1. Discuss & give comments on operational issues of BBA Home-financing (20 marks)

BBA is known to be a sale of an object against an obligation to provide payment on a given future date. It is a contract of exchange, whereby the commodity exchanged is delivered immediately and the price is paid by installments. It is the most picked and common type of Islamic financing as only few people can afford to buy a house, land, consumer goods and others on cash terms. However, the BBA financing is widely used for housing purchases especially for those which are still under construction (Hanafi and Kasim, 2009).Although house and commercial property financing are common examples, cars, machinery, or any other assets can be financed using this concept. BBA or bai-mu’ajjal simply implies deferment of payment of price irrespective of whether the cost and mark-up are known to parties or not (Obaidullah, 2006). More often it includes features of a murabaha, which implies a sale on a cost-plus basis. In addition, Bai bithaman ajil (BBA) is a Shariah approved mechanism (Obaidullah, 2006).

The issues with BBA financing method is that, the seller of the property would be the Bank. The Shariah requires the bank to hold ownership of the property and to hold all liabilities arising, including defects. However, as learnt the current BBA documentations show that the bank merely acts as a financier rather than a seller and excludes itself of all liabilities. This, of course, ignores the Shariah principle of “al-Ghorm bil Ghonm” (no reward without risk), “Ikhtiar” (value-addition or effort) and “al-Kharaj bil Daman” (any benefit must be accompanied with liability), thereby this would cause the rendering of BBA profit to be caught up with riba (Meera and Razak, 2009).

Another issue of concern here is the availability of iwad (counter value) in BBA financing. As confirm by Rosly (2005), the Quran uses trade (al-bay) because the profit generated from trading incorporates risk-taking, while the contractual profit from loan transactions (riba) is risk-free. It further asserts that al-bay implies the existence of iwad required by the Shariah to be a lawful profit in Islam. Three elements of iwad that should exist are risk (ghorm), work and effort (ikhtiar) and liability (daman). Iwad is the basic trait or the conditio sine quo non of a halal or lawful sale (al-bay), because a sale is necessarily an exchange of value against an equitable return and compensation for the goods or services exchanged. According to Ibn al-‘Arabi, every increase which is without an iwad or equal counter value, is riba Meera and Razak, 2009).

Rosly (2005) also stated that there is also an issue of no risk involvement in the current BBA financing. Hence, it does not contribute to the concept of al-bay in the Quran. In trading transaction, liability (Daman) should also be taken into account whereby the supplier provides guarantees on the goods sold. However in the current BBA home financing, the customer is forced to face the financial burden of paying for the house even before it is completed, as he has engaged in a ‘debt contract’ with the bank upfront. The BBA contract is not seen as conforming to the maqasid al-Shari’ah that removes hardship (raf’ al-haraj) and preventing harm (daf’ al-darar) in the economic sphere by ignoring the concept of iwad. It leaves the welfare of people unprotected. This is a possible crime when the transaction is done under an Islamic label (Meera and Razak, 2009).

In addition, another issue that arises from the long-term BBA financing is the mismatching of BBA funds against its short-term deposit tenor. Whilst conventional financing has the ability to address this mismatch in the cost of funds through the variable interest rate (BLR + a spread), BBA financing cannot do this since customers are charged a fixed profit rate for the entire period of financing (Meera and Razak, 2009). As an example, assume that a customer wishes to buy a houses priced at RM200, 000. The customer puts a down-payment of 10 percent, which is RM20, 000 and finances the remaining 80 percent, i.e. RM180, 000 using the BBA method. Also

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assume that the Annual Profit Rate (APR) charged by the bank is 10 percent per annum and the duration of financing is for 20 years. The Islamic bank would first buy the house for RM180, 000 and then sell the house to the customer at a profit, with deferred payments over the 20-year period (Meera and Razak, 2009).

