What is Islamic Microfinance ?

Abdul SamadAbdul Samad Shariah AdvisorShariah Advisor

The Bank of KhyberThe Bank of Khyber

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Why Islamic Banking?Why Islamic Banking?

The body which is promoted by Hiram sources The body which is promoted by Hiram sources is bound to hellfire.is bound to hellfire.

On the Day of Judgment, a person will not be On the Day of Judgment, a person will not be moved from the place where he stand until he moved from the place where he stand until he is asked about the sources of his income and is asked about the sources of his income and

they way he spent it.they way he spent it. Purifying of the needs of life (food, drink, Purifying of the needs of life (food, drink,

clothes house etc) is one of the most clothes house etc) is one of the most important reason for the acceptance of important reason for the acceptance of

prayers by Allahprayers by Allah..

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Rulings In Islam Rulings In Islam These 5 primary objectives follow by These 5 primary objectives follow by Shariah Shariah can be observed though the can be observed though the Al Al

Ahkam Ahkam (rulings) upon which (rulings) upon which Fiqh Fiqh (Islamic (Islamic Jurisprudence) rotate around. The rulings Jurisprudence) rotate around. The rulings

are categorized as follows: are categorized as follows: a. Wajib (obligatory)a. Wajib (obligatory) e. Haram (unlawful)e. Haram (unlawful)

b. Mustahab (recommended) (Sunnat) b. Mustahab (recommended) (Sunnat) c. Mubah (permissible) c. Mubah (permissible)

d. Makruh (disliked)d. Makruh (disliked)

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RulingsRulings Wajib- An obligatory action or something that Wajib- An obligatory action or something that

shall be performed. Anyone who leave it is shall be performed. Anyone who leave it is liable to gain the punishment of Allah s.w.t. in liable to gain the punishment of Allah s.w.t. in the Here after as well as a legal punishment in the Here after as well as a legal punishment in

this world.this world. Haram- An unlawful action or the one that shall Haram- An unlawful action or the one that shall

not be performed and is strictly prohibited. not be performed and is strictly prohibited. Anyone who engages in it is liable to gain the Anyone who engages in it is liable to gain the

punishment of Allah s.w.t. in the Here after as punishment of Allah s.w.t. in the Here after as well as a legal punishment in this world.well as a legal punishment in this world.

Mustahab- A recommended action or something Mustahab- A recommended action or something that should be performed.that should be performed.

Mubah- A permissible action or something that Mubah- A permissible action or something that is neither encouraged nor discouraged.is neither encouraged nor discouraged.

Makruh- A disliked action or something which is Makruh- A disliked action or something which is abominable and should be avoided but not in abominable and should be avoided but not in

strictly prohibitory terms.strictly prohibitory terms.55

Islam and ShariahIslam and Shariah

Islam

Aqidah(Faith & Belief)

Shariah(Practices & Activities)

Akhlaq(Morality & Ethics)

IBADAT(Man to God Worship)

Muamalat(Man to Man Activities)

Political Activities Economic Activities Social Activities

Banking & Financial Activities66

Human Financial NeedsHuman Financial Needs

Fulfillment of Financial Needs

Own Capital Others’ Capital

Equity Financing Debt Financing

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External (Equity & Debt) External (Equity & Debt) FinancingFinancing

Equity FinancingEquity Financing Debt FinancingDebt Financing

Al-Musharakah Al-Musharakah (Joint (Joint Venture Profit Sharing)Venture Profit Sharing)

Uqud al-MuawadhatUqud al-Muawadhat

(Deferred Contracts of (Deferred Contracts of Exchange)Exchange)

Al-Mudarabah Al-Mudarabah

(Trustee Profit Sharing)(Trustee Profit Sharing)Al-Bai’ Bithaman (Mu)Ajil Al-Bai’ Bithaman (Mu)Ajil (Deferred Installment Sale)(Deferred Installment Sale)

OthersOthers Bai’ al-Murabaha Bai’ al-Murabaha

(Cost Plus Profit Sale)(Cost Plus Profit Sale)

Al-Ijarah Al-Ijarah (Leasing)(Leasing)

Bai’ al-Salam Bai’ al-Salam (Commodity (Commodity Sale)Sale)

Bai’ al-Istisna’ Bai’ al-Istisna’ (Sale on Order)(Sale on Order)

Equity MarketEquity Market Debt MarketDebt Market

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Most Important Islamic Most Important Islamic Teaching Related To BusinessTeaching Related To Business

1.1. Elimination of Interest (Elimination of Interest (RabaRaba) ) 2.2. The prohibition of uncertainty (The prohibition of uncertainty (GhararGharar))3.3. The prohibition of Gambling (The prohibition of Gambling (QimarQimar))4.4. The precipitation of games of chance (The precipitation of games of chance (MaserMaser))5.5. Honesty and Fair Trade (Honesty and Fair Trade (Ghishsh Ghishsh and and KhilabahKhilabah))6.6. Spending in the Good CauseSpending in the Good Cause7.7. Buy Back Buy Back 8.8. Two Mutually Two Mutually Conditional ContractConditional Contract9.9. Entitlement to profit depends on liability Entitlement to profit depends on liability for riskfor risk

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InterestInterest

Interest, Usury, or Riba is forbidden Interest, Usury, or Riba is forbidden in almost all major religions of the in almost all major religions of the

world e.g.world e.g.

JudaismJudaism

ChristianityChristianity

IslamIslam

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Riba in QuranRiba in Quran

God has permitted trade and forbidden interest….God has permitted trade and forbidden interest….”” ((The Cow – Sura Al-Baqara 2:275)The Cow – Sura Al-Baqara 2:275)

OO believersbelievers, fear Allah, and give up what is , fear Allah, and give up what is still due to your from the interest (usury), still due to your from the interest (usury), IF IF [indeed] you are true believers[!!!][indeed] you are true believers[!!!].. If you do not do so, then take If you do not do so, then take Notice of War from Allah and his Messenger.Notice of War from Allah and his Messenger.

