BBA ISLAMIC FINANCE

EIB 10203 (ISLAMIC ECONOMIC AND FINANCE 1)

TITLE:
The current issue in Islamic banking that will affect development

GROUP:
IF22

PREPARED BY:
HATTA BIN KHARTANI (62289113658)
AMIRUL AMRI BINTI ALWE (62289113943)
MOHD AZHARI BIN WAHAB (62289313030)
NUR IZZATY BINTI SALIM (62288113786)
ANNUR ASSHIELA BINTI MOHD ANUAR (62289113796)

PREPARED FOR:
SIR AHMAD MONIR BIN ABDULLAH



Table of Contents
Abstract...................................................................................................................................... 3
Introduction ................................................................................................................................ 4
The Concept of Musharakah Mutanaqisah ................................................................................. 5
Data Analysis ............................................................................................................................. 7
Musyarakah Mutanaqisah issue in Islamic Finance .................................................................... 9
(MMP) FOR HOME FINANCING USING AL-IJARAH ...............................................................13
AS THE INCOME GENERATING ENGINE ...............................................................................13
Conclusion ................................................................................................................................15
Reference .................................................................................................................................16





















Abstract

The dual-banking system in Malaysia is expected to place Islamic finance at a
disadvantage because of its over-dependency on fixed rate asset financing such as bai
bithaman ajil and murabahah. Currently, the Islamic finance system is being faced with
a number of paradoxes and it is consistently being criticized for the overuse of contracts
which has been declared to be Islamically permissible. This study focuses on The
current issue in Islamic Finance thath will affect development. Subsequently, this study
proposes Musharakah Mutanaqisah (MM) as an alternative issue can be affect
development. However, the requirement of large funds from each participant in an MM
contract and the complicated procedure to determine the rental rate could hinder
bankers or business entities from implementing MM contracts.













Introduction

Musharakah (Partnership): The Arabic word musharakah is a derivative from the
root word sharaka, which literally means sharing, and mixing shares of two or more
parties to make them interchangeable. Technically, Hanafi scholars define musharakah
as a contract between partners on both capital and profit. The Malikis define it as
permission to transact where each of the partners permits the other to transact where
each of the partners permits the other to transact with the same property (Al-Dardir,Al-
Sharh Al-Kabir, 3/348). ShafiI scholars define partnership as a confirmation of the
rights of two or more people over a common property (Al-Sharbini, Mughni Al-Muhtaj,
3/221). According to Hanbali scholars, it is the amalgamation of rights or the freedom to
use (Ibn Qudamah, Al-Mughni, 5/3). See ISRA Islamic Financial System: Principles and
Operations for further details.




The Concept of Musharakah Mutanaqisah

Figure 1

Basically, the Musharakah Mutanaqisah (MM) arrangement involves three steps:
i) The first step is to create a joint ownership in the property under partnership
agreement (shirkah al-milk), wherein the client will pay 10% down payment
from the total amount of asset that is considered the initial share and the
financer will provide the balance (90%).
ii) The second part of this arrangement is that the financier leases his share in
the asset under Ijarah contract to his client and charges rent from him.
Basically, the Annual Percentage Rate (APR) is determined by the rental rate
by dividing the annual rent with the original price of the asset. APR formula is
stated as shown below:
APR % 100 12 price Asset months rental Monthly
The annual rental rate is determined from similar asset in the particular
location. In this paper, RM 1000 is the monthly rental payment to be used in
MM calculation. Each rental payment is jointly shared between the customer
Sharikat al-
Aqad between
the bank and
the customer,
e.g. at 90:10
The objective
of the
partnership is
to acquire and
own an asset
Musharakah
The Customer rents the bank's
undivided share and
for completed house: pays the
rental payment.
For house under constructions:
pays ijarah mausufah fi dhimmah
Ijarah
Th customer
will continue to
buy the units
representing
the bank's
share gradually
until the house
is fully owned
by him
Sale
and the bank according to the respective shareholding, at that point in time,
and it will keep changing as the customer redeems the financiers share. The
customers share ratio will therefore, increase after each rental payment until
eventually fully owned.
iii) The third step in the abovementioned arrangement is when the client wishes
to redeem the share of the financier by adding extra monthly payments at a
specified time. The monthly redemption payment can be determined in the
Mathematical Derivation equation as below:


