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Saturday, February 27, 2010


The application of bay’ al-‘inah (sale and repurchase back) and bay’ al-dayn(sale of debts) is making the Islamic financial industry lost its identity. The issues are serious to the Islamic financial market movement, as it is not about minor details of religious practices (furuq) but sadly dealing with the fundamental (usul) of religion. This time it is riba or usury. Its application in Islamic financial market is partly caused by the lack of knowledge in riba that is both definite and decisive. For this reason, it is critical to put things straight and get to the basics again. This project paper endeavours to explore the critical issues in regard to both instruments and other concepts available in Islamic commercial law that can be employed as alternatives.

1.0       Introduction

One critical task of Islamic banking is to ensure that the behaviour of fund providers and users compliance with the Quranic spirit of justice (‘adl) and cooperation (ta’awun). Driven by the profit motive, Islamic banks today have rationalised the application of murabahah[1] and bay’ bithaman ajil[2] (BBA) leading to a wholesale recognition of positive time preference. However, the worst scenario would be the application of bay’ al-‘inah[3] and bay’ al-dayn[4] likes in Malaysia has further driven Islamic banking and finance towards losing its identity as a system. The Islamic financial products introduced to satisfy the customers’ tastes and preferences and also the Islamic bank’s attitudes for being risk-adverse, the principle of ‘al-ghurm bil-ghunm (no pain, no gain) has been isolated from financing. This point holds true for bay’ al-‘inah and bay’ al-dayn or combination of both products as they are intended to satisfy the customer’s desire for fixed income and risk-free investments. As lending has been the traditional approach in banking, Muslims thought that only bai al-inah, murabahah and BBA serve as the best alternative to lending. The same may apply in the design of salam[5] and istisna’[6] financing, where Muslims may see them as a loan instead of sale and purchase contract.

The same applies to the banking firms; for example, in the practice of al-ijarah, al bay’ (financial leasing instead of true leasing) is usually applied. In this way financiers do not bear the risks of ownership and other obligations attached to it. The banking firms for being risk-adverse generally perceived the application of mudarabah[7] and musyarakah[8] as risky ventures, in turn, resorts more into application of bai al-inah, murabahah and BBA, to suit to customers’ preferences.

The bay’ al-‘inah and bay’ al-dayn issues are serious to the Islamic financial market movement, as it is not about minor details of religious practices (furuq) but sadly dealing with the fundamental (usul) of religion. This time it is riba or usury. For this reason, it is critical to put things straight. This means getting back to basics. This project paper endeavours to explore the critical issues in both concepts and to propose other concepts available in Islamic commercial law to be employed as alternatives.

2.0       Critical issues in bay’ al-‘inah and bay al-dayn

            2.1       Bay’ al-inah

Bay’ al-‘inah is generally defined as sale-based on the transaction of Nasi’ah (delay). The (prospective) debtor sell to the (prospective) creditor some asset for cash which is payable immediately; the debtor immediately buys simultaneously the same asset for a greater amount for a future date. Thus, the transaction amounts to a loan. Technically, the application of bay’ al-‘inah involves two set of transactions; (i) al-bay’ al-mutlaq[9] (cash sales), and (ii) murabahah or BBA (deferred sale), both of which are executed after one another. The process could take place in the reverse form too whereby the deferred sale is preceded by a cash sale and vice versa (known as reverse ‘inah), but in both ways each party gets what it intended to achieve. It is worth noticing that the contract of murabahah and BBA is instrumental in making the bay’ al-‘inah transaction possible.

Bay’ al-‘inah trade is not found in any classic Islamic commercial law. However, bay’ al-‘inah is a legal sale in the Shafi’i Mazhab, in which it says the intention or niyyah is not a significant element in determining the validity of a contract. According to Shafi’i Mazhab, such sales are to be allowed because in the words of Imam Shafi’i, contracts are valid (sahih) by the external evidence that they were properly concluded; the unlawful intention (niyyah or qasd) of the parties is immaterial, it does not invalidate their act, unless expressed in that Act. Imam Malik and other medinite jurists hold these transactions as invalid or void. They consider the second transaction along with the first, and regard the grounds viable enough to suspect that the purpose is to exchange an amount of money with a higher amount that is deferred, which forms a prohibited riba. The same opinion is shared with Hanbali and Hanafi jurists.

