Comments on the CMP documents for Islamic Housing (SHFC)

Maharlika J. Alonto

In light of housing initiatives for Marawi IDPs, Socialized Housing Finance Corporation (SHFC) will
engage communities for an Islamic Community Mortgage Program (CMP) project. Accordingly, SHFC will
pay for the acquisition cost of the CMP project, where it shall extend a loan to an identified homeowners’
association (HOA) for the purpose of acquiring properties identified by its member-beneficiaries (MBs).
The proceeds of the loan shall be exclusively used to finance the acquisition of properties, payable
monthly over a maximum term of twenty-five (25) years. The said loan to HOA shall bear ‘Hijara Fee’ of
6% per annum, where monthly payment per MB shall be computed based on an aggregate amount. Under
this loan agreement, the HOA shall have the primary responsibility of collecting monthly payments due
from each MB, and will remit the same to SHFC.

The diagram below sums up the understanding of the current CMP of SHFC:

Simultaneous to the Loan Agreement between SHFC and HOA, a lease agreement is signed between the
HOA and its member beneficiaries (MBs). The HOA will lease the properties to respective MBs, and shall
receive rental for the use and occupation of the properties. Lease term is for a period of 25 years, parallel
to the term of the loan agreement between SHFC and HOA. The MB shall possess and have the right to
use, maintain, and operate the property, but the sole and exclusive ownership of the property rests with
the HOA. In addition, the MB has the option to purchase the land, where all rental payments will be
considered as installment payment for the purchase price of the property. Upon expiration of the lease,
and payment of all rentals due and payable to the HOA, the full title and ownership shall vest to the MB.
The HOA will execute the Deed of Absolute Sake and all rental payments shall be credited against the
purchased property.

Comments:

1. In the Loan Agreement provided, it was indicated that the loan payment will include a Hijara fee
(which is assumed to mean Ijarah/Lease). This gives the assumption that the loan payment
includes a rental component. There was no mention of when the loan payment commences,
whether it starts when the use or occupation of the property financed, or at some other time
period. The term for such loan was maximum of 25 years, which is parallel to the term of lease
given in the Lease Agreement. The basic permissibility of Ijarah contract concerning a specified
asset, is that the lease contract should be preceded by acquisition of either the asset to be leased
or the usufruct of that asset. The Ijarah contract shall not be executed until the said property has
been acquired, as Ijarah is the leasing of property under which a permissible benefit in the form
of usufruct is obtained for a specified period in return for a consideration. In the Loan Agreement,
there is no delineation of what is considered as mere borrowing, from the envisioned Lease
Agreement. Why is a rental fee charged when there is no indication of how the loan agreement
is completed, and when the lease contract starts? Rental should only run from the time the lessee
starts to benefit from the asset or once the lessor makes the usufruct of the asset available.

Therefore, the CMP Loan Agreement is considered a debt instrument and cannot represent a
lease contract because the objective of such instrument was to lend a monetary consideration for
acquisition of an asset. The ‘Hijara’ fee of 6% could not be construed to be rental income since
the said rate was indicated as cost of the borrowing:

“The loan shall be payable monthly over a maximum term of twenty-five (25) years and
shall bear Hijara Fee at the rate of six percent (6%) per annum.”

In addition, said loan contract cannot be considered a phase of the subsequent lease contract.
Consequently, the term ‘Hijara’/Ijarah should not be used in the agreement to mean rental, but
if any, should be indicated as interest to the borrowed amount.

2. In Islamic finance, no two contracts are allowed to be combined. The CMP Loan Agreement was
taken as the initial phase of the corresponding Lease Agreement. However, the components are
not one and the same - the parties in the Loan Agreement are not consistent with the parties
mentioned in the Lease Agreement, and the subject matters are distinct. The subject matter in
the Loan Agreement is the borrowing of funds for acquisition of property, while the subject matter
of the Lease Agreement is the payment for usufruct of the assets acquired. Ijarah is a contract of
sale of usufruct, where consideration paid must only represent the benefit on the use of the
underlying asset being leased. Hence, the use of ijarah and loan in the same setting can be
misleading as these are two incongruent contracts in Islamic finance. The sale of usufruct means
a temporary transfer of benefits, where it can be derived from the use of properties which are
owned by one party but possessed and used by another party. Loan is merely a debt obligation,
not tied to an asset or sale of its usufruct.
 If the CMP initiative was envisioned to be an Islamic lease transaction, it should have been a lease
(similar to Ijarah Muntahia Bitamleek) contract between SHFC and the HOAs, with a
corresponding agency contract between the HOA and its MBs for the collection of rental
payments. SHFC should be the owner-lessor of the properties, as it is the party paying for the
acquisition of the assets, and ultimately, receives the rental income from the MBs.

3. Because the Loan Agreement does not entail sale of usufruct but merely financing asset
acquisition, the indicated ‘hijara’ fee in the debt obligation is considered as Riba/usury, which is
not permissible in Islam. To determine the rental fees to be levied in an Ijarah contract, it must
take into consideration the benefits derived from the asset and its usufruct. Such rental
consideration paid by the lessee should only pertain to the property in operation, where each MB
with a different property having a separate Ijarah contract concerning their respective property,
different from the other MB contracts.

