Farah najwa md isa
Equity based contracts are one of the structure used in Islamic finance, elaborate on this
category by giving a special focus on Mudarabah. You are required to discuss the Shariah
issues in Mudarabah along with the challenges faced by the industry when this underlying
principle is used as deposit instruments or financing facility.
Mudarabah is a form of an Islamic equity-based investment instrument. In a Mudarabah
arrangement, the financier (rabbal-maal) provides the entire capital required to finance the
project, while the entrepreneur (mudarib) provides the expertise and labour. The entrepreneur
shares equity ownership with the financier and the profits (or losses) from the project are shared
between the financier and the entrepreneur at a predetermined ratio. In principal, any financial
loss under mudharabah financing must be borne by the Islamic banking institution. However, if
the loss is caused by negligence, mismanagement or breach of contracted terms by the
entrepreneur, then the entrepreneur is liable for the loss. The liability of the entrepreneur is
therefore limited to his time and effort, except when losses are suffered due to the entrepreneur‟s
misconduct, negligence or violation of the conditions mutually agreed to by both the financier
and the entrepreneur.
There are two sets of contractual relationships applicable to this structure. The financier obtains
funds from depositors pursuant to a contract known as unrestricted Mudarabah (Mutlaqah).
Depositors agree that their funds may be used by the financier, at its discretion, to finance an
open-ended list of potentially profitable investments and they expect to share with the financier
the overall profits accruing to the financier‟s business. For example, Islamic banking institution
does not impose any limitation on the type of business, place of business, methods of payment
from the entrepreneurs and period of investments. In this case, the Islamic banking institution
will not have any recourse to the customer should the business incur losses due to the investment
policy as there would have been no such policy prescribed by the Islamic banking institution in
the first place. This type of mudharabah, for example, may be used towards financing a
customer‟s working capital requirements.
The second set of contractual arrangements, between the financier and the entrepreneur, is
known as restricted Mudarabah (Muqayyadah). The financier agrees to finance a specific project
carried out by a specific entrepreneur and to share any profits according to a certain percentage.
For example stipulate a particular business or particular place for the customer to invest the
capital. The entrepreneur is bound by all these restrictions and any violation of these restrictions
may make the entrepreneur liable for the loss, if any. This type of mudharabah financing may be
used for contract financing of a specific project awarded to the customer.
Three conditions must be met in the mudarabah structure. First, the financier should not reduce
credit risk by obtaining collateral and it must bear entirely and exclusively all the financial risk.
However, collateral may be requested to reduce moral hazard, such as misconduct by the
entrepreneur. Second, the rate of profit belonging to each party must be determined strictly as a
percentage and not as a lump sum. Third, the entrepreneur should have the absolute freedom to
manage the business. Mudarabah is usually employed in investment projects with short gestation
periods and in trade and commerce. The structure may include a promise on behalf of the
“borrower” to buy-out the financier after the completion of the project.
Some of the jurists allow mudarabah to be terminated if one of the two parties rescinds it,
because it is an optional not a binding contract. However, others said that mudarabah is binding
and it cannot be rescinded if the mudarib commences work. Premature termination may disrupt
business and harm at least one of the parties. This would be against the Shariah spirit of
mudarabah. At the time of termination and some profit has been earned on the principle amount,
it shall be distributed between the parties according to the agreed ratio. However, mudarib will
be given the opportunity to sell or liquidate the earned if not in cash, so that the actual profit may
be determined. Mudarabah can be used with the investors who are capable to work and also
observed to be potentially quite promising in the field of microfinance or financing of small and
medium enterprises. The bank provides the adequate finance as a capital owner in exchange of a
share in the profit to be agreed upon. The growth of the Islamic finance market has been
While Islam employs various practices that do not involve charging or paying interest, the
Islamic financial system promotes the concept of participation in a transaction backed by real
assets, utilising the funds at risk on a profit-loss sharing basis. This profit-loss sharing concept as
a basis of financial transactions, that are a progressive one as it distinguishes good performance
and encourages better resource management. Islamic equity in Malaysia is an Islamic financing
institution, which would fit in its overall framework and suit its socio-economic mission and
goals. In Islamic financing contract, Islamic equity is based on the concept of Musharakah and
Mudarabah. Shariah prohibits riba, gharar and maisir on financial transactions, Islamic finance
contains different financing techniques to fulfill the needs of Islamic entrepreneurs who require
financing. Since the mudarabah equity-based contract is the focusing category, which is
document representing a contract or conveyance of rights, obligations or monies done in
conformity with the Shariah, form the foundation of sukuk issuances.
