Malaysia’s move to liberalise Islamic banking may raise some eyebrows | Beyond Brics | FT.com

Malaysia is well known in the Islamic finance world for a liberal interpretation of religious principles that has made the country a centre of innovation. But eyebrows will be shooting skywards in more conservative countries over its latest decision to allow banks to impose late payment penalties on customers who default.

The country’s Shariah Advisory Council, a statutory body that sets the rules for Islamic finance, said on Tuesday that it would allow the imposition of late payment charges as a deterrent against default, under the concepts of gharamah (fine or penalty) and ta’widh (compensation).
Banks will not be allowed to treat the gharamah element as income, and any payments must be channelled to specified charitable bodies. However, ta’widh payments can be treated as income, to the extent that they are imposed as compensation for actual losses incurred by the Islamic banking institutions.

That stops banks making a profit out of the penalties, which would be contrary to accepted Islamic principles. But it is an important move because it will impose some pain on borrowers who are thinking of defaulting, which will in turn make banks more willing to extend loans.