Modern collateral instruments and underlying assets for collateral: a sharīʿah compatibility analysis
Collateral or security is an integral part of the banking industry as it serves as a risk mitigation device. It is a common practice for banks and financial institutions to request security from their customers for financing facilities that will act as a “cushion” for the financial institutions...
| Main Authors: | , , , |
|---|---|
| Format: | Monograph |
| Language: | English |
| Published: |
International Shari’ah Research Academy for Islamic Finance (ISRA)
2018
|
| Subjects: | |
| Online Access: | http://irep.iium.edu.my/70771/ http://irep.iium.edu.my/70771/ http://irep.iium.edu.my/70771/1/70771%20-%20Modern%20collateral%20instruments%20and%20underlying%20assets%20for%20collateral.pdf |
| Summary: | Collateral or security is an integral part of the
banking industry as it serves as a risk mitigation
device. It is a common practice for banks and
financial institutions to request security from their
customers for financing facilities that will act as a
“cushion” for the financial institutions in case of
customer default. Like conventional banks, Islamic
banks also require security under their financial
arrangements. Most of the security instruments and
the underlying assets used and accepted within the
Islamic financing sphere mirror the conventional
practices. This necessitates a discussion on the
compatibility of these practices with the Sharīʿah.
This research adopts a qualitative comparative
study of the legal position of modern collateral
instruments and the Sharīʿah position. From the
legal perspective, the research is undertaken by
way of doctrinal analysis of statutory provisions,
relevant case law and a review of secondary sources
in the form of books, journal articles and reports.
The Sharīʿah position is established by a review of
classical and contemporary writings, especially
the juristic discourse on rahn and ʿuqūd altawthīqāt. The research also relies on a focus group
discussion (FGD) conducted at the International
Centre for Education in Islamic Finance (INCEIF)
on 19 September 2017. Twenty-five participants
comprising industry practitioners, experts, selected
Sharīʿah scholars and legal advisors were asked
to identify specific issues pertaining to collateral
arrangements in the market from the practical, legal
and Sharīʿah perspectives.
The study finds that the most common form of
security or collateral instrument used by banks for
their corporate clients is the charge over corporate
assets. The study also discovers that the Islamic
security contract of rahn is the closest equivalent
to the modern collateral instrument of charge.
While a fixed charge has a lot of similarities with
a traditional rahn contract and is generally capable
of meeting rahn requirements, there is no exact
comparable equivalent of a floating charge under
the Sharīʿah. It is true that a floating charge does not fulfil the requirements of rahn as stipulated by the
majority of jurists (Ḥanafīs, Shāfiʿīs and Ḥanbalīs).
Nevertheless, the opinion of the Mālikī jurists
(which is the view preferred by the researchers)
can be applied to tolerate the features of a floating
charge that include elements of uncertainty and
jahālah in the underlying assets. This is because,
since a security contract is supplemental in nature,
the strict conditions of a primary sale contract
should not be applied to a rahn contract. Further,
making the conditions more flexible accords with
the main objective of the rahn contract, which is to
provide reassurance to the creditor regarding the
debtor’s obligation in the event of failure to pay the
debt.
The changing nature of the assets subject to a floating
charge also exposes the floating charge to the
possibility that the assets may subsequently become
Sharīʿah non-compliant. The research found that
an asset that is Sharīʿah non-compliant in itself is
not permissible for rahn purposes from the Sharīʿah
perspective. However, there are assets that become
Sharīʿah non-compliant due to external factors;
for example, due to exterior elements such as ribā
(interest) in conventional fixed deposits and bonds.
This type of asset is permissible for rahn purposes
provided that the ḥarām element is excluded.
In addition, the common law accepts that some
contractual arrangements, although not primarily
created to secure debt obligations, may be used as
security contracts. These are known as quasi-security
arrangements and include debenture, contracts
of indemnity or guarantee and assignments.
Under Islamic law, the Islamic security contracts
of kafālah/ḍamān and ḥawālah may be said to be
comparable to, although not exactly the same as,
some of the quasi-security contracts under common
law such as contracts of indemnity or guarantee and
assignments.
Finally, the study analysed four types of ‘modern’
asset classes in term of their permissibility for use
as the underlying asset in a rahn contract, apart from the traditionally accepted asset classes. These
include shares, book debts, deposit accounts and
intellectual property (IP). It is found, with regard to
shares, that shares which are Sharīʿah non-compliant
because the core business of the company is noncompliant cannot be used as collateral for Islamic
financing. However, shares that are Sharīʿah noncompliant due to the contribution of Sharīʿah noncompliant activities that exceed certain benchmarks
can be used as Islamic collateral, but only up to the
ḥalāl portion, excluding the ḥarām portion. With
regard to a charge over book debts, it is equivalent
to a charge over receivables or rahn al-duyūn. Based
on the Sharīʿah discussion on rahn al-duyūn, the
researchers are of the view that book debts are
permissible as collateral assets for rahn. This is
because the registration of the book debts may be regarded as a form of constructive possession by the
creditor, which would fulfil the rahn requirement.
As for deposit accounts, the use of a conventional
fixed deposit as collateral is allowed provided that
such collateral is limited to the principal amount of
the instrument only. Lastly, the use of IP as collateral
or subject matter of rahn is possible as long as the
security agreement is clear enough to contain all
the information needed to ensure that the security
transaction is valid. |
|---|