Islamic Mode of Financing

7/28/2019 Islamic Mode of Financing

1/39

Islamic Mode of Financing

Muhammad Kaleem Khan


2/39

Islamic Finance System - An introduction

Based on QURAN and SUNNAH

Demands socio economic justice

Prohibits all kinds of RIBA Prohibits all forms of exploitation

Provides equal opportunities to all

Condemns accumulation of wealth in few hands

Encourages acts of benevolence


3/39

Principles of Islamic Finance

Prohibition ofRIBA

Alkharajo bil dhaman (entitlement to profit is associated

with corresponding risk) Prohibition of sale of goods before acquiring ownership

Prohibition of sale of food stuff before possession

Prohibition of debt for debt

Avoidance ofGharar (uncertainty)


4/39

Prohibition of Riba (in Quran)

ALLAH has permitted BAI(sale)and prohibited

RIBA(AlBaqarah: 275)

O you believers, fearALLAH and give up whatever isleft in lieu of RIBA if you are indeed believer, Watch

out!If you do notobey this order (and give up all

outstanding RIBA), then there is a declaration of

waragainst you from ALLAH and HIS PROPHET.

However, if you repent you have entitlement only toyour principals.Neither you inflict zulmon others, nor

the others should do zulmon you. (Al Baqarah: 278


5/39

Prohibition of Riba (in Hadith)

Obadah ibn Samit directly reports from the

Prophet as saying: Buyand sell gold for

gold, silver for silver, dates for dates,

wheat for wheat, salt for salt, and barley

for barley on the like for like basis.

Whosoever gave more or took more, verily

he made a RIBA deal. However, trade gold

for silver as you wish subject to thecondition that the exchange be hand to

hand(spot). Trade wheat for dates or

barley for dates also likewise.


6/39

Islamic Contracts

Musharaka (Profit and Loss sharing)

Modaraba (Profit sharing)

Musawamah (Bargaining sale) Ijarah (Leasing)

Salam (Advance payment sale)

Istisna (Contract of manufacturing)

Murabaha (Cost plus margin sale)


7/39

Musharakah

Hadees-e-Qudsi

Allah Subhan o Tallah has

declared that he will become

a prtnert in a businessbetween two Mushariks untill

they indulge in cheating or

breach of trust. (Khayanah)


8/39

Definition of Musharakah

Under Islamic jurisprudence, Musharakah

means

A joint enterprise formed for conducting

some business in which all partners share

the profit according to a specific ratio while

the loss is shared according to the ratio of

contribution.

It is an ideal alternative for the interest

based financing with far reaching effectson both production and distribution.


9/39


10/39


11/39

Rules and Regulations of Shirkat-ul-Aqd

Common conditions

Existence ofMutaaqideen (Partners)

Capability of partners: Must be sane & mature

Contract must be take place with free consent, withoutany fraud

Presence of commodity


12/39

Rules and Regulations of Shirkat-ul-Aqd

Special Conditions

Commodity should be capable of an agency

Rate of profit sharing should be determined

Profit and loss sharing


13/39

Management of Musharakah

Every partner has right to take part in management

Partner may agree upon condition that mgt shall be

carried out by one of them.

Sleeping partner shall be entitled to the profit allocated tothe extent of his investment.

If partners agree to work for the joint venture, each one

of them shall be treated as agent of the other in all

matters of business.


14/39

Difference b/s Interest based financing and

musharikah

Interest Based Financing

A fixed rate of return on a

loan advanced by the

financier is predeterminedirrespective of the profit

earned or loss suffered

by the deb

The financier cannotsuffer loss.

Musharikah

Musharikah does not

envisage a fixed rate of

return. The return isbased on the actual profit

earned by the joint

venture.

The financier suffer loss ifjoint venture fails to

produce fruits.


15/39

Difference b/s Interest based financing and

musharikah

Interest Based Financing

Results are injustice either to

the creditor or to the debtor. If

debtor suffers a loss, it is injust

on the part of the creditor toclaim a fixed rate of profit. If

debtor earns a very high rate

of profit, it is injustice to the

creditor to give him only small

proportion of profit leaving therest for the debtor.

Musharikah

The returns of the creditor are

tied up with actual profits

occurred through the

enterprise. The greater theprofits of the enterprise, the

higher the rate of return to the

creditor. If the enterprise earns

enormous profits, all of it

cannot be secured by thedebtor exclusively but will be

shared by common people e.g

Depositors in the bank.


16/39

Applications of Musharakah

Investment accounts depositors are sleeping partners,

bank also invests its own funds

Stock companies

Mutual funds Project financing

Import/export financing


17/39

Mudarabah


18/39

Mudarabah

This is a kind of partnership where one partner gives

money to another for investing in a commercial

enterprise.

Investment comes from first partner who is called Rab-

ul-Maal while the management and work is an exclusive

responsibility of the other, who is called Mudarib and

the profit generated are shared in a predetermined ratio.


19/39

Types of Mudarabah

Al Mudarabah Al Muqayyadah (restricted Mudarabah):

Rab ul maal may specify a particular business or a

particular place for the mudarib.

Al Mudarabah Al Mutlaqah (unrestricted Mudarabah): If

Rab-ul-maal gives full freedom to mudarib to undertake

whatever business he deems fit. However Mudarib

cannot with consent of Rab-ul-Maal lend money to

anyone. Mudarib is authorized to do anything, however if

they want to do extraordinary work, which is beyond thenormal routine of traders, he cannot do so without

permission of Rab-ul-Maal.


20/39

Difference b/w Musharakah and Mudarabah

Musharakah All partners invest.

All partners participate in

mgt.

All partners share theloss to the extent of the

ratio of their investment.

The liabilities of partners

is normally unlimited. All assets are jointly

owned by all partners

according to prop. of their

respective investment.

