Shariah Sales vs. Riba Loan

Shariah
Compliant Sales
and Riba-Based
Transactions: A
Comparison

Prepared by:
Mohd Shahrulnizam Abd Hamid
msnra2@yahoo.com

Shariah Rules in
Financial Transactions

INCEIF
Shariah Compliant Sales and Riba-Based Transactions: A Comparison

Page 1

Abstract
Allah S.W.T makes it very clear that He forbids interest based transactions and allowing sales.
He also rejects the idea of making riba and sale transaction as the same as He gives clear
distinction among both two transactions. The objective of this paper is to compare between
Shariah compliant sale and Riba based transaction in a critical manner. The comparisons
derived later should be seen from general perspective of both system, and not going into any
particular product. In this paper, we will reproduce the definitions, history and background and
Islamic rulings concerning both systems. Then, we will also outline the types of Shariah
compliant products and interest based transactions. Later, we will compare both transactions and
give examples of banking system. Lastly, we will discuss few issues concerning both model and
end this paper with the discussion on a case study of micro financing in Islam.

Keyterms: Shariah compliant sales, history of banking, riba based transaction, asset backed,
asset based, money backed, money based, Gharar, Bay Inah, interest rate, Musyarakah
Mutanaqisah, Home loan, AITAB, Hire purchase, Micro Financing, Grameen Bank.


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1.0 Introduction
Banking was originally started in Babylonia during 3000 to 2000 B.C. It was actually the
activities of temples and palaces which provide safe places for the storage of valuables. Initially
deposits of grain were accepted and later other goods including cattle, agricultural implements,
and precious metals. Banking industry developed further. Later, in 350 B.C, the history recorded
that the interest rates in Greece was 10 percent for run-of-the mill business and between 20 to 30
percent for risky business. The modern banking was established its root in the 16
th
century. This
was proven by the establishment of maximum 10 percent interest by Henry VIII in 1545
followed by the founding of Bank of Genoa in 1585 and other significant developments as
recorded in the history
1
. During the remaining 400 years, the banking industry was grown up to
be the most important sector in the economy.

In 1963, a new set of banking was started when Ahmad Elnaggar opened the first Islamic
Bank ever in the world. Being in an Egyptian town of Mit Ghamr, the bank was operated based
on profit sharing system. Later, in 1975, the first modern commercial Islamic bank, Dubai
Islamic Bank, opened its doors to the public. In the same year, Islamic Development Bank was
established which signs the internationalization process of Islamic banking and finance. Today,
Islamic banking and finance is no more a new thing to the world. From Egypt to Malaysia to
United States, Islamic banking and finance is recognized and practiced throughout the world.
Given all the developments, the history of banking system still develops everyday and every
second.

Why are we discussing on banking while the assignment is on Shariah compliant sales
and riba-based transactions? This is because, the main operation of Islamic banking is sales
while the main operation of conventional banking is interest based loans. By analyzing banking
system, we will find major differences between both transactions, especially in practical side.

1
(Davies & Davies, 1998, pp. 162-177)
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Page 3

This assignment will mainly discuss on Shariah compliant sales and riba based
transactions, their models, differences and complications which will arise due to the practices of
both systems. Specifically, this assignment will analyze the differences of model of Shariah
based sales such as Murabahah, Bay Bithaman Ajil (BBA), Bay Inah, Tawaruk, Ijarah, Ujr,
Salam and Istisna to their counterpart of riba based transactions which is the various types of
loans. To make the discussion realistic, we will also take examples from banking practices as
well as other sources in order to derive the differences of both systems in terms of how the
models are practiced nowadays. Lastly, we will discuss few issues pertaining to both systems. In
addition, this assignment will provide additional discussion on micro financing issue and its
applicability in Shariah based transaction.

2.0 Definitions and rulings of the concept of Shariah compliant and Riba.
To begin with, we need to clearly define the riba based transaction and Shariah compliant
sale. The word Riba is an Arabic word, literally refers to excess, addition and surplus, while
the associated verb implies to increase, to multiply, to exceed, to exact more than was due, or to
practice usury
2
. Lanes Lexican presents the comprehensive meaning of Riba as:
to increase, to augment, swellings, forbidden addition, to make more than what is
given, the practicing of usury or the like, an excess or addition, or an addition over and
above the principal sum that is lent or expended

Technically, as practiced today, Riba means the practice of charging financial interest or
a premium in excess of the principle amount of loan
3
. Moreover, Ibn Arabi, Mujahid and
Tabari, the classical scholars, interpreted Riba as increase which has no wealth corresponding to
it or as reward for waiting or that increase which accrues to the lender on account of deferred
payment due to an extension in the actual period of loan
4
. Comprehensively, the Riba based
transaction means any transaction that using Riba based facility (i.e. loan) as a mean of payment.

On the other hand, Shariah compliant sale is the counterpart of the former transaction. Its
basis is the Religion of Islam. Shariah compliant means the sale is conducted under the principles

2
(Zamil Iqbal and Abbas Mirakhor, 2007)
3
4

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of Islamic Shariah, binding to its rules and regulations and abides by all the objectives of Shariah
(Maqasid Shariyyah). According to Al- Majalla Al- Ahkam Al- Adaliyyah (The Mejelle), sale is
interpreted as follow;
Sale consists of exchanging property for property. It may be concluded or non-
concluded.
In addition, Wehbah Al-Zuhayli (2001) defined sale as an exchange of one item for
another. The Arabic term bay refers both to the activities of buying and selling. From the above
interpretation, it states that the sale must be concluded by selling of property, not trading of
money.

