‫ش‬

َ ْ
‫خ‬ َ ‫ي‬ ‫و‬
َ ُ ‫ه‬َ ‫سول‬ُ ‫َّللا َو َر‬
َ ‫َو َمن يُ ِط ِع ه‬
‫ون‬َ ‫َّللا َويَت ه ْق ِه فَأ ُ ْولَ ِِ ََ ُُ ُُ ل ْلََئ ِِ ُُز‬
َ‫ه‬
And he who obeys Allah and His Messenger,
and fears Allah, and is careful of (his duty to)
Him, these it is that are the achievers.
[24:52]
 Fundaments of
Islamic Finance

Lecture 1, 2,
3, 4
Learning Objectives
 Primary and Secondary Functions of a
bank
 Understand how funds are used by
Islamic Banks
 Shariah Compliant Modes of Finance
 Participatory Modes of Finance
 Mudarabah
 Musharakah
Reading List
 AAOFI, 2004
 Wahba Zuhaili, Fiqlul Islami Wa Adilatuhu
 Wahba Zuhaili, Financial Transactions in
Islamic Jurisprudence.
 Moore, Philip, “Islamic Finance”
 Al-Mawsu’ah al-Fiqhiyyah (pp. 33-92)
 Hassan, Hussain Hamid (1992), The
Jurisprudence of Financial Transactions,
published in ‘Lectures in Islamic Economics’,
IDB/IRTI, pp.105-108.
 Durani & Boocock (2006), “Venture Capital,
Islamic Finance and SMEs”
Functions of Bank
 Primary Functions
 Demand deposit
 Savings and Time deposits
 Making loans and investments

 Secondary Functions
 Money Transfers
 Agency Service
 Venture capital
 Letter of Credit
Shariah Complaint Modes of Finance

 Participatory Modes of Finance

 Mudaraba
 Musharaka
 Trade Based Modes of Finance
 Bai Mu’ajjal
 Bai’ Salam and Istisna’a
 Bai’ Murabaha and Musawamah
 Leasing
 Ijarah.
 Some Accessory Contracts
 Wakalah (Agency)
 Tawarruq
 Ji’alah
Mudaraba

 The term Mudarabah is interchangeably

used with Qirad and Muqaradah.
 An investor or group of investors
(Rabul-Mal) provide the capital.
 The profit is shared according to the
pre-agreed proportions,
 While the loss has to be borne
exclusively by the investors.
 Mudarib is only responsible for the
management.
Rab-ul-Mal Mudharib
(Lender/Financier) (Borrower/Entrepreneur)

INVESTMENT

EFFORTS
Profit
(In agreed Ratio)

Mudharabah (Partnership)
Loss
(To be borne by the
Rab-ul-Mal only)
Mudaraba

 Amount of Profit can not be fixed;

 Profit cannot be any percentage of the
capital invested;
 Any ambiguity or ignorance regarding
capital or ratio of profit makes the
contract invalid.
Types of Mudaraba

 Mudaraba al-Muqayyaddah
(Conditional)
 Conditions must not be prejudice to
the interest of the business or
counterproductive.

 Mudaraba al-Mutlaqah (Unconditional)

Mudaraba – Rabul-Mal

 Will provide all the capital required.

 No say in the running of the business.
 Can ask for guarantee to return funds,
which can only be enforced if:
 Mudarib is negligent;

 Capital should preferably be in the form

of legal tender money. Why?
 Capital given for Mudaraba must be free
from all liabilities.
 Not allowed to work for the business.
Mudaraba – Mudarib
(Entrepreneur)
 An agent to the Rabul-Mal he
undertakes the business and shares the
profit.
 He works in different capacities: trustee,
agent, indemnifier/liable and wage
earner.
 Freedom to act according to his
discretion.
 Sole responsible for managing the
Mudarba.
Mudaraba – Treatment of Profit/Loss

 Both parties in Mudaraba are at liberty

to agree on the proportion or ratio of
profit-sharing.
 Different proportions can be negotiated
upon the different situations.
 Reserves can be created by mutual
consent.
 If losses occur, the loss be can be
compensated by the profit of the future
operation or the reserves created.
 Profits are shared when they accrue.
 Please look at the last handout!
Mudaraba – Condition of the contract

 Before the work starts:

 Contract should be clearly stipulated
 Capital should be quantifiable and liquid
money
 Profit sharing ration should be clearly
stipulated
 When the work starts:
 Rabul-Mal should hand over the capital.
 The Mudarib should abide by the terms
of the contract.
Mudaraba – Condition of the contract

 When the work starts generating the

profit:
 Profits are shared when they accrue.
Mudaraba – A Critique
 Asymmetric Information
 Entrepreneur has more information about his
abilities, objectives and business ideas than
the investor.
 Adverse Selection
 Risk of choosing a bad company to invest in
requires careful investigation and relevant
credit check
 Moral Hazard
 Risk that once entrepreneur receives the funds
he may engage in immoral or harmful
behaviour motivated by slef-interest.
Musharaka

 Musharaka is derived from the term

Sharikah (partnership).
 “The Musharaka contracts are based on
a partnership process in which several
parties contribute to the financing and
the management of a Sharia’a compliant
project.” (Ref.?)
 A man who shares in profit must also
bear the risks. (Hadith: Earning are
concomitant to risks.)
Musharaka - Forms
 Partnership in Ownership (Shirkatulmilk)
 Two or more people are joint owner of
one thing.
 Mixing of ownership, either mandatory
or by choice.
 Optional