Sukuk is similar to bonds of capitalist system, but money is invested concrete projects and profit
share is distributed to clients instead of interest earned. According to Muhammad Al-Bashir
(2008), a basic requirement for Shariah compliance of any sukuk structure shall be backed by
tangible assets. A concern has been voiced regarding the limited number of assets eligible for
sukuk under the ownership may result of Islamic financial institutions looking for fund raising.
This shortfall of eligible assets could impede or slow down the regular issuance of sukuk. Recent
innovation has permitted the substitution of the sukuk asset to address these apprehensions.
Sukuk al-Mudarabah structure. (Rahail Ali, 2011)
The issuer Special Purpose Vehicle (rabbal-mal) issues sukuk, which represent an undivided
ownership interest in an underlying asset or transaction. The issuer contributes the proceeds of
the sukuk as capital of the mudarabah. Profit generated from the mudarabah is distributed
between the issuer and the mudarib in pre-agreed proportions, with profit in excess of periodic
distribution amounts paid to the mudarib as incentive fees. Then, the issuer distributes profits to
sukuk holders as periodic distribution amounts. The obligor executes a purchase undertaking in
favour of the issuer (as trustee) for sukuk redemption at maturity or early redemption (usually tax
redemption) following default. Typically, the obligor will decide whom to appoint after being
presented with competing proposals, and will sign a mandate on the service provider‟s standard
Last couples of years, Sukuk al-Mudarabah gained popularity and yet has been issued without
being wholly reliant on the existence of underlying tangible assets in order to generate a return
for the Sukuk holders. Under the concept of assure fully of the invested capital is returned to
investors, one party guarantees the investors that the business venture is profitable and if there
are any losses incurred, the former shall acquire the investors‟ ownership in the venture for
redemption at par (effectively 6 months). In return, the investors reciprocate by „rebate‟ of profits
within the range of time of the venture by limiting their return to a conventional reference rate
plus spread or any other benchmark they agree on. If their share of profit exceeds the benchmark,
the excess profit goes to the other party as incentive fees. In 2007, Sheikh Muhammad Taqi
Usmani (President of the Shariah Council of the AAOIFI) commented that most of the Sukuk al-
Mudarabah violates the principles of risk and profit sharing which not in line with the principles
of Shariah in his paper.
As a result, the Accounting and Auditing Organization for Islamic Financial Institution
(AAOIFI) Shariah board announced a statement on sukuk was produced which seeks to provide
some guidance in relation to sukuk structures after convened a series of meetings. They that
banned issuers from “purchase undertaking” to purchase the Sukuk asset back from the Sukuk
holders at a nominal agreed value at the end of the tenure of the Sukuk or at the point of default
has impacted the global Sukuk industry. Sukuk al-mudharabah‟s structure is directly affected by
AAOIFI‟s pronouncement. Besides that, Sukuk al-musharakah and Sukuk Istithmar affected too.
Thus, issuers have opted to issue Sukuk Ijarah which is seen as a viable alternative in the present
According to Sheikh Muhammad Taqi Usmani (2007), there are two issues had been addressed
which are the common redemption features applied are fully recovers investor of capital and
related return and the redemption price and its return are always structured in advance without
consideration to any loss or risk. This redemption features run against the character of the
mudarabah principles, prospectively invalidating them or creating a situation in which the
redemption feature may not be enforceable in some courts. Islamic scholars unanimously agreed
that the role of the mudarib is ultimately to use his best effort to make a profit for the Sukuk
holders (rabbal-mal), for which the investment agent is entitled to be paid an agreed proportion
of the profit. It is not the role of the mudarib to guarantee the capital repayment of the Sukuk in
the form of a purchase undertaking or otherwise. Likewise, the mudarib cannot bear any losses
from the venture unless upon his fault or negligence.