But, if you repent, you can have your principal. But, if you repent, you can have your principal. Neither should you commit injustice, Neither should you commit injustice,

nor should you be subjected to it.”nor should you be subjected to it.”

(The Cow – Sura Al-Baqara 2:278-9)(The Cow – Sura Al-Baqara 2:278-9)

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Riba in Quran (Riba in Quran (Related in context to Related in context to 2:278)2:278)

The only reward of those Who make War upon Allah & his The only reward of those Who make War upon Allah & his Messenger, Messenger, and strive after corruption in the land, will be and strive after corruption in the land, will be that they will be that they will be

1.1. Killed Killed

2.2. Or, Crucified, Or, Crucified,

3.3. Or, have their Hands and Feet on alternate sides Cutoff, Or, have their Hands and Feet on alternate sides Cutoff,

4.4. Or, will be Expelled out of the land. Or, will be Expelled out of the land.

Such will be their degradation in the world, and Such will be their degradation in the world, and

in the hereafter, theirs will be an terrible doom.”in the hereafter, theirs will be an terrible doom.”

(Quran: The Table Spread - Al-Maida Chapter 5: Verse 33)(Quran: The Table Spread - Al-Maida Chapter 5: Verse 33)1212

Riba in HadithRiba in Hadith

The Prophet cursed The Prophet cursed the the receiverreceiver and and

the the payerpayer of interest, of interest,

the one who the one who recordsrecords it and it and

the the witnesseswitnesses to the transaction to the transaction

and said:and said: “They are all alike (in guilt).” “They are all alike (in guilt).”

(Sources: Jabir Ibn Abdullah, Muslim, Tirmidhi, Musnad Ahmed(Sources: Jabir Ibn Abdullah, Muslim, Tirmidhi, Musnad Ahmed1313

RIBA RIBA RIBA

Riba-Al-Fadl Riba-Al-Nasiyah

Sarfi Sood Tijarti Sood

Simple Sood

Compound Sood

Simple Sood

Compound Sood 1414

The prohibition of uncertaintyThe prohibition of uncertainty ((GhararGharar))

There are strict rules in Islamic finance There are strict rules in Islamic finance against transactions that are highly against transactions that are highly

uncertain or may cause any injustice or uncertain or may cause any injustice or dishonesty against any of the parties. dishonesty against any of the parties. 

The concept of The concept of GhararGharar has been broadly has been broadly defined by the scholars in two ways.defined by the scholars in two ways.

First, First, GhararGharar implies uncertainty. implies uncertainty. Second, it implies dishonesty. Second, it implies dishonesty.

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Classical Examples of Classical Examples of GhararGharar Selling goods that the seller is unable to deliver Selling goods that the seller is unable to deliver Selling known or unknown goods against an Selling known or unknown goods against an

unknown price, such as selling the contents of unknown price, such as selling the contents of a sealed box   a sealed box  

Selling goods without proper description, such Selling goods without proper description, such as shop owner selling clothes with unspecified as shop owner selling clothes with unspecified sizes   sizes  

Selling goods without specifying the price, such Selling goods without specifying the price, such as selling at the 'going price'   as selling at the 'going price'  

Making a contract conditional on an unknown Making a contract conditional on an unknown event, such as when my friend arrives if the event, such as when my friend arrives if the time is not specified   time is not specified  

Selling goods on the basis of false description Selling goods on the basis of false description Selling goods without allowing the buyer the Selling goods without allowing the buyer the

properly examine the goods properly examine the goods The Prophet (pbuh) prohibited the pebble sale and the Gharar The Prophet (pbuh) prohibited the pebble sale and the Gharar

sale.sale.1616

QimarQimar Qimar includes every form of gain or Qimar includes every form of gain or

money, the achievement of which depends money, the achievement of which depends purely on luck and chance.purely on luck and chance.

All Lotteries and Prize schemes based All Lotteries and Prize schemes based purely on luck come under this prohibition.purely on luck come under this prohibition.

O O ye who believe! Intoxicants and ye who believe! Intoxicants and gambling, sacrificing to stones, and gambling, sacrificing to stones, and

(divination by) arrows, are an abomination, (divination by) arrows, are an abomination, of Satan’s handiwork…..:of Satan’s handiwork…..: (5:90-91) (5:90-91)

He who played Qimar has disobeyed Allah He who played Qimar has disobeyed Allah and His Messenger.” and His Messenger.” (Ibn Majah )(Ibn Majah )

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Honesty and Fair TradeHonesty and Fair Trade ((Ghishsh Ghishsh and and KhilabahKhilabah))

Thus Manipulations and Mismanagement like Thus Manipulations and Mismanagement like Hoardings Hoardings

Black marketingBlack marketing CheatingCheating

Profiteering Profiteering Short weighting Short weighting

Hiding the defective quality of the goods Hiding the defective quality of the goods are are prohibited in Islamic Financial System.prohibited in Islamic Financial System.

The prophet (PBUH) said: the truthful The prophet (PBUH) said: the truthful

honest merchants are with the prophets honest merchants are with the prophets In the Day of Judgment.In the Day of Judgment.

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Spending in the Good CauseSpending in the Good Cause The Islamic economic approach is one, which The Islamic economic approach is one, which

is directed towards the achievement and is directed towards the achievement and actualization of actualization of justicejustice in human relations. in human relations.