 Compulsive

 Not for sharing of profit but co-owners

may use the property individually or
jointly.
 It is lawful for one partner to sell his
share to other partner.
 Musharaka - Forms
 Partnership by Contract (Shirkatul’Aqd)
 Created by offer and acceptance
 “It is an agreement between tow or more
persons to combine their assets, labour
or liabilities for the purpose of making
profit.” (AAOIFI, 2004 p. 200)
 Partners are agents of each other and a
partner cannot sell his share without the
other partners consent and cannot sell
his share without the other partners’
consent and cannot guarantee capital or
any profit of the other partner.
Partnership by Contract (Shirkatul’Aqd)

 Shirkatulamwal
 All the partners invest some capital into a
commercial enterprise.
 The own the enterprise as per their share in the
capital
 Shirkatula’mal
 Partners are jointly undertake to render some
services to their customers and share the fee
charged by them according to the agreed ratio
and each partner bring his own resources.
 Shirkatulwujooh
 Partnership in creditworthiness
Partnership by Contract (Shirkatul’Aqd)

 Shirakah-al-Mufawadah
A partnership where two persons, being
the equal of each other in respect of
property, privileges, and religious
persuasion, enter into a contract of
partnership.
 Shirak al ‘Inan or General Partnership
 Where any two persons become partners
in any particular business or where they
become partners in all matters of
commerce indifferently.
 Involves collective capital of the partners
Musharaka
 Three common conditions:
1. Agency (hand of trust)
2. Qualification (age, sanity,…)
3. Specification of profit sharing ratio
(no fixed profit for any partner.)
 Malikite consider it as irrevocable
while others consider Shiraka
contract a revocable.
Shirak al ‘Inan in Banking
 Suitable for joint business,
 adaptable to any situation
 Practicable in current advanced
commercial practices
 “A joint enterprise formed for
conducting any business with the
condition that all partners shall share
the profit according to a specified ratio,
while the loss will be shared according
to the ratio of contribution to the capital
of the joint business.”
 Shirak al ‘Inan - Conditions
 Capital can be invested in any proportion
 Power of appropriation in the property and
participation in the affairs of the Shirakah may
be different and;
 disproportionate to the capital invested by
partners.
 Profit may be divisible unequally and
disproportionate to the capital invested
 Profit sharing ratio may be pro rats ration (in
proportion to capital contribution)
 Loss is to be shared in proportion to the capital
invested.
Shirak al ‘Inan - Conditions
 Each partner is an agent (Wakil) to the
other partner
 No partner is responsible for
indemnification of the acts of
commissions and omissions on the part
of the other partner (s).
 Bank can keep control and supervision
rights over the project and leave the day-
to-day project work to the second
partner.
Musharik -1 Musharik-2
(Financier) (Entrepreneur)

INVESTMENT

Investment + EFFORTS
Profit
(In agreed Ratio)

Musharaka (Partnership)
Loss
(To be borne by the in
the ratio of Capital
Invested)
Musharaka - Types
 Permanent or Continuous Musharaka
 The partnership process continues until the
project is finished.
 Each partner retain their share in the capital
 Partner can sell his share to a third party
 Diminishing Partnership
 Musharaka Muntahiya Bittamleek
 One partner agrees to gradually sell parts of its
capital shares in the Musharaka project to
other party against a specific amount of
money.
 Share in profit also decrease in line with the
share in capital.
Musharaka - Guarantees
 All partners in Shiraka maintain the
assets of the partnership as a trust.
 No one is liable except in cases of
breach of the contract, misconduct or
proven negligence, such as:
1. A partner does not abide by terms and
conditions;
2. A partner work against the norms of
the concerned business;
3. The established ill-intention of a
partner.
 Musharaka –Third Party Guarantee
 The third party should not be legally and
financially related to Musharaka by
owning more than 50% of the capital of
the guaranteed joint venture.
 The guaranteed joint venture should not
own more than half of the capital of the
guarantee-providing entity.
 The Musharaka contract should not
conditional on such a guarantee.
 Fulfilment of promise by a third party is
not a condition for validity of the
contract.
Musharaka – Application in Banking
 Partnership
 Limited Liability companies and bodies
corporate
 Term financing to customers in order to
finance the project
 Make sufficient liquidity available
 Housing finance
 Fixed asset financing
 Musharaka – Letter of Credit
 What is a Letter of Credit
 “Letter of Credit” is derived from the French
word “accreditation”, a power to do something.
 Latin word “accreditivus”, meaning trust.
 “A letter of credit is a document issued mostly
by a financial institution, used primarily in trade
finance, which usually provides an irrevocable
payment undertaking.”
 Often referred to as a documentary credit;
 The source of payment for a transaction,
meaning that redeeming the letter of credit will
pay an exporter.
After a contract is concluded between Seller consigns the goods to a carrier
buyer and seller, buyer's bank in exchange for a bill of lading.
supplies a letter of credit to seller.
Seller provides bill of lading to bank Buyer provides bill of lading to carrier
in exchange for payment. Seller's and takes delivery of goods.
bank exchanges bill of lading for
payment from buyer's bank. Buyer's
bank exchanges bill of lading for
payment from buyer.
 Musharaka: The Letter of Credit
 A Mushraka contract is signed between
the bank and his client showing
 the Musharaka capital,
 the type of trade,
 the profit-sharing ratio, and
 other related provisions
 The L/C is opened in the name of both
bank and his client.
 The margin that is paid by the client is
treated as his share in the Musharaka
capital.
Modern Corporations

