Islamic Banking and Finance Products Zubair Mughal Chief Executive Officer AlHuda : Centre of Islamic Banking & Economics Editor in Chief. Islamic Banking and Finance News , True Banking. 2

Islamic Banking Modes Murabaha Ijarah Musawama Musharaka Diminishing PRODUCT TREE Islamic Banking Modes Partnership Based Modes Trade Based Modes Rental Based Modes Murabaha (Cost Plus Profit Sale) Musawama (Bargain sale ) Salam (Commodity Sale) Istisna (Sale on Order) Ijarah ( Leasing ) Diminishing Musharaka ( Transfer of Ownership) Musharaka (Joint Venture Profit Sharing ) Mudaraba ( Trustee Profit Sharing)

Musharakah Characteristics All parties share in the capital All parties share profits as well as losses Profits are distributed as per agreed ratio Loss is borne by the parties as per capital ratio Every partner is agent of other

MUSHARAKAH May be in any agreed ratio PROFIT Rs. 100 Rs. 60 Rs. 40 PARTNER A PARTNER B VENTURE Rs.1000 Rs.1000 Rs. 50 Rs. 50 LOSS Rs.100 Must be according to capital ratio

Mudarabah One partner (Rab al Mal) contributes capital and the other (Mudarib) contributes his skills or services to the venture Venture may for a fixed period or purpose Both share profit in pre-agreed ratio Loss is borne by Rab al Mal only, Mudarib loses his services

MUDARABAH PROFIT 60 % 40 % VENTURE RABBUL MAL MUDARIB SERVICES CAPITAL RABBUL MAL MUDARIB ALL MONETORY LOSS LOSS OF SERVICES LOSS

Trade Based Mode in Islamic Banking and Finance ( Murabaha – Salam – Istisna etc.)

Basic Rules of Bai Existence of Product/Commodity Ownership of Product/Commodity Possession of Product/Commodity

Basic Rules of Bai Unconditional basis Product have value/Price. Bai on Such product which is permissible in Islam.

Basic Rules of Bai Product Must be Identify, clear with all demanding Qualities. Not based on any incident, struggle etc Price must be clearly identified.

Bai (Buying & Selling) Basic Kinds of Bai

Kinds of Bai Bai Musawamah Bai Murabaha Bai Surf Bai Salam Bai Istisna’ Bai Urboon

Basic Kinds of Bai Bai Eenna Bai Touliya Bai Wadhia

Bai There are three basic type of Bai’s which are using in Islamic Banking as the mode of financing in Pakistan Murabahah Salam Istisna’

Murabahah 16

STAGES OF MURABAHA 2. Agency Stage 3. Acquiring Possession 1. Promise Stage 2. Agency Stage 3. Acquiring Possession 4. Execution of Murabaha 5. After Execution of Murabaha 17

Stage One (a) for Murabaha financing 1- Promise stage Stage One (a) for Murabaha financing 1. Client approach the bank for facility through Murabaha. Facility approved Bank Client STEP BY STEP MURABAHA FINANCING 1.The client and the institution sign an overall agreement whereby the institution promises to sell and the client promises to buy the commodity from time to time on an agreed ratio of profit added to the cost. This agreement may specify the limit up-to which the facility may be availed. 2.An agency agreement is signed by both parties in which the institution appoints the client as his agent for purchasing the commodity on its behalf. 3.The client purchases the commodity on behalf of the institution and takes possession as the agent of the institution. 4.The client informs the institution that it has purchased the commodity and simultaneously makes an offer to purchase it from the institution. 5.The institution accepts the offer and the sale is concluded whereby ownership as well as risk is transferred to the client. All the above are necessary to effect a valid murabaha. If the institution purchases the commodity directly from the supplier it does not need any agency agreement. Note: The most essential element of the transaction is that the commodity must remain in the risk of the institution during the period between the third and the fifth stage. The above is the only way by which this transaction is distinguished from an ordinary interest-based transaction 18 18

Stage One (b) for Murabaha financing 1- Promise stage Stage One (b) for Murabaha financing 1. Client and bank sign an agreement to enter into Murabaha. Murabaha Facility Agreement MOU Bank Client STEP BY STEP MURABAHA FINANCING 1.The client and the institution sign an overall agreement whereby the institution promises to sell and the client promises to buy the commodity from time to time on an agreed ratio of profit added to the cost. This agreement may specify the limit up-to which the facility may be availed. 2.An agency agreement is signed by both parties in which the institution appoints the client as his agent for purchasing the commodity on its behalf. 3.The client purchases the commodity on behalf of the institution and takes possession as the agent of the institution. 4.The client informs the institution that it has purchased the commodity and simultaneously makes an offer to purchase it from the institution. 5.The institution accepts the offer and the sale is concluded whereby ownership as well as risk is transferred to the client. All the above are necessary to effect a valid murabaha. If the institution purchases the commodity directly from the supplier it does not need any agency agreement. Note: The most essential element of the transaction is that the commodity must remain in the risk of the institution during the period between the third and the fifth stage. The above is the only way by which this transaction is distinguished from an ordinary interest-based transaction 19 19

