International Journal of Islamic and Middle Eastern Finance and

Management
Shariah parameters reconsidered
Saiful Azhar Rosly
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Saiful Azhar Rosly, (2010),"Shariah parameters reconsidered", International Journal of Islamic and Middle
Eastern Finance and Management, Vol. 3 Iss 2 pp. 132 - 146
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IMEFM
3,2 Shariah parameters reconsidered
Saiful Azhar Rosly
International Center for Education in Islamic Finance (INCEIF ),
Kuala Lumpur, Malaysia
132
Abstract
Purpose – The purpose of this paper is to explain three additional parameters, namely
maqasid al-Shariah, financial reporting, and legal documentation of contract for determining
Shariah legitimacy of financial instruments in Islamic financial institutions. Currently, contract (’aqd )
is the only parameter recognized by Shariah scholars at the supervisory level.
Design/methodology/approach – This analysis begins with examining the pitfalls of the contract
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approach and proceeds to present the maqasid, financial reporting and legal documentation
approaches in ascertaining absolute Shariah compliant of financial products.
Findings – The paper argues that the four approaches must be applied in package in determining
Shariah compliant status to avoid costly errors that might lead to litigations and loss of
competitiveness in the Islamic financing business.
Originality/value – The paper provides new insights and integrated analysis of Shariah auditing
where knowledge clusters concerning the Shariah, economics, finance and accountancy, and law are
algamated to ascertain wholesome Shariah viewpoint.
Keywords Islam, Contracts, Financial reporting, Legal action
Paper type Research paper

1. Introduction
This paper intends to examine an issue in Islamic finance pertaining to the role financial
reporting, legal documentation and intent of the Shariah in determining the legitimacy
of Islamic financial instruments. Currently Shariah scholars constituted the only party
responsible in determining Shariah compliant status of financial instruments. Their
front-end role is common knowledge, namely issuing opinions on the legality of
financial products offered by the Islamic banking, takaful, mutual funds, and wealth
management business based on the requirement of ’aqd or contract. However, the push
for innovation to satisfy commercial objectives has led many Islamic financial
institutions (IFIs) to adopt conventional principles and instruments. Fatwas issued by
Islamic jurists may run in conflict with their lucrative positions in international
corporate Shariah Boards (Hegazy, 2005). Issues include bench-making bank profit rates
against interest rates, penalty charges on late payments, charging profit from delay or
installment payment (murabaha), sale-buyback involving two parties (bay al-’inah),
sale-buy back using three interrelated parties (tawarruq munazzam), purchase
undertakings in musharakah sukuks, sale and repurchase agreement at par value in
ijarah sukuks, sale of debt at discount (bay al-dayn), promise (wa’ad ) and the
enforcement of contract (’aqd ), profit-rate swap and paying upfront profit on Islamic
International Journal of Islamic and
Middle Eastern Finance and investments, securitization of receivables, and future cash flows. These unresolved
Management issues have led many people including consumers to accuse Islamic finance as one that
Vol. 3 No. 2, 2010
pp. 132-146 “closes the front door of riba while opening the back door of riba” or an activity only
q Emerald Group Publishing Limited
1753-8394
bearing “form over substance.” Disturbing mood such as these deserves an
DOI 10.1108/17538391011054372 investigation.
 2. Four methods in determining Shariah compliance Shariah
In Islam, wealth can be created in many ways. Workers earn wages and salary by selling parameters
their labor. Retailers earn profits from the promotion and sale of their merchandizes.
Lawyers and investment bankers earns fees by rendering their professional services. In reconsidered
other words, Islam cherishes the fact property changes hands by way of trade and
commercial activities (al-bay’). When the transfer of property is transacted the wrong
way (bathil ), say by way of riba and gambling, rather than al-bay, then injustice (zulm) 133
prevails.
One who innovates will always go back to basic knowledge when something about
his work is found inadequate. The same applies to innovation involving Islamic
financial instruments. For example, it is of great importance to find ways to manage, say,
liquidity. Through innovation, new methods are designed to improve liquidity in
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banking firms and hence increase efficient use of funds, thus maximizing bank’s
earning. To avoid unnecessary losses arising from market volatilities by any means,
hedging is inevitable. Innovation in Islamic financial instrument for hedging purposes
help producers position themselves against these volatilities in a manner permitted by
Islam.
The market is also looking for better ways to accommodate changes in the cost of
funds in the existing home and car financing facilities. Entrepreneurial financing under
a musharakah framework is yet to be employed by Islamic banks. Hence, to take a
leading role in economic growth, Islamic banking must innovate in order to command a
niche in specific areas that conventional banks cannot compete.
When innovation in Islamic finance is highly sought for by the industry and other
stakeholders, it is usually conducted along certain explicit Shariah principles. The
common use of the expression “Shariah principles” which is to convey full compliance
with Islamic law in the financial transactions is a norm today. Usually, adhering to
Shariah principles or staying “Shariah compliant” means observing strictly to the
permissibles (halal ) and abstaining from the prohibited (haram) as commanded by God.
In current practice, Shariah principles may well imply the divine rules (ahkam shari’)
concerning interest (riba), ambiguities (gharar), gambling (maisir) and impure
commodities such as intoxicants and pork. This method of aligning Shariah principles
to the main and fundamental legal rulings (ahkam) concerning business and financial
transactions as mentioned above, is both pragmatic and sensible. In this way, people
can easily distinguish Islamic banking from conventional banking.
Principles can also mean values, major beliefs and doctrine rather rulings per se.
In this way, it gives a broader perspective of the Shariah and helps accommodate a wider
scope of thinking in Islamic finance. However, existing conventions may have
positioned Shariah principles as synonymous with legal rulings. These principles such
as the prohibition of riba, gharar, and maisir in financial transactions are also distinct
Islamic legal rulings (hukm shari’). However, when Shariah principles are made equal to
“legal rulings or values” (ahkam), it tends to narrow down the general meaning of
Shariah principles into the purviews of the permissables (halal ) and prohibitions
(haram) and hence, their Shariah technicalities.
It is here that the ’aqd, i.e. contract was given a special role in determining Shariah
legitimacy of financial products and but tends to overlook financial reporting and legal
documentation aspects of the transactions When a Shariah compliant product is found
suspicious, it does not fit well into the financial reporting of transaction. The same
 IMEFM affects the welfare of customers when legal documentations favored the IFIs. These
3,2 events further raised questions whether the contract has readily fulfilled the intent of the
Shariah (maqasid al-Shariah).
The following sections examine each parameter and argue that these parameters
should be complementary to one another. By doing so, Islamic financial products will
show consistency in both substance and form and thus help enhance their Shariah
134 compliant position. The four parameters are given below (Figure 1):
(1) ’aqd;
(2) maqasid al-Shariah;
(3) financial reporting; and
(4) legal documentation.
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2.1 The ’aqd approach