Generally, those who oppose bay’ al-‘inah have does so primarily on the assumption that there exists an agreement between the parties to carry out the two sales in that order, so that the process results in one of the parties invariably ending up obtaining immediate cash against a future obligation settling a higher amount. It seems that both parties are pretentious and have no commitment to the sale contract. The fact that both parties have no intention of using the asset as any consumer does betrays one principle of contract in Islam, namely the objective of contract (maudu ‘ul aqdi). In the case of banking firms; the sale and resale contracts initiated by either the bank or the customer saw no event by which either party has assumed risk-taking and value-addition in rationalising the profit taken. In both transactions, each party has made a prior guarantee that in every sale there will exist an automatic resale. As such, neither is exposed to market risks and liability arising from, say defective goods sold, if any. Bay’ al-‘inah is just a legal device (hilah) that using Islamic commercial law (i.e. through trade and commerce) to obtain cash without implicating riba; to make forbidden thing permissible. The object of sale comes into play by virtue of a trick to get away with interest payments and receipts. Impliedly, bay’ al-‘inah implicates back door for interests.

            2.2       Bay’ al-dayn

Dayn or debt is basically a liability of a person to pay certain amount of money or in kind and the obligation will reside until it is completely discharged. Dayn is more general than qard (loan) whereby, in qard contract, creditor lends money or item to the debtor on a condition that the debtor will return the value of the money to the lender at a specific time. Thus, this is the source for dayn to arise. Therefore, the qard is only a type of dayn. Bay’ al-dayn (debt trading) in Islamic commercial law point of view is referring to the principle of selling the dayn which results from mu’awadhat maliyyah contracts (exchange contracts) such as murabahah, BBA, ijarah and others. In Islamic commercial law, dayn can be traded only at par under the purview of hiwalah (transfer of debt). There is no room to profit from a debt trading. According to most of Hanafis, Hanbalis and Shafi’s jurists, bay’ al-dayn is not allowed to a non-debtor or a third party at all. Such opinions are based on the forbidden sale of bai’ al-kali bil kali[10] (a debt that is paid by debt) and a sale of gharar[11], which implicates the sale of a thing which the seller does not possess; debt is intangible asset in nature.

Zahiris maintained that the sale of debt is disallowed to third party or even to the debtor himself. Hanafi Mazhab looked at bai’ al-dayn from the aspects of potential risks to the buyer, debtor and the nature of the debt itself. Thus, Hanafis also disallowed bay’ al-dayn to the third party regardless of the types of debts because the risks cannot be overcome in the context of debt selling.  This is because the debt is in the form of mal hukmi (intangible assets) and the debt buyer takes on a great risk because he cannot own the item bought and the seller cannot deliver the item sold. Contrary to that, Shafi’is maintain that the sale of a debt is allowed if it is confirmed debt (dayn mustaqir) and was sold in exchange for ‘ayn (goods) that must be delivered immediately. Furthermore, the debt sold must be traded at par value. Ibn al-Qayyim, a Hanbali jurists confirmed that bai’ al-dayn is completely in agreement with Shariah and there was no general nas or ijmak (consensus on legal opinion) that prohibited it. What was stated was the prohibition of bay’ al-kali bil kali. Thus, bay’ al-dayn for deferred payment is not allowed. The Malikis also shared the same view with Ibn al-Qayyim except that Malikis imposed eight conditions to be fulfilled in order to protect the rights of the debt buyer, to avoid debt selling before qabadh and to avoid riba. The study shows that the ikhtilaf (differences of opinion) among past Islamic jurists centred on the ability to deliver the items sold. As for Hanafi jurists, the prohibition for the sale of dayn to third party for the fear that the buyer will have to bear great risks holds the truth in it. This is especially true if there is an absence of supervision and control. The fifth condition set by Maliki Mazhab for bay’ al-dayn relates to the exchange of ribawi items: the debts can only be sold at par value.

