Religiosity and threshold effect in social and financial

performance of microfinance institutions

Mohammad Ashraful Mobin

2 Days Specialized
Training Workshop on
Islamic Micro Finance
6th Global Islamic
Microfinance - Kenya

Why Islamic Finance?

The body which is promoted by Hiram
sources is bound to hellfire.
On the Day of Judgment, a person will
not be moved from the place where he
stand until he is asked about the sources
of his income and they way he spent it.
Purifying of the needs of life (food, drink,
clothes house etc) is one of the most
important reason for the acceptance of
prayers by Allah.

Rulings In Islam
These 5 primary objectives follow by
Shariah can be observed though the Al
Ahkam (rulings) upon which Fiqh (Islamic
Jurisprudence) rotate around. The rulings
are categorized as follows:
a. Wajib (obligatory)
e. Haram (unlawful)
b. Mustahab (recommended) (Sunnat)
c. Mubah (permissible)
d. Makruh (disliked)

Rulings
Wajib- An obligatory action or something that
shall be performed. Anyone who leave it is
liable to gain the punishment of Allah s.w.t. in
the Here after as well as a legal punishment in
this world.
Haram- An unlawful action or the one that shall
not be performed and is strictly prohibited.
Anyone who engages in it is liable to gain the
punishment of Allah s.w.t. in the Here after as
well as a legal punishment in this world.
Mustahab- A recommended action or something
that should be performed.
Mubah- A permissible action or something that is
neither encouraged nor discouraged.
Makruh- A disliked action or something which is
abominable and should be avoided but not in
strictly prohibitory terms.

Islam and Shariah

Islam

Aqidah
(Faith & Belief)

Shariah
(Practices & Activities)

IBADAT
(Man to God Worship)

Political Activities

Akhlaq
(Morality & Ethics)

Muamalat
(Man to Man Activities)

Economic Activities

Banking & Financial Activities

Social Activities

Human Financial Needs

Fulfillment of Financial Needs
Own Capital

Others Capital

Equity Financing

Debt Financing

External (Equity & Debt)

Financing

Equity Financing
Al-Musharakah (Joint
Venture Profit Sharing)

Debt Financing
Uqud al-Muawadhat
(Deferred Contracts of
Exchange)

Al-Mudarabah
(Trustee Profit Sharing)
Others

Al-Bai Bithaman (Mu)Ajil

(Deferred Installment Sale)

Equity Market

Debt Market

Bai al-Murabaha
(Cost Plus Profit Sale)
Al-Ijarah (Leasing)
Bai al-Salam (Commodity
Sale)
Bai al-Istisna (Sale on Order)

Most Important Islamic

Teaching Related To Business
1.
2.
3.
4.
5.
6.
7.
8.
9.

Elimination of Interest (Raba)

The prohibition of uncertainty (Gharar)
The prohibition of Gambling (Qimar)
The precipitation of games of chance ( Maser)
Honesty and Fair Trade (Ghishsh and Khilabah)
Spending in the Good Cause
Buy Back
Two Mutually
Conditional Contract
Entitlement to profit depends on liability for risk

WHAT IS ISLAMIC
BANKING?

WHAT IS BANK?
The name bank derives from the
Italian word banco "desk/bench.
In practice, the word Bank means an
institution which borrows money from
people and lends money to people for
interest or profit and provided other
financial services.

BANKS ENGAGE IN THE

FOLLOWINNNG ACTIVITIES.

Accepting money

Processing of payments by way of

telegraphic transfer, internet banking, or
other means;

Issuing bank drafts and bank cheques

Lending money

Providing documentary and standby

letter of credit, guarantees, performance
bonds, securities underwriting commitments
and other forms of off balance sheet
exposures
Safekeeping of documents and other items in
safe deposit boxes

WHAT IS ISLAMIC BANKING?

Islamic banking has been defined
as banking in consonance with the
ethos and value system of Islam
and governed, in addition to the
conventional good governance and
rick management rules by the
principle laid down by Islamic
Shariah.