In developing new Islamic financial products, Shariah principles have been applied as
the litmus test of legality. In the conduct of innovation, Shariah scholars however tend to
align Shariah principles around the parameters of contract (’aqd ). In this way, the new
product will receive Shariah compliant status when it has fully complied with the
requirement of the contract at hand. Hence, permissibility (halal ) and prohibitions
(haram) of actions in using financial instruments are fully determined by the legality of a
contract (al-aqd ).
In Arabic, al-aqd literally means an obligation or a tie. It is an act of “putting a tie to
a bargain.” The Mejelle has defined contract as “the obligation and engagement of two
contracting parties with reference to a particular matter.” Contract is a source of
obligation and its faithful fulfilment is a duty in accordance with Surah 5, Verse 1 of
the Qur’an: “Oh ye who believe, fulfill your undertaking” and then in another verse, the
Holy Qur’an call upon believers to observe their engagement as they will be accounted
for all their engagements. In the Quran, Surah 17, Verse 34 reads:“And fulfill every
engagement (ahd) for every engagement will be inquired into (on the day of
reckoning).”

Aqad
approach

Maqasid Financial
shariah reporting
approach approach

Figure 1. Legal
Four Shariah compliant documentation
parameters approach
 The validity of contract rests on the fulfillment of the four principles of contract Shariah
namely: parameters
(1) buyer and seller; reconsidered
(2) price;
(3) subject matter; and
(4) offer and acceptance (Rayner, 1991). 135
For an example, a valid subject matter means that first, it is pure (mal-mutawawim) and
second, seller holds legal ownership of goods. Valid price means that price must be set on
the spot and make known to the buyer. Valid buyer and seller mean they are rational (aqil
baliqh) enough to conduct the trade so as to understand their respective roles and
obligations. In other words, the elements of ambiguities (gharar) must be avoided in all
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contracts as its presence will make the contract defective and turned it null and void.
When gharar exists in the contract, it (i.e. the contract) will cease to become valid. Under
this circumstance, counterparties can receive no protection from the legal system. Some
examples of contracts are given below.

2.2 Murabaha contract

Based on the ’aqd parameter, the murabaha contract is valid because it has fulfilled all
the requirements or pillars of a valid contract. For example, in an Islamic home financing
scheme, the bank serves as the seller while the customer as the buyer. The object of trade
is the house. The price is known and agreed by both parties on the spot. But questions
can be raised to further examine the validity of the contract. For example:
Q1. Does the bank actually purchase the asset and ultimately holds ownership
prior to sale?
Q2. How is the murabaha price determined?
Q3. To what extent profit determination has implicated time value of money with
upfront fixed compensation since the murabaha deals with installment sale?
Q4. What will happen to the customer when he defaulted on the murabaha
facility?
Q5. Who is liable when the house sold is found defective upon delivery?
Q6. Has the principle of al-kharaj bil daman being applied in this contract (Vogel
and Hayes, 1998)?
For this reason, it is imperative to further explore new boundaries of knowledge to
tighten the meaning of Shariah compliance beyond the context of fiqh, i.e. ’aqd.

