Wealth - Islamic perspective

Document Sample
Wealth - Islamic perspective Powered By Docstoc
					Islamic Financial Instruments

                               Najmul Hassan
                                 General Manager,
         Corporate Banking & Business Development

                   Islamic Finance

 Islamic Shariah is the set of rules &
  regulations which are to be followed by
  Islamic Banks.

 Scholars study these laws and guide the
  bank on how to apply them on day to
  day transactions.


              Rules of Sale

• Since Murabaha is a sale transaction, rules
  of Shariah regarding sale need to be

• Sale is defined in Shariah as

   “Exchange of a thing of value, by another
     thing of value, with mutual consent”

            Legitimacy of sale

• “But Allah has permitted trade” [2:275],
• “But take witnesses whenever you make a
  commercial contract” [2:282],
• “But let there be among you traffic and
  trade by mutual good will” [4:29],
• “It is no crime for you to seek the bounty
  of your Lord” [2:198].

                 Rules of Sale

Rule 1
  The subject of sale must exist at the time of sale

Rule 2
  The subject of sale must be in the ownership of
  seller at the time of sale. Hence, what is not
  owned by the seller cannot be sold.

                 Rules of Sale

Rule 3
  The subject of sale must be in the physical or
  constructive ownership of seller at the time of

  “Constructive Possession” means where the
  buyer has not taken physical delivery of goods,
  but the goods are under his control. And all
  rights and liabilities of the goods have passed to
  him,i.e. the goods are at his risk.

                Rules of Sale

Rule 4
  The sale must be instant and absolute. Thus a
  sale attributed to a future date or a sale
  contingent on a future event is void.

                Rules of Sale

Rule 5
  The subject of sale should be an object of value.
  A thing having no value according to the usage of
  trade cannot be sold.

Rule 6

  The subject of sale should not be a thing used for
  a Haram purpose, e.g. pork, wine etc. The
  subject should be Maal-e-mutaqawwam

                Rules of Sale

Rule 7
  The subject of sale should be specifically known
  and identified to the buyer. The subject of sale
  must be identified by pointing out or by detailed
  specification which can distinguish it from other
  things not sold.

Rule 8

  The delivery of the sold commodity to the buyer
  should be certain and should not depend on a
  contingency or chance.
                 Rules of Sale

Rule 9

  The certainty of price is a necessary condition for
  the validity of sale.

Rule 10

  The sale must be unconditional. A conditional
  sale is invalid, unless the condition is recognized
  as a usual practice of trade



• Murabaha is a particular kind of sale and
  not a financing in its origin.

• Where the transaction is done on a “cost
  plus profit” basis i.e. the seller discloses the
  cost to the buyer and adds a certain profit
  to it to arrive at the final selling price.


• The distinguishing feature of Murabaha
  from ordinary sale is:

  - The seller discloses the cost to the

  - And a known profit is added.


• Payment of Murabaha price may be:

   1) At spot
   2) In installments
   3) In lump sum after a certain time

• Hence, Murabaha does not necessarily
  imply the concept of deferred payment.



1) Direct – where the financier himself
   purchases directly from the market or
   3rd party.

2) Indirect – where the financier appoints
   the customer as an ‘Agent’ to make
   purchases from the market before
   buying it from the bank.

                   Shari’a Source

The Holy Quran says “And Allah has permitted trade”

 It is further mentioned“But let there be among you
traffic and trade by mutual goodwill” (4:29)

According to Imam Shafi in Al-Umm: “If an individual
shows another a good and says: buy this, and I will
give you this much profit in it; and then the second
man buys it then the purchase is valid. If the first party
said: I will give you this much profit in it , but I retain
an option, then he may conclude the sale or leave
it.”(See Financial Transactions in Islamic Jurisprudence
Vol1 Pg 361)                                           17
                   Shari’a Source

As for making the promise to purchase the item once
the bank acquires it binding on the ultimate buyer, we
may take a ruling by ‘Ibn Shabramah from the Maliki
school that any promise that does not result in
permitting that which is forbidden or forbidding that
which is permitted is binding.
The Malikis use this principle to make the promise
binding, especially if the promise leads another entity
to undertake a financial obligation.

