Abstract
The unwillingness of contemporary Islamic banks to undertake real business risks has left many to ponder on whether the objectives laid down by the industry's founders have been realized. The need for real risk taking by Islamic banks is critical to justify the profits they earn in the forms of margins, rents, or service charges. This chapter analyzes issues relating to ownership risk (ḍamān al-milkiyyah) in Islamic banking by examining three of its popular products, namely Murabahah (mark-up sale), Ijarah (leasing), and Musharakah Mutanaqisah (diminishing partnership). Following close scrutiny, the chapter concludes that principles of ownership risk as laid down in Fiqh Muamalat (law of transactions) are violated in each of the studied products. Unfortunately, the problem extends beyond these products to include a number of other Islamic financial products. The author calls for closer attention to this important Shari'ah concept of ownership risk in designing Islamic finance products and offers some policy recommendations to improve the current situation.
TopIntroduction
The rapid growth of Islamic banking industry within the last several years signifies an important achievement. Total assets of the Islamic finance industry was estimated at US$2.4 trillion in 2017 and is expected to increase to reach US$3.8 trillion by 2023. As of 2017, market share of Islamic banking was equal to 71% of the entire industry, or US$1.7 trillion with an annual growth rate of 5% (Reuters, 2018). The current state of Islamic banking, however, does not match the original expectation of its founding fathers, where Islamic banking was initially envisioned to be the catalyst of economic growth and prosperity through its engagement in mainly profit and loss sharing based financing.
When one undertakes careful observation of the majority of product structures offered by contemporary Islamic banks, striking similarities are found with the financing products of conventional banks in terms of operations. The fundamentals of Islamic banking products are supposed to align with Shari’ah principles, and financing provided to businesses and individuals must be based on the principles of true sale, partnership and provision of genuine services in order to earn profits. Nevertheless, the current structures of most Islamic banking products leave room for suspicion as to whether such transactions are done in reality. One critical issue to remember in this line of reasoning is the need for risk taking by Islamic banks to justify their earnings in the forms of margins, rents or service charges. True risk taking should be reflected in various aspects of Islamic banking products, such as the possibility of loss in partnership-based contracts; and exposures to market risk in sales transactions and ownership risk which arise when there are elements of transfer of ownership and its related benefits within the products.
In this chapter, the author analyzes only one of such risks, namely ownership risk. The chapter begins with a brief introduction of the concept of ownership in Islam, followed by description of ownership related risk and liabilities in Shari’ah (ḍamān al-milkiyyah). Once the reader obtains clear understanding of the ownership risk concept, the author continues with an analysis of some popular products offered by Islamic banks and specifically investigates whether the risk and liability related to ownership (ḍamān al-milkiyyah) are correctly assigned in the structuring of those products in contemporary Islamic banks. The investigation and analysis focus on Islamic banking products such as Murabahah (mark-up sale), Ijarah (leasing) and Musharakah Mutanaqisah (diminishing partnership). The chapter also examines issue of ownership risk in some other Islamic finance products such as Takaful and Sukuk. Thereafter, it looks into some real court cases directly related to violation of ownership risk principles in Islamic finance industry. The chapter concludes with some policy recommendations.
Key Terms in this Chapter
Maqasid al-Shari’ah: It stands for Objectives of Shari’ah , which gives general description of objectives in Shari’ah rulings intended by Law Given (i.e. Allah). The objectives are divided into three parts in terms of their priority, namely darruriyyat (essentials), hajiyyah (complementaries), and tahsiniyyah (embellishments), respectively.
Takaful: An Islamic alternative to conventional insurance where participant in a Takaful scheme agree to donate a certain proportion of the premium ( tabarru’ ) into a Takaful pool to assist other Takaful participants suffering from defined loss or damage. Takaful scheme recognizes the elements of shared liability, joint indemnity and mutual assistance. Takaful fund is generally managed by a Takaful operator for a fee or a share of the investment profit.
Ijarah (Leasing): It is an agreement which refers to hiring of labor for a wage or a durable good’s usufruct for a rental payment. However, in modern term, Ijarah generally refers to operating or financial lease where one party (lessor) agrees to the sale of the usufruct of his or her durable goods to another party (lessee) for an agreed fee and specified period.
Mudarabah: A joint venture agreement in which one party (capital provider or rabb al-mal ) invests with capital and the other party (entrepreneur or mudarib ) invests with his skill or labor. The profit of the venture is shared according to a pre-agreed ratio, while the entire loss is born by the capital provider unless it was due to negligence of the entrepreneur.
Musharakah Mutanaqisah (MM): A mode of Islamic financing, where the bank and the client enter into a contract of joint property ownership. Throughout the financing period, the client will rent the bank’s share in the property and increase his ownership through gradual acquisition of the bank’s share through payment of periodic instalments.
Sukuk: A Shari’ah compliant investment certificate with certain underlying asset which represents contribution into an investment pull organized by a Special Purpose Vehicle (SPV) which was established to finance a certain project of the issuing company. It can be based on different Shari’ah contracts, such as Musharakah , Mudarabah , Ijarah or Murabahah . Depending on the type of contract used, the returns and structuring of Sukuk may vary.
Ownership Risk (?aman al-milkiyyah): Risk and liabilities that the owner of a certain asset should carry for profits and benefits associated with ownership of the given asset could be justified as Shari’ah compliant or halal (permissible) in Islam.
Mudarabah (Mark-up Sale): A contracts correspond to mark-up sale, where the bank purchases a commodity and sells it to the client with additional mark-up over the cost. Such contract belongs to contracts of fiduciary sales ( Buyu’ al-amanah ) because the seller is supposed to disclose both the cost and the profit margin to the buyer.
Bai Bithaman Ajil (BBA): A type of Murabahah (mark-up) sale where payment is generally made on a deferred basis. Bai Bithaman Ajil is also called with different names in some countries such as Bai’ al Muajjal in Pakistan or Bai’ Muazzal in Bangladesh.
‘Iwad (An Equivalent Counter Value): An essential requirement of a lawful sale transaction in Shari’ah . Three essential elements of ‘iwad are the existence of risk ( ghurm ), the existence of work and effort ( ikhtiar ), and taking of liability ( ?aman ).