A bit on Islamic banking principles

I first came across housing loans based on Islamic banking principles, 20 years ago. I was told, from housing developer's point, we still get the progress payments according to the Standard Sale and Purchase Agreement, and leave the rest to the purchaser and the bank providing the loan. It was the first time I came across novation agreements which is the Islamic way of doing away with the 'interest' factor and replace it with something more halal. Basically, the bank buys the property and resells it to the purchaser at a price which is inclusive of the total interest at the end of the loan period.

According to Wikipedia: “In contract law and business law, novation is the act of either replacing an obligation to perform with a new obligation, or replacing a party to an agreement with a new party. In contrast to an assignment, which is valid so long as the obligee (person receiving the benefit of the bargain) is given notice, a novation is valid only with the consent of all parties to the original agreement: the obligee must consent to the replacement of the original obligor with the new obligor.A contract transferred by the novation process transfers all duties and obligations from the original obligor to the new obligor...”

I had no idea what could happen in case a borrower defaults. So it comes to me as shocking when a friend forwarded the following article:

Questionable Islamic banking principles
Two brothers who borrowed RM264,317 from RHB Islamic Bank to buy an apartment saw the loan balloon to RM624,263.42 in three years.

KUCHING: Bank Negara Malaysia must immediately investigate the practice of banks charging interests on loans under the Islamic banking principles as this is tantamount to borrowing money from loan sharks, claims Sarawak DAP.

According to party secretary Chong Chieng Jen, under the Islamic banking principles, a borrower who defaults on his loan payment would be charged future interests on the period of the loan, if, for instance, it is a 30-year loan.

He cited two brothers surnamed Chang who suffered as a result of the Islamic banking principle.

The Changs in October 2006 borrowed RM264,317 from RHB Islamic Bank Bhd to part-finance the purchase of an apartment.

After paying the loan for a year, sometime in October 2007, the borrowers defaulted and in July 2009, the RHB Islamic Bank entered judgment against the borrowers for a sum of RM624,263.42.

According to Chong, on Jan 6, 2011, the apartment which was the security for the facility was auctioned off for about RM200,000. After deducting expenses, a net RM192,750.31 was paid towards part-settlement of the outstanding amount owed by the borrowers, leaving an outstanding sum of RM431, 513.11.

RHB Islamic Bank has now filed a bankruptcy notice on the RM431, 513.11 claiming the borrowers owed them the amount.

“In a short span of three years, the borrowers’ loan of RM264,317 has ballooned to RM624,263.42.

“The borrowers requested for their statements of account from the bank, but it refused to give them one.

"From the figures above, it is obvious that RHB Islamic Bank is charging future interest for 30 years on the amount owed and all future interests are now debited into the present account of the borrowers.

“The effect is similar to loan sharks’ interest rate,” said Chong, who is also the Kota Sentosa assemblyman and Bandar Kuching MP.

‘Courts have different views’

According to the letter of offer in the Chang case, the interest rate for the first year is 1.25% per annum, the second year 3.5% per annum and thereafter 7.6% per annum.

“Given such interest rates and the fact that the borrowers have made regular payments in the first year, the amount outstanding plus interest up till July 2009 (date of judgment) should not be more than RM285,000.

“After deducting the proceeds of the auction sale of the apartment, the total outstanding debt should not exceed RM100, 000.

“However, under the Islamic banking principles, the total outstanding debt is now RM431,513.11,” he said.

Chong called on Bank Negara to look into the matter urgently given the gross injustice in the method of calculation under the Islamic banking principles.

He said that one of the borrowers is a government servant while the other is doing some small business.

“They are able to repay an outstanding sum of RM100,000. However, given the alleged outstanding sum of RM431,5113.11, it is impossible for them to pay and it is also highly inequitable to compel them to pay.

“If RHB Islamic Bank were allowed to proceed with the bankruptcy proceedings, the borrowers’ career and small business will be adversely affected,” he said.

Chong said that the court has different views on the issue. Some judges said that such calculation is wrong, while others said that is the purchase price, and the banks have the right to calculate as such.

“As the court has different views, Bank Negara has to step in and once and for all ensure that all banks are subject to the same ruling.

“Lots of people don’t know about these Islamic banking principles as the banks will never tell their clients. This is a serious problem affecting the banking industry,” he said.

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