Islamic Capital Markets:

Products and Analysis

Priyonggo Suseno

1
 Capital Markets

• Capital markets bring together the

demanders and suppliers of long-
term funds
• Capital markets also allow people
who hold previously issued
securities to trade those securities
for cash in the secondary market

2
DEVELOPMENT OF THE INDONESIA
CAPITAL MARKET
CAPITAL
MARKETS

EQUITY DEBT

Corporate Equity-linked Public Private

Securities Derivatives Debt Debt

Shares Warrants, MGS, GICs Cagamas

ICULS, etc. MSB Bonds

Govt Backed PDS

Securities
3
 Capital Market Instruments

• Common stocks – profit-sharing

• Bonds – fixed income

4
Islamic Capital Market

The demand and supply of

long-term funds - based on
Shariah principles

5
 SHARIAH PRINCIPLES FOR ISLAMIC
CAPITAL MARKET TRANSACTIONS

• Principle #1 : Prohibition of interest as riba

• Principle #2: Application of al-bay’ (trade
and commerce)
• Principle #3: Avoidance of gharar (ambiguities) in
contractual agreements
• Principle #4: Prohibition of maisir (gambling)
• Principle #5: Disengagement from production of
prohibited commodities – pork,
liquor.

6
 Islamic Capital Market Instruments

• Shariah Compliant stocks – profit-sharing

• Islamic Bonds – fixed income

7
 Islamic Bonds in Malaysia
• BBA Islamic debt securities (BAIDS)
• Murabahah Notes Issuance facilty
(MuNif)
• Sukuk Al-Ijarah
• Islamic Asset-Backed Securities (IABS)

Islamic Bonds in Indonesia

• Obligasi Syariah

8
 Islamic Financial System
Islamic Definition: Quranic rules and
Financial regulations that
govern the flow of funds from the
System surplus spending unit (SSU) to the
deficit spending unit (DSU).
Islamic
Surplus Deficit
Sector
Financial
Sector
Market

Direct Islamic
Money Indirect Takaful
Financial Market Financial
Market Market

Commercial
Capital Market Banks
Unit
Trusts

Finance
Islamic Islamic Companies Merchant
Bond Equity Banks
Market Market
9
“Allah has allowed al-bay’ AL-BAY’
but prohibits riba”
(TRADE & COMMERCE)

Al-Bay

Cotract of Profit-Sharing
Contract of Exchange
Uqud al-Istiraq

Contract Sale Control of Sale Al-Mudharabah Al-Shirka

Exchange Goods for Money Exchange Services for Money (Trustee Partnership) (General Partnership)

Spot Sale with mark-up Ijarah

(Al-Murabahah) Deferred Sale Forward Wakalah
Bay’al-musawaammah Bay’ Muajjal Sale
Bay Wadhiah, Mutlak
Kafalah

Al-Murabahah
Bai-Bithaman Ajil Istisna’ Salam
Credit sale

10
 Problem of Choice

Choices made by consumers,

producers and government must be
based on sound knowledge

11
 Problem of Choice

Allocation of Capital

Shariah Compliant Non-Shariah

Compliant

12
 RIBA AND SALE

If in a sale transaction, an excess of one commodity is

without an equivalent return (‘iwad, badal), it will be
contrary to the requirement of valid bay’.

Riba is an unjustified increase in capital whether in

loans or sales for which no equal compensation or
return is given

13
 Al-Bay’
Spot Deferred (Muajjal)

Cost-Price + Mark-up = Selling Price

‘IWAD

Ghurmi
Ikhtiyar Daman
(eg.ownership risk) (Value-added) (Liability)
14
 Al-Bay’
Spot (=$100) Discount (<$100) Deferred (Muajjal) >$100
Mutlak Wadhiah

$1000 + $100 = $1100

‘IWAD

Ghurmi Ikhtiyar Daman

(eg.ownership risk) (Value-added) (Liability)
15
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
Observing the foundation Risk-Taking (ghorm)
principles of Hard work (kasb)
of contracts (‘aqd) Accountability (daman)

16
 PRINCIPLES OF CONTRACT (‘AQD)

• Agents of contract
• Objective of contract
• Subject matter
• Consideration
• Ijab & qabul

17
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
foundation Risk-Taking - Yes
Cash Murabahah Hard work -Yes
Accountability -Yes

18
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
Al-Bai-Bithaman Ajil foundation Risk-Taking - No
(sale with deferred Hard work -No
Payments)
Accountability -No

19
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
Al-Bay’ al-’inah foundation Risk-Taking - No
(sale buy-back) Hard work -No
Accountability -No

20
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
Bay’ al- Dayn at foundation Risk-Taking - No
discount Hard work -No
Accountability -No

21
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
at-tawriq foundation Risk-Taking - No
(buy sale-back) Hard work -No
Accountability -No

22
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
Mudarabah foundation Risk-Taking - Yes
(trustee partnership) Hard work -Yes
Accountability -Yes

23
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
Musyarakah foundation Risk-Taking - Yes
(general partnership) Hard work -Yes
Accountability -Yes

24
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
Istisna’ foundation Risk-Taking - Yes
(sale by order) Hard work -Yes
Accountability -Yes

25
 Law and Ethics

“Allah has allowed al-bay’ and prohibits riba”

(Al-Baqarah 275)

Law Ethics & Morality

Legal rules based

on ethical
Salam foundation Risk-Taking - Yes
(sale by order) Hard work -Yes
Accountability -Yes

26
 1.Al-Bay’
2.Al-Ijarah RISK
3.Salam (Ghurmi) ISLAMIC NORMATIVE
4.Istisna’
5.Mudarabah THEORY OF
6. Musyarakah
PROFIT

= ‘IWAD WORK &

PROFIT (Equivalent countervalue) EFFORT
(Ikhtiyar)

LIABILITY
(Daman)
27
 Principle Components of ‘iwad

1. Risk-taking
(Al-Ghorm bil Ghonm)
(no reward without risk)

2. Value-addition (Ikhtiyar)

3. Liability
(Al-Kharaj Bil Daman)
(any benefit must be accompanied with liability;
liability is an obligation accompanying gain)
28
 Islamic papers

a. Coupon Bonds
BAIDs (Al-Bai Bithaman Ajil Islamic debt securities)

b. Zero Coupon
Murabahah Notes Issuance Facility (MuNif)
Khazanah zero-coupon

c. Floating rate
SaNif ( Al-Ijarah Notes Issuance Facility)
Istisna’
Muqarada

29
 Instrument #1
Al-Bai-bithaman Ajil Islamic
Private Debt Securities

30
 BAIDS-ISLAMIC COUPON BOND
(5) Bay Al-Dayn - Redemptions of Primary and Secondary Notes at Par Value

(2)Cash Payment $100 m

ISSUERS Bay’ al-’Inah (1-4) INVESTORS

(1) Sells underlying assets

to investors for $100 million

• (3)Sells back the underlying assets for

$124 million

(4)Bay al-Dayn Issuance of Primary and Secondary Notes at Par Value

Primary Notes (Principle): $100 million
31
Secondary Notes (profits): $24 million
Bay’ Al-’Inah Islamic Bonds (BAIDS)
1 & 2 = Asset Purchase Agreement (APA) = cash sale
3 & 4 = Asset Sale Agreement (ASA) = credit sale
1) Sells asset X to financiers for $100m