Comparison of the Islamic and Conventional

systems

Conventional Banking
Conventional Banks take deposit on interest
basis and lend on the basis on interest. A part
of interest is paid to the depositors and the
remaining interest is left for the bank as its
income. If this residual is more than its
expenses, it will have Net Income otherwise it
will have Net loss.
Islamic Banking
Islamic Banking accepts deposits on PLS basis
and invest in Shariah based modes. Whatever
is the profit, it is shared with depositors. If
there is a loss it will also be shared.
14

OBJECTIVES OF ISLAMIC
BANKING

Shariah compliant banking, to enable

Muslims to do their banking
transaction a Halal way.
Achieving the goals and objectives of
an Islamic economy.

DEPOSITS

A deposit is an account at a banking

institution that allows money to be
deposited and withdrawn by the
account holder. These transactions
are recorded on the bank's books.
All deposit appears as liability on
Balance Sheet of the Bank.

CATEGORIES OF DEPOSIT IN
ISLMIC BANKING
The Shariah option for deposit
mobilization can be worked out by
respecting two principles:

The aim of the exchange at hand must

be recognizes in Shariah.
The modalities to achieve the said
must be Shariah Compliant.

GENERAL MOODES OF ISLAMIC BANKING

USED TO RAISE DEPOSITS
Depositors

1.
2.

Deposit can be accepted by islamic bank on basis of:

Amanah
Qarid
Investment Accounts
Islamic banks generally use Musharakah and
Mudarabah based product for obtaining investment
account.

These deposits are based on the Shariah principles of

profit and loss sharing, and the banks use them, along
with its own funds in businesses which are Shariah
compliant.
Wakala model can also be used for Investment Account.

Definition of Qard

In Islamic Shariah, loans called

Qard have only one concept as far
as return thereon is concerned i.e.
these are interestfree.
These are repayable in exactly
equal amounts in which these are
paid.

Definition of Amanah

To give any commodity / asset to

anybody for the sake of safety is
called Amanah.
Anything given as Amanah is
considered to be something held in
trust, and the same can not be
used.

Shirkah

MEANING OF SHAIRKAT

The literal meaning of Musharakah is

sharing.
The
root
of
the
word
"Musharakah" in Arabic is Shirkah, which
means being a partner.
Under Islamic jurisprudence, Musharakah
means a joint enterprise formed for
conducting some business in which all
partners share the profit according to a
specific ratio while the loss is shared
according to the ratio of the contribution.

Shirkat-ul-Ammwal
Definition:
It is an agreement between two or
more persons to invest a sum of
money in a business and share its
profits according to agreement. The
investment
of
this
partnership
consists of capital contributed by the
partners.

SHIRKAT-UL- AMWAL:
Capital of Musharakah
It should be known, ascertained and available at
the time of contract.

The value should be agreed upon in case of kinds;

Capital paid in different currencies should be valued into
the currency of Shirkah;

Capital advanced by the parties. Should be uniform

(currency of partnership).
Share capital in a Musharakah can be contributed
either in cash or in the form of commodities
In the letter case the market value of the
commodities shall determine the share of the
partner in the capital.

Management of
Musharakah

Each partner has right to take part in Musharakah

management.
The partner may appoint a managing partner by
mutual consent.
One are more of the partners may decide not to
work for the Musharakah and work as a sleeping
partner.
It is not allowed to specify a fixed remuneration to a
partner Musharaka who manages funds or provides
some form of other services, such as accounting;
However, it is permissible to give him a greater
share of profit than he would receive solely on the
basis of his share in the partnership capital;

Distribution of Profit
The ratio of profit distribution must be agreed
at the time of execution of the contract.
It is not necessary for sharing profit according
to proportionate capital contribution;
It is not allowed to defer the determination of
profit until realization of profit.
The ratio must be determined as a proportion
on the actual profit earned by the enterprise.

1.
2.

Not as percentage of partners investment.

Not in lump sum amount.
It is not allowed to defer the determination of profit
until realization of profit.
A sleeping partner cannot share in the profit more
than the percentage of his capital.