In the Malaysian context, the trading of Islamic debt securities instruments (or Islamic bonds) is regulated by the Central Bank of Malaysia and Securities Commission to safeguard the parties involved. Therefore, the conditions set by the Maliki Mazhab and the fears of risks by Hanafi Mazhab are overcome by the regulation and surveillance set by these regulators. In the case of Islamic bonds as practiced in Malaysia, a bond that matures at par value can be sold at a discount before maturity. For example, the creditor (i.e. investor) is forced to sell at a discount the Islamic bond for liquidity purposes. But in the capital market, practically no non-debtor will buy debt at par value, unless he can make some capital gain from it. A bond worth RM1,000 (par value) may be sold for RM920 to the third party. Likewise, the third party can sell the bond at a profit before maturity. If he anticipates that the interest rate is falling (this in turn will increase the bond’s price), he can sell it at the higher price than RM920. If he anticipates the interest rate will rise (this in turn will decrease the bond’s price), he may sell it immediately or hold the bond till maturity and redeem it at par. In this way, he still making profit of RM80 (RM1,000 - RM920 = RM80).

What practically happened is that Malaysian jurists hold the view that the sale of securitised debts is similar to the sale of properties: the process of securitisation of the debts will glue the bonds or papers to some underlying assets and thus can automatically qualify itself as property (al-mal). Hence, the characteristics of debt securities are now different from currency or money (ribawi item). Since a property can be sold at any price, thus, the Islamic bond as a property can be disposed at any price agreed upon by the contracting parties. In a contract of sale, the subject matter or object of sale must generate usufruct (manfa’ah) to the buyer. For example, people buy food for consumption or buy houses to protect them from the heat or cold. But the bond or dayn in this sense is not the commodity or property, but only a legal right to a loan (i.e. right to future cash flow arising from loan repayments) represented by a piece of document in the form of papers or certificates. The underlying of it is more of a future monetary claim. Thus, the bond or dayn is indeed money in nature, not property. Therefore the sale of dayn must only be made at par value. Even if the underlying debt was not the result of a moneylending transaction (qard), the question of riba arises if it was sold not at par value. Islam does not recognise money as a subject-matter of trade. Money has no intrinsic utility; it is only a medium of exchange; each unit of money is 100% equal to another unit of the same denomination, therefore, there is no room for making profit through the exchange of these units inter se. When the bonds are sold at a discount or premium, the sale of dayn is similar to the unequal exchange of money for money; it implicates riba al-fadl[12]. Hence, any profit created from the sale of dayn is unlawful.

3.0       Other concepts available in muamalat to be employed as alternatives

            3.1       Musyarakah mutanakisah or diminishing musyarakah

Musyarakah is applicable in different modes of financing for Islamic banks. Musyarakah can be used as for project financing, to finance import and export, as working capital of a running business or to purchase assets (e.g. motor vehicle or house). In fiqh[13], the concept of musyarakah is used in much wider sense. However, in the context of Islamic banking operations, we are concerned with one type of musyarakah, that which is known in fiqh as ‘inan (unequal-shares) partnership i.e. sharikat ‘inan fi al-mal[14] since it is this form which is seen to be the most appropriate for Islamic banking environment. Musyarakah financing can be utilised for purely commercial purposes which are usually of a short term nature, or for participation in the equity of medium to long term projects. The type of musyarakah available are; (a) commercial musyarakah, (b) decreasing participation or known as musyarakah mutanaqisah, and (c) permanent participation. Application of musyarakah will let more involvement of Islamic banks in the sense of a real business venture.

