 In this module, we would look at the treatment of default in case of murabaha. And afterwards, we would look at the treatment of early payment rebate as well. Strictly speaking, in case of any Islamic financing, there must not be any default penalty. Default penalty is actually core of the prohibition of riba. In the times of ignorance, the most famous type of suit was actually a default penalty. For example, if a person borrowed 100 days from another person for 3 months, if a person borrowed 100 days from another person for 3 months, the loaner would say, I give you another 3 months, but instead of 100 days, I give you 200 days. That is an example of default penalty. And Allah Subhanahu Wa Ta'ala prohibited riba primarily because of this default penalty. Hence, when I say that there should not be any default penalty in Islamic banking and finance, this is to ensure that Islamic banks inadvertently do not end up charging riba. So, important thing is that from a principal viewpoint, there should not be any default penalty in Islamic banking and finance. And if there is some kind of penalty imposed because of default or because of delay, that should not be part of the contract of the financing facility. It could be a separate arrangement between the two parties or imposed by a third party. So, default penalty, strictly speaking, should not be in Islamic banking and finance. Similarly, offering rebate on early payment, that should be completely in full discretion of the seller. If someone has bought a loan on the basis of payment deferred basis, and after a few years, the customer who has bought the loan says, I have the money, take it from me, then the shopkeeper should not be allowed to reduce the amount of the rebate. Otherwise, there is no obligation on the seller to reduce the price because someone is paying early. So, keep these two things in mind. As a principal, there is no guarantee of default penalty in Islamic financing and if Islamic banks do not give early payment rebate, then there is no problem with Islamic viewpoints. But, we see that default penalty and early payment rebate are actually doing Islamic banks. So, these two things, default penalty and early payment rebate, they are being practiced by Islamic banks. The question arises, why? The main reason for this is that we, Muslims, Mashallah, are not able to fulfill our obligations. If I owe to someone some money, even I have money available, it is quite likely that I would not pay, i.e. I would default. In case of Islamic banks, in case of the customers of Islamic banks, if there is no default penalty, their customers would be willfully defaulting on them. To stop this, contemporary Sharia scholars have allowed Islamic banks to impose a default penalty on the condition that the banks would not benefit from the money collected in the form of default penalty. Now, they have collected the penalty. Sharia scholars say that that money should be given in charity because if the bank uses that money, that would be considered as riba. Similarly, if a bank has sold a car on a murabha financing basis and the disclosed profit was such and such, the car's price was Rs. 20 lakh in the market. The bank has sold it for Rs. 30 lakh on a car financing basis. And this facility was for 5 years. The customer had money and he said three years later that he would like to pay all the money. I want to pay early. So give me some rebate. There is no provision of this rebate in Islamic law. i.e. Islamic law does not obligate the bank or the seller to reduce the price. If the Islamic bank does not do this, then the Islamic banks will be greatly defamed because conventional banks actually offer early payment rebate. So the regulators actually ask Islamic banks to offer early payment rebate as well. We will come to this later. Let's look at the default penalty. So a customer owes debt of Rs. 500,000 to this bank and this credit facility is for 5 years. The monthly installments are Rs. 8,333.33. The customer pays these monthly installments and actually up to this point, when it has made 50 installments already out of 60 installments, it defaults. It does not pay the installment at that time. So that is the case of a default. What happens? By that time, the customer has already paid Rs. 416,666 out of Rs. 500,000 worth of debt. And the total amount outstanding at that time is Rs. 83,333.33. This loan is still remaining and the customer has defaulted that I cannot pay money. Bank of course would start negotiating and it took the bank about 3 months before the customer was in a position to start paying and at that time the bank would like to settle this thing. So in case of Murabaha, how would Islamic Bank determine the amount of late payment penalty? There are different formulas in the world. Malaysia would have a different formula than what Pakistan would have. But I would give example of a general formula. And a simple formula for your understanding. That late payment penalty formula is this. This is equal to say 1% of the number of days of default. That 90 days of default, 3 months would be the end use of the passes. So the number of days of default, divided by total number of days of facility left would be divided by the remaining 10 months. And multiply this whole with the amount outstanding, which was Rs. 83,000. So in this way, when you put all these figures, 90 over 200, because it was 210, the remaining 3 months would be 7 months. So that one, this would give a late payment penalty of 357.1. This would give to the customer bank. And the customer, most of this amount would give out in the form of charity. Most why? Because in all these processes, the administrative costs of the poor bank are involved. So if there are any costs involved, the remaining amount would give out to the charity. Now I used 1% in the last formula. In certain jurisdictions, the rate that 1% is actually replaced with a rate which is used by conventional banks. Why? Because it was observed that if late payment penalty was softer in case of Islamic banks, then conventional banks, then a customer who owes certain amount to a conventional bank and certain amount to an Islamic bank would default on the financing by Islamic bank. To ensure that this kind of moral hazard problem doesn't occur, the regulators allow Islamic banks to charge a penalty based on a rate which is actually equivalent to what the conventional banks are allowed. Anyway, in case of Islamic banks, whether this penalty is this much or that much, this is going to go into a charity.