If you’ve been on the lookout for personal financing products, you may have noticed that they fall under two categories: Shariah-compliant and conventional financing.
For those unfamiliar with Shariah financing, it may seem like a niche offering. However, it has grown rapidly in Malaysia over the past few years. In 2019, it accounted for 34.1% of total financing in the country – a marked increase from 14.9% in 2008.
Malaysia has even been recognised as the most developed Islamic finance market in the world, and has also been ranked first on an index that measured the state of Islamic finance leadership internationally.
What is Shariah-compliant personal financing?
Despite its growing popularity, it’s not always obvious to Malaysians what Shariah-compliant personal financing is, or even whether non-Muslims can apply for it (yes, they can!).
Shariah-compliant personal financing is simply a form of providing funds to consumers that adheres to Islamic law (or Shariah).
Islamic law prohibits business transactions that involve interest, uncertainty and gambling. These prohibitions are meant to uphold justice, fairness and transparency. In line with Shariah principles of ethics and social responsibility, Islam also prohibits industries that are considered harmful, such as tobacco and alcohol.
What terms do you need to know?
Conventional banking jargon can be confusing. Shariah-compliant personal financing, with its Arabic terms, can be even more so. But don’t worry – here are the definitions for some of the common Shariah financing terms you’ll come across.
1. Riba
Riba literally means “to increase”. It refers to any transaction in which interest is involved.
Unlike conventional loans, Shariah financing prohibits riba. Riba is haram (unlawful) because it’s considered exploitative; lenders get to increase their wealth without any effort, while borrowers carry the risk.
2. Murabaha (or Murabahah)
At this point, you may be wondering: if Islamic financing products do not charge interest, how do they make a profit?
Here’s where murabaha comes in. This is Islamic finance’s counterpart to a conventional loan, except that it doesn’t actually involve loaned money or any chargeable interest. In a murabaha, the bank (or financial institution) purchases an asset for a customer. Then, the bank sells this asset to the customer at a profit that must be agreed upon upfront by both parties. The customer would typically repay the bank in instalments.
In Malaysia, profit rates are based on the Base Financing Rate (BFR), which in turn is influenced by the Overnight Policy Rate (OPR) set by Bank Negara Malaysia.
3. Tawarruq
A tawarruq is also known as a reverse murabaha or commodity murabaha. It is similar to a murabaha, except that it’s taken a step further.
There are two main stages in a tawarruq. The first stage is the murabaha, in which the bank buys an asset for the customer and sells it back to the customer at a profit. This asset cannot be something that exists as a medium of exchange, such as gold or silver. The second stage is when the customer sells the asset to a third party to obtain cash (this transaction is done via the bank). Then, the customer repays the bank in installments.
In a tawarruq contract, the customer isn’t interested in using the asset itself – it’s just a means of obtaining the cash.
Therefore, Saiful enters into a tawarruq contract with Bank C. The bank purchases RM20,000 worth of crude palm oil, and sells it to Saiful at RM25,000. Saiful then resells the crude palm oil to a third party (through the bank; Saiful doesn’t personally conduct the transaction) for RM25,000. Now, Saiful has the cash he needs to refinance his debts. He would then need to repay the bank for the purchase through monthly installments.
How is Shariah-compliant personal financing different from conventional financing?
On the surface, Shariah-compliant personal financing is similar to its conventional counterpart. But as Shariah financing prohibits riba, it differs in these two aspects:
| Shariah-compliant personal financing | Conventional personal financing | |
|---|---|---|
| Ceiling rate | Profit rates can be fixed rates or floating rates. Floating rates can be adjusted according to changes in the OPR, but cannot exceed a pre-determined ceiling rate. | Interest rates can be fixed rates or floating rates. Floating rates can be adjusted according to changes in the OPR, but may not have a ceiling rate. If market rates rise, you may incur higher installments. |
| Late repayments | The penalty for late repayments cannot be more than 1% per annum, and cannot be compounded. | As the late repayment penalty can be compounded, you may incur higher charges. |
The prohibition of riba can be advantageous to consumers, as it can mean lower interest or late penalty charges.
Shariah-compliant personal financing is for everyone
Shariah-compliant personal financing is not only for Muslims, it’s for anyone looking for a form of financing that places emphasis on fairness, transparency and social responsibility.
This means tangible benefits for you: the emphasis on transparency and prohibition of riba means that there are no hidden compound interest charges.
Of course, as with any financial commitment, you’ll still need to make an informed decision before taking out any funding.