Rules of Loss
Determination/Distribution

Sharing of Loss:

As a matter of principle the loss has to be shared

according to the ratio of capital contribution;
Partners are not allowed to adopt any other mechanism
except the mechanism that ensure distribution of loss
among partners on pro rata basis;
Any other arrangement, even agreed upon by partners,
will be invalid and void.
It is not allowed to hold one partner or group of
partners liable for entire loss.

MUDARABAH

Mudaraba Introduction Definition

Mudaraba is a kind of partnership

where one partner gives money to
another for investing in profitable
avenues.
The investor (fund supplier) is called
Rabb-ul-Mal ( ) while the
person who utilizes this fund (the fund
manager) is called Mudarib ( )
who is exclusively responsible for
management of the business.

Capacities of Mudarib
Mudarib has different capacities for
which rules are different. Listed down
are his roles:

Ameen (trustee):
Mudarib holds money and assets of Mudarabah as trustee;
Therefore, he is responsible for management of assets
honestly;
In case of actual loss he is responsible for nothing;
Wakeel (Agent):
Mudarib manages Mudarabah as an agent of owner;
Therefore his actions are considered as of Rabbul Maal;
Actual loss is born by Rabbul Maal in case it happens;
Shareek (partner):
Mudarib becomes partner in the profit that Mudarabah
generates;

Mudaraba Introduction - profit

& loss distribution

Profit and Loss distribution:

The Mudaraba contract should mention profit sharing

ratio in defined and clear terms;

The profit sharing ratio should be:

specific;

of the expected profit;

Apart from the agreed proportion of the profit, the
Mudarib cannot claim any periodical salary or a fee or
remuneration for the work done by him for the
Moradabad.
The Mudarib & Rab-ul-Maal cannot allocate a lump sum
amount of profit for any party nor can they determine the
share of any party at a specific rate tied up with the
capital.

Mudaraba Vs Musharaka
. Mudaraba:

1. The
contribution
comes from Rabbul
Maal (the investor);
2. The
Rabbul
Maal
(investor)
is
not
permitted to manage
the business;
3. The Mudarib manages
the business only;
4. The Mudarib can also
invest in the capital of
Mudarabah.

Musharaka:
1. The contribution comes
from all partners in
form
of
cash,
commodities, services
or liability in case of
reputation partnership;
2. The work, as a general
rule, is to be done
jointly by the parties;
3. A partner or some
partners
may
be
sleeping;

CATEGORIES OF DEPOSIT IN
ISLMIC BANKING
Investment Account

Depositors

Profit & Loss Sharing

Saving Accounts

Current Account

Fixed Investment
Accounts

Security Deposit

DIFFERENCE IN DEPOSITS &

INVESTMENT ACCOUNTS
Investment Account

Deposits Account

These are not

guaranteed.
Their nature is
investment
Investment account
holders are in
participatory modes.

These are guaranteed.

Return paid to the

account holders is
their portion in profit
of the bank.

Interest paid to the

depositors is treated as
bank expenses.

It is liability of the bank

It is loan to the bank.

COMPONENTS OF VALID
SALE
SALE

CONTRACT

Offer/Acceptance
Buyer/Seller

SUBJECT
MATTER

Existence
Ownership
Possession

PRICE

Physical
Constructive

Certain

Valuable

Halal Purpose
35

POSSESSION

Instant and absolute

Unconditional

Types of sale

A trust sale is a type of sale in which buyer

and seller agree on disclosure of actual cost
while General sale is a type where seller
quote a price whit out disclosure of cost;In
trust sales honest disclosure of cost by seller
is necessary;
Bay TauoliaThere are three types of trust
Cost to cost
sale:
Bay
sale;
Below the cost
Wadia
Bay
sale;
Murabaha Cost plus profit

sale;

36

Musawamah
Musawamah is a general kind of sale in
which price of the commodity to be
traded is stipulated between seller and
the buyer without any reference to the
price paid or cost incurred by the
former. Thus it is different from
Murabaha in respect of pricing formula.
Unlike Murabaha, seller in Musawamah
is not obliged to reveal his cost.
37

Murabaha

In literary terms, Bay

Murabaha ( ) means
sale on profit.
In Arabic, its origin is Rabah )
)which means profit.
Technically, it is a contract of
sale in which the seller
declares his cost and profit.
It may be on spot basis, or on
deferred payment basis.