                    Shari’a Source

In the first Conference in Dubai (1979), it was ruled
that: “This type of promise is legally binding on both
parties based on the Maliki ruling, and religiously
binding on both parties for all the other schools. In this
regard, what is religiously binding can be made legally
binding if this is beneficial and can be regulated legally.”

                   Shari’a Source

The second Conference in Kuwait (1983) ruled thus:
“The conference determines that the mutual promises
involved in murabaha sales to the one who orders the
initial purchase is permitted after the bank owns and
gains possession of the sold object, and then sells it to
the one who ordered its purchase with the promised
profit margin.
This sale is valid as long as the bank is exposed to the
risk of destruction of the goods prior to delivering it to
the final buyer, as well as the obligation to accept the
return of the goods if a concealed defect was found. .”

                    Shari’a Source

   Cost-plus, sale is a legally permissible contract by
    the testimony of the majority of jurists and
    companions of the Prophet (pbuh).
   This type of sale satisfies all the legal requirements
    for sale, and it provides a valuable service in
    economic markets since it allows those
    knowledgeable of market conditions to make a profit
    and those without such knowledge to obtain the
    goods at a good price.
   It was narrated that ‘Ibn Masud (RA) ruled that
    there was no harm in declared lump-sum or
    percentage profit margins.

                   Shari’a Source

   The conditions of murabaha are as follows:
   Knowledge of the initial price: The second buyer
    must know the price at which the seller obtained the
    object of sale, since knowledge of the price is a
    fundamental condition for the validity of sale.
    Knowledge of the profit margin: Since the profit
    margin is a component of the price at which the
    second buyer obtains the goods, knowledge of that
    margin is essential for knowledge of the price, which
    is in turn a condition of validity for the sale.


The present day Murabaha transactions are
 being practiced under the guidelines given
 by Accounting & Auditing
 Organization of Islamic Financial
 Institutions (AAOIFI) and Islamic Fiqh
 Academy which have representation of
 scholars of all Islamic Fiqhs.


Basic rules for Murabaha financing:

•   Asset to be sold must exist.
•   Sale price should be determined.
•   Sale must be unconditional.
•    Assets to be sold:
    a) Cannot be used for un-Islamic purposes.
    b) Should be in ownership of the seller at the time
       of sale; physical or constructive.


Basic rules for Murabaha financing:

•   Re-negotiation of price after concluding the
    transaction and roll over of Murabaha are not

•   Discounting of Murabaha instrument is not

Step by step Murabaha financing
 (under Agency arrangement)


1. Client and bank sign an agreement to enter
   into Murabaha (MMFA).

         Bank                     Client
                   Agreement to


2. Client appointed as ‘Agent’ to purchase
   goods on bank’s behalf

          Bank                          Client
                      Agreement to


3. Bank gives money to Agent/supplier for
   purchase of goods.

          Bank                                  Client
                       Agreement to
        Disbursement to the agent or supplier


4. The agent takes possession of goods on bank’s

  Transfer of Risk          Vendor
                                        of goods

        Bank                               Agent


5(a). Client makes an offer to purchase the
      goods from bank through a declaration.

           Bank                    Client

                    Offer to


5(b). Bank accepts the offer and sale is

                  Murabaha Agreement
                    Transfer of Title
         Bank                           Client


6. Client pays agreed price to bank according to
   an agreed schedule. Usually on a deferred
   payment basis (Bai Muajjal)

          Bank                          Client
                     Payment of Price


                Murabaha Documentation

There are a number of documents involved in a
Murabaha financing transaction. The most
essential of these documents are:

• Master Murabaha Financing Agreement
• Agency Agreement
• Order Form / Draw Down Notice
• Declaration
• Purchase Evidences
• Demand Promissory Note
• Payment Schedule
               Murabaha Documentation

Master Murabaha Financing Agreement (MMFA)

• Its an agreement between the client and the
  Bank whereby the client agrees to purchase
  goods from the Bank from time to time as per
  terms and conditions of this agreement.
• This is an over all facility agreement under
  which various Sub-Murabahas may be executed
  from time to time.
• Hence it needs to be signed once, i.e. at the
  time the facility is sanctioned.

