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MODES OF ISLAMIC
FINANCE

Mufti Mahmood Amhad

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 PRODUCT TREE

Islamic Modes

Partnership Based Trade Based Rental Based

Modes Modes Modes

Musharaka Murabaha Ijarah

Mudaraba Musawama Diminishing
Salam Musharaka
Istisna 3
PARTNERSHIP BASED
MODES
MUSHARAKA

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WHAT IS MUSHARAKA?

Musharaka literally means Sharing.

The word Musharaka has been derived

from “Shirkah” which means being a
partner.

It is an ideal alternative for the

interest based financing with far
reaching effects on the economy.
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 WHAT IS MUSHARAKA?

“Musharaka means a joint

enterprises formed for conducting
some business in which all
partners invest capital in the form
of money or in kind”.

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 Types of Shirkah
SHIRKAH

SHIRKAT-UL-MILK SHIRKAT-UL-AQD

IKHTIARI GAIR IKHTIARI

SHIRKAT- SHIRKAT- SHIRKAT-

UL-AMWAL UL-AAMAL UL-WUJOOH

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 Presen
Shirkat-Ul-Milk
• It means joint ownership of two or more
persons in a particular property.

• This kind of Shirkah may come into existence

in two different ways:

1. Optional Shirkat-ul-Milk (Ikhtiari)

2. Compulsory Shirkat-ul-Milk (Ghair

Ikhtiari)

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 Presen
Shirkat-Ul-Milk
Optional Shirkat-ul-Milk (Ikhtiari)

• If two or more person purchase any property,

it will be owned jointly by both of them and
the relationship between them with regard to
that property is called “Shirkat-ul-milk.”

• Here this relationship has come into existence

at the option of the parties, as they
themselves elected to jointly purchase the
asset.

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 Presen
Shirkat-Ul-Milk
Compulsory Shirkat-ul-Milk (Ghair Ikhtiari)

• This comes into existence without any

effort/action taken by the parties.

• For example, after the death of a person all

his heirs inherit his property, which comes
into their joint ownership as a natural result
of the death of that person.

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SHIRKAT-UL-AQD

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 Presen
Shirkat-Ul-Aqd
• Shirkat-ul-Aqd (contractual partnership)
means an agreement between two or more
parties to combine their assets, labour or
liabilities for the purpose of making profits.

• It can also be translated as a joint commercial

enterprise.

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 Presen
Shirkat-Ul-Aqd
Shirkat-ul-Aqd is divided into three types:

 Shirtkat-ul-Amwal (contractual partnership)

 Shirtkat-ul-A’mal (vocational partnerships)

 Shirtkat-ul-Wujooh (liability partnership)

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 Presen
Shirkat-Ul-Aqd
Shirkat-ul-Amwal (Contractual Partnership)

• A partnership between two or more parties

whereby each partner contributes a specific
amount of money.

• The profit is distributed according to the

partnership agreement and the losses are
borne in accordance with the contribution of
each partner to the capital.

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 Presen
Shirkat-Ul-Aqd
Shirkat-ul-A’mal (Vocational Partnership)

• It is an agreement between two or more

parties to provide services pertaining to a
profession, vocation or skilled trade.

• The service partnership has no monetary

capital, because the subject matter of the
partnership is rendering services.

• The profit shall be distributed among the

partners according to the agreed ratio, but
the contract should not specify that a lump
sum be paid from the profit to a particular
partner.
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 Presen
Shirkat-Ul-Aqd
Shirkat-ul-Wujooh (Partnership in Liability)
• It is a bilateral agreement between two or
more parties to buy assets on credit on the
basis of their reputation for the purpose of
making profit.

• The partnership in credit worthiness has no

monetary capital.

• The profit shall be distributed according to the

agreement. However, the loss will be borne
by each partner according to the ratio that
each partner had undertaken to bear in
proportion to overall assets that are
purchased on credit. 16
 Presen
Musharakah
• The term Musharakah has been introduced
recently by those who have written on the
subject of Islamic modes of financing

• It is normally restricted to a particular type of

“Shirkah”, i.e. Shirkat-ul-amwal, where two
or more persons invest some of their capital
in a joint commercial venture.

• However, sometimes it includes Shirkat-ul-

a’mal also where partnership takes place in
the business of services.

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Features of Musharaka

profit is shared according to an

agreed ratio between the partners
at the inception of Musharaka
Agreement.

However, according to Sharia’h

principles the loss is shared as per
the ratio of investment.