3. The maqasid parameter

Shariah principles can best be understood from an angle it is destined for, namely the
purposes and objectives of Islamic law (maqasid al-Shariah) (Rosly, 2006a, b). This will
prove more effective since it allows IFIs to match their products and commercial
viability more accurately to the demands of Islamic ethics and morality and hence justice
(’adl ). This is because the maqasid of Shariah serves to do two essential things, namely
tahsil, i.e. the securing of benefit (manfaah) and ibqa, i.e. the repelling of harm or injury
 IMEFM (madarrah) as directed by the Lawgiver (Masud, 1977). In this respect, innovation in
3,2 Islamic finance and all endeavours to test the legality of a new product must readily
comply with the intent or purpose (maqasid ) of the Shariah.
Based on the above argument, it is worthy to examine what constitutes the maqasid
al-Shariah. One purpose of the Shariah is the preservation and protection of the basic
necessities (daruriyat) of man without which life would probably be filled with anarchy
136 and chaos and thus become meaningless. Basic necessities in Islamic law are religion
(din), life (nafs), progeny (nasl ), intellect (’aql ), and property (mal ). For example, the
prohibition on drinking wine (khamr) is based on two reasons. First, the intoxication
effect will make one lose his senses. This prohibition therefore serves to repel the harm
of losing one’s senses. The second concerns the protection of the intellect. It serves to
preserve the benefits when man strives to purse knowledge and seek the bounties
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of God.
In relation to the protection of property (al-mal ), the prohibition of riba serves to repel
the harm incurred by the payment of interest as it depletes one’s property. Thus, by
prohibiting riba, the harmful effects (madarrah) of poverty and widening of the income
gap can be pre-empted. Likewise, the positive Quranic attitude towards trade and
commercial activities (al-bay’) serves to secure the benefits of mutual help and equitable
transactions evident in the business environment. People engaging in al-bay will take a
natural path in dealing with risk and return as both move in a harmonious fashion. By
conducting al-bay and thus deriving benefits from it, it can turn the business of money
lending less profitable than trading.
The maqasid of Shariah will also assure that an IFI will provide services that can
repel the harm (madarrah) commonly found in the Western mode of financing. If the
harm is still obvious in the new Islamic financing product, it (i.e. the harm) must be
eliminated at all cost. Otherwise, the product will not reflect the true ideals of Islam. For
example, hedging against price volatility is an important ingredient in business today.
Manufacturers who buy raw material as inputs seek to buy them at the cheapest cost
possible. Some will buy forward, i.e. buy the commodity now to be delivered and paid for
at a specific future date. The price is set on the spot on the day the contract is arranged.
There are serious disagreements among Shariah scholars on this matter. Some say this
kind of forward contract is permissible as it has fulfilled the requirements of a valid
contract while others say the contrary as the contract involves betting against unknown
events and thus akin to gambling (maisir) and therefore invites harm and injustice (zulm)
to the counterparties.
When the issue is examined from the contract (’aqd ) perspective alone, i.e. applying
rules of contract in determining legality, it may overlook the very purpose of the Shariah
and hence unable to repel the harm it is initially intended to do. If it can be proven that
forward contract is free from harm either from the gambling element or ambiguities
(gharar), then it should prove beneficial to Islamic finance and hence be adopted by IFIs.
However, if it the contract is found valid (sahih) from the ’aqd perspective but has been
shown to have adversely affected the general welfare, as evidenced say in the Orange
County and Barring scandals, the product should be reviewed with more rigour in
juristic terms. When something has failed to repel the harm, it defeats the very purpose
of the Shariah.
Fulfilling the maqasid al-Shariah should therefore constitutes the underlying
principle of Islamic financial innovations as it safeguards rulings based on fiqh from
 moving into unwanted territory. The purpose of the Shariah and the rulings of contracts Shariah
(’uqd ) should not be in conflict with one another. If it does, the maqasid shall stand above parameters
the rulings of contracts. This is because the former is based on the Divine Law while the
latter is founded on human understanding ( fiqh). reconsidered
In this manner, the legality of a financial contract cannot be judged only from the
contract (’aqd ) aspect but equally important is benefits and disbenefits to the general
public. For example, if Islamic financial products are found to make people fall into debts 137
and bankruptcy, how can one explain it is a worthy alternative to conventional
financing? On the contrary Islamic products should enhance economic growth, reduce
poverty and bring happiness to human beings.
The recent subprime crisis in the United States should be a lesson to Islamic banking.
Sale of mortgage loans called for the issuance of collateralized debt obligations by
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special purpose vehicle (SPV) companies. The securitization of loan receivables by the
SPV is an issue in Islamic finance in Malaysia. While Shariah allows securitization of
physical assets, it prohibits the sale of murabaha receivables although Malaysia Shariah
scholars at the bank supervisory level have allowed this (Securities Commission 2004).
The subprime crisis is partly rooted in securitization of loan receivables as well as
imprudent loan origination (Eichengreen, 2008).

