Collateral is an important tool that modern financial institutions use to mitigate credit risk. It is normally used to recover payment of the outstanding obligation in the event of customer default. Collateral may be in the form of either tangible assets, such as real estate or vehicles, or financial assets such as fixed deposits or shares. Islamic banks also apply collateral as an important credit risk mitigation device. However, the collateral for Islamic banks has different characteristics from that of the conventional system in the sense that the former has to be Sharīʿah compliant.
The present study undertakes to discuss the fiqhī perspective on the use of a Sharīʿah non-compliant asset as collateral having the characteristics of rahn (pledge). Specifically, the study aims to achieve the following research objectives:
(1) To discuss the concept of pledge from the fiqhī perspective;
(2) To deliberate the use of Sharīʿah non-compliant assets as a pledge;
(3) To assess the application of Sharīʿah non-compliant assets as pledges in Islamic banks.
The study is library-based, benefitting from various classical sources, Qurʾānic texts and Prophetic traditions to reach a cohesive understanding of the Sharīʿah position pertaining to the use of prohibited assets as rahn. The study also examines the various forms of pledge available and offered in the market using document analysis as well as discussion with industry practitioners.
The study affirms that the concept of pledge in the current banking structure is not something new in Islam. Islamic law recognises the concept of rahn as a security contract. The study found that the requirements of rahn in Islam follow the conditions of the asset in a sale contract: it must be recognized by the Sharīʿah as valuable and be existent, identifiable, deliverable and owned by the pledger. The reason for these requirements is that the function of a pledge is to settle the outstanding obligation by selling it in the event of debtor default. This is only possible if the pledge is legally recognised subject matter of the sale contract. Any item which is permissible as the subject matter of a sale is also permissible as collateral. Therefore, a Sharīʿah non-compliant asset does not qualify to be the subject matter of rahn.
The study also revealed that Sharīʿah non-compliant assets in relation to their use as rahn are categorised into two major types: First is the asset prohibited in its essence (li dhātih), and second is the asset prohibited due to an external reason, namely, the means of its acquisition (li kasbih). The former refers to an asset that the Sharīʿah has prohibited due to an essential attribute (waṣf). In other words, it is an asset prohibited in its essence because it is harmful or unclean. These include pork, wine and other impure items. Jurists unanimously agree that these items cannot be used as pledge. The second category of Sharīʿah non-compliant asset is further subdivided into four classes, namely:
(1) An asset acquired without the consent of the owner;
(2) An asset acquired with the consent of the owner through a void (bāṭil) contract;
(3) An asset acquired with the consent of the owner through a voidable (fāsid) contract;
(4) An asset acquired with the consent of the owner by unlawful possession without the use of any nominate contract.
For a Sharīʿah non-compliant asset acquired without the consent of owner, or with the consent of owner but via a void (bāṭil) contract or by unlawful possession without any contract such as by bribery or gambling, the study concluded the following:
(i) For a non-monetary asset, it is not permissible to accept it as rahn due to the absence of ownership.
(ii) If the asset is monetary, there are two different scenarios:
(a) If the money is not commingled with other money, it is not permitted for use as rahn.
(b) If the money has been mixed with other money, it is permissible to accept it as rahn up to the limit of the amount of the ḥalāl portion.
As for the Sharīʿah non-compliant asset acquired through a voidable (fāsid) contract, the study found that the asset can be used as rahn, according to the Ḥanafī School, provided that the contract has undergone rectification or the purchaser has taken possession of the asset with the seller’s consent.
Based on the established Sharīʿah framework presented in the paper, the study concludes that a conventional fixed deposit or a conventional bond can be used as a pledge limited to the principal amount or the issuing price of the instrument, respectively. A Sharīʿah non-compliant unit trust may also be utilised as a pledge capped at the value of investor’s initial investment and subsequent top-ups. Furthermore, the shares of companies with mixed assets that comprise Sharīʿah-compliant and Sharīʿah non-compliant assets may be accepted as rahn provided that the core business activities of the company are Sharīʿah compliant. A share which comprises mixed activities can also be used as rahn valued up to the amount of the Sharīʿah-compliant portion only. The shares of a company not meeting the financial ratio benchmark may also be utilised as rahn. An insurance policy can be accepted as a pledge limited to the total amount of premiums the policyholder has paid.
This framework has been developed based on the fundamental Sharīʿah ruling on rahn. Other considerations, such as maṣlaḥah, ḥājah, dharīʿah, that may form a basis to depart from its original ruling are put aside and left to the discretion of the respective Sharīʿah authorities on a case-by-case basis.
The paper acknowledges the possible gap between the established framework and the prevailing practices. This is particularly true since the paper only deals with the issue of collateral that has the characteristics of a pledge. Further studies may examine each and every form of collateral available in the market such as debentures, charges, assignments, securities, etc.
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