 Joint Stock Companies

 Shirakahal ‘Inan
 Combination of Musharakah and
Mudarabah
Musharaka – Venture Capital
 What is Venture Capital Finance?
 An activity by which investors support
entrepreneurial talents with finance and
business skills to exploit marker
opportunities and thus obtain long term
capital gains.
 An equity based investment activity
particularly tailored for solving the
financing problems of SMEs.
 Musharaka is an ideal for Venture Capital
financing;
Musharaka – Venture Capital
 SME’s cannot not provide necessary
collateral/security to enjoy finance from
conventional system.
 SME’s typically suffer from inability to
access conventional banking funds at the
start-up or sometimes the post start stage.
 Because of very low liquidation values
and vulnerability to debt-servicing crises.
 SME is ideally suited to equity rather than
debt financing, therefore, Musharaka is an
ideal basis for Venture Capital Finance.
Musharaka – Venture Capital
 Features of Venture Capital Finance
 Equity Finance
 Long term investment in young start-
up companies
 Managerial assistance to talented
entrepreneurs
 Capital gains
 Musharaka – Venture Capital
 Types of Venture Capital Finance
 Business Angels: or informal equity suppliers
targeting running SMEs rather than start-ups
 Corporate Venture Capital: led by cash-rich
corporations to satisfy various strategies of their
own;
 Social Venture Capital: geared to community
needs.
 Corporate Venture Capital Funds: The primary
source of post war start-up equity finance for
technology-oriented firms like Microsoft, Apple
Computers, Intel etc.
Musharaka – Venture Capital
 Venture Capital Finance Properties
 Mostly closed-end funds with
maturities ranging between 10-15
years.
 Fundamentally addressed to resolving
Adverse Selection and Moral Hazard.
 Questions
1. Why should management of mudarabah be left to the
sole discretion of mudarib without interference from
the financier [rabb al-mal]?
2. Given that rabb al-mal cannot give directions to the
mudarib in the management of commercial operations,
what is the jurist description of the alternative
arrangement which permits this condition?
3. What is the empirical relationship between return and
risk?
4. Given the provisions of risk-sharing in mudarabah,
which of the following three characteristics is typical
of an Islamic economic agent: risk-aversion, risk-
neutral or risk-loving?
5. Why is it not possible to treat the fixed interest rate as
a ‘share in profit’?
 Trade Based
Modes of Finance
 Trade Based Modes of Finance
 Bai’ Mu’ajjal
 Bai’ Murabaha
 Bai’ Musawamah
 Bai’ Salam (Trust Sale) and
 Bai’ Istisna’a (Order Sale)
Basic Principles of Trade
 The commodity or asset being sold or
the purpose of such sale should not be
against the basic injunctions of Islamic
Shariah.
 The sale should take place with the free
and mutual consent of the seller and
buyer
 Subject of the sale, Price, date and place
of delivery, time of payment of price
must be agreed.
 Seller must be either owner/agent.
 The subject of sale (Mabi’) should be
Transferrable to the ownership of another
person.
 The subject of sale must exist at the time
of sale
 The Mabi’ should be well defined in and
in the ownership of the seller.
 The Mabi’ must be in the physical or
constructive possession of the seller.
 Sale must be instant and absolute.
 A certain price is stipulated once and
for all.
 The subject of the sale should be
specifically known and identified to the
buyers.
 The sale must be unconditional.
Bai’ Mu’ajjal

 Sale on credit i.e. creating receivables.

 Musawamah
 Normal sale where parties bargain on
price, goods delivered and payment is
deferred.
 Murabaha
 “Cost-Plus Sale”, parties bargain on the
margin of profit over the known cost
price.
 The seller has to reveal the cost and

provide all cost-related information.