4. Accounting and financial reporting approach

Accounting can be defined as the process of identifying, measuring and communicating
economic information to permit informed judgement and decisions by users of the
information (Alexander and Christopher, 2007). In Islam accounting fall under the
purview of hisb and part and parcel of the al-hisbah system (Islahi, 1966).
The purpose of financial statements or financial reporting is to provide information
about the financial strength, performance and changes in financial position of an
enterprise that is useful to a wide range of users in making economic decisions
(van Greuning, 2006). It serves to eliminate ambiguities (gharar) and fraud (tatfief ) in
financial contract through factual reporting of the said transaction. More importantly,
financial reporting explained what exactly was transacted in the business dealings such
that one is able to know whether, say, a transaction is a loan or a sale, whether a sale is a
true one or not. This is important because accounting information is used by investors
who make economic decisions by making predictions of future cash flows of company
they invested in. For this reason, financial reporting should be understandable, relevant,
reliable and comparable as laid by the International Financial Reporting Standard. This
is an Islamic imperative that all IFIs must subscribe to such that stakeholders can gauge
its real value to society.
In financial accounting, a balance sheet or statement of financial position is a
summary of a persons or organization’s assets, liabilities and ownership equity on a
specific date, such as the end of its financial year. A balance sheet is often described as
a snapshot of a company’s financial condition (Alexander and Christopher, 2007).
A company balance sheet has three parts: assets, liabilities, and shareholders’ equity.
The main categories of assets are usually listed first and are followed by the liabilities.
The difference between the assets and the liabilities is known as the net assets or the net
worth of the company. Thus, zakat can be computed on the net worth of the company.
According to the accounting equation, net worth must equal assets minus liabilities.
 IMEFM The application of trading and commercial principles (al-bay) in Islamic banking
3,2 requires banking firms to adhere to financial reporting standard whose purpose is to
provide true information of business transactions. For example, when the transaction
uses the contract of ijarah (leasing), then the leased asset must be reported in the
balance sheet as fixed asset. The purchase of the leased asset is subject to tax whose
payment is recorded as operating expense in the income statement. Depreciation
138 allowances are recorded as an expense, thus the company that took the leasing option
can benefit from the tax allowances to improve earnings. Some examples of Islamic
financial products are given in the followings:
.
Al-ijarah thumma al-bay (AITAB) or al-ijarah muntahia bittamleek, i.e. leasing
with intention to own or buy, is currently a Shariah complaint contract applied for
car financing. As specified by the contract of ijarah, the leased asset should be
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recorded as fixed (ijarah) asset. But when AITAB in Malaysia, operates under the
conventional Hire-Purchase Act 1967, it (i.e. AITAB) is treated as a financing
activity rather than a true lease as no recording of ijarah asset is evident in the
balance sheet. Instead AITAB transactions are recorded as financing and
advances which is synonymous to loan and advances in conventional financing
leasing or hire-purchase.
. Murabaha or al-bai’ bithaman ajil (BBA) contract, the bank is expected to purchase
the asset before making the sale. The principle that “one must not sell what one
does not own” confirms that the bank must hold ownership of asset prior to sale
and thus recording it in the balance sheet. Such accounting treatment is an
inevitable fact and any Islamic bank that failed this test is guilty of riba since it
indicates that no true sale exists. Although bank may hold the asset for a few days
or even hours, proper accounting must be uphold.
.
Bay al-inah: financial reporting and disclosure can prove that a bay al-inah sale is
not a true sale but only a fictitious one. Although the ’aqad approach says bay
al-inah is valid (sahih), but not actual sale ever took place between the financier
and the customer since no recording of asset purchase is evident in the balance
sheet of the bank. At this juncture, there is a conflict between juristic validity and
financial reporting. Such inconsistency in the Islamic financial system, suggests
that the contract approach cannot stand alone anymore and must find
supplementary devices to secure complete Shariah legitimacy.
.
Sukuk al-ijarah: this participatory certificate is not similar with conventional
asset-backed securities as the latter is based on lending and borrowing contract
and the SPV holds legal and beneficial ownership of asset. The SPV issued fixed
income securities in order to borrow from the investors. These securities are
backed by the underlying assets such as mortgage receivables. In sukuk al-ijarah,
the Shariah stipulated investors as legal and beneficial owners of the underlying
assets. This condition however is not fulfilled in most existing sukuks. The
Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI) (2007) ruled in February 2008 that a sukuk is not Shariah compliant
when the SPV fails to transfer ownership of asset to the holders or investors. When
ownership is held by the investors, the underlying asset may decline in value in
an event of falling real-estate prices or will increase during an economic upturn.
 As such, investment is deemed permissible as it has observed the legal maxim, Shariah
al-ghorm bil-ghonm, meaning no profit without liability. parameters