1 1
1
0

n
n
x
C x P x
A
A= amount redemption Monthly
x = Rental rate (rental charge divided by asset price)
P = Asset Price
n = Redemption period
Other equations can also be used for computing total monthly payments which
are similar to the normal annuity formula excluding the interest rate and replacing it with
the rental rate. The formula is stated as below:

1 1
1
0

n
n
x
B x x
M
payment monthly Total M
x Rental rate

0
B Financers contribution into the partnership
n = redemption period
Data Analysis

This part shows the calculation for both instruments, the Bai Bithaman Ajil and the
Musharakah Mutanaqisah, and the annuity formula will be used for each periodic
payment for both instruments. The results will be presented according to the
comparative purpose:
i) Annual Profit Rate (APR) could be charged by financer to their client;
ii) Periodic payments should be paid by client to the financer;
iii) Total payments should be paid by client to the financer at the end of the
financing (for BBA) or leasing (for MM) period.

Measurement factors for both instruments are determined based on the same example
and stated as shown below:
Type of asset = A house
Asset price = RM 150,000
Clients down payment = RM 15,000(10% from asset price)
Duration of financing = 15 years
i) Additional information for BBA:
Annual Profit Rate = 14%
ii) Additional information for MM:
Rental payment = RM 1,000
APR or Rate of Return (IRR) = 0.67%

Bai Bithaman Ajil Calculation
a) Annual Instalments
=
1 ) 1 (
) 1 (

n
n
i
PV i i

=

1 14 . 0 1
000 , 15 000 , 150 14 . 0 1 14 . 0
15
15

RM RM

= RM 21,979.21
b) Monthly Instalments
=
months
Instalment Annual
12

=
months
RM
12
21 . 979 , 21

= RM 1,831.60
c) Total Payment
= Down Payments + (Monthly Instalment x 15 years)
= RM 15,000 + (RM 1,831.60 x 12 months x15 years)
= RM 344,688.15

Musharakah Mutanaqisah Calculation
a) Monthly Rental
= RM 1,000
b) Monthly Redemption
=

