11

INTRODUCTION TOINTRODUCTION TOISLAMIC BANKING & ISLAMIC BANKING &

FINANCEFINANCEByBy

Muhammad AyubMuhammad Ayub (Former) Head, Islamic Banking, NIBAF (Former) Head, Islamic Banking, NIBAF

State Bank of PakistanState Bank of Pakistan

Presented at Presented at AlHuda CIBE Workshop at LahoreAlHuda CIBE Workshop at Lahore

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Topics to be DiscussedTopics to be Discussed

Why Islamic Banking?Why Islamic Banking? The Prohibition and Concept of RibaThe Prohibition and Concept of Riba Key Misconceptions – General MythsKey Misconceptions – General Myths Features of an Islamic Bank – OverviewFeatures of an Islamic Bank – Overview Overview of Islamic finance ModesOverview of Islamic finance Modes Shirkah – Musharakah and MudarabahShirkah – Musharakah and Mudarabah MurabahaMurabaha IjarahIjarah Diminishing MusharakahDiminishing Musharakah

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Islamic Banking?Islamic Banking?

Banking encompassing Islamic injunctions Banking encompassing Islamic injunctions

To avoid: To avoid: Riba –Earning returns from loans and debts or Riba –Earning returns from loans and debts or

Selling debt contracts at discountSelling debt contracts at discount Gharar – Absolute Risk or Excessive uncertainty Gharar – Absolute Risk or Excessive uncertainty

in contracts, Gambling and chance-based in contracts, Gambling and chance-based games (Qimar)games (Qimar)

General ProhibitionsGeneral Prohibitions unethical practicesunethical practices

Shariah Compliance & Prudent BankingShariah Compliance & Prudent Banking

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Riba ProhibitionRiba Prohibition

All revealed religionsAll revealed religions Severe Prohibition in Quran $ SunnahSevere Prohibition in Quran $ Sunnah

Unanimity on Riba Prohibition;Unanimity on Riba Prohibition; Problem then?Problem then? InterpretationInterpretation ConsensusConsensus

55

Quran Guides on Def of RibaQuran Guides on Def of Riba

Financial Liability:Financial Liability:Qard (Loan) : to give anything in ownership of other Qard (Loan) : to give anything in ownership of other

by way of virtue - same or similar amount of that by way of virtue - same or similar amount of that thing would be paid back on demand or at the thing would be paid back on demand or at the settled time.settled time.

Dayn (Debt) : Incurred by way of trade or rent or any Dayn (Debt) : Incurred by way of trade or rent or any other credit transaction - ought to be returned at other credit transaction - ought to be returned at the settled time without any profit.the settled time without any profit.

Verse 2: 279 guides that whatever is over and above Verse 2: 279 guides that whatever is over and above the principal of loans or debts is Riba.the principal of loans or debts is Riba.

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Riba?Riba? All increases in wealth or benefits accruing All increases in wealth or benefits accruing

to a person without any labour, risk, or to a person without any labour, risk, or expertise.expertise.

One who wishes to earn profit on his One who wishes to earn profit on his monetary investment must bear the loss or monetary investment must bear the loss or damage accruing to the business where his damage accruing to the business where his money capital is to be used.money capital is to be used.

Nature of transaction important.Nature of transaction important. Trading- Bai- Risk taking, value additionTrading- Bai- Risk taking, value addition Leasing – Ijarah - Risk taking, value additionLeasing – Ijarah - Risk taking, value addition

Exchange transaction – Monetary transactionsExchange transaction – Monetary transactions Lending – a virtuous act; not a businessLending – a virtuous act; not a business Hand to hand exchange of currenciesHand to hand exchange of currencies

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Misconceptions - MythsMisconceptions - Myths

Any Return on deposits is Riba;Any Return on deposits is Riba; Any prefixed return – RibaAny prefixed return – Riba Islamic banking: cost-less money Islamic banking: cost-less money

available – Approach of Businesses available – Approach of Businesses Repayment of loans not a serious issue Repayment of loans not a serious issue

–be waived of–be waived of Trade profit similar to interest on loans / Trade profit similar to interest on loans /

debtsdebts

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RealityReality

Differentiating: Trading, loaning and Differentiating: Trading, loaning and leasingleasing

Return by way of pricing of goods and their Return by way of pricing of goods and their usufruct needs to be fixed: permissible. usufruct needs to be fixed: permissible.

Islamic banking is also a business, It does Islamic banking is also a business, It does not mean availability of cost free money. not mean availability of cost free money.

Repayment of debts is must.Repayment of debts is must. Time value of money is accepted to the Time value of money is accepted to the

extent of pricing of goods but not in the extent of pricing of goods but not in the form of conventional opportunity cost form of conventional opportunity cost concept.concept.

