UNIVERSITI TEKNOLOGI MARA

COURSE:
ISLAMIC FINANCE
(FIN 546)

INDIVIDUAL PROJECT:
CASE STUDY REVIEW

BY:

MUHAMAD ANIS SYAZWAN BIN MOHMAD HARIS 2024783737

PREPARED FOR:
DR. NORASHIKIN BINTI ISMAIL
 Practical Application of Kafalah in Islamic Contract Of Kafalah (Guarantee) In Islamic
TITLE OF ARTICLE Banking in Malaysia Finance: Extending the Frontiers of Islamic
Law

1. Aishath Muneeza
AUTHOR’S NAME Abdulqadir Ibrahim Abikan
2. Zakariya Mustapha

DATE OF REVIEW 6 January 2020 2017

• Absolution of guaranteed debtors • Definition And Legality

• The role of multiple guarantors • Types Of Kafalah
• The right or recourse and recovery • Cotemporary Applications
KEY HIGHLIGHT from principal debtors • Fee For Kafalah
OF THE ARTICLE • Harmonize existing legislation with • Development And Juristic Views
shariah principles • Modes Of Kafalah
• Challenges And Innovations
• Shariah Compliance
Introduction

The concept of Kafalah also known as guarantee is an important component in the realm of
Islamic banking in Malaysia. Kafalah serve as a mechanism or tool to secure financial
obligations while holding to Shariah principles. Unlike conventional banking practices that
often rely on collateral, Kafalah facilitates financial transactions through third party
assurances. This research paper explores the practical application of Kafalah in Malaysian
Islamic banking. They also examining its alignment with a relevant legislative framework which
is Malaysian Contracts Act 1950 and how its compliance with shariah rules. This research
paper also highlights on Kafalah versatility in structuring products like personal and bank
guarantees, Islamic credit cards and deposits insurance system.

The integration of Islamic principles into modern financial systems has enabled the
growth of Islamic banking worldwide. Among the numerous of shariah contracts that has been
utilized, Kafalah stands out as a vital tool for managing liabilities. However, the discrepancies
between Shariah interpretations and Malaysian legal framework have pose a significant
challenge to its application. This report examines these issues, identifies their causes and
proposes a viable solution.
Issues In The Application Of Kafalah

The issue of absolution of guaranteed debtors in kafalah contracts present a significant

challenge within the framework of Islamic finance especially in jurisdiction like Malaysia where
conventional legal principles dominate. According to section 81 Contract Act 1950, it states
that creditors can release debtors from liability once the guarantor fulfils the obligation. This
provision effectively allows the guarantor to bear complete responsibility for the loan and
absolves the debtor totally. However, this approach will conflict with shariah principles which
state that the debtor and guarantor should be jointly accountable unless otherwise specified
in the contract. In Islamic jurisprudence, the role of the guarantor which is Kafil is to provide
support and assurance to the creditor rather than replacing or absolving the debtor totally.
Such absolution leads to a transformation of the kafalah contract into Hawalah also known ad
debt transfer in which involves shifting liability to a third party. Hawalah is a separate shariah
concept with its own distinct rule and applications. Transforming a kafalah contract into
hawalah will not only creates confusion but also risks in violating Islamic principles by blurring
the distinctions between these two types of contracts.