FEATURES OF
BANKING MURABAHA
Murabaha finance is not a loan
given on interest, it is a sale of
Asset(s) for cash/deferred price.
It is the obligation of the Seller
to disclose the Cost and Profit to
the Buyer.
39

FEATURES OF
BANKING MURABAHA

Murabaha Transaction can either

be a cash sale (Spot Payment
Murabaha) or a credit sale
(Deferred Payment Murabaha)
or a combination of both.
Payment of Murabaha Price can be
made in lump sum or in
installments.
40

FEATURES OF
BANKING MURABAHA

Murabaha Finance can only be used

for the purchase of fresh Asset(s)
only.
Buy-Back arrangement is prohibited.
This means that Murabaha transaction
cannot be executed for the Asset(s)
already purchased by the Customer.
41

Scope of Murabaha

Murabaha is a fixed price sale and is

normally used for short term financing;
Murabaha cannot be used as a substitute
for cash advancing or pure cash based
running finance facility;
The transaction can be used in order to
meet the working capital requirements
however it cannot be used to meet
liquidity requirements;
Murabaha can be used for long term as
well but it such a case it would be a fixed

42

VARIOUS
MODELS OF
MURABAHA
FINANCE
43

MODEL - I

TWO PARTY REALTIONSHIP

Bank Customer

MODEL - II

THREE PARTY RELATIONSHIP

(Bank-Vendor) and Customer

MODEL - III

THREE PARTY RELATIONSHIP

Bank and (Vendor-Customer)
44

MODEL - I

The simplest possible Model emerges

when the transaction involves two
parties only, i.e Bank and the
Customer.

The Bank is also vendor and sells the

Asset(s) to its Customers on deferred
payment basis.

From Shariah perspective it is an

ideal Model and its profits are fully
justified because Bank assumes all
risks as Vendor/Trader.

45

MODEL I GRAPHICAL PRESENTATION

2

Customer

46

Bank/Vendor

MODEL I - PHASES
Phase 1:
The customer approaches Bank (Vendor)
and identifies Asset(s) and collects relevant
information including cost and profit.
Phase 2:
Bank sells Asset(s) to the Customer,
transfer risk and ownership to the Customer
at certain Murabaha Price.
Phase 3:
Customer pays Murabaha Price in lump sum
or in installments on agreed dates.
47

MODEL - II
In

most cases Murabaha Transaction

involves a third party (i.e. Vendor)
because Bank is not expected to
engage in sale of variety of products
required for variety of Customers.

The

Bank directly deals with the

Vendor and purchases the Asset(s).

48

MODEL II
The

Bank sells the purchased

Asset(s) to the customer on
cost plus basis.

There

are two distinct sale

contracts at different point of
times. First between Bank and
Vendor and second between
Bank and the Customer.

49

MODEL II GRAPHICAL
PRESENTATION

Customer

50

Vendor

5
2
6

3
4

Bank

MODEL II - PHASES

Phase 1:
Customer identifies and approaches the
Vendor or Supplier of the Asset(s) and
collects all relevant information.
Phase 2:
Customer approaches the Bank for
Murabaha Financing and promises to buy
the Asset(s).
Phase 3:
The Bank makes payment to vendor
directly.
51

MODEL II PHASES
Phase 4:
Vendor delivers the Asset(s) & transfers
the ownership of Asset(s) to the Bank.
Phase 5:
Bank sells the Asset(s) to Customer on
cost plus basis and transfers ownership.
Phase 6:

Customer pays Murabaha Price in lump

sum or in installments on agreed dates.
52

MODEL III BANKING

MURABAHA

53

This Murabaha Model is mostly

practiced model in Banking now a
days and therefore we will look at it in
more detail.
We will also look at the
documentation required at different
stages of the transaction.
It is also a three-party structure but it
is bit complicated than previous ones.