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Riba - UnanimityRiba - Unanimity

Banu Thaqif of Taif, not to forego Banu Thaqif of Taif, not to forego interest on their receivables; Banu Amr interest on their receivables; Banu Amr ibnal Moghirah refused to pay interest; ibnal Moghirah refused to pay interest; Referred to the H Prophet, the Referred to the H Prophet, the Revalation came:Revalation came:

“O you who believe. Fear Allah, and give up the Riba that remains outstanding if you are (in truth) believer”. (11:278).

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RibaRiba - - Unanimity Unanimity ( (Contd)Contd)

““If you do not do so, then be sure of If you do not do so, then be sure of being at war with Allah and his being at war with Allah and his Messenger. But, if you repent, then Messenger. But, if you repent, then you have your principal”. (11:279)you have your principal”. (11:279)

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And if you repent, And if you repent, then you have your then you have your principal.principal. Wrong not, and you shall not be Wrong not, and you shall not be wronged ”. {without inflicting or receiving wronged ”. {without inflicting or receiving injustice}injustice}

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And fear the day when you shall be brought back And fear the day when you shall be brought back to Allah.to Allah.

Then shall every soul be paid what it earned and none shall be dealt with unjustly.

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Riba versus BaiRiba versus Bai

Those who protested and argued that lending on interest was like an act of trade, were admonished through revelation that while ‘trade’ was permitted, ‘riba’ was forbidden and in loan transactions they were entitled to their principal sums only.

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Some other MythsSome other Myths

Credit and cash market prices of a Credit and cash market prices of a commodity must be samecommodity must be same

Profit margin on credit sale by banks Profit margin on credit sale by banks resembles Riba.resembles Riba.

Sharing vs. Non Sharing instruments:Sharing vs. Non Sharing instruments: Permissibility & Priority two different Permissibility & Priority two different

aspectsaspects Money can be rented like other assetsMoney can be rented like other assets

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RealityReality

Profit margin that Islamic banks charge in their Profit margin that Islamic banks charge in their trade operations is permissible if trading principles trade operations is permissible if trading principles given by Islam are properly taken care of. given by Islam are properly taken care of.

PLS modes have preference but Debt creating PLS modes have preference but Debt creating modes also permissible; Banks can use any modes modes also permissible; Banks can use any modes keeping in view the Risk Profile of the investors keeping in view the Risk Profile of the investors and nature of business and cash flow of and nature of business and cash flow of entrepreneurs.entrepreneurs.

Money cannot be rentedMoney cannot be rented

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They used to say that it is all equal whether we They used to say that it is all equal whether we increase the price in the beginning of the sale, increase the price in the beginning of the sale, or we increase it at the time of maturity. It is or we increase it at the time of maturity. It is this objection which has been referred to in the this objection which has been referred to in the verse by saying “They say that the sale is very verse by saying “They say that the sale is very similar to Riba.” (Ibn-Abi-Hatim)similar to Riba.” (Ibn-Abi-Hatim)

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Types of RibaTypes of Riba Riba Al-Fadl - sale transactions, Riba Al-Fadl - sale transactions,

Quality premium in exchange of low Quality premium in exchange of low quality with better quality goods of same quality with better quality goods of same kind; prohibited e.g. dates for dates, kind; prohibited e.g. dates for dates, wheat for wheat etc.wheat for wheat etc.

Riba Al-Nasia - loan transactions. Riba Al-Nasia - loan transactions. Riba Al-Nasia (Riba Al-Ouran) involved in Riba Al-Nasia (Riba Al-Ouran) involved in

credit/delay; modern banking transactions credit/delay; modern banking transactions falls under Riba Al-Nasia, falls under Riba Al-Nasia,

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Overall ConsensusOverall Consensus Council of Islamic Ideology (CII): Preliminary WorkCouncil of Islamic Ideology (CII): Preliminary Work CII Report on Elimination of Interest from the CII Report on Elimination of Interest from the

Economy (June, 1980) – Economy (June, 1980) – Unanimously EndorsedUnanimously Endorsed Representation of all Muslim sects in PakistanRepresentation of all Muslim sects in Pakistan

Justice Dr. Tanzil-ur-Rahman (J Afzal Cheema)Justice Dr. Tanzil-ur-Rahman (J Afzal Cheema) Mawlana Zafar Ahmad AnsariMawlana Zafar Ahmad Ansari Mufti Sayyahuddin KakakhelMufti Sayyahuddin Kakakhel Khawaja Qamruddin SiyalviKhawaja Qamruddin Siyalvi Mawlana Muhammad Taqi UsmaniMawlana Muhammad Taqi Usmani Mawlana Muhammad Hanif NadviMawlana Muhammad Hanif Nadvi Allama Syed Muhammad RaziAllama Syed Muhammad Razi Mr. Khalid M IshaqMr. Khalid M Ishaq