In Islam, it is clearly stated that Allah has approved sales while forbidding Riba. In Al-
Baqarah verse 275-280, Allah states His command on forbidding Riba as follows:

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(275) Those who eat Riba (usury) will not stand (on the Day of Resurrection) except like the
standing of a person beaten by Shaitan (Satan) leading him to insanity. That is because they say:
"Trading is only like Riba (usury)," whereas Allah has permitted trading and forbidden Riba
(usury). So whosoever receives an admonition from his Lord and stops eating Riba (usury) shall
not be punished for the past; his case is for Allah (to judge); but whoever returns (to Riba
(usury)), such are the dwellers of the Fire - they will abide therein.
(276) Allah will destroy Riba (usury) and will give increase for Sadaqat (deeds of charity, alms,
etc.) And Allah likes not the disbelievers, sinners.
(278) O you who believe! Be afraid of Allah and give up what remains (due to you) from Riba
(usury) (from now onward), if you are (really) believers.
(279 ) If you do not do so, then take notice of war from Allah and His Messenger. But, if you
repent, you can have your principal. Neither should you commit injustice nor should you be
subjected to it.
(280) And if the debtor is in misery, let him have respite until it is easier, but if you forego it as
charity, it is better for you if you realize.

About the background of the revelation of verses 278 and 279 of this set of Quranic
tenets, Shaikh Taqi Usmani said in Shariat Appellate Bench of the year 2000 under paragraph 23
and 24 on page 528 to 529;


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After the conquest of Makkah, the holy Prophet (pbuh) had declared as void all the
amounts of Riba that were due at that time. The declaration embodied that nobody
could claim any interest on any loan advanced by him. Then the holy Prophet (pbuh)
proceeded to Taaif, which could not be conquered, but later on the inhabitants of Taaif,
who belonged mostly to the tribe of Thaqif, came to him and after embracing Islam
surrendered to the holy Prophet (pbuh) and entered into a treaty with him. One of the
proposed clauses of the treaty was that Banu Thaqif would not forego the amounts of
interest due on their debtors but their creditors would forego the amounts of interest.
The holy Prophet (pbuh) instead of signing that treaty simply ordered to write a
sentence on the proposed draft that Banu Thaqif will have the same rights as other
Muslims have. Banu Thaqif, having the impression that their proposed treaty was
accepted by the holy Prophet (pbuh), claimed the amount of interest from Banu Amr
Ibnal- Mughirah, but they declined to pay interest on the ground that Riba was
prohibited after embracing Islam. The matter was placed before Attaab ibn Aseed (God
be pleased with him), the Governor of Makkah. Banu Thaqif argued that according to
the treaty they were not bound to forego the amounts of interest. Attaab ibn Aseed
placed the matter before the holy Prophet (pbuh) on which the following verses of

Surah al-Baqarah was revealed:
O those who believe, fear Allah and give up what still remains of the Riba if you are
believers. But if you do not do so, then listen to the declaration of war from Allah and
His Messenger. And if you repent, yours is your principal. Neither you wrong, nor be
wronged. (278279)
At that point of time, Banu Thaqif surrendered and said that they had no power to wage
war against Allah and his Messenger.
5

3.0 The core differences of both transactions
They are few core differences between Shariah compliant sales and Riba based
transactions. These differences create totally different applications and implications towards the
society. We will underlie three core differences which in term of the highest authority which

5
(Ayub, 2007, p. 45)

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govern the transactions, underlying principles which guide the transactions and the intrinsic
values attached to each transaction.
First, the highest authority that governs the transactions is totally different in Shariah
compliant sales and riba-based transactions. In Shariah compliant sales, the ultimate authority is
given to the All- Creator, Allah S.W.T., who has revealed the Shariah law and put the dos and
donts of any transactions, whether it is financial transaction or not. Thus, man as the creation of
Allah is commanded to follow all the rules and regulations underlined in Shariah. On the other
hand, the highest authority governing riba-based transactions is human itself, put under many
names and brands. They hold ultimate authority in determining what is right and what is wrong.
Thus, based on their mind only, they decide the fate of other human king.

Second, derived from the first argument, the Shariah compliant sales and Riba based
transactions lie on the totally different principles. While Shariah compliant sales lie on the
divinely revealed and guided Islamic Shariah principles, Riba based transaction lie on human
made and human controlled principle. Justice Muhammad Taqi Usmani, in his book An
Introduction to Islamic Finance describes the basic difference between both systems on page
17-18 as follows:

Yet, the basic difference between capitalist and Islamic economy is that in secular
capitalism, the profit motive or private ownership are given unbridled power to make
economic decisions. Their liberty is not controlled by any divine injunctions. If they are
some restrictions, they are imposed by human beings and are always subject to change
through democratic legislation, which accept no authority of any super human power.

After recognizing private ownership, profit motives and market forces, Islam has put
certain divine restrictions on the economic activities. These restrictions being imposed by
Allah Almighty, whose knowledge has no limits, cannot be removed by any human
authority.

The differences in underlying principles lead to the differences in practical and implications to
the society. Wahbah Al-Zuhayli has outlined 6 core values (i.e. principles) that governs sale in

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Islam. They are the avoidance of excessive profits, truthful and complete disclosure of
information, ease of conduct, avoidance of swearing, even if truthful, frequent paying of charity
and documentation and witnessing of all debts. The sic values of sale is the determination
whether one is ethical in conducting their sales or not.

