INSTRUMENT AND CONTRACT 1 Snurazani/PB303

Understand Islamic financial instruments

Describe the Islamic financial instruments that are available in Malaysia:

Al-Wadiah, Mudharabah, Musyarakah, Bai Bitaman Ajil, As-Salam, Murabahah, al- Ijarah, Wakalah, Kafalah, Ar Rahn, Qardul Hassan, Hiwalah, Al Dayn.

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Some of the Muslim countries like Pakistan, Iran, Malaysia, U.A.E, Jordan and Sudan have introduced many Islamic financial instruments in order to mobilize the idle resources for long-term productive and development activities on the basis of Islamic principles.

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Islamic finance is emerging as a rapidly growing part of the financial sector in the Islamic world.

Islamic finance is not restricted to Islamic countries, but is spreading wherever there is a sizable Muslim community.

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All Islamic banks and IBS banks have set up Shariah Committees to guide them on Shariah matters and to make sure that they function in a manner that is in line with the Shariah.

In addition, the advice of the Shariah Advisory Council which is the highest Shariah body set up at Bank Negara Malaysia, can be sought to ensure uniformity in views and practices.

The members of the Shariah Committees and the Shariah Advisory Council are academicians and Shariah experts in Islamic banking and finance.

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Mudharabah is a profit sharing arrangement between two parties, that is, an investor and the entrepreneur.

The investor will supply the entrepreneur with funds for his business venture and gets a return on the funds he puts into the business based on a profit sharing ratio that has been agreed earlier.

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The term mudarib: a user of the capital of an investor /entrepeneur

The term rabb al-mal: the investor

The mudarib, regarded as an entrepreneur, contributes management input, itself viewed as a form of capital.

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The principle of Mudharabah can be applied to Islamic banking operations in 2 ways:

I. Between a bank (as the entrepreneur)and the capital provider (customer)

II. Between a bank (as capital provider) and the entrepreneur (customer)

▪ Losses suffered shall be born by the capital provider.

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Islamic Banking offer investment accounts to their customer.

Under the arrangement, the deposits will be used by the bank for investment purposes, whereby the profit will be shared between the bank and the customers.

At the same time, the investment account holders bear part of the loss if the investments were not profitable.

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1. You supply funds to the bank after

agreeing on the terms of the

Mudharabah arrangement.

2. Bank invests funds in assets or in

projects.

3. Business may make profit or incur

loss.

4. Profit is shared between you and

your bank based on a pre-agreed

ratio.

5. Any loss will be borne by you. This

will reduce the value of the assets/

investments and hence, the amount

of funds you have supplied to the

bank.

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Is used in the mobilization of demand and savings deposits.

The bank is entrusted with the safe keeping of the customers’ deposit - can be withdrawn at any time upon demand by the customers.

Payments of dividends are not obligatory but at the discretion of the bank since the customer already benefit from the safe custody of their money. 11 Snurazani/PB303

Wadiah means custody or safekeeping. In a Wadiah arrangement, you will deposit cash or

other assets in a bank for safekeeping. The bank guarantees the safety of the items kept

by it.

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Know the Shariah

concept used and be clear of your rights and responsibilities

1. You place money in a bank and the bank guarantees to return the money to you.

2. You are allowed to withdraw the money at anytime.

3. Bank may charge you a fee for looking after your money and may pay hibah (gift) to you if it consider fit.

4. This concept is normally used in deposit-taking activities, custodial services and safe deposit boxes.

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Wadi’ah is a safe custody contract between the depositor(customer) and the custodian(bank).

2 types of Wadi’ah

Wadi’ah Yad Amanah ia a trust contract. ◦ The custodian is a trustee, the deposited asset must be WADI’AH

kept and cannot be used and also not liable for any loss/damage unless due to his/her negligence.

Wadi’ah Yad Dhamanah is a guarantee contract. ◦ The custodian can use and gained profit from the deposited asset

and the custodian is liable for any loss/damage to the deposited asset.