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Other ProhibitionsOther Prohibitions

Compensation-based restructuring of debts Compensation-based restructuring of debts

Selling debt contracts at discount ExcessiveSelling debt contracts at discount Excessive

uncertainty in contracts (Gharar)uncertainty in contracts (Gharar)

Gambling and chance-based games Gambling and chance-based games

Forward foreign exchange transactions Forward foreign exchange transactions

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GhararGharar Excessive uncertainty regarding subject matter Excessive uncertainty regarding subject matter

and the price;and the price;

Inadequacy and Inaccuracy of Information - Inadequacy and Inaccuracy of Information - Uncertainty - lack of adequate value-relevant Uncertainty - lack of adequate value-relevant information – Transparency and disclosure .information – Transparency and disclosure .

Any bargain in which the subject matter / result of Any bargain in which the subject matter / result of it is hidden; settlement risk / counterparty risk it is hidden; settlement risk / counterparty risk involvedinvolved

Only exception: "Salam” (forward sale with Only exception: "Salam” (forward sale with prepayment)." and “Istisna´a” (order to prepayment)." and “Istisna´a” (order to manufacture)manufacture)

Rationale of this exemption.Rationale of this exemption.

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GamblingGambling

Maysir (game of chance) :getting something Maysir (game of chance) :getting something too easily or getting a profit without too easily or getting a profit without working for it.working for it.

Qimar includes every form of gain or Qimar includes every form of gain or money, acquisition of which depends purely money, acquisition of which depends purely on luck and chance.on luck and chance.

All Lottery based prize Schemes covered All Lottery based prize Schemes covered under the definition of gambling and Maysir.under the definition of gambling and Maysir.

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EncouragementsEncouragements

BenevolenceBenevolence

Transparency and disclosuresTransparency and disclosures

Purification of incomePurification of income

Comprehensive and universal ethical Comprehensive and universal ethical

approachapproach

DocumentationDocumentation

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Welfare Economy FrameworkWelfare Economy Framework

Socio-economic JusticeSocio-economic Justice Distributive JusticeDistributive Justice Ethics and value systemEthics and value system Functioning of the Market & Role of the State:Functioning of the Market & Role of the State:

Right of ownership, freedom of enterprise, over Right of ownership, freedom of enterprise, over seeing role of the State.seeing role of the State.

Transparency and disclosures Transparency and disclosures Competitive price mechanismCompetitive price mechanism Creating additional value and sharing gainsCreating additional value and sharing gains

Closer linkage between real economy & financeCloser linkage between real economy & finance Society happy both materially and spiritually.Society happy both materially and spiritually.

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Businesses / Modes of ArabsBusinesses / Modes of Arabs

Trading, Muzara’ah, Musaqat (Gardening with Trading, Muzara’ah, Musaqat (Gardening with Shirkah), Services (Ujrah and Ijarah) – The Shirkah), Services (Ujrah and Ijarah) – The Main businesses;Main businesses;

Barter and the Money based transactions;Barter and the Money based transactions; Individual Businesses, with self capital or Individual Businesses, with self capital or

arranged on Riba;arranged on Riba; Loans, Debts (Credit /Future contracts – Loans, Debts (Credit /Future contracts –

Salam/SalfSalam/Salf PartnershipPartnership

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Impact of contractsImpact of contracts Bai: Definite transfer of ownership of goods against Bai: Definite transfer of ownership of goods against

payment of price-spot, delayed and forward; payment of price-spot, delayed and forward; Profit Profit permissiblepermissible

Ijarah (leasing): Transfer of usufruct of goods. Any Ijarah (leasing): Transfer of usufruct of goods. Any thing which cannot be used without consuming its thing which cannot be used without consuming its corpus, or whose corpus changes its form in the corpus, or whose corpus changes its form in the process of its use, cannot be leased out like money, process of its use, cannot be leased out like money, edibles, fuel, etc. edibles, fuel, etc. Rental permissibleRental permissible

Riba: Exchange transactions involving temporary Riba: Exchange transactions involving temporary transfer of ownership of assets against payment. transfer of ownership of assets against payment. Any Any return prohibited.return prohibited.

Qadr Hassan / Tabarrue: Temporary transfer of Qadr Hassan / Tabarrue: Temporary transfer of ownership of goods/assets free of any payment;ownership of goods/assets free of any payment;

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What Islamic Banking?What Islamic Banking?

