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Bai Bithaman Ajil (BBA) - Financing

Introduction
Bai Baithaman Ajil (BBA) is one of the common instrument practiced in
modern Islamic banking & finance. (in Malaysia, Brunei and Indonesia at least)
The BBA is a deferred instalment sale whereby bank capitalizes its profit up
front in the sale of the property to the customer who in turn is required to pay a
fixed sum until the tenure ends.
BBA is an extension of the Murabahah (cost plus) contract, mainly used for
Medium and long-term financing.
It is important to know the difference between Murabahah Sale and BBA for
further clarification.

Special features of BBA & Murabahah


Murabahah

BBA

Final Price should be contractually

(aqd al-amanah)

agreed and known to both parties

Payment of price is deferred

Time and mode of payment should


be ascertained

No need to state the cost price &


amount of mark-up

Sale & Purchase based on trust

Requires full disclosure &


transparency between parties

Cost and mark-up must be


disclosed

Payment of price either spot or


deferred (if deferred should be

Long-term financing

defined as in BBA)

Short term financing

History & Development


The BBA is widely practiced in countries like Malaysia, Indonesia and Brunei. It
has been launched by almost all financial institutions in Malaysia since it was
implemented by Bank Islam Malaysia Berhad (BIMB) in 1983.
According to the statistics in BIMB granted 77.6% of its total financing under
BBA and 9.7% under Murabahah in 1984.

In 1997, BIMB used BBA and Murabahah as its main income generating products
of up to 90.5% of its total assets.
Other banks also reported similar percentages as compared to BIMB.

On the contrary, It is a highly controversial subject among Fuqahas


worldwide and widely being debated

with regards to its

permissibility and majority of the Middle Eastern Shariah Scholars


have disapproved it.

Even though some Shariah councils have agreed on its


permissibility, a guideline from the Council of Islamic Ideology
(Pakistan) in its report on the elimination of interest states that:
However, although this mode of financing is understood to be
permissible under the Shariah, it would not be advisable to use it widely or
indiscriminately in view of the danger attached to it of opening a back
door for dealing on the basis of interest

Source: The Council of Islamic Ideology Pakistan, (1977), Elimination of Interest from the Economy: Government of Pakistan

Bai Bithaman Ajil structure


Murabahah
Means a sale contract which selling price is equal to cost price plus
profit margin (or mark-up sale).
Two types of murabahah:
Cash murabahah : the purchase settled in cash.
Credit murabahah : a credit sale with the purchase settled by
installment payments.
In a credit sale involving assets & properties, one will use the
long-term credit murabahah contract or BBA.

Source: Saiful Azhar Rosly (2005)

The BBA in the


Market

The contracts
involved
The Property Sale
Agreement (PSA) :
the bank sells the house
to the customer at BBA
price.
The Deeds of
Assignment / Charge :
the bank holds the
house as collateral.

The Property Purchase


Agreement (PPA) :
the bank buys the house
from the customer.
The Property Sale
Agreement (PSA) :
the bank sells the house
to the customer at BBA
price.
The Deeds of
Assignment / Charge :
the bank holds the
house as collateral.

Pricing Mechanism of BBA

Fixed Rate BBA Financing

Example on Calculation of Monthly Installment


Profit Margin = Profit rate X Purchase price X financing tenure

Profit

Selling Price = Purchase price + Profit margin

Rate

The Property Sale

Monthly Installment = Selling Price / Financing tenure


(months)
Eg :
Purchase price or Financing amount = RM 100,000
Profit rate = 9% p.a.
Financing tenure = 10 years

Tenure

Profit margin = RM100,000 X 9% X 10 years = RM 90,000


Selling Price = RM 100,000 + RM 90,000 = RM190,000
Monthly installment = RM 190,000 / 120 months = RM 1584

Monthly installment is calculated based fixed profit rate as shown in the above illustration
Normally the profit rate charged would be higher than the conventional mortgage rate by 2% to
3% depending on various factors such as short to middle term monetary environment; the pricing
and cost of funds of each financier
Ibra would be given at the discretion of the financier if the customer redeem the financing earlier
than the contracted tenure.