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Musyarakah refers to a partnership or a joint business venture to make profit.

Profits made will be shared by the partners based on an

agreed ratio which may not be in the same proportion as the amount of investment made by the partners.

Losses incurred will be shared based on the ratio of funds invested by each partner.

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The bank shares the cost of the project with the entrepreneur based on an agreed proportion

both parties have the right to participate in the management of the project as well as to waive such rights.

The profit from the project will be shared according to an agreed ratio

not necessarily the same as the share of the cost.

In the event of losses, these will be shared by both parties according to an earlier agreed cost-sharing formula.

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Musharakah is used by Islamic banks for structured trade financing, real estate financing, project financing, working capital financing, asset financing, pre-export shipment financing and Import financing.

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A Murabahah transaction involves the sale of goods at a price which includes a profit margin agreed by both parties.

However, in Murabahah, the seller must let the buyer know the actual cost for the asset and the profit margin at the time of the sale agreement.

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Murabahah was originally an exchange transaction in which a buyer purchases items from a seller at a specified profit margin payable to the seller.

It is assumed that the seller will reveal his costs accurately, such that the profit-margin can be agreed accurately.

Hence this type of sale is a form of 'trust sale' since the buyer must trust that the seller is disclosing his true costs.

Where a trader acts on behalf of another party in buying goods, the murabahah mark-up may be seen as a payment for the trader's service in locating, transporting and delivering the goods.

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A customer agrees to buy the goods from the bank on arrival.

The bank in turn issues a letter of credit and settles the payments to the negotiating bank using its own funds.

Later it sells the good at a marked-up price to the customer, and the settlement by customer to the bank is done either on cash or installment term.

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The Islamic bank purchases an asset or equipment at the request of a client and leases / rents it to the client a price that includes a fair return for the bank.

an arrangement under which the lessor leases equipment, building or other facility to a client at an agreed rental as agreed by both parties.

Lease contracts can be either an operating lease, where

the Islamic bank is essentially acting as warrantor of the asset leased and a financial lease, where the client deals directly with the supplier and the ownership titles remains with the bank until it is transferred to the client.

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The ijarah contract is essentially of the same design as an installment leasing agreement.

Where fixed assets are the subject of the lease, such can return to the lessor at the end of the lease period, in which case the lease takes on the features of an operating lease and thus only a part amortization of the leased asset's value results.

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In an financial lease approach, the lessee can agree at the outset to buy the asset at the end of the lease period in which case the lease takes on the nature of a hire purchase known as ijarah thumma al’bai (literally, lease and ownership).

Refers to two contracts undertaken and subsequently as follows:

Al-Ijarah contract (leasing/renting); and

Al-Bai’ contract (purchase).

Under the first contract, the hirer leases the goods from the owner at an agreed rental over a specified period. Upon expiry of the leasing period, the hirer enters into a second contract to purchase the goods from the owner at an agreed price.

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Also known as bay mu'ajjal (deferred payment sale) in which payment is made in installments some time after delivery of the underlying goods.

The bank determines the requirements of the customer in relation to the period and manner of his repayment (normally by installments).

Having done that, the bank purchases the asset and subsequently sells it to the customer at an agreed price which includes the actual cost of the asset to the bank and a profit margin which varies according to the value and type of the asset.

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1) You pick an asset you would like to buy. 2) You then ask the bank for BBA and promise to buy the asset from the bank through a resale at a mark-up price. 3) Bank buys the asset from the owner on cash basis. 4) Ownership of the goods passes to the bank. 5) Bank sells the goods, passes ownership to you at the mark-up price. 6) You pay the bank the mark-up price in installments over a period of time.

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CONTINUE

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This is a contract whereby a person (principal) asks another party to act on his behalf (as his agent) for a specific task.

where a person nominates another person to act on his behalf.