Another example, let’s say the monthly payment for the above financing is RM1, 737.04, payable for 240 months which adds up to RM416, 889.35 in total. The difference between this figure and the original financing of RM180, 000 which equals RM236, 889.35 is the total profit for the Islamic bank from this transaction. The profit of RM236, 889.35 is capitalized upfront in the BBA mode, unlike under the conventional mortgage, where the interest due is not recognized until the elapse of time. One important difference of the BBA compared with the MMP and the conventional mortgage is that of the balance of financing remaining before the expiry of the duration of financing. For our example, the BBA balance after 10 years (i.e. after 120 payments) is the total of the remaining 120 payments, i.e. RM208, 444.80 whereas under conventional mortgage, this amount would represent the total interest paid for the loan over the 20-year period. The Islamic bank, however, may give some rebate for the early repayment, but the amount of rebate is determined at the discretion of the bank. Since the selling price is a price, indeed, Shari’ah prohibits the rebate to be stated as part of the contract. Even after ten years of repayment, the balance under the BBA mode can even exceed the original financing of RM180, 000. It is regretful to say that Islamic banking within the fractional reserve system can indeed be very damaging to the economy (Meera and Razak, 2009).

In the recent legal rulings in Malaysia regarding the validity of BBA is a wake-up call for the development of Islamic financial products. Initially, the High Court of Malaysia ruled out that the ten contracts of Bank Islam Malaysia Berhad were found to be structurally faulty. The Court added that the defaulters are not liable to pay more than the original financing amount. Thus, these deprive Bank Islam’s profit arising from the transaction. Following the appeal filed by Bank Islam, the Court of Appeal held that the BBA facility offered by Islamic financial institutions is valid and legally binding. The decision reaffirmed that Bank Islam’s practices in relation to BBA contracts are Shariah-compliant and valid (Musa and Smolo, 2009).

In conclusion, BBA is of a questionable in terms of its validity because of the modus operandi implemented in Malaysian Islamic banks. The extensive use of BBA contracts and overdependence of Islamic banks on it will result in convergence of Islamic bank into conventional, interest-based banks (Musa and Smolo, 2009). All along this paper has discussed some problems in BBA application. The way forward is to amend some of the existing law and regulations. For instance, the Land code Act and Legal probation governing sale contracts. This amendment can facilitate a smooth application of BBA financing which will be suitable to the customer as well as compliant with Shariah requirement.

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2. Comparisons between housing Loan, BBA and MMP (20 marks)In this context, we would discuss about the comparisons between housing loan, BBA and

MMP. The areas that we would focus on are the context of sale, compliance, and utility for each respective type of financing. And we shall finalize by analyzing which mode of financing is more acceptable form of financing in Islamic Finance field.

According to Meera and Razak (2009), home is a basic necessity for human life. Owning a good home is an aspiration and a dream of everyone. People are able to fulfill this need by building a home on their own, purchasing it or renting it from others. Indeed, payment for home mortgage normally takes a good chunk of one’s monthly income. A lot of people in this day and age find it more practical to rent a house rather than buying one. With the rising cost of living in this part of the world, it is easy to see where they are coming from. Renting does seem to be the more practical option, instead of laying out a huge sum of money to buy a home. And since mobility is sometimes demanded by one’s career, renting a home becomes an even more lucrative option (Meera and Razak, 2009).

Home mortgage loans are quickly gaining prominence as the option of choice for many families. A home mortgage loan is, in its essence, a loan for the purchase of a house. The loan taker will have to pay the down payment, but the lending institution who would grant the loan taker such a home mortgage loan would pay the balance of the purchase (Ezilon Infobase, 2005). Thereafter, he would have to pay the lending institution in stated installments. These installments are meted an interest rate, and it’s just a matter of looking for a loan package with a favorable interest plan for you (Ezilon Infobase, 2005). However, this conventional home mortgages are, of course, interest-based and forbidden in Islam. Accordingly, Islamic financial institutions have introduced a number of Shariah-compliant modes for home ownership, the dominant of which are the al-Bay’ Bithaman Ajil (BBA) and the Musharakah Mutanaqisah Partnership (MMP) contracts (Meera and Razak, 2009).

The housing loan taker could start using the house immediately, even while he is in the process of paying off the said home mortgage loan. A home mortgage loan is actually called a rent-to-own arrangement by some quarters; only, it passed through a middle party, namely the lending institution. Therefore, the loan takers can indeed use the house even during the pendency of the loan (Ezilon Infobase, 2005).

For the home mortgage loan security, the lending institution is expected to keep the deed of the house. This means that, as a general rule, the loan taker cannot alienate the house or assign the rights to the same to someone else. However, just because the lending institution holds the deed to the house, this doesn’t mean that we won’t be able to partake of any interests in proportion to what we have paid. With every installment we satisfy, our equity to the house increases. Equity merely pertains to the alienable rights you have over the property. Since full equity cannot be granted until full satisfaction of the debt, you could only alienate the portion of the house which we have successfully paid for (Ezilon Infobase, 2005).