Per Shariah fatwas used in Islamic finance, the rental must be specified, either as a lump sum
covering the duration of the Ijarah contract, or by installments for parts of the duration. It may
also be for a fixed or variable amount, depending on what the parties have agreed upon. Hence,
the ‘Hijara’ fee of 6% per annum indicated in the CMP agreements must be calculated for the
entire duration of the lease and converted into a specified total rental amount, payable in lump
sum or in installments. In case the parties agree on a floating rental, the amount of rental of the
first period must be specified in lump sum, and the subsequent rentals may be determined
according to a certain benchmark that is based on a clear formula, and subject to minimum and
maximum ceiling.

4. The CMP Lease Agreement is a finance lease, where a lease contract and a sale transaction are
combined, ending in MBs acquiring ownership of the assets at the end of the lease term. Finance
lease however is not the same as an Ijarah contract, or Ijarah Muntahia Bitamleek.

One of the forms of Ijarah used in Islamic financial services industry is a form of leasing contract
which includes a promise by the lessor to transfer the ownership in the leased asset to the lessee
at the end of the lease term. This is known as Ijarah Muntahia Bitamleek. The transfer of the
asset to the lessee is executed through a separate document from the Ijarah contract, by way of:
(1) a promise to sell for a consideration or payment of the market value of the leased property;
(2) a promise to give the asset as a gift for no consideration; or (3) a promise to give as a gift
contingent upon the payment of remaining installment payments. The separate promise or
undertaking is independent of the Ijarah Muntahia Bitamleek contract and cannot be an integral
part of the Ijarah. The transfer of ownership of the leased asset cannot be made by executing the
lease agreement along with the sale contract, whereby the sale is effective on a future date.

Ordinary Ijarah as a leasing contract, is where ownership and usufruct of the asset reverts to the
lessor at the end of the lease term of the Ijarah contract.

5. In both CMP Loan, and Lease Agreements, there is a certification by the Al Qalam Shariah Board.
However, no statement of compliance is specified, including a framework of how Shariah
compliance was arrived at.

The foundation of corporate governance in Islamic financial services requires an additional layer
of governance for the purpose of Shariah compliance. This includes an organizational or internal
arrangement within the agency, such as composition and convening of its Shariah Board, Internal
Audit division, and Shariah division (management). At a minimum, the agency (either SHFC or Al
Qalam) should have a Shariah Framework, and an Internal Shariah compliance review, as the
primary mechanisms of ensuring compliance.

The Philippines has no law requiring internal Shariah Boards, hence any agency with Islamic
financial products and services can opt to convene an Ad Hoc Shariah body outside its
organizational structure. However, it is remains SHFC’s responsibility to seek its own Shariah
oversight to ensure that its Islamic finance programs are shariah-compliant.

A Shariah compliance or oversight body is composed of independent, specialized jurists who are
learned in Islamic commercial jurisprudence, and are experts in Islamic financial transactions. It
should have a clear mandate and responsibility for ensuring that SHFC adheres to Shariah rules
and principles with respect to all Islamic financial products and services that the agency offers. If
SHFC is keen on mandating this CMP as Shariah-compliant, it is highly recommended that a
Shariah Compliance Report or Statement be issued at each Islamic financial transaction.

Below is a sample Shariah Board Statement from Kuwait Finance House:

As a reiteration, SHFC should identify the qualities of Al – Qalam Institute for Islamic Identities
and Dialogue in Southeast Asia, that warrants its Shariah Board as a viable Shariah oversight body
for the agency. It is recognized that Al-Qalam is a resource center of the Ateneo de Davao
University, and does not represent itself as a Muslim institution in both its mandate and activities.
Therefore, caution must be taken that such institution is not be understood to be a Shari’ah
council for purposes of Islamic financial services until and unless the Institute has presented the
necessary requisites of an independent Shariah compliance unit for Islamic financial services.

For qualifications of membership in Shariah bodies, we can look at Bank Negara Malaysia (Central
Bank of Malaysia), in absence of legislation on Shariah councils in the Philippines:

BNM Guidelines on Shariah Committee

1 April 2005
 All Shariah Committee members are expected to participate and engage themselves
actively in deliberating Shariah issues put before them.

Qualifications:
• A member of a Shariah Committee shall be an individual. A company, institution or body
shall not constitute a Shariah Committee for the purpose of these Guidelines.

• The proposed member of the Shariah Committee shall at least either have qualification
or possess necessary knowledge, expertise or experience in the following areas:
(a) Islamic jurisprudence (Usul al-Fiqh); or
(b) Islamic transaction/commercial law (Fiqh al-Mu'amalat).

• It should however be noted that paper qualification on the above subjects will not be
mandatory as long as the candidate has the necessary expertise or experience in the above areas

Composition:
To ensure that the Shariah Committee would be able to function effectively, the composition of
the Shariah Committee shall consist a minimum of three (3) members.

In addition to the Shariah Committee, an Islamic financial institution is required to have a

minimum of one officer, preferably a person with knowledge in Shariah, who will serve as the
secretariat to the Shariah Committee.