Banking encompassing Islamic injunctions Banking encompassing Islamic injunctions

To avoid: To avoid: Riba –Earning returns from a loan contract or Riba –Earning returns from a loan contract or

Selling debt contracts at discountSelling debt contracts at discount Gharar – Absolute Risk or Excessive uncertainty in Gharar – Absolute Risk or Excessive uncertainty in

contracts, Gambling and chance-based games contracts, Gambling and chance-based games (Qimar)(Qimar)

General ProhibitionsGeneral Prohibitions unethical practicesunethical practices

Shariah Compliance & Prudent Banking Shariah Compliance & Prudent Banking Achieving the goals and objectives of an Islamic Achieving the goals and objectives of an Islamic

economy.economy.

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A Paradigm Shift!A Paradigm Shift!

ConventionalConventional Borrowing on Borrowing on

interestinterest Lending on Lending on

interestinterest Money – the Money – the

Subject matterSubject matter Services against Services against

wages or wages or commissioncommission

IslamicIslamic Trading- Shariah Trading- Shariah

RulesRules LeasingLeasing Doing other real Doing other real

sector businesses sector businesses through sole through sole proprietorship or proprietorship or ShirkahShirkah

Services against Services against wages or wages or commissioncommission

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Principles of Islamic FinancePrinciples of Islamic Finance Lending a virtuous act – Not a business. Lending a virtuous act – Not a business.

Prohibition of Riba and Gharar; permission of Prohibition of Riba and Gharar; permission of trading. trading.

All gains to principal not prohibited.All gains to principal not prohibited. Deciding Factor: nature of transaction.Deciding Factor: nature of transaction.

Profit to be earned by sharing risk and Profit to be earned by sharing risk and reward of ownership through pricing of reward of ownership through pricing of goods, services or benefits.goods, services or benefits.

Time has value that can be discounted only Time has value that can be discounted only through price; not in the form of interest, through price; not in the form of interest, sometimes negative value as well.sometimes negative value as well.

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Profit linked with LiabilityProfit linked with Liability

Ownership cannot be separated from the risk Ownership cannot be separated from the risk of its lossof its loss

Al Kharaj Bil damanAl Kharaj Bil daman The above implies that entitlement to return The above implies that entitlement to return

from an asset is intrinsically linked to the from an asset is intrinsically linked to the liability of loss of that assetliability of loss of that asset What that implies for the attitude towards What that implies for the attitude towards

risk?risk? What that implies for time value of money?What that implies for time value of money?

in loansin loans in deferred salesin deferred sales

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Cardinal Principles Cardinal Principles (Contd)(Contd)

Ability to cause ‘value addition’.Ability to cause ‘value addition’. Differentiating: Trading, loaning and leasingDifferentiating: Trading, loaning and leasing

Ownership TransferOwnership Transfer in: Sale of assets, Loans and in: Sale of assets, Loans and Leasing;Leasing;

Any thing which cannot be used without consuming Any thing which cannot be used without consuming its corpus, cannot be leased out like money, edibles, its corpus, cannot be leased out like money, edibles, fuel, etc.fuel, etc.

Taking rent on leasing of asset permissible while rent Taking rent on leasing of asset permissible while rent on loan is prohibited.on loan is prohibited.

Repayment of loan- Must.Repayment of loan- Must. Husan al qada: Repaying a loan in excess of the Husan al qada: Repaying a loan in excess of the

principal.principal. Debt contracts cannot be sold at discount.Debt contracts cannot be sold at discount.

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Cardinal principlesCardinal principles

Risk and return / rights and liabilities must go Risk and return / rights and liabilities must go side-by-side;side-by-side;

The subject of exchange has to be valid and The subject of exchange has to be valid and should not involve Gharar;should not involve Gharar;

Notional assets stand no where in Islamic Notional assets stand no where in Islamic finance;finance;

Non-existing assets can become the subject Non-existing assets can become the subject matter of exchange with the conditions matter of exchange with the conditions applicable to Salam;applicable to Salam;

The main objective of exchange transactions The main objective of exchange transactions has to be completion of the exchange process has to be completion of the exchange process from the both sides. from the both sides.

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Alternative Financing Alternative Financing PrinciplesPrinciples

Participation and sharing principleParticipation and sharing principle

Deferred trading principleDeferred trading principle

Interest free loans Interest free loans

Combination of contractsCombination of contracts

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Wealth and trading rulesWealth and trading rulesForms of Forms of

Wealth (Mal)Wealth (Mal)ClassificationClassification Trading ruleTrading rule

Goods, durable Goods, durable assets, shares assets, shares of companiesof companies

Non-debtsNon-debts Market pricesMarket prices

Pooled assets Pooled assets are traded in are traded in accordance accordance

with the rule of with the rule of the dominant the dominant

assetsassetsServicesServices

UsufructsUsufructs

Money, gold Money, gold and silverand silver

MoneyMoney Sarf Sarf

DebtsDebts Pure debtsPure debts Hawala al Hawala al dayndayn

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Exchange RulesExchange Rules Different for different contracts and types of wealth:Different for different contracts and types of wealth:

Goods, Durable assets, Shares representing pool Goods, Durable assets, Shares representing pool of assets - Market based pricingof assets - Market based pricing

Gold silver or any monetary units (Athman) – Gold silver or any monetary units (Athman) – Rules of Bai al SarfRules of Bai al Sarf

Usufruct and services (Leasing/ Services)Usufruct and services (Leasing/ Services)

Loans/Debts – Repayment or Assignment of the Loans/Debts – Repayment or Assignment of the same amount.same amount.

Well-Known Injunction on exchange of six Well-Known Injunction on exchange of six commodities: Gold, Silver, Wheat, Barley, Dates and commodities: Gold, Silver, Wheat, Barley, Dates and Salt.Salt.

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Exchange Rules (Nawawi)Exchange Rules (Nawawi) Illah Illah (Effective Cause of prohibition): Unit of value (Effective Cause of prohibition): Unit of value

and Edibilityand Edibility

When underlying When underlying illah illah is different, short fall/excess is different, short fall/excess and delay both are permissible, e.g. sale of gold for and delay both are permissible, e.g. sale of gold for wheat.wheat.

When commodities of exchange are similar, excess When commodities of exchange are similar, excess and delay both are prohibited, e.g. gold for gold or and delay both are prohibited, e.g. gold for gold or wheat for wheat, Rupee for Rupee, etc.wheat for wheat, Rupee for Rupee, etc.

When commodities of exchange are heterogeneous When commodities of exchange are heterogeneous but the but the illahillah is same, as in the case of gold for silver is same, as in the case of gold for silver (medium of exchange) or wheat for rice (edibility), (medium of exchange) or wheat for rice (edibility), then excess/deficiency is allowed, but delay in then excess/deficiency is allowed, but delay in exchange is not allowed.exchange is not allowed.

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Exchange of Currencies Exchange of Currencies Contd)Contd)

Special rules for exchange of monetary Special rules for exchange of monetary values.values.

Currency Futures: Some scholars forbid them Currency Futures: Some scholars forbid them while others distinguish between the two while others distinguish between the two cases:cases:

First, where First, where one currency is delivered on spot and one currency is delivered on spot and the other is delayedthe other is delayed - - forbiddenforbidden. .

Second, Second, permitted,permitted, involves the involves the future exchange of future exchange of both currencies at the previously agreed rate.both currencies at the previously agreed rate.

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Banking - A BusinessBanking - A Business Banking or Benevolence ?Banking or Benevolence ?

Principle of Islamic banking business: Sharing of Principle of Islamic banking business: Sharing of profit and loss on post facto basis arising from:profit and loss on post facto basis arising from:

i.i. (Deferred) Trading– profit margin for the (Deferred) Trading– profit margin for the sellerseller

ii.ii. Rentals on leased assetsRentals on leased assetsiii.iii. PLS PLS iv.iv. Combination of contractsCombination of contracts

Return free (loans)Return free (loans)

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Main Financial ContractsMain Financial ContractsA. Debt creating Modes (Low Risk Category)A. Debt creating Modes (Low Risk Category)

1.1. Qard Al-Hasan (interest-free loan)Qard Al-Hasan (interest-free loan)2.2. Bai Muajjal (Price deferred sale)Bai Muajjal (Price deferred sale)3. 3. Murabaha and Musawama Murabaha and Musawama 4. 4. Salam (Commodity sale)Salam (Commodity sale)5.5. Istisna´a (Istisna´a ((Order to Manufacture)(Order to Manufacture)

B. Semi-debt ModesB. Semi-debt Modes1. 1. IjaraIjara

C. Sharing or Non-debt Modes (Full Risk C. Sharing or Non-debt Modes (Full Risk Category)Category) 1. 1. Musharaka (Close to Venture Capital)Musharaka (Close to Venture Capital)2. 2. Specific Purpose Mudaraba Specific Purpose Mudaraba 3. 3. General Purpose MudarabaGeneral Purpose Mudaraba

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conditions for Valid saleconditions for Valid sale

General Rule:General Rule:

Commodity should have come Commodity should have come into existenceinto existence. .

It should be in ownership of the It should be in ownership of the seller.seller.

The commodity should also be The commodity should also be under physical or constructive under physical or constructive possession of the seller.possession of the seller.