Murabah – A Bai’ Al Amanah
 Declaration of the cost to the seller.
 Tawliyah (resale at the stated original
price, no profit, no loss.)
 Wadhi’ah (resale at discount price)
 Murabaha (sale with a fixed profit
margin over the cost.)
 Murabaha
 “the sale of anything for the price at
which it was purchased by the seller and
an addition of a fixed sum by way of
profit”. (Al-Hidaya by Al-Marghinani,
1957, p.282)
 “the sale at capital cost plus a known
profit, the knowledge of of capital cost is
a precondition in it”. (Ibn Qudamah)
 “Murabah is conducted and completed
by exchanging goods and price including
a mutually agreed profit margin, then and
there.” (Imam Malik, Kitab al Fiqh al Mazahib al-Arbaia, p. 559)
 Murabaha _ Conditions
 Goods to be treated should be real, but
not necessarily tangible.
 Currency and monetary units which are
subject to Bai’ al Sarf cannot be sold
through Murabaha.
 Credit documents that represents debt
owed by someone cannot be traded.
 The seller must state the original price
and the additional cost incurred on the
sale item and true to his words.
 The margin of profit on the price so
reached has to be mutually agreed.
 Any Majhul price cannot become a basis
for Murabaha.
 What happens if the Seller gives
incorrect statement about the price/cost
of goods?
 Murabaha - Conclusion
 Murabaha is lawful kind of sale but has
its own limitations.
 The Medieval Murabaha was not a mode
of finance, it was a kind of trade.
 Contemporary jurists have accepted it as
a mode of business and an alternative to
financing with certain limitations.
 Level of transparency and Justice.
Murabaha and Credit Sale
 Murabaha-Mu’ajjal
 Sale with profit on Deferred payment
basis.
 Lump sum payment or instalments
 “Sale with an agreed profit margin over
the cost price along with deferred
payment.”
 “A sale is valid either for ready money or for a
future payment provided the period be fixed,
because of the words of the Holy Quran
“Trading is lawful” and also because there is a
tradition of the holy Prophet (SAW) who
purchased a garment from a Jew, and promised
to pay the price at a fixed future date by
pledging his iron breast-coat. It is indispensably
a requisite of business but the period of
payment should be fixed. Uncertainty in the
period of repayment may occasion a dispute
and jeopardise the execution of the transaction
since the seller would naturally like to demand
the payment of the price as soon as possible,
and the buyer would desire to defer it.” [p.242]
Prompt Payment vs. Deferred Payment
 The receipt of the agreed price is the sole
right of the seller.
 The difference between cash and credit
price is allowed if provided one price is
settled at the finalisation of the contract.
(Hanafi, Shafi and Hanbalis)
 It is in accordance with the Fiqh
principle, profit goes with loss (“Al-
Ghunm bil Ghurm”).
 Murabaha vs. Conventional Loan
 The banker in a Murabaha must have some
form of actual ownership, registered or not,
constructive or physical.
 The closing date for Murabaha transaction may
be extended but the extension or rollover may
not result in an increase in the mark-up or a
penalty.
 If the payment is late no form of penalty may be
charged for the profit of the creditor (i.e. Bank)
 Most Islamic scholars do not agree early
payment discounts etc.
Murabaha in Practice
 Short-Term financing for financing of
working capital needs.
 Long-Term financing requirements for
financing of fixed assets.
 Housing Finance
 Murabaha Sale of securities and
commodities which may be used by the
client as a Tawaruq or Reverse
Murabaha.
Murabaha – How ?
 Direct Trading by Bank Management
 Bank Purchases Through a Third
Party/Agent
 Murabaha Through the Client as Agent
 Deferred Payment

BANK CLIENT
Goods
Cash Payment
Goods

SUPPLIER
 Murabaha To Purchase Order
 Modern Murabaha transaction by banks
takes the form of Murabaha to Purchase
Order (MPO)
 Murabaha lil ‘amri bil Shira/Murabaha li
Wa’da bi Shira.
 Purchase in response to customers
request.
 Promise to purchase is a part of the
requisition.
 Client can nominate the Supplier but bank
needs to ensure that the supplier is in
associated with client.
 MPO – A Bunch of Contracts

 A master contract which stipulate the

overall facility to be availed, followed by
an agreement to purchase or promise by
the client to purchase the article when
offered by the bank.
 An agency contract whereby the agent,
who could be client or any third party has
to purchase the items from the marker.
 The actual Murabaha contract.
 1 NEGOTIATION
(To determine the needs)

SELLER BUYER

First Purchase
2

4 Promise to 5
3 Purchase
(PO)
Appointment
of agent for
Delivery,
payment or Murabaha Sale
both.
FINANCIAL INSTITUTION
 Bai Murabaha –Risks for the Bank
 Customer refuses to purchase goods
after taking possession as agent.
 Client has already purchased goods and
needs finance (Bai al ‘Inah).
 Goods/assets already consumed by
client.
 Overdue/Missed payment
 Default risk
 Supplier may not perform his obligations.
 Purchase from or resale to associate or
subsidiaries.
MPO – Unresolved Questions
 Should the promise be unilateral or bilateral,
binding or nonbinding?
 What is remedy if the client backs out?
 What should be the sequencing of the various
actions of the bank and the client?
 When the actual Murabaha is to be executed
what happens if the client makes early
payment or delays in making payment of the
agreed price?
 What structure and modus operandi of
Murabaha can be adopted to fulfil the needs of
various stakeholders along with ensuring
Shariah compliance?
Bai’ Salam/Bai; Salaf
 “Price paid in advance at the time of making
the contract for prescribed goods to be
delivered later”.
 The parties stipulate a certain time for supply
of goods of specified quantity and quality.
 “Forward transaction of a defined nature.”
 “..who ever pays money in advance (for fruit)
(to be delivered later) should pay it for a known
quality, specified measure and weight of
course along with the price and time of
delivery.”
 Bai’ Salam – Economic Role
 The period of delivery ranging from one year to
three years suggests that the amount of
advance was not small.
 Buyers were not the consumers of the goods;
they were traders or prospective traders.
 The price received in advance might have met
both the productive and consumptions
requirements of the farmers.
 Money could also be used for fixed investment
(three years).
 Bai’ Salam - Features
 Subject Matter of Salam
 any thing that can be determined in Quantity and
quality.
 Payment of Price – Salam Capital
 Any legal tender
 Could be in terms of goods as well
 Salam capital should be advanced in full.
 Period and Place of Delivery
 Due date and place delivery
 Khiyar (Option)
 Amending or Revoking the Salam Contract
 Penalty for Nonperformance
 Goods Produced

BANK CLIENT
Financing
Goods Produced

NEEDS

CASH PAYMENT
Revenue

Goods
Market NEEDS
Salam – In Practice

CLIENT Purchase against Advance Cash BANK

Payment and Deferred delivery.