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Features of Musharaka
Each partner has a right to take part
in Musharaka management.

The partners may appoint a

managing partner by mutual consent

One or more of the partners may

decide not to work for the
Musharaka and work as a sleeping
partner.
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 Capability of Partners: Must be sane &
mature and be able of entering into a
contract. The contract must take place
with free consent of the parties without
any fraud or misrepresentation.
If one or more partners choose to
become non-working or silent partners.
The ratio of their profit cannot exceed
the ratio which their capital investment
bears so the total capital investment in
Musharakah.
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 All assets of Musharakah are jointly owned
in proportion to the capital of each partner.
 All partners must contribute their capital in
terms of money or species at an agreed
valuation.
 Share capital in a Musharakah can be
contributed either in cash or in the form of
commodities. In the latter case, the market
value of the commodities shall determine
the share of the partner in the capital.
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 Sharing of loss
In the case of a loss, all the Muslim jurists are
unanimous on the point that each partner shall
suffer the loss exactly according to the ratio of
investment. Therefore, if a partner have invested
40% of the capital, he must suffer 40% of the
loss, not more, not less, and any condition to the
contrary shall render the contract invalid. There is
a complete consensus of jurists on this principle.
‫الربح علی ما اصطلحا علیہ والوضیعۃ علی قدر راس المال‬
Profit is based on the agreement of the parties,
but loss is always subject to the ratio of
investment
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MUDARABA

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 Glossary:
 Mudarib : Working Partner (brings
effort)
 Ras-ul-Maal : Investment
 Rab-ul-Maal : Investor (brings capital)
 Wakeel : Agent
 Ameen : Trustee
 Kafeel : Guarantor
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 WHAT IS MUDARABA?
Mudaraba is a special kind of partnership
where one partner gives money to another
for investing it in a commercial enterprises.

The investment comes from the first partner

who is called “Rabb-ul-Mal”.

while the management and work is an

exclusive responsibility of the other, who is
called “Mudarib”.
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 Types of Mudarabah
 There are 2 types of Mudarabah namely:
 1. Al Mudarabah Al Muqayyadah(restricted Mudarabah) :
Rab-ul-Maal may specify a particular business or a
particular place for the mudarib, in which case he shall
invest the money in that particular business or place.
 2. Al Mudarabah Al Mutlaqah (unrestricted Mudarabah):
However if Rab-ul-maal gives full freedom to Mudarib to
undertake whatever business he deems. However Mudarib
cannot, without the consent of Rab-ul-Maal, lend money
to anyone. Mudarib is authorized to do anything, which is
normally done in the course of business.

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 Capital in Muzarabah
 The basic principle is that the capital in
Mudarabah is valid just the way as it is in
Shirkah which according to Hanafi fiqh should
be in liquid form but according to other
scholars equipment, land etc can also be
included as capital.
However this is subject to the determination of
exact amount of the assets before it is used for
Mudarabah. If the assets are not correctly
evaluated, the Mudarabah is not valid.
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 Mudharabah Fasidah
 If the Mudarabah agreement becomes Fasid due to any
reason, the Mudarib’s status will be like an employee,
meaning:
 he will not be sharing any profit and will just get
Ujrat-e-Misl (ordinary pay) for his job.
 He can be given in void Mudarabah when it has
produced profit but if it fails to produce profit, Ujrat-e-
Misl will not be given.
 UJRAT-E-MISL(The salary or wage of Mudarib
according to the market value of that work. It should
not exceed the profit share under the correct
Mudarabah.)
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 Distribution of Profit & Loss
 It is necessary for the validity of Mudarabah that the
parties agree, right at the beginning, on a definite
proportion of the actual profit to which each one of
them is entitled. The Shariah has prescribed no
particular proportion; rather it has been left to their
mutual consent. They can share the profit in equal
proportions and they can also allocate different
proportions for Rab-ul-Maal and Mudarib. However
in extreme case where the parties have not
predetermined the ratio of profit, the profit will be
calculated at 50:50.
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 Termination of Mudarabah
 If all assets of the Mudarabah are in cash form at the time
of termination, and some profit has been earned on the
principal amount, it shall be distributed between the parties
according to the agreed ratio. However, if the assets of
Mudarabah are not in cash form, it will be sold and
liquidated so that the actual profit may be determined. All
loans and payables of Mudarabah will be recovered.
 The provisional profit earned by Mudarib and Rab-ul-
Maal will also be taken into account and when total capital
is drawn, the principal amount invested by Rab-ul-Maal
will be given to him, balance will be called profit which
will be distributed between Mudarib and Rab-ul-Maal at
the agreed ratio.