                Murabaha Documentation

Agency Agreement

• Through this agreement, the Bank appoints
  customer its agent to select and procure specified
  goods for the Bank.

• This agreement needs to be signed once,
  between the client and the bank to cover the
  specified agency period.The disbursement of
  funds is done under this agreement.

• The customer should define a comprehensive list
  of assets and commodities that he may procure
  during the course of business from time to time.
                Murabaha Documentation
Order Form
 • This document is executed at the time of each
   sub-Murabaha request i.e. each time when
   the customer requires funds for the purchase
   of assets.

 • Through this document customer requests the
   bank to purchase the assets from the supplier
   and undertakes that it will purchase the
   assets from the bank once the bank acquires
   them from the market.
 • The customer also undertakes to compensate
   for the actual loss the bank may suffer in case
   he fails to purchase the assets from the bank.
                Murabaha Documentation
• This is the most important part of the Murabaha
• Declaration is to be signed by the customer
  immediately after the purchase of goods as
  Bank’s agent but before the actual consumption.
• This document establishes the actual sale
  transaction, i.e. transfer of ownership of goods
  from the Bank to the customer
• At this stage the specific details of the assets
  must be known i.e. quantity, quality, cost etc.

                Murabaha Documentation
• Purchase Evidences in the form of bills, sale
  invoice, sales tax invoice must be furnished
  along with the Declaration, specifying the full
  details of the goods purchased.
• The cost of goods must be inclusive of all cost
  including sales tax, transportation and handling
• Proper timing of declaration is extremely
  important especially in cases of perishable or
  immediately consumable commodities.
• Murabaha price (Cost of Goods + Profit) should
  be determined at this stage and stated clearly in
  the Declaration.                             40
               Murabaha Documentation
Payment Schedule

• The Payment Schedule specifies the amount that
  the Client will make from time to time or at once
  towards the payment of Murabaha price.
• This shall be implemented after the execution of
• The dates mentioned in the schedule
  corresponds to the day when the payment
  becomes due on the client.

Practical Issues in Murabaha

                  Issues in Murabaha

1. Timing of Declaration
• A Murabaha financing arrangement consists of
  a series of documents to be executed at various
  stages, the sequence and timing of which is
  extremely important.
• Through declaration, the client and the bank
  execute an important step of a valid Murabaha
  sale i.e. Offer & Acceptance
• Declaration is to be signed by the customer
  when it has purchased and taken possession of
  the goods as the Bank’s agent.
• Declaration must be signed while the goods are
  still in existence and have not been used in the
  production process or sold to some other entity.
               Issues in Murabaha

2. Rollover in Murabaha
• Rollover in Murabaha is not possible since each
  Murabaha transaction is for the purchase of a
  particular asset. A new Murabaha can only be
  executed for the purchase of new assets.

• It is advisable that there must be a gap of 1-2
  days between maturity of the previous Murabaha
  and disbursement of the new one.

               Issues in Murabaha

3. Rebate on early payments

• This is normally prohibited by Shariah Board
  since it can make the Murabaha transaction
  similar to conventional debt.

                  Issues in Murabaha

4. Penalty on late payments
• As soon as the Murabaha is executed (declaration
  signed) the Murabaha price becomes a receivable
  (Dayn) for the Bank.
• As per the rules of Islamic fiqh any amount charged
  over and above the “dayn” amount will be Riba.
• Hence bank cannot charge any late payment
• The bank may, however, ask the customer to pay a
  forced charity in case of overdues so as to create a
  disincentive for him to delay the payment
                  Issues in Murabaha