5. Legal documentation of contract approach reconsidered
The ’aqad approach primarily pays attention to the fulfillment of the pillars of contracts.
Indirectly, rights of contracting parties are defined and made explicit in contracts. The
purpose of legal documentation is to provide security and protection to contracting 139
parties when their rights, obligations, and responsibilities are clearly spelt out in the
terms of agreement or contract. This security enabled them to seek legal protection in
case the outcome of the contract is not realized as agreed upon in the agreement.
In Malaysia, consumers usually receive legal protection from three legal principles
and provisions under (Rosly, 2006a, b):
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(1) Contractual law. A contract is a legally binding agreement between two parties
by which each party undertakes specific obligations or enjoys specific rights of
that agreement. In Malaysia, the Law of Sale of Goods 1957 and the Law of
Hire-Purchase 1967 provides ample provisions for consumer protection such as
passing the asset’s title to the buyer.
(2) Law of tort. The law of tort deals with liabilities of the seller. If the consumer
suffers injury or harm from the goods sold (i.e. found to be defective and
dangerous) the seller is liable to pay damages.
(3) Regulatory (penal) statutes. These affect specific activities that directly or
indirectly affect the consumer. They serve to impose standards on goods,
services or safety measures by prohibiting specific activities or requiring certain
things to be satisfied. Some examples of regulatory statues in Malaysia are the
Price Control Act 1946, Control Supplies Act 1961, Weight and Measure Act 1972,
Trade Description Act 1972 and the Direct Sales Act 1993.
Business malpractices (tatfief ) can take various forms such as large business
organization to monopolize production and kill the competition, misuse of trademarks
and patents, sale of duplicate goods by unscrupulous traders, malpractices in direct
sales, misrepresentation of cheap sales, misleading price indications, deceptive labeling
of products, exploitation, and malpractices in housing and real estate transactions. Since
the Islamic banking business is no longer confined to financial transactions alone but
more importantly the conduct of buying and selling involving possessions and delivery
of goods, it is now more exposed to moral hazards commonly evident in the retail and
wholesale business. Thus, consumer protection is next in line to be seriously looked at in
Islamic finance innovation.
Consumer protection is a form of government regulation which protects the interests
of consumers. For example, a government may require businesses to disclose detailed
information about products – particularly in areas where safety or public health is an
issue, such as food. Consumer protection is linked to the idea of consumer rights (that
consumers have various rights as consumers), and to the formation of consumer
organizations which help consumers make better choices in spending.
Consumer protection law or consumer law is considered an area of public law that
regulates private law relationships between individual consumers and the businesses
that sell them goods and services. Consumer protection covers a wide range of
topics including but not necessarily limited to product liability, privacy rights, unfair
 IMEFM business practices, fraud, misrepresentation, and other consumer/business interactions.
3,2 Such laws deal with bankruptcy, credit repair, debt repair, product safety, service
contracts, bill collector regulation, pricing, utility turnoffs, consolidation, and much
more. There are many compelling reasons why consumer needs protection. Some major
ones are as follows: Poor bargaining position, consumer safety, information gap, and
advertising practices.
140 In order to protect the consumers from business malpractices and manipulation, they
can be informed about their rights. The International Organization of Consumer Union
outlined seven rights of the consumer, such as right to adequate product information,
right to quality and safety of goods and services, right to choose, right to be heard, right
to get consumer education, right to healthy environment and right to redress (Sim, 1991).
The concept of right in Islam lies in the definition of ’huquq, pl. of haqq. The word
haqq meaning “something right, true, just, real”; haqq in its primary meaning is one of
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the names of Allah (s.w.t), and it occurs often in the Qur’an in this sense, as the opposite
of batil (vain, false, unreal). A further meaning of haqq is “claim” or “right,” as a legal
obligation. Islamic law distinguishes the haqq into two kinds: one is the rights relating to
God, and the second is right relating to individuals. The rights relating to God are the
rights that relate to public interest. They are linked to God due to the seriousness of the
rights and the comprehensiveness of their benefit. The rights relating to individuals are
those which are related to individual interest. Therefore, pardon and compromise is not
permissible in the rights relating to Allah while in the rights relating to individual it is
permissible (Sanusi and Rosly, 2008).
Under Islamic jurisprudence, haqq is defined as “the exclusive power over something,
or a demand addressed to another party which the Shariah has validated in order to
realise a certain benefit.” In Islamic finance, commercial right is confined to something
that has monetary value (qima maliyya). The concept is confined to rights having
monetary value, which the law protects, i.e. the right of maintenance for dependants, the
right to demand wages for work done and the right to demand the delivery of object of
the sale upon payment of its price. Such rights are personal and material, as they are
designated in the law.