Musyarakah mutanaqisah or diminishing musyarakah is a new instrument for musyarakah products and was introduced in Egypt. Another term for musyarakah mutanaqisah is musyarakah muntahiyah bittamlik. It is a form of partnership contract whereby the Islamic bank agrees to transfer gradually (by way of selling its shares in one payment or in instalments based on terms agreed by both parties) to the other partner its (the Islamic bank’s) share in musyarakah, so that the Islamic bank’s share declines and other partner’s share increases until the latter becomes sole proprietor of the venture. Therefore, the bank and its clients can participate either in a joint ownership of a property or an equipment, or in a joint commercial enterprise. The share of the bank is further divided into number of units and it is understood that the client will purchase the units of the share of the bank one by one periodically, thus increasing his own share until all the units of the bank are purchased by him so as to make him the sole owner of the property or commercial enterprise. The majority of the current Islamic jurists are unanimous in accepting it as one of the halal (permissible) instruments. This is because it has features that do not contradict the nas and general principles of the Shariah. These features are as follows:

*      inan company (form of partnership, in which each partner contributes both capital and work);
*      promise from the financial institution to sell its share of the company to its partner; and
*      the institution sells all of its partner fully or partially.

Diminishing musyarakah has taken different forms in different transactions. For example, say ‘A’ wants to participate into one business venture, say restaurant, but he is short of fund. He approaches one of the Islamic banks, say ‘B’ and ask if the bank agrees to participate in the business venture. After analyzing the business plan and track record of ‘A’, ‘B’ agrees to participate because ‘B’ believed the business is viable. Total working capital of the business is RM100,000 : 80% will be financed by ‘B’ whilst ‘A’ has to come out with another 20%. At the same time, the share of ‘B’ is further divided into eight units, each unit representing 10% ownership of the restaurant. The agreement states that every 1 month, ‘A’ will purchase one unit of the share of ‘B’. When the restaurant is operated, it generated net profit of RM5,000 on a daily basis. Since ‘B’ has 80% share in the restaurant, it is agreed that 80% of the net profit earned will be given to ‘B’ and the remaining 20% will be retained by ‘A’ who has 20% share in the restaurant. This means that RM4,000 is earned by ‘B’ and RM1,000 by ‘A’ on a daily basis. After 1 month, ‘A’ purchases one unit from the share of ‘B’. Consequently, the share of ‘B’ is reduced to 70% and the share of ‘A’ is increased to 30%. Therefore, from the date of purchased, ‘A’ will be entitled to RM1,500 being 30% from the RM5,000 daily net profit earned whilst ‘B’ will be entitled RM3,500 being 70% from the RM5,000 daily net profit earned. This process will go on until after the expiry of eight months, whereby the whole restaurant will be owned by ‘A’ and ‘B’ will take back its original investment on top of profit distributed as aforesaid.

Islamic financial institutions (IFIs) in Europe have been using diminishing musyarakah as the mode for house financing. For example, the client wants to purchase a house but need additional funds. Thus, he approaches one of the financiers who agree to participate in joint arrangement to buy the house with him. The condition is the financier will finance 80% from the price whilst 20% will be borne by the client. At the same time, the share of the financier is further divided in eight equal units, each unit representing 10% ownership of the house. The agreement states that every 3 months, the client must purchase one unit of the share by paying 1/10th from the price of the house. After purchasing the property jointly, the client uses the house for his residential requirement and pays to the joint owner for using their ownership in the property. After 1 month, the client purchases one unit from the share of financier. Consequently, the share of financier is reduced to 70% and the share of client is increased to 30%. Hence, the rent payable to the financier is also reduced to that extent. For the next 3 months, the client will purchase another unit of the share; this will reduce the financier share to 60% whilst increasing his share in the property to 40%. Consequently, the portion of rent paid to the financier is also reduced by that portion. This process goes on in the same fashion until after the end of two years (i.e. 24 months), the client purchases the whole share of the financier reducing the share of financier to ‘zero’ and increasing his own share to 100%. The financier will get back his investment along with rental income distributed to him as aforesaid.

Application of diminishing musyarakah can also be used in the capital market. For example, ABC Holdings buy a property worth RM125 million and sells it to XYZ Holdings for RM150 million based on the principle of BBA within 120 months. As ABC Holdings requires liquidity, it can get the project investors involved by issuing sukuk[15] based on musyarakah mutanaqisah. For that purpose, ABC Holdings puts in its share (the smaller part, say 10%) in musyarakah mutanaqisah for the purchase of the property (which costs RM125 million). The investors hold the majority part (90%). ABC Holdings will then buy back all the shares from the investors every month according to the amount and duration agreed upon i.e.120 months. This will end at the point when ABC Holdings owns all the shares back.