As for BBA, the BBA is basically a sale contract which provides the buyer the benefit of a deferred payment, whereby the deferred price of the sale object carries an additional profit. It is an extension of the murabahah (cost plus) contract, whereby the commodity exchanged is “delivered” immediately but the sale price with profit is paid in installments. Although the BBA is widely used in Malaysia, Indonesia, Brunei and few other countries, it has been subjected to too much controversy among the fuqaha worldwide with regards to its permissibility; where most of the Middle East scholars have rejected it because it could result just like riba (Meera and Razak, 2009).

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On the other hand, the Musharakah Mutanaqisah Partnership (MMP) contract is based on a diminishing partnership concept. There are two portions to the contract. First, the customer enters into a partnership (musharakah) under the concept of ‘Shirkat-al-Milik’ (joint ownership) agreement with the bank. Customer pays, for example, 10% as the initial share to co-own the house whilst the bank provides for the balance of 90%. The customer will then gradually redeem the financier’s 90% share at an agreed portion periodically until the house is fully owned by the customer. Second, the bank leases its share (90%) in the house ownership to the customer under the concept of ijarah, i.e. by charging rent; and the customer agrees to pay the rental to the bank for using its share of the property. The periodic rental amounts will be jointly shared between the customer and the bank according to the percentage share holding at the particular times which keeps changing as the customer redeems the financier’s share. The customer’s share ratio would increase after each rental payment due to the periodic redemption until eventually fully owned by the customer (Meera and Razak, 2009).

Bendjilali and Khan (1995) and Usmani (2002) basically agreed on the implementation process of Musharakah Mutanaqisah Partnership. They have basically agreed that the product could help the people to less rely on other financing facilities such as the BBA, Murabahah or so on. It is best to implement MMP for house financing or machinery financing as agreed by scholars whereby both assets can be leased out according to agreed rental. Joint ownership of a house or machinery is accepted by all schools of Islamic jurisprudence since the financier sells its shares to the customer (Usmani, 2002). The concept of diminishing musharakah is not confined to home ownership only. It can also be applied to other forms of acquiring assets such as buying a car or a taxi for earning income by using it as a hired vehicle. Creating joint ownership in the form of Shirkah al-Milk is allowed in the Shariah (Meera and Razak, 2009).

From all the above information, it is obvious that the MMP may be more attractive to the bankers compared to the BBA contract because rarely the annual rental rate equals 10 percent which means ten years’ rental equals the original price of the house. This can be deduced from the fact that mortgages generally exceed ten years. The norm in Malaysia is about 20 to 25years. Indeed, two-generation mortgages have even been proposed (Berita Harian, 2005).

Hence, the MMP is suited to be practiced, for example, by housing cooperatives where the funds are provided by the members for the benefit of the members themselves. While providing cheaper housing for members, the MMP also provides returns to the investing members in the form of rentals and sale of properties. Indeed, observations show that globally the MMP is being successfully practiced in a cooperative setting (Meera and Razak, 2009). An additional benefit of implementing the MMP by housing cooperatives is that it avoids new money creation as in the fractional reserve banking. By avoiding money creation and operating under a profit-and-loss sharing setting, the MMP can bring about a harmonous balance between the monetary sector and the real economy and thereby is likely to contribute towards the achievement of the maqasid al-Shari’ah (Meera and Razak, 2009).

In conclusion, given these comparisons, we find that by exercising the MMP brings stability into the economy by promoting positive partnership instead of negative indebtedness thus assisting in the equitable distribution of society’s wealth by minimizing the large number of debt defaults and bankruptcies that are observed in the current financial system (Meera and Razak, 2009).

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3. The importance of deposits mobilization in Islamic Institutions

Deposits are the main source of funds for commercial banks, merchant banks, finance companies and discount houses based on the license granted by the Central Bank. Deposits can be either cash, claims or money, such as cheques which are placed in depositor’s accounts, bank loans or money from investments. Depositors are essentially the economic surplus units such as households, corporations, investors and government (Khir et al., 2008). Hence, banks could not survive and function without deposits as the funds collected are being used for lending purposes. Deposits and savings are crucial in order a country to develop and it can indirectly help to support a better living standard of people (Khir et al., 2008).