5.1 Legal actions against Islamic banking customers

The need for protection the rights of the consumer in Islamic banking can be readily seen
from four civil cases involving disputes between Islamic banks and their customers
(Rosly, 2005). These cases relate to defaults of murabaha facilities and its impact on the
defaulting customers. There are five celebrated cases on Islamic banking disputes in
Malaysia such as:
(1) Bank Islam Malaysia Bhd v. Adnan b. Omar.
(2) Dato’ Haji Nik Mahmud v. Bank Islam Malaysia Bhd.
(3) Tinta Press Sdn. Bhd v. Bank Islam Malaysia Bhd.
(4) Affin Bank Bhd v. Zulkifli Abdullah.
(5) Taman Ihsan Jaya v. Malaysian Finance Bhd

5.2 Lessons
There are valuable lesson learned from the cases. In the first case, defendant did not
understand the concept of BBA and how it affects settlement of debt outstanding balance.
 He thought all along that the contracted price under BBA is equal to the cost price of Shariah
BBA asset sold. In the second case, the Dato’ Haji Nik Mahmud assumed that the facility parameters
is based on a buy and sell concept. But it did not appear to be so as no transfer
of ownership is evident in the sale as the land is put under charge to the bank. In the third reconsidered
case, the customer has failed to understand the contract he has entered with the bank. He
was made to understand that it was a like a loan but the contract is actually based on
leasing. Finally, the fourth case demonstrated the fact that an Islamic bank can freely 141
imposed a selling price that surpassed the evils of riba when the customer is required to
pay up all unearned (i.e. accrued) profits when he defaulted on the financing facility.
The contract of BBA or murabahah currently forms the basis of almost all Islamic
financial products today, both in Malaysia as well as the Middle-east. It forms a
component in bay al-inah, tawarruq and commodity murabahah and the sukuks as well.
Although BBA is theoretically a sale contract, it does not seem to conform to the Law of
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Good Sale Act 1957. There is an implied condition that the seller has the right to sell and
readily transfer the title of ownership to the buyer. This implies that the seller must hold
legal ownership of the goods prior to the sale.
In the case of Dato’ Nik Mahmod v. BIMB, a true sale is not evident since the transfer
of asset title from the sale was not effected as the ownership of land remains with the
plaintiff. In the case BIMB v. Adnan Omar, the land is put under charge with the bank
which means that the defendant has remained the legal owner of the land over the
financing period.
The most celebrated foreclosure case is between Malaysian Finance Bhd and
Taman Ihsan Jaya Bhd where the High Court judge Justice Datuk Abdul Wahab Patail
ruled that the sale between the two parties in the above is “not a bona fide sale” but a
financing transaction instead. According to the documentation of the BBA agreement,
true sale between the counter parties as required by any contract of sale is not evident.
As there is no transfer of ownership from the seller to the buyer, he declared that that
the BBA sale is null and void and that the customer (i.e. who defaulted on his debt
obligation) has to pay back only the principle amount to the bank. Fortunately, the case
is a foreclosure case, hence the ruling is not a binding one. According to the judge, a
bona fide sale is evidenced only when the bank directly purchase the property from the
vendor or by a novation agreement from its customer and then sold the property to the
customer.
It is thus, important that the rule of ownership must prevail in all sales bearing the
contract of al-bay. Playing down with this rule can imply violation of the Law of Good
Sale Act 1957. However, if the contract is written down to evident a financing agreement
rather than a sale agreement, the judge will act on the former and not on the latter. As
Islamic banking and finance in Malaysia is gaining more ground, legal cases may soon
involve disputes dealing with takaful and Islamic private debt securities. It is important
for the proper authorities to see that civil courts are able to preside over prospective cases
to come.

5.3 Abandon housing

Abandon housing problem usually emerge when housing developers failed to pay their
contractors for the work done. Failure to pay up is explained by several factors including
malpractices such as siphoning bank loans (i.e. bank payments on behalf of customers)
by unscrupulous developers who divert the money to other activities not related to the
 IMEFM development of estates or inability to obtain sufficient bridging loan facilities from
3,2 banks. In the worst scenario, the housing project will fall under receivership while
customers are forced to continue paying their monthly installments although the
prospect of delivery is close to zero. The victims may end up making two payments,
namely bank loans and rentals.
Consumers who purchase properties under BBA financing are not sparred from the
142 abandon housing debacle. Although no legal cases have emerged, complaints and
grievances are not new in the media. Islamic banks as the selling party should be
proactive in dealing with property developers as the latter are responsible to deliver the
asset according to the specification agreed upon. However, it is common knowledge that
Islamic banks remain to play as financiers rather than a true seller. The same applies to
BBA purchases via government financing scheme.
In principle, the BBA sale deals with two parties, namely the bank as the selling party
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and say, Mr Ismail as the buying party. But prior the BBA sale, the bank must purchase
the house from the vendor/developer. This purchase does not constitute a BBA sale.
Existing banking law in Malaysia (Banking and Financial Institutions Act 1989) does
not allow a conventional bank to buy asset for profits. They are not allowed to purchase
and sell assets to earn money. In this way banks, cannot buy houses and other properties
from vendors. They only provide financing, i.e. make loans.
The same does not apply to Islamic banking. Civil transactions require the customer
to purchase the property from the housing developer. The Islamic banking Act 1983 is a
civil law and stays under the jurisdiction of civil court. It allows Islamic banks to buy
property from the housing developer but only to see the banks refusing to do so. This is
because Islamic banks do not want to assume the risk of ownership. They will incur
losses if unable to make the sale.
When an Islamic bank is not keen to purchase the property and holds ownership risk,
the customer usually do so with the housing developer. Assuming that the price of
property is $60,000, Ismail met with a housing developer/vendor and signed a sale and
purchase agreement (S&P) based on a 20 percent down payment, i.e. $12,000. In
conventional practice, Ismail will look a banking loan to finance the remaining balance,
i.e. $48,000. Assume that Maybank has approved the loan and pays the developer
the remaining balance on behalf of Ismail. Ismail uses a loan facility to purchase the
property from the housing developer on cash basis. To secure payments over the
duration of the loan, Ismail will pledge the property as collateral via the deeds of
assignment. Given interest rate charges at 4 percent flat over 20 years, Ismail will pay the
bank an additional $38,400 in interest. His monthly installment payments amounts to
$360, i.e. [($48,000 þ $38,400)/240].To sum up, conventional financing is made up of two
basic contracts, namely:
(1) contract of loan between the bank and Ismail; and
(2) deeds of assignment/charge.

