No debt sales, no progress for Islamic finance

By Mohd Johan Lee. Available at: http://www.guardian.co.uk/business/feedarticle/8573843

The sale of debt to third parties, especially through multiple securitisations, has been blamed for fueling the worst global financial crisis in generations. But some banking experts say the sale of debt is key to developing a liquid secondary Islamic bond market and a deeper, more sophisticated sharia banking system.
The global total of asset-backed securities issued and sold to investors fell by 79 percent to $441 billion in 2008, as overleveraged borrowers, banks and investors exited the market, according to think-tank International Financial Services London.
1. How does Islam view the sale of debt?
2. Does Islam allow the sale of debt between creditors and debtors and why?
3. Does Islam allow the sale of debt to third parties and why?
4. Does a prohibition on the sale of debt obstruct the development of the Islamic finance industry? If yes, how? Are there other ways in which such sales could be structured?

KUALA LUMPUR, June 24 – The sale of debt is, to certain extent, permissible in muamalat (economic transactions). One needs to study relevant practices under the muamalat to understand the do’s and the don’ts regulated by the sharia with regards to such buying and selling of debt. Like the sibling of transfer of debt (hawala al dayn), the straight forward sale of debt in its simplest form is generally permissible. This single-tier debt sale is widely known as bay al-dayn, namely sale of the debt. Such sale involves only the direct sale from the original creditor (the person who has the right to collect the indebtedness) to the purchaser. The only concern in such a single-tier debt sale is the purchaser, or rather to whom the creditor may sell this debt to. Here, two possible scenarios would be drawn. Should the creditor decide to sell the debt to the debtor himself (and thus reverting it back to where it begins), all the four mazhabs (of the Sunni) have agreed in principle that it is permissible. This sale is known as Bay al-Dayn li al Madin.

According to all the schools of religious law, the creditor has the full right to sell his debt to the debtor at any price. Here the practice of willing buyer, willing vendor should be adopted. Yet, some in the Hanbali’s school stress on differentiating between confirmed and non-confirmed debt. While the sale of the former is allowed, the sale of the latter is not permissible due to the uncertainty (gharar) involved in it. On the other hand, the Zahiri’s school is of the view that debt should not be sold. It may only be waived. To them, the debt is an uncertain right because the debtor may ignore or refuse to settle it (in the obvious, modern example of an NPL, non-performing loan, situation). Thus to sell a debt is to perform a sale of uncertainty (Bay al Gharar) and not permissible in Islamic economic transactions.

This discussion on Bay al-Dayn li al Madin should be differentiated from Bay al-Dayn li ghayr al Madin, namely the sale of debt to a third party and subsequently that of Bay al-Duyun (sale of debts), which is also known as Bay al Kali bil Kali. The sale to a third party (Bay al-Dayn li ghayr al Madin) would normally take place when a creditor would like to have instant cash instead of waiting for it to be fully paid up through the passage of time. Here, the creditor would sell it to any third party at a discount price on a cash payment basis. The jurists differ on the legitimacy of this practice.

The Hanafi’s, Shafi’i’s (some), Hanbali’s and Zahiri’s view this sale as not permissible regardless whether the debt is a confirmed or non-confirmed sale. However, some of the Shafi’i’s and Hanbali’s scholars like Ibn al-Qayyim are of the view that this sale is allowed with regards to the confirmed debt. Yet, according to al Shirazi, al Subki and al Nawawi, of Shafi’i’s school, the creditor has the right to sell his dayn subject to 3 conditions namely, the debt must be a spot debt, the debtor must have accepted the sale and the purchase consideration sum must be on spot basis. It is therefore the opinion of many contemporary jurists (especially those in support of debt sale in Malaysia) that such a sale to a third party is permissible so long as certain conditions and requirements are fulfilled.

However, most of the Middle Eastern jurists are of the view that such sale is not permissible due to hadith which states that ‘don’t sell what you don’t possess”. Those in support of the permissibility of such sale is of the view that the needs of the maqasid justifies it. Also, the fact that there is no explicit source of the shariah that prohibits such practice make it permissible under muamalat. The main concerns that led to the prohibition of such bay al dayn are the uncertainty, the risk, the absent of qabadh (control and ownership of the item) and the breaching of the rule of riba. To those who argue for such a sale, the existence of a transparent modern Islamic banking system and the development of the current system as to a remote ownership and control (through scriptless transaction for example) as well as the requirement of spot purchase consideration sum have circumvented earlier issues. Also, to mitigate the gharar issue, Malaysian Islamic bankers with the approval of their shariah advisors have long required certain conditions as to the maturity period of the debt, the payable period of the debt, to name a few.

As with the riba requirement of money in exchange for the same value of money (m1=m1), the sharia advisory council of the Securities Commission of Malaysia has submitted that since what has been sold is not a legal tender, the requirement of m1 for m1 should not be applicable. Thus the fact that the debt is sold at a discounted price is not an issue. It is indeed for the development of Islamic banking and monetary market that the sale of debt on spot be allowed. Without such practice, the creditors and bankers in an Islamic banking system cannot securitise their debts as practiced by the conventional system.

Thus, the permissibility of such debt sales is crucial to ensure the liquidity of the Islamic money market and Islamic banking system. Without such debt sales, the Islamic finance industry can not be developed forward. This is because, without such debt trading, Islamic bankers will be stuck with their debt. As in typical banking practice, a low liquidity ratio would incapacitate the investment (and depository) business.

Best Regards
ZULKIFLI HASAN
KUALA LUMPUR

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