2) Cash
Payment
Issuer $100m
Financiers
3) Sells X for $124m

4) Deferred payments $124m

(DAYN BBA)

Issuance of PN $100m and SN$24m as IOUs

32
 Bay’ Al-’Inah Islamic Bonds (BAIDS)
(Sale Buyback) – NO Asset Securitization
1) Sells asset X to financiers for $800m

2) Cash
Payment
Issuer $800m
Financiers
3) Sells X for $820m

4) Deferred payments $820m

(DAYN BBA)

Issuance of PN $800m and SN$20m as return

33
 Structuring an Islamic Bond in Malaysia

Step 1:
Bay al-’inah Securitization – Securitization of underlying assets using the contract
of Bay’ al-’inah (bay’ mutlak {spot sale} + al-murabahah {sale by deferred
payments})

Step 2:
New Islamic bond issues (IPOs)– Issuance or selling of Islamic debt certificate
(Shahdah al-dayn) to investors
(at par value / at a discount)

Step 3:
Trading of Islamic debt certificates in the secondary market– buying and selling of
Islamic debt certificates in the secondary market via the contract of bay’ al-dayn at
a discount

34
Al-Bai-Bithaman Ajil Notes Issuance Facility (BAIDS)
1st Stage
Cost of financing : $100 million
Annual profit rate: 8%
Underlying asset: Land and building
Issue Date : 5th February 1999
Maturity: 5th. February 2002

Tenure: 3 years

Total profit: $100,000,000 x 8% x 3 = $24 million

Selling price = cost of financing + profit margin = $124 million

2nd Stage
Number of Primary notes : 100,000 units
Price per unit = $100,000,000/100,000 = $1000
Number of Secondary notes = 500,000 units
Price per unit = $24,000,000/500,000 = $48
Semiannual profit payments = $3.98

1 6 12 18 24 30 36
• • • • • • •
$0m $4m $4m $4m $4m $4m + $100m 35
 Islamic bonds:
Legal Documentation

• Asset Purchase Agreement (APA) : The

primary subscribers will purchase from the
issuer the underlying asset at the purchase price

• Asset Sale Agreement (ASA): The underlying

asset sold to the issuer at a selling price which
shall be made up of the original price and profit
margin to be imposed by the primary subscriber.

36
 Islamic Bond – Legal Documentation
(Malaysia)
“In accordance with the financing procedure under the Syariah principle of al-
bai-bithaman ajil, the Issuer has simultaneously with or immediately after the
execution of the Asset Purchase Agreement (APA) entered into the Asset Sale
Agreement (ASA) with the Primary Subscriber whereby the Primary subscriber
will sell to the Issuer the Asset at the Sale Price and the Sale Price shall be paid
on a deferred payment basis and upon the terms and conditions in the Asset
Sale Agreement (ASA)”

THE APA AND ASA DO NOT MENTION ASSET SECURITIZATION

“Obligations of the issuer on the settlement of the selling price

shall be securitised through the issuance of the BAIDS or ABBA”.
(Standard statement in IPDS termsheets)

37
Securitization of asset that does not belong to
the securitizing party.

“Obligations of the issuer on the

settlement of the selling price shall
be securitized through the
issuance of the BAIDS or ABBA”.

38
Abrar Discount Berhad, a pioneer on Islamic securitization in
Malaysia defines securitization as:

“ an act of rendering an illiquid asset liquid through

the issuance of Debt securities issued pursuant
to debt created under any underlying Islamic
contracts of financing, namely BBA, murabahah
and al-ijarah”.
[1] See Wan Abdul Rahim Kamil Wan Mohamed Ali, “Securitization of Debt financing : The Islamic alternatives,
Seminar on Islamic IPDS, 24th September 2003, Malaysia.

39
Shariah Advisory Council (SAC) of the
Securities commission.

“ If the structure is based on securitization of Islamic

debt, then the question of underlying asset is very
crucial – definition and qualification of asset, free from
any encumbrance, syariah complaint asset, asset that
can be traded on deferred payment that creates
indebtness, sale of asset and transfer of ownership,
fixed income if the securities were to be traded at the
secondary market, on the basis of mudarabah or
musyarakah”.

See Mohd Daud Bakar, Structuring Islamic PDS : Role of Independent Syariah
Advisers, Securities Seminar of Islamic PDS, Commission, Malaysia 2001.

40
 The Securities Commission

“Securitization as an arrangement, which

involves the transfer of assets or risks to a
third party where such transfer is funded
by the issuance of debt securities to
investors. Payments to investors in
respect of such debt securities are
principally derived directly or indirectly
from the cash flow of assets”.

41
 Rating Agency Malaysia (RAM)

“ in most instances, Islamic bonds in Malaysia debt market are

raised pursuant to a contract of sale; the most common are
those based on the principles of BBA and murabahah. The sale
contract entered into between the issuer and the subscriber
consequently results in an ‘IOU’ on the part of the issuer. The
issuer than undertakes an Islamic bond issue, matching the
indebtedness which arose from the BBA transaction. The bonds
indicate the issuer’s obligation to pay their face value and the
right of the bondholders to receive payments”.
[1]See Rating Agency Malaysia, “Setting Risk Assessment of Islamic bonds in Perspective”, Islamic Finance Bulletin, Rating Agency Malaysia, September
2003.