            3.2       Mudarabah contract

Mudarabah is a contract between two parties whereby one party called rab al-mal (investors) entrusts money to second party, called mudarib for the purpose of conducting the trade. The mudarib contributes his labour and time and manages the venture according to the terms of the contract. One of the essential characteristics of this contract is that the profit, if any, will be shared between the investor and the mudarib on a pre-agreed proportional basis. The loss, if any, should be borne by the investor alone. Another essential characteristic is that the capital provider or investor is not allowed to interfere in the management of the business. He may have the right to oversee, monitor and supervise the way the business is run, its progress, its prospects and others, but the day-to-day control of the business is the sole right of the mudarib. It is worth noticing that the arrangement in mudarabah contract fits well with the structure of venture capital.

Mudarabah contract can be applied in various ways in conducting banking, trade and finance. The arrangement is normally be used in IFIs to set-up the investment accounts. The funds under mudarabah contract for investment accounts holders (IAHs) include both unrestricted and restricted IAH funds. For unrestricted IAHs, the funds will be invested at IFIs discretion, normally in the same asset pool as that in which shareholders’ funds of IFIs and those from current accounts are placed. On the contrary, the funds of the restricted IAHs are invested in asset pools that are separately designated and distinct from shareholders’ funds.

IFIs can also participate in venture capital with entrepreneurs by using mudarabah contract for project financing. IFIs provide financing to the projects and the entrepreneurs as the mudarib act as the mangers of the project. The IFIs do not interfere in the day-to-day functioning of the project. The profit is to be shared between the parties according to an agreed ratio determined ex-ante, but the losses will be completely borne by the IFIs.

Mudarabah can also be used to finance import and export. For example, mudarabah structure can be used in the issuance of Letter of Credit (LC) which is normally used in the import and export transactions by the bank. For example, the client is about to import/ purchase stocks from oversea suppliers. He can informs the bank of his LC requirements and negotiates terms and conditions of the mudarabah financing for this LC. The client will then places a deposit with the bank under wadiah[16] principles and the full amount of the cost of the goods to be imported/ purchased as per mudarabah agreement. As such, he will appoint the bank as the mudarib. The bank, acting as the mudarib, establishes the LC and pays the proceeds to the negotiating bank utilizing the client’s deposit. After disposing the goods, the bank will share with the client the profit from the venture according to the terms and agreement of the venture.

4.0       Conclusion

One of the most important characteristics of Islamic financing is that it is an asset-backed financing. The conventional / capitalist concept of financing is that the banks and financial institutions deal in money and monetary papers only. Islam, on the other hand, does not recognise money as a subject-matter of trade. Money has no intrinsic utility; it is only a medium of exchange; each unit of money is 100% equal to another unit of the same denomination, therefore, there is no room for making profit through the exchange of these units inter se. Because of lack of understanding in money, the current issue on sale of dayn has arisen. For these reasons, it is critical for us to get to the basics again. We are not only need to know what leads to riba, we also need to know are the basic components of Islamic legitimacy in Islamic commercial contracts, so that there’ll be no more hilah is used to legitimize what is forbidden in Islam. The application of bay’ al-‘inah and bay’ al-dayn is making the Islamic financial industry lost its identity.

The bay’ al-‘inah and bay’ al-dayn issues are serious because it is dealing with the fundamental (usul) of religion which is riba or usury. Bay’ al-‘inah is just a legal device (hilah) that using Islamic commercial law (i.e. through trade and commerce) to obtain cash without implicating riba. The object of sale comes into play by virtue of a trick to get away with interest payments and receipts. However, the main purpose of bay’ al-‘inah is to legitimize riba which is forbidden in Islam. In Islamic commercial law, sale of dayn at par value is permissible since this is equal to the exchange of equivalence for equivalence (mithlun bi mithlin) and the debt must be confirmed debt. There is no room to profit from a debt trading. However, what is happening in the capital market like in Malaysia, is sadly discouraging and directly contradicts to the principle of Shariah. The selling of bonds at premium or discount is equivalent to the unequal exchange of money with money, thus, implicates riba al-fadl to arise. Now, it is the time to seek other alternatives for bay’ al-‘inah and bay’ al-dayn  such as musyarakah and mudarabah contracts. It is only when we get to the basics; maqasid al-Shariah or the objectives of Shariah can be achieved.