Sale against advance

Cash payment and
deferred delivery
BUYER
Bai’ Salam – Case Studies
 Agriculture Finance
 Salam For Working Capital (Steel Mill)
Bai’ Salam –Risks for the Bank
 Counterparty and delivery risk
 Commodity – Price Risk
 Commodity – Marketing Risk
 Bai’ Istisna (Order to Manufacture)
 An asset is transacted before it comes to
existence.
 A commodity is transacted before it is
manufactured.
 Legalised o the basis of Istihsan (Public
interest)
“Istisna is evolved into Islamic jurisprudence due to
specific needs in the area of manual work, leather
products, shoes, carpentry etc. However, it has grown
in the modern era as one of the contracts that make it
possible to meet major infrastructure and industrial
projects such as the building of ships, aeroplanes and
other large machinery……..”
 Sale is executed at the time of entering
into the Istisna contract.
 Therefore, no need to renew an
exchange of offer and acceptance after
the subject matter is prepared.
Bai’ Istisna - In Practice
 Financing manufacturing/
 Construction of houses
 Building of Bridges, roads and
Highways
Istisna –Case Studies
 Housing Finance
 Export
 Government Projects
Bai’ Istisna – Risk for the Bank
 No claim in case of non-performance.
 Delivery Risk
 Sale not permissible before delivery
 Asset Risk
 Price Risk
 Marketing Risks

 Quality Risks
Bai’ Salam vs. Bai’ Istisna
 The subject of Istisna is always a thing
which needs manufacturing, while
Salam can be effected on any thing, no
matter whether it needs manufacturing
or not.
 It is necessary for Salam that the price
is paid in full in advance, while it is not
necessary in Istisna.
 The contract of Salam, once effected,
cannot be cancelled unilaterally, while
the contract of Istisna can be cancelled
before the manufacturer starts the work.
Bai’ Salam vs. Bai’ Istisna
 The object of the Salam is a liability on the
seller to deliver, thus should be in the form of
fungible goods i.e. easily replaced from the
market should the seller be unable to deliver.
Under the Istisna, the asset manufactured
must meet specification of the order and the
buyer has the right not to take possession of
the asset if the specifications are not met.
 The time of delivery is an essential part of the
sale in Salam while it is not necessary in
Istisna that the time of delivery is fixed. Any
penalty for charged late delivery can reduce
the price of an Istisna contract but in a Salam,
the penalty amount is paid to charity (not
taken as benefit for the buyer).
Islamic Financial
Instruments

LEASING
Leasing - Conventional

 A lease is an agreement between you

(the lessee) and the finance company
(the lessor). You will pay a periodic fee,
usually monthly, for the use and possibly
ownership of equipment.
 “Asset finance or leasing is a way of
purchasing equipment, machinery or
other assets without having to pay the
full amount upfront.”
 The Finance and Leasing Association
(FLA) estimates that some 15% of office
equipment is financed through a lease.
Hire Purchase

 Hire Purchase is a loan linked to a

specific purchase, such as a car. It’s a
way of obtaining the use of an asset
before payment is completed - once
you sign the agreement you can drive
the car away the same day.
Hire Purchase - Features
 You don't legally own the goods until
you've paid back all the money you owe.
This means that you cannot modify or
sell them without the lender's permission
 Your contract is with a finance company
(not the retailer) who will own the goods
until the final payment is made
 The finance company can take the goods
back if you don't keep up your
repayments
 You will be liable for any damage caused
to the goods during the contract period.
Ijara - Definition
 Derived from al-’Ajr and means
compensation, substitute, consideration,
return or counter value (al’Iwad)
 It refers to hiring or renting any
asset/commodity to benefit from its
usufruct.
 Kira and Istijar are also used for the
same meaning.
 Ijara - Definition
 “Ijara is a contract of a known and proposed
usufruct of a specified asset for a specified
time period against a specified and lawful
return or consideration for the service or return
for the benefit proposed to be taken, or for the
effort or work proposed to be expended.”
[Zuhayli, 2003, pp. 386-387]
 “Ijara is the sale of usufruct (not of ‘Ain) of any
commodity in exchange of Ujrah, wages or
rent, and covers houses, shops, riding/work,
animals, jewellery, clothes etc.”
BASIC RULES OF LEASING
 Transferring of usufruct not ownership
To another person for an agreed rent, at an
agreed consideration.
 Subject of lease
Valuable, Identified and Quantified
 Consumable things cannot be leased
out
Anything which cannot be used without
consuming cannot be leased out; e.g.,
money, wheat etc.
 BASIC RULES OF LEASING
 All Liabilities of ownership are borne by
lessor
Since corpus of leased property remains in
the ownership of the seller.
 Period of lease
Must be determined in clear terms at the time
of contract
 Lease for specific purpose only
If no specific purpose is identified in the
agreement, then it can be used for any
purpose for which it is used in normal course
 BASIC RULES OF LEASING
 Lessee as Ameen
The lessee is liable to compensate the lessor for
every harm to the leased asset caused by any
misuse or negligence. The leased asset shall
remain in the risk of the lessor throughout the
lease period.

