EXGA 6309: ISLAMIC BANKING & FINANCE

(SEMESTER 2, 2010/11)

ASSIGNMENT:

“Even though there is no ijmak (general consensus) on the validity of bai

al-inah in terms of Shariah, this type of financing is widely practised by
Islamic banks in Southeast Asia.” Discuss this statement.

SUBMISSION DATE:
11 March 2011

BY:
NOORSHIZATULSHIMA BINTI NORDIN (EGA 080040)
A. Meaning of Bai al-inah and mechanism

Bai al-‘inah involves the sale and buy-back transaction of assets by a seller. Under the
contract, the bank first sells an asset to the customer at a price comprising the financing
amount plus the bank’s profit margin, whereby the payment by the customer is on deferred
payment term (first contract). The bank will subsequently, buy back the asset from the
customer on cash basis which is equivalent to the financing amount (second contract). There
are two agreements involve in bai al’inah transaction in which the bank agrees to buy the
asset from the client cash (Purchase Agreement) on condition that the same client will buy
back the asset immediately from the bank at a higher price and by deferred payment (Sale
Agreement).

It is also called ‘two-party inah’ because the whole transaction takes place between two
parties. The contracts in this case are independent, each being a complete and full-fledged
contract not made conditional to the other. As a result, there would be a creation of legal
consequences in the form of rights and obligations on the parties. Then, it will be carried out
to its end through formal and unconditional transfer of possession of the traded asset. Jurists
of the Shafii School hold this type of transaction reprehensible, however, valid while some
others hold it invalid.

B. Scholars Opinions on Bai al-‘inah

According to Kamal Khir et al (2008), Islamic jurists have different views on the permissibility
of using the bai al-‘inah as a mode of financing. Majority school of thoughts considered bai
al-‘inah as not permissible because it is the zariah (way) or hilah (legal excuse) to legitimise
riba (usury). Bai al-‘inah is also rejected by both Maliki and Hanbali schools and considered
the transaction invalid. Their opinion is based on the opinion of Sadd Zariah that is aimed at
preventing practices that could lead to forbidden acts, in this case, riba. The Hanafi school
considered bai al-‘inah as permissible only if it involves a third party, which acts as an
intermediary between the seller (creditor) and buyer (debtor).

In addition, The Maliki and Hanbali schools consider bai al-‘inah unlawful because the
internal intention of both parties is suspect. They argue that the sale contract is used to hide
the real intention of borrowing and lending money involving riba. According to both schools,
legality of a contract is determined by the motive of the contracting parties. According to the
schools, in bai al’-inah, the motive of the contracting parties is illegal. Therefore the sale is
not valid because it constitutes a legal device (trick) to secure a loan with interest. This view
is based on a bai al-‘inah transaction brought to the knowledge of Aishah (wife of the
Prophet saw) reported as:

“Aliah binti Anfa’ narrated that the wife of Zayd Ibn Arqam said to Aishah: I had
sold a slave to Zayd Arqam for 800 dirhams to be paid in future. Then I bought
him back from Zaid for 600 dirhams cash. Aishah replied: Very bad is what you
sold and bought. Tell Zaid that e had nullified his struggle (jihad) with the
Prophet unless he repented. In this case, Aishah disapproved the practice of
the 2 sales (bai al-‘inah).”

1
However, Shafii School regards bai al-inah permissible because according to the school, all
contracts are valid if the external evidence (rukun & syarat) of the contract of sale is fulfilled.
The intention (niyyah) of the contracting parties has no effect on the validity of the sale.
There is no means to know the hidden intention, unless it is expressed explicitly. Hence, only
the external intentions of both parties are considered. Both contracts cannot be nullified by
assumptions of ulterior motives as long as both contracts fulfil the requirements of sale.
Hence the bai al-‘nah contract is valid and effective.

The Shafii School also disputed the authenticity of the report regarding Zaid bin Arqam with
arguments that:

1) The report is weak in terms of transmission (sanad) and wording (matan). The
narrator i.e. Aliah binti Anfa is an unknown figure and hence the chain of
transmission is weak. The report is also weak in terms of wording because Aishah
is not in capacity to determine the rewards for Zaid’s struggle (jihad) with the
Prophet.

2) Even if the report is true, there are 2 differing views (i.e. Aishah’s view) hence the
matter is still subject to interpretation (ijtihad).

According to Shafii School, a contract is valued by what is disclosed and one’s niyyah
(intention) was up to Allah to judge. The basis for the opinion of the majority of the Islamic
jurists is the hadith dialogue between Aishah and the slave Zaid bin Al-Arqam which showed
the prohibition of bai inah. Shafii school criticised the hadith used by the majority of the
Islamic jurists as the basis for their argument. According to Shafii school, the hadith could
not be used as a basis for the hokum since it was weak (Kamal Khir et al., 2008).

