditing and Governance Standards for Islamic Financial Institutions, Bahrin Ayub, M. (2009), Understanding Islamic Finance, Retrieved from http://books.google.com.my/. Meera, A.K.M & Razak, D.A.(n.d) , Islamic home financing through Musharakah Mutanaqisah and al-Bay Bithaman Ajil contracts: A comperative analysis, Working paper, Department of Business Administration, Kulliyyah of Economics and Management Sciences, International Islamic University Malaysia. Mohamed Ibrahim, S.M. (2009), Accounting and Auditing for Islamic Financial Institutions, Kuala Lumpur: The Global University in Islamic finance. Mokni, R.B.S (2010, April-June), Islamic banks: regulation and supervision, New HorizonIslamic Banking, 36-38. Paxford, B. (2010, April-June), Questions of price and ethics: Islamic banking and its competitiveness, New Horizon-Islamic Banking, 18-19.

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Razali, S.S. (2008) , The principles of gharar in Bai Bithaman Ajil contract, Paper presented at the MFA Conference 2008. Talib, A.A (2000), Islamic banking financing instruments and the concept of substance over form: the case of Bai Bithaman Ajil, Accounting, Commerce & Finance: The Islamic Perspective Journal, 4(1&2), 48-57. Usmani, M.T. (2002), An introduction to Islamic finance, Retrieved from http://books.google.com.my/.