Third, Shariah compliant sales and Riba based transactions are differed on the underlying
intrinsic value. For Shariah compliant sales, they were backed by real assets and any changes in
value (i.e. profit) were clearly based on the intrinsic value of the specific assets. For example, in
Murabahah transaction, a seller (i.e. Bank) will acquire an asset (i.e. a house) at cost price. Later,
he will sell the asset to another party at cost price plus profit, which make the selling price,
which he is required to disclose the cost and profit amount to the customer. The transaction is
clearly backed by a real asset, which is a house in our example. Furthermore, the profit gained by
the bank is clearly based on the selling transaction of the asset itself.

Comparing it to the Riba based transaction of acquiring a house. Initially, a customer will
go to a person (i.e. Bank) and says that he want to buy a house. Later, the bank will offer him a
loan scheme with specified interest rates, payment period and other conditions. The transaction is
not a sale transaction, but a loan. It is not backed by any real asset. The profit gained by the bank
was based solely on the loan.

Discussing on the matter of sales, Islam has outlined clear rules and regulations on that
matter. In conducting sales, it must be backed by a real asset, as discussed earlier. In addition, the
asset must be fully acquired first before being sold to another party. Third, the asset must possess
the same quality as stated in the contract, or the customer can either accept the defeated asset as
it is, defaulted or ask for lower price.

4.0 More differences of both models
Despite the three core differences, Shariah Compliant sales and riba-based transactions
also differed on several other grounds. These differences make the clear distinction whether a
transaction is allowed by the shariah or not. The differences are asset backed issue, uncertainty
elimination, risk taking responsibility, impact on the society,

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1. Money- backed and asset- backed transactions.
First, the Shariah compliant sales and riba-based transactions are differed on the
asset-backed or money backed issue. Riba based transactions are conducted as money
backed transactions. The transactions are only deal with money and not the real assets.
Thus, they are trading money as commodity which is prohibited in Islam. In Islam, the
role of money must be kept as a medium of exchange and its value is determined by other
commodities. For example, if you want to buy a house costs RM 1 million, the riba-based
transaction will acquire you to make a loan of RM 1 million and pay back, let say, RM
1.5 million in deferred payment. The RM 500 000 is the profit derived from the deal. The
transaction done is actually selling money for more money. As commonly practiced
especially by conventional banking, the profit of RM 500 000 must be paid to the lender
regardless of what happen to the borrower or the asset. Even if earthquake destroys the
house, somebody (i.e. the borrower or the insurance company) should settle the loan. It is
an undeniable liability to the lender because the deal between the lender and the customer
is money for money. Thus, the destroyed house is not a concern of the lender. This will
put the lender in zero-risk position. Eventhough the conventional banking products are
called with different names, they are operated using the same model- interest bearing
model.
On the other hand, Shariah Compliant sales are asset backed transactions. All
sales transaction must be conducted on real asset value, and the asset must exist and fully
owned by the seller. Thus, the transaction done is a selling of a real asset for a sum of
money. The transaction must be of exchange of a commodity or asset for money and vice
versa. There are few Shariah-based contracts that can facilitate the sale transactions such
as Murabahah, Commodity Murabahah, Musyarakah Mutaaqisah, Ijarah and Salam. For
example, to buy a house of RM 1 million, a buyer can buy from a seller either cash or
credit. In addition, a financial intermediary can facilitate the deal by purchasing first the
house, fully owned it and then sell it to the buyer at higher price. The difference between
the cost price and the selling price is the profit to the financial intermediary. The price is
fixed, cannot be fluctuated as happen in riba based transactions.

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Muhammad Taqi Uthmani had outlined five differences between asset-backed
sale and money trading. The first difference is that, in riba-based transaction, the lender
has no concern on the usage of money, whether it is halal or haram. The lender only
concerns on the money lent and the interest promised to him as his profit. Contrary to
riba-based transactions, the financier in shariah compliant sales must possess the asset
first, before resale it to another party. In acquiring the asset, he must ensure the
commodity is halal and profitable. This system will prevent the occurrence of prohibited
elements in the transactions.

2. Uncertainty elimination issue.
In any transaction, the uncertainty (gharar) will occur. The difference is that,
whether the uncertainty is big or small, significant or not. Gharar means uncertainty,
hazard, chance, stake or risk. The prohibited uncertainty refers to the significant
uncertainty or hazard caused by lack of clarity regarding the subject matter, the price in a
contract or exchange or the legal documentations involved.
Those general conditions specify that the sale must not include any of the
following six shortcomings: uncertainty or ignorance, coercion, time-restriction,
uncertain specification, harm and corrupting conditions. A sale content any of the
shortcomings will be held invalid and void. Thus, it is very clear that Islam prohibits
uncertainty.
In riba based transaction, a significant uncertainty is not really eliminated and not
a big concern of both the seller and the buyer. Their concern is just on the loan
transaction. As the interest rate, payment period and payment method are certain, they do
not care on other matters concerning the whole transaction. In Islam, gharar (uncertainty)
is really a concern especially in business transactions. Islam prohibits the existence of
excessive uncertainty and makes it compulsory for both buyer and seller to avoid it. The
presence of excessive uncertainty will make a contract void and turn invalid. As Shariah
compliant sale is a sale of property, it is really important to ensure that there is no
excessive uncertainty occurs in the transaction. From the contract preparation to the sale
conclusion, gharar should be eliminated carefully.