42
 Islamic bonds:
Legal Documentation

• Asset Purchase Agreement (APA)

• Asset Sale Agreement (ASA)
• Trust Deeds
• Issuing and Paying Agency Agreement

43
 Instrument #2
Islamic Asset-Backed Securities

44
 Ambang Sentosa Islamic Asset-Backed
Securitiy (IABS)
The first Islamic asset-backed debt securities (IABS) worth
RM986 million were issued on 26th June 2003 by Ambang
Sentosa Sendirian Berhad with Abrar Discount Berhad
acting as lead arranger. Ambang Sentosa is a special
purpose vehicle (SPV) whose main purpose is to raise
funds from investors by the issuance of al-bai-bithaman ajil
Islamic debt securities (BaIDS). Under the transaction, the
Originator, namely Maxisegar Sdn Bhd will sell its right,
title and interest over the Balance Purchase Price or
receivables (the “Asset”) arising from a selected pool of
sale-purchase agreements (SPAs) entered between the
seller and the end-purchasers to the issuer. The payment
to Maxisegar originated from the proceeds of BaIDS
issuance by Ambang Sentosa. Ambang Sentosa was able
to issue BaIDS to the investors from the sale and resale of
the receivables it acquired previously from Maxisegar by
way of gift (Hibah).
45
 Instrument #3
Sukuk Al-Ijarah

46
 Al-Ijarah Munthahia Bithamleek
(Leasing ending with ownership)
(Lessor must hold ownership title )

(3) Leasing of asset

Banks- Syndication (4) Rental payments

Swa.ltd
(lessor) With a Put Option. (lessee)

(7) Revenues (6) Application

(2) Cash (1) Delivery of
Asset of Asset
Payment
Stage 1: Syndication of banks
Supplier of Malioboro Plaza
(lessor) purchase Plaza on
Asset Project with
cash basis
(Owner of Malioboro cash flow
Stage 2: Banks leased
Plaza)
Plaza to Swa ltd..

47
 The Malaysian Experience
• Measures to improve the Malaysian PDS market
– SC has recently implemented the following KEY MEASURES which will
assist in the development of the local Bond Market
• Introduction to a SHELF REGISTRATION SCHEME (for Public
companies only)
• DISCLOSURE-BASED REGIME which will expedite the approval
process
• LIBERALIZATION OF ISSUING REQUIREMENTS to allow
GREATER FLEXIBILITY for various categories of potential issuers
to participate
• Establishment of the Shariah Advisory Council and Islamic Capital
Market Unit to promote issuance of Islamic Instruments.
– LOFSA, as the international gateway has undertaken the following
measures:-
• Spearheading the development of a global network of Islamic
Money Market
• Establishment of Labuan International Financial Exchange, which
is accessible for issuance of Islamic instruments
48
 Istisna’ Financing
Each party has the option to rescind the contract before it is implemented
but binding once it has been constituted.
Once constituted, if the Al-Masnoo does not conform to
specifications, the mustasni has the right to revoke the contract

Al-Sani’
(The Ultimate Subject matter
Payment
Seller) Al-Masnoo of certain
In:
Specification (can be
a.Spot Cash
maufactured or obtained
b. Installment
from the market)
c. Bullet
a. Kind
b. Type
Price:
c. Quality
• Known
d. Quantity
b. Cannot be
increased or Al-Mustasni’
Delivery:
decreased on (The Ultimate
a. Fixing delivery date
account of increases Buyer)
is necessary
or decreases in price
of inputs 49
 Istisna’ Financing
• Subcontracting the Istisna’ project
Deliver X 2002
Sani
Contractor
Seller
Manufacture
Manufacturer Subcontract X

Payment Deliver X 2002

In 2000
To deliver X in 2002

Bank

50
 Bay’ Salam as a Mode of Finance
5. Payment on delivery $100,000

1. Purchase order Buyer

$100,000
at $1 per unit

4. Delivery on due date

Farmer on behalf of the bank
6. Farmer
deliver 2. Salam
payments financing 3. Payment
$100,000 at 90c per $90,000
unit

Bank
51
 Bay’ Salam as a Mode of Finance

A. Salam contract between 1. Purchase order Buyer

Farmer & Bank $100,000
at $1 per unit
Farmer: al-Muslam ileihi
Bank : Rabb us Salam 4. Delivery on due date 5. Payments
$100,000
Commodity : Muslam Farmer on behalf of the bank
on delivery
fihi
2. Salam
financing 3. Payment
at 90c per $90,000
B. Farmer contracted
unit
by the Buyer to
supply the commodity
on a specified date
Bank
52
 Types of Islamic Debt Securities

1. COMMERCIAL PAPERS[CP]
(Usually for working capital purposes)

2. MEDIUM TERM NOTES [MTN]

(Usually for long-term working capital)

3. BONDS
(For long-term capital expenditure financing
requirement, project financing for concessionaires,
infrastructure and utilities)

53
 Project Financing

A financing of a particular economic unit in

which a lender is satisfied to look initially to the
cash flows and earnings of that economic unit
as the source of funds from which a loan will be
repaid and to the assets of the economic unit as
collateral for the loan.

54
 Goal in Project Financing

The ultimate goal in project financing is to arrange

a borrowing for a project which will benefit the
sponsor and at the same time be completely non-
recourse to the sponsor, in no way affecting its
credit standing or balance sheet. This can be
accomplished by using the credit of a third party to
support the transaction

55
Company A is
ISLAMIC PROJECT FINANCING
a concession
holder to a
RM200 million
privatized infrastructure
Project.
It holds beneficial
Q = f(L, K)
interest in SPV for and on
behalf of investors Co. A Trustees
Securities “colateralized (A Bank)
against cashflow generating ability
Underlying SPV
Asset
and redemption
of securities IPDS
1. SPV issue IPDS to Islamic Investors
2. Cash proceeds injected into Co. A -
production Investors
3. SPV receives payments from Co. A and
pays them as profits to the Investors

56
 Project Financing: The Participants

1. Contract Awarder
(e.g the government)

2. Sponsors (e.g. individuals, corporations)

3. Special Purpose Vehicle [SPV]

(Project Company)

4. Trustee (e.g. bank)

5. Financiers (Investors)
57
1. Sponsor : A party interested in supporting a project
financing. A party providing the credit to support a project
financing

2. Trustee: Acts for and behalf of the Financiers

Some duties of a Trustee

a. to exercise reasonable diligence in ascertaining whether the
assets of the Issuer or its guarantors are sufficient to
discharge the debt as and when it become due
b. to exercise reasonable diligence in ascertaining that there
has been no breach of the covenants, terms and provisions
of the Trust deed

Trust Deed(trust indenture)

In a loan, a contract defining the obligation of the borrower and
appointing a trustee to represent the interests of lenders.
58
Financial Instruments in Islamic Project
Financing

a. Al-Bai’- Bithaman Ajil Islamic Debt

Securities (BAIDS)

b. Al-Ijarah Islamic Debt Securities

(IJIDS)

59
 Al-Bay’ Bithaman Ajil IDS

a. Bay’ al- ‘Inah

( Bay’ al- Mutlakah [spot sale]followed by Al-bay’
bithaman Ajil[deferred sale])

b. Bay’ al-Dayn at a discount

60
Overview of the Global Financial Markets
CAPITAL MARKETS

EQUITY DEBT HYBRIDS

SECURITIZED DEBT TRADITIONAL LOANS

PRIVATE DEBT SECURITIES GOVERNMENT'S SECURITIES

61
 Bay’ al-’inah : Real (Bathin) vs
Declared (Zahir) Intention
1) Bay’ al-’inah is a legal sale in the Shafi’ school, in which it says the
intention or niyyah is not a significant element in determining the
validity of a contract. This is the viewpoint taken up by the the Shariah
scholars in Malaysian Central Bank (BNM) and the Securities
Commission.

