An overview of AAOIFI Standard Number Four is presented. It should be noted only a summary and overview of the standard is presented, the full standard is available from AAOIFI.
The aim of this standard is to outline rules governing the use of set-off in settling debts, the Shari’a requirements and conditions applicable to set-off, what is permissible or not permissible in this procedure and the most significant practices of Islamic financial institutions (institution/institutions) in this regard.
This standard shall apply to the settlement of debt by way of set-off. The standard shall not apply to discharge of liability by way of transfer, solving of obligation, composition, acquisition of a right payable or bilateral cancellation of a contract.
This standard is issued on 29 Safar 1422 H, corresponding to 23 May 2001.
A set-off is the discharge of a debt receivable against a debt payable. It is divided into two main forms: mandatory set-off and contractual set-off.
A mandatory set-off is a set-off that occurs without the need for bilateral agreement or consent of both indebted parties and, in some cases of mandatory set-off, it is one party that is forced to comply with the request of the other party for set-off. It is divided into compulsory set-off (on both parties) and set-off on demand (of the person with the superior debt whereby the other party is obliged to comply with the demand).
A contractual set-off is the discharge of two debts by the consent of the two parties to extinguish their obligations towards each other.
It is permissible for the institution and its customers or other institutions to exchange bilateral promises that debts that may be created between them in the future will be settled by way of set-off, in which case all the conditions mentioned in the items 2/1 and 2/2 will be applicable at the time of actual set-off. However, if the currencies of the two debts differ, a bilateral exchange of promise of set-off should be concluded on the basis that a set-off will take place based on the current currency exchange rate at the time of actual set-off; this ruling is to prevent the practices of riba by roundabout methods or by implied agreement for practicing riba.
The followings are some rules of set-off to modern transactions:
The currency swaps that are concluded on the basis of riba are not permissible. This is because in this process it is the interest-based securities that are set-off against, interest-based securities.