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For example, let say Karimah wants to buy a house costs RM 200 000. If she uses
riba-based transaction through conventional banking, she is required to make a loan
contract of borrowing RM 200 000. Assume that she is charged with 5 % simple interest
rate annually for 25 years. Thus, the total amount that she has to pay is as follow;

From the above calculation, the total amount need to be paid at the end of the loan
facility is RM 450 000. As long as the principal amount, interest rate charge, payment
period and few rules and regulation concerning the loan are taken care, it is enough for
both parties. Unfortunately, the fluctuation of interest rate in the market is not taken care
of. This will open door for manipulation of interest rate and the changes of total amount
that must be paid to the lender. The other charges such as late payment fines, lawyer
fees, insurance premium and maintenance also will increase the cost of borrowing. Some
of the charges are only written as other charges in the original contract and the bank
will determine later what the charges are. Due to many uncertainties involve, it is normal
that the total amount need to be paid to the bank is not RM 450 000 but more than that.
The system itself has put the customer in the uncertainty area.
Contrary to the riba-based transaction, Shariah compliant sales must possess
clarity in its transaction as it is a real asset sale. Thus, the scope of the contract should be
broader compared to riba-based transaction. In the contract, not only the financing
amount should be stated, the quantity and specifications of the product, ownership, profit
rate, the model used in conducting the sale transaction, and the final price of the product
must be clearly stated and understood by both parties. Let take the above example.
Assume that Karimah has found a house costs RM 200 000. Now, instead of going to
conventional banking, she chooses the Shariah compliant sales operated by Islamic

Principal amount: RM 200 000
+ Yearly interest charge: RM 10 000 x 25 years RM 250 000
Total amount of the loan facility RM 450 000


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banking sector. Approaching an Islamic bank, she will be given the profit rate of 5% for
tenure of 25 years.

In Shariah compliant sale, let use Commodity Murabahah model, after a
commodity/ asset/ item is sold on an agreed price, the price cannot be change. It is fixed.
Thus, a customer need only to pay up to RM 450 000 for the facility. Any increase in
price will be considered as prohibited. A financier cannot impose any other charges into
the contract. Any fluctuation in interest rate and profit rate, the economic instability and
inflation cannot affect the price of the commodity.
In addition, the ownership transfer also must be carefully observed in Shariah
based transaction. One cannot sell what he does not own yet. In Shariah compliant sale,
ownership of the commodity being sold is transferred to the buyer just at the time the sale
is executed and this transfer is definite and permanent. The ownership transfer is not
affected by the nature of the payment, whether it is paid on the spot or deferred. It is free
from any ambiguity of ownership right. In contrary, Muhammad Ayub has described the
pattern of ownership transfer in Riba based transactions as leading to a temporary
transfer of ownership, not definite and permanent. This will open the door of uncertainty
and strong ambiguity. The lender can anytime, upon default, take back the commodity
and left the borrower for nothing.

3. Risk taking responsibility
Risk taking responsibility is among the main issue in Shariah compliant
transaction. In any Shariah compliant sale, the seller must take a risk to entitle him the
profit gained from the transaction. The risk is the conter value of the profit earned. One of

House cost: RM 200 000
+ Yearly profit rate: RM 10 000 x 25 years RM 250 000
Ending price of the house: RM 450 000


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the fiqh maxims in Islam is Al- Ghorm bil Ghonm which means the profit must come
with responsibility of risk. If a seller does not want to be exposed to any risk, thus he is
not entitling for the profit gained from the transaction. Another Fiqh Maxim is Al-
Dhoman bil Kharaj which also means that any profit must come along with
responsibility of risk. For example, a car dealer should bear the risks of damage, loss or
maintenance cost occurred during the time the car is in his possession. After the sale, the
risks are transferred to the new owner.
On the contrary of Shariah compliant sale, Riba based transaction is not concern
on this issue. Since they are not trading the commodity, they have no concern on the
responsibility of risk as mentioned by Islam. In trading money, they are not bound to any
risk of damage, loss or maintenance of the property. For example, a seller in riba based
transaction will only facilitate the buying of a house by giving loan to the borrower.
Thus, from the start, the borrower is entitled the risk associated with the house, not the
lender. As practiced by conventional banks nowadays, they will only bear the risk of
holding money. The risks associated with the house will not be entitled to the bank, but it
is the responsibility of the borrower. In this transaction, the lender earns a profit without
any counter value, which is the risk. This will make their profit questionable as it is
earned out of a thin air.

4. Impact on the society.
Due to their different principles, the outcome to the society will also be different.
By implementing riba based transactions, the society will be educated to make more
loans regardless whether they really need it or not. The credit-society will be
accustomed to credit making culture and will see it as a way to gain something and of
course at the cost of others. People will see the activity of taking profit (interest) without
much effort and risk responsibility (the counter values of profit) as good and as a part of
the economic system. One day, they will argue that interest is necessary in building the
economy and without interest, the economy will surely collapse. It is the time when
interest is a part of the life of most of the people. Almost every transaction they do is
attached with interest, either they give it or take it or at least witness it.

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On the other hand, Shariah compliant sale will develop the status of the people.
There are few products which called Shariah based products. They are introduced by the
Shariah itself and has been practiced even before the era of Islam. Musyarakah,
Murabahah and Mudharabah are the example of Shariah based products. By
implementing these three products in sale transactions, the economy standard of the
people can be increased. Let takes Musyarakah contract as our example. In Musyarakah
contract, the partnership must invest the capital and run the business together. The profit
will be divided on the profit ratio as agreed upon the agreement and the losses should be
divided according to the capital contribution ratio. By applying Musyarakah instead of
investment loan, both the lender and the borrower must ensure the profit for the
partnership business. Thus, both parties will put their full effort and abilities in running
the business which will open a greater chance for the business to grow faster and
profitable. In Mudharabah contract, one party will put his capital into the business and the
other party will put his expertise and effort into the business. The profit will be divided
according to the profit sharing ratio while the loss will be borne fully by the capital
provider.
By applying Mudharabah contract instead of interest- bearing loan, more people
with excellent entrepreneurship skills will have more opportunity to open a business and
spur the economy and increase the life standard of the society. Both Musyarakah and
Mudharabah contracts promote the value of partnership, mutual development and capital
redistribution to those who in need of it for various reasons. On the other hand, interest
bearing loans will acquire its borrower to pay the interest profit regardless they are
making profit or loss. This system will stop some entrepreneur from having their own
business and will negatively affect the economic development of a country. As
entrepreneurship (normally small and medium enterprise) is the biggest provider of
liquidity in a country, it is important to have them exist everywhere. Thus, it is the
responsibility of those who have capital (individual or financial intermediaries) to
promote entrepreneurship and Islam has provided the methods to accomplish the task- the
Musyarakah and Mudharabah contract.