The same procedure applies for Islamic banks. When bank refuses to purchase the
property from the vendor, Ismail will instead buy the property from the housing
developer. He puts up $12,000 as down-payment to secure the Sales and Purchase
agreement on his favour. In this manner, Ismail becomes the legal and beneficiary
owner of the property. But how could Bank A sell the property to Ismail via BBA
contract when in the first place it does not own the asset? The Holy Prophet says “do not
 sell what you don’t own.” Bank A must be careful not to violate this critical Shariah Shariah
injunction. parameters
To so do, Bank A must purchase the property from Ismail via the property purchase
agreement (PPA). The current practice indicates that the bank pays the customer reconsidered
$48,000, which it passes down to the housing developer. Once the bank holds property
ownership via PPA, it then sells the property to Ismail via the property sale agreement
(PSA). Here, the terms are as follows: 143
.
Seller (Bank A) and buyer (Ismail).
.
Object of sale: low-cost house.
.
Price of object: cost price $48,000) þ profit margin ($38,400) ¼ $86,000.
.
Monthly installment payments ¼ $86,000/240 ¼ $380.
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Similar with conventional practice, Ismail pledges the house as a collateral via the
deeds of assignment or charge. It says that the bank holds beneficial ownership of the
property in the manner that it holds the right to sell it if Ismail defaults the BBA
facility.
To summarize, BBA sale consists of three contracts, namely:
(1) PPA. Bank buys property from customer.
(2) PSA. Bank sells property to customer at BBA price.
(3) Deeds of assignment/charge. Bank A holds property as collateral.

It seems that the above agreements were drawn to treat BBA as a loan rather than
a sale (al-bay’). In a true BBA sale as spelt out by the AAOIFI, the bank should
purchase the house from the housing developer/vendor. S&P agreement should have
taken place between the bank and housing developer. In this manner, the bank will hold
risk of ownership (ghorm) and thus holds and deserve the right to earn profits from
the sale.
Buying properties and placing them in the banking book is a risky decision as well as
costly business decision for Islamic bank managers. For this reason, Islamic banks in
Malaysia have yet to conduct a true purchase from housing developers. Instead, S&P
agreement has only involved customers and developers. To secure ownership (milkiyah),
Islamic banks have instead introduced the PPA before executing the PSA.
When Islamic banks truly purchase the property from the developer, then the BBA
sale shall consists of the following agreements:
.
PSA. Bank sells property to customer at BBA price.
.
Deeds of assignment/charge. Bank holds property as collateral.

When a housing developer is not able to deliver the houses during the stipulated
construction period or failed to deliver at all, the customer who secured the purchase
under conventional loan will take legal action against the developer. However, under
current BBA financing facility, the same should apply since the bank does not actually
own the property (Yasin, 2003). In this way, the rights of the customer as a buyer are not
protected well since he instead of the bank will take the trouble to take legal action
against the housing developer.
 IMEFM 5.4 Defective products
3,2 The law of torts usually handles the nature of liability held by the selling party. One
example is property damages from construction or production defects caused by
negligence of the manufacturer. For example, in a BBA financing purchase some defects
are found in the houses newly delivered by a housing developer. Should the customer
make complaints to the developer or should they leave the matter to the Islamic bank as
144 the true selling party?
In conventional financing, the latter is true, but should Islamic banking do the same
thing? By virtue of the BBA contract, it is apparent clear that the bank should take
responsibility over the damages. The customer must be informed about their Islamic
rights of option (khiyar) in the BBA contract. The right must be exercised by the buyer
onto the bank as the selling party and not the developer instead.
The issue at hand is khiyar al’-ayb or option of defect. It is about the option given to
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the customer to cancel the BBA contract when a defect on the goods sold is found. In
the BBA agreement, the bank is expected to take forceful action onto the developer for
instant remedies to see that the defects are removed. The khiyar al-’ayb or the option of
defect is a legal right (Rayner, 1991). This means the customer does not need to
stipulate a special clause or provision of the option at the time of contracting. It comes
automatically with the BBA sale. According to the Mejelle, “any buyer in Islamic law
has an automatic implied warranty against latent defects in the goods purchased.”
The legal documentation approach should be able to lay out what is desirable in the
contract approach in writing. Both should be in congruence and do not move in opposite
direction. The documentation approach explain the rights and responsibility of
contracting agents while the contract approach articulate what the transaction is
made of.