1 0067 . 0 1
000 , 15 0067 . 0 1 000 , 150 0067 . 0
180
180

RM RM

= RM 288.25

Musyarakah Mutanaqisah issue in Islamic Finance

In Islamic banking system which using Musyarakah Mutanaqisah product in
housing finance and asset ownership. Musyarakah Mutanaqisah product is product that
is best in Islamic banking system because it together in giving profit to second party.
However, there are also a few issue and problem which occurred in this product that
was applied by this Islamic banking system.
Bank still impose fine fee on customer when they commit tabulation back their
payment when fail to do follow original payment schedule that done. Customer will ask
bank to do tabulation back on monthly payment that they need to explain according to
their ability. Therefore, payment period will be longer and this forced to make internal
change contract agreement that they don ago. Therefore, issue that has arisen now,
bank will impose fee on tabulation back payment and payment of fines because do not
meet contract agreement carried out earlier. Apart from that too, customer having to pay
back payment charge in manage agreement document that is new for tabulation back.
This meaningful, customer forced to bear again between new agreement contract
provision payment bank and customer because do new payment tabulation that
customer need to obey to financing done.
Issue this obviously show them do not practice partnership principle properly
because in lose any liability partnership or profit must be borne by both sides who did
partnership. Apart from that too, any cost imposed in doing partnership is need to be
borne by all members share together because they agreed in doing partnership whether
profit or loss and all capital contribution carried out it with. In banking system carried
out, any cost in implementing this partnership have been incurred by customer only
while bank only bearing cost capital only. This obviously shows inequality in suffering
problem in the partnership. Bank also imposing fines on customer because failure
explain instalment payment as scheduled.
Hence, should follow partnership principle, in suffering aspect carried out is
needs by party second cooperation who did partnering. This can reduce burden
customer to keep administrative cost that need to be explained alone. Although in
ending is owned by customer only on asset, however partnership course of doing must
be together pay cost imposed and can reduce partner burden. This is due to in ending,
bank also will obtain profit from partnership because installment payment explained is
exceed payment issued by the bank when issuing partnership capital.
Apart from that too, second issue arise is on takaful guarantee payment on
house. This guarantee should be borne by both sides because property ownership is
joint ownership and it is liability with. In this partnership, they are responsible bear with
protection expenditure on their property and not just burden to one joint member only.
This is because, protection on property imposed is giving benefit to both sides that
shares that beside guarantee safety on property. What done by bank nowadays
according to mutanaqisah partnership concept is, bank only provide takaful service or
suggest takaful company to clients ensure property. On the other hand, bank not
together bear pledged against property. They can perform partnership on property
guarantee although in this contract, in this contract ending property will be owned by
one art only. However, partnership course of doing, those who share had to look after
with property security from happen any flaw or destruction that probability happen
during partnership still done. Therefore, bank also need with pay guarantee cost and in
the ending when property become property only one party, bank may impose a little
service fee (al-ujr) to customer because yard heart together bear guarantee.
Next issue is determination of rental price. First, is studies which mainly focused
on the rate of return of bank deposits and factors influence its volatility. As an example
for this kind of study is Chong and Liu (2008) which has attempted to show the
relationship between Islamic bank deposit rate with conventional fixed deposit rate in
Malaysia. Using time series data ranges between April 1995 April 2004, Chong Liu
(2008) was able to provide evidence that rate of return in Islamic bank deposit is highly
pegged to interest rate in Islamic bank fixed deposit.
Second is those studies which are directly discuss the amount of bank deposits
and its determinants. One study is done by Haron and Azmi (2008). The study uses
macroeconomic variables as explanatory variables as explanatory variables to predict
the behavior of bank deposits in Malaysia and revealed that growth in the economy and
an increase in money supply. Composite index and consumer price index, continue to
increase Islamic bank deposits. Furthermore, Haron and Azmi (2008) also empirically
proven that any increase and Islamic bank deposits will decrease and vice-versa.
Another study conducted to investigate the behavior of Islamic bank deposits is
by Kasim et al. (2009). Using monthly data covering the period from January 1999-
2006, this study the impact of monetary policy shock on Islamic banks balance sheet in
Malaysia. The study convincingly provides evidence that the impacts of policy shocks
are more destabilizing on the Islamic bank balance sheet item are more sensitive to
interest rate changes compared to their conventional counterparts.
Haron and Ahmad (2000), moreover, examines the effects of conventional
interest rates and rate of profits on funds deposited with Islamic banking system in
Malaysia. The negative relationship emerged between the interest rate of conventional
banks and the total deposits in Islamic banks provides evidence for the existence of the
utility maximization theory among the Muslim customers. Meanwhile, Kasri and Kasim
(2009) provide similar conclusion for similar study done for Indonesia. It supports Haron
and Ahmad (2000); Haron and Azmi (2008) and Kasim et al. (2009) by concluding that
higher Islamic deposit is significantly correlated with higher rate of return and lower
interest rate.
Third, is a group of studies which combine the discussion between rate of return
on bank deposits and the volume of the deposits. Bacha (2004) seminal work discusses
causality relationships between conventional bank interest rate with Islamic banking rate
of return as well as between conventional fixed-deposit and Islamic bank deposit. Using
time series data spread from January 1994-2003, the study shows that the changes in
conventional banks interest rates and total deposits Granger cause changes in Islamic
banks rate of return and total deposits repectively.
Zainol and Kasim (2010) examines the determinants of rate of return and total
deposits in Islamic banking. Utilizing 10 years monthly data spread from January 1997-
2008, they found that Islamic banks rate of return and conventional banks interest rate
are cointegrated and have a long-run equilibrium. Furthermore, the study also indicates
the profit motive among Islamic banks depositors due to the significant impact of the
mudharabah deposit rate with the total deposit and negatively significantly related with
the changes in conventional fixed-deposit rate.
In the case pf inflation, study the relationship between inflation. Tax rate increase
and consumption behavior in US using data spread from 1071-1984 and conclude that
inflation has a substantial impact in consumption. However, this effect is more on
services, particularly financial services. Rather than on nondurable goods. During the
time of high inflation, people reduce their very costly and insignificant expenditures for
their real consumption. One of the best choice is by reducing cost of services charged
by financial institutions. Huybens and Smith (1999) provides evidence which indicate a
significant and economically important, negative relationship between inflation and
banking sector development.












