It is necessary to bear in mind that there are basically two categories of financing, loans and investments. Under loans there is basically one type that is provided for by the Shariah which is Qard Al Hasan - a loan granted on compassionate grounds free of interest or service charge. Only certain categories of people qualify. The other category includes mudaraba, murabaha, ijarah, musharakah etc.
Islam makes a distinction between two categories of defaulting debtors. One type is he who defaults by necessity, i.e. a person whose financial situation is such that with the best of intentions he simply lacks the means of paying. The Qur'an is explicit that this is the debtor who deserves compassion and to be given a grace period. It is required that the defaulter be given respite until he is able to pay. The Holy Qur'an expressly states:
"And if the debtor is in difficulty, grant a delay until a time of ease. But if ye remit it (the debt) by way of charity, that is best for you if ye only knew. (2:280)
This verse suggests that creditors should readily grant pressed debtors additional time to pay. Islam does not encourage a creditor to give an extension to every debtor who defaults. The extension is for debtors in genuinely dire straits.
As for the second type, the debtor who refuses to pay even though he has the
means, he is a perpetrator of injustice (zulm) who, far from deserving alms, exposes himself to possible punishment.
The Holy Prophet SAW condemns the person who delays the payment of his dues without a valid cause. He said in a hadith "The well off person who delays the payment of his debt subjects himself to punishment and disgrace".
The fulfilment of one's obligation under all contracts is a religious duty for every Muslim. Allah says:
"O ye who believe! Fulfil (all) your undertakings." (5:1) And He says:"...and keep the covenant. Lo! of the covenant it will be asked." (17:34)
So he who defaults deliberately contravenes Allah's law. The Prophet S.A.W. for this reason said in a hadith: " the defaulting (matl) of a man of means (ghaniyy) is wickedness (zulm)."
With regards to enforcement of the debt, the contract entered into between the Islamic financial institution and its client is legal and valid and in the event of default the Islamic financial institution can exercise its right in court to enforce the contract based on a creditor and debtor relationship.Some Islamic jurists hold that that which is compulsory in religion is enforceable in law. Also there is a majority view that anything prohibited in the Shari'ah if committed can be punished under what is called ta'zeer, where the punishment is not specified.
On the penalty to be imposed on the defaulter, the Judge exercises his discretion depending on the nature of default. He can admonish, threaten, disgrace or even jail the defaulter and if necessary dispose of his asset to pay the debt. However, it is generally agreed by Islamic jurists that a monetary fine is not one of the options open to the Judge in this case as this would amount to a monetary penalty for delayed payment, which is riba or interest.
Some contemporary views suggest that such a fine is permissible if it is applied to charity as a deterrent, but this seems to some as, at best, doubtful in its validity.
On what measures an Islamic bank can take to protect itself from defaulting clients, firstly, Islamic banks operating in a non-Islamic environment will need to ensure that the laws of the land punish defaulters on commercial contracts or have deterrents as a fall-back. Secondly, and perhaps more importantly the onus is higher in an Islamic bank for establishing the character of the borrower, by obtaining a character reference, possibly a credit check of the client's past borrowings. The primary assumption is that this situation should not arise as every true Muslim should pay his debts when due as a religious obligation.
And Allah knows best