Mobilization of funds from saving-surplus units in the economy is an important task of financial intermediaries. A financial intermediary attempts to achieve this goal by creating and selling a variety of financial products that match the needs of the saving-surplus unit. A Muslim saver is in some ways different. While needs related to returns, liquidity, maturity, safety, stability and the like are important to him or her, the Muslim saver has a unique concern, which is the Shariah-compliance matter. Islamic deposit products allow no trade-off in the matter of Shariah-compliance. Islamic banks are engaged in mobilizing savings from this unique group of savers by offering Shariah-compliant products that also vary with respect to other dimensions of return (no existence of riba element), risk, liquidity, maturity, safety, stability and this like(Khir et al., 2008).

Success stories of Islamic banks in mobilizing large amount of funds were heard back in the 1980s up to now. Hence, deposits in almost all Islamic banks were growing at a very rapid pace. Many studies testify to the highly successful deposit mobilization by Islamic banks. According to one estimate, the data relating to the period 1980-1986 showed that the growth of Islamic banks was relatively better - in most cases - than the growth of other kinds of banks. This resulted in increasing the shares of Islamic banks in total deposits. These early institutions have now matured, and have achieved a considerable degree of success in terms of market penetration. This is all the more remarkable given that the markets in which they were established already had well developed commercial banks. Indeed, some markets, especially in the Gulf, were viewed as over-banked (Egyptian Banking Institute, 2009).

We can understand from deposit in an IFI concept that the depositor provides capital to an Islamic bank to run banking operations. For the deposit mobilization, the depositor is entitled to a share of the profits agreed by the depositor and the bank. The share can be a third or a half of the profits depending on prior agreement between the depositor and the bank. This agreement is set at the beginning of the contract. However, if the bank does not guarantee the depositor that the business must be profitable although the bank will conduct the investment on best efforts basis to ensure it is profitable. Nevertheless, in the event of a business failure, the depositor will bear the losses (Idris, 2009).

Deposits are the main source of funding which is used to derive income. It is the cheapest mode of funding compared to other financial components. Islamic financial institutions sources of funds as well as the types of financing proposed by IFI’s have evolved over time. In addition, the sources of funds can be classified into current accounts, savings accounts and investment accounts (Khir et al., 2008). Plus, the deposit products in IFI’s are strictly govern by Shariah principles. For either operating conventional banking or Islamic banking, deposits are its main source of funding for which it uses to produce income. Study has shown that deposits contribute 75 percent of a bank’s total fund. Customers’ deposits mainly are used by Banks to give out loans to deficit economic units or borrowers. Apart from this, banks also mobilize deposits by

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purchasing trading securities, investments and maintain some as cash in hand to meet withdrawals on demand. The larger the amount of deposits a bank receives from its customers, the better is its capacity to give out loans and the higher is the interest income (Idris, 2009). Idris (2009) also stated that due to this positive relationship between deposits, loan and interest income, banks are competing intensively and aggressively among other deposit-taking institutions to obtain higher deposits by offering attractive deposit rates or rates plus other appealing packages depositors. Islamic banks are equally aggressive in attracting additional deposits.

As for the economy, bank deposit is the main source of money supply that can be mobilized to generate economic growth and wealth creation. Banks create credits by giving out loans to borrowers and investors (Jaffee, 1989). The ability to create credit enable them to supply money to borrowers, suppliers and investors to conduct economic activities, such as opening up plants, funding their working capital requirements, financing their business expansion or increasing their investments. Such economic activities create job opportunities, increasing productivity and income, which subsequently lead to wealth creation in the economy. In addition, for interest-bearing deposits, interest rate is very important. When market interest rates rise, so would deposit rates and this would attract higher deposits to flow into the economic system (Idris, 2009).

In banking, the basic concept would be borrowing public funds and at the same time lending out to make profit. Interests are used to reward depositors while borrowers must pay interest on loans. The same applies in IFIs, however the contracts applied are not based on interest bearing debt, but it is al-bay which basically means sale (Idris, 2009). In IFIs, the reward given would be in a shape of hibah (gift) as Islamic banks cannot promise to give depositors a fixed contractual income as doing so makes them no different to conventional banks (Idris, 2009).This hibah is given out and calculated on the basis of bank performance and is based from some well designed formulas that also comply with the Shariah values (Idris, 2009).