Floating Rate BBA Financing


Monthly installment is calculated based on Effective Profit Rate( EPR) at the time of the
application for the financing facility.
In most cases, the monthly installment would remain the same for the whole financing tenure.
Depending on the benchmark profit rate, IFR (Islamic Financing Rate) which is normally
referenced to the BLR (Base Lending Rate) or the KLIBOR (Kuala Lumpur Interbank Offered
Rate), the EPR would be adjusted accordingly based on the formula shown in the illustration below
EPR = IFR minus 2.0% ;

OR

EPR = KLIBOR plus 0.2%

Normally the contracted profit rate (CPR) is calculated based on the following formula :
CPR = IFR plus 4.0%; which is also benchmarked against the movement in IFR.
In the event that the EPR exceeds the CPR (like in the example below at T1), the EPR charged
will equivalent to CPR. In here, the CPR served its purpose as a maximum ceiling profit rate
charge
Profit
Rate
CPR = IFR + 4.0%

EPR = IFR - spread

T0

T1(12)

T2( 6)

Tenure

Floating Rate BBA Financing


Example on Calculation of Monthly Installment and Selling Price
Eg :
Purchase price or Financing amount = RM 100,000
CPR (Contracted Profit Rate) = 10% p.a.
Financing tenure = 10 years
Profit margin = RM100,000 X 10% X 10 years = RM 100,000
Selling Price = RM 100,000 + RM 100,000 = RM100,000
Monthly installment is calculated differently where it is based on the EPR
EPR = IFR minus spread i.e.
EPR = 6.0% - 2.0% = 4.0%
Using the financial calculator, the month installment is RM 1013 per month.
Example on Calculation of Ibra based on difference between EPR and CPR
Eg.
At the point T2, EPR = 6%, CPR = 10%. The Ibra = CPR EPR (10%-6%) = 4%
At the point T1, EPR = 12%, CPR = 10%. The Ibra = CPR EPR (10%-12%) = -2% (No rebate)
and the effective profit rate charged = CPR

Comparison at a glance
Fixed Rate BBA

Floating Rate BBA

Fixed monthly installments for whole


financing period based on fixed profit rate
charged

Fixed monthly installments for whole

Profit calculated on monthly rest basis

Profit calculated on daily rest basis

Selling price is determined by CPR

Selling price is determined by CPR

No advantage on pre-payment or extra


payment made by customer

There is advantage on pre-payment or


extra payment made by customer less
profit charged by the financier

Ibra or rebate would be given in the case


of early settlement of financing

Ibra or rebate would be given in case early


settlement of financing; extra payment and
also for the differences between Effective
Profit Rate (EPR) and the CPR on daily basis

Beneficial to the bank in event of


deflationary interest environment
Beneficial to the customer in event of
inflationary interest rate environment

financing period based on Effective Profit


Rate (EPR) which is similar to conventional
pricing calculation

Beneficial to the bank as it reduces the


asset liabilities mismatch
Beneficial to the customer as they can
reduce the profit charged by bank

Critical Evaluation

Fixed rate BBA financing is no longer offered in the Malaysian Islamic financial
market as at today. Almost all the Islamic banks have moved to offer the alternative
floating rate BBA financing to compete with the conventional banks mortgages
products.
However, all Islamic banks in Malaysia still have the fixed BBA financing in their
assets portfolio base.
Unique product innovation to resolved the issues stated earlier by financier: assetliability mismatch; creation of competitive level playing field with conventional banks
in terms of product flexibility and pricing; risk mitigation arising from this
mismatching.
New issue with this new product : issue of pricing benchmarking against
conventional benchmark based on interest rate (BLR = Base Lending
Rate)
While the customer is ascertained to get ibra or rebate from the financier, the
Shariah requirement that the financier cannot fixed the amount of ibra
upfront and the amount of ibra payable would be at the discretion of the bank,
leaves the customer at the whim and fancy of the financier
Other earlier issues with fixed rate BBA financing remain unresolved.

Issues Relating to BBA

Issues highlighted in the High Court and the Court of Appeal


High Court
(Arab-Malaysian Finance Bhd
v Taman Ihsan Jaya Sdn Bhd
& Ors [2009] 1 CLJ 419)

Court of Appeal
(BIMB v Lim Kok Hoe and Ors
(Unreported )

Apply the concept of equitable


interpretation

The issues raised by the


learned judge is not novel and
has been decided in 2 cases;
Adnan v BIMB (unreported)
and Datuk Hj. Nik Mahmud v
BIMB [1998] 3 CLJ 605

Use the case of Affin Bank Bhd


v Zulkifli Abdullah (2006) 1
CLJ 438
BBA contracts were contrary
to basic principles of Islam

High Court judgment is set


aside and the cases need to be
sent back to the High Court to
be heard on their merits.

