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Conventional or Islamic loan financing?
02/06/2006 The Sun - Law & Realty By Kalathevy Sivagnanam

TODAY, most banks and financial institutions offer to a purchaser of property, a choice of either a conventional loan or Islamic financing. When asked about the difference between these two types of financing, the general answer is that both are the same, except in a conventional loan, the purchaser will pay interest, and in Islamic financing, the purchaser will pay a profit.

A common home Islamic financing facility is offered under the Shariah principle of Al-Bai Baithaman Ajil (BBA). In BBA financing, a bank's customer buys a property from the vendor under an agreement of sale. The bank then, at the request of the customer and with the consent of the vendor, steps in to become a party to the sale agreement by executing a novation agreement between them, making the bank now the purchaser of the property. The bank's purchase price is described as the loan facility amount.

At the same time, between the bank and the purchaser, the bank sells the property to the customer at a selling price which comprises the bank's purchase price and a predetermined profit margin. The agreement is usually called the property sale agreement. Since Islamic financing entails a predetermined profit to be made by the bank, a customer will never have to worry about a sudden hike or changes in the interest rates. Right from the onset, he will know the total amount which he has to pay to the bank. His monthly instalment of the bank's selling price will not change throughout the tenure of the financing.

In a conventional loan, the customer will repay to the bank the loan amount, together with interest at the prescribed rate. The prescribed rate is based on a margin above the bank's base lending rate (BLR), and both the margin and the BLR are variable from time to time. In a case of late payment or default, the bank is entitled to charge compound interests. Interest payable may also be capitalised and the capitalised amount will be subject to further interests.

The contrast in obligations and liabilities of a bank's customer under a conventional loan and under Islamic financing, did not really manifest itself until the recent case of Zulkifli Bin Abdullah v. Affin Bank Berhad, a decision of the Kuala Lumpur High Court in December 2005.

Zulkifli bought a house from a vendor and applied for BBA financing from his employer, Affin Bank. The bank paid the balance sum due to the vendor (the facility amount) and Zulkifli was required to repay to the Bank the facility amount over a period of 18 years by a fixed monthly amount. The total payment of RM466,847.28, is the bank's selling price to Zulkifli. Zulkifli's facility was restructured because he had defaulted in his repayment and also because he had left his employment with the Bank. The restructuring involved a revision of the bank's purchase price, the bank's selling price, the tenure of the facility and the monthly instalments payable. Zulkifli agreed with all the terms of restructuring, and hence agreed to pay to the bank the revised selling price of RM992,363-40, over 25 years. After making some payments, Zulkifli defaulted, and the bank commenced an action to sell the property by way of public auction. The Bank claimed that the balance due from Zulkifli was RM958,909-21, being the difference between the revised selling price and the amount he had paid.

The Learned Judge did not agree with the bank's calculation of the amount due and held that the bank is not entitled to claim for profit margin for the full tenure of the facility over 25 years. His reasonings are summarised as follows:

• Under a conventional loan, the amount due by a borrower over and above the loan amount (i.e. interest and late payment interest), is limited to the period from release of the loan until the loan amount is fully settled, and not for the full original tenure of the loan where no interest is applied on the unexpired tenure. However, in this case, the bank is seeking to claim the profit on the unexpired tenure of 25 years.

• The bank's selling price in BBA financing, is not a sale price paid in a single payment, but is a series of equal monthly instalments. The profit margin is calculated with the profit rate applied to the full tenure.

• If the customer is not given the full tenure to pay the selling price, then the bank is not entitled to claim for the bank's profit margin for the full tenure, as to allow the bank to do so would mean that the bank is able to a earn a profit twice upon the same sum at the same time.

• The profit margin charged on the unexpired part of the tenure is unearned profit and not actual profit, and therefore cannot be claimed under BBA.

The Court then recalculated the bank's profit margin up to the date of judgment and held that the balance due by Zulkifli was RM582,626.80 instead of RM958,909-21. The bank is however entitled to profit per day until full payment. Zulkifli therefore got away with having to pay substantially less than what he had agreed to pay to the bank for the restructured facility. The bank did not appeal against the decision.

Both the legal fraternity and the banking industry were quite alarmed and concerned over this decision. The main concern is whether payment of a daily profit instead of a fixed profit, is Shariah compliant. The Learned Judge distinguished this case from a few other High Court decisions which allowed banks to claim for the profit margin for the whole original tenure, in cases where the facility is terminated before the end of its tenure. The decision appears to contradict a basic Shariah principle, which prohibits the giving and receiving of riba (interest). In conventional loans, a bank lends you money and in return, you repay the loan with interest. Islamic financings are trade transactions where the profit is fixed right from the start which the customer has contracted from the beginning to pay. Further, if there is early settlement of the selling price, the bank is allowed to give an ibra (rebate) to the customer. But the Learned Judge held that as ibra is entirely discretionary, it is not relevant to the issue whether in the event the loan facility is terminated due to the customer’s failure to pay, the bank is entitled to the unearned profit margin of the entire unexpired period or tenure of the loan facility.

In the light of this decision which is different from other High Courts on the matter, it is important for a purchaser who requires financing to fully understand the different obligations and liabilities under a conventional loan and BBA Financing. Why Zukifli’s decision has attracted so much attention is because the view held by practitioners of BBA Financing, until now, is that a borrower has to pay what he has contracted to pay, that is, the bank’s selling price which is calculated up to the full period of the loan. As such, other High Courts may not follow the decision in Zukifli’s case.

Therefore, as a customer of the bank, you have a right to be informed of your obligations under the different forms of financing. If you are unsure, you should always check with your banks and their solicitors who are under a duty to explain the effects of such documents to you.

The writer is a member of the Conveyancing Practice Committee Bar Council Malaysia


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