 Lease of jointly owned property

Is permitted and rentals shall be distributed
between all the joint owners according to the
proportion of their respective shares in the
property.
BASIC RULES OF LEASING
 Determination of Rental
The rental must be determined at the time of
contract for the whole period of lease.
Ijara – Shariah Rulings (Al-Kasani)

 The contracted usufruct has to be

ascertained to avoid any dispute.
 The lease period must be specified.
 Benefiting from the hired goods should
be possible
 The handing over of the assets for their
benefit is essential
 The usufruct of the asset must be lawful
 The usufruct must be tradition of the
people.
Ijara - Conclusion
 Ijara is only valid for things which
possess Manafa’ah (Usufruct) and
which can be hired or utilised but their
corpus or substance (‘Ayn) is not
consumed.
 All those assets taking benefit from
which is not possible without
consuming them cannot be given on
lease.
 The genus of the asset leased and the
rent should not be the same.
Features of Ijara Contract

 It is a contract.
 Known usufruct is transferred.
 Of a particular asset
 For a specified time period
 Against agreed-upon rental
Ijar vs. Bai’

 In Bai’ ownership of the corpus of the

asset is transferred while in Ijara the
corpus of the asset remains in the
ownership of lessor and only its
usufruct is traded.
 Ijara is always time bound, while sale
implies definite transfer of ownership
of the sold asset just after the sale is
executed.
Determination of rent

 Aggregate cost incurred in the purchase,

construction or installation of the asset
by the lessor.
 The lessor cannot increase the rent
unilaterally.
 There can be different rates for different
phases based on any agreed benchmark
during the lease period.
 Lease period or rent both could be
reviewed.
 In a long term lease rent could be tied
with a variable and well defined
reference rate or benchmark or
enhancing the rent periodically.
 The rate of inflation, any price index,
growth rate or any well-defined returns
rate in real sectors of an economy can
be used for benchmarking.
 Scholars suggest that the relation
between the rent and the reference rate
should be subjected to a ceiling or limit.
 Sub-lease by the Lessee
 Security/Guarantee in Ijarah
 Liabilities of the Parties
 There is no liability on a lessee (or
employee)
 All liabilities emerging from the
ownership shall be borne by the lessor,
but the liabilities relating to the use of the
property shall be borne by the lessee.
 The leased property shall remain in the
risk of the lessor.
 Ijara is a binding contract therefore,
cannot be revoked/amended unilaterally.
 If the leased asset is damaged to the
extent it is no more usable the contract is
terminated.
 If the lessee stops using the asset
without the lessor’s consent, accrual of
the rental will continue.
 Death of either party.
 Failure in Payment of Due rent
 Rent is a debt payable by the lessee.
 Shariah Scholars allow that a donation
or any amount of penalty payable to
charity.
 Enforce collateral to cover the rent.
LEASE AS A MODE OF FINANCING

 Leasing should not be interest-based

loan or replacing interest with rent,
rather it should comply with all of the
following conditions of Islamic leasing:
LEASE AS A MODE OF FINANCING

1. The commencement of lease

Unlike the contract of sale, the agreement of Ijarah
can be effected for a future date. Hence, it is
different from Murabaha.
2. Rent should be charged after the
delivery of the leased asset to the
lessee
and not from the day the price has been paid. If
the supplier has delayed the delivery after
receiving the full price, the lessee should not be
liable for the rent of the period of delay.
LEASE AS A MODE OF FINANCING

3. Different relations of the parties

There are two separate relations between the
institution and the client: one of an agent and the
other of a lessee.
LEASE AS A MODE OF FINANCING

4. Difference between Murabahah and

leasing
 A Murabaha can not be transacted on a future
date as the sale would be executed simultaneously
after taking delivery from the supplier and seller
would never bear its risk which Shariah does not
permit . But in leasing it is permissible, because in
leasing the asset remains under the risk and
ownership of the lessor throughout the leasing
period.
LEASE AS A MODE OF FINANCING

5. Expenses consequent to ownership to

the lessor
As the lessor is the owner of the asset, he is liable
to pay all the expenses incurred in the process of
its purchase and its import to the country of the
lessor for example expenses of freight and
customs duty etc.
6. Lessee as Ameen
The lessee is responsible for any loss caused to
the asset by his misuse or negligence. He can
also be made liable to any normally occurring
LEASE AS A MODE OF FINANCING

7. Variable Rentals in Long Term

Leases
In this case the lessor has two options:
 A lease contract can have a condition that the
rent shall be increased according to a specified
proportion (e.g. 5%) after a specified period (like
one year).
 He can contract lease for a shorter period after
which the parties can renew the lease at new
terms and by mutual consent
LEASE AS A MODE OF FINANCING

8. Penalty for late payment of Rent

The lessor cannot charge an additional amount

in case the lessee delays payment of the rent.

9. Penalty of late payment is given to

charity by lessee
LEASE AS A MODE OF FINANCING

10. Termination of Lease

If the lessee contravenes any term of the agreement,
the lessor has a right to terminate the lease
contract unilaterally. If not then it can be
terminated through mutual consent only. However,
in such a case he cannot charge rentals of
remaining period.
11. Insurance of the assets
If the leased property is insured under the Islamic
mode of Takaful, it should be at the expense of the
lessor and not at the expense of the lessee
LEASE AS A MODE OF FINANCING

12. The residual value of the leased

asset
Through a mutual agreement of Lease, after the expiry of
the lease period, the corpus of the leased asset cannot
be transferred to the lessee, otherwise it becomes hire
purchase.
It is a well-settled rule of Islamic jurisprudence that one
transaction cannot be tied up with another transaction so
as to make the former a pre-condition for the other.
However, the lessor may enter into a unilateral undertaking
to sell the leased asset to the lessee at the end of the
lease period. This undertaking will be binding on the
lessor only.
LEASE AS A MODE OF FINANCING