5.0 Types of Shariah compliant contract

Page 15

There are two types of Shariah sales;
1. Shariah based sales
Shariah based sales are the types of sales that derived from Shariah itself. The types are
initiated and found in the Islamic Shariah.
2. Shariah compliant sales
Shariah compliant sale is the broader concept of Shariah sales, which consists the Shariah
based sales plus the structured sales that comply with Islamic Shariah rulings.

There are many Shariah compliant products, which some are Shariah based and others are
structured to meet Shariah rules. Among the Shariah based products are;
1. Murabahah
Murabahah is a sale of good at the cost price plus a known profit. The special features of
Murabahah is that the cost must be disclosed upon contract agreement and the profit
amount is agreed by both parties.
2. Bay Inah
Bay Al- Inah is buy-back sale. The basic Bay al- Inah sale is that when a person sell an
item to another person for cash payment and buy back the same item for higher price,
either cash or normally on deferred payment.
3. Tawaruk
Tawaruk is the advance version of Bay al-Inah in which three parties involve in the sale
transaction. In Tawaruk, a man will sell his item for cash to the other person. Later, the
person will resell the item to another person either for cash or on deferred payment.
4. Ijarah
Ijarah is the leasing, renting sale
5. Ujr
Ujr is the employment contract. Under employment contract, the traded (rented) item is
the usufruct (manfaah al-mal). The usufruct is the expertise, effort and time of an
employee.
6. Salam

Page 16

Bay Al- Salam is a future contract in which the price is paid now and the product is
delivered later as specified. There are few restrictions that must be observed in
conducting Salam transaction as it is an exception to the general principal of sale in Islam
(i.e. sale is spot transaction of cash and product)
7. Istisna
Istisna is a manufacturing sale in which a party can order a product from a manufacturer.
The price can be paid in lump sum or in deferred, either before the contract or during the
contract. Some scholars say that Istisna is part of Salam while others categorize it as a
special exception of sale regulation to facilitate unique human wants and preferences.

In addition, the Shariah compliant products are;
1. Bay Bithaman Ajil (BBA)
BBA contract is a Murabahah sale with deferred payment. Unlike normal Murabahah,
BBA is conducted as credit purchase and the price is normally higher compared to the
spot price. This is done to absorb the risk associated with the time.
2. Al- Ijarah Thumma Al-Bay (AITAB)
AITAB is an Ijarah contract which ended with the sale of the item/property either by
market price, token value or the last installment payment is considered as the price of
buying the item/property.
3. Al- Ijarah Muntahia Bit Tamleek (IMBT)
IMBT is an Ijarah contract which after the Ijarah period, the item/property will be given
to the tenant either as a gift or by token value. It is almost similar to AITAB contract.

6.0 Types of Interest bearing loans

There are two types of interest rate as practiced from the ancient time which;
1. Simple interest rate
Simple interest rate is computed by a fixed rate and fixed amount throughout the loan
tenure. For example, for a loan of RM 1000, let say the interest rate is 10% for 5 years,
thus the interest amount need to be paid yearly is 10% of RM 1000 = RM 100. Each year,

Page 17

the borrower need to pay RM 100 as the interest and it is fixed. Thus, the total amount of
interest paid for the whole tenure is RM 500.
2. Compounding interest rate
Compounding interest rate is the system practiced everywhere nowadays, especially by
conventional banks. It gives more profit to the lender and burdens the borrower more.
The interest is computed from the principal amount plus the summation of interest paid.
We use the above example to portray the real transaction. Let say a borrower take a loan
of RM 1000 of 10% interest rate and 5 year period, the interest calculation is as follow;

Year Principal Paid Interest computation
(Principal + accumulated interest)
Interest must be
paid for the year
1 RM 200 10% x RM 1000 RM 100
2 RM 200 10% x (RM 1000 + RM 100) RM 110
3 RM 200 10% x (RM 1000 + RM 210) RM 121
4 RM 200 10% x (RM 1000 + RM 331) RM 133.10
5 RM 200 10% x (RM 1000 + RM 464.10) RM 146.41
Total interest paid for the whole tenure RM 610.51

From the above table, compounding interest rate results in RM 610.51 interest paid for
the whole tenure which is much higher compared to simple interest of RM 500 interest
paid for the whole tenure.

7.0 Comparisons on the practice of Islamic Banks and Conventional Banks
Shariah compliant sales and Riba based transactions are also differed in term of the
model. Since the principles which govern the transactions differ, the consequences models of
each product should also differ a lot. In this section, we will discuss and compare few products
of Islamic Banking and Conventional Banking.

Page 18

1. Musyarakah Mutanaqisah Home Financing vs. Home Loan Scheme
Firstly, we will look at home financing products. In relation to the sale contract, we will
compare the Home Financing-i of Kuwait Finance House (KFH) representing Islamic Banking to
the Maybank MaxiHome representing Conventional Banking. In this comparison, we will look at
the detail models, operational side and the implications to the customers.