5. Subject matter of Murabaha

•   Murabaha cannot be done in all commodities, e.g.
    Murabaha can not be done in currencies.
•   Murabaha cannot be used for paying utility bills,
    wages, overhead expenses, etc.
•   As per general rules of sale subject matter must
    - In existence
    - Having intrinsic utility
    - Usable for a Halal purpose (buyer must intend
      to use it for the same purpose)
    - Capable of ownership/delivery
    - Specified and quantified at the time of sale
    - Must be in Bank’s ownership/possession at the
      time of sale                                 47
                 Issues in Murabaha

6. Purchase Evidence

•   In order to ensure that the customer actually
    purchased the assets as claimed, the
    customer is required to submit asset purchase
    evidence along with declaration.
•   The purchase evidence must confirm that the
    asset purchase took place after the agency
•   Asset purchase may be in the form of
    Invoices, delivery orders, truck receipts etc.

               Issues in Murabaha

6. Purchase Evidence…..(Contd)

• In some cases, however, it may be too
  burdensome for the client to submit all the
  invoices as the number of invoices may run into

• For example, cotton purchases are generally in
  small quantities from various sources and
  hence for each Sub-Murabaha there may be too
  many invoices to submit. It is suggested to
  furnish samples of invoices along with summary
  of all purchases.

              Issues in Murabaha

7. Direct Payment in Murabaha

• Currently in many cases the disbursement is
  made to the customer as an agent.

• In order to ensure transparency of the
  Murabaha it is better that the bank disburses
  the funds directly to the supplier.

                Issues in Murabaha

7. Direct Payment in Murabaha…..(Contd)
•   Direct payment can be made in the following
    - The bank can pay the supplier directly via
      cash, cheque, pay-order etc.
    - The bank may credit the Murabaha funds in
      the customer’s account and only allow him to
      issue pay orders/demand drafts from his
      account in favor of the suppliers.

                 Applications of Murabaha

• Purchase of raw material; for meeting working
  capital needs of trade and industry.
• Medium to long term requirements for purchase
  of land, building and equipment.
• Trade finance products including imports,
  exports and alternative to bill purchase.



•   Ijarah is a term of Islamic Fiqh
•    Literally, it means “To give something on
•   The term “Ijarah” is used in two situations:
    1. It means ‘To employ the services of a
       person on wages’ e.g. “A” hires a porter at
       the airport to carry his luggage
    2. Another type of Ijarah relates to paying
       rent for use of an asset or property defined
       as “LAND” in Islamic Economics
               Ijarah: Shari’a Source

•    Leases, like sales, are among the contracts
    that are explicitly discussed in Islamic Law
•    Leases differ from sales due to the time
    limitation involved in leases, in contrast to
    sales where no time limit is allowed.
• The proof from the Sunnah is derived from the
  Hadith: “Pay the hired worker his wages before
  his sweat dries off”.

              Ijarah: Shari’a Source

• Narrated by Ahmad, Abu Dawud, and Al-Nasai
  with the wording: “The farmers during the
  time of the Prophet (pbuh) used to pay rent
  for the land in water and seeds. He (pbuh)
  forbade them from doing that, and ordered
  them to use gold and silver (money) to pay
  the rent”
• It is impermissible to charge a rental for gold
  or silver coins, or for any consumable good
  measurable by weight or volume.

                Ijarah as a mode of financing

• Ijarah is an Islamic alternative of Leasing.
• Leasing backed by an acceptable contract is an
 acceptable transaction under Shariah.
• The question of whether or not the transaction
 of leasing is Shariah compliant depends on the
 terms and conditions of the contract.
• Several     characteristics    of    conventional
 agreements may not conform to Shariah thus
 making the transaction un-Islamic and thereby
 invoking a prohibition.                         57
                Key Differences

 Risk and rewards of ownership lies with the
  owner i.e. any loss to the asset beyond the
  control of the lessee should be borne by the

 Late payment penalty cannot be charged to the
  income of the Lessor.

 Lease and Sale agreement should be separate
  and non contingent.

