Bank Negara Malaysia (BNM) should help those who have defaulted on their Bai Bithaman Ajil (BBA) home financing so that consumers who have put their faith in Islamic financing are not shortchanged.

Presently, consumers who default on the popular BBA will end up much worse off compared to those who default on their conventional housing loans. For example one consumer with a BBA home financing was asked to pay half a million ringgit even though the bank only released about RM10, 000 to the developer. (This never happens with a conventional housing loan.)

As the BBA is an Islamic home financing scheme, it is different from conventional housing loan because interest is not allowed to be charged. The BBA involves two contracts. In the first, the consumer is deemed to have sold the property to the bank. This poses potential problems when the property is still under construction.

In the second, the consumer buys the property back from the bank at a very much higher price as it includes the profit element for the bank (known as the Bay al-Inah concept). The consumer then makes monthly payments based on the price that is sold to him by the bank.

In the abovementioned case, the consumer had bought a condominium (under construction) for RM249, 500. Under the contract, the bank was supposed to buy this home from him and sell it back to him at RM744, 766. He was then given a period of 30 years to pay back the amount via monthly instalments.

Unfortunately, the condominium project was later abandoned. By then the bank had released RM9,563 to the developer. The consumer then offered to repay the bank RM10, 000. But the bank wanted much more - RM505, 368 to be exact. (This is basically equal to the profit the bank should have realised plus the amount already paid to the developer.)

As the BBA is a sales contract that includes profit, a customer can - in the event of a default - owe more than the original financing amount taken. A few of the customers unhappy with the astronomical sums they were asked to pay then took their banks to court.

In 2008, High Court Judge Abdul Wahab Patail argued that the BBA sale was not a genuine sale as the profit charged by the banks was nothing more than the interest payment in a conventional loan. Since the profit element of the BBA was a sham, the contract had gone against ‘shariah’ principles.

It follows that defaulters need not pay more than the original financial amount that they had received. Under our example, it means that the customer only has to pay RM10,000.

However in April 2009, the Court of Appeal ruled that the BAA contract is ‘shariah’ complaint and therefore binding. It also stated that the BBA is a sales transaction and should not be compared to a loan transaction.

The reversal of the High Court’s verdict was much welcomed by the banks as they can now collect the profit portion of the sale transaction. In our case, it means that the bank has the right to sue the customer for RM505, 368.

(The bank, however, unexpectedly withdrew the court case in February 2009 but still demands payment of about RM22,000. By then the case has been dragging for 12 years and had cost him much in terms of emotional distress and in legal fees).

The current global financial meltdown means that increasingly more people are expected to default on loans in the coming months. This is where BNM can play an important role. It can protect Islamic financing customers by:

• Regulating the rebate that the banks can and should give to BBA defaulters to reduce the outstanding balance.

BNM should ensure that the amount of rebate given is large enough so that the financing balances under the BBA would be made similar to the balance under conventional financing. The banks cannot be trusted to be given the discretionary power to fix the rebate as they like.

• Phasing out BBA contracts and replacing them with the ‘musharakah mutanaqisah’ (MM) concept so that defaulters do not end up owing astronomical sum to the banks. A handful of banks have already introduced the MM contract.

The MM is basically a diminishing partnership contract whereby the bank and customer would co-own the house. Thereafter, the customer would pay a monthly rental on the property to the bank.

As the house is jointly owned, part of the rental would therefore actually belong to the customer himself. Accordingly, over time the customer’s share of ownership of the property would progressively increase and he eventually ends up fully owning the house.

Recognise that the Bay al-Inah concept can pose serious problems for the financing of properties still under construction. Hence the BBA and MM contracts should be applicable only for completed properties.

The writer is president, Consumers Association of Penang .