Kafalah is the guarantee for a loan and all loans must be repaid in due course according to Islamic law. The law allows the lenders to demand some sort of security for the loan in the cases where the borrower fail to repay the loan. As for the Shariah Advisory Council of Bank Negara Malaysia, kalafah is defined as a guaranteed contract on certain asset, usufruct and/or services provided by a guarantor to the parties involved. In international trade and finance, kafalah plays an important role in facilitating trade across border by which the bank is asked as a guarantor of payment in the international trade transaction. Islamic banks are able to offer bank guarantee, standby letter of credit and shipping guarantee using the concept of kafalah. Additionally, kafalah can be used to indemnify a third party from financial losses if one party fails to perform its part of the deal. Such application is used in the form of letters of guarantees. In Malaysia, the guarantee facility is not only issued by Islamic banks but also by financial institutions such as Cagamas SRP Berhad and Credit Guarantee Corporation Berhad.
Kafalah in RHB Islamic Bank
The practice in Malaysia had shown that Kafalah concept is usually practiced by Islamic Banks in trade financing sector in two products which are bank guarantee and shipping guarantee. For this, we can look at bank-guarantee product from RHB Islamic Bank. Below figure illustrates how Kafalah is undertaken in a letter of guarantee by RHB Islamic Bank.
Kafalah: The Structure Flow of Islamic Bank Guarantee (IBG) from RHB Islamic Bank
- Customer enters into a contractual agreement with the beneficiary (e.g. a Statutory Body) to fulfill an obligation.
- Customer approaches RHB Islamic Bank to request the issuance of Islamic Bank Guarantee (IBG) facility.
- RHB Islamic Bank issues IBG to the customer, as a surety to discharge the liability of beneficiary in case the customer defaults. In return, a sum amount of fee is charged to the customer.
- In the event of default by the customer, the beneficiary will claim from RHB Islamic Bank. RHB Islamic Bank makes immediate payment on first demand provided the claim meets all the conditions of the guarantee.
- If there is no default, the beneficiary will return the IBG to the customer followed by RHB Islamic Bank’s cancellation upon maturity.
Kafalah: Shariah issues
In bank guarantee, the guarantor (RHB Islamic Bank) charges the customer a certain fee. However, this practice remains a matter of debate among Shariah scholars. This is because some scholars like Hanafi, Shafie, Maliki and Hambali schools did not permit charging fee for a guarantee due to the nature of the contract (benevolent contract) and in the condition the customer defaulted, the relationship between the guarantor and guaranteed party will change into debtor-creditor, thus, charging a fee will lead to riba.
In contrast, some contemporary scholars like Shaykh Ahmad Ali Abdullah from the OIC International Islamic Fiqh Academy permits charging a fee provided that the guarantee is not in the form of a loan (Qard). Besides that, there is no issue on riba as the commitment provided from the guarantor is considered as counter value following the fiqh maxim – al kharaj bi daman (profit comes with liability). The Shariah Advisory Council of Bank Negara Malaysia has allowed charging fee on letter of guarantee based on this basis.
- The method used by RHB Islamic Bank in determining the actual cost RHB Islamic Bank used one of the three methods in charging fees on bank guarantee which is by calculating the actual cost. Although this method is allowed by AAOIFI, one thing to ponder is how the bank calculates its actual cost. There are always risks that the bank imposed unnecessary fees to increase the profit margin.
- The guarantee that the customer will pay back to the bank RHB Islamic bank and some other banks accept collateral or pledge or cash deposits from the customer before agreeing to issue the letter of guarantee to secure the bank’s risks. Islamic banks are not exposed to any cash outlays unless their customer defaults on the performance of a certain act.
Source: Service Based Contract Used in Islamic Finance: A Comparison of Hawalah, Wakalah, and Kafalah, Maryam Sofia Mohd Suhaimi
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