Difference b/w Conventional Lease &

Difference b/w Conventional Lease & Ijarah
  1. The Lessor cannot increase the rent
  2. Expenses to be borne by the parties:
     • Lessor- expenses relating to the corpus
       of the asset i.e. insurance, accidental
       repairs etc. will be borne by the lessor
     • Lessee- actual operating/overhead
       expenses related to running the asset will
       be borne by the lessee

Difference b/w Conventional Lease & Ijarah
  3. Two contracts into one contract is not
     permissible in Shariah therefore, the bank
     cannot have the agreement of hire and
     purchase into one agreement, only the bank
     can undertake/promise to purchase the
     leased asset
  4. Under conventional Lease, the Lease
     rental starts from the date of payment by
     Lessor.Under Shariah, the correct way to
     charge rent is after delivery of the asset to
     the Lessee. Because rent is charged for use
     of the asset
Process of Ijarah

                        .   .
  VENDOR          ISLAMIC   BANK   Agreement-1

 The customer approaches the Bank with the
  request for financing and enters into a promise
  to lease agreement.
 The Bank purchases the item required for
  leasing and receives title of ownership from the
 The Bank makes payment to the vendor
                Ijarah as a mode of financing
                                                    .       .
  VENDOR          ISLAMIC   BANK   Agreement-2

 The Bank leases the asset to the customer after
  execution of lease agreement.
 The customer makes periodic payments as per
 Title transfers to the customer

               Types of Ijarah

1. Direct – where the bank purchases an asset
  from a 3rd party and leases the same to the

2. Sale   &   Leaseback     –   where   the      bank
  purchases an asset already owned by the
  customer and leases back to the same person.
  This is permissible with certain conditions.

Rules of Ijarah
                   Rules of Ijarah

• Ownership of the leased asset remains with the
  Lessor during the term of Ijarah.

• Since ownership of the leased asset remains with
  the Lessor, all rights and liabilities relating to
  ownership are borne by the Lessor.

• The period of Lease must be determined in clear

• The Lessee is responsible for damage to the asset
  caused by fraud or negligence.
                  Rules of Ijarah

• Any damage to the asset not caused by the
  Lessee’s neglect, is to be borne by the Lessor.

• Normal maintenance is Lessee’s responsibility

• Lease rentals for the entire lease period must be

  a) Different amounts of rents can be fixed for
     different periods, but they must be known.

  b) The rent may be tied to a known benchmark,
     acceptable to both the parties.
                  Rules of Ijarah

• The Lease period will start when the asset has
     been delivered to the Lessee

  - in a usable condition

  - whether or not the Lessee has started using it

• Insurance is a cost related to ownership of the
  assets, and therefore should be borne by the

Ijarah Documentation
               Ijarah Documentation

 Undertaking to Ijarah
 Ijarah Agreement
   • Description of the Ijarah Asset
   • Schedule of of Ijarah Rentals
   • Receipt of Asset
   • Demand Promissory Note
 Undertaking to Purchase Ijarah Asset
 Sale Deed

              Applications of Ijarah

• For long and medium term fixed asset


• Retail products

  Ijarah as a mode of financing
Auto Finance – Car Ijarah
• First Islamic Car Financing Scheme

• Free from Interest/Riba

• It is not a Hire-Purchase agreement

Product Features
• For all Locally manufactured new cars
• Term                      3, 4 and 5 years
• No upfront Insurance Payment
• No advance Rental

Diminishing Musharakah


•   Musharakah is a form of partnership (Shirkat)
    between two or more parties whereby each
    party contributes to the capital of the partnership
    in equal or varying proportions either to establish
    a new venture or share in an existing one.

•   There are two types of Shirkah:

      1. Shirkat-ul-Milk

      2. Shirkat-ul-Aqd


1.   Shirkat-ul-Milk

     Joint ownership of two or more persons in a
     particular property.

2.   Shirkat-ul-Aqd

     A partnership affected by mutual contract. It can
     also be translated as a joint commercial

                  Diminishing Musharakah

• In Diminishing Musharakah the bank and the client
  participate either in joint ownership of
   – a property or an equipment,
   – or in a joint commercial enterprise

• The share of the bank is divided into a number of

• The client purchases these units one by one
  periodically until he is the sole owner of the

                   Diminishing Musharakah

•    Most commonly, Diminishing Musharakah is used
     in cases of Shirkat-ul-Milk

•    This concept is based on Declining ownership of
     the financier

•    Three components involved :

    1.   Joint ownership of the Bank and the customer
    2.   Customer as a lessee uses the share of the
    3.   Redemption of the share of the Bank by the
         customer                                      78
                  Diminishing Musharakah

Concept of Musha’

• Musha’ means undivided ownership of the asset

Lease of Musha

• It is allowed to lease Musha to other joint owner.