13. Ijarah Wa Iqtina

The lessor may sign a separate promise to gift the
leased asset to the lessee at the end of the lease
period, subject to his payment of all amounts of
rent. The validity of this arrangement is subject to
two basic conditions:
Firstly, the agreement of Ijarah itself should not be
subjected to signing this promise of sale or gift.
Secondly, the promise should be unilateral and
binding on the promisor only.
LEASE AS A MODE OF FINANCING

14. Sub-Lease
If the leased asset is used differently by different
users, the lessee cannot sub-lease the leased
asset except with the express permission of the
lessor.
1. the rental rate decided at the time of the agreement .
2. expenses under Ijarah are as follows:
• Lessor- expenses relating to the corpus of the asset i.e.
insurance, accidental repairs etc. will be borne by the
lessor
• Lessee- actual operating/overhead expenses related to
running the asset will be borne by the lessee
3. two contracts into one contract is not permissible in
Shariah therefore, we cannot have the agreement of hire
and purchase into one agreement, only we can
undertake/promise to purchase the leased asset
Modern Forms of Leasing

 Financial Lease or Hire-Purchase

 Security or Financing Lease
 Operating Lease
Potential of Ijara
 Ijara is conducive to the formation of
fixed assets and medium and long-term
investments.
 Payment of Ijara rental can be unrelated
to the period of taking usufruct by the
lessee.
 Ijara can be contracted on an existing
asset or a building and even an asset
that is yet to be constructed.
 The Ijara rate can be fixed or floating,
providing a clear formula is mutually
agreed with a floor and a cap.
Risk Mitigation in the case of Ijara

 The bank has purchased the asset as

per the undertaking by the customer,
but the latter refuse to take the asset on
lease.
 The customer may default in payment of
the due rental.
 Asset risk of major maintenance/
destruction.
 Early termination of lease agreement.
Risk Mitigation in the case of Ijara

 The lessee may use the assets

carelessly, requiring the bank to bear
major maintenance expenditure.
 Rate of return risk du to inflation.
 Sale of asset at maturity – the
customer may not buy.
 Conventional Islamic
Financing lease contain hire- The Ijara contract does not
purchase arrangements. contain any condition. The lease
remains subject to all Ijara rules;
sale is not a part of it.

Customer is responsible for all All risks pertaining to ownership

kinds of loss or damage. are borne by the Islamic bank (the
lessor).

The insurance expense of the Takaful at the expense of the

asset is borne by the lessee. lessor.
 Conventional Islamic
If insurance company does not The lessor bears the risk of
compensate the entire Takaful claim settlement.
outstanding amount in the case
of loss, the customer is liable to
pay the balance.

If the asset is lost are stolen Rent is consideration for usage

lessee needs to pay rent until the of the leased asset, and if the
settlement of the insurance asset has been lost/stolen the
claim. concept of rental becomes void.

The lessor is given an Ijara is binding contract and if

unrestricted power to terminate there is no contravention on the
the lease unilaterally at his sole part of the lessee, the lease
discretion. cannot be terminated.
 Conventional Islamic
Extra amount is charged if rent is No extra amount could be
not paid. This amount is income charged.
of lessor.

On completion of the lease Customer is not obliged to buy

period asset are automatically these assets. He may purchase
transferred to the lessee. this asset through a formal sale
deed if he considers it beneficial
for him.
Upfront payment has to be made Lessor normally take only a
in the form of down-payment, the security deposit, which is
first year’s insurance premium refundable if the lease is not
and other insurance, first finalised. The bank has authority
month’s rental etc. to recover only actual expenses
not including the cost of funds.
 Ijara - Definition
 “Ijara is a contract of a known and proposed
usufruct of a specified asset for a specified
time period against a specified and lawful
return or consideration for the service or return
for the benefit proposed to be taken, or for the
effort or work proposed to be expended.”
[Zuhayli, 2003, pp. 386-387]
 “Ijara is the sale of usufruct (not of ‘Ain) of any
commodity in exchange of Ujrah, wages or
rent, and covers houses, shops, riding/work,
animals, jewellery, clothes etc.”
BASIC RULES OF LEASING
 Transferring of usufruct not ownership
 Subject of lease
 Consumable things cannot be leased
out
 All Liabilities of ownership are borne by
lessor
 Period of lease
 Lease for specific purpose only
 BASIC RULES OF LEASING
 Lessee as Ameen
 Lease of jointly owned property
 Determination of Rental
 Conventional Ijara
 Financial Lease – Hire Purchase
 Bank buy the asset either directly or
through Lessee.
 Fix the rent. (How?)
 Long-term (75% of the assets useful life),
non-cancellable rental agreement.
 ownership of the asset is transferred to
the lessee at the end of the lease term;
 The lease commences on the day on
which the price is paid by the bank
 The risk of ownership is borne by the
lesse.
 Conventional Ijara

 Security or Financing Lease

 It involves a situation where a sale of
goods is structured as a lease to avoid
certain legal consequences, including the
requirement to register a PPSA financing
statement in some jurisdictions.
 It involves the effective transfer of all
risks and rewards associated with the
ownership to the lessee.
 Operating Lease
 Possession of the asset given to the
lessee, ownership remains with the
lessor, to have its use in return for
rental.
 The lessor takes back equipment/asset
when the lease ends.
 Ijara - Contemporary
 Ijarah Muntahia-bi-Tamleek
 Sale and Lease Back Arrangement
 Customer already owns an asset
 He sells the asset to the bank and then
takes on rent for his use.
 Should only be used in exceptional
circumstances.
 The sale agreement must be executed
before entering into Ijara.
 Lease asset can be sold back to customer
after a reasonable period.
Case study