In conclusion, the basic requirement of Islamic Finance requires money to be mobilized in productive investments. This means that there should not be idle money at any point (Idris, 2009). Whoever holds idle cash or demand deposits exceeding the nisab over a year must pay zakat. According to Rosly (2005), this is one way how Islam discourages people to hold idle cash for an indefinite time. Deposits are equally important to Islamic banks as a source of funds as in conventional banks. But unlike its counterparts, Islamic banks need to comply with Shariah principles which prohibit any payment of interest or a fixed return on deposits. To attract idle cash or deposits from the public for sustaining their financing activities and wealth creation, Islamic banks are offering deposits whose returns are based on wadiah, mudharabah or qard hasan (Idris, 2009).The mudharabah or profit-loss sharing basis of Islamic banking is conceived as more production oriented and growth promoting than its interest-based counterparts. Further, the replacement of interest with profit-loss sharing principle is also said to increase investment opportunities in the economy (Homoud, 1983). Furthermore, IFIs would do well if they practice a cheaper mode of getting the deposits from customers, for example like reducing the overhead cost of the bank to suit an effective management (Hassan, 2004). Thus, the speed at which Islamic Banking has grown and the rate at which it has progressed makes it pertinent to study it systematically so as to ensure its soundness and stability.

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4. What do you understand by Ar-Rahn? Explain (20 marks)Ar-Rahn, or mortgage or collateral, is defined in the Islamic jurisprudence as

“possessions offered as security for a debt so that the debt will be taken from it in case the debtor failed to pay back the due money”. The term “rahn” is commonly used in fiqh al-muamalah, in Islamic law (Maulidia, 2003). Basically, Ar-Rahn simply means a loan guarantee or pawning in Islamic perspectives (Maulidia, 2003).

To prove the legality of whether mortgaging in Islam is acceptable or not can be seen in the Holy Quran. In surah Al-Baqarah, it is stated that “And if you are on a journey and cannot find a scribe, then let there be a pledge taken (mortgaging); then if one of you entrust the other, let the one who is entrusted discharge his trust (faithfully), and let him be afraid of Allah, his Lord. And conceal not the evidence for he, who hides it, surely his heart is sinful. And Allah is All-Knower of what you do”, [Quran 2: 283].

There are nine conditions of Ar-rahn, as opposed by Abdelhaleem (2003) and Kharofa (2000), which are all stated below:

1. The indebted party cannot be coerced into putting up a collateral; 2. An orphan’s property cannot be put up as a collateral by the trustee, unless under

exceptional circumstances; 3. The property held as collateral must be liquid; 4. The property held as collateral must be distinct from other properties; 5. The ownership does not change, therefore the owner is responsible for the cost of

upkeeping the property even when it is pledged as a collateral. Likewise, the owner continues to enjoy any secondary benefits to the property;

6. There is disagreement among the scholars on whether the property pledged as a collateral can be used. Many of the scholars say that the property cannot be used by either the debtor or the borrower, while many argue that the owner (the borrower in this case) can continue to use the property;

7. If the property held as collateral is lost or damaged while in possession of the trustee, without any negligence on his part, there is no guarantee by the trustee;

8. The ownership of the property cannot be transferred until the debt is settled or the debtor allows for such a transaction;

9. If the borrower cannot pay back at the expiry of the term, the judge will order the property pledged as collateral to be sold in the open market, even if it is the residence of the borrower.

Despite similarities between conventional and Islamic finance industry in pawning, there are, however fundamental differences between these two. As Syafi’i Antonio said, among the differences is that in rahn, mortgagers or debtors charged with no interest but entrustment cost, conservancy cost, and custody cost, as well as appraisal cost. Here, whereas interest can accumulate, costs of rahn can be paid once and specified in advance (Maulidia, 2003). As stated by Idris (2009), conventional pawnbrokers make money through the high interest earned and the surplus gained from the ownership transfers. This concern over higher interest rates, usurious and exploitative activities imposed by the conventional pawnshop makes the customers choose to deal with the Islamic pawnshop (Razak, 2008). Islamic alternative to interest-based pawnbroking are offered in a commercial contract in Islamic Law which known as al-rahn (Idris, 2009).

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Generally, the modus operandi for conventional and Islamic pawnshop transaction is quite similar (Razak, 2008).

Furthermore, the contract (aqad) in the Islamic pawnshop is different from the conventional pawnshop. In the Islamic pawnshop, the loan granted is based on four concepts which are. al-qardhul hassan (loan without interest), al-wadiah yad dhammanah (keeping valuable goods by guarantee), al-ujrah (storage fees) and ar-rahn (collateral). On the other hand, the storage fee is based on the value of gold and not on the amount of the loan. In addition to this, the fee is charged differently by each Islamic pawnbroker (Razak, 2008).