Home Financing-i product of KFH is operating using Musyarakah Mutanaqisah
partnership concept. It is also called Diminishing Partnership contract. The Shariah Advisory
Council of Bank Negara Malaysia in its meeting held on 6
th
February 2006 resolved that the
financing product structured based on Musyarakah Mutanaqisah contract is permissible. The
permissibility was recognized in Islamic Muamalat
6
. Saiful Azhar Rosly has clearly describes the
model of Musyarakah Mutanaqisah in his book Critical Issues on Islamic Banking and
Financial Markets. To simply explain how the model works, he gives a diagram to facilitate the
discussion. The diagram has been reproduced below. Now, let us assume that a customer intents
to buy a house which cost RM 100 000. In Malaysian case, normally the customer needs to pay
10% deposit to confirm the purchase. After paying the RM 10 000 deposit, he will approach an
Islamic bank to assist the purchase. The bank will review his documents and upon approval, the
bank will pay the remaining RM90 000 to the developer. Now, both customer and the bank have
share in the house, in which the customer owns 10% of the house while the bank owns the
remaining 90% share.

Later, the partnership will rent the house to the customer on the market rental value. In
addition to the rental amount, the customer also needs to pay extra amount to buy the share of the
bank in that house. Let say the market rental value is RM500 and as agreed upon the contract, the
customer will buy the banks share amounted of RM300 monthly. Therefore, the monthly
payment is RM800. By these transactions, the profit of RM 500 arise which Rm50 is for the
customer and RM 450 is for the bank. Therefore, the monthly amount paid by the customer in
order to buy the banks share is RM 350 (RM300 of rental plus RM50 of profit). Thus, the shares

6
(Bank Negara Malaysia, 2007, pp. 20-21)

Page 19

of the bank are diminishing while the shares of the customer are increasing. The whole
transactions are summarized in the diagram below.

As shown and described above, in Musyarakah Mutanaqisah contract of buying a house,
there are two sales transactions involved. Firstly, the sale of the house conducted by the customer
and the bank. Secondly, the sale of the banks shares of the house partnership to the customer.
Customer Share Capital
of 10%
RM 10 000
Bank Share Capital of
90%
RM 90 000
Musyarakah Mutanaqisah Partnership (MMP)
The MMP invests the RM 100 000 capital in Al-
Ijarah rental business
HOUSE
Monthly Ijarah
payment RM 800
Actual rental value
RM 500 (Share the
rental profit)
Customer Profit (10%)-
RM 50
Bank Profit (90%)-
RM 450
Customer share purchase
RM300
Increases
customers
shareholding
Reduces banks
shareholding

Page 20

These transactions involve sale of real asset (house) and intangible asset (shares) which has been
fully and legally owned before they are resale to another party. Thus, according to Shariah, the
above sale transactions are valid as well as the profit gained from the contracts are lawful.

2. AITAB Car Financing vs. Hire Purchase Car Loan
AITAB car financing is operated under Al-Ijarah (leasing) contract. Al-Ijarah Thumma
Al-Bay means leasing ended with purchase, or simply known as hire purchase contract. What
are the differences of AITAB and Hire Purchase contract offered by conventional banking?
Nurdianawati and Asyraf Wajdi have illustrated the practice of Islamic banking in
Malaysia of AITAB contract. In Malaysian context, AITAB client normally identifies and
approaches vendor or dealer of the asset he needs. The dealer then prepares all related documents
pertaining to AITAB financing on behalf of the bank. Here, the dealer merely acts as an agent to
the bank. Once the client and the bank concluded the AITAB contract, the car will be delivered
to the client, hence effectively commencing rental payment. Upon completing all the agreed
payment, both parties shall enter into another agreement in which the customers pay a nominal
amount of RM1 signifying sale contract. The basic operation of AITAB is depicted in the
diagram below.

Page 21

On the other hand, Conventional Hire Purchase is a loan in which a customer will borrow from a
lender and the lender will purchase the car and hire it to the borrower. After the agreement is
finished, the borrower will have to buy the car and own it.

8.0 Issues
8.1 Bay inah is the back door to riba
Bay Inah is a controversial product. The majority of scholars prohibit the application of
Bay Inah in the financial industry. Bay Inah is known as buy-back-sale in which a person will
sell an item and then buy it back, either just after the first transaction or sometime later. Literally,
the word Inah means contracting a loan (salaf). Inah can also derive from the word Ayn
which means present asset, or simply a cash. It also derives from the word Ianah which
means assistance, in which one is assisted through Bay Inah process to fulfill his needs.
Technically, the Hanafi jurist Ibn Abidin describes Bay Inah as a sale of an item at profit
on deferred payment, for its subsequent buyback by the original seller at a lower price, for the
purpose of settling the debt. One hadith narrated by Abdullah ibn Umar concerning Bay Inah is
as follow;

Page 22

When men become frugal with money (literally gold and silver coins) and trade on the
basis of Inah, and (when they) follow the tails of cows and leave jihad in the path of
Allah, Allah will send down a trial that He would not remove until they revert to their
religion.

From the meaning of the above hadith, it is clear that Bay Inah is illegal or prohibited in
Islam. Among the main four Mazhab, three of them prohibit Bay Inah while only Imam Shafie
make Bay Inah permissible, but on strong restrictions. Imam al-Shafie in describing his
principle concerning Bay Inah said in Al-Umm;
When one purchases a commodity from another and takes its delivery, and the price
happens to be on deferred terms, it is not objectionable for him to sell it to the person
from whom he had purchased it or to someone else, for a cash price less than his
purchase price or higher, or on credit, or against another commodity.

