FINANCIAL INSTRUMENT : CONTRACT

The economic activities in any economic system can be viewed as contracts between
economic agents. A contract is also financial instruments, whose terms and conditions define
the risk and return profile of the instrument. In Islam, a contract is deemed legal and lawful by
the Sharia if the terms of the contract are free of any prohibition. In other words, if a contract
does not have or involve any of the prohibited elements, such as riba or gharar, and does not
violate any other rule or law, it is considered valid. For example, although a contract to invest
in a company producing alcohol may be free of riba and gharar, it would still be invalid in the
eyes of the Sharia, since it deals with the production of alcohol, which is prohibited in Islam.
From a business and commercial point of view, certain contracts can be grouped
together based on their function and purpose in the economic and financial system. This
classification given us a framework to understand the nature of credit creation, types of
financing instruments, intermediation and the different roles played by each group in the
economic system.
Transactional contracts deal with the real sector of economic transactions that facilitate
the exchane, sale and trade of oods and services. These contracts are basrd on trade or
exchange-based activities. Exchange could be on the spot or on a deferred basis and could be
of goods for goods, or of goods for price, or goods for promise to pay. These contracts create
assets, which further become the basis of financing and investment oppoturnities; thus they
form the very core of an extended economic and financial system.
Financing contracts offer ways to create an extend creadit, facilitate financing of
transactional contracts, and provide channels for capital formation and resource mobilization
between investors and entrepreneurs. The distinguishin feature of financing contracts is the
absence of a debt contract. Financing contracts are meant either for the financing of
transactional contracts in the form of trade finance or asset-backed securities, or for providing
capital through equity partnerships, which can take several forms, such as partnership, co-
ownership, or diminishing partnership.
Intermediation contracts are to facilitate an efficient and transparent execution of
transactional and financial contracts. Intermediation contracts provide the economic agents
with a set of tools to perform financial intermediation as well as to offer fee-based services foe
economic activities. These contracts include mudarabah (a trustee finance contract),
musharakah (equity partnership), kifala (guarantee), amanah (trust), takaful (insurance),
wakalah (agency), and jo’alah (fee-based service).
Finally, social welfare contract share contracts between individuals and the society to
promote the well-being and wellfare of the less privileged. Although facilitation of such
contracts is beyond the scope of intermediation, anintermediary can certainly offer community
services by institutionalizing social-welfare contracts.

ZamirIqbal and Abbas Mirakhor. 2011. An Introduction to Islamic

Finance: theory and Practice, Second Edition