Islamic pawn broking business in practice make money by taking form of storage fees charged on the pledged property. There is a standard formula on how these fees are determined. On failure to pay the loan after a prolonged reminder, the operator holds the right to put the collateral on auction. The rahn company will claim loan plus storage fees due to them. The surplus therein will be returned back to the rahin. In case if the rahin could not be located, the proceeds will then be forwarded to Bait-ul-mal which the rahin is entitled to make future claims (Idris, 2009).

In Kelantan, one of the states in Malaysia, the scheme of Al-rahn was set upon March 12, 1993. It is to be noted here that al- rahn in Kelantan is applicable to both Muslims and Non-Muslims customers. The main features that distinguish from the conventional pawn-broking shops are, it does not allow forfeiture of valuables. Apart from that the system also does away with interest charges and only levies certain fees for the safe-keeping of valuables (Abdullah, 2009).

According to Idris (2009), its best for people to opt for al-rahn as it can be a better choice and alternative to finance stocks purchases compared to credit cards and share-financing loans. At least the money an individual obtains via al-rahn is backed is backed by productive assets. Apparently, confirmed by Skully (2005), gold is the only permitted item in the Islamic-based pawnshop. Gold have several advantages as collateral over other items. Firstly, gold is easily resold and so there is potentially auctioning the collateral should the borrower not redeem the pledge. Secondly, gold’s purity can be easily determined and so the risk of mispricing the collateral can be minimized. Thirdly, gold chains and rings typically require only a small flat envelop for storage and so can be kept securely in the bank safe at little, if any, additional cost.

In order to have a successful Islamic pawnshop practice, there is a need to strengthen the customer service part. The present study revealed that customer service is significantly associated with acceptance (amin et al., 2007). Indeed, this result offers points for local authority and businesses to consider. First and foremost, the approval for the transaction must be efficient and fast. Second, the pawnshop must offer advice service or merely consultation to facilitate the customer’s transaction. Third, the pawnshop must be free from the issue of discrimination. To be a successful system, Islamic-based pawnshop needs to treat individuals fairly regardless of their races. One thing for sure, the customer’s record must be kept confidential. The record of the customers must be kept properly and only the customers and the business know of such record made (amin et al., 2007).

In conclusion, pawn broking is collateral on loan system and known to be one of the oldest systems. The pawn broking system was fully utilized by the lower income group for fast cash following simple procedures. In addition, it can also be an economic tool to improve the socio-economic development of the lower and middle income society, and it is truly in line with the co-operative principle. Therefore, the right choice of doing it is all in our hands.

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5. Describe the practices of Islamic trades finance in Malaysia (20 marks)

In order to succeed in today’s global marketplace and win sales against foreign competitors, exporters must offer their customers attractive sales terms supported by appropriate payment methods. This is mainly because getting paid in full and on time is the ultimate goal for each export sale. Therefore, an appropriate payment method must be chosen carefully to minimize the payment risk while also accommodating the needs of the buyer. During or before contract negotiations, we should consider which method is mutually desirable for both trader and customer (ITA, 2008).

In Malaysia, there are four methods of Islamic trade finance facilities as mentioned by Idris (2009) which are available are being mentioned below:

(a) Islamic Letter of Credit(b) Trust Receipt-i(c) Islamic Accepted Bill (IAB)(d) Kafalah Shipping Guarantee

Letter of credit (LC) is a secure means of acquiring prompt payment on the sale of goods. This LC facility, exporters can obtain a quick and secure as well guaranteed payment of goods from the banks. It can be issued using either the principles of wakalah ( agency) or murabahah (mark-up) as well as Musharakah (profit/loss sharing). One example from Musharakah LC which is promoted by Bank Negara Malaysia in their list of approved products and is not necessarily practiced by IFIs alone, requires customer to inform the bank of his LC requirement and negotiates the terms of musharakah financing for the purchase /import of goods, and requests the bank to open LC. The customer will then deposit his share of the price of imported goods as his share of the cost of goods to be shared purchased/ imported under a musharakah agreement. This can be done by placing funds in deposit account such as wadiah yad dhamanah. After this, the bank opens the LC and pays the negotiating bank using the customer’s deposit and bank’s own share of financing and the bank will then releases import documents to the customer. The customer will then be able to take the possession of goods and its disposes. Finally, both bank and customer will share the profit as per their musharakah contract (Idris (2009).