 Aristec Textiles in Leicester has

requested and Ijarah facility for the
following assets to Markfield Islamic
Bank. (The client is willing to deposit
10% of the value of the Ijara asset as a
security deposit/earnest money.)
1. Company cars 20 £ 100K (L/C established)
2. Trucks 20 £ 500k
3. Dyeing plant £ 200K (already owned by client)
4. Looms 50 £ 100K (operating for a year)
 Issues
1. Which asset will the bank finance through a
direct lease and which through sale and
lease-back? What factors will it consider
before allowing sale and lease-back
transaction?
2. One year after leasing the looms for his
factory, Aristec reports that 5 of the looms
have broken and have to be repaired. The
loss adjustor for the Takafol company, after
inspection, reported that the looms broke
down due to poor maintenance on the part of
the client and will take a month to be repaired
at a cost of £ 500 per loom. How should the
bank calculate future rentals and the rental
for the time when the looms are broken?
3. The cars were leased for a tenure of five
years and Aristec has used them to
varying degree. Two years down the
line Aristec requests the bank to sell
him ten vehicles at a price of £ £ 4K
each. Should the bank accept his offer
and what consideration should
determine the decision? The
outstanding Ijarah investment is £
£3500 per car, and prepaid expenses,
including Takafol outstanding are £ 200
per car.
5. In the same year, one of the car is
destroyed in an accident. Police and loss
adjustor reported that accident was not the
fault of the client. The remaining
outstanding is the same as given in
previous question. The Takafol amount
recovered by the bank is £ 4500 and the
client deposited a security deposit £ 500.
What amount is the bank legally bound
under the Ijara agreement to give to the
client? In view of the satisfactory payment
behaviour, in what ways can the bank
accommodate the client without burdening
itself?
Islamic Financial
Instruments
Learning Objectives
 Istijar
 Tawarruq
 Wakala
Bai’ al-Istijar (Supply Contract)

 A repeat sale/purchase arrangement of

normal sale in which a seller agrees to
sell various amount/units of a
commodity from time to time.
 Seller may deliver the commodity
agreed upon once in a number of
consignments and
 the price may be determined in advance,
with every consignment or after the
delivery
Bai’ al-Istijar (Supply Contract)

 The terms and conditions of any normal

cash or credit sale.
 An agreement between the buyer and
supplier, whereby the supplier agrees to
supply a particular product on an
ongoing basis
Wakalah (Agency)

 Literal meaning
 “Looking after”
 “Taking custody”
 “application of skills”
 “remedying on behalf of others”

 Tawkeel
 To appoint someone to take of charge of
something.
 Delegate any job to any other person.
Wakala

 What is Wakala?
 Wakala is a responsibility.
 Wakil must discharge his
responsibility in the way a trustee
discharge his responsibility in the case
of Amanah.
 Types of Wakala

 Wakil-bil-Kusoomah (to take up various

disputes/cases on behalf of the principal)
 Wakil-bil-Taqazi al Dayn (Receiving
debts.)
 Wakil-bil-Qabza al Dayn (possession of
debt)
 Wakil-bil-Bai’ (agency for trading)
 Wakil-bil-Shira (agency for purchase)
Wakala - Conditions
 Subject matter of the Wakala or the act to
be performed should be known.
 An act to be carried out by an agent
should be one that admits
representation. E.g. Sale and purchase,
letting and hiring, borrowing and lending,
assignment of debt, guarantee and
pledges, taking and making payments
etc.
 A Wakala contract may be specific or
general.
Wakala - Conditions
 The agent must perform according to the
instructions of the principal.
 Agents will collect price and make
payments on behalf of the principal.
 An action performed by the Wakil on
behalf of the principal is deemed an
action by the principal.
 A Wakala contract come to an end with
mutual agreement, unilateral termination,
discharging of an obligation, destruction
of the subject mater death or loss of
legal capacity.
 Wakaltul Istismar
 Funds management on behalf of investors
 Banks can get pre-agreed fee
 This fee can be fixed in a lump sum or as a
monthly or annual remuneration in
percentage of the amount of investment or
the net value of the funds..
 But fee must be agreed in advance.
Tawarruq
 Hanbali and Shafi’s discussed it.
 To buy on credit and sell at spot value
with the objective of getting cash.
 Transaction is not the need of the buyer.
 Shariah issues:
 Cansell to the third paty
 Cannot sell to the original seller

 Bai’Inah vs Tawaruq
 Qardal Hassan is more prefferable.
Ju’alah
 A contract in which one party (the Ja’il)
undertakes to give a specific reward (the
Jua’l) to anyone who may be able to
realise a specific or uncertain required
reults.
 E.g. Finding a stolen car
 The determination of the end result of the
transaction is considered to be sufficient
to make it permissible.
 Jualah is useful tracsaction in events
that cannot be accomplished through
Ijarah.
 Parties of Juualah:
 Offeror
 Worker

 How Banks are using it?

 Collectionof Debt
 Securing Permissible Financing Facility
 Brokerage