References :

Dr. Zainal Azam Abdul Rahman. 2003. “Islamic Securities Play A Key Role”. The Star. Tuesday 3 June 2003. Pp 22.
Dr. Zainal Azam Abdul Rahman. “Currency Fluctuation And Its Effects On Debts And Obligations In Islamic Law”. Jurnal Undang-Undang. Pp 21-38.
Dr. Zainal Azam Abdul Rahman. “Krisis Mata Wang Dari Perspektif Islam”. Mingguan Malaysia.
Rosly, Saiful Azhar. 2005. Critical Issues on Islamic Banking and Financial Markets: Islamic Economics, Banking and Finance, Takaful and Financial Planning. Kuala Lumpur: Dinamas Publishing.
Munawar Iqbal and David T.Llewellyn. 2002. Islamic Banking and Finance: New Perspectives On Profit-Sharing and Risk. United Kingdom. Edward Elgar Publishing.
Resolutions of The Securities Commission Shariah Advisory Council. 2nd Edition.

[1] Murabahah : Sale at specified margin. However, the term is now used to refer to a sale agreement whereby the seller purchases the goods desired by the buyer and sells them at an agreed marked-up price, the payment being settled either in instalments or in lump sum.
[2] Bai’ bithaman ajil : Trading at cost plus specified mark-up. A variation form of murabahah (sale at specified margin) with purchase payments is deferred and payable at a certain particular time in the future (e.g. via installments).
[3] Bai’ al-‘inah : Sales and repurchase back. Refers to trading whereby the seller sells his assets to the buyer at agreed selling price (with a specified mark-up) to be paid by the buyer at a later date. After that, the buyer sells back the assets to the seller at a cash price, lower than the agreed selling price.
[4] Bai’ al-dayn : Sale of debt or liability. According to large majority of fuqaha (jurists who give opinion on various juristic issues in the light of Quran and the Sunnah), debt cannot be sold except at its face value.
[5] Salam : A sale whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advanced price fully paid on the spot.
[6] Istisna’ : A contract whereby a manufacturer (contractor) agrees to purchase (build) a deliver a well-described good at a given price on a given date in the future.
[7] Mudarabah : A profit and loss sharing contract in which one party provides the financial capital and the other manages the enterprise. While profit is shared, loss is borne by the financier.
[8] Musyarakah : Similar to mudarabah contract, with the difference that both partners participate in the management and the provision of capital and share in profit or loss.
[9] Al-bay’ al-mutlaq : A general sales. Normally, the meaning resorts to the cash sales.
[10] Bai’ al-kali bil kali : A debt sale that is paid by debt. It is a type of credit sale in which on the date of the discharge of the debt, the debtor seeks extension with the promise to pay something in addition. The creditor then sells the debt again to the debtor for another period and increases the price. In this case, the debtor did not receive anything in exchange when being charged for extending the period of payment.
[11] Gharar : Literally means deception, danger, risk and uncertainty. Technically, means exposing oneself to excessive risk and danger in a business transaction as a result of uncertainty about the price, quality, quantity of the counter-value, date of delivery, the ability of either the buyer or the seller to fulfill his commitment or ambiguity in the terms of deal.
[12] Riba al-fadl : Riba pertaining to trade contracts. It refers to an exchange of different quantities (but different qualities) of the same commodity.
[13] Fiqh : The science of understanding of divinely-revealed law. Islamic jurisprudence covering all aspects of life including economic.
[14] Sharikat ‘inan fi al-mal : A form of partnership which is termed as limited investment partnership.      
[15] Sukuk : Refers to a financial paper showing entitlement of the holder to the amount of money shown on it. It is a form of financial note.
[16] Wadiah : A contract whereby a person leaves a valuables with someone for safekeeping. The keeper can charge a fee, eventhough in Islamic culture it is encouraged to provide this service froo of charge or to recover only the costs of safekeeping without any profit.

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