The person who takes on the task is an agent who will be paid a fee for his services.

Example

A customer asks a bank to pay someone under certain terms. The bank is therefore the agent for carrying out the financial transaction and the bank will be paid a fee for its services. 28 Snurazani/PB303

Banks normally charge fee for agency services rendered by them on behalf of their clients. An agency contract could be specific or general; it could be both commutative and non-commutative; the nature of activity to be undertaken should be clearly defined to avoid any disputes.

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The contract of Wakalah is about the provision of service.

sale and purchase, letting and hiring, borrowing and lending, assignment of debt, guarantee, pledge, gifts, bailment, taking and making payments, litigation and relinquishment, admission and acknowledgment of rights.

Islamic banks use the concept of Wakalah in various Islamic products such as Musharakah, Mudarabah, Murabaha, Salam, Istisna´a and Ijarah.

It is also used in payment and collection of trade bills, fund management and securitization.

For example, if Wakalah is for the sale or purchase of specific goods, the kind, quality and other necessary attributes of the commodity should be clearly mentioned.

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Simple example – Takaful Insurance It is essentially an agent-principal relationship, where the takaful operator acts

as an agent on behalf of the participants and earns a fee for services rendered. The fee can be a fixed amount or based on an agreed ratio of investment profit

or surplus of the takaful funds. 31 Snurazani/PB303

A Takaful company as the insurer/operator has the right to employ the agent either on a full-time or part-time basis.

The agent is presenting the company in which these selected people have to promote and develop the products offered by their company as they are bound to the contract of al-Wakalah.

It is under the agent’s responsibility to identify the potential participant and disseminate information regarding the concept and policy practiced in Takaful business.

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They need to explain thoroughly to these people so they will get comprehensive understanding and lead to no misconceptions.

The agent is obliged to convince people of its advantages compared to the conventional in order to gain competitive advantage and good credibility. This can also be a proof that Islam has always provides a comprehensive ways of life.

An agent may also assist the Takaful company by collecting the fund. Since they are representing their company, it is very important for them to produce good image and build strong relationship in effort to maintain good credibility and integrity of Takaful business.

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Ar-Rahn,or mortgage or collateral, is defined in the Islamic jurisprudence as “possessions offered as security for a debt so that the debt will be taken from it in case the debt or failed to pay back the due money.”

It is an Islamic pawn broking that allows gold and jewellery to be used as a surety against the credit.

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In practice, the Bank will retain the gold as collateral, and charge fee

for safekeeping service. The gold will be valued at the prevailing market price and the loan amount will be lower than the market value of the gold.

The safekeeping period and fees is predetermined and agreed on by both parties (Bank and Customer).

At the end of this period, the loan must be repaid to the bank and the collateral reclaimed.

No interest is charged, but if the loan is not repaid within the agreed period, the bank retains the right to seize and auction off the gold used as collateral.

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By definition, Ar Rahnu is an Islamic Pawn Broking Facility whereby the Bank will grant the Customer an interest free loan which is to be paid within specific agreed upon period.

In return, Customer will surrender their jewellery

which is to be kept by the Bank. This is to ensure that the loan will be paid either through normal payment of the advance made or through auction.

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In addition, the Customer has to pay for the monthly

safekeeping fees in order for the Bank to safe keep the jewellery. The safekeeping fees are to be paid in full upon expiry of the loan period, redemption or extension of the facility (if applicable).

If the Customer is unable to pay the amount owing at the

end of the tenure, the Bank has the right to dispose the jewellery in order to settle the loan amount together with the safekeeping fees incurred.

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Under this arrangement, a finance is given for a fixed period on a goodwill basis and the borrower is only required to repay the amount borrowed. However, the borrower may, if he so wishes, pay an extra amount (without promising it) as a way to thank the lender.

Example

A lender who lent RM5,000 to a borrower on Qard will expect the borrower to return exactly RM5,000 to him at a later date.