6. Concluding thoughts
It is important to see the consistency and stability of form and substance in the four
methods explained above. As an example, when it is found that the murabahah/BBA
contract is valid via the aqad approach, the financial reporting approach should be able
to show that the bank has initially hold ownership prior to the murabahah sale in which
the object of trade is recorded as fixed asset in the bank’s balance sheet prior to disposal.
Once the murabaha sale is executed, the bank holds murabahah receivables instead. The
legal documentation approach should evident transfer of ownership from the vendor to
the bank and from the bank to the customer through proper registration of ownership.
The sale contract should grant legal protection to the customer in case the asset
delivered was say, defective. Likewise, the bank should receive protection from the court
if the customer defaulted on his murabaha debt obligation. Hence, dispute resolutions
can be settled fairly. The maqasid approach should provide insights that the murabaha
contract does not embrace values in riba. If riba, through interest-bearing lending and
borrowing is responsible for the global financial turmoils, murabaha financing is not
expected to produce economic bubbles leading to similar crises. Usually, the aqad
approach resorts to screen the contract from the explicit contact with riba, gambling
(maisir) and ambiguities (gharar) as well as the type of commodities traded. It however
may not be able to test say, ownership risk unless it looks into the legal papers of
the murabaha facility or studied banking book. It is imperative for Shariah scholars at
the supervisory level to recognize the role of legal documentation and financial reporting
 arising from products they have given approval to. Likewise, the impact of the Shariah
transaction on the society should also be acknowledged. This involves incorporating the parameters
maqasid al-Shariah in the examination of contracts applied in the Islamic banking
business. reconsidered

References
AAOIFI (2007), Shariah Standard on Sukuk, Accounting and Auditing Organization for Islamic 145
Financial Institutions, Bahrain.
Alexander, D. and Christopher, N. (2007), Financial Accounting: An International Approach,
Prentice-Hall, London.
Eichengreen, B. (2008), “Ten questions about the subprime crisis”, Financial Stability Review,
No. 11, pp. 19-28.
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Hegazy, W. (2005), “Fatwas and the fate of Islamic finance: a critique of the practice of fatwa in
contemporary Islamic financial markets”, in Nazim Ali, S. (Ed.), Islamic Finance: Current
Legal and Regulatory Issues, Islamic Finance Project, Harvard Law School, Cambridge.
Islahi, A.A. (1966), Economic Concepts of Ibn Taimiyah, The Islamic Foundation, London.
Masud, M.K. (1977), Islamic Legal Philosophy: A Study of Abu Isaq al-Shatibi’s Life and Thought,
Islamic Research Institute, Lahore.
Rayner, S.E. (1991), The Theory of Contracts in Islamic Law, 1st ed., Graham & Trotman,
New York, NY.
Rosly, S.A. (2005), Critical Issues in Islamic Financial Markets, Authorhouse, Bloomington, IN.
Rosly, S.A. (2006a), “Consumer rights in Islamic banking”, paper presented at the National
Economic Outlook Conference 2007-2008, Malaysian Institute of Economic Research,
Kuala Lumpur.
Rosly, S.A. (2006b), “Innovation in Islamic finance”, INCEIF Monthly Bulletin, INCEIF,
Kuala Lumpur.
Sanusi, M. and Rosly, S.A. (2008), “Fiqh muamalat for Islamic financial practitioners”,
unpublished, International Islamic University Malaysia, Kuala Lumpur.
Sim, F.G. (1991), History of the International Organization of Consumer Union, Consumer Union,
Yonkers, NY.
van Greuning, H. (2006), International Financial Reporting Standards: A Practical Guide,
The World Bank, Washington, DC.
Vogel, F.E. and Hayes, S.L. (1998), Islamic Law and Finance – Religion, Risk and Return, Brill,
Boston, MA.
Yasin, N.M. (2003), “Appeal court decision on al-bay’ bithaman ajil (BBA): misundertanding
and/or the true state of affairs?”, in Idid, S.A. and Shing, W.K. (Eds), Judicial Decisions
Affecting Bankers and Financiers, LexisNexis, Kuala Lumpur.

Further reading
AAOIFI (2002), Shariah Standard, Accounting and Auditing Organization for Islamic Financial
Institutions, Bahrain.
American Accounting Information (1966), A Statement of Basic Accounting Theory, American
Accounting Association, Evanston, IL.
Demetriades, D.G. and Tyler, C.R. (2004), Mejelle-Majallah el-Ahkam-i-adliya, Other Press,
Kuala Lumpur (translation).
 IMEFM About the author
Saiful Azhar Rosly is a Professor of Islamic Economics and Banking at INCEIF and has taught
3,2 Islamic economics, Islamic banking and finance, and Islamic capital market courses since 1983
when he first joined the International Islamic University Malaysia. He is currently director for
EON Capital Islamic Bank (Malaysia) Berhad. Saiful has also served as Director of Research at
the Malaysian Institute of Economic Research. He joined INCEIF in 2006 as professor and head of
the banking department. INCEIF is a graduate university that specializes in Islamic finance
146 education and offers Masters and PhD in Islamic Finance. INCEIF’s flagship program is the
Chartered Islamic Finance Professional (web site: www.inceif.org).
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