2) The central issue here is none other than the distinction between real
and declared intentions. According to Rayner, “It may be concluded
that the Malikis and Hanafis give due effect to the real intention or niyyah
of the parties, but that as regards illicit motives both schools
are reluctant to make such an uncertain element as motive a
dependent factor of a legal act. The Hanbali school however, always
gives precedence to real intention over declared intention. In general,
the tendency of Muslims law seems to be to give priority to the
declared intention. Indeed, in the Shafi’ school, this is not just a tendency
but a doctrinal stance”.
62
Islamic Equity Market
Shariah Stock Screening

63
 Trading of Stocks
in Islam

Demand Side Supply Side

Avoidance Production
Rules of of Gharar Approach
Capital-Structure
Transaction Approach
(Contracts) Al-Ghorm Q = f (K,L)
bil Ghonm DEBT/EQUITY
Al-Shirkatul Q must be free
Anwal Contratrading from the following
elements: Debt: Islamic
(Partnership in Short-selling
Gambling bonds
Capital / Equity
Participation) Futures Alcoholic drinks
Swine Equity: Mudrabah
Options
Narcotics Musyarakah
No legal claims
on capital and Permissible Riba
Tatfief (Fraud) DEBTinterest/E = 0
returns stocks
Ihtikar (hoarding) (Zero-riba)
Purification
DEBTinterest/E > 0
(Ribawi)
64
 THE MODERN CORPORATION

Management Joint-Stock
Providers =
of Capital
+ & Company
skills

No capital protection
Receive
Risk-Taking Wage & Salaries
Profit Sharing

65
 COMPANY BASED ON
MUDARABAH PRINCIPLES

Management Mudarabah
Providers =
of Capital
+ & Partnership
Skills

No capital protection
Risk-Taking Profit-Sharing
Profit-Sharing

66
 COMPANY BASED ON
MUSYARAKAH PRINCIPLES

Providers Providers
of Capital of Capital Musyarakah
+ = Partnership
& &
Management/Skills Management/Skills

No capital protection No capital protection

Risk-Taking Risk-Taking
Profit-Sharing Profit-Sharing

67
 The Objective of Business is to
Make Profits

PROFIT

RISK-TAKING HARD WORK ACCOUNTABILITY

Controllable Risk Uncontrollable Risk

Unsystematic Risk Systematic Risk

68
 Risks in Business
Total Risk

Uncontrollable Risk Controllable Risk

Pure Risk Speculative Risk Speculative Risk Operational Risk

Market Risk Financial Risk

Car accidents Human Risk
Fire damages Legal Risk
Recession Credit Risk
Death Regulatory Risk
War Interest rate Risk
Earthquakes Political unrest System Risk
FOREX Risk
Floods Change in consumer
tastes Liquidity Risk

69
 Business & Risks

Business Organizations Total Risks

Enterprise
Market risk
Credit risk
Mudarabah Partnership Interest-rate risk
Foreign exchange risk
Business risk
Musyarakah Partnership Liquidity risk
Legal risk
Regulatory risk
Corporation/Joint stock company

70
 Speculative Risk
A deliberate act by a businessperson who hopes to
gain by that action but recognizes the chance for a loss
to result instead

SPECULATIVE RISK

MARKET RISK FINANCIAL RISK

71
 PURE RISKS

AN EVENT THAT OFFERS AN EVENT THAT

NO POSSIBILITY OF GAIN OFFERS
CHANCE POSSIBILITY OF LOSS

72
 Al-Ghorm bil Ghonm
No Reward Without Risk

Speculative Risk

Pure Risk

73
 Al-Ghorm bil Ghonm
No Reward Without Risk

Speculative risk
(Market Risk/Price Risk)

Speculative Risk
(Financial Risk)

Speculative Risk
(Operating Risk)

Pure Risk
74
 Impact of Risks on Firm’s Income
Income Statement : Non-Banking Firm Market risk
• Revenues (gross sales) $256,425
• Cost of goods sold $104,765 Financial
• Gross profit $151,660 risk
• Operating expenses $59,480
Pure risk
• Administrative expense $71,205
(cost of insurance
• Total operating expense $130,685 on employees)
• Income before taxes $20,975
Pure risk
• Income taxes $8,390
(fire insurance)
• Net Income $12,585
Operation risk
(system failure)
Regulatory risk Market risk
Financial risk
Pure risk
Operation risk
Regulatory risk
75
 Impact of Risks on Firm’s Income
Income Statement : Islamic Banking Firm Credit Risk
Structure Risk
• Income $300,000
• Expenditure $100,000
Pure risk
• Profit before zakat and tax $200,000 (cost of insurance
• Zakat $50,000 on employees)
• Taxation $50,000
• Minority interest $100,000 Regulatory risk
• Profit after zakat, taxation
and minority interest $10,000
$90,000

Note: Expenditure = cost of deposits

+ overhead cost Credit risk
Structure risk Pure risk
Pure risk (fire insurance)
Regulatory risk
76
 Risk Management
Speculative Risk Pure Risk

Impact on Firm

OPTIONS OF RISK MANAGEMENT

Risk Risk
Avoidance Prevention/Reduction Risk Transfer

Insurance
Derivatives

77
 SHARIAH PRINCIPLES FOR ISLAMIC
FINANCIAL TRANSACTIONS

• Principle #1 : Prohibition of interest as riba

• Principle #2: Application of al-bay’ (trade and commerce)
• Principle #3: Avoidance of gharar (ambiguities) in
contractual agreements
• Principle #4: Prohibition of maisir (gambling)
• Principle #5: Disengagement from production of
prohibited commodities – pork, liqour.

