July 10, 2019
By Dr Hanudin Amin
Tawarruq personal financing provides equilibrium for a surplus bank customer to assist a deficit bank customer in an Islamic way.
The former deposits a sum of financial resources to the bank for emergencies (i.e. tawarruq savings account) or even for short-term investments (i.e tawarruq fixed account), and later the bank finances a customer’s financial need by approving a certain sum of money that the customer requests and such a facility is defined as financial assistance.
The latter uses the money for his basic need consumptions, marriage, umrah, house renovation and medical expenses, inter alia. The uses of the funds obtained should be halal.
Three questions are offered:
Question #1: What is the modus operandi of tawarruq personal financing?
Question #2: Does compounding interest occur in tawarruq personal financing?
Question #3: What are issues associated with tawarruq personal financing? Likewise, a tawarruq contract is widely employed in Islamic financing products ranging from a short of tawarruq personal financing to a long of tawarruq home financing.
Tawarruq has some interesting features. I uncover a few here:
- PURPOSES – Personal consumptions within an Islamic parameter and mainly for basic needs;
- PRICING – An individual can opt whether a fixed or a floating rate. Both are determined by Base Rate;
- COLLATERAL FREE – There is no requirement for collateral and guarantors. Bank relies on 5Cs to approve the financing application. 5Cs include Character, Capacity, Capital, Collateral and Condition; and
- SHARIAH COMPLIANCE – The transaction considers a commodity to meet Shariah
This facility works based on these stages:
- APPLICATION – The customer submits an application and completes the form and the necessary documents. The customer signs the agreement Offer to Purchase (OTP) to buy a commodity which is sold to him without knowing clearly the quantity and type of commodity. The completed form is considered ijab to complete the rukun sighah in a sale transaction. This takes a minimum of 3 days and a maximum of 14 days;
- COMMODITY – The bank will buy the commodity in bundle from the Broker A in the international market to meet the financing application which includes murabahah transaction in the bank branches. This includes personal financing product, business financing etc. The bank is only obliged to own the commodity for a maximum of 2 hours;
- MARK-UP – Then, the bank immediately sells the commodity to the customer on a murabahah basis (mark-up);
- SALE AGENT – The customer, in turn, appoints the bank as an agent through the appointment of a bank as sale agent (ABSA) to sell back the commodity to Broker B. The appointment is vital as the bank has the expertise to find a new commodity buyer. The appointment is done at the first stage to facilitate customers from not approaching the bank frequently;
- PURCHASE COST – The bank as a representative of the customer will sell the commodity to Broker B at the purchase cost. The transactions involving stage 3 to stage 5 should be done in a maximum of 2 hours;
- FINANCING AMOUNT – The proceeds (i.e. equal to the amount applied for personal financing) from the Broker B will be credited to the customer’s account after the customer signs the acceptance of purchase (AOP) which is viewed qabul. This process is done within a minimum of 24 hours and a maximum of 3 days. At this stage, the customer will identify the selling price of the commodity he bought from the bank; and
- MONTHLY REPAYMENT – The customer pays the selling price on monthly instalment until the maturity.
These stages are monitored by the bank gingerly to meet Shariah compliance.
Pertaining to the second issue, tawarruq personal financing has no element of compounding interest. In a conventional personal loan, riba al-jahiliyyah is widely found out of penalty or extra payment once a debtor is unable to service the loan on time. In our context, however, accumulated ta’widh is allowed out of compensation subject at 1%.
For instance, Imran has two months of unpaid monthly instalments from a whole of January to the whole of February. 2018. Assume the monthly instalment is RM1,000. The ta’widh paid is RM1,000*1%*31/365 = RM 0.85 for the whole of January. Imran is also unable to pay the instalment for a whole of February. Hence, the ta’widh is RM2,000*1%*28/365 = RM 1.53. If he decides to settle the amount on 1st March 2018, the total ta’widh to be paid is RM2.38, computed as RM0.85+RM1.53. No compounding interest exists. The actual sum to be paid on 1st March 2018 is RM2,002.38, calculated as RM2,000 + RM2.38.
Compounding interest, however, only takes in a personal loan. To illustrate, we assume the debtor is John. Assume his monthly instalment is RM1,000. He did not pay the monthly instalment from a whole of January to a whole of February 2018. The penalty rate is assumed at 8%. In January 2018, the amount of penalty paid is, p*r*t, in which p is monthly instalment, r is penalty rate and t is a number of days late. RM1,000*8%*31/365 = RM 6.79. In February, he is still unable to repay the full instalment. Thus, the amount of penalty is RM2,006.79*8%*28/365= RM12.32. If he settles the instalments 1st March 2018, John needs to cash out a total sum of RM2, 019.11, calculated as RM2, 000 + RM6.79 + RM12.32.
Pertaining to the third issue, the following issues expounded but are not confined to:
CONDITIONALITY – Tawarruq personal financing is found to be similar like his sister, bay al -inah. In the latter case, the issue is serious when the second contract does not follow, which is the buyback from the bank. It begins when the bank sells the asset to the customer, in which the customer will pay the monthly instalment on deferred payment basis and the bank will hand over the asset. Later, the bank buys back from the customer. If the customer refuses to sell it, does bay al-inah occur? Does it also occur in tawarruq personal financing?
AGENCY PROBLEM – In general, the bank serves two roles in the tawarruq masrafi (organised tawarruq). The bank serves two functions, firstly, as the customer’s purchasing agent, and secondly the customer’s selling agent. The problem here is the authenticity of these roles, whether it is in existence in reality or just a theory.
DELIVERABILITY – To be Islamic, the transacting commodity must be made available and accessible among the transacting parties to ensure deliverability can take place. If the availability and accessibility are not met, the financing product is invalid. The full ownership should take place before the seller can sell the commodity to the buyer.
To address, there are two possible suggestions that can strengthen the competitiveness and receptiveness of this facility. Firstly, if bankers are well-trained, the Shariah compliance can become a culture if all are in tandem. This requires a mentor-mentee programme, where close supervision by a proficient banker is brought into play to guide young bankers for a quality task.
Secondly, an exemplary example of best practices for tawarruq personal financing should be offered in book and brochure formats, both are accessible online and offline to allow inexperienced customers to turn their query into actual demand. These formats can improve customers’ confidence and words of mouth.
Taken as a set, a tawarruq contract has made a personal financing product being competitive and distinctive in the Malaysian Islamic banking industry, not only benefiting the bank’s profit segmentation but also fulfiling the customer’s short term financing need, at least.
*Dr Hanudin Amin is an associate professor in Labuan Faculty of International Finance, Universiti Malaysia Sabah, Labuan International Campus. He has a PhD from the International Islamic University Malaysia (IIUM) in Islamic Banking and Finance (PG310163). He can be contacted at firstname.lastname@example.org