Application of Guarantee contracts in Islamic Financial Transaction: Analysis of BNM and AAIOFI

<jats:p>A guarantee (Kafalah) is considered an effective Islamic finance contract aimed at providing assurance and security by having a third party; the guarantor, commit to fulfilling the financial obligations of the debtor in case of default. However, Bank Negara Malaysia (BNM) policy document considered guarantee as the term (kafālah) while the Accounting and Auditing Organization for Islamic Financial Institutions (AAIOFI) considered it as the term Damān. The term guarantee falls within the category of non-compensatory contract in classical Islamic financial contracts whereby there are no returns or compensation available for contracts like benevolence loans (Qard), gifts (Tabarru/Hibah), guarantee (Kafalah), and assignment of debt (Hawalah). In the modern financial setting, this might not fulfill one of the objectives of Islamic financial institutions to offer services for profit. This study explores the application of Guarantee (Kafalah) as a non-compensatory and noncommutative contract, falling under the category of Uqud Ghair Mua’wadha in Islamic Financial Institutions. Contracts such as benevolence loans (Qard), gifts (Tabarru/Hibah), guarantees (Kafalah), and assignment of debt (Hawalah) are characterized by the absence of return or compensation.
This study uses the doctrinal approach of the qualitative method in exploring juristic meaning, justification, and implications of the shariah terms. It analyses the sustainable implication of its application in contemporary Islamic finance institutions between BNM and AAIOFI. This study found that despite the classical implication of guarantee as a non-compensatory contract guarantee contracts cannot yield a direct profit; yet can generate income through, Wakālah (agency fee), such as issuing LCs guarantees. These may be charged based on expenses incurred, potentially in amount-based (possibly slabs) but not time-based structures. The finding shows that the comparative analysis of regulatory frameworks by BNM and AAIOFI underscores the challenges of harmonizing global standards with local contexts, highlighting the necessity for ongoing dialogue and collaboration to ensure coherence and adaptability in Islamic finance regulation.</jats:p>