The result of this effort is The result of this effort is falahfalah or success and or success and salvation, and salvation, and hayah tayyibahhayah tayyibah or good life in or good life in

this world and the hereafter. this world and the hereafter. So Islamic banks don’t permute to establish So Islamic banks don’t permute to establish

any relation with any relation with commodities, services and commodities, services and individuals whose moral practices are doubtfulindividuals whose moral practices are doubtful

Some people spend Allah’s wealth (i.e. Some people spend Allah’s wealth (i.e. Muslim’s Wealth) in an unjust manner, such Muslim’s Wealth) in an unjust manner, such

people will be put in the (Hell) fire on the day people will be put in the (Hell) fire on the day of resurrection” (of resurrection” (Bukhari and Ahmad)Bukhari and Ahmad)

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Buy BackBuy Back

The financier sells an asset to the The financier sells an asset to the customer on a deferred-payment basis, customer on a deferred-payment basis,

and then the asset is immediately and then the asset is immediately repurchased by the financier for cash at repurchased by the financier for cash at

a discount. a discount.

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Two Mutually Conditional Two Mutually Conditional ContractContract

Two mutually contingent contract have Two mutually contingent contract have been prohibited by the holy prohibited by been prohibited by the holy prohibited by

the holy Prophet (pbuh). the holy Prophet (pbuh). The sale of two item in such a way that one The sale of two item in such a way that one

who intends to purchase good is obliged to who intends to purchase good is obliged to purchase the other also at any given price.purchase the other also at any given price.

One sale transaction with tow prices.One sale transaction with tow prices. Combining sale and lending in one Combining sale and lending in one

contract.contract.2121

WHAT IS WHAT IS ISLAMIC ISLAMIC BANKING?BANKING?

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WHAT IS BANK?WHAT IS BANK?

The name The name bankbank derives from the derives from the Italian word word bancobanco "desk/bench. "desk/bench.

In practice, the word “Bank” means an In practice, the word “Bank” means an institution which borrows money from institution which borrows money from people and lends money to people for people and lends money to people for

interest or profit and provided interest or profit and provided

other financial services.other financial services.2323

BANKS ENGAGE IN THE BANKS ENGAGE IN THE FOLLOWINNNG ACTIVITIES.FOLLOWINNNG ACTIVITIES.

Accepting money Accepting money Processing of payments by way ofProcessing of payments by way of

telegraphic transfertelegraphic transfer, , internet bankinginternet banking, , or or other meansother means;;

IssuingIssuing bank drafts and and bank cheques Lending money Lending money

Providing documentary and standbyProviding documentary and standby letter of credit, guarantees, , guarantees, performance

bonds, , securities underwriting securities underwriting commitments and other forms of off commitments and other forms of off

balance sheet exposures balance sheet exposures Safekeeping of documents and other Safekeeping of documents and other

items initems in safe deposit boxes 2424

WHAT IS WHAT IS ISLAMIC ISLAMIC BANKING?BANKING?

Islamic banking has been defined Islamic banking has been defined as banking in consonanceas banking in consonance with the with the

ethosethos and and value systemvalue system of of Islam Islam and governedand governed, in addition to the , in addition to the

conventional good governance and conventional good governance and rick management rules rick management rules by the by the principleprinciple laid down by laid down by Islamic Islamic

Shariah. Shariah. 2525

Comparison of the Islamic and Conventional Comparison of the Islamic and Conventional

systemssystems Conventional BankingConventional Banking Conventional Banks take deposit on interest Conventional Banks take deposit on interest

basis and lend on the basis on interest. A basis and lend on the basis on interest. A part of interest is paid to the depositors and part of interest is paid to the depositors and the remaining interest is left for the bank as the remaining interest is left for the bank as its income. If this residual is more than its its income. If this residual is more than its expenses, it will have Net Income otherwise expenses, it will have Net Income otherwise it will have Net loss. it will have Net loss.

Islamic BankingIslamic Banking Islamic Banking accepts deposits on PLS Islamic Banking accepts deposits on PLS

basis and invest in Shariah based modes. basis and invest in Shariah based modes. Whatever is the profit, it is shared with Whatever is the profit, it is shared with depositors. If there is a loss it will also be depositors. If there is a loss it will also be shared. shared.

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OBJECTIVES OF ISLAMIC OBJECTIVES OF ISLAMIC BANKINGBANKING

Shariah compliant banking, to enableShariah compliant banking, to enable MuslimsMuslims to do theirto do their banking banking

transactiontransaction – a Halal way.– a Halal way. Achieving the Achieving the goalsgoals and and objectivesobjectives of of

an an IslamicIslamic economy. economy.

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Types of contractTypes of contract

Trade

Leasing

Employment

Partnership

Paid agency

Services against fee

Compensatory / Financial Contract

CONTRACT

Gift

Nikah

Money lending

Guarantee (Damanat)

Non-paid agency

Rights transfer (Hawalah)

Non Compensatory / Social Contract

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COMPONENTS OF VALID COMPONENTS OF VALID SALESALE

SALE

CONTRACT SUBJECT MATTER

PRICE POSSESSION

•Offer/Acceptance•Buyer/Seller •Existence

•Ownership•Possession•Valuable•Halal Purpose

•Certain•Physical•Constructive

Instant and absolute Unconditional

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DERIVATION OF DERIVATION OF MURABAHAMURABAHA

The word “Murabaha” has been The word “Murabaha” has been derived from the Arabic word derived from the Arabic word “Ribah”“Ribah”, which has literary , which has literary meaning of profit.meaning of profit.

The Murabaha can be denoted The Murabaha can be denoted as “Sale With Profit”.as “Sale With Profit”.