Mudarabah Only Rab-ul-maal invest.

Management is carries

out only by Mudarib.

Only Rab-ul-Maal suffersloss.

The liability of Rab-ul-

Maal is limited to his

investment. Assets are solely owned

by Rab-ul-Maal.


21/39

Combination of Musharakah &

Mudarabah

A contract of mudarabah normally presumes that themudarib has not invested anything to the mudarabah. Heis responsible for the management only, while all theinvestment comes from rabb-ul-mal. But there may be

situations where mudarib also wants to invest some ofhis money into the business of mudarabah. In suchcases, musharakah and mudarabah are combinedtogether.


22/39

DIMINISHING MUSHARIKAH


23/39

Diminishing Musharikah

A financier and his client participate either in jointownership of a property or an equipment, or in joint

commercial enterprise.

The share of the financier is further divided into a number

of units and it is understood that the client will purchasethe units of the share of financier one by one periodically ,

thus increasing his own share until all the units of the

financier are purchased by him so as to make him the

sole owner of the property or the commercial enterprise,

as the case may be.


24/39

Examples of DM

House Financing

DM for carrying business of services (e.g taxi

transportation)

DM in Trade

Uses

All purchases of fixed assets

House Finance

Plant and factory finance Car/Transport Financing

Project financing of fixed assets


25/39

MURABAHA


26/39

Murabaha

Murabaha is a particular kind of sale where the sellerexpressly mentions the cost of the sold commodity he

has incurred and sells it to another person by adding

some profit. Thus murabaha is not a loan given on

interest; it is a sale of commodity for cash/deferred price.

The Bai Murabaha involves purchase of a commodity by

a bank on behalf of client and its resale to the latter on

cost-plus profit basis.

Under this arrangement the bank discloses its cost and

profit margin to the client.

In other words, rather than advancing money to a

borrower, the bank will buy the goods from a third party

and sell those goods on to the customer for a pre agreed

price.


27/39

A simple sale in Arabic is called Musawamah a

bargaining sale without disclosing or referring to what

cost price is .

However when the cost price is disclosed to the client, it

is called Murabahah. A simple Murabaha is one where

there is cash payment and Murabah Muajjalis one on

deferred payment basis.


28/39

Step by Step Murabaha Financing

Overall agreement b/w client and institution, whereby

institution promises to sell and client promises to buy

commodity.

An agency agreement is signed. Institution appoints the

client as his agent for purchasing the commodity on its

behalf.

Client purchases commodity on behalf of institution and

takes possession as agent of institution.

Client informs the instituion that it has purchased the

commodity and simultaneously makes an offer to

purchase it from institition.

Instituion accepts the offer. Ownership as well as risk is

transferred to the client.


29/39

Uses of Murabaha

Short/medium/ long term finance for:

Raw material

Inventory

Equipment Asser financing

Import financing

Export financing (pre-shipment)

Consumer goods financing

House financing

Vehicle financing

Land financing

Shop financing


30/39

SALAM

This mode of financing is especially for agriculture sector by


31/39

This mode of financing is especially for agriculture sector by

modern banks.

In Salam, the seller undertakes to supply specific goods to

buyer at a future date in exchange of an advanced price fully

paid at spot.

Financing through purchase, deferred delivery of goods,

payment spot.

To meet the needs of small farmers who need money to grow

their crops and to feed their family up to the time of harvst.

When Allah declared Riba haram, the farmers couldnt get

usurious loans. Therefore Holy Prophet (SAW) allowed them to

sell their agricultural products in advance.

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

Salam is beneficial for seller because they receive the price in

advance , beneficial for byuer because normally the price in

Salam is lower than the price in spot sales.


32/39

ISTISNA


33/39

Istisna is a sale transaction where a commodity is

transacted before it comes into existence.

It is an order to manufacturer to manufacture a specific

commodity for purchase.

The manufacturer uses his own material to manufacture

the required goods.

In Istisna, price must be fixed with consent of all parties

involved. All other necessary specifications of the

commodity must also be fully settled.


34/39

Difference b/w Istisna and Salam

Istisna

The subject on which

transaction of Istisna is

based, is always a thingwhich needs to be

manufactured

The price in istisna does

not necessarily need to

be paid in full in advance.

It is not even necessary

to pay the full price at

delivery.

Salam

The subject can be any

thing that need

manufacturing or not. The price has to be paid

in full in advance.


35/39

Difference b/w Istisna and Salam

Istisna

The time of delivery does

not have to be fixed in

Istisna. The contract can be

cancelled before the

manufacturer starts the

work.

Salam

The time of delivery is an

essential part of sale.

The contract cannot becancelled unilaterally.


36/39

IJARAH


37/39

'to give something on rent'.

In the Islamic jurisprudence, the term 'Ijarah' is used fortwo different situations.

In the first place, it means 'to employ the services of a

person on wages given to him as a consideration for his

hired services." The second type of Ijarah relates to the usufructs of

assets and properties, and not to the services of human

beings.

The lessor i,e, the financial institution purchases theasset through the lessee himself. The lessee purchases

the asset on behalf of lessor who pays price to the

supplier, either directly or through the lessee.


38/39

Difference b/w Istisna and Ijarah

Istisna

The manufacturer either

uses his own material

and if it is not availablewith him, obtains it to

make the ordered goods.

The purchaser has a right

to reject the goods after

inspection.

Ijarah

The material is provided

by the customer and the

manufacturer uses onlyhis labor and skill.

Right of rejection of

goods after inspection

does not exist.


39/39

Ijarah wa iqtina

Lessor signs a separate promise to gift the leased asset

to the lessee at the end of lease period, subject to his

payment of all amount of rent.

Islamic Mode of Financing

Documents

Transcript of Islamic Mode of Financing