Our writings are like children with their parents. We try to improve and monumentalize them to the best of our abilities but once they leave our house they lead a life of their own. So is the case with a Diminishing Balance Model I designed for Islamic home finance and presented at a conference in early 2010 at the Riphah International Islamic University, Islamabad. I was happy; it attracted attention so much so that the Executive Director of ISRA travelling with me back to Kuala Lumpur expressed the desire to publish it in his esteemed International Journal of Islamic Finance where it appeared as the lead article in Volume 3, Number 1 June 2011. The model was admired by Mr. Agil Natt the then President and CEO of INCEIF. Later on Mr. Daud Vicary Abdullah who now decorates that position hailed the model as a break through innovation in Islamic finance. I started calling it the Zubair Diminishing Balance Model (ZDBM) with affection.
The romance was then over. The model was presented in a faculty seminar at INCEIF. It received a lot of comments having many constructive queries but were, in my opinion, also ill-informed in some measure. I had to defend the child, put a lot of flesh on it and provided shield to ward off the incoming brickbats. The revision is awaiting publication in a prestigious journal. The child has grown into an adult but still stays with me. I present the bare bones of this model here for the learned readers of the blog to seek comments for improvement. Let me start with a brief of the illustrative case I used in the ISRA article.
A client of an Islamic bank books a house costing $100,000 with a seller paying $20,000 as the earnest money for a 3 months wait. He approaches the bank for the remaining $80,000 financing payable in 20 half-yearly installments. The bank spells out the terms as follows. “You have already paid $20000 to the seller as earnest money. The remaining $80000 the bank shall pay for acquiring a proprietary share in the house, you acting as our agent. For getting back the amount $80,000 in half-yearly installments over a period of ten year, we shall put a yearly mark-up of 8% for our ownership share in the house. However, the mark-up amount will be reduced proportionate to the return of our money. That would help reduce your liability to the bank. The registration of the house in the court will be in your name but you will have to sign simultaneously a mortgage deed pledging the property with the bank as security until installments are all cleared”. The client agreed.
The bank provides him a Table detailing his half-yearly installment payments. A portion of the table is produced below. This is a simple table; the arrows showing how the return on capital will be calculated. The de facto average rate of return the client will pay to the bank is [$33600/80000] /10 = 4.2% per annum.
Leaving out the finer legal and regulatory positions of the ZDBM, we may tentatively identify its structure as consisting of three mutually exclusive and independent contracts for consecutive execution.
- A sale contract involving the customer, the bank and the seller giving co-ownership of the house to the first two in a 20:80 division. The customer will work as the agent of the bank under an appropriate letter of authority.
- A second contract whereby the bank sells his share to the customer with an agreed 8% mark-up over cost, $80000.
- A third contract whereby the customer mortgages the house with the bank until the installments have all been paid in full.
The above Figure shows the mutual contractual relationship of the three parties. The seller will be out of the picture after the first contract. The client and the bank will stay together for 10 years. The structure we have suggested may be suitably amended by the Shari’ah scholars, if the need be. In the next posting I shall compare the ZDBM with the MMP to bring out its merits, insha Allah.