Sale based financing has always been a main point of argument between the Bank and Customers. The single matter of “Selling Price” which is a requirements of all Sale-based financing such as Bai-Inah, Murabaha, Istisna’, Commodity Murabaha and Bai Bithaman Ajil, has resulted in many disputes especially in the scenarios of Early Settlement. At any point of time, the Customer will see the outstanding Selling Price of their financing, and as the Selling Price is imbued with the profit to be earned for the financing, this figure is always seen as “expensive” for the Customer.
For example a financing of RM100,000 with a 8.0% p.a. financing rate for 3 years. The monthly instalments, whether a conventional financing or Islamic financing, will be RM3,133-64. This calculation is the same for all banking. The main contention is the fixing of the selling price, which is a mere basic formula of RM3,133-64 x 36 months (3 years) = RM112,810-92. Essentially this is the same amount a conventional loan will eventually collect. A grand total of RM112,810-92. The only difference is that under conventional banking, that amount of RM112,810-92 is not fixed as a ceiling, so technically, the customer may end up paying more than that should the base lending rate increases. There is no issue of Islamic financing is more expensive because of this. The maximum amount on the financing that a Bank can collect is RM112,810-92.
But what some customers see is different. For example, for a conventional loan, if the customer wants to early settle on the 12th month, the customer is required to pay off the principal amount outstanding i.e. RM69,286-41. For an inquiry on Islamic product for the same period, the Bank usually informs customer on the outstanding Selling Price (RM75,207-28), which includes the unearned profits(RM5,920-87) for the financing. Of course, for early settlement, we will usually grant discretionary rebate on the Selling Price, which effectively wipes out the unearned profit amounts. What the customer eventually will pay will be exactly the same as what a conventional loan will indicate i.e. Outstanding Selling Price (RM75,207-28) less Unearned Profit (RM5,920-87) = RM69,286-41. With proper understanding of the Islamic product mechanics, you will find Islamic products nowadays are at par with the conventional loans structure.
The requirement to provide Schedule of Payment
Whether justifiable or not, the perception when it comes to calculations for Islamic Banking products, it is felt to be too complicated to understand. Under this new guidelines, the above calculation is now needed to be made clear and transparent. The purpose is to improve understanding of the structure.
Customers must therefore be provided with a schedule of payment, with clear illustration that at any point of time the customer can have an indication of what is the “rebate” (the unearned profit still yet to be earned), provided that the customer follow the schedule of payment (monthly instalments). This is also in line with the requirement that the Banks are now required to provide mandatory “Ibra” under the following scenarios i.e:
- Early Settlement – whenever the customer intends to make a lump sum early settlement, the unearned portion must be waived as a rebate.
- Refinancing – same scenario as Early Settlement, where rebate is on the “unearned profit”
- Restructuring – if the restructuring resulted in the reduction of tenure, the “unearned profit” for the shortened tenure
- Default Settlement – this refers to the point where during settlement (default cases) i.e. the default judgment amount is actually settled by the customers. The Ibra is only given once the amount is settled (provided that there is remaining “unearned profit” not earned yet).
By issuing a “schedule of payment”, the Bank commits the amount of rebate in such instances where rebate is mandatory, and provides a basis of “equal” comparison between an Islamic structure and a conventional loan.
As a matter of clarity on the above, it is also prudent to make distinction to the types of Ibra’ that can be given, into two types:
- Ibra (rebate) arising from the above scenarios i.e. early settlement, refinancing, restructuring, and default settlement, and/or
- Ibra (rebate) arising from the discount given for the difference between the maximum selling price and the price calculated against a benchmark, which is incurred based on certain events. For example, a sale price based on a profit rate of 9% but the seller agrees to provide a discount of 3% on the sale price based on certain scenarios e.g. good payment record, or low funding cost (Base Financing Rate). Therefore the customer (buyer) is paying profit for 6% where he enjoys the rebate of 3%.
The guideline on Ibra’ therefore only applicable for the above item 1, as item 2 is generally still deemed as discretionary (instead of mandatory) in the eyes of the Islamic industry.
Overall, the requirement for the Schedule of Payment is a good step to increase transparency and a useful tool to explain to customer the workings of Islamic Banking product. This guidelines goes a long way to dispel the notion that Islamic products are inherently more expensive than conventional products. The requirement that Bank MUST give Ibra’ for early settlements provide a lot of comfort to the customers and with the Schedule, customers can see exactly where they financially stand at any point of time. It is a good Guideline issued by BNM.
Ibra’ Scenario for Recovery
One of the things to remember is that during recovery stage of a default account (within financing tenure), Ibra’ is to be given only on settlement. Therefore, the Letter of Demand (LOD) issued will be based on “Outstanding Sale Price” and a disclaimer that “Ibra’ will be given upon full settlement” of the default financing. For example, the Sale Price Outstanding is RM200,000 (where outstanding principal with earned profit is RM120,000 and unearned profit amount is RM80,000) therefore the LOD must be based on RM200,000. But once the customer able to make full settlement, the Ibra must be given starting from the base amount of RM80,o00 i.e. outstanding unearned profit.
Ibra’ on the Differential Pricing
The guidelines very clearly outlines the different scenarios where Ibra is given for settlements. However, it is very silent when it comes to the Ibra’ arising from the differential pricing of the floating rate structure between the contracted ceiling rate and the effective profit rate. For example, the contracted ceiling rate = 12% p.a. and the effective profit rate = 8% p.a. The customer will only be charged 8% and the differential amount of 12% less 8% = 4% p.a. This 4% constitute a natural Ibra arising from the floating rate mechanism. I presume, this Ibra is not part of this guidelines.