One of the cornerstones of Islamic finance is its focus on sustainability and protecting the interests of the entire community. You may be aware that Islamic finance prohibits riba or interest, and it’s principally against any arrangement that deals with the exchange of money for a larger amount of money paid in the future.
So, you might wonder, how does one get a personal financing without paying interest?
Read on as we take you through the fundamentals and 5 key advantages of Shariah-based Islamic personal financing in Malaysia.
1) Stability from asset-backed transactions
Islamic finance benefits from the stability of asset-backed financing. Banks provide funds based on trade that involves actual goods and services and the underlying assets in transactions must be tangible and in line with Islamic principles.
Islamic banks in Malaysia offer personal financing using the Murabahah Tawaruq Shariah concept. This arrangement consists of two Sale and Purchase contracts. The first contract is between the bank and the customer. The bank sells a specific commodity to the customer at a profit.
The second contract is between the customer and a third party. The customer then sells the commodity on a cash basis to a third party. The customer pays the bank in instalments at a later date. The entire process enables the customer to get cash or liquidity and more significantly, they do not have to pay any interest on it.
2) A wide range of products
Malaysia has a stellar 30-year track record in the Islamic banking and financial industry. The country contributes US$125 billion worth of Islamic assets, and the amount is expected to grow to US$390 billion by 2018.
Malaysia also has the world’s most structured and advanced Shariah Governance Framework (SGF). Its robust governance environment offers products that adhere to the highest Shariah standards. This is integral to Islamic finance as it propels towards a comprehensive and wholesome development of the sector.
The country has also become one of the leading innovators of Islamic financial products. As such, retail banking customers have many choices where they may choose suitable Shariah-based facilities to meet their personal financing needs.
Islamic banks offer Personal Financing-i facilities to a wide range of customers. Their minimum age could be as young as 18 years with the minimum income as low as RM1,500. The financing amount ranges from RM5,000 to RM250,000.
And that’s not all! Many Islamic banks offer unsecured personal financing products too. These products do not require a guarantor or a collateral.
3) No compounding interest for late payments
Islamic finance does not allow compounding interest charge on late payment as it firmly believes the penalty for default should not be oppressive to customers. That said, Islamic banks still need to prevent the public from taking advantage of the rules. Hence, institutions charge a much lower rate to manage losses incurred from defaults. This ensures the sustainability of the Islamic banking system in the long run.
Islamic banks in Malaysia use the mechanisms of ta’widh and gharamah to charge for late payments. Ta’widh refers to a fine agreed by both the parties. Banks claim this compensation when customers fail to pay or delay their debt repayments. The customers bear the losses due to the late payment. Ta’widh is permissible and recognised as income and the banks impose the charge based on the actual loss incurred.
Bank Negara Malaysia (BNM) has fixed the annual rate of ta’widh at 1% of the outstanding principal balance. The customer’s liability does not exceed this percentage.
On the other hand, gharamah refers to the additional penalty/charge that banks impose. Customers who delay in financing settlement have to pay gharamah, and this is over and above the amount of ta’widh.
The BNM has also set the rate of charge and it is non-compounding. Customers pay the penalty based on the outstanding principal balance. Banks do not recognise gharamah as income. Instead, they channel the amount to specified charitable bodies determined appropriate by the Shariah Committee of Islamic banks.
4) Complete clarity with fixed repayment amount
Islamic banks calculate and fix the monthly payment amount at the beginning of the term. Customers have complete clarity as they’re already aware of their exact dues for the entire period in advance. They pay this fixed amount of instalment payment throughout their financing tenure. Plus there is no surprise cost to customers at a later stage of financing.
The tenure for personal financing products usually ranges from two to ten years.
Islamic banks also pay ibra (rebate) for early financing repayment. Customers who settle their personal financing dues before maturity enjoy this incentive. Islamic banks are in a position to give the rebate by reducing the profit component of the monthly instalments. Most Islamic banks also do not impose any early settlement fee.
5) Highest standards of ethical banking
Islamic finance focuses on the concepts of human well-being and achieving a good life. It stresses on striking a balance between the material and spiritual needs of people. The system, thus, emphasises on community values and a fair distribution of wealth.
Islam forbids exploitation and injustice to customers. Financial and business transactions must be transparent and accurate. As a result, Islamic banks disclose all necessary information at the outset so that there is no scope of banks taking advantage over customers.
Islam banking also prohibits uncertainty, risk or speculation (gharrar). This protects customers against unexpected losses and also prevents possible disagreements over incomplete information.
In short, Islamic finance focuses on stability, transparency and justice and customers are well protected in the system.
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