AAOIFI that represents the consensus of leading scholars prefers that these redemption features
are executed at a market price. Theoretically, the market price purchase removes the certainty of
a guaranteed return of capital at a profit. There is significant discussion on the determination of
market price that turns on to three factors: cost, regulation, and willingness to execute. It seems
that Shariah standards and resolutions are aligned on the “rightful” application ofpurchase
undertaking to reflect the risk and profit sharing principles of Mudarabah structures.
Nevertheless, the industry is still witnessing the issuance of such Sukuk contracts, although at far
lower level post-AAOIFI announcement but the purchase undertaking covers the Sukuk face
value although it is provided by a third party that fulfils the required conditions. Instead, there
has been an increasing momentum for the issuance of Sukuk Ijarah where it is permissible for the
lessee to undertake acquiring the leased asset at a fixed price, hence delivering the fixed returns
profile that are demanded by current investors.
Debt based contracts are one of the structure used in Islamic finance, elaborate on this
category by giving a special focus on BBA. Discuss the Modus Operandi of BBA home
financing in Malaysia along with the Shariah issues related. You are required to include in
your discussion the legal documentations which include Sale and Purchase Agreement,
Property Purchase Agreement and Property Sale Agreement.
Definition and Concept
Bay‟ Bithaman Ājil (BBA) is deferred installment sale where under this contact of sale, a Islamic
bank may finance its customers who intend to acquire an asset and to defer the payment of the
asset to a specific period by paying installment based on the agreed financing period. BBA in
essence is a sales contract, differing from a cash sale (bay' al-nuqud) only by virtue of the
payment system. Payments are deferred to some future date whereas in the cash sale they are to
be made immediately. BBA must still fulfill the principles and conditions of a sale contract,
which has four aspects, namely the agents of contract, the objective of contract, the object of
contract and the offer and acceptance. While the BBA is widely used in Malaysia, Indonesia,
Brunei and few other countries, it has been subjected too much controversy among the
fuqaha worldwide with regards to its permissibility; where most of the Middle East scholars have
The price elements in the BBA and spot sale are spelled out in the objective of the contract. In
spot sale, the offer price must reflect the current market determined price while in BBA, the offer
price will include sometime element, since payment will be made in some future time. In the
conventional system, home financing is, of course, usually interest-based and is forbidden in
Islam. The BBA home financing, however, does not alter much the above equation. Instead of
charging the customer interest, financiers charge a profit derived through a buy-and-sell contract
which is permitted in Islam but regretfully, the profit rate is dependent on the market interest rate
due to arbitrage activities. Therefore, while the BBA is practiced as Shariah compliant in some
countries, it is, nonetheless, converging to the conventional mode where the computational
formulas are similar to the conventional and where the profit rate tracks the market interest rate.
The difference between the fixed-rate BBA and the conventional mode is that once the profit rate
is fixed in the BBA, say at 7% per annum, it will remain the same for the entire duration of
financing. This, in fact, causes problems for the financiers as it is difficult to estimate accurately
the cost of funds and hence the appropriate profit rate over long periods like 20 years, due to the
volatility of economic conditions. This encourages customers to refinance their home from BBA
to conventional during low interest periods. BBA is a facility provided by the financier to assist
the customer pay the cost of financing, e.g. a house, over the tenor of financing, example 20
years, at a fixed rate determined by the financier. The financier initially buys the house from the
customer (cost of financing amount) and sells it back to the customer, plus of its profit margin.
As the seller of the property, the Shariah requires the bank to hold ownership of the property and
to hold all liabilities arising, including defects. But currently, BBA documentations show that the
bank merely acts as a financier rather than a seller and excludes itself of all liabilities. This, of
course, ignores the Shariah principle of “al-Ghomn bil Ghorm” (no reward without risk), “Ikhtiar”
(value-addition or effort) and “al-Kharaj bil Daman” (any benefit must be accompanied with
liability), thereby rendering the BBA profit to be implicated with riba.
