fundamentals of islamic finance explained through islamic contracts
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T.I.E.S. @ennovient.comWednesday, May 06, 2015
Islamic Banking and Finance
- Explained Through Islamic Contracts
T.I.E.S. @ennovient.comWednesday, May 06, 2015
Topics
• Principles of Islamic Banking and Finance
• Islamic Contracts*
– Equity based
– Sale based
– Lease based
* Unless otherwise mentioned, the content in these slides is referred from the
PGDIBF course material published by The Institute of Islamic Banking & Finance,
Hyderabad – 028 (http://www.islamicbankinst.com)
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Principles of Islamic Banking and Finance
• The foundation on which Islamic Banking
and Finance is based:
– Interest free (no Riba)
– One must own something to sell (no Short-
Selling)
– Risk sharing
(Contd...)
T.I.E.S. @ennovient.comWednesday, May 06, 2015
Principles of Islamic Banking and Finance
– Have contractual certainty
– No excessive speculation (no Gharar)
– No investments or financial transactions in
industries that produce/consume products or
services related to Gambling, Pork or Liquor
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Islamic Contracts
• Islamic contracts can be grouped into:
– Equity based
– Sale based
– Lease based
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Islamic Contracts- Equity based
• Mudarabah
• Musharakah
• Sukuk
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Mudarabah
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Islamic Equity Contracts- What is Mudarabah?
• It is a Trust Financing or Profit Sharing contract
• Only one party provides capital (Rab-al-maal) and
the other expertise (Mudarib)
• Only one party undertakes the management and
disposal of the capital (Mudarib)
• Only the capital owner (Rab-al-maal) bears the loss,
whereas the two parties share the output
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Islamic Equity Contracts- Where is Mudarabah applied?
• Islamic banks (Mudarib) relationship with
depositors (Rab-al-maal)
• Islamic banks (Rab-al-maal) relationship with
businesses or entrepreneurs (Mudarib)
• Islamic mutual funds (Mudarib) relationship with
unit holders (Rab-al-maal)
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Islamic Equity Contracts- How can Mudarabah be applied in India?
• Mutual funds that promise to invest in companies
approved by Shariah board. There are two such
mutual funds that are operating currently in India
viz., Tata Ethical Fund and Taurus Ethical Fund
• Providing seed capital to pre-revenue companies for
incubating their innovative ideas
• Using Limited Liability Partnership (LLP) structure
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Musharakah
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Islamic Equity Contracts- What is Musharakah?
• It is a Profit & Loss Sharing contract
• Both parties provide capital either in equal or unequal
proportions
• Both parties can be part of management and disposal
of the capital
• All partners share the profit according to a specific
ratio while the loss is shared according to the ratio of
the contribution.
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Islamic Equity Contracts- Where is Musharakah applied?
• Project Financing
– Short term and Long term
– Real estate, Infrastructure finance etc...
• Partnership Financing
– Seasonal businesses
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Islamic Equity Contracts- How can Musharakah be applied in India?
• Venture financing through equity investments
• Providing seed capital to pre-revenue companies for
incubating their innovative ideas
• Using Limited Liability Partnership (LLP) structure
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Sukuk
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Islamic Equity Contracts- What is Sukuk?
• Actually, it is an Islamic Investment Certificate and is
often referred to as an Islamic Bond
• Similar to a conventional bond, but, is structured to
make it Shariah compliant
• Backed by real underlying assets, rather than being
simply paper derivatives
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Islamic Equity Contracts- Where is Sukuk applied?
• Any government or a business that is planning to raise
capital from public sources. For e.g.,
– Malaysian global Ijarah Sukuk worth $500 million issued by
Malaysian government to investors across the world
– Ijarah Sukuk Saxony-Anhalt Germany worth Euro 100 million
issued by German government
– Sukuk Al Intifaa Makkah worth $390 million issued by a
Corporation selling usufruct rights as weekly time shares
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Islamic Contracts- Sale based
• Salaam (Forward Sale)
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Salaam
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Islamic Sale Contracts- What is Salaam?
• It is a Forward Purchase contract i.e. Price is paid in cash for
future delivery of the commodity
• Similar to futures in modern commodity market
• Buyer is NOT allowed to sell the commodity before actual
delivery i.e. possession
• Sale price has to be determined at the time of contracting and
must be paid in full to the seller
• Commodity should be something that is going to be produced
by the seller and it cannot be existing at the time of contract
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Islamic Sale Contracts- Where is Salaam applied?
• Advances to farmers for raising crops
• Working capital needs of Manufacturers
• Finance commercial and industrial activities, especially
during the phases prior to production
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Islamic Sale Contracts- How can Salaam be applied in India?
• Working capital requirements of Micro, Small and
Medium Enterprises (MSMEs)
• Pre-harvest financial needs of Farmers
• Using Co-operatives Societies or Limited Liability
Partnership (LLP) structure
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Islamic Contracts- Lease based
• Murabahah
• Ijarah
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Murabahah
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Islamic Lease Contracts- What is Murabahah?
• It is Cost Plus financing contract
• Deferred price is higher than the cash price
• Both parties must know the due date of payment in
case of deferred payment or due dates in case of
installments
• It is impermissible to charge any increment over the
principal if the buyer defaults on payment
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Islamic Lease Contracts- Where is Murabahah applied?
• Credit Sale
• Used to finance expensive consumer goods like
Cars, Furniture and Household appliances
• Used to finance Housing and Capital goods such as
Machinery and Equipment
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Ijarah
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Islamic Lease Contracts- What is Ijarah?
• Enables lessee to possess and use the assets it needs
without pumping large amounts of money
• Does not transfer ownership of assets, but, only ownership
of benefits
• Can be: A) Operational Lease, or B) Lease Purchase
• Lessor bears all the costs of basic maintenance on which the
permanence and suitability of the leased object depends.
• Permissible to make the lessee bear the cost of routine
maintenance
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Islamic Lease Contracts- Where is Ijarah applied?
• Lease of movable assets viz., Clothes, Appliances and
Jewellery etc...
• Lease of fixed assets viz., Houses, Office buildings etc...
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FOUR rules of Islamic Contracts
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Islamic Contracts
• There are four basic rules for judging
the validity of conditions in a
contract*.
* Ethica’s Handbook of Islamic Finance (http://www.ethicainstitute.com)
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Islamic Contracts
Rule 1:
– A condition that is not against the contract
is a valid condition.
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Islamic Contracts
Rule 2:
– A condition that seems to be against the
contract but is in the market practice is
not void if its void ness is not proven with
the clear injunctions of Qur’an and
Sunnah.
T.I.E.S. @ennovient.comWednesday, May 06, 2015
Islamic Contracts
Rule 3:
– A condition that is against the contract
and not in the practice of the market but
is in favor of one of the contractors or
subject matter is void.
T.I.E.S. @ennovient.comWednesday, May 06, 2015
Islamic Contracts
Rule 4:
– A condition that is against the contract not
in market practice, and not in favor of any
contractor is a void condition.
T.I.E.S. @ennovient.comWednesday, May 06, 2015
Q & A
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