DEFINITION OF DEFINITION OF MURABAHAMURABAHA

  

Murabaha Murabaha is a particular kind is a particular kind of of sale sale where Seller expressly where Seller expressly mentions the cost it has incurred mentions the cost it has incurred on purchase of the Asset(s) to be on purchase of the Asset(s) to be sold and sells it to another sold and sells it to another person by adding some profit, person by adding some profit, which is known to Buyer.which is known to Buyer.

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MusawamahMusawamahMusawamah is a general kind of sale in Musawamah is a general kind of sale in which price of the commodity to be which price of the commodity to be traded is stipulated between seller and traded is stipulated between seller and the buyer without any reference to the the buyer without any reference to the price paid or cost incurred by the price paid or cost incurred by the former. Thus it is different from former. Thus it is different from Murabaha in respect of pricing formula.Murabaha in respect of pricing formula.

Unlike Murabaha, seller in Musawamah Unlike Murabaha, seller in Musawamah

is not obliged to reveal his cost.is not obliged to reveal his cost.

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VARIOUSVARIOUS

MODELS OF MODELS OF MURABAHA MURABAHA

FINANCEFINANCE

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MODEL - IMODEL - ITWO PARTY REALTIONSHIPTWO PARTY REALTIONSHIP Bank – Customer Bank – Customer

MODEL - IIMODEL - IITHREE PARTY RELATIONSHIPTHREE PARTY RELATIONSHIP (Bank-Vendor) and Customer(Bank-Vendor) and Customer

MODEL - IIIMODEL - IIITHREE PARTY RELATIONSHIPTHREE PARTY RELATIONSHIP Bank and (Vendor-Customer)Bank and (Vendor-Customer)

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MODEL - IMODEL - I The simplest possible Model The simplest possible Model

emerges when the transaction emerges when the transaction involves two parties only, i.e Bank involves two parties only, i.e Bank and the Customer. and the Customer.

The Bank is also vendor and sells The Bank is also vendor and sells the Asset(s) to its Customers on the Asset(s) to its Customers on deferred payment basis.deferred payment basis.

From From Shari’ahShari’ah perspective it is an perspective it is an ideal Model and its profits are fully ideal Model and its profits are fully justified because Bank assumes all justified because Bank assumes all risks as Vendor/Trader.risks as Vendor/Trader.

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Bank/VendorCustomer1

2

3

MODEL I – GRAPHICAL PRESENTATIONMODEL I – GRAPHICAL PRESENTATION

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MODEL I - PHASESMODEL I - PHASES

Phase 1:Phase 1: The customer approaches Bank (Vendor) The customer approaches Bank (Vendor) and identifies Asset(s) and collects and identifies Asset(s) and collects relevant information including cost and relevant information including cost and profit.profit.

Phase 2:Phase 2:Bank sells Asset(s) to the Customer, Bank sells Asset(s) to the Customer, transfer risk and ownership to the transfer risk and ownership to the Customer at certain Murabaha Price.Customer at certain Murabaha Price.

Phase 3:Phase 3:Customer pays Murabaha Price in lump Customer pays Murabaha Price in lump sum or in installments on agreed dates.sum or in installments on agreed dates.

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MODEL - IIMODEL - II

In most cases Murabaha In most cases Murabaha Transaction involves a third party Transaction involves a third party (i.e. Vendor) because Bank is not (i.e. Vendor) because Bank is not expected to engage in sale of expected to engage in sale of variety of products required for variety of products required for variety of Customers.variety of Customers.

The Bank directly deals with the The Bank directly deals with the Vendor and purchases the Vendor and purchases the Asset(s).Asset(s).

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MODEL IIMODEL II The Bank sells the purchased The Bank sells the purchased

Asset(s) to the customer on Asset(s) to the customer on cost plus basis.cost plus basis.

There are two distinct sale There are two distinct sale contracts at different point of contracts at different point of times. First between Bank times. First between Bank and Vendor and second and Vendor and second between Bank and the between Bank and the Customer.Customer.

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Customer Bank

Vendor1

2

34

6

5

MODEL II – GRAPHICAL MODEL II – GRAPHICAL PRESENTATIONPRESENTATION

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MODEL II - PHASESMODEL II - PHASESPhase 1:Phase 1:

Customer identifies and approaches the Customer identifies and approaches the Vendor or Supplier of the Asset(s) and Vendor or Supplier of the Asset(s) and collects all relevant information.collects all relevant information.

Phase 2:Phase 2:

Customer approaches the Bank for Customer approaches the Bank for Murabaha Financing and promises to Murabaha Financing and promises to buy the Asset(s).buy the Asset(s).

Phase 3:Phase 3:

The Bank makes payment to vendor The Bank makes payment to vendor directly. directly.

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MODEL II – PHASESMODEL II – PHASES

Phase 4:Phase 4:

Vendor delivers the Asset(s) & transfers Vendor delivers the Asset(s) & transfers the ownership of Asset(s) to the Bank.the ownership of Asset(s) to the Bank.

Phase 5:Phase 5:

Bank sells the Asset(s) to Customer on Bank sells the Asset(s) to Customer on cost plus basis and transfers ownership.cost plus basis and transfers ownership.

Phase 6:Phase 6:

Customer pays Murabaha Price in lump Customer pays Murabaha Price in lump sum or in installments on agreed dates.sum or in installments on agreed dates.

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MODEL III – BANKING MODEL III – BANKING MURABAHAMURABAHA

This Murabaha Model is mostly This Murabaha Model is mostly practiced model in Banking now a practiced model in Banking now a days and therefore we will look at it in days and therefore we will look at it in more detail.more detail.

We will also look at the documentation We will also look at the documentation required at different stages of the required at different stages of the transaction.transaction.