78
 SHARIAH PRINCIPLES
FOR RISK MANAGEMENT

#1 RISK AVOIDANCE

• Principle #1
Prohibition of interest as riba
• Principle #2:
Application of al-bay’ (trade and commerce)
• Principle #3:
Avoidance of gharar (ambiguities) in contractual agreements
• Principle #4:
Prohibition of maisir (gambling)

79
 SHARIAH PRINCIPLES
FOR RISK MANAGEMENT

#2 Risk Reduction
• Principle #1
Prohibition of interest as riba
• Principle #2:
Application of al-bay’ (trade and commerce)
• Principle #3:
Avoidance of gharar (ambiguities) in contractual agreements
• Principle #4:
Prohibition of maisir (gambling)

80
 SHARIAH PRINCIPLES
FOR RISK MANAGEMENT

#3 Risk Transfer
Insurance & Financial Derivatives
• Principle #1
Prohibition of interest as riba
• Principle #3:
Avoidance of gharar (ambiguities) in contractual agreements
• Principle #4:
Prohibition of maisir (gambling)

81
 INSURABLE RISK

•PREDICTABLE
• PURE
•MEASURABLE
•SPREAD OVER A LARGE GEOGRAPHIC AREA
•ACCEPTABLE TO THE
INSURANCE COMPANY

82
 Impact of Risks on Firm’s Income
Income Statement : Banking Firm
Credit Risk
Structure Risk
• Income $300,000
• Expenditure $100,000
Pure risk
• Profit before zakat and tax $200,000 (cost of insurance
• Zakat $50,000 on employees)
• Taxation $50,000
• Minority interest $100,000 Regulatory risk
• Profit after zakat, taxation
and minority interest $10,000
$90,000

Credit risk
Structure risk Pure risk
Pure risk (fire insurance)
Regulatory risk
83
Risk Management for the
Islamic Banking Firm

84
An Islamic Bank Average Balance Sheet
Assets Liabilities

Cash Wadiah Demand

Deposits
Financing
BBA Mudarabah
Deposits
Murabahah NICD
AITAB
Musyarakah
Bonds
GII Equity capital
Islamic Common stocks
Premises and fixed assets Surplus
Undivided
profits
85
 Islamic Bank Profit Equation

Profit = (rfinancing x F) – (rdeposit x D)

Where:
F = Size of financing
rfinancing : rate of return on financing
rdeposit: rate of return on deposit
D = size of deposit

Profit = (0.1 x $100m) – (0.05 x $100m)

Profit= $1m – $0.5m = $500,000

86
 OUR FOCUS:

SHARIAH PRINCIPLE #2

Application of
Al-Bay’ (trade and commerce)

Profit creation with equivalent

counter-value (‘iwad)

87
Principle Components of ‘iwad

1. Risk-taking
(Al-Ghorm bil Ghonm)
No reward without risk

2. Value-addition (Kasb)

3. Liability
(Al-Kharaj Bil Daman)
Profit is accompanied with
responsibility/accountability

88
 “No Reward Without Risk”
“Acquisition of profits must be accompanied with the
possibility of loss”
(Al-Ghorm bil Ghonm)

• Risk is the possibility of loss and gain

• Risk refers to uncertainty about the outcome of trading and
commercial transactions
• Business outcomes are unknown
• Some business make money, some lose money
• There is no guarantee that all business will be successful
• Law in nature - “ no pain,no gain”.

89
 Risks faced by Islamic Banks
• Ownership risk – price of the product sold by Islamic
bank may be above or below cost.
• Legal risk – risk of litigation when Shariah features of
the facility is not stated or evident in the legal
documentation
• Credit risk – failure to collect outstanding Islamic
receivables.
• Structural risk – structure of product may adversely
impact performance
90
The Islamic Banking Firm
Al-Ghorm bil Ghonm
No Reward Without Risk
Market Risk/Price Risk
Business Risk

Credit risk

Structure Risk

Pure Risk

Legal Risk

91
BBA Islamic Banking Firm
Al-Ghorm bil Ghonm
No Reward Without Risk

Credit Risk

Structure Risk

Pure Risk

Legal Risk

92
Partnership Islamic Banking Firm
Al-Ghorm bil Ghonm
No Reward Without Risk

Market Risk

Pure Risk

Operation Risk

Business Risk

93
Types of Risks in Islamic Banking Products

Al-Bai-bithaman ajil Credit risk & Structure risk & legal risk

Murabahah &
Al-Ijarah Thumma Credit risk & legal risk
Al-Bay

Mudarabah/Musyarakah Price Risk

Salam & Istisna Price Risk

Bay’ al-’inah/Bay’ al-dayn Credit risk & legal risk

94
 Islamic Banking Act 1983

“Islamic bank” means any company which carries

on Islamic banking business and holds a valid
license; and all the offices and branches of such a
bank shall be deemed to be a bank”

“Islamic banking business” means banking

business who aims and operations do not involve
any element which is not allowed by the Religion of
Islam”

95
 Risk 1

Ownership Risk
(Daman Milkiyah)

96
 To make profits:

An Islamic bank does not make loans

INSTEAD

An Islamic bank buys and sells (al-bay’)

assets and commodities

97
 Ownership risk leads to
price risk

• The seller as rightful owners of goods must

bear losses if market price < cost price.

• Drop in market price may be caused by

many factors including fall in household
income, changes in tastes, natural
calamities, political instability etc.

98
 Ownership risk
TRADING - CASH SALE

• Seller is risking his capital

• Capital is used to purchase goods
• If cost price < selling price, capital will appreciate.
• If cost price > selling price, capital will depreciate
• Since capital is subject to appreciation and
depreciation, the seller is entitled to profits, if any.

99
 Ownership risk = Price risk =market risk
Cash Sale at a profit:

$28
$20
+ $8 = Selling price
Cost price Profit margin with
Cash payment

1) Bank as the selling party faces price/market risk

2) That is, a legal owner, the bank is subject to
ownership risk (daman milkiyah)
3) If market price > cost price ----profits

100
Price risk Market risk Ownership risk
Cash Sale at loss :

$15
$20
+ $-5 = Selling price
Cost price Profit margin with
Cash payment

1) Bank as the selling party faces price/market risk

2) That is, a legal owner, the bank is subject to
ownership risk (daman milkiyah)
3) If market price < cost price ----losses

101
 Islamic ethics and morality
(AKHLAK) demands that people
conduct business on the basis of
the principle:

“No Reward Without Risk”

(Al-Ghorm bil Ghonm)

102
 Risk 2

Credit Risk/Default Risk

103
 Credit Risk/Default risk

• Risk of default emerges when an Islamic bank

sells assets on credit basis
• Bank purchases the asset at market price and
sells it to the customer on credit i.e. at a credit
price.
• Profit gained by way of time value of money

104
Risks in Islamic Banking that uses credit
financing

• Credit risk

• Inflation risk

• Forex risk

• Interest-rate risk

105
 Credit Sale :
Credit/default risk

$38
$28
+ $10 = Credit
Market price Profit margin Price

1) Bank as the selling party faces credit risk

2) That is, a seller-creditor, the bank faces risk of default
3) Bad debt = losses
4) Successful collection = profits

106
 Non-Performing Financing (NPF)
2003

• Islamic banks (BIMB, BMM) = 10.8%

• Commercial banksIslamic = 6.9%
• Finance companiesIslamic = 2.7%
• Merchant bankIslamic = 13.2%
• Conventional banks = 7.7%

107
 Risk 3

Legal Risk

108
 Islamic Banking and Consumer
Protection

• Defendant thought that BBA = loans (BIMB vs

Adnan Omar)
• Plaintiff thought that BIMB applies buy and sell
principle (BIMB vs Dato’ Nik)
• Defendant thought that Islamic banks make Islamic
loans (BIMB vs Tinta Press)