However, later Shafii School such as al-Nawawi viewed that bai al-‘inah contract as
discouraged makruh) based on two main explanations. Firstly, the prohibition is indicated in
the fatwa of companions (athar) and hadith. The most commonly quoted legal evidence in
this matter was an athar narrated from Aishah which was used by Hanafis, Malikis and
Hanbalis as the main legal evidence to rule the impermissibility of bai al-inah. Secondly, the
practice of the contract was seen merely as hiah (legal stratagem) to legalise riba (Amir
Shaharudin).

Hanbalis justified their ruling based on a hadith which showed the condemnation of the
contract by the Prophet. Narrated by Ibn Hanbal on the authority of Ibn Umar, the Prophet
was reported as saying:

“If people are busy with counting every single dinar and dirham, trading based
on al-hadith, following behind cows (i.e. farming activities), and abandoning the
duty of jihad for the sake of Allah will make misfortune befall them, and will not
remove it from until they return to their religion (Ibn Qudamah, 1999, pp. 260).

2
Amir Shaharudin pointed out in his article that Shafii School did not cite the above hadith but
only mentioned the athar of Aishah. According to Shafii School, Aishah and Zaid bin Arqam
are in disagreement in determining the legality of the ‘double sale’ contract. Since both of
them are companions, Shafii School is in the opinion that no opinion can overrule the other.
In addition, Shafii School presumed that Aishah prohibited the contract not because of the
double sale contract but rather because the credit transaction was agreed with unknown
period (when the slave was sold in credit).

C. Mechanism of Bai al-‘inah in Malaysia

Bai al-‘inah contract is commonly practised by Islamic banks in the Southeast Asia. Bai
al-‘nah is currently in practice in Malaysia for personal and education financing, Islamic credit
crad, etc. Whereby the customer pays the selling price in instalments as per agreed payment
schedule. Kamal Khir (2008) outline the modus operandi of bai al-‘inah in Malaysia as
follows –

Step 1: The customer approaches the bank for personal financing and submits an
application from with necessary documents (identification credential, collateral, other income
source, etc) to the bank for credit screening.

Step 2: The bank and the customer agrees on bai al-‘inah as an underlying financing
principle. Bank identifies the asset that will be traded under bai al-‘inah contract.

Step 3: The bank will sign a first contract with the customer, whereby it sells the asset at a
selling price (financing amount + profit margin) on deferred terms and the ownership is
transferred to the customer.

Step 4: The bank will sign a second contract with the customer, whereby it buys back the
asset sold to the customer at a price equivalent to financing amount, i.e. the purchase price.

Step 5: The bank pays to the customer the financing amount on cash basis.

Step 6: The customers pays the selling price to the bank as per agreed payment schedule.

D. Justifications of Malaysian Shariah Scholars Accepting Bai al-‘inah

Syariah Advisory Council of The Malaysian Securities Commission (SAC) decided to accept
the opinions of the Shafii and Zahiri mazhab who permitted bai al-‘inah based on the
opinions of past Islamic jurists on the issue of bai al-‘inah. Islamic capital market in Malaysia
developed capital products based on bai al-‘inah contract. When institutions or individuals
are in need of capital for a specific purpose, they can use this method of payment, using
their assets as mortgage. As they will still require the assets, this method allows them to
liquidate without losing the asset (Kamal Khir et al, 2008).

3
The Malaysian Shariah scholars had favoured the opinion of Shafii School in accepting the
bai al-inah contract in creating a number of Islamic banking products. The following
instruments are the resolutions by the National Shariah Advisory Council pertaining to the
acceptability of the contracting Islamic money market products and Islamic credit card.

1) Resolution on Money Market Transaction

Al-inah transaction is perceived as a suitable contract to be introduced in Islamic
inter-bank money market. In this transaction, Shariah compliant asset (for example
government investment issues) will be sold by a financier (for example central
bank) to the recipient bank at X price of deferred terms. Then, recipient bank will
sell back the asset to the financier on cash basis at Y price. The deferred price of X
is higher than the cash price of Y, hence the difference is regarded as profit to the
financier. Both sale contracts are executed separately. The question is whether the
application of bai al-‘inah as explained above is complies with the concept of bai
inah which is acceptable in shariah.

The Council in its 8th meeting held on 12th December 1998 resolved that bai al-inah
transaction in the Islamic inter-bank money market is permissible based on the
following conditions:
(i) bai al-inah transaction must strictly follow the mechanism which is
accepted by the Shafii school, and
(ii) the transacted asset is not a ribawi item.