Basically, BBA financing is employed by the bank to provide medium to long term financing to
the clients who intend to acquire - houses / shop houses , land, motor vehicle, consumer goods,
shares, overdraft facility, education financing package, personal financing, and other suitable and
acceptable goods. The modus operandi of al-Bay‟ Bithaman Ajil (refer diagram) by following
Step 1 - The Bank may finance the customers who wish to acquire a given asset but to defer the
payment for the asset for a specific period or to pay by installments under the principle of BBA.
Step 2 - The bank first determines the requirements of the customer in relation to his period and
manner of repayment.
Step 3 - The bank purchases the asset concerned.
Step 4 - The Bank subsequently sells the relevant asset to the customer at an agreed price which
comprises the actual cost of the asset to the bank; and the Bank‟s margin or profit and allows the
customer to settle the payment by installments within the period and in the manner so agreed.
Step 5 - The contract of Al-Bay Bithaman Ajil has been utilised by the Bank to provide the
customers medium and long term financing to acquire such items which may include landed
properties, houses, motor vehicles, furniture, stock and shares. It is a simple contract whereby the
Bank purchases the items on a cash basis and sells such items on a deferred payment basis to
customers requiring financing.
The Legal Documentation
For the BBA Islamic financing facility in Malaysia, the financing of the acquisition of assets
such as house and land happens in two conditions:
1) When an Issue Document of Title (IDT) has been issued and yet to be issued.
2) When there is Option of Defect (khiyar al-ayb) takes place.
The legal documentation for these two situations has some differences. In a situation where the
Issue Document of Title has not been issued, the bank which provides financing facility to the
client will secure the right, title and interest of the client under the contract of sale and purchase
with the developer, as security by way of an assignment. In doing so, the bank and the client will
sign a Deed of Assignment. On the other hand, if the property taken as security has already had
an Issue Document of Title or Strata Title as the case may be and the charger have interest in the
property presently vested upon him, a security by way of charge can be created over the land or
property as an encumbrance. Hence, the first charge and second or subsequent charges may be
created in the prescribed statutory Form 16A and annexure. The practice of creating legal charge
in Islamic banking is at par with the practice of its conventional counterpart. Upon default, the
financier may, after proper notice, initiate proceedings to secure back the amount including
selling the security by way of public auction or private treaty sale. As for the BBA facility,
basically three main agreements are of supreme importance.
A. Sale and Purchase Agreement (SPA)
It is not part of the documentation for the facility applied by the client. However, it is the
most important among agreements in obtaining such a facility from banks. To better
understanding, an example might help. For instance, Mr. Adam intends to buy a house from a
seller. Based on the Third Schedule of Housing Developers (Control and Licensing)
Regulation 1989, the Sale and Purchase Agreement (Principal Agreement) will be signed
between the two parties. Accordingly, Mr. Adam would have to pay 10 per cent of the price
of the property.
The signing of this agreement is compulsory, as the customer must provide the bank with
this agreement before the application for financing can proceed. Let‟s say that before 1996,
a novation agreement was signed between Mr. Adam (the client), the seller and the bank (as
the financier) but this practice was later abolished. It has been argued that the developer or
seller refused to be a party to the agreement because they did not want to be responsible for
rights and liabilities that might be attached to it. Furthermore, it is not the concern of them as
from whom and how the client acquires the money to purchase the house. Besides, it was
also argued that, this novation agreement was also insignificant, because by virtue of the
client paying 10 per cent of the price, he has acquired the beneficial ownership of the house.
It is his right then to do whatever he wants with the house, including selling it to someone
else. It is not the concern of the seller or developer on that matter. There is the clause;
“When the introduction or imposition of variation of any law order, regulation or official
directive or any change in the interpretation or application thereof by any competent
authority makes it apparent to the Bank that it is unlawful or impractical without breaching
such law order and regulation or official directive for the bank to maintain fund or give
effect to the Bank‟s obligations hereunder the Bank shall not then be liable or obliged to
make available the facility.”
