Tuesday, April 23, 2019

The Islamic Bank Personal Loan Facility


Personal financing is a term financing facility to meet personal financial needs like to go on a holiday or to finance your children’s education etc., which is calculated based on either a fixed rate or variable/floating rate. As the name indicates, customers that take personal financing generally require cash to be used for personal obligation/use. As such, there is no underlying asset exist in generic personal financing.

Islamic personal financings (loans or credits) are a part of the many Islamic finances available at most of the Islamic banks or banks that provide Islamic banking services/interest free banking services as subsidiary, windows, etc. models. Personal loans provided by Islamic banks are more widely known as personal Islamic financing.

In Islamic banking no money is actually loaned to the client, rather the bank will “buy” the item for clients and sell it back to them at a marked-up price. In Islamic personal financing, there are different types of financing facility that are Shari’ah compliant which are Murabahah, Tawarruq and Ar Rahnu.  Murabahah is a type of salling commodity where the commodity is sold for cash at a deferred price. Where as ‘Tawarruq’ refers to purchasing of an asset with a deferred price, and then selling it to a third party to obtain cash. Ar- Rahnu or also known as Ar Rahn, is an Islamic pawn broking where a customer places a pledge or security (normally gold) as a collateral in return for a loan.

3.1 Tawarruq Personal Financing


Tawarruq contracts can be used in many Islamic banking products including in personal financing products. Generally, Tawarruq is used in generating cash using sale of an underlying commodity. In the case of car or house financing, the asset (car or house) to purchase can be the underlying asset to generate the financing. However, since Islam prohibits the practice of riba’ which is charging additional interest over a loan, Islamic bank cannot generate return from giving out loan as the requirement of loan in Islam is without charging interest. So the alternative to giving loans is through the use of Tawarruq contract to generate cash from trading of commodities.


Tawarruq Personal financing process

3.2 Tawarruq Cash Line Personal Financing


Personal cash line financing is a credit facility normally used by current account holders to allow them to make withdrawal more than the actual amount available in the account. For the case of Islamic bank, the bank would use the Tawarruq contract to generate extra cash to allow current account holders to withdraw more than what is available in the account. The process flow of the application of Tawarruq contract is similar to Personal financing product however it has some additional features.

Let’s see how it works

Let’s say a customer wants to take a cash line, after the process of generating cash (you may refer to the process in Tawarruq Personal Financing process right above), the financing (principal) amount of purchase price and profit portion of selling price will be assigned into the customer’s current account throughout financing period. The amount will be set as a Facility Limit, whereby the customer is allowed to withdraw/utilize the amount only up to the limit given. 

The outstanding balance (the outstanding debt to be repaid to the bank) depends on the utilisation of the amount. The higher the amount utilised, the higher the outstanding balance. However, when the customer makes a deposit into his current account, the outstanding balance will be reduced. The profit will only be charged on the amount utilized and ibra' (rebate) will be given for unutilised portion. For this purpose, there would be a rebate mechanism that takes place.

3.3. Ar-Rahnu Personal Financing

Ar- Rahnu or also known as Ar Rahn, is an Islamic pawnbroking where a customer places a pledge or security (normally gold) as a collateral in return for a loan. In other word Ar-Rahnu is a short term loan (Qardh) product whereby a customer will pledge gold or other accepted security (referred to as gold) as collateral for the loan given. Ar-Rahnu facility is provided  based on the Qardh, Rahn and Wadiah Yad Dhamanah contracts inline with the principles of Shari’ah

 The Islamic Pawn broking/ Ar Rahn is needed because it help us to get the loan in cash that we want without fulfilling criteria, formalities and paperwork that are required when we are applying for personal loans and credit cards. Despite the numerous credit alternatives available, one point is certain - people do not like formalities and paperwork. Going to the bank for a small loan may require them to surrender their personal documents. And choosing an illegal money lender can be outright risky and dangerous too. But The Islamic Pawn broking/ Ar Rahn is best solutions if you desperately need a quick small money in cash, like a school opens next week and the kids at home need new books, uniforms, etc. 

 The conventional pawnbrokers make money through the high interest earned and the surplus gained from the ownership transfers. However, the Islam's alternative to interest-based pawnbroking offers a commercial contract known as Al-Rahn, where the customer can place an amount of gold with the bank with small fees (ujrah), usually 2%, charged for safekeeping (Wadiah Yad Dhamanah), and receive an interest free margin of advance (Qardul Hasan) with the gold being held as collateral (Al-Rahn) for a tenure of mostly up to 6 months, with 2- month extensions thereafter.

 The process how the short term Ar Rahnu Loan Works

 Take a look at the steps below to know how the interest-free loan (Qard Hassan loan facility) is offered by Islamic banks operates. 
  1. Under the concept of Ar Rahnu, the customer or borrower approaches the bank (the lender) for a short term loan to meet its liquidity requirement.
  2. The loan arrangement requires the customer to pledge his assets usually gold or other jewellery under the Ar Rahnu (pledge) arrangement. The safe keeping of the jewellery by the bank is based on the Wadi'ah yad Damanah contract
  3. The bank will lend the money for a certain period for example, six months. The margin of financing range between 50 to 70 percent of the value of the jewellery. This will also depend on the purity of the jewellery. The bank will keep the jewellery as a collateral.
  4. The borrower redeems the jewellery upon maturity of the loan.
    Ar Rahnu Loan Process
    How would a company running an Islamic pawn business (murtahin), given that interest (riba) is not implicated in the rahn pawn broking business, make money? The answer is simple. Profits take the form of storage fees charged on the pledged asset. These fees are determined by the available standard formula. For example, in the case of a pledge valued at $1,000, the pledger (rahin) is required to pay a storage fee, say a percentage of the total value of the pledge. Here’s an example:
    1. According to most Islamic banks, a pledge valued at less than $1,000 would cost the rahin $4 a month [(1,000/100) x 40 cents]. Normally, only about half of the pledge value is given to the rahin as an interest-free loan. Thus, a $500 loan payable in 6 months would incur a storage cost of $24 ($4 x 6).
    2. At the end of the term, the rahin would pay the murtahin $524. The rahin can ask for a periodic loan extension provided he pays an additional storage fee. The operator has the right to put the collateral on auction on failure to pay the loan after a prolonged reminder,. 
    3. The rahn company would claim loan plus storage fees due to them. The surplus therein would be returned to the rahin. In case he cannot be located, the proceeds would be forwarded to the bait al-mal from which the rahin is entitled to make future claims.








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