Shariah Non-compliance Income (SNCI) in Tawarruq Home Financing in Malaysia: An Exploratory Study

Islamic bank differs from conventional counterpart as its operates and managed accordance to the principles of Islamic law (Shariah). Islamic banks must ensure that all of their businesses, operations, and activities are Shariah-compliant. However, it is undeniable that the Islamic banks are constantly exposed to Shariah Non-compliance events such as failure to meet Shariah requirements or Shariah standards, which resulted in generating Shariah Non-compliance Income (SNCI). Tawarruq based financing is responsible for a higher proportion of Shariah Non-compliance events in Malaysian Islamic banks, accounting for 40% of these incidents. Therefore, this study explores the SNCI contributed by tawarruq contract by focusing on home financing products offered by Islamic banks in Malaysia. SNCI in tawarruq home financing were explored through document analysis and semi-structured interview conducted with three experts, which consist of two practitioners and one academician from different institutions and had different positions. Empirical findings from document analysis and semi-structured interview revealed that sequence of sale contract, disclosure of contract, possession and delivery, wakalah agreement, ta’widh, renewal of financing, and purpose of financing are significantly contributed to the SNCI in tawarruq home financing. Sequence of sale contract was found to be the most significant factor that contribute to the Shariah non-complaint events in Malaysia tawarruq home financing. The findings from this study highlight at least three policy implications to mitigate Shariah Non-compliance events. First, Islamic banks should strengthen their Shariah governance frameworks, enhance transparency in contractual terms, and improve procedural rigor to ensure compliance. Second, regulatory bodies should enforce stringent compliance audits and reporting requirements to mitigate Shariah Non-compliance risks. Finally, banks should invest in training programs to build a deeper understanding of Shariah principles among staff and ensure that technological solutions are leveraged to monitor and enforce compliance effectively. This comprehensive approach can significantly reduce SNCI, thereby enhancing the credibility and financial stability of Islamic banking institutions in Malaysia.