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Hibah means transfer of ownership of an asset to a person without any consideration in return.

It is a unilateral contract and also a benevolent act.

In the Islamic financial system, an Islamic banking institution normally applies the hibah concept to reward wadi`ah and qard depositors.

▪ In certain cases, there are also instances of giving hibah to customers, such as hibah to customers who conduct timely payments as scheduled.

▪ In the takaful industry, application of the hibah concept is used in several family takaful products in which participants may give hibah in the form of assigning the takaful benefit to the nominee or recipient of hibah.

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Example: Some of the Islamic banking institutions give hibah to wadi`ah

yad dhamanah depositors as token of appreciation for the depositors’ confidence in the institutions.

The Qard contract obliges a borrower to return the loan amount to the lender without promising to pay any additional amount. However, in current practices, a borrower sometimes gives hibah to the lender at his own discretion when paying off the debts.

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Basis of the Ruling Even though the act of giving hibah by the borrower to the

lender is recommended in Islam, it cannot be conditional in the contract as it may amount to riba.

Any addition to the amount of qard upon repayment, whether in terms of amount, attributes, giving of an asset or benefit, is permissible as long as it is unconditional.

The ruling on giving hibah to a lender is similar to the ruling on giving loan with benefit, which is prohibited if such hibah is conditional in the contract, but it is allowed if it is not made as conditional

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CONTINUE

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Also knows as “sales by order” or “future delivery”

Salam is essentially a transaction where two parties agree to carry out a sale/purchase of an underlying asset at a predetermined future date but at a price determined and fully paid for today. Seller agrees to supply specific goods to the buyer at a future date in

exchange of an advanced price fully paid at spot. Price is in cash but the supply of goods is deferred.

Total payment is paid in advanced .

Commodity- agricultural products, fungible or generic goods. E.g. Paddy rice, wheat, corn etc

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The idea behind such a ‘prepayment’ requirement has to do with the fact that the objective in a Ba’i Salam contract is to help needy farmers and small businesses with working capital financing.

Since there is full prepayment, a Salam sale is clearly beneficial to the seller. As such, the predetermined price is normally lower than the

prevailing spot price.

This price behavior is certainly different from that of conventional futures contracts where the futures price is typically higher than the spot price by the amount of the carrying cost

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Purpose of Salam To meet the needs of small farmers who need

money to grow their crops and to feed their family up to the time of harvest.

To meet the need of working capital To meet the needs of liquidity problem. To meet the need of traders for import and export

business.

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Benefits

beneficial to the seller - he receives the price in advance

beneficial to the buyer - price in salam used to be lower then the price in spot sales.

o Salam may be used by Islamic banks for trade financing in pre-shipment export finance, project financing, commodity financing and agricultural financing.

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Original Salam

1. “ Pak Hassan have 5 acres of land that could be cultivated with paddy. He could produce 5 tonne of paddy in 6 months. However, Pak Hassan does not have enough money to start the project. He approaches an Islamic bank for financing.

2. The bank bought 5 tonne of paddy from Pak Hassan using a Salam contract at a price of RM 1.20/kg. The market price of paddy was RM1.80/kg. Therefore the bank paid the total selling price (1.20 x 5,000 kg = RM6,000) to Pak Hassan on Day 1.

3. Pak Hassan used this money to start his project. The project cost was RM 3,500. After 6 months. Pak Hassan delivered 5 tonne of paddy to the Islamic bank.” Pak Hassan would gain a gross profit of RM 2,500 (Salam price – Project Cost).

4. The Islamic bank could make profit by selling the paddy in the market at

RM1.80/kg. Then, the bank would enjoy a gross profit of RM3,000 [(1.80

1.20)x5000 kg]. 48 Snurazani/PB303

Both parties in Salam will face the risk of price movement. If the

price of paddy goes up, Pak Hassan would have to forego the

opportunity of making higher profit because he has sold the paddy

to the bank at the salam price, while the bank may enjoy a higher

profit than the above. On the other hand if the paddy price goes

down to say RM1.00/kg, then Pak Hassan will be in a comfortable

position because he has already sold to the bank at RM1.20/kg. The

bank will now face the risk of loss because it could not recover

its cost.