This clause refers to the situation whereby the Bank would be allowed to disoblige itself
from fulfilling the terms and conditions of the agreement made with the client. However,
these exemptions are only allowed with some qualifications with the introduction of new
law; the new law has been regulated or new official directive has been issued by a relevant
authority; or change in the interpretation or application of related law.
B. Property Purchase Agreement (PPA)
This is an agreement made between the client and the bank. The most significant wording of
this agreement normally reads:
“The Customer has applied to the Bank for a financing and the Bank has approved the said
application and the Customer has agreed to enter into this Agreement with the Bank,
whereby the Bank, at the Customer‟s request purchases from the Customer the Property at
the purchase price ……”
The customer will apply to the bank for financing and the bank will approve it. Then the
bank will purchase the customer‟s property at the purchase price. It should be noted that
most of the time, the purchase price consists of the remaining balance of the price of the
house (90 per cent), and some other costs such as lawyer‟s fees, MRTA, etc. This will
certainly, increase the financing amount to be more than the remaining price of the house.
However, the financing amount that the bank is able or willing to finance is negotiable
between the client and the bank. In allowing so, the policies of the bank, creditworthiness of
the client would be among the factors to determine the financing amount to be eventually
granted to the client. The provision reads:
“Not withstanding anything contained in this agreement, the Customer(s) hereby agree,
covenant and undertake to pay to the Bank compensation on overdue installments and
payments of the Purchase Price on the date of maturity of the BBA facility as follows:
- For failure to pay any installments of the BBA Facility from the date of first drawdown
until date of maturity of BBA facility, the compensation rate that shall be applied is one
per centum (1 per cent) per annum on the overdue amount or any other method
approved by Bank Negara Malaysia;
- For failure to pay any installments and which failure continues beyond the maturity date
of the BBA facility, the compensation rate that shall be applied is the Bank‟s current
Islamic Money Market Rate on the principal balance or any other method approved by
Bank Negara Malaysia.
- The amount of such compensation shall not be compounded on the principal amount.”
The customer shall take Takaful Mortgage Plan and shall indemnify the bank against all the
losses, all charge and other cost related to this PPA.
C. Property Sale Agreement (PSA)
Again, this agreement is signed between the client and the bank. The most significant
wording of the agreement normally reads:
“The Bank hereby agrees to sell and the customer hereby agrees to purchase the Property at
the Sale Price upon the terms and subject to the conditions herein contained.”
This agreement valid when the bank need reselling the customer‟s property upon deferred
payment include profit margin. The Property Sale Agreement shall be signed after the signing
of the Property Purchase Agreement so as to allow the bank to sell back the asset to the client.
The manner, in which the payment of the price to be made will be detailed, based on the
agreement reached between the bank and the client.
These are some provisions related to the documentation of BBA financing as practised in
Malaysia. It is rightfully submitted that there are also other issues which are also important
and need to be discussed. However, it is hoped that this brief discussion on some issues is
able to shed light over important clauses contained in the BBA facility agreements.
For example, assume that a customer wishes to buy a houses priced at RM200,000. The customer
puts a down-payment of 10 percent, i.e. RM20, 000 and finances the remaining 80 percent, i.e.
RM180, 000 using the BBA method. Also assume that the Annual Profit Rate (APR) charged by
the bank is 10 percent per annum and the duration of financing is for 20 years. The Islamic bank
would first buy the house for RM180, 000 and then sell the house to the customer at a profit,
with deferred payments over the 20-year period.
The monthly payment for the above financing is RM1,737.04 payable for 240 months which
adds up to RM416, 889.35 in total. The difference between this figure and the original financing
of RM180, 000 which equals RM236, 889.35 is the total profit for the Islamic bank from this
transaction. The profit of RM236, 889.35 is capitalized upfront in the BBA mode, unlike under
the conventional mortgage, where the interest due is not recognized until the elapse of time. One
important difference of the BBA compared with the conventional mortgage is that of the balance
of financing remaining before the expiry of the duration of financing. In this example, the BBA
balance after 10 years (i.e. after 120 payments) is the total of the remaining 120 payments, i.e.