Two exceptions to this rule- Salam & Istisna´aTwo exceptions to this rule- Salam & Istisna´a

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Contract of Valid BaiContract of Valid Bai

C e rta inM u ta 'a yyan

K n o w n(M a lo o m )

P riceT h am an

U se a b le(n o t p roh ib ited

in S ha ria h)

V a lua b le

O w n ersh ip /risk o fse lle r

V a lid fo rO w n ersh ip /P o ssess ion

E x iste n t/e x ista b le

S u b jec t M a tte r(M a b e 'e )

C o n s tru c tive(H u km i)

P h ys ica l(H a q iq i)

D e live ry/C o n ve ya n ce(Q a b za)

V a lid B a i

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Principles of Credit SalePrinciples of Credit Sale Installments Sale permissible, even if the deferred Installments Sale permissible, even if the deferred

price exceeds the spot price.price exceeds the spot price.

Deferred prices can vary so long as price not Deferred prices can vary so long as price not finalised. finalised.

Sale cannot take place until the parties agree to a Sale cannot take place until the parties agree to a particular price & mode of payment. particular price & mode of payment.

Not permissible to fix the spot price on cash basis, Not permissible to fix the spot price on cash basis, then to charge interest expressly tied with different then to charge interest expressly tied with different periods. periods.

Commercial papers are lawful types of Commercial papers are lawful types of authentication of a debt by putting it down in writing; authentication of a debt by putting it down in writing; - Treated by Shariah near to mandatory.- Treated by Shariah near to mandatory.

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Two main prohibited SalesTwo main prohibited Sales

Bai al inah – Buy-back arrangementBai al inah – Buy-back arrangementCreditor purchasing assets from debtor on Creditor purchasing assets from debtor on

cash and selling back to him on creditcash and selling back to him on credit

• Bai al Dayn - sale of debtBai al Dayn - sale of debt

• Trading of debt securitiesTrading of debt securities

• On face value- Hawalah - PermissibleOn face value- Hawalah - Permissible

• On premium or discount – Not permissibleOn premium or discount – Not permissible

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Rules in MurabahaRules in Murabaha Basic concept: Sale on mutually agreed profit margin Basic concept: Sale on mutually agreed profit margin

on the known cost of goods; payment of sale price is on the known cost of goods; payment of sale price is deferred. deferred.

Real, tangible goods to be traded and not papers of Real, tangible goods to be traded and not papers of debt or credit documents.debt or credit documents.

Murabaha cannot be used as mode in case no Murabaha cannot be used as mode in case no commodity is purchased by the client.commodity is purchased by the client.

Buy-back arrangement: not allowed.Buy-back arrangement: not allowed.

MUAJJAL; Credit price may include margin of mark-up, MUAJJAL; Credit price may include margin of mark-up, taking into consideration the deferred payment. As a taking into consideration the deferred payment. As a debt, no return can be charged on the amount of debt, no return can be charged on the amount of Note/Bill.Note/Bill.

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MURABAHA ContdMURABAHA Contd Seller having a good title Seller having a good title physical / constructive possession.physical / constructive possession. Defaulter: different punishments, penalty for Defaulter: different punishments, penalty for

charity.charity. Solatium through court (out of penalty).Solatium through court (out of penalty). Client as Agent to the BankClient as Agent to the Bank; ; Better to have a third party as agent; Better to have a third party as agent; Roll-over.Roll-over. Asset price Risk or commodity risk ( client Asset price Risk or commodity risk ( client

might not take delivery);might not take delivery); Market risk, Market risk, Credit risk, Credit risk, Reputational RiskReputational Risk

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Rules in MusawamahRules in Musawamah

AA general kind of sale: Price bargained without any general kind of sale: Price bargained without any reference to the price paid or cost incurred.reference to the price paid or cost incurred.

Seller not obliged to reveal his cost. Seller not obliged to reveal his cost.

Different from Different from MurabahaMurabaha in pricing formula only. in pricing formula only.

MusawamahMusawamah can be used for big single deals. can be used for big single deals.

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Salam and Parallel ContractsSalam and Parallel Contracts (Future Sale) (Future Sale)

Prepayment of price in full for goods to be delivered in Prepayment of price in full for goods to be delivered in future.future.

Allowed by Holy Prophet (SAW) himself to meet Allowed by Holy Prophet (SAW) himself to meet farmers’ money need.farmers’ money need.

Banks will receive contracted commodities, not money.Banks will receive contracted commodities, not money.

Parallel Parallel Salam:Salam: a bank can sell a commodity purchased a bank can sell a commodity purchased through through SalamSalam for even the same date of delivery or the for even the same date of delivery or the quantity;quantity; As long as the two contracts are not made As long as the two contracts are not made

conditional on each other.conditional on each other.

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Purpose of SalamPurpose of Salam To meet the need of farmers who need money To meet the need of farmers who need money

to grow their crops and to look after their family to grow their crops and to look after their family up to the time of harvest.up to the time of harvest.