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This is one type of trade financing in Islamic Banking system through issuing letter of guarantee. The customers are required to place certain amount of deposits with the bank as collateral to the guarantees.

Example: BIMB offered BG-I.

It is an irrevocable written obligation issued by Bank Islam to pay an agreed sum, in case the customer defaults in fulfilling his obligation.

This product is issued under the Kafalah contract, BG-I is Bank Islam’s irrevocable undertaking to guarantee performance of financial standing of a customer.

BG-I is not a financing instrument.

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Islamic banks use Al Kafalah to issue Bank and Shipping guarantees. Al Kafalah is a contract made between the Bank and another party

whereby the Bank agrees to discharge the liability of a third party in the case of default by the third party. As a surety, the third party will give the bank some form of collateral and pay a

small fee for the services.

Under the Kafalah Shipping Guarantee, the Bank gives a surety to

the owner of the shipping vessel, to discharge goods to the importer pending receipt of the original bill of lading.

Under the Kafalah Bank Guarantee, the bank guarantees the company's standing to facilitate any business activities that may require such guarantees.

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The transfer of debt from the transfer or (Muheel) to the payer (MuhalAlaihi). The transfer of right, on the other hand ,is a replacement of a creditor with another creditor.

To transfer a debt from one person (debtor) to another with the same price, it comes to consequence than the liability of the debtor is abolished. In other words, the first obligator is freed from any financial obligations.

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Nature: A has a debt owing to him from B and A himself owes a debt to C. All three agree that C, instead of realizing his due from A, and A his due from B, C shall realize his duties from B.

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Refers to debt financing, i.e. the provision of financial resources required for production, commerce and services by way of sale/purchase of trade documents and papers.

Only documents evidencing real debts arising from bona fide merchant transactions can be traded.

It is a short-term facility with a maturity of not more than a year.

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Bai' Al Dayn refers to the sale of a debt arising from trade and services transaction in the form of a deferred payment sale. The customer sells this debt to the Bank at a discount.

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Additional Info….

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Diminishing Musharakah

Used by Islamic banks for home financing, real estate financing, project financing and equity financing

Provides a method through which the bank keeps on reducing its equity in an asset against periodical payments, ultimately transferring ownership of the asset to the client.

The rental payments to the bank reduce with the bank’s diminishing equity in the asset until no further rental payment has to be made.

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For example, the Bank may contribute 90% and the Buyer 10% of the purchase price.

The client makes the promise to purchase the bank’s share and purchases the units at different stages. Over a period of up to 20 years, the client will make monthly purchase instalments through which the Bank will sell its share of the home to buyer.

The bank leases out its share to the client for the use of the property with the option to buy it, the bank receiving agreed rental payments for the use of the property.

Periodically, the client purchases a pre-agreed percentage of the bank’s share in the property, thereby increasing the client’s ownership in the property and reducing the bank’s share by a similar amount.

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Another trading mode where specific goods or an asset is made against a purchase order for deferred delivery.

Istisna’a may be used by Islamic banks in: construction projects, industrial equipment, plants and machinery, ships, aircraft and

various capital goods, contract financing, asset financing, and trade financing to enable a client exporter to purchase raw materials.

Total payment can be done upfront or at the end or by installment .

Commodity- construction or manufacturing products i.e. it is unique goods. E.g. Buildings, set of table, car, gate etc

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The bank agrees to construct and to sell the project to be constructed at the bank’s selling price to the client and thereafter it requests a third party to construct the project.

Upon completion, the contractor will handover the project to the Bank or the Bank will authorize the contractor to deliver the project directly to customer. The payment can be flexible depending on the agreement between the bank and the client.