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 Musharaka Vs Mudaraba
Musharaka Mudaraba

All partners invest. Only Rab-ul-Mall

invests.
All partners share loss Only Rab-ul-Mall
in the ration of suffers loss.
investment.
All partners can take Mudarib is solely
part in management of responsible for
business. management of
business. 31
As soon as the partners The goods purchased by
mix up their capital in a the Mudarib are solely
joint pool, all the assets owned by Rab-ul-maal and
become jointly owned by the Mudarib can earn his
all of them according to share in the profit only in
the proportion of their case he sells the goods
respective investment. All profitably.
partners benefit from the
appreciation in the value
of the assets even if profit
has not accrued through
sales.

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TRADE BASED MODES
MURABAHA FINACE

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 WHAT IS MURABAHA?
Murabaha is one of the most commonly used
modes of financing by Islamic Banks and
financial institutions.
Murabaha is a particular kind of sale
where Seller expressly mentions the cost
it has incurred on purchase of the
Asset(s) to be sold and sells it to another
person by adding some profit, which is
known to Buyer.
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 Features of Murabaha
 Murabaha finance is not a loan given on
interest, it is a sale of Asset(s) for
cash/deferred price.
 Murabahah is a mode of financing as old as
Musharakah. Today in Islamic banks world-
over 66% of all investment transactions are
through Murabahah.
 Murabaha Finance can only be used for the
purchase of fresh Asset(s) only.
 It is a fixed price sale and normally is done
for short term. 35
 Step by step Murabahah 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
 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.

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 4. The client informs the institution that it has
purchased the commodity and at the same time
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 conditions are necessary to effect a
valid Murabahah.
 If the institution purchases the commodity
directly from the supplier, it does not need any
agency agreement.

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 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.

Issues in Murabahah
1. Securities against Murabahah
 Payments coming from the sale are receivables
and for this, the client may be asked to furnish a
security.

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 Guaranteeing the Murabahah
 The seller can ask the client to furnish a 3 rd party
guarantee. In case of default on payment the
seller may have option to the guarantor who will
be liable to pay the amount guaranteed to him.
There are two issues relating to this:
 a) The guarantor cannot charge a fee from the
original client.
 b) However the guarantor can charge for any
documentation expenses.

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 Penalty of default
 Another issue with Murabahah is that if the client
defaults in payment of the price at the due date, the price
cannot be changed nor can penalty fees be charged.
 In order to deal with dishonest clients who default in
payment deliberately, they should be made liable to pay
compensation to the Islamic Bank for the loss
suffered ?????.
 a) The defaulter may be given a grace period of at-least
one-month.
 b) If it is proven beyond doubt that the client is
defaulting without valid excuse then compensation can
be demanded ????.
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 Rollover in Murabahah
Murabahah transaction cannot be rolled over for a
further period as the old contract ends. It should
be understood that Murabahah is not a loan rather
the sale of a commodity, which is deferred to a
specific date.
Once this commodity is sold, its ownership
transfers from the bank to the client and it is
therefore no more a property of the seller.

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 Rebate on earlier payments
Sometimes the debtors want to pay early to get
discounts. However in Islam, majority of
Muslim Scholars including the major schools
of thought consider this to be un-Islamic.
However if the Islamic bank or financial
institution gives somebody a rebate on its own,
it is not objectionable especially if the client is
needy.

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 Basic mistakes in Murabahah Financing
 1. The most common mistake is to assume that
Murabahah can be used for all types of
transactions and financing. This mode can only be
used when a commodity is to be purchased by the
customer. If funds are required for some other
purpose Murabahah cannot be used.
 2. In some cases, the sale of commodity to the
client is affected before the commodity is
acquired from the supplier. This occurs when the
various stages of the Murabahah are skipped and
the documents are signed all together.
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 Murabaha Vs Interest Bearing Loans
Murabaha Loan

Murabaha Transaction is Asset backing is not

always asset backed.
It is fixed price contract.
Price can not be increased
in case of default.
It is purely sale and
purchase transaction.
condition for Interest
bearing loans.
Interest is charged on daily
basis from the Customer.
It is lending of money and
charging of interest.

Relationship between Bank Relationship between Bank

and Customer is Seller and and Customer is Creditor
Buyer. and Debtor. 44
MUSAWAMA

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 WHAT IS MUSAWAMA?

This is another kind of sale where

disclosure of cost and profit is not
compulsory by the Seller and price is
determined as lump sum.