It is also a three-party structure but it It is also a three-party structure but it is bit complicated than previous ones.is bit complicated than previous ones.

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MODEL III – BANKING MODEL III – BANKING MURABAHAMURABAHA

The product of Murabaha that is The product of Murabaha that is being used in Islamic Banking as a being used in Islamic Banking as a mode of finance is something mode of finance is something different from the Murabaha used different from the Murabaha used in normal trade .in normal trade .

It is called It is called Murabaha to the Murabaha to the Purchase Orderer .Purchase Orderer .

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MODEL III – BANKING MODEL III – BANKING MURABAHAMURABAHA

It is a bunch of contracts completed It is a bunch of contracts completed in steps and ultimately suffices the in steps and ultimately suffices the financial needs of the client.financial needs of the client.

THE SEQUENCE OF THEIR EXECUTION THE SEQUENCE OF THEIR EXECUTION IS EXTREMELY IMPORTANT TO MAKE IS EXTREMELY IMPORTANT TO MAKE THE TRANSACTION SHARIA’H THE TRANSACTION SHARIA’H COMPLIANTCOMPLIANT..

4646

BankCustomer

Vendor4

3

MODEL III – GRAPHICAL MODEL III – GRAPHICAL PRESENTAIONPRESENTAION

2

1

5

5

6Offer Acceptance

7

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PHASE I – PROMISE TO PURCHASE AND PHASE I – PROMISE TO PURCHASE AND SELLSELL

The Customer approaches the Bank The Customer approaches the Bank for Murabaha Finance and promises for Murabaha Finance and promises to purchase the Asset(s) from the to purchase the Asset(s) from the Bank which, the Customer will Bank which, the Customer will purchase as an Agent of the Bank. purchase as an Agent of the Bank.

Master Murabaha Finance Agreement Master Murabaha Finance Agreement (MMFA) shall be signed by the Bank (MMFA) shall be signed by the Bank and the Customer at this stage. This and the Customer at this stage. This is basically a Memorandum of is basically a Memorandum of Understanding between two parties.Understanding between two parties.

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PHASE II – APPOINTMENT OF PHASE II – APPOINTMENT OF AGENTAGENT

In the absence of expertise required In the absence of expertise required to purchase particular kind of to purchase particular kind of Asset(s), the Bank appoints Asset(s), the Bank appoints Customer as its Agent to buy Customer as its Agent to buy Asset(s) on its behalfAsset(s) on its behalf

Types of Agency AgreementTypes of Agency Agreement

•Global Agency•Specific Agency

ON ASSET BASIS ON TIME BASIS

•Limited Period•Open Ended

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PHASE III & IV – PHASE III & IV – PURCHAHSE OF ASSETS BY AGENTPURCHAHSE OF ASSETS BY AGENT

The Customer identifies the Vendor, The Customer identifies the Vendor, selects the Asset(s) on behalf of the selects the Asset(s) on behalf of the Bank and advice its particulars, Bank and advice its particulars, including the Vendor’s name and including the Vendor’s name and purchase price to the Bank.purchase price to the Bank.

If the supplier is nominated by the If the supplier is nominated by the Customer itself, guarantee for good Customer itself, guarantee for good performance can be demanded from performance can be demanded from

the Customer.the Customer.

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PHASE III & IV – PHASE III & IV – PURCHAHSE OF ASSETS BY PURCHAHSE OF ASSETS BY

AGENTAGENT The Customer takes possession of the The Customer takes possession of the

Asset(s) as an Agent of the Bank.Asset(s) as an Agent of the Bank.

It is the obligation of the It is the obligation of the Customer(Agent) to ensure, at this Customer(Agent) to ensure, at this stage, that Asset(s) supplied is in stage, that Asset(s) supplied is in accordance with the given accordance with the given specifications.specifications.

To ensure that a fresh Asset(s) are To ensure that a fresh Asset(s) are purchased by the Agent, Bank’s staff purchased by the Agent, Bank’s staff should verify actual purchase of should verify actual purchase of Asset(s).Asset(s).

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PHASE III & IV–DOCUMENTATIONPHASE III & IV–DOCUMENTATION

DECLARATION FROM CUSTOMER (AGENT)DECLARATION FROM CUSTOMER (AGENT)

The Customer (Agent) will inform the Bank, The Customer (Agent) will inform the Bank, through this document, that it has taken the through this document, that it has taken the possession of Asset(s) on behalf of the Bank.possession of Asset(s) on behalf of the Bank.

This This Transactional DocumentTransactional Document shall be an shall be an integral part of Master Murabaha Financing integral part of Master Murabaha Financing Agreement (MMFA).Agreement (MMFA).

This declaration must contain the statement This declaration must contain the statement that Customer has inspected the Asset(s) to that Customer has inspected the Asset(s) to ensure that its appropriateness and ensure that its appropriateness and suitability to the customer.suitability to the customer.

Steps Of Banking Murabaha Steps Of Banking Murabaha

MOU

Order Form

Agency Agreement

Purchase

Payment of Purchase Price

Possession

Offer and Acceptance (Declaration)

Payment of Murabaha Price

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Short/ Medium Term Short/ Medium Term Financing (Murabaha)Financing (Murabaha)

Supplier

Customer

Bank

3. Customer buys the goods as Bank’s agent. Cost: $100

1. Execution of Murabaha Agreement.

4. Disbursement of the Facility. Facility Amount: $100

2. Bank appoints the Customer as its agent to buy the goods.

5. Under the Murabaha Agreement the Bank will immediately sell the goods at $110 (cost plus a profit margin) payable on a deferred

payment terms.