Causes Of The Issue

One of the primary causes of the challenges that surrounding the application of kafalah in
Islamic finance is the misalignment between the Contract Act 1950 and Shariah principles.
The Contract Act legal framework which governs most of the contractual agreements in
Malaysia and other jurisdictions were influenced by British legal traditions. This predates the
development of Islamic finance and does not account for the specificities and ethical
considerations of contract like kafalah. Contract Act provides a general legal structure for
agreement and obligations that lacks provisions of charitable and non-commercial nature of
kafalah as envisioned in classical Islamic jurisprudence. As example, the act in the Contract
Act 1950 does not distinguish between gratuitous and commercial guarantees that will
potentially leading to interpretations conflicting with the principles of shariah. This
misalignment will create a situation where Islamic financial institutions must navigate a
conventional legal environment that does not fully support or recognize the nuances of their
operations. All of this will cause to a confusion, operational inefficiencies and potential conflicts
with shariah compliance
 Another significant cause of the challenges is the inconsistent practices among Islamic
banks. Even though there were some institutions that adhere strictly to shariah principles and
offer kafalah as what they really are, there were a few other institutions that introduced fee
structures and operational practices that resemble conventional banking modes. These will
not only undermine the uniformity of Islamic finance but also cast a doubt on its credibility. The
issue of charging fees for kafalah has been a contentious topic. Soe argues that charging fees
contradicts the gratuitous nature of kafalah. Although they justify these fees as administrative
costs that necessary to operations, but this practice has sparked debates about whether such
charges is permissible modifications or a deviation from its original purpose. This
inconsistency in how Islamic banks handle kafalah not only confuses consumers but also
raises questions on ethical and religious integrity of Islamic financial practices

Additionally, the lack of unified and comprehensive guidelines will also be one of the
challenges. While efforts have been made to standardize shariah practices such as the
issuance of the Kafalah Policy Document (2018) by Bank Negara Malaysia, the
implementation of these guidelines has been uneven across financial institutions. This uneven
application results in fragmented industry where some institutions strictly comply with the
guidelines while others interpret and apply them selectively. This will lead to discrepancies in
how kafalah is applied especially in a context of fees and conditions of guarantees. For
example, some banks might limit fees to administrative cost while others might include profit
elements under the name of service charges. This lack of standardization will weaken
consumer trust and poses challenges for the global recognition of Islamic financial instruments
as a consistent and reliable alternative to conventional banking products.
Evidence Of The Issues

The issue surrounding the application of kafalah are evident in both legal and operational
practices as illustrated by cases and studies in Islamic finance

One case that show the challenges is Bank Kerjasama Rakyat Malaysia Bhd v. Sea
Oil Mill (1979). In this case, the court upheld that a guarantor’s liability was equal with the
debtor’s liability which means that guarantor was equally liable for the entire debt. This
decision is rooted in the Contract Act 1950 which governs guarantees in Malaysia. However,
this interpretation is consistent with shariah principles where it emphasizes proportional
liability among co – guarantors. Under shariah principles, the liability should be distributed
fairly to ensure that no single guarantor bears an undue burden. This case highlights the
tension between conventional legal framework and Islamic jurisprudence and make the
application of kafalah in Islamic finance become more complicated.

From the provided sources, the conversion of kafalah to hawalah through absolution
is considered as significant divergence from shariah. Abdulqadir Ibrahim Abikan’s study
emphasizes that kafalah is designed to create joint liability without exonerating the debtor.
Additionally, the Muneeza and Mustapha study highlights that section 81 of the contracts Act
explicitly allows for debtor absolution which is inconsistent with shariah. Islamic finance views
the guarantor’s role as a support mechanism. The transformation into Hawalah will introduces
elements of Gharar which is uncertainty and this will misalignment with the original contract.
Furthermore, the policy document by Bank Negara Malaysia does not specifically prevent
absolution which presents operational issues for financial institutions.

Another pressing issue is the charging fees for kafalah. Traditionally, this fee is
classified as a tabbaru which means voluntary act under shariah. But classical Islamic scholars
have emphasized that kafalah should not involve financial gain apart from minimal fees to
cover administrative costs. Unfortunately, contemporary practices have deviated from this
principle where studies shown that including those on Islamic banks in Malaysia reveal that
some institutions charge fees for kafalah that are comparable to those in conventional banking.
As example, a review of several Malaysian Islamic banks shows that out of twelve major
banks, there were six that impose fees similar to conventional practices while other were adopt
their own varied formulas for determining charges.
 This commercialized approach to Kafalah has raised concerns on how its compliance
with shariah principles. There were critics argue that charging significant fees could be viewed
as a form or Riba (interest) or Gharar (excessive uncertainty) that were both are prohibited in
Islam. Furthermore, Bank Negara Malaysia ‘s Kafalah Policy Document (2018) permits
Islamic banks to charge fees for guarantees either as a fixed amount or a percentage of the
guaranteed amount. However, the lack of uniformity in fee structures across banks make the
ethical and religious compliance become questionable towards consumers.
Proposed Solutions for Addressing Challenges in Kafalah