It is clear that Imam Shafie made Bay Inah permissible but on few strong restrictions which are;
1. The buyer has taken the ownership and delivery.
2. The intention for cash money or doing Bay Inah is not expressed explicitly.
3. The first contract cannot be a condition for the second contract.
4. The original buyer has absolute rights either to resell the property, sale it to other person
or keep it.
Due to the strict restrictions imposed by Imam Shafie- the only approval for Bay Inah- it is not
easy in practicing Bay Inah especially in modern banking industry. All the regulations must be
observed strictly by Islamic banks to ensure the validity of the contract. Any small violation will
rendered the contract as void and invalid from the perspective of Shariah. Many contemporary
bodies of Shariah scholars such as the Islamic Fiqh Academy, the Islamic Banking Conference
and Shariah Supervisory Boards of few Islamic banks has ruled the adoption of Bay Inah as
prohibited in the context of banking transactions for the purpose of financing. Many of them
argue that the application of Inah can easily be misused in a purpose of disguising a riba contract.
They base their arguments on the hadith stated above and the rejections of many Companions
and Muslim jurists on Bay Inah application.

Page 23

In addition, the groups who support the application of Bay Inah in financial sectors argue
that as long as the intention is not expressed explicitly and all the restrictions are carefully
observed, there is no reason to prohibit it. It is not the role of a man to judge the intention of
other fellow man, it is the role of Alah. Furthermore, Imam Shafie argued that one has the full
capacity, after fully acquiring an asset, to sell it to anybody, even to the original seller.

Critical Assessment of Bay Inah Legality in Financial Transaction
If reviewed from the perspective of Maqasid Shariah, a question arise is that whether the
application of Bay Inah is essential in Islamic banking or not? If we are not implementing Bay
Inah, will our financial sector collapse, or be in hardship?
The industry is divided into two groups concerning the legality of Bay Inah application
in Islamic financial sector- the supporters and the opponents. The have their own arguments in
supporting their idea. As the Muslim jurists also differ in permissibility of Bay Inah, both
opinions can be accepted and applied accordingly.

Arguments for Bay Inah Validity
Those who support Bay Inah application in financial sector argue that Bay Inah is
important in facilitating the needs of the customers, especially in providing personal financing
and credit cards. To improve and compete with conventional banking, Islamic banking need to
be creative and offers better products to the customers as well as earn enough profit in sustaining
the business. As personal financing and credit card is merely a loan contract, there are only a few
models can be used to facilitate the contract- either Bay Inah or Tawaruq. The supporters also
come out with a hadith in which Rasulullah has permitted the employment of sale transactions in
intention of avoiding any involvement in riba-based transactions. The hadith is reproduced as
follow;
A companion Abu Said Al-Khudri narrates that a man from the region of Khaybar who
had been contracted for the upkeep of a plantationcame to the Prophet with some dates of good
quality. When the Prophet asked him whether all the dates of Khaybar were of similar quality the
man replied in the negative, and added that they used to obtain a measure of better dates against
two measures of ordinary dates, and two measures against three measures. The prophet forbade

Page 24

him from doing that, and directed him to sell the low quality dates against silver coins, and then
purchase better dates against silver.
Reported by Al- Bukhari and Muslim.

Regarding the discussion on intention attach to Bay Inah transactions, the Muslim jurists differ
in this matter. Imam Hanafi considered intentions as valid source of ruling while Imam Shafie
regarded intention as cannot affect ruling. He stated that intention is the right of Allah to judge.
In Al- Umm, he noted the basis of his arguments as follow;

The principle I adhere to is that with regard to every contract that is valid in its external
form, I do not consider it invalid due to suspicion or on the basis of any practice
prevalent among the traders. I hold their intention offensive. If the intention was such
that were it to be revealed, it would have resulted in the invalidity of the contract.

It is clear that Imam Shafie allows Bay Inah as he did not take into account the intention of
those who involve in the transaction. In addition, the proponents of Bay Inah further argued that
when the contract themselves are free from any elements which can invalidate the contract, the
contract must be upheld as valid an any foul intentions will not affect its validity.

Arguments for Bay Inah Invalidity
Majority Muslim jurists held Bay Inah trasaction as invalid and void. Their arguments
base on the hadith produced on page 3. In addition, another hadith also condemn Bay Inah
practice;
A time will come over people when they will seek to permit riba through sale
This hadith clearly refers to a practice of legalizing riba through sale, just like Inah. In another
hadith by Aisyah, which is the strongest argument against Inah, it is reported that Aisyah has
stated that the practice of Inah could bring about the annulment of her jihad, in spite of the fact
that no apostasy has taken place. The hadith by Aisyah clearly indicates that the Inah practice is
prohibited especially when it is organized like for personal loan or credit card. It seems that, the
intention for money is very clear, even though it is not expressed explicitly. Imam Hanafi has
regarded Inah practice as prohibited because the intention is not for the asset but for the cash

Page 25

money. Hanafi School values intention as one of ruling element, which either a good or bad
intention will affect the ruling.
Moreover, the invalidity of Inah transaction due to the shubhah element (suspicion)
contained in it. In other words, eventhough not explicitly involving any lending and borrowing
on interest, it involves the element of riba. Thus, avoiding suspicion is better than trapped into
the sinful wrongdoings.

