KUALA LUMPUR, June 25 (Reuters) – Malaysia’s central bank has ordered sharia banks to give borrowers a rebate for early settlement under new rules designed to prevent legal disputes and restore confidence in Islamic financing contracts.

The ruling from Bank Negara’s sharia advisers will standardise the use of rebate, or ibrar, in bai bithaman ajil and murabaha financing contracts which are widely used in Malaysia’s $95 billion Islamic finance market.

Unlike conventional loans which levy interest on the accrued portion upon default, Islamic contracts are often asset sales where banks are entitled to the entire sum based on the whole tenure of the contract, regardless of when default occurs.

In practice, Islamic banks can grant a rebate to waive their right to the unaccrued sum but such discounts are discretionary, resulting in legal disputes. If a rebate is not given, sharia financing contracts can be more costly than conventional loans.

“In line with the need to safeguard maslahah (public interest) and to ensure justice to the financiers and customers, Islamic banking institutions are obliged to grant ibrar to customers for early settlement of financing based on buy and sell contracts,” the ruling said.

The ruling, effective June 7, requires the right of rebate to be specified in contracts. The method of computing the rebate will be determined by the central bank.

Ibrar is derived from the traditional Islamic notion of loans where charitable financing is extended to the poor and the lender writes off the debt if the borrower can’t afford to repay.

Some practitioners said the ruling would resolve uncertainties relating to the use of ibrar but was difficult to reconcile with the sharia’s tenets.

“It throws into doubt the legal principle which has traditionally been that ibrar cannot be compelled because it is at the discretion of the creditor,” said Mohamad Illiayas, an Islamic banking lawyer in Kuala Lumpur.

“In murabaha, bai bithaman ajil and bai ina contracts the price is one of five critical elements, the absence of which, or uncertainty or ambiguity with regard to any of the five elements would render a contract void.”

Figures on the value of bai bithaman contracts are hard to come by but Malayan Banking (MBBM.KL) had earlier estimated that these contracts, along with bai inah and bai al dayn (debt trading contract) account for over 80 percent of the Islamic banking portfolio in Malaysia.

Islamic banking assets in Malaysia, which has the world’s largest bond market, totalled about $95 billion or 19.6 percent of total banking system assets as at December 2009, according to central bank data.

Figures were not available on the number of Islamic financing defaults in Malaysia. (Click on [ID:nISLAMIC] for more Islamic finance stories and ISLAMIC for a speed guide) (Editing by Kim Coghill)