The values of Islamic financial contracts are fairness, risk and profit sharing, as well as protection and security for each party. Islamic financial contracts intend to produce the legal consequences that each party wants to realize.  

However, according to a report by the Indonesian Supreme Court, there were more than 2,000 disputes at the cassation level related to Islamic banking transactions. The increasing number of Islamic financial disputes shows substantial challenges in applying Islamic finance in Indonesia. It is undeniable that there must be hurdles within systems and some unsolved questions among those who use Islamic financial products.

There are at least two burning issues in the application of Islamic financial contracts that are often the source of disputes. The most common issue is ibra’, whereby the financial consumers expect to get a rebate in a murabaha contract when they settle their debt before the contract maturity.

In a murabaha contract, the financial consumers buy the product that the bank has purchased in the first place. In this regard, each party is bound to the price of this sale and purchase contract. However, it seems unfair if there is no appreciation for those who can commit to settling the debt earlier than maturity. 

In this regard, the Indonesian Ulema Council (MUI) issued sharia resolution No. 23/DSN-MUI/III/2002. The fatwa states that Islamic financial institutions may provide a deduction from the payment obligation. However, the rebate should not be written in the contract but fully at the bank’s discretion. The fatwa enables a fairer transaction while maintains the financial sustainability of the banks.

Nonetheless, financial consumers know little about the different characteristics of this kind of financing compared to the conventional one. The banks and all Islamic financial institutions have to put their efforts into educating and advising consumers based on their financial needs. Furthermore, it is important for the Islamic financial institutions to fully disclose and highlight this issue in their product disclosure sheet. By doing so, the consumers will be much more aware and it will reduce potential disputes in the future.

The second burning issue is ta’widh, or penalty for debtors due to default. This issue is often considered a non-sharia compliance practice and has no significant difference from the conventional financial system. However, it is much easier to understand if we look at both parties. Once a default occurs, then another party will bear the risk. Therefore, losses must be eliminated based on sharia principles, and its loss will not be removed unless it is replaced.

Fatwa DSN MUI Series 129/DSN-MUI/VII/2019 also incorporated such conditions. For instance, the compensation should be based on the real cost that occurred due to default. The cost is also to be detailed and can be traced, such as incurred direct variable cost. By explaining that ta’widh only refers to the real cost, therefore it can be mentioned in the agreement between parties for future certainty.

Misinformation surrounding Islamic financial products and their features can lead to a variety of problems, such as misleading transactions, financial disputes and even public distrust. These hurdles do not only affect the development of Islamic banking institutions but also the growth of the whole Islamic finance industry

Therefore, financial literacy on Islamic financial contracts must be increased for all financial consumers in Indonesia. The campaign should cover the comprehension of general Islamic financial contracts and their risk features. Banks and consumers should step up this effort.

The suggestions and evaluations are provided to gain productive input for a better Islamic financial system. Furthermore, the prevention of disputes is always important and better than mediation. Thus risk mitigation is worthwhile rather than disqualifying the values of Islamic finance.

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Nuha Qonita has a licentiate degree in Islamic Law from Al Azhar University in Cairo and an MSc in Islamic finance from Durham University in the UK. Randi Swandaru is a PhD candidate of Islamic Finance in Kuala Lumpur.