Sharīʿah non-compliant assets as rahn (pledge) in Islamic banking products: a fiqhī perspective

Abstract

Purpose

The purpose of this study is to present a framework regarding the use of Sharīʿah non-compliant assets as rahn (pledge) and to provide the Sharīʿah analysis on the application of numerous collateral instruments, including financial assets such as shares, unit trusts, current accounts and investment accounts which are Sharīʿah non-compliant.

Design/methodology/approach

The study adopts a library-based approach to examine the concept and requirements of rahn, deliberate the classification of Sharīʿah non-compliant assets and delineate the Sharīʿah views on the use of Sharīʿah non-compliant assets as pledges. It also examines the various forms of pledge available and offered in the market using document analysis as well as through discussion with industry practitioners.

Findings

In general, the study concludes that Sharīʿah non-compliant assets, either due to their essence or due to the means of acquisition where there is no ownership from Sharīʿah perspective, cannot be used as rahn. This study also provides the Sharīʿah analysis on the use of modern instruments such as shares, unit trusts, current accounts, investment accounts and insurance policy as pledges.

Originality/value

The paper provides a reference source for regulators in formulating an appropriate policy and framework on Sharīʿah-compliant collateral; Sharīʿah committees of Islamic financial institutions in arriving at Sharīʿah decisions on collateral; and industry practitioners in establishing internal policies and procedures on collateral.

Citation

Hussain, L. and Ali, M.M. (2017), "Sharīʿah non-compliant assets as rahn (pledge) in Islamic banking products: a fiqhī perspective", ISRA International Journal of Islamic Finance, Vol. 9 No. 2, pp. 196-199. https://doi.org/10.1108/IJIF-08-2017-0018

Introduction

Collateral is an important tool that banking institutions use to manage the risk of customer default. In such an event, the bank may claim from the collateral to recover payment of the customer’s outstanding obligation. Practically, collateral may be either in the form of tangible assets, such as real estate and vehicles or financial assets such as bonds, ṣukūk and shares. Collateral is normally charged to secure a financing facility. Over the past decade, Islamic banking products have witnessed a remarkable development, shifting from plain vanilla products to more sophisticated and exotic structures and features. This trend has been accompanied by the introduction of numerous unprecedented collateral instruments, including financial assets such as shares, unit trusts, current accounts and investment accounts. These may raise issues, particularly if they involve Sharīʿah non-compliant elements.

Against this background, there is a need for Sharīʿah investigation of the use of Sharīʿah non-compliant assets as collateral in the modern banking arena. A cursory review of the literature finds that there is lack of research on this aspect, perhaps due to the complexity of the issue and the fact that it is a relatively new area.

Research objectives

The study aims to achieve the following research objectives:

• to discuss the concept of rahn (pledge) from the fiqhī perspective;

• to deliberate the use of Sharīʿah non-compliant assets as rahn; and

• to assess the application of Sharīʿah non-compliant assets as pledges in Islamic banks.

Research methodology

The study is library-based, benefitting from various classical sources, Qurʾānic texts and Prophetic traditions to reach a cohesive understanding of the Sharīʿah position pertaining to the use of prohibited assets as rahn. It also looks into fatwas, resolutions, standards and other related literature. The study further examines the various forms of pledge available and offered in the market using document analysis as well as discussion with industry practitioners.

Sharīʿah requirements of rahn

The requirements of rahn in Islam follow the conditions of the asset in a sale contract: it must be recognized by the Sharīʿah as valuable and be existent, identifiable, deliverable and owned by the pledger. The reason for these requirements is that the function of a pledge is to settle the outstanding obligation by selling it in the event of debtor default. This is only possible if the pledge is legally recognized subject matter of the sale contract (Ibn Qudāmah, 1388H, p. 4/253). Any item which is permissible as the subject matter of a sale is also permissible as collateral. On this basis, jurists developed the famous legal maxim which states, “What is permissible to be sold is also permissible to be pledged” (al-Zarkashī, 1405H, p. 3/139). Inversely, a Sharīʿah non-compliant asset does not qualify to be the subject matter of rahn. The Rahn Exposure Draft issued by Bank Negara Malaysia (BNM) clearly states that the subject matter of the rahn contract shall be collateral (marhūn) that is recognized by the Sharīʿah (BNM, 2017, p. 5). The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in its Sharīʿah standard no. 39 also requires pledges to be Sharīʿah compliant. It states: “The mortgage asset should be a Sharīʿah-permissible property. It should also be well specified (through pointing, naming or description) and be possible to deliver” (AAOIFI, 2015, p. 970).