RM208, 444.80 whereas under conventional mortgage, this amount would represent the total
interest paid for the loan over the 20-year period. The Islamic bank, however, may give some
rebate for the early repayment, but the amount of rebate is determined at the discretion of the
bank. Since the selling price is a price, indeed, Shariah prohibits the rebate to be stated as part of
the contract. Note that even after ten years of repayment, the balance under the BBA mode can
even exceed the original financing of RM180,000. Nevertheless, considering all the socio-
economic effects of fiat money, we regretfully assert that Islamic banking within the fractional
reserve system can, indeed, be very damaging to the economy.
In legal documentation of conventional loan agreement, it is stated that the bank has the right to
recall the facility, repossess the property and terminate the facility. In BBA financing, the
situation is different. This is due to the fact that the ownership of the house has been transferred
to the client by virtue of the PSA. Hence, the Bank has no right whatsoever to repossess the
house. What the bank is entitled to is the payment price of the property. Therefore, the
conventional clause on „right to recall‟ is not appropriate for the BBA facility. However, this
clause can be included in the BBA financing facility with certain modification. The right to recall
the BBA financing facility means that the Bank has all the right to terminate the facility and
claim for the unpaid amount, but not the right to repossess the property. If the property is used as
collateral, the bank can sell the property and claim on the unpaid amount and release the balance
to the client.
Besides that, third party financing can occur in two situations. First, the property is owned in a
joint ownership, but the application for financing is made only by one applicant. Second, the
property is owned by one person only, but the application is made by joint applicants (the owner
and the other person). In both circumstances, a letter of gift will be executed. In the former, the
joint owner of the house will execute a letter of gift on his portion of the property in favour of the
applicant before the facility can be processed, whilst in the latter, the owner will execute the
letter of gift in favour of the other applicants before the facility can be processed.
Example of this is Mudarabah Cagamas Bond This bond was issued by Cagamas Berhad. Under
this facility, BIMB sells its Islamic housing financing facilities (BBA Receivables) to Cagamas
Bhd based on the concept of sale of debt at a discount. Following this transaction, all rights of
BIMB with regard to the debt are transferred to Cagamas Bhd. It means that the right to receive
debt from the BBA installment will be transferred to Cagamas. Therefore, the institution would
transmit to Cagamas all the installments received from the clients under the BBA on a monthly
basis. Cagamas, on the other hand, would issue mudarabah bonds to raise the necessary funds to
finance the purchase of these receivables. Through this, the bond‟s holders become investors to
this business and Cagamas is the entrepreneur. They will benefit from the cash flow stream
derived from the house financing portfolio. Following the rules of mudarabah, any profit derived
from this business would be shared on a pre-agreed ratio between Cagamas Bhd. and the holders
of the bonds and any losses or diminution of the amount invested will be fully borne by the
holders of the bonds.
The Shariah issue of concern here is the availability of iwad (counter value) in BBA financing.
According to Saiful Azhar (2005), the Qur‟an uses trade (al-bay) because the profit generated
from trading incorporates risk-taking, while the contractual profit from loan transactions (riba) is
risk-free. It further asserts that al-bay implies the existence of iwad required by the Shariah to be
a lawful profit in Islam. Three elements of iwad that should exist are risk (ghorm), work and
effort (ikhtiar) and liability (daman).
Iwad is the basic trait or the conditio sine quo non of a halal or lawful sale (al-bay), because a
sale is necessarily an exchange of value against an equitable return and compensation for the
goods or services exchanged. According to Ibn al-„Arabi, every increase which is without
an iwad or equal countervalue, is riba. Iwad is the necessary requirement to be fulfilled in trading
(al-bay) as it brings along a sense of equity and justice into a business that rendered it superior to
an interest-bearing system.
