Download - Fundamentals of Islamic Finance explained through Islamic Contracts

T.I.E.S. @ennovient.comWednesday, May 06, 2015

Islamic Banking and Finance

- Explained Through Islamic Contracts


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)


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...)


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


Islamic Contracts

• Islamic contracts can be grouped into:

– Equity based

– Sale based

– Lease based


Islamic Contracts- Equity based

• Mudarabah

• Musharakah

• Sukuk


Mudarabah


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


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)


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


Musharakah


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.


Islamic Equity Contracts- Where is Musharakah applied?

• Project Financing

– Short term and Long term

– Real estate, Infrastructure finance etc...

• Partnership Financing

– Seasonal businesses


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


Sukuk


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


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


Islamic Contracts- Sale based

• Salaam (Forward Sale)


Salaam


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


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


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


Islamic Contracts- Lease based

• Murabahah

• Ijarah


Murabahah


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


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


Ijarah


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


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...


FOUR rules of Islamic Contracts


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)


Islamic Contracts

Rule 1:

– A condition that is not against the contract

is a valid condition.


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.


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.


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.


Q & A

Download - Fundamentals of Islamic Finance explained through Islamic Contracts

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