To finance someone who is in need to grow something To finance someone who is in need to grow something or acquire something for further sale.or acquire something for further sale.

To meet the need of traders for import and To meet the need of traders for import and export business.export business.

The buyer also enjoys a lower purchase price, since he The buyer also enjoys a lower purchase price, since he pays in advance.pays in advance.

Acceptance of Time. Value of Money through pricing of Acceptance of Time. Value of Money through pricing of goodsgoods

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Salam ConditionsSalam Conditions

Fungible – homogeneous goodsFungible – homogeneous goods

not where delivery has to be simultaneous, not where delivery has to be simultaneous, e.g. Gold, silver or currencies.e.g. Gold, silver or currencies.

Date and place of delivery must be specified Date and place of delivery must be specified in the contract.in the contract.

In case of a number of commodities, the In case of a number of commodities, the amount and delivery period should be amount and delivery period should be separately fixed.separately fixed.

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Salam Conditions Contd…Salam Conditions Contd…

The bank can sell the Salam Commodity The bank can sell the Salam Commodity through a parallel contract of Salam for the through a parallel contract of Salam for the same date of delivery.same date of delivery.

For a parallel Salam, the two contracts should For a parallel Salam, the two contracts should be independent and separately enforceable.be independent and separately enforceable.

Bank can also obtain a unilateral ‘promise to Bank can also obtain a unilateral ‘promise to purchase’ from a third party. purchase’ from a third party.

AgencyAgency To sell anywhere in the marketTo sell anywhere in the market

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Istisna’a (Order to Manufacture)Istisna’a (Order to Manufacture)

Istisna’a,Istisna’a, an agreement for order to manufacture, an agreement for order to manufacture, culminating into a sale at an agreed price; culminating into a sale at an agreed price;

The things to be manufactured must be known and The things to be manufactured must be known and specified to the extent of removing any ignorance specified to the extent of removing any ignorance or lack of knowledge of its kind, type, quality, and or lack of knowledge of its kind, type, quality, and quantity.quantity.

Price be known in advance that can be readjusted Price be known in advance that can be readjusted only by mutual consent of the parties.only by mutual consent of the parties.

5151

Istisna’a (ContdIstisna’a (Contd))

Prepayment not necessary in Prepayment not necessary in Istisna’aIstisna’a Not necessary for seller to Not necessary for seller to

manufacture the commodity himselfmanufacture the commodity himself

Parallel Parallel Istisna’aIstisna’a contract; without any contract; without any condition attached to the original condition attached to the original

Istisna’aIstisna’a contract. contract.

5252

Salam, Istisna DifferentiatedSalam, Istisna Differentiated

ISTISNA’ISTISNA’ The subject on which The subject on which

transaction of Istisna’ transaction of Istisna’ is based, is always a is based, is always a thing which needs to thing which needs to be manufactured.be manufactured.

Price must be fixed, Price must be fixed, but need not to be but need not to be paid in advancepaid in advance

SALAMSALAM Subject can be Subject can be

anything; Agri anything; Agri produce, produce, Manufactured goods Manufactured goods all units of which are all units of which are normally of the same normally of the same ..

Price has to be paid Price has to be paid in full in advancein full in advance

5353

Salam, Istisna DifferentiatedSalam, Istisna Differentiated

ISTISNA’ISTISNA’ Time of Delivery Time of Delivery

does not have to be does not have to be fixed ; can be fixed ; can be delivered before the delivered before the settled time.settled time.

The contract can be The contract can be cancelled before the cancelled before the manufacturer starts manufacturer starts working.working.

SALAMSALAM Time of delivery is an Time of delivery is an

essential part of the essential part of the salesale

The contract cannot The contract cannot be cancelled be cancelled unilaterally.unilaterally.

5454

Distinction of IstisnaDistinction of Istisna

Penalty on defaultPenalty on default

Shart-e-JazaiShart-e-Jazai

5555

Ijarah RulesIjarah Rules

Subject Matter:Subject Matter: The corpus of the leased asset should exist till the The corpus of the leased asset should exist till the

expiry of lease period; expiry of lease period; The corpus of the leased asset should remain in The corpus of the leased asset should remain in

the ownership of the lessor during the whole the ownership of the lessor during the whole period of lease; in case of Shirkah pro-rata period of lease; in case of Shirkah pro-rata ownership.ownership.

The lessor must accept responsibility of any The lessor must accept responsibility of any defect in leased asset (without negligence of the defect in leased asset (without negligence of the lessee) which hinders the intended use of asset.lessee) which hinders the intended use of asset.

