Introduction- Islamic Banking
Broadly, Islamic Banking is a system that follows Islamic Law (Shariah), principles and Islamic-based economics. Essentially it prohibits the collection of interest but rather instalments paid or payable to the Islamic financial institution consists of a pre-determined profit component. Further, Islamic law prohibits investing in businesses that are considered unlawful, or “haram” or contrary to Islamic values. To the consumer, whether Muslim or otherwise, Islamic Banks have much greater social and moral responsibility to ensure that their principles of financing are fair to the everyone.
A fundamental difference between Islamic financing and conventional loans is in an Islamic financing transaction, a bank essentially buys the property from the seller or you (in case of refinancing), and re-sells it to you plus profit, while allowing you to pay for the purchase in instalments. A conventional loan is given on a debtor/creditor borrower/bank relationship. “Interest”, representing the bank’s cost of funds is charged.
To the customer, the Islamic bank’s profit is calculated prior to approval of financing application based on the total principal amount, tenure and agreed profit rate. . Policies such as daily or monthly rests apply in the same manner to both Islamic and conventional financing. Similarly, monthly instalments are calculated using the standard amortisation mathematical model. A further similarity between interest and profits on the home finance is the rate for Base Lending Rate (BLR) and the Islamic Base Floating Rate (BFR) is at 6.75% at current.
In Islamic financing , profit is calculated upfront and for the whole tenure of the financing facility based on the standard amortisation table. The “sale price”, which consists of the principal and the profit is then determined. In fixed-rate Islamic financing as in most conventional fixed rate loans, the monthly instalment and tenure of the facility are determined at the onset of the finance facility and does not change throughout the tenure of the loan. In a variable rate Islamic finance, any increase in the profit rate will either lengthen the tenure of the loan or change the monthly instalment amount just like in conventional loans. A decrease in the profit rate will result in rebates to the customer or a shorter tenure similar to conventional loans. A major difference between Islamic loans and conventional loans is that there is a lot more clarity if/when BFR is revised and there are any changes to your financing terms.
Another difference between Islamic floating profits and conventional floating interest is that with the former, there is usually a
ceiling rate, ie a maximum profit an Islamic loan provider will earn. To the consumer, this is an advantage because historically, BLR has increased to as high as 12.27%.
An often overlooked benefit of Islamic finance is that unlike most conventional loans that charge “penalty interests” on late payments, an Islamic financing provider cannot and therefore does not charge “compounding penalty interest”, as it is against Islamic principles. Additionally, Islamic banks are governed more strictly on Islamic policies relating to late payment interest at 1% and hidden fees and charges.
As Islamic financing involves a sale to the financial institution and buy back from the customer, the Loan Facility Agreement in a conventional loan is replaced by a Sale And Buy-back Agreement in an Islamic financing facility. The total loan amount determined at the onset of the loan will be the buy-back price. From a legal perspective this is essentially comparable to a charge on the property by the financial institution under conventional financing. Other financing documentation is similar to conventional loans.
To the consumer, the difference between the Islamic Sale And Buy back Agreements and a conventional Loan’s Facility Agreement is that, should a customer chooses to materially alter the terms of the finance such as increase the facility amount to more than the approved limit, a new Sale And Buy-back Agreement need to be drawn up and signed whereas a conventional loan would only need to be up-stamped and hence cheaper.
A common misconception is that since the purchase price in the buy-back agreement is determined at the start of the financing facility, if a customer chooses to repay early, he must bear all profits to the Islamic bank as calculated upfront on the whole finance tenure. In practice, Islamic banks refund the access profits in the form of a rebate, therefore clearly offsetting the total calculated upfront profits. An additional benefit in Islamic finance is early repayment penalties are often lower than conventional banks. Bank Islam for example, has an early settlement penalty of only 2% for a period of 5 years.
Stamp duty discount
The stamp duty payable on an Islamic financing facility is cheaper by 20% compared to the stamp duty payable on a conventional loan. This incentive was announced in the 2007 Budget and is available from Sept 2, 2006 to Dec 31, 2009. A further Government incentive is a stamp duty waiver for the redeemed amount when refinancing from a conventional to an Islamic home finance.
In general, house owners insurance related to Islamic financing offer wider coverage than the standard fire insurance. For example, the Long Term Houseowner’s Takaful (LTHT) covers damages related to natural disasters and “acts of God”.
Islamic financing also offers other attractive features equivalent to that of conventional loans, such as stepped-up payments, no repayments during construction period and free moving cost low lock-in penalties.
An additional overlooked benefit of Bank Islam financing is that maximum debt service ratio for your total commitments is 75%.
Obtain an Islamic Financing Package Quotation
Islamic banks in Malaysia have come a long way since the Islamic Banking Act came into effect on the 7th of April 1983. In these 25 years, Islamic banks have needed to compete in the market with conventional banks. Contrary to popular belief, Islamic banks offer very competitive home financing products with very attractive features. There are currently 12 fully fledged Islamic Banks and more than 150 different Islamic home financing packages in Malaysia. Therefore, when shopping around for financing for your property, it may be worthwhile considering an Islamic financing package.
This article has been provided courtesy of Bank Islam Malaysia Berhad. Bank Islam Malaysia Berhad is the first Islamic Bank established in Malaysia in 1 July 1983. After two and a half decades in operations, Bank Islam Malaysia Berhad has proven that Islamic banking has a way forward with its activities expanding rapidly throughout the country. The bank was listed on the Main Board of the Kuala Lumpur Stock Exchange on 17 January 1992. Bank Islam has 90 branches. For further information see
www.bankislam.com.my. For a free consultation contact
For a complete list of fixed rate loans, please visit www.money3.com.my
Asian Finance Bhd
4th June 2008