Legislative Reforms

A key solution to the challenges in implementing kafalah is revising Contracts Act 1950 to
better align with shariah principles. As for now, the act does not fully address the unique
aspects of kafalah such as proportional liability and recourse mechanisms. Under the act,
guarantors can be held liable for the entire debt. This can be seen and referred in the case of
Bank Kerjasama Rakyat Malaysia Bhd v. Sea Oil Mill (1979) where its emphasis on shariah
fairness and proportionality among guarantors. Legislative amendments should clarify the
liability of multiple guarantors ensuring that they share debt proportionally unless otherwise
agreed. Additionally, the revised act should define the conditions for recourse and recovery,
specifying that creditors must first seek payment from the principal debtor before approaching
the guarantor. Such changes would harmonize the legal framework with Islamic jurisprudence
and reduce inconsistencies in applying kafalah in Islamic banking practices.

Standardization Across Banks

Another critical solution is the enforcement of uniform guidelines for kafalah across Islamic
financial institutions. Bank Negara Malaysia (BNM) has taken steps in this direction with its
Kafalah Policy Document (2018). This policy provides regulatory guidance on implementing
kafalah contracts. However, the document’s implementations were uneven across banks and
this has led to inconsistencies which particularly in fee structures. For instance, some banks
impose fees similar to conventional banking making the concerns about shariah compliances
arise. To address this, Bank Negara Malaysia (BNM) should mandate a standardized
approach to fee calculation where they restricting charges to actual administrative costs. They
should also develop template contracts that define guarantor liabilities clearly and ensure they
align with shariah principles. Standardization would enhance consumer trust and provide a
much greater consistency in Islamic banking operations.
Education And Awareness

Education is vital in order to improve the application of kafalah. Islamic financial institutions
should invest in training programs to ensure that their staff, especially those in shariah
compliance roles to fully understand the principles and practicalities of kafalah. The training
should focus on distinguishing kafalah from conventional guarantees and explaining its own
unique ethical and legal dimensions. Public awareness campaigns are equally important to
educate clients or community on how kafalah operates and its benefits as an Islamic financial
instrument. Clear communications can help clients or community appreciate the value of
kafalah in promoting fairness and trust in financial transactions. Such initiatives will foster a
better understanding and broader acceptance of kafalah based products.

Conclusion

In conclusion, the issue of absolution of guaranteed debtors in Kafalah contracts stems from
a combination of legal misalignment, inconsistent practices and ambiguous guidelines.
Dressing these issues requires legislative reforms, standardization across banks and
education and awareness. By implementing all of these measures, Islamic financial institutions
can uphold the principles of shariah, ensure consistency, in their practices and strengthen the
credibility of Islamic finance as an ethical and equitable system.
References

• Muneeza, A., & Mustapha, Z. (2020). Practical Application of Kafalah in Islamic

Banking in Malaysia. PSU Research Review, 4(3), 173–187.
• Bank Negara Malaysia (2018). Kafalah Policy Document. Retrieved from BNM
Website.
• Rahim, A.K.A., Naim, A.M., & Zainol, Z. (2015). "The Application of Al-Kafalah in
Islamic International Trade Financing Products." Global Journal Al Thaqafah, 5(1), 69-
80.
• Abikan, A. I. (2017). Contract of kafālah (guarantee) in Islamic finance: Extending the
frontiers of Islamic law. Journal of Shariah Law Research, 2(1), 157-178.

• Hassan, R. (2011). Islamic Banking and Takaful. Pearson Custom Publishing, Kuala
Lumpur.
• Abu Backer, H. S. (2005). Janab’s Series to Law, Practice, and Legal Remedies. Janab
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