Sale – Separate and independent contractSale – Separate and independent contract

5656

Flexibility in IjarahFlexibility in Ijarah

Fixed Vs. variable / floating returnFixed Vs. variable / floating return

Time of execution of the contractTime of execution of the contract

Potential in Sukuk IssuePotential in Sukuk Issue

5757

Shirkah - PartnershipShirkah - Partnership

Commingling by two or more persons Commingling by two or more persons either their money or work or obligations either their money or work or obligations to earn a profit or a yield or appreciation in to earn a profit or a yield or appreciation in value and to share the loss if any value and to share the loss if any according to their proportionate according to their proportionate ownership.ownership.Musharakah, Mudarabah, Diminishing Musharakah, Mudarabah, Diminishing MusharakahMusharakah

5858

Types of PartnershipTypes of Partnership

Musharakah: All partners provide funds not Musharakah: All partners provide funds not necessary equally, and all have right to wok;necessary equally, and all have right to wok;

Shirkatulmilk: Partnership in OwnershipShirkatulmilk: Partnership in Ownership Automatic –compulsoryAutomatic –compulsory Arranged - OptionalArranged - Optional

Shirkatulaqd: General / Commercial Shirkatulaqd: General / Commercial partnership – for joint businesspartnership – for joint business

Musharakah – general contractual Musharakah – general contractual partnershippartnership

One party provides capital and the other One party provides capital and the other managementmanagement

5959

Profit / Loss SharingProfit / Loss Sharing

Profit distribution: as per agreed ratio;Profit distribution: as per agreed ratio; Loss: in proportion to the investment of Loss: in proportion to the investment of

each party. each party. Profit allocation: in percentages of earning Profit allocation: in percentages of earning

(profit) and not a sum of money or a percentage (profit) and not a sum of money or a percentage of the capital or investment.of the capital or investment.

No guarantee of the capitalNo guarantee of the capital Loss?Loss?

6060

Structures of MusharakahStructures of Musharakah

Permanent Musharakah: partners can sell - as in Permanent Musharakah: partners can sell - as in case of Shares of Joint Stock Companies.case of Shares of Joint Stock Companies.Temporary (Redeemable) Musharaka: for limited Temporary (Redeemable) Musharaka: for limited time period, e.g. PTCs or Musharakah based time period, e.g. PTCs or Musharakah based TFCs; After agreed time period(s), TFCs; After agreed time period(s), Diminishing Musharakah: one partner promises to Diminishing Musharakah: one partner promises to buy the share of the other partner gradually until buy the share of the other partner gradually until the title to the property is completely transferred to the title to the property is completely transferred to him.him.

6161

Reference RatesReference Rates Reference rates needed for executing and pricing the Reference rates needed for executing and pricing the

contracts.contracts.

Different scales for different kinds of financial Different scales for different kinds of financial contracts.contracts.

For Conventional finance: Only one reference rate For Conventional finance: Only one reference rate (interest rate), (interest rate),

Islamic finance: debt/semi-debt contracts and non-Islamic finance: debt/semi-debt contracts and non-debt (equity) contracts, debt (equity) contracts,

Therefore, two reference scales are needed: Therefore, two reference scales are needed: • Price mark up/rent reference scale Price mark up/rent reference scale • Share ratio reference scale, through the Central Share ratio reference scale, through the Central

Bank Mudaraba ratio or Interbank Mudaraba ratio.Bank Mudaraba ratio or Interbank Mudaraba ratio.

6262

ChallengesChallenges Parallel Functioning of the two systems – the Parallel Functioning of the two systems – the

greatest challengegreatest challenge Creating AwarenessCreating Awareness Catering to the education and training needs. Catering to the education and training needs. Development of Shariah compliant financial Development of Shariah compliant financial

instruments - for SLR, Govt. Financing.instruments - for SLR, Govt. Financing. Changes in legal and taxation structure.Changes in legal and taxation structure. Responsibility of advising, coordination and Responsibility of advising, coordination and

leadership by any institution/authority for the leadership by any institution/authority for the transformation process.transformation process.

Commitment at all levels.Commitment at all levels. Ultimate Objective: To establish banks that are Ultimate Objective: To establish banks that are

Shari’ah compliant, enjoy depositors’ confidence, Shari’ah compliant, enjoy depositors’ confidence, and are efficient and stable!and are efficient and stable!

6363

Key Areas in Future Key Areas in Future DirectionDirection

Justifiable profit distribution mechanismJustifiable profit distribution mechanism Focusing asset managementFocusing asset management Potential scope of Shari’ah complaint Potential scope of Shari’ah complaint

financial engineeringfinancial engineering Financial stabilityFinancial stability Shari’ah complaint risk management toolsShari’ah complaint risk management tools Corporate governance, transparency and Corporate governance, transparency and

disclosures requirementsdisclosures requirements

6464

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