To restrict from falling into riba transactions, AAOIFI prohibits any form of embedded interest rates in exchange rates. AAOIFI also prohibits any currency trading involving any conditions, options or deferment, or in the forward or futures market. This is supported by the firm standpoint of Umar Ibn Al-Khattab (r.a.), whom essentially denounced the time value of money as “Do not sell gold for gold or silver for silver except in equal quantities. Moreover, do not trade gold for silver with one of them deffered. Even if your trading partner asks you to wait until he can fetch the money from his house, do not except the deferment, I fear that you will fall into riba” (Idris (2009). Therefore, this is one of the resolution done by the International Fiqh Academy in order to resolve this matter (Idris (2009).

As for the trust receipt, it is actually a financing method used to finance domestic or international trade drawn against LC, specifically under the murabahah contract or Inward Bills for collection under the wakalah concept. Under the murabahah concept, the bank will appoint the customer as its agent to purchase goods what the customer requires on behalf of the bank. The bank will pay the supplier based on the invoice value and the bank will resell the goods to the customer on deferred payment terms at a price inclusive of the bank’s profit margin. The

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deferred payment terms of sale of goods granted to the customer constitutes a creation of debt. This is secured in the form of Bill of exchange drawn by the bank and accepted by the customer and payable upon maturity (Idris (2009).

On the other hand, Islamic Accepted Bill (IAB) is a mode of financing available for imports and domestic sales in the primary market. It can be divided into three parts, which consists of IAB Import/ purchase, export/ sale and the basis of bai’ al-dayn (debt) (Idris (2009). As an example, the IAB purchase and import process starts with the bank draws a bill of exchange to be accepted by the customer. The amount drawn is the full selling price payable by the customer to the bank on the maturity date of the financing. The nature of the document essentially involves the creation of an IAB as a security to finance working capital in the form of a cash purchase of raw materials at cost which is sold back to the customer inclusive of a profit margin (murabahah), with the customer acting as an agent to the bank. The bank will then appoint the customer as its agent and it is called wakalah. The process of this would actually start by the customer purchasing merchandise at cost on behalf of the bank as per letter of credit or invoice. Then the bank will sell or deliver the merchandise at the murabahah credit price to the importer or purchaser when the goods are received. And this credit price should not exceed 200 days. To securitize the credit inherent in the murabahah letter of credit, the bank will draw a bill on the customer who will then accepts the bill at full amount of the mark-up price. If the bank wishes to sell the bill to a third party, it may do so at a discounted price (Idris (2009).

Kafalah Shipping guarantee is a guarantee which is required by an importer when the bill of lading is required to take delivery of the goods is yet to be available. Under this contract, a third party becomes a guarantor for the payment of debt. It is a pledge given to the reditor that the debtor will pay the debt (Khir et al, 2008).It is a letter of indemnity issued by a bank on behalf of the buyer/importer. It is signed by the buyer or importer and countersigned by the bank and is addressed to the owner/agent of the ship for the release and delivery of the goods without the production of the Bill of Lading. The non-production of the Bill of Lading is common in shipping industries and technically the cargo should not be release until the Bill of Lading is presented. The fundamental reason for this is that if the owner delivers an expensive cargo to the wrong hands, hence the guarantee will effectively absolves him from subsequent court action. The process of this issuance of guarantee would start with the buyer applying for a Shipping Guarantee and then present it to the shipper and take the delivery of goods. The bill of lading will be forwarded by the exporter’s bank. The buyer’s bank will then reimburse the seller’s bank and presents the relevant documents to the buyer for payment. The buyer will decide whether he wants to pay in cash or to seek financing. The Shipping Guarantee will then be presented to the shipping company in exchange and the Shipping Guarantee will then be return to the bank (Idris (2009).

The above explanations and examples are just some illustrations of the method of trade financing being used in Malaysia. Most trade finance instruments being used in Malaysia are murabahah (mark-up), al-kafalah (guarantee) and al-wakalah (agency). In conclusion, Islamic finance trade finance system can be used to facilitate more sophisticated and automated trade finance facilities by following the Islamic banking framework. The key function of the system is to process the documents electronically and straight through the processing by interfacing with external payment networks. It enables the centralization of the management of trade finance operations and others (Idris (2009).

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