109
Legal Disputes in Civil Courts involving Islamic
banking transactions

• BIMB versus Tinta Press (1987)

• BIMB versus Adnan Omar (1994)
• BIMB versus Dato’ Haji Nik Mahmood (1996)

110
Islamic Shariah Principles 1. Defense based on
bonds Islamic law
of contracts
2. Judge based
Islamic
Product opinion
Credit
Cards on what is
agreed on paper

AITAB Legal Documentations

Civil
Law
BBA
Litigations

Civil
Plaintiff Defendant
(Islamic Bank)
Court (Customer)

111
 Dato’ Haji Nik Mahmud vs Bank Islam Malaysia (BIMB)

This case is about Dato’ Haji Nik Mahmud who has defaulted on a BBA facility
but took a legal action against Bank Islam for not complying to the Kelantan Malay
Reservation Enactment. The BBA facility was given to the plaintiff to develop a
piece of land that he owns. The facility is actually a bay al-‘inah sale but named
as al-bai-bithaman ajil (BBA). To develop the land (i.e. in the state of Kelantan),
the plaintiff needs a sum of RM520,000. To do so, the plaintiff sells the land
using the property purchase agreement (PPA) for RM520,000 and
immediately resold by the defendant via property sale agreement (PSA) for
RM629,200. The defendant contested that the property (Kelantan Malay Reserve
land), cannot be handed to Bank Islam as it is not a Malay. Upon further
investigation, the judge found that no transfer of title has taken place between
the plaintiff and defendant and the proprietorship still remains with the
plaintiff. In this way the case brought up by the plaintiff does not hold. This
case has clearly shown that what has taken place is in fact a plain collateralized
loan given by the bank to the plaintiff as no actual transfer of ownership was
evident in the BBA facility.

112
 Bank Islam Malaysia (BIMB) v. Adnan b. Omar

This case involves a bay’ al-‘inah transaction although it was called bai-
bithaman ajil. The defendant (i.e. Adnan b. Omar) was granted a facility
amounting to RM583,000. He however, has defaulted on his payments. In the
bay’ al-‘inah sale, the defendant sold a piece of land to the plaintiff for RM125,000
which the plaintiff simultaneously resold the land for RM583,000 payable by the
defendant in 180 monthly installments. The defendant charged the land to the
plaintiff as a security for the debt. In the above case, the judge was in favour of
the plaintiff. The judge in her judgement says that the defendant knew with
full knowledge that the facility was to implement a loan and the repayment
is made inclusive of the profit margin. The judge agrees with the plaintiff
that the amount of advance was RM583,000 and not RM125,000. In this way,
the defendant cannot dispute the amount. He is required to settle the full
amount and not the amount he actually received i.e. RM125,000. But later on

appeal, the judge ordered Bank Islam to give the defendant the rebate (ibra).

113
 Tinta Press Pte vs Bank Islam Malaysia (BIMB)

In the above case, the Bank Islam Malaysia brought a legal action
against Tinta Press for defaulting on its rental obligation. The bank
intends to recover possession of the equipment and to recover arrears of
rent. The defendant says that the facility was a loan but the Bank
Islam denies it as it does not give out qardu hasan loan. The Supreme
Court says that the facility was in fact based on a lessor-lessee
relation. Bank Islam as the lessor is the legal owner the equipment while
the defendant only has the right to use it. The court is in favor of Bank
Islam Malaysia. The judge makes no reference to the contract of ijarah
i.e. leasing.

114
 MORE LITIGATION CASES COMING SOON IF
THEORY IS NOT EQUAL TO PRACTICE

1) Based on theory - Customers to bring cases

against Islamic banks

2) Based on practice - Islamic banks to bring cases

against customers

115
 LEGALITY OF ISLAMIC
FINANCIAL INSTRUMENTS

116
 Risks arising from deferred payments

$5 $33
$8
Additional Selling price
$20 + Profit margin
+ margin if = With
Cost price if payment
payment Deferred
settle in cash
by credit payment

1. Once the sale is secured on credit, the bank faces:

a. risk of default – credit risk
b. inflation risk
c. foreign exchange risk
d. structural risk

117
 BBA Legal Documentation

1. Sale and Purchase Agreement (SPA)

2. Property Purchase Agreement (PPA)
To secure 3. Property Sale Agreement (PSA)
ownership 4. Deeds of assignment/Charge

Sale with condition Option of

Defect not
granted

118
 BBA Legal Documentation

• Property Purchase Agreement (PPA)

The provision states: “The Agreement between the
customer and the bank wherein the bank purchases the
property from the customer for the purpose of
immediately selling the same to the customer on
deferred terms under the Shari’ah principles of BBA”.
Here, the customer sells his (beneficial right) over the
property to the bank with immediate buying it back.
There are express provisions in PPA to state that
“Beneficial ownership and/or rights’ of the property shall
pass to the bank upon the execution of this agreement.”

119
 BBA Legal Documentation

• Property Sale Agreement (PSA)

This agreement reflects the act of reselling the same to the
customer upon deferred payment which includes bank’s profit
margin. The agreement also state “Beneficial ownership of and
rights of the property shall pass to the customer upon the
execution of this agreement.”

PSA = BBA

120
 Bai-bithaman Ajil Interest-bearing loan

Debt Obligation Debt Obligation

Capital = $100,000 Loan = $100,000

Profit = $80,000 Interest = $80,000
Selling price = $180,000
Upon default customer must Upon default, customer
Pay back $180,000 must pay back $100,000
Credit price plus outstanding interest

BIMB versus Adnan Omar

The PPA requires the defendant to pay
the credit price 121
 BBA & CONSUMER PROTECTION

Legal Documentation according

Al-Bai-bithaman ajil to civil law

Settlement based on
Default Selling price – Automatic rebate?

Liability on
Defective product property developers

Non-Delivery Must pay installments

(Abandon projects)

122
 BBA & CONSUMER PROTECTION
Legal Documentation according to
Al-Bai-bithaman ajil Shariah Principles

Based on Selling price with

Default Automatic rebate

Liability on the
Defective product selling party i.e. Islamic bank

Non-Delivery Payment on hold

(Abandon projects)

123
 Al-Bai-bithaman Ajil
• To secure ownership, Islamic bank executes the
Property Purchase Agreement (PPA). The PPA
requires the customer to buy the property at a
stipulated price (i.e. market price plus fixed profit
margin) via the Property Sale Agreement (PSA).
By doing so, the PPA is in fact a sale with
condition.

124
 Credit Murabahah is valid since
it has fulfilled the principles of contract

1. Buyer and Seller are rational

2. Object of trade = al-mal mutawaqim
3. Price is set on the spot and known
4. Seller owns goods prior to sale
5. Consent

125
 Laws of contract puts no concern
about profit gained via time value

Why credit price > cash price?

