Contract structure
Ta'widh and Gharamah
Two different late-payment charges: one is meant to reimburse the bank's real costs and it keeps that money, the other is a fine and in some countries the bank must give it away.
How it works
When you pay late, an Islamic card cannot charge you interest on the arrears. Instead, two mechanisms are used and they are not the same thing. Ta'widh is compensation for a loss the bank actually suffered, such as the cost of chasing you: letters, calls, legal fees. Gharamah is a fine, imposed to make you pay on time, with no need to prove any loss at all. The split matters to you because of where the money goes. Where both are allowed, the bank may usually keep the ta'widh as income but must channel the gharamah to charity. That is why an Islamic card statement can show a late charge and a note saying part of it is donated. Whether a bank should be able to charge either of these is the single sharpest disagreement between the standard-setters.
What it looks like in numbers
Illustrative figures, not a real product. You owe RM 2,000 and pay 30 days late. The bank shows a late payment charge of RM 20. Under the Malaysian model, the part representing the bank's actual recovery costs is ta'widh and the bank keeps it as income; the rest is gharamah and must go to charitable bodies rather than to the bank's profit. Under AAOIFI's standard, a bank could not stipulate any financial charge for the delay at all, could only recover the legal and other expenses it actually incurred to recover the debt, and could ask you to sign an undertaking to donate an amount to charity if you procrastinate. The RM 20 line on your statement therefore means different things depending on which rulebook your bank follows.
The argument
Scholars do not all agree about this structure. Both positions are set out here because you are entitled to see the disagreement rather than one side of it.
Why it is accepted
Bank Negara Malaysia's Shariah Advisory Council, at its 4th meeting on 14 February 1998, 95th meeting on 28 January 2010 and 101st meeting on 20 May 2010, resolved that a late payment charge combining gharamah and ta'widh is permissible subject to four conditions: ta'widh may be charged on late payment arising from exchange contracts such as sale and lease, and on qard; it may be imposed only after the settlement date has passed; the institution may recognise ta'widh as income because it compensates actual loss; and gharamah 'shall not be recognised as income. Instead, it has to be channeled to certain charitable bodies'. The SAC's reasoning rests on the hadith that delay by a rich person in paying a debt is a tyranny, on the maxim 'neither harming nor reciprocating harm', and on an analogy to usurpation (ghasb). DSN-MUI's card fatwa takes the same shape: clause Keenam (a) permits ta'widh for costs the issuer actually incurred through the cardholder's lateness, and clause Keenam (b) permits a late charge which 'akan diakui seluruhnya sebagai dana sosial', that is, will be recognised entirely as social funds.
Why it is challenged
AAOIFI prohibits it. Shariah Standard No. 3, clause 2/1/2, states that 'it is not permitted to stipulate any financial compensation, either in cash or in other consideration, as a penalty clause in respect of a delay by a debtor in settling his debt, whether or not the amount of such compensation is pre-determined; this applies both to compensation in respect of loss of income (opportunity loss) and in respect of a loss due to a change in the value of the currency of the debt'. Clause 2/1/3 bars even a court claim for such compensation. Only actual legal and recovery expenses may be recovered, under clause 2/1/4. AAOIFI's Appendix B explains that any increase in the amount of the debt for delay is riba, and points back to a decision of the International Islamic Fiqh Academy that 'it is impermissible from the Shari'ah perspective to stipulate a condition of compensation in the case of delay in the settlement of a debt'. The Fiqh Academy said the same in Resolution No. 109 (3/12) at its 12th session in Riyadh in September 2000: 'the imposition of a penalty clause in debt contracts is usurious in the strict sense'. The one route AAOIFI does allow is the charity undertaking at clause 2/1/8: a debtor may undertake that, if he procrastinates, he will donate an amount or a percentage of the debt to charitable causes through the institution.
Where AAOIFI stands
Against. AAOIFI Shariah Standard No. 3 clauses 2/1/2 and 2/1/3 prohibit stipulating or claiming financial compensation for late payment of a debt, including opportunity loss and currency depreciation. Clause 2/1/4 allows recovery of actual legal and other recovery expenses. Clause 2/1/8 permits a charity undertaking. Clause 2/4 permits non-financial pressure such as adding the defaulter to a blacklist. So in AAOIFI jurisdictions the late-payment lever is a donation and a bad credit record, not a fee to the bank.
The rulings that govern it
AAOIFI · Shariah Standard No. (3), Procrastinating Debtor, clauses 2/1/1 to 2/1/4 and 2/1/8
Deliberate default by a solvent debtor is prohibited. No financial compensation may be stipulated or judicially claimed for delay. Actual recovery expenses may be recovered. A charity undertaking for procrastination is permitted.
Read the sourceOIC International Islamic Fiqh Academy · Resolution No. 109 (3/12), 12th session, Riyadh, 25 Jumada al-Akhirah - 1 Rajab 1421 AH / 23-28 September 2000
A penalty clause in a debt contract is usurious in the strict sense. Penalty clauses remain permissible in construction, supply and manufacturing contracts where the obligation is not a debt.
Read the sourceBank Negara Malaysia Shariah Advisory Council · Shariah Resolutions in Islamic Finance, 2nd edition, item 81 (4th meeting 14 February 1998; 95th meeting 28 January 2010; 101st meeting 20 May 2010)
A late payment charge combining ta'widh and gharamah is permissible. Ta'widh may be recognised as the institution's income; gharamah may not and must be channelled to charitable bodies.
Read the sourceDSN-MUI · Fatwa No. 54/DSN-MUI/X/2006 on Syariah Card, clause Keenam
The issuer may charge ta'widh for costs it actually incurred because of the cardholder's late payment, and may charge a late charge which is recognised entirely as social funds.
Read the source
What to watch for
- Ask the bank to split its late charge into ta'widh and gharamah, and ask what proportion goes to charity. If it cannot answer, that is informative.
- A late charge that is a percentage of the outstanding balance behaves like interest whatever it is called. A charge tied to the bank's actual recovery costs will not scale neatly with your balance.
- In Malaysia the SAC also ruled that a bank may not charge you compensation for settling early (24th meeting, 24 April 2002). If you are quoted an early settlement penalty, question it.
- Non-financial consequences are permitted everywhere. AAOIFI expressly allows blacklisting, so a late Islamic card payment can still damage your credit record.
- Paying a charity charge is not a free pass. Every body cited here treats deliberate late payment by someone who can afford to pay as wrongdoing in itself.
Sources
- AAOIFI, Shariah Standards, 2015 English edition, Shariah Standard No. (3) Procrastinating Debtor, issued 27 Safar 1421 AH / 31 May 2000, amended by the Shariah Board at meeting No. (38), 26-28 June 2014.
- OIC International Islamic Fiqh Academy, Resolution No. 109 (3/12), 12th session, Riyadh, September 2000.
- Bank Negara Malaysia, Shariah Resolutions in Islamic Finance, 2nd edition (2010), items 81 and 82.
- DSN-MUI, Fatwa No. 54/DSN-MUI/X/2006 tentang Syariah Card, clause Keenam.
This explains the mechanism, not the ruling