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Being a construction or manufacturing contract,

Istisna’ is very suitable for project financing.

Example: Commercial or residential buildings, road construction, aircraft and vessel construction

The seller could either manufacture the commodity on his own or he could find another sub-contractor to do the job.

The contract of Istisna can be cancelled before the manufacturer starts the work.

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How? – Parallel Istisna 1. Client asks the bank to construct a house for him with clear

specification . The cost to construct the house is RM300,000.

2. The bank agrees and signs an Istisna’ contract with the client. (The bank is the seller in the first Istisna’. The selling price that the bank charges is RM450,000 – i.e. Cost of construction plus profit to the bank).

3. The bank then finds a contractor for the construction and asks him to handle the project.

4. The contractor agrees and signs an Istisna ’ contract with the bank. (Now the contractor is the seller in the second Istisna ’. The contractor charges the full construction cost, say RM400,000 ).

5. Upon completion, the contractor delivers to the bank and the bank delivers to the client.

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How? – Parallel Istisna

Payment in this contract could be very flexible .

Banks would release progressive payment i.e. payment according to stages of completion of construction.

Being the seller in the first Istisna ’, the bank is liable to any non-completion of the house or any non-conformance to specification risk.

Therefore, it is very important to have a project management team to ensure the selection of projects to be financed using Istisna’ is carefully made.

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Refers to the buying and selling of foreign currencies

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Refers to commissions or fees charged for services.

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Shari’ah credit cards consist of three permissible contract structures:

Kafalah, Wakalah and Qard.

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Under Kafalah, the card issuer guarantees payments on behalf of the cardholder to merchants and other third parties

UnderWakalah, the card issuer is considered an agent of the card holder, he pays the merchants on behalf of the card-holder; with a promise to provide the card holder with a loan to pay the amounts resulting from the use of the credit card.

Under Qard, the card issuer acts as the lender to the card holder withdrawing cash from the card issuing bank and the card holder is liable to immediately return the amount of funds utilised.

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Sukuk were broadly used by Muslims in the middle ages as papers representing financial obligations originating from trade and other commercial activities.

However, the present structure of Sukuk are different from the Sukuk originally used and are akin to the conventional concept of securitization, a process in which a special purpose vehicle (SPV) is setup to acquire assets and to issue financial claims on the assets, the ownership of the underlying assets is then transferred to a large number of investors through certificates representing proportionate value of the relevant assets.

The AAOIFI standard indicates that the underlying business contract or arrangement for Sukuk must be consistent with Shari’ah.

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As an asset-backed security with a stable income, Sukuk may be seen as an Islamic equivalent of bond.

However, fixed income interest bearing bonds are not permissible in Islam, hence Sukuk should comply with investment principles within the Islamic law, which prohibits the charging, or paying of interest.

Sukuk is an Islamic financial certificate that provides an investor with ownership in an underlying asset.

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The issuer of a Sukuk sells an investor the certificate, who then rents it back to the issuer for a predetermined rental fee.

The issuer also makes a contractual promise to buy back the bonds at a future date at par value.

The claim embodied in Sukuk is not simply a claim to cash flow but an ownership claim.

A Sukuk basically represents either a proportional or an undivided interest in an asset or pool of assets.

The degree of asset ownership rights subsequent to ownership interest carries the right to a proportionate share of cash flow or other benefits and risks of ownership.

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Sukuk may have similar characteristics to conventional asset-backed bonds but are structured in accordance with Shari’ah and may be traded in the market.

Sukuk should be considered as a new asset class with a relatively attractive pricing. Income from securities must be related to the purpose for which the funding is used, and not simply comprise income that may be attributed to any form of interest; and securities should be backed by real underlying assets, rather than being simply paper derivatives.