Initial findings

The study finds that Sharīʿah non-compliant assets in relation to their use as rahn are categorized into two major types: first is the asset prohibited in its essence (li dhātih) and second is the asset prohibited due to an external reason, namely, the means of its acquisition (li kasbih). The former refers to an asset that the Sharīʿah has prohibited due to an essential attribute (waṣf). In other words, it is an asset prohibited in its essence because it is harmful or unclean. This category includes pork, wine and other impure items. Jurists unanimously agree that these items cannot be used as a pledge. The second category of Sharīʿah non-compliant assets is further subdivided into four classes, namely:

1. an asset acquired without the consent of the owner;

2. an asset acquired with the consent of the owner through a void (bāṭil) contract;

3. an asset acquired with the consent of the owner through a voidable (fāsid) contract; and

4. an asset acquired with the consent of the owner by unlawful possession without the use of any nominate contract.

For a Sharīʿah non-compliant asset acquired without the consent of the owner, or with the consent of the owner but via a void (bāṭil) contract or by unlawful possession without any contract such as by bribery or gambling, the study concludes that it is not permissible to accept a non-monetary asset as rahn due to the absence of ownership. However, if the asset is monetary, there are two different scenarios:

1. if the money is not commingled with other money, it is not permitted for use as rahn; and

2. if the money has been mixed with other money, it is permissible to accept it as rahn up to the limit of the amount of the ḥalāl (permissible) portion.

As for the Sharīʿah non-compliant asset acquired through a voidable (fāsid) contract, the study found that the asset can be used as rahn, according to the Ḥanafī school, provided that the contract has undergone rectification or the purchaser has taken possession of the asset with the seller’s consent.

Based on the established Sharīʿah framework presented in the paper, the study concludes that a conventional fixed deposit can be used as a pledge limited to the principal amount. In this regard, the Sharīʿah Standards and Operational Requirements of Murabahah issued by BNM also states that an interest-bearing debt-based asset such as a conventional fixed deposit certificate may be used as collateral provided the collateral is valued up to the principal amount (BNM, 2016, p. 17).

The study also concludes that a conventional bond can be used as a pledge limited to the issuing price of the instrument. The Exposure Draft of Rahn clearly states: “Where a Shariah non-compliant financial asset is used as a collateral, the collateral value must be limited to the principal amount of the financial asset” (BNM, 2017, p. 5).

A Sharīʿah non-compliant unit trust may also be utilized as a pledge capped at the value of the investor’s initial investment and subsequent top-ups.

Furthermore, the shares of companies with mixed assets that comprise Sharīʿah-compliant and Sharīʿah non-compliant assets may be accepted as rahn provided that the core business activities of the company are Sharīʿah-compliant. A share which comprises mixed activities can also be used as rahn valued up to the amount of the Sharīʿah-compliant portion only. The shares of a company not meeting the financial ratio benchmark may also be utilized as rahn.

An insurance policy can be accepted as a pledge limited to the total amount of premiums the policyholder has paid. This is because the insurance company does not have a right to the premium paid by the policyholders, whereas the policyholders have no right to the coverage. Therefore, the policyholder cannot use the insurance policy as a pledge due to the absence of ownership rights associated with it. However, he can use the benefit of the insurance policy as a pledge up to the amount of the premiums he has paid.

Conclusion

This framework has been developed based on the fundamental Sharīʿah ruling on rahn. Other considerations, such as maṣlaḥah (benefit/interest), ḥājah (need), dharīʿah (means), that may form a basis to depart from its original ruling are put aside and left to the discretion of the respective Sharīʿah authorities on a case-by-case basis. The paper acknowledges the possible gap between the established framework and the prevailing practices. This is particularly true because the paper only deals with the issue of collateral that has the characteristics of a pledge. Further studies may examine each and every form of collateral available in the market such as debentures, charges, assignments, securities and others.