MODEL III BANKING

MURABAHA
The

product of Murabaha that is

being used in Islamic Banking as a
mode of finance is something
different from the Murabaha used in
normal trade .
is called Murabaha to the
Purchase Orderer .

It

54

MODEL III BANKING

MURABAHA

It is a bunch of contracts completed

in steps and ultimately suffices the
financial needs of the client.

THE SEQUENCE OF THEIR

EXECUTION IS EXTREMELY
IMPORTANT TO MAKE THE
TRANSACTION SHARIAH COMPLIANT.

55

MODEL III GRAPHICAL

PRESENTAION
3

Vendor

5
5
2

Bank

Customer
6
Offer

Acceptance
1

56

How Murabaha works in Islamic

finance?

How Murabaha works in Islamic

finance?

Steps Of Banking Murabaha

MOU

Order Form

Agency Agreement

Purchase

Payment of Purchase Price

Possession

Offer and Acceptance

(Declaration)

Payment of Murabaha Price

Ijarah

Lexically, Ijarah means to give

something on rent or to provide
some service for consideration.

In Islamic jurisprudence, there are

two different types of Ijarah;

The first one is an employment or

service contract by virtue of which
a person provides services to
employer and against those
services he gets Ujrah i.e.
remuneration of services.

Ijarah

The second type of Ijarah

which is more common in
Islamic finance, is a
contract in which: fifty

the owner of an asset (other

than consumables) transfers
its usufructs
to another person
for an agreed period
against an agreed
consideration.

In this case, the term Ijarah

is synonym to the English
term leasing.

Basic Rules of Ijara

It is necessary for valid lease that

the corpus of the leases property
remains in the ownership of the lessor.
The period of lease must be
determined in clear terms.
The lease period shall start from
the date on which the leased asset
has been delivered.
62

Liabilities of Parties

Lessor Responsibilities:
Since corpus of leased property remains
in the ownership of the lessor therefore all
liabilities of ownership are borne by lessor.
Expenses:
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 example expenses
of shipment and customs duty etc.
63

Lessee Responsibilities:

Being user of the lease asset lessee

can be made liable to any normally
occurring wear and tear.
The lessee cannot use the leased
asset for any purpose other then the
purpose specified in the lease agreement.
If no such purpose is not specified in
the agreement, the lessee can use it for
whatever purpose it is use in normal
course.
64

Lessee as Ameen:

The
lessee
is
liable
to
compensate the lessor for every
harm caused to the leased asset by
his misuse or negligence.

65

Rental

The rental must be determined at

the time of contract for the whole
period of lease.
It is permissible that different
amount of rent are fixed for different
phases provided that the amount of
rent for each phase is specifically
agreed upon at the time of affecting a
lease.
The lessor cannot increase the rent
unilaterally and any agreement to this
effect is vied.
66

Rental

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).
The rent or any part thereof may be
payable in advance before the delivery of
the asset to the lessee, but that amount so
collected by the lessor shall remain with
him as Amana and shall be adjusted
towards the rent after its being due.
67

In Case of Late Payment

The lessor cannot charge an

additional amount in case the lessee
delays payment of the rent.
Penalty of late payment is given to
charity by lessee.

68

Termination: contractual

Lease is binding contract.

It cane be terminated by mutual
consent.
The lessor may terminate it when
the lessee doesnt pay the rent or fails
to pay it on time or because of
violation of any other term and
condition of the agreement.
69

Termination: contractual

With total destruction of the

leased asset
Upon the expiry of term.
Two parties may terminate it
before it begins to run.