Sale

Features:

• Fixed rate financing only

Uses:

• Inventory Financing

•Financing commodity purchase

Tenor:

•12-18 months

Risks:

•Credit Risk

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SALAMSALAM

5454

INTRODUCTIONINTRODUCTION There are There are three basic conditionsthree basic conditions for validity for validity

of a sale in Shariah :of a sale in Shariah : The purchased commodity must be The purchased commodity must be

existing;existing; The seller should have acquired the The seller should have acquired the

ownership of that commodity; andownership of that commodity; and The commodity must be in the physical or The commodity must be in the physical or

constructive possession of the seller.constructive possession of the seller.

There are only two exceptions to this There are only two exceptions to this principle in Shariah:principle in Shariah: Salam (which is also called as Salaf); andSalam (which is also called as Salaf); and Istisna. Istisna.

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DEFINITIONDEFINITION

The seller undertakes to supply The seller undertakes to supply specific goods to the buyer at a specific goods to the buyer at a future date in exchange of an future date in exchange of an advanced price fully paid at spot.advanced price fully paid at spot.

The price is paid immediately in The price is paid immediately in cash but the supply of purchased cash but the supply of purchased goods is deferred to a fixed date.  goods is deferred to a fixed date.  

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FROM WHERE SALAM FROM WHERE SALAM STARTEDSTARTED

Before prohibition of interest farmers used Before prohibition of interest farmers used to get interest based loans for growing to get interest based loans for growing crops and harvesting. After prohibition of crops and harvesting. After prohibition of interest, they were allowed to do Salam interest, they were allowed to do Salam transactions. This helped them to get money transactions. This helped them to get money in advance for their needs.in advance for their needs.

During the days of our prophet (SAAWS), the During the days of our prophet (SAAWS), the merchants going with caravans used to get merchants going with caravans used to get interest based loans for purchasing the interest based loans for purchasing the commodities. After prohibition of interest, commodities. After prohibition of interest, they were allowed to do Salam.they were allowed to do Salam.

5757

BENEFIT TO THE SELLERBENEFIT TO THE SELLER

The seller gets in advance the The seller gets in advance the money he wants in exchange of his money he wants in exchange of his obligation to deliver the obligation to deliver the commodity later.commodity later.

He benefits from the Salam sale by He benefits from the Salam sale by covering his financial needs covering his financial needs whether these are personal whether these are personal expenses or expenses for expenses or expenses for productive or trading activity.productive or trading activity.

5858

BENEFIT TO THE BUYERBENEFIT TO THE BUYER

The purchaser or the Bank gets the The purchaser or the Bank gets the commodity it is planning to trade on commodity it is planning to trade on the time it decides. the time it decides.

The Bank will also benefit from the The Bank will also benefit from the cheap prices because usually the cheap prices because usually the Salam sale is cheaper than the cash Salam sale is cheaper than the cash sale. This way the Bank will also be sale. This way the Bank will also be secured against the fluctuations of secured against the fluctuations of price.price.

5959

PARALLEL SALAMPARALLEL SALAM

The Bank being the purchaser of Salam The Bank being the purchaser of Salam commodity can further sell on Parallel Salam commodity can further sell on Parallel Salam in a similar manner as it has previously in a similar manner as it has previously purchased on first Salam without making one purchased on first Salam without making one contract dependent on the other. However, in contract dependent on the other. However, in such case, the date of delivery shall not be such case, the date of delivery shall not be earlier than the date of receipt of such earlier than the date of receipt of such commodity. commodity.

The Bank also has the option of waiting to The Bank also has the option of waiting to receive the commodity and then sell it for cash receive the commodity and then sell it for cash or deferred payment.or deferred payment.

6060

FLOW OF SALAM TRANSACTIONFLOW OF SALAM TRANSACTION

SALAM PURCHASER

SALAM SELLER

Delivery of Commodity

Salam on CreditSalam Sale

ISLAMIC BANK

Purchaser Seller

21 3

6161

SALAM BASED FINANCIAL SALAM BASED FINANCIAL PRODUCTSPRODUCTS

Agriculture financingAgriculture financing Working Capital FinancingWorking Capital Financing Commercial and industrial financingCommercial and industrial financing Export financingExport financing Operations and capital cost financingOperations and capital cost financing

6262

DIFFERENCE BETWEEN DIFFERENCE BETWEEN SALAM AND MURABAHASALAM AND MURABAHA

Salam Murabaha

In Salam, delivery of purchased goods is deferred, price is paid on spot.

In Murabaha, purchased goods are delivered at spot, price may be either on spot or deferred.

In Salam price has to be paid in full in advance.

In Murabaha price may be paid on spot or deferred.

Salam is not executed in the particular commodity but commodity is specified by specifications.

Murabaha is executed in particular commodity.

Salam cannot be effected in respect of things, which must be delivered at spot. e.g. Salam between wheat and barley.

Murabaha can be executed in those things, subject to the conditions of hand to hand transfer and equal quantities.

6363

BASIC RULESBASIC RULES

6464

SPECIFICATION OF SPECIFICATION OF COMMODITYCOMMODITY

The commodity (Al-Muslam fihi) The commodity (Al-Muslam fihi) should be known. It must be should be known. It must be monitored by specifications to the monitored by specifications to the maximum possible degree, only maximum possible degree, only negligible variation is tolerated. negligible variation is tolerated.

It must also be ensured that the It must also be ensured that the commodity is possible to be commodity is possible to be delivered when it is due.delivered when it is due.

6565

SPECIFICATION OF SPECIFICATION OF COMMODITYCOMMODITY

Only those goods can be sold Only those goods can be sold through Salam contract in which the through Salam contract in which the quality and quantity can be exactly quality and quantity can be exactly specified. In other words it can be specified. In other words it can be done only in such items which can be done only in such items which can be weighed, measured or counted.weighed, measured or counted.

