Modern Islamic finance: The Contract (‘Aqad) Approach
The nature of Islamic finance today is largely fashioned by Islamic finance jurists who hold the authority in determining the Shariah value of financial products. Shariah status is given by virtue of contract validation according to which a financial instrument that uses a contract deemed valid by Islamic finance jurists shall receive Shariah legitimacy.
Since the Holy Quran has condemned interest and enjoins profit creation via trading (bay’), the Islamic finance jurists have resorted to apply the explicit meaning of al-bay i.e trading in determining Shariah legitimacy of financial instruments. By trading, they usually make reference to sale of goods and services. For example, a contract of sale consists of the followings pillars:
1) Buyer and seller
2) Object of sale
4) Offer and acceptance
A valid contract must ensure that each of the above pillars does not contain the following prohibitions:
1) Interest as riba
2) Ambiguities (gharar)
3) Gambling (maisir)
4) Prohibited commodities such as liquor, pork etc.
As an example, both buyer and seller must be rational. Object of sale is a permissible property (mal-mutaqawim). The seller must also hold ownership (milkiyah) before making the sale. Price must be determined on the spot. The offer and acceptance is made explicit by way of written document or verbal statement. These requirements must be strictly observed to avoid ambiguities (gharar) in the contract. Some sale contract become invalid (bathil) if it is inclined to gambling such as selling fish in the water or determining price using stones or arrow. As long as the contracting parties have fully observed the legal requirement concerning their transaction, the contract of sale is deemed valid (sahih).
The contract approach therefore looks at the explicit or external (zahir) property of contracts. It does not give qualification to the role of intention (niyyah) of the contracting parties. In doing so, the Contract Approach has given birth to a number of products where profits are created by virtue of time value. It opens Islamic banking to a variety of credit sales and credit-based transactions. These are:
a) Al-murabahah (sale with lumpsum deferred payment)
b) Al-bai-bithaman Ajil (BBA) (sale with installment payment)
c) Bay’ al-‘inah (sale-buyback with installment payment)
d) Tawaruq (installment sale + cash sale)
e) Bay’ al-dayn (sale of debt at discount)
f) Ijarah Thumma Al-bay AITAB (interest-free financial leasing)
In 2004, BBA and murabahah constitute 49.9 percent and 7 percent of total Islamic bank financing respectively while AITAB accounting for 24 per cent.
Table 1 Islamic Banking System 2004 Malaysia
Bai bithaman ajil 49.9
Ijara Thumma Al-bay 24.0
Source: Bank Negara Malaysia 2004
In other words, total credit financing has accounted for 80.9% of total Islamic financing. This essay concludes that the Contract Approach has led Islamic banking into offering credit-based products (CBP) as a means to generate profit. The implications are examined in the next essay.