Fixed profit margin created from waiting.
Making money from waiting is unethical and
immoral because no work and effort is implicated.

It goes against the Principle “profit goes with

responsibility”

126
Implications of Daman Milkiyah
(ownership risk)

127
 Al-Bai-bithaman Ajil Asset Financing
Risk of Ownership
(Daman Milkiyah)

• In BBA, daman milkiyah is secured using bay’ shart

implicating two sales in one transaction.
• BBA scheme does not provide warranties (khiyar’
‘aib). In this way, the obligations and responsibilities
to daman milkiyah are not properly observed by
Islamic banks.

128
 Dato’ Haji Nik Mahmud vs Bank Islam
Malaysia (BIMB)

BAI-BITHAMAN AJIL
DAMAN MILKIYAH NON-EXISTENT
The plaintiff sells the land using the property purchase agreement (PPA)
for RM520,000 and immediately resold by the defendant via property sale
agreement (PSA) for RM629,200.

The judge found that no transfer of title has taken place between the
plaintiff and defendant and the proprietorship still remains with the
plaintiff.

129
 Risk 4

Structural Risk

130
 Structural Risk

Product structure that may

jeopardize bank performance

Al-Bai-bithaman Ajil – Fixed rate

asset

131
1. BBA is a fixed rate asset
2. Contract price = selling price
3. In determining the selling price, the bank sets the profit
margin rate per annum, say 10%
4. Cost price (CP) = $100,000
5. Financing period = 10 years
6. Total profit margin (TPM) = (0.1 x $100,000) x 10 = $100,000
7. Selling price = CP + TPM= $100,000 + $100,000 = $200,000
8. Selling price cannot change throughout financing period
9. BBA contract will become invalid if selling price is changed to
accommodate changes in market interest rate
10. If market interest rate increases?
11. If market rate decreases?

132
 Dual-Banking System in Malaysia
(Size of Islamic Banking Assets {SPI + BMM + BIMB}=7.3%
of total bank assets)

Banking & Financial

Islamic Banking Act
Institution Act 1989
1983
Conventional banks
Bank Muamalat
(interest-based)
Malaysia (BMM)
Sistem Perbankan
Bank Islam Malaysia
Islam (SPI)
(BIMB)

133
 Zero economic volatility
CONVENTIONAL BANKS
Profit = (iL x L) – (iD x D)
iL = 10%, iD = 5%
L = D = $100 million

Profit = (0.1 x 100) – (0.05 x 100) = 1m – 0.5 m = $500,000

ISLAMIC BANKS
Profit = (rF x F) – (rD x D)
rF = 10%, rD = 5%
F = D = $100m

Profit = (0.1 x 100) – (0.05 x 100) = 1m – 0.5 m = $500,000

134
Case 1: Rising interest rate
by 5% : CONVENTIONAL BANKS
Profit = (iL x L) – (iD x D)
iL = 15%, iD = 10%
L = D = $100 million

Profit = (0.15 x 100) – (0.1 x 100) = 1.5m – 1 m = $500,000

Similar performance

135
Case 1: Rising interest rate
by 5% : ISLAMIC BANKS
Islamic banks have 2 options:
1. To increase hibah rates in order to remain competitive in the
deposit market
2. Not to increase hibah rates
REMINDER : ISLAMIC BANKS CANNOT INCREASE
BBA PROFIT RATE!

Option 1:
Islamic Bank
Profit = (rF x F) – (rD x D)
rF = 10%, rD = 9%
F = D = $100m

Profit = (0.1 x 100) – (0.09 x 100) = 1m – 0.9 m = $100,000

Profit declines and adversely affects bank performance
136
Case 1: Rising interest rate
by 5% : ISLAMIC BANKS
Islamic banks have 2 options:
1. To increase hibah rates in order to remain competitive in the deposit market
2. Not to increase hibah rates
3. REMINDER: ISLAMIC BANKS CANNOT INCREASE PROFIT RATES!

Option 2:
Islamic Bank
Profit = (rF x F) – (rD x D)
rF = 10%, rD =10%
F = D = $100m

Profit = (0.1 x 100) – (0.05 x 100) = 1m – 0.5 m = $500,000

Profit remains the same in the short-run
Customer deposits migrated to conventional banks that offer higher deposit rates.
Size of deposit declines
Forced to seek Mudarabah placements which is more expensive in the money market.
Profit declines. Islamic banks as losers. Non-Muslim customers as gainers.
137
Case 1: Declining interest rate
by 3% : CONVENTIONAL BANK

Able to adjust interest rates downwards

Loans are flexible rate assets
Profit = (iL x L) – (iD x D)
iL = 7%, iD = 2%
L = D = $100 million

Profit = (0.07 x 100) – (0.02 x 100) = 0.7m – 0.02m = $500,000

Similar performance

138
Case 1: Declining interest rate
by 3%: ISLAMIC BANKS
Islamic banks have 2 options:
1. To cut hibah/dividend rates to reflect market rate
2. To maintain hibah/dividend rate
REMINDER: CANNOT CUT PROFIT RATE!

Option 1:
Islamic Bank
Profit = (rF x F) – (rD x D)
rF = 10%, rD =2%
F = D = $100m

Profit = (0.1 x 100) – (0.02 x 100) = 1m – 0.2 m = $800,000

Profit increases
Islamic banks as winners. BBA home purchasers as losers since they cannot
enjoy lower installment payments due to the excess liquidity in the market

139
Case 1: Declining interest rate
by 3%: ISLAMIC BANKS
Islamic banks have 2 options:
1. To cut hibah/dividend rates
2. To maintain hibah/dividend rate
REMINDER: CANNOT CUT PROFIT RATE!

Option 2:
Islamic Bank
Profit = (rF x F) – (rD x D)
rF = 10%, rD =5%
F = D = $100m

Profit = (0.1 x 100) – (0.05 x 100) = 1m – 0.5 m = $500,000

Profit remain the same
Islamic depositors winners. Performance of Islamic banks unaffected. BBA home purchasers as
losers since they cannot enjoy lower installment payments due to the excess liquidity in the
market.
Islamic banks may not want to take this option since they will relatively lose out!
If they did increase hibah/dividend rates, deposits are expected to move from conventional banks
to Islamic banks. In the long-run increasing hibah may bring a positive impact on deposits.
140
 ISLAMIC RISK MANAGEMENT TOOLS

• Credit risk – apply conventional methods. Reduce BBA

& murabahah
• Legal risk – Observe true label/Shariah Standard
• Structural risk – Floating rate option. Use Ijarah &
musyarakah mutanaqisah
• Ownership risk – Islamic banks have stayed away from
doing actual sale (al-bay’) transactions
• Regulatory risk – Government-friendly policy
on dual-financial system

141
LIQUIDTY MANAGEMENT IN
ISLAM

142
 Shariah financial instruments traded for
liquidity at discount

• BAIDS
• MuNif
• Islamic accepted bills (AIB)
• Negotiable Islamic Certificates of deposits
• Khazanah bonds
• Islamic negotiable instruments (INI)
143
 Debt Trading
(Bay’ Al-Dayn)

Objective #1: Liquidity

(sells debt at discount)

Objective #2: Capital Gains

(Sells debt at a premium)

Objective #3: Redemption on maturity

(sells debt at par value or premium)

144
 Al-Hiwalah and Bay’ al-Dayn : Sale of Debt
Dayn or debt is a payable right to the future cash flow arising from a loan. So if Ali borrow
RM10,000 from Amir, the dayn or debt belongs to Amir, the creditor.
He has the legal right to collect payments from Ali.