70

Procedure of Banking Ijarah

Undertaking to Ijarah

Agency Agreement

Purchase

Payment of Purchase Price

Lease Agreement

Finance Lease (Ijarah)

Features:
1. Customer
buys the
property as
Banks agent.
Cost: $100

Manufacturer /
Supplier

Customer
2. Execution of
Ijara Agreement

Lease

Floating rate financing

3.
Disbursement
of the Facility.
Facility
Amount: $100

possible

4. Bank
appoints the
Customer as its
agent to buy
the property.

Financing Big Ticket items

Bank

5. Under the Ijara Agreement the Bank will lease the

property immediately.

Can be used for refinancing

Uses:

Financing Capital
Expenditure

like Aircraft, VLCCs, LNG

Carriers, etc.
Tenor:

5-7 years
Risks:

Credit Risk
Performance Risk
Cost Overruns
Ownership Risk

Diminishing Musharakah
Diminishing Musharakah
(DM is a type of Shirkah where one
partner purchases the other
partners share gradually

FEATURES OF DIMINISHING
MUSHARAKAH

IN SHIRKAT-UL-MILK (JOINT OWNERSHIP)

Two partners purchase any asset

(machinery/property)
and
their
intention is that one or both
partners will use this asset or
they rent out their share and one
Shareek undertakes to purchase the
share of other gradually.

Diminishing Musharakah in
Shirkat ul Milk with Ijarah

A and B invest their capital and

purchase a joint asset e.g. a house.
A separate Musharaka agreement
is executed.
B promises to sell his shares to A
gradually or A promises to buy Bs
shares in the jointly owned
property.
A and B enjoy their rights as
partners as they share the risks
and rewards in the ratio of their
joint investment.

Diminishing Musharakah in
Shirkat ul Milk with Ijarah

A uses the asset while he

pays rent to B in proportion
of Bs ownership in the joint
property according to the
pre-agreed benchmark.
Expenses incidental to
ownership are shared in
proportion of ownership,
while expenses relating to
use are borne by A who uses
the property.
A will keep buying Bs shares
until he acquires the
complete ownership.

Diminishing Musharaka
Ownership Transfer

Diminishing Musharaka
Monthly Rentals

Rs

Procedure of DM
D M Agreement (Bank +Client)

Undertaking to Ijarah (from the client)

Sale Agreement (Client + owner of the house)

Payment of Purchase Price (to the owner of the

house)

Lease Agreement (Bank + client)

Diminishing Musharakah

Bank enters into a participation (Shirkat-ul-Milk) arrangement

with the Customer

Bank provides the larger share of the purchase price of the

vehicle

Bank rents out its share of the vehicle to the customer

The customer makes regular scheduled investments to increase

its equity in the property over the life of the transaction

The monthly/ periodic payments are structured to reflect a

portion of rent and a portion of purchase price i.e. EMI = Rent +
Purchase of Share

Once the customer has purchased all of the Banks share the
ownership will transfer to the customer with free and clear title
to the vehicle

ISLAMIC BANKING MODEL

Bank
Equity

Operational Expenses

POOL OF
FUND
S
PLS
Depositors

Investmen
t
Income/
Loss from
Investmen
t

SBP
Current
Deposit

Current
Deposit

Income
from
non fund
business

Idle fund
Distributabl
e
Income

Depositor
s
PLS

Reserves

Equity

Comparison of the Islamic and

Conventional systems

Conventional Banking

Equation of Banks Failure

Admn Exp + Interest Exp > Total Income + Reserves
Equation of Banking System Failure
Admn Exp + Interest Exp > Total Income + Reserves + Equity

Islamic Banking

Equation of Banks Failure

Operational Losses > Reserves + PLS Deposits
Equation of Banking System Failure
Operational Losses > Reserves + PLS Deposits + Equity
Operational Losses
Operational Losses = Income (Losses) from Invest Admn
Exp

AlHuda CIBE FZ LLE - U.A.E

P: + 971 56 9286664, + 971 55 938 99 00
AlHuda Center of Islamic Banking & Economics - Pakistan
Ph: (92-42) 35913096 - 98, Fax: (92-42) 35913056
Email: info@alhudacibe.com
Website: www.alhudacibe.com