Shariah Principles

                Shariah Principles

• To create joint ownership in property is called
  Shirkat-ul-Milk and is expressly allowed by all
  schools of Islamic Jurisprudence.

• All Muslim Jurists agree on the permissibility
  of the Financier leasing his share in property
  to client and charging him rent i.e. the
  permissibility of leasing one’s share to his

• Promise of client to purchase units of share of
  financier is also allowed.

                Shariah Principles

• The Transactions cannot be combined in a
  single agreement and they have to be
  executed independently. This is because it is
  a well settled rule of Islamic Jurisprudence
  that one transaction cannot be made a
  condition for another.
• Instead of making the transactions a pre-
  condition for one another there can be one-
  sided promises from one party to another

Basic Structure

                   Diminishing Musharaka

MBL                     Ownership             CUSTOMER

 The customer approaches the Bank with the request for
  Project financing

 The Bank enters into a Musharaka (Joint Ownership)
  agreement with the customer and both of them pay their
  respective shares to the seller of the asset.

 Customer pays rent for the use of bank’s share in the

                     Diminishing Musharaka

MBL                           Ownership               CUSTOMER
                      Gradual Transfer of Ownership

 The customer approaches the Bank with the request for
  Project financing

 The Bank enters into a Musharaka (Joint Ownership)
  agreement with the customer and both of them pay their
  respective shares to the seller of the asset.

 Customer pays rent for the use of bank’s share in the
 Ownership of the asset is gradually transferred to the customer
  upon payment of asset price.
Legal Documentation

                       Legal Documentation

1. Musharakah Agreement

  Purpose: This is the main agreement that establishes the Bank’s
  share in the Musharakah Property.
     - Both parties share
     - Musharakah Property detail

2. Payment Agreement (Rent Agreement)

  Purpose: This agreement is signed after Main Musharakah
  Agreement. Bank gives its share to the customer via this
     - Rent Schedule
     - Formula of calculation
                          Legal Documentation

3. Undertaking to Purchase Musharakah Units
     Purpose: This is an undertaking by the customer to purchase
     Bank’s Musharakah units.

        - Normal Sale Price
        - Additional Unit Purchase Price

4.    Undertaking to Sell Musharakah Units
     Purpose: This is an undertaking       by   the   Bank   to   sell   its
     Musharakah units from time to time.

        - Normal Sale Price
        - Additional Unit Purchase Price


Diminishing Musharakah is commonly used for the
purpose of financing of fixed assets by various
Islamic banks.

    • House financing
    • Car Financing
    • Plant and machinery financing
    • Factory/Building financing
    • Agriculture land financing
    • All other fixed Assets

EasyHome - Islamic Housing Finance
First complete Islamic Home Finance
facility in Pakistan!

  Halal, Quick, Affordable & Hassle free

• A Comprehensive solution with:

 Easy Buyer - Buying a home is Easy & Halal

 Easy Builder - Building a home is Easy & Halal

 Easy Renovate - Renovating a home is Easy &

 Easy Replacement - Replacing your existing
mortgage is Easy & Halal
The Way Forward

                      The Way Forward

   Islamic banking is a viable alternative – however it is
    still in the development stage and has to go a long

   It needs to be supported in its mission to eliminate
    Riba from our business.

   Islamic options were unavailable in the past. Its not
    the case anymore. The onus is on us now.

   Positive criticism is always welcome but one should
    not be judgmental before having any knowledge.

   Ulema, bankers and professionals need to coordinate
    more frequently to help R&D.                      95
Jazak Allah
Thank you


Shared By:
fanzhongqing fanzhongqing http://