Critical assessment on the issue
After deep assessment, we found that both sides have their own arguments and both have
strong reasons of permitting or prohibiting Inah transaction. Thus, we take the medium approach
in the sense that, one, especially Shariah Advisory Board need to analyze the situation and
condition of a country before making rulings on Inah transaction. In Malaysia, the Shariah
Advisory Council ruled that Inah transaction is permissible, taking into consideration the opinion
of Imam Shafie. This ruling, maybe, has resulted by the needs of liquidity in the industry and to
ensure the competitiveness of Islamic finance compared to conventional finance. In doing so, the
SAC of Bank Negara should take precautionary measures in ensuring the implementation of Inah
transaction is compliant with Shariah as well as will prosper the economy of the country. In
addition, we have taken one of the ijtihad of prominent Muslim jurist- Imam Shafie. If the ijtihad
(opinion) is right, we will get two rewards- rewards of doing ijtihad and reward of doing right
thing. On the other hand, if the ijtihad is wrong in the knowledge of Allah, we will be rewarded
with one one reward- the reward of making ijtihad. One thing for sure, there is no wrong ijtihad
in Islam. It is upon our judgement to decide whether to apply Bay Inah or not. If we have other
choice which Muslim scholars can mutually agree on it, it is a better choice. Either Bay Inah is
the back door to riba or not, it is we who decide it through our actions and perceptions.
Remember, one third of the religion concerning the intention.

9.0 Case Study: Establishing Shariah Compliant Micro Financing Model
Muhammad Yunus is a well known person who had established Grameen Bank.
The origin of Grameen Bank can be traced back to 1976 when Professor Muhammad
Yunus, Head of the Rural Economics Program at the University of Chittagong, launched
an action research project to examine the possibility of designing a credit delivery system

Page 26

to provide banking services targeted at the rural poor. The Grameen Bank Project
(Grameen means "rural" or "village" in Bangla language) came into operation with the
objective of eliminating poverty in Bangladesh.
Initially, after some study, he found 42 poor people in Jobra Village. They only
need the total amount of USD 27 to come out from poverty. He astonished. A poor family
just needs 50 cents to get out from poverty. Poverty arises because of this 50 cents? He
asked himself. Starting from that day, he started giving micro credit to the poor people.
As 2004, his Micro-credit model has helped more than 40 million people throughout the
world.
The model introduced by Muhammad Yunus and later followed by many
countries and associations throughout the world are using interest-based loans. How to
make them Shariah compliant?
There are few ways to offer Shariah compliant Micro financing products to the
poor. As elevating poverty is a concern in Islam, we need to design Shariah compliant
Micro financing so the poor have the chance to get out from poverty without engaging in
riba.
First, for income generating purposes, we may offer Micro financing using
Musyarakah or Mudharabah model. In helping the poor, the profit sharing ratio can be
arranged to benefit the poor people more. Second, for non-income generating purposes,
such as for settling debt or buying food, we may offer Micro financing products using
Bay Inah or Tawaruk models. Third, we may finance their small production of plants
and crops behind their house through Salam contract. In addition, Istisna contract can be
used to facilitate Micro financing of building a slightly better house for their family as
shelter is considered as a basic need in Islam. Remember, they just need small amount of
financing, ranging from few dollars to few hundred dollars only. They do not need
thousands or millions of dollars, but this what the big commercial banks cannot give.

10.0 Conclusion
Conclusively, Shariah compliant sale is totally different with riba based transaction. The
differences have been outlined in this paper. The most important thing is that, as a Muslim, how
we solve the problem of riba and educate other Muslim to left riba based transactions and resort

Page 27

to Shariah compliant sales. It also important to note that the activists of Shariah compliant sales
must provide enough solutions for the people to choose Shariah compliant sales. If one people
get out of riba and conducting Shariah compliant sale due to our effort of developing this
industry, we, insyaAllah, will get rewards from Allah as we completing the purpose of Islam
which to bring out people from Zulumat (darkness, i.e. riba) to the Nur (light, i.e. Shariah
approved sales). Wallahu alam.

References


Page 28

Abdullah, Nurdianawati Irwani;Asyraf Wajdi Dasuki. (2009). A Critical Appraisal of Al-Ijarah
Thumma al-Bay (AITAB) operation: Issues and Prospects. 4th International Islamic Banking
and Finance Conference (pp. 5-6). Kuala Lumpur: Monash University of Malaysia.

Al-Zuhayli, W. (2001). Financial Transactions in Islamic Jurisprudence. Damascus: Dar Al-
Fikr.

Ayub, M. (2007). Understading Islamic Finance. West Sussex, England: John Wiley & Sons
Ltd.

Bank Negara Malaysia. (2007). Shariah Resolution in Islamic Finance. Kuala Lumpur,
Malaysia: Bank Negara Malaysia.

Glyn Davies and Roy Davies. (1998). A comparative chronology of money; Part 1: From the
origins of agriculture to the industrial revolution. Journal of Management History, Volume 4,
Issue 3 , 162-168.

Qutb, S. (2000). Tafsir Fi Zilalil Quran- Terjemahan Bahasa Melayu. Kuala Lumpur: Pustaka
Aman Press Sdn. Bhd.

Rosly, S. A. (2008). Critical Issues on Islamic Banking and Financial Markets. Kuala Lumpur:
Dinamas Publishing.

Usmani, M. T. (2007). An Introduction to Islamic Finance. Karachi: Maktaba Ma'ariful Quran.

Yunus, H. M. (1957). Tafsir Quran Karim. Jakarta: P.T Hidakarya Agung.

Yunus, M. (1999). Banker to the poor : micro-lending and the battle against world poverty. New
York: PublicAffairs.

Zamil Iqbal and Abbas Mirakhor. (2007). An Introduction to Islamic Finance: Theory and
Practical. Singapore: John Wiley & Sons (Asia) Pte Ltd.

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