Salam can only be carried out in the Salam can only be carried out in the items in which variations in numbers items in which variations in numbers make no difference.make no difference.

6666

DELIVERY CONDITIONSDELIVERY CONDITIONS

Due date of delivery must be agreed at Due date of delivery must be agreed at the commencement of the contract.the commencement of the contract.

The place of delivery should also be The place of delivery should also be known. If it is not known, the place known. If it is not known, the place where the contract took place shall be where the contract took place shall be considered to be the place of delivery, considered to be the place of delivery, unless it is impracticable. In such a unless it is impracticable. In such a case, the place of delivery shall be case, the place of delivery shall be decided according to customary decided according to customary practices.practices.

6767

DELIVERY CONDITIONSDELIVERY CONDITIONS

Before delivery, goods will remain at the Before delivery, goods will remain at the risk of seller.risk of seller.

After delivery, risk will be transferred to After delivery, risk will be transferred to the purchaser.the purchaser.

Possession of goods can be physical or Possession of goods can be physical or constructive.constructive.

Transferring of risk and authority of use Transferring of risk and authority of use and utilization / consumption are the and utilization / consumption are the basic ingredients of constructive basic ingredients of constructive possession.possession.

6868

SALE BEFORE POSSESSIONSALE BEFORE POSSESSION

Commodity purchased under Salam Commodity purchased under Salam can not be sold earlier than taking can not be sold earlier than taking possession thereof. However, a very possession thereof. However, a very small school of though is of the view small school of though is of the view that this restriction should apply to that this restriction should apply to the food commodities only.the food commodities only.

These commodities can, however, be These commodities can, however, be sold under parallel Salam or may be sold under parallel Salam or may be promised to be sold at a future date.promised to be sold at a future date.

6969

PARALLEL SALAMPARALLEL SALAM

There must be two separate and There must be two separate and independent contracts, one where independent contracts, one where the Bank acts as buyer and other in the Bank acts as buyer and other in which it is a seller.which it is a seller.

The two contracts cannot be tied up The two contracts cannot be tied up and performance of one should not and performance of one should not be contingent on other.be contingent on other.

7070

BUY BACKBUY BACK

Salam arrangement cannot be used Salam arrangement cannot be used as a buy back facility where the as a buy back facility where the seller in the first contract is also the seller in the first contract is also the purchaser in the second. purchaser in the second.

Even if the purchaser in the second Even if the purchaser in the second contract is a separate legal entity contract is a separate legal entity but owned by the seller in the first but owned by the seller in the first contract, it would not tantamount to contract, it would not tantamount to a valid Parallel Salam agreement.a valid Parallel Salam agreement.

7171

An An IjaraIjara is a lease purchase contract in which a financial institution is a lease purchase contract in which a financial institution

purchases capital equipment or property and leases it to an enterprise. purchases capital equipment or property and leases it to an enterprise.

The financial institution may either rent the equipment or receive a The financial institution may either rent the equipment or receive a

share of the profits earned through its use. share of the profits earned through its use. Ijara wa-IqtinaIjara wa-Iqtina is the same as Ijara except that the lessees can acquire is the same as Ijara except that the lessees can acquire

ownership of the asset by making installment payments. The ownership of the asset by making installment payments. The

responsibilities of the various parties to an Ijara wa-Iqtina contract are responsibilities of the various parties to an Ijara wa-Iqtina contract are

given below:given below: The bank buys the assets from the vendor The bank buys the assets from the vendor The bank then leases the asset to the customer The bank then leases the asset to the customer The bank collects periodic rentalsThe bank collects periodic rentals The title of the asset remains with the bank under an operating The title of the asset remains with the bank under an operating

Ijara.Ijara. Title passes to the customer under an Ijara muntahia bittamleek, Title passes to the customer under an Ijara muntahia bittamleek,

either gradually over the period of the contract or at the end.either gradually over the period of the contract or at the end.

Islamic Bank

Vendor

Customer (lessee)

Transfer of title to the bank

Assets leased to the customer- title does (not)

pass at the end of the lease term

Payment of purchase price

I jarah installments

Ijarah- Concepts

7272

Procedure of Banking IjarahProcedure of Banking Ijarah

Undertaking to IjarahUndertaking to Ijarah

Agency AgreementAgency Agreement

PurchasePurchase

Payment of Purchase PricePayment of Purchase Price

Lease AgreementLease Agreement

7373

Finance Lease (Ijarah)Finance Lease (Ijarah)

Manufacturer /Supplier

Customer

Bank

1. Customer buys the property as Bank’s agent. Cost: $100

2. Execution of Ijara Agreement

3. Disbursement of the Facility. Facility Amount: $100

4. Bank appoints the Customer as its agent to buy the property.

5. Under the Ijara Agreement the Bank will lease the property immediately.

Lease

Features:

• Floating rate financing possible

•Can be used for refinancing

Uses:

• Financing Capital Expenditure

•Financing Big Ticket items like Aircraft, VLCCs, LNG Carriers, etc.

Tenor:

•5-7 years

Risks:

•Credit Risk

•Performance Risk

•Cost Overruns

•Ownership Risk7474

Ijara is used to raise finance against an asset XYZ Real Estate Deal : Sale/leaseback of existing properties to

fund construction of new buildings Client sells its existing asset to the Bank. The sale can be a

beneficial transfer of ownership or actual legal title transfer Bank leases the asset back to the client for the period of

financing, against periodic lease rentals. The rentals will comprise of only profit (during grace period) and

both profit and principal payments (during amortisation period).