(MMP) FOR HOME FINANCING USING AL-IJARAH
AS THE INCOME GENERATING ENGINE














Figure 2
If money is tight, the bank can direct the customer to increase the true rental
value while keeping the added premium constant. The opposite is true when interest
rates decline. This rental adjustment technique, although not thoroughly transparent
from the Shariah viewpoint, requires more research in order to gain acceptance.
There is one last point, though. To apply MMP in banking, one must identify who
owns the asset? The bank or the customer? How does the asset appears in the banks
balance sheet? Theoretically, both should hold legal claim on the house. But what type
of business entity the MMP should adopt? Will the Banking and Financial Institution Act
1989 (BAFIA) recognizes the partnership as a business entity? Finally, it is the
partnership ant nit the bank alone the purchases the asset. The pricing of rental and
Customer Share Capital
$10,000
10%
Bank Share Capital
$90,000
90%
MUSYARAKAH MUTANAQISAH
PARTNERSHIP (MMP)
The MMP invest the $100,000
Capital in the Al-ijarah-rental business
HOUSE
Monthly Ijarah
Payment
$800
Actual rental Value
$500
Share purchase
Reduces
Banks
shareholding
Increase
Customers
shareholding
Customer 10%
Profit - $50
Bank 90%
Profit - $450
Customer share
Purchase $300

changes in premium payments for share buy-back requires meticulous care so that
periodic adjustment to market movement in property and rental prices reflects win-win
deal.
The law states, Wealth must not circulate only among the rich ones among you
(Sura 59:7). Economic justice therefore implies that wealth creation must not be
monopolized by the few rich. In this way, the establishment of unit trusts serves to
promote welfare, as it opens new opportunities for the average man to participate in the
capital market. On this matter, Islamic banks deserve praise, but more is better. Doing
so does not necessarily mean providing them access to the capital market via ASBI
scheme alone. It also means providing direct finance to small and medium-scale
industry. Unlike conventional banks, Islamic banks have extra flexibility to inject funds
into the SMIs since it can invest in equities via mudarabah, musyarakah, salam and
istisna financing.
Musyarakah instruments run on profit- sharing principle (PLS). This means SMIs
are not required to place collaterals over the capital injection. For example, under the
musyarakah framework, banks provide equity funds into the project and take an active
role in the management of the project as well; which means they no longer act as debt
collectors.
Experience in Pakistan has shown that an equity approach in banking does not
work too well. Banks are not ready to manage equity-based projects simply because
they not familiar with the project financing. The high exposure to market risk chased
deposits away and deprived banks of funds. There is no apparent mechanism the bank
can use to deter the business partner from abusing the contract. This explains why
Islamic banks around the world have opted to use al-bai-bithman ajil contracts in their
business.



Conclusion

By using musyarakah mutanaqisah partnership financing concept with more
raising further concept quality according to Islamic law track, so much more developed
usage on mutanaqisah concept because it is concept that is effective in housing
finance. Therefore, if any change on responsibility from bank or customer must refer to
original contract that carried out and change carried out is well founded and still giving
profit to both sides. Therefore, when making internal change contract, price should be
explained in early contract carried out by getting agreement of two party split to prevent
occurrence of usury of gharar in contract change. Apart from that too, Musyarakah
Mutanaqisah can give confidence and belief on customer in using Islamic banking
system that is transparent and true. Although this product said will reduce bank profit
compared to financing product the rest, however this product will attract many more
customers and additionally can keep profit that is prolonged to bank. With effectiveness
on mutanaqisah contract this, this will give development that is developed in property
ownership apart from can build further country economy because with the existence of
mutanaqisah concept, it will encourage public to own property and will reduce poverty
rate in country because they afford to own their own asset. With according to Islamic
law track set, this product will be more thrive and able to give service that is best in
Islamic banking system beside gives profit that deeper this Islamic banking because can
attract even more customer to use this Islamic banking system.








Reference

http://www.kantakji.com/media/8275/n309.pdf

http://www.ukm.my/fep/perkem/pdf/perkemVIII/PKEM2013_2B2.pdf
Saiful Azhar Rosly. 2005. Page 141 Musyarakah Mutanaqisah Home Financing:
Critical Issues on Islamic Banking and Financial Markets.
Saiful Azhar Rosly. 2005. Page 253 Islamic Banking and Economic Development:
Critical Issues on Islamic Banking and Financial Markets.