Shariah and Legislation on BBA


Hadith of Jabir that the Prophet (p.b.u.h) bought a camel outside
the City of Medina and the payment was settled later.
In Hidaya;
A sale is valid either for ready money or for a future payment provided
the period be fixed because of the word of the Holy Quran; Trading is
lawful and also because there is a tradition of the Holy Prophet p.b.u.h
who purchased a garment from a Jew, and promised to pay the price at
a fixed future date by pledging his iron breast-coat

Islamic Banking Act 1983


Central Bank of Malaysia Act 1958

Current Issues vis--vis BBA in Malaysia


The structure of Bay Inah is used;
Liability of the owner (maintenance, repair, takaful, etc;
Non-existence (in case of house under construction or to be
constructed);
Inability of the customer to pay (default in payment);
Two situations must be differentiated;
With valid excuse ( in constraint circumstances)
Should be indulged with some leniencies
And if he (the debtor) is in constraint, then he must be given respite until
he is well of (al-Baqarah: 280)

Dishonest clients who deliberately avoid to pay. The jurists differ:


No, any extra charge is riba
Yes, but this amount must be channeled to charity. Penalty only to
deter the client from further default. The well-off person who delays
the payment of his debt, subjects himself to punishment and
disgrace.
In Malaysia, it is considered as tawidh (compensation) to the bank.
(SAC of BNM & SC)
compared the delay in paying off a debt with ghasb (usurpation) for
both of them are an act of obstructing the use of property and
exploiting it in a tyrannical way.
1% only allowed and cannot be compounded.

Outstanding Issues on BBA


Back door to interest based transactions
Those who disallow the practice of BBA argue that BBA opens
the back door to interest based transactions. They argue that if
the difference between spot and deferred prices of a
commodity is to be recognized, logically we can not reject
interest, which in fact is based on the difference in value of
money between spot and deferred.

Outstanding Issues on BBA


The Hadith:
The Prophet prohibited two sales in one.

One of the interpretations of the Hadith deduced that it is a


sale contract with two different prices, that is one price in spot
payment and the other deferred.
Counter argument: The different prices are only mentioned to
the client during the negotiation period. Once the client is
settled to a certain period of payment, only one quotation of
price is offered to the client.

Outstanding Issues on BBA


Selling of the Non-existent

BBA in Malaysia is applied over property under


construction as well as completed property.
This might contradict the ruling on the existence of
subject matter in a sale contract. If the opinion of the
majority of jurists is to be applied, the BBA facility on
property under construction is not allowed.
To avoid any conflicting issues that might arise, it has
been recommended that banks use other types of
financing for property under construction. For instance,
banks can use the contract of parallel istisna as it relates
to the financing of asset involving future delivery.

Outstanding Issues on BBA


Transfer of Ownership
It is argued that since BBA is actually a kind of sale
contract, the transfer of ownership and the taking of
possession must truly happen.
In terms of the practice of BBA in Malaysia, the
execution of PPA and PSA in the facility should result in
transfer of ownership, irrespective of whether the
registration of the transfer is made or otherwise.

Conclusion
of BBA
Issues
The Property
Sale
Impact of BBA court cases to the industry in Malaysia
Industry's development and innovation

The industry moving forward


Musharakah Muthanaqisah Partnership (MMP)
Consensus by Shariaah Scholars on the permissibility of MMP
Musharakah and Ijarah concepts
Beneficial to Customers rather than Financiers

Conclusion
The Property Sale
Comparison
Between MMP and BBA Contracts
BBA
Uses buying and selling concepts.
Selling price does not reflect the
market price but rather uses
interest rate as benchmark.
Fixed selling price for fixed rate
BBA.
Fixed amount to be paid by
customers. Rebate decided by
the financier.

MMP
Practices Musharakah and Ijarah
concepts.
Rental income reflects the
market price as the rental value
is determined by the market.
Financier
manage
better
liquidity rate by adjustable
rental income.
Total price paid for property can
be lower.

One step at a time always works both ways..

The Property Sale

The End.
Thank You.

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