Al-Hiwalah: If Amir (Muhal) owes Imran RM10,000 (muhal ‘alaih) he can instruct Imran to collect
the payments from Ali (Muhil). That is, the debt is now transferred from Amir to Imran with no
increase in norminal value.

Dhawa Ta’ajjal: Amir sells his debt to Ali at a discount. This is the case of selling the debt to the
debtor himself on spot or cash basis.

Selling the debt to the third party:

a. The debt must be confirmed (dayn mustakhir). That is the debt is deliverable (dayn ) and under
possession.
B. Payment on cash basis.

Basic difference between Al-Hiwalah and Bay’ al-Dayn: In al-Hiwalah, the creditor must inform the
debtor about the debt transfer. But in bay al-dayn, this is not necessary.

No discounting is allowed in the sale of debt to the third party as this amounts to riba.

145
 Sale of Debts (Bay’ Al-Dayn)

(1) Sells Bonds

to Second party

ISSUER INVESTORS
(First Party) (2)Bond Purchases (Second Party)
from First Party
Cash payment

(3)Sells Bonds
(4)Cash
to Third party
(5) Redemption Payment
at Par value
on maturity Secondary Market
(Third Party)

146
Transfer of Debt (Al-Hiwalah)

Lending $10,000
1/6/99
First Party Early repayments
Second Party
(Creditor) 1/7/99 $9,500 (Debtor)

Full repayment $10,000

Instructs 1/10/99
Pay $10,000
third party
to collect payments
from second party
Third Party

147
 Argument in support of Debt trading
at a discount
Khazanah Benchmark Islamic Bond

Dayn Al-Murabahah : Debt arising from murabahah sale

Khaznah sells its assets (shares) to Principle Dealers (PD) and
then buys it back by way of al-murabahah.

Resale to Khazanah is based on the cost of capital plus profit

margin, which Khazanah will pay upon maturity.

Murabahah payment that is still not paid represent the rights of

the PD to the debt. The deferred murabahah payments is dayn
that belongs to the PD

148
 Argument in support of Debt trading at a discount
Khazanah Benchmark Islamic Bond

DEBT ARISING FROM MURABAHAH SALE = HAK MALIY

(PROPERTY)

DEBT = PROPERTY
(Malaysian View)
According to the Maliki School, the right to deferred murababah payments
is haq maliy that is right to wealth that can be traded (buy and sell).

The right to the debt represent by Shahdah al-Dayn (debt certificates) can
be used to obtain cash upon redemption at maturity

Price per unit is set through a bidding process al-Muzayadah

149
 David Bowie bonds

PAPERS = PROPERTY

WHY?

UNDERLYING ASETS
INCOME RECEIVABLES
FUTURE INCOME ROYALTY
150
 MALAYSIAN VIEW

DEBT = PROPERTY

Since debt = property, it ie debt can

be sold at any price

eg. $100 debt can be exchanged for $80

million cash (discounting)
151
 DEBT = MONEY
(Middle-Eastern View)

Money can be exchanged with

money of equivalent value

If $100 million (debt) is exchanged for $80

million (cash) then, the surplus is riba

152
 The Role of bay’ al-’inah and
Bay’ al-dayn in the creation
of Islamic bonds in Malaysia

1) A debt certificate (Shahdah al-dayn) is not al-mal or property

2) To turn a debt certificate into al-mal,so that it can be traded at any
price set by market forces, the government Shariah experts (GSE)
approved the conversion process by way of bay al-inah asset
securitization

3) Once the debt certificates attain the status of al-mal via the bay’ al-
’inah securitization, they can be sold as tradables at any price since
the transaction is based on valid object of sale.

4)This gives rise to the creation of Islamic zero-coupon bonds and

trading of Islamic bonds in the secondary market at a discount.

153
 Sale of debt (bay’ al-dayn) to the
debtor at a discount is allowed under
the Dhawa Taajal principle

154
 Dha’wa Ta’ajjal
(Debt discounting in Early Payments)

Narrated by Ibn Abbas when Rasulullah s.a.w.

directed Bani Nadhir to evacuate from
Madinah, they said: “there are still debts due
to us, then Rasulullah s.a.w. replied: “give
discount and asked for early payment”
(Hadiths narrated by Baihaqi)

155
 Hadiths narrated by Iman Bukhari in the
case of Ka’ab and Ibn Abi Hadrad

“While Kaab was discussing with Abi Hadrad on

how would he pay his debt to Kaab in a mosque,
they did not realize that they had raised their voice
that caused Rasulullah s.a.w. who was in his
house to hear their discussion, Rasullulah rhen
said: give discount on the debt. Kaab then replied:
I have already given, then Rasulullah asked Abu
Hadrad to pay the discounted debt”
156
 According to some Shafi’s and some
Hanbalis like Ibn Qayim, the creditor has
the right to sell his Dayn to a third party if
the Dayn is Mustaqir (confirmed) only

157
Sale of debt to a third party is not allowed due to gharar. According
to Hanafis, Shaf’is, some Hanbalis and Zahiris, the dayn either
mustaqir or gayur mustaqir cannot be sold to a third party.

• Do not sell what you do not possess

• Do not sell fishes in the water
• The Prophet (saw) prohibited the sale of a
missing slaves, offspring
• Will lead the selling of money for money with
different value

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 Disallowance of Bay dayn to a third party

• Sale of undeliverable item (bay’ ma’ajjuz at-

taslim)

• Sale of unpossessed item (bay’ ma la tamlik)

• Sale of ribawi

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 Types of Bay’ al-dayn

• Bay al-dayn at par value – permissible

• Bay al-dayn at a discount to the debtor –
permissible
• Bay al-dayn to a third party at par value –
permissible
• Bay al-dayn to a third party at a discount -
prohibited – widely used in Malaysia

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THANK YOU
WASSALAM

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