Saiful Azhar (2005) also opined that there is no risk taking in the current BBA financing, and,
hence, does not merit the Qur‟anic concept of al-bay. Daman (liability) should also exist in a
trading transaction whereby the supplier provides guarantees on the goods sold. However in the
current BBA home financing, the customer is forced to face the financial burden of paying for
the house even before it is completed, as he has engaged in a „debt contract‟ with the bank at the
outset. By ignoring the concept of iwad, the BBA contract is not seen as conforming to the
maqasid al-Shariah that removes hardship (raf‟ al-haraj) and preventing harm (daf‟ al-darar) in
the economic sphere, thereby leaving the welfare of people unprotected – a possible crime when
the transaction is done under an Islamic label.
Another issue that arises from the long-term BBA financing is the mismatching of the BBA
funds against its short-term deposit tenor. Whilst conventional financing has the ability to
address this mismatch in the cost of funds through the variable interest rate, BBA financing
cannot do this since customers are charged a fixed profit rate for the entire period of financing.
There are two main purposes of financing intended in the practice of BBA in Malaysia, are to
finance the acquisition of an asset and to provide liquidity (cash). It is within the purview of the
second purpose that refinancing has also utilized the BBA mode of financing as far as the
Malaysian practice is concerned.
Compare and contrast between the equity based financing and debt financing facility.
Islamic banks with an aim of bringing revolution to the economy with interest free ethical
banking should be able to invent product out of the box with different structures. That was the
dream of first generation Islamic economists to free the economy from the burden of fixed rate
interest and from the debt based economy leading to credit crunch. Most of the Islamic scholars
in their literature talked about designing a banking system based on profit-loss sharing which
brings equity and justice to the society. Debt based products was allowed to practice only in
exceptional circumstances. But in the course of time, permission of exception has turned into
norms and core activities of Islamic banking practice nowadays. In principle of Islamic Shariah,
“profit comes with risk” because, it is invested in fixed rate return basis and it gives priority over
equity shareholders though both equity and preference shareholders suffers same risks. Islamic
equity based on mudarabah, all the shareholders shares same risk and benefit by their investment
or human labour and effort.
Islamic banks create debt with sale of assets in BBA (deferred payment). Islamic Shariah does
not have any restriction on amount of profit if the mechanism of earning profit is Shariah
compliant. Therefore, it is necessary to understand arguments of Islamic economists about use of
both equity (profit -loss sharing) and debt financing. There some expertise negate the use of
other Shariah permissible debt-based contracts alongside the equity-based contracts, they do
assert that the socio-economic objectives including social justice, economic growth, efficiency
and stability that Islamic economics seeks to achieve are better served by resorting primarily to
Saiful Azhar (2005) stated that, equity financing fulfills the essence of Shariah requirement in
Islamic Banking and Finance as it fulfills the counter value (iwad‟). However, particularly if
debt-contract there is no risk, effort and liability then no way by any stretch of the imagination
could such a contract be considered to contain any element of justice. Mudarabah equity finance
contain these elements of risk, effort and liability hence surely it is clear for all to see that these
equity financing contracts are more just and hence more in line with the Maqasid or objectives of
Shariah. This means that equity based financing is more just as both the borrower and lender
share both profits and losses as compared to the case of debt financing where one party is made
to take all the risk.
Islam very much encourage profit that come from trade and productive investment, while fixed
predetermined payment (like riba) is prohibited since it is not a function of the profits and losses
incurred in a venture. This is among the reason why many scholars hold the views that unless
Islamic banking institutions resolve to profit-loss sharing financing instruments, the
socioeconomic justice as envisioned by the Islamic banking system would never happen.
Therefore, an ideal Islamic banking model is reflected through its balance sheet structure that is
dominated by profit -loss sharing on both assets and liabilities sides. The equity based system
which is an ideal model to be implemented in Islamic Banking and Finance helps to create more
value added in the economy and indeed contribute to economic growth. Therefore, since equity
and profit sharing financing is considered to be superior compared to debt-like financial
instruments in Islamic economics, the evidence of current practice indicates that the Islamic
banks have deviated from the aspiration stand of Islamic economics.
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INCEIF (2006), Applied shariah in financial transactions, topic 6, the application of
INCEIF (2008), Deposit and Financing practices of Islamic Bank on retail financing of home
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