The accountabilities of the respective parties involved in Sukuk transactions should be defined in a transparent manner in the contract. Sukuk should be a means for the equitable distribution of wealth by allowing all investors to benefit from the true profits resulting from the enterprise in equal shares.

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Sukuk may have similar characteristics to conventional asset-backed bonds but are structured in accordance with Shari’ah and may be traded in the market.

Conventional bonds the issuer is contractually obliged to pay regular interest to bond holders on specific dates; the amount of interest is determined as a fixed or a floating percentage of the capital, and bond issuer guarantee the return of principal when redeemed at maturity, regardless of whether the enterprise was profitable or not.

However, Sukuk are basically investment certificates consisting of ownership claims in a pool of assets where holders are entitled to share in the revenues generated by the Sukuk assets and share in the proceeds of the realization of the Sukuk assets.

Expected returns on Sukuk are tied to the returns earned through the underlying assets.

Another distinguishing feature of a Sukuk is that in instances where the certificate represents a debt to the holder, the certificate will not be

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The market for Sukuk is now maturing and different Sukuk structures have been emerging over the years; they can be of many types depending upon the type of Islamic modes of financing and trades used in its structuring.

The AAOIFI issued standard for different types of Sukuk, classifying some of these Sukuk as tradable and others as non-tradable based on the type and characteristics of the issued Sukuk.

The most important and common among those are Murabahah, Mudarabah, Mudarabah, Ijarah, Salam and Istisna’a.

There are also other diversified and mixed asset Sukuk that emerged in the market such as hybrid Sukuk, where the underlying pool of assets can comprise of Murabahah, Ijarah as well as Istisna’a.

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Used by Islamic banks for export/import financing

L/Cs are not treated as a as a guarantee but rather as a fee based banking service to facilitate trade.

Islamic banks usually issue L/Cs on the basis of Wakalah, Murabaha or Musharakah.

All operations must fulfil the requirements of the Shari´ah.

The processing of L/Cs usually involve two banks, the L/C opening bank and the correspondent bank to whom the L/C is sent for advising the exporter.

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When using the Wakalah concept, the bank acts as the agent of the importer;

he deposits with the bank the full amount of the L/C to cover the import transaction and the bank opens the L/C;

after shipment of goods and submission of stipulated documents by the exporter, the bank makes payment using the client’s deposit.

The bank charges a fee/commission (Ujrah) for its services.

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In the case on LC using Murabaha, the procedures of Murabaha still apply except that payment to the bank is not deferred.

the Islamic bank opens the L/C and

after shipment of goods and submission of stipulated documents, it makes payment to the exporter, using the bank’s own funds

It takes delivery of the goods on arrival and sells the imported goods to the client

the bank recovers its cost and gets a small commission for services rendered as an agent.

The client repays the bank on a deferred basis as agreed. 77 Snurazani/PB303

In the case of a Letter of Credit with Musharakah

the client deposits with the bank an agreed share of the cost of the imported goods, representing the client’s share in the transaction.

After shipment of the goods and submission of the stipulated documents, the bank makes full payment to the exporter, using the client’s deposit and the bank’s own funds for the balance.

After the imported goods are sold at the market price, the bank and the client share the profit at a pre-agreed ratio.

The client may also purchase the bank’s share of the imported goods at the market price

78 Snurazani/PB303

Islamic banks are allowed to charge a handling commission/fee, as a service charge to for processing L/Cs, documentation and payments; the amount various according to the service and to the L/C amount involved.

For example, the bank can also charge its client an issuing commission, plus other charges such as postage, an advising fee, or a confirmation fee. These fees are usually not relative to the amount of the L/C and its duration.

The bank may also charge an amendment fee in case the exporter requires amendments to the L/C terms. It may also charge a commission for accepting the Bill of Exchange, as it becomes the bank’s obligation to make the payment on the due date.

79 Snurazani/PB303

80 Snurazani/PB303

81 Snurazani/PB303

82 Snurazani/PB303