2) Resolution on Credit Card

Islamic banking institution proposed to offer Islamic credit card based on the
combination of bai inah and wadiah concepts. The proposed mechanism is as
follows:
(i) The customer purchases an asset from the bank on deferred terms (the
purchase price comprise cost plus profit) for example, RM11,800
(RM10,000 + RM1,800) to be paid within one year by the customer;
(ii) The customer thereafter will sell back the asset to the bank on cash
basis (at cost value); for example, RM10,000. The selling price of asset
is lower than the purchase price. This is the mount which will be
credited into a marginal wadiah account of the bank for the customer’s
use.

The Council in its 18th meeting held on 12th April 2001 resolved that the mechanism
of Islamic credit card which applies bai al-inah concept to generate funds for credit
purposes by a customer who request for the Islamic credit card is permissible.

Amir Shaharudin pointed out in his article that the Malaysian Shariah scholars legalise the
practice of bai al-‘inah based on two main justifications as follows:

4
 1) Firstly, they argue that the contract was not clearly prohibited either in the Quran
and sunnah. They do not accept the validity of the athar and the hadith which
indicate the prohibition of the contract as they considered the athar of Aishah as
weak evidence due to unreliable narrator in its chain of narrators. Even if the chain
of narrators is accepted, the athar still regarded as invalid evident because its
textual content appears to contradict the general principle of Islamic law. This is
because Aishah was reported to have invalidated the reward of jihad that Zaid bin
Arqam had involved together with the Prophet. In the athar, she was reported
saying that inform Zaid that his conduct has eliminated all his rewards for
participating in jihad with the Prophet if he does not repent. Such a statement could
not be taken into consideration since Aishah was not in capacity to do so.

2) Secondly, the Malaysian scholars argue on the basis of maslahah, in which refers
to the need or interest of Muslims contemporary society. The scholars accept the
argument that credit card has become an important banking facility for majority
Muslims. In today’s world, the card is crucial for daily business dealings and
commercial transactions. Considering this need, the scholars support the bank’s
initiative to create a credit card that is Shariah compatible. In this regard, bai al-
inah is viewed as a key contract since it provides a makhraj (mode of problem
solving). The contract can help the society as well as the Islamic banks achieve
their respective goals.

E. Revisiting the Ruling on Bai Inah

The Regional Shariah Dialogue which was held on 28 th and 29th June 2006 aims at
harmonising and promoting understanding amongst the shariah scholars who are involved in
Islamic finance. The dialogue had specifically focused on finding the best solution to resolve
the issue of the use of bai al-‘inah and tawarruq in Islamic financial system. The Council and
the participating Shariah scholars had taken a comprehensive approach with regard to bai
al-‘inah and tawarruq transactions.

Resolution: The Council in the Regional Shariah Scolars Dialogue on 29 th June 2006
resolved that:
(i) The permissibility of bai al-‘inah and tawarruq is still a matter of juristic
disagreement among the shariah scholars backed by their own basis of
justifications;

(ii) The basis relied upon to justify the permissibility of tawarruq is similar with
the basis to justify the permissibility of bai al-‘inah. Therefore, both concepts
shall be ruled similarly;

(iii) Bai al-‘inah concept is still necessary in the context local Islamic finance Bai
al-‘inah concept is still necessary in the context local Islamic finance Bai
al-‘inah concept is still necessary in the context local Islamic finance
development. However, the market players are required to strengthen and

5
 enhance the operational process and documentation to comply with the
features of bai al-‘inah as permitted; and

(iv) Since bai al-‘inah concept is still regarded as a matter of juristic

disagreement among the Shariah scholars, it is more desirable that Islamic
financial institutions to limit its use in products which face difficulty in
structuring them based on other consensually accepted contracts.

In conclusion, in Malaysia, Bank Negara Malaysia endorsed bai al-‘inah as legal and the
main argument for legalising bai al-‘inah is public interest (maslaha). Until another alternative
is devised, bai al-‘inah will be used in order to meet the need for cash and liquidity by
Muslims without having to resort to conventional riba based borrowing which is definitely
prohibited. The legalising of bai al-‘inah is also supported by the legal maxim “choosing
between two evils”. Hence bai al-‘inah (lesser harm) is chosen against riba (severe harm).
Nevertheless, Islamic banks are advised to limit the use of bai al-‘nah. Instead other
mechanisms should be devised so that Malaysian products are accepted in the global
market.

6
References

Kamal Khir et. Al. 2008. Islamic Banking: A practical Perspective. Selangor. Longman

The Bay’ al-Inah Controversy in Malaysian Islamic Banking by Amir Shaharudin. Islamic
Science University of Malaysia. (http://www.kantakji.com/fiqh/Files/Markets/p118.pdf)

Islamic Banking and Takaful Department, Bank Negara Malaysia