The profit can be linked to a floating rate index, such as Libor. At the end of the term, Bank transfers the asset back to the

client either as a gift or at a nominal sum or at the termination

price (if bullet repayment). During the lease period, Bank is liable for insurance and major

maintenance as owner of the property. However, Bank can

appoint the client as its agent to perform these tasks

Ijarah…illustrative dealIjarah…illustrative deal

7575

MUZARA'AMUZARA'A Muzara’a is partnership in crops in which Muzara’a is partnership in crops in which

one party presents land to another for one party presents land to another for cultivation and maintenance in cultivation and maintenance in consideration for a common defined share consideration for a common defined share in the crop.in the crop.

7676

MUZARA'AMUZARA'A It can take several forms. It can take several forms.

1.1. For instance, contract based arrangement For instance, contract based arrangement can specify that land and other physical can specify that land and other physical factors of production for the enterprise factors of production for the enterprise could come from one party while labor could come from one party while labor could be provided by the other party.could be provided by the other party.

2.2. Incidence of a three-party in which the first Incidence of a three-party in which the first party provides land, the second provides a party provides land, the second provides a combination of required physical inputs, combination of required physical inputs, and the third provides labor.and the third provides labor.

7777

MUZARA'AMUZARA'A The location and characteristics of the land The location and characteristics of the land

to be cultivated under Muzara'a must be to be cultivated under Muzara'a must be clearly identified and submitted to the clearly identified and submitted to the party that is to implement the operation.party that is to implement the operation.

The production goal of the enterprise must The production goal of the enterprise must be defined in terms of end products i.e. be defined in terms of end products i.e. crops or live stock to be grown.crops or live stock to be grown.

The period in which the Muzara'a contract The period in which the Muzara'a contract is to be effective must be defined.is to be effective must be defined.

7878

MUGHARASAMUGHARASA Mugharasa (agricultural) partnership is a Mugharasa (agricultural) partnership is a

partnership in which one party presents a partnership in which one party presents a treeless piece of land to another to plant treeless piece of land to another to plant trees on it on the condition that they share trees on it on the condition that they share the trees and fruits in accordance with a the trees and fruits in accordance with a defined percentage.defined percentage.

7979

MUGHARASAMUGHARASA The functions and obligations of each The functions and obligations of each

individual or party in the contract must be individual or party in the contract must be clearly and unambiguously defined.clearly and unambiguously defined.

The location and characteristics of the land to The location and characteristics of the land to be cultivated under Mugharasa must be be cultivated under Mugharasa must be clearly identified.clearly identified.

The production goal of the arrangement must The production goal of the arrangement must be defined in terms of end products.be defined in terms of end products.

The period in which the Mugharasa contract is The period in which the Mugharasa contract is to be effective must be defined.to be effective must be defined.

Method of distribution of output must be Method of distribution of output must be stated clearly in the contract.stated clearly in the contract.

8080

Summary of the Presentation Summary of the Presentation

Islamic Banking is a system where deposits Islamic Banking is a system where deposits collected on profit & loss sharing basis are collected on profit & loss sharing basis are invested in profitable Projects using any invested in profitable Projects using any Shariah based mode and their net income/loss Shariah based mode and their net income/loss is shared between the depositor and the bank.is shared between the depositor and the bank.

It has three parts.It has three parts. Collection of deposits on pls basis.Collection of deposits on pls basis. Investing deposits in profitable ventures using Investing deposits in profitable ventures using

shariah based modes.shariah based modes. Distributing profit and loss among depositors Distributing profit and loss among depositors

and the bank.and the bank.8181

(From Economists Point Of View)(From Economists Point Of View)

It is the pooling of cash resources (means) of It is the pooling of cash resources (means) of the economy and diverting it to projects the economy and diverting it to projects which have the greatest positive impact on which have the greatest positive impact on the GNP and distributing the benefits of the GNP and distributing the benefits of increased GNP among the segments of the increased GNP among the segments of the economy. economy.

It has three parts.It has three parts. Pooling of cash resources.Pooling of cash resources. Diverting it to projects which have positive impact Diverting it to projects which have positive impact

on GNPon GNP Distributing GNP benefits to resource providersDistributing GNP benefits to resource providers Benefiting the Different segments of the economy Benefiting the Different segments of the economy

through increased GNPthrough increased GNP8282

Funds supply – summary of possible Funds supply – summary of possible ways in Islamways in Islam

8383

ISLAMIC BANKING MODELISLAMIC BANKING MODEL

Current Deposit

SBP

Operational Expenses

Income/Loss from Investment

Income from non fund business

POOL OF FUNDS

PLSDeposit

ors

BankEquity

ReservesDistributa

bleIncome

EquityDepositors

PLS

Idle fund

Investment

Current Depo

sit

8484

Comparison of the Islamic and Comparison of the Islamic and Conventional systemsConventional systems

Conventional BankingConventional Banking Equation of Banks FailureEquation of Banks FailureAdmn Exp + Interest Exp > Total Income + ReservesAdmn Exp + Interest Exp > Total Income + Reserves Equation of Banking System FailureEquation of Banking System FailureAdmn Exp + Interest Exp > Total Income + Reserves + Admn Exp + Interest Exp > Total Income + Reserves +

EquityEquity

Islamic BankingIslamic Banking Equation of Banks FailureEquation of Banks FailureOperational Losses > Reserves + PLS DepositsOperational Losses > Reserves + PLS Deposits Equation of Banking System FailureEquation of Banking System FailureOperational Losses > Reserves + PLS Deposits + EquityOperational Losses > Reserves + PLS Deposits + Equity Operational LossesOperational LossesOperational Losses = Income (Losses) from Invest ± Admn Operational Losses = Income (Losses) from Invest ± Admn

Exp Exp 8585

Thank YouThank You

8686