Stage One (c) for Murabaha financing 1- Promise stage Stage One (c) for Murabaha financing . Client submit the purchase requisition to the bank. purchase requisition /Promise to the bank. Bank Client STEP BY STEP MURABAHA FINANCING 1.The client and the institution sign an overall agreement whereby the institution promises to sell and the client promises to buy the commodity from time to time on an agreed ratio of profit added to the cost. This agreement may specify the limit up-to which the facility may be availed. 2.An agency agreement is signed by both parties in which the institution appoints the client as his agent for purchasing the commodity on its behalf. 3.The client purchases the commodity on behalf of the institution and takes possession as the agent of the institution. 4.The client informs the institution that it has purchased the commodity and simultaneously makes an offer to purchase it from the institution. 5.The institution accepts the offer and the sale is concluded whereby ownership as well as risk is transferred to the client. All the above are necessary to effect a valid murabaha. If the institution purchases the commodity directly from the supplier it does not need any agency agreement. Note: The most essential element of the transaction is that the commodity must remain in the risk of the institution during the period between the third and the fifth stage. The above is the only way by which this transaction is distinguished from an ordinary interest-based transaction 20 20

2- Agency stage 2. Client appointed as agent to purchase goods on bank’s behalf Bank Client Agreement to Murabaha Agency Agreement 21

Disbursement to the Supplier 2- Agency stage Stage Two for Murabaha financing . Bank gives money to supplier through client’s account for purchase of goods. Agreement to Murabaha Bank Client Islamic Bank Agency Agreement Disbursement to the Supplier 22

3. Acquiring Possession Stage three for Murabaha financing . Client purchases goods on bank’s behalf and takes their possession. Client purchases goods and takes possession Transfer of Risk Vendor Bank Client 23

4. Execution of Murabaha Stage four (a) for Murabaha financing . Client makes an offer to purchase the goods from bank. Bank Client Offer to purchase 24

4. Execution of Murabaha Stage four (b) for Murabaha financing . Bank accepts the offer and sale is concluded. Murabaha Agreement + Transfer of Title Bank Client 25 25

4. Execution of Murabaha Stage four (b) for Murabaha financing . Client pays agreed price to bank according to an agreed schedule. Usually on a deferred payment basis (Bai Muajjal) Bank Client Payment of Price 26

GENERAL MECHANICS VENDOR ISLAMIC BANK CUSTOMER Transfer of Title Transfer of Title VENDOR ISLAMIC BANK Agreement CUSTOMER Payment of Purchase Price Payment of Marked-up Price The customer approaches the Bank with the request for financing The Bank purchases and receives title of ownership from the vendor The Bank makes payment to the vendor The Bank transfers the title over to the customer upon payment The customer makes payment up-front or on a deferred basis 27 27

Theory & Practice of Murabahah Documentation: Declaration Securities as per security documents Demand Promissory Note Schedule of payment

Risk Dimensions Credit Liquidity Credit Credit Prising risk Banking Risks Credit Liquidity Credit Prising risk Market Foreign Exchange Solvency Operational 29

Murabahah Calculation Exercise : Purchase of poultry feed stock Murabahah Facility: 180 Days Payment: Six monthly installments Rate of Profit: 10% p.a. Carriage cost: 5% Murabahah transaction: Rs. 50,000 Securities: Personal surety or Pledge of feed stock, etc.

Murabahah Calculation Exercise Particulars Amount (Rs.) Cost of goods Rs. 50,000 Rate of Profit 10% p.a. Carriage 5% of cost Total cost 50000 x 5% 50000 + 2500 =52500 Profit calculation 52500 x 10% x 6/12 = 2625 Murabahah Price 52500+2625= 55125 Amount of Installment 55125/6 = 9187.50 Cost = 8750 Profit= 437.50

Following 3 Basic Rules of Bai are exceptional for Salam & Istisna’ Important Note Following 3 Basic Rules of Bai are exceptional for Salam & Istisna’ Existence of Product/Commodity Ownership of Product/Commodity Possession of Product/Commodity

Salam Pay 100% amount in Advance. Product must be quantified, identified and Measured with quality. Date of delivery, Time, Place must be mentioned clearly in advance. Salam is not valid for a specific farm/land/garden.

Istisna’ Not necessary to pay the 100% amount in advance Like Bai salam. Price must be decided on beginning of the contract. Qualities, features of that product must be clearly identified.

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