Our day to day normal sales transaction

can easily be classified as Musawama.
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SALAM FINACE

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Hazrat ibn Abbas(R.A) said I declare that a Salaf
(Salam) contract in which the commodity is
guaranteed for future delivery has been permitted
by Allah and read:
O you who believe! When you transact a debt
payable at a specific time, put it in writing.
(Surah Al Baqara, verse 282)
Hazrat Ibn Abbas(R.A) is reported to have said: The
prophet (peace be upon him) had came to
Madinah and found that people were selling dates
for deferred delivery after a duration of one or
two years on a Salam basis. The Prophet (peace
be upon him) said: Whoever pays for dates on a
deferred delivery basis (Salam) should do so on
the basis of specified scale and weight. 48
 Conditions for valid sale

The basic conditions for a validity of a sale in

Sharia'h are three:

The purchased commodity must be existing,

The seller should have acquired the
ownership of that commodity and,
The commodity must be in the physical or
constructive possession of the seller.

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 WHAT IS SALAM?

There are only two exceptions to this principle

in Sharia'h:
Salam
Istisna

Salam is a particular kind of sale in which,

Seller agrees to supply specific goods to the
Buyer at a future date in exchange salam price
fully paid in advance.
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Conditions of Salam Finance
Total price is invariably paid in advance but the
supply of goods is deferred.

Only those goods can be sold through a Salam

contract in which the quantity and quality can be
exactly specified e.g. precious stones cannot be sold
on the basis of Salam.

Salam cannot be effected on a particular commodity

or on a product of a particular field or farm.

The exact date and place of delivery must be

specified in the contract. 51
The concept of parallel salam
If the seller enters into another separate Salam
contract with a third party to acquire goods of
same specification which corresponds to that of
the commodity specified in the first Salam
contract so that the seller can fulfill his
obligations under that contract then this. Second
contract is called:
‫زى‬
( ‫ ) لا^^سلم^ لا^^موا‬Salam muwazi. Parallel Salam.

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ISTISNA FINANCE

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 WHAT IS ISTISNA?

It is an order to the producer or

manufacturer to produce/manufacture a
specific commodity for the purchaser.

Istisna is also a particular kind of sale

which is executed before the Asset come
in to existence.

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 Conditions of Istisna Finance

 The subject matter of Istisna is always a thing

which requires manufacturing.

 Quality and Quantity should be agreed in

absolute term.
 Purchase price should be fixed with mutual
consent and not necessarily to be paid in fully
in advance.
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IJARAH (LEASING)

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 WHAT IS IJARAH?

Ijarah refers to the transfer of usufruct

(right to use) of an asset by the owner to
another person for an agreed period and
agreed consideration (rental).
Ijarah is Sharia'h compliant alternative of
conventional leasing products.

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 Two kinds of IJARAH
 Contracts to get services on human
capital is Ijarah tul amal (employment)
 The contract to get usufruct of an asset is
Ijarah tul ain (leasing)

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BASIC PRINCIPLES OF IJARAH
 Leasing is a contract whereby the owner of some
thing transfers its usufruct to another person for
an agreed period , at an agreed consideration.
 There are four essential elements in this contract;
 Parties
 Subject Matter
 Consideration
 Period

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RIGHTS AND OBLIGATIONS
 Rent cannot be increased or decreased without
mutual consent.
 A part of rent can be received in advance.
 Insurance of the lease asset is the responsibility
of the lessor.
 The lessee can sublease the asset with the
permission of the lessor.
 The lessee is responsible for any defect due to
his negligence or misuse.
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Sale and lease back is that type of transaction
in which customer sells it operating asset(s) to
the Bank and then acquires the same under
lease arrangements from the Bank, which is
permissible in some situations under Sharia.

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 Leasing/Ijarah Contract

Conventional Leasing Car Ijarah

There are two types of The Ijarah contract does

contracts, Financial lease not contain any condition
and loan for car financing. that makes the contract
Both these contracts void under Sharia'h
contain conditions that perspective.
contravenes the principles
of Islamic Sharia'h.

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 Rights & Liabilities of Lessor and Lessee
Conventional Leasing Car Ijarah

In Conventional Leasing All risks pertaining to

Products, the Customer is
responsible for all kinds of
losses or damages to the Leased
asset, irrespective of the
circumstances.
ownership are borne by Lessor.
Customer only bears usage-
related risks

If the insurance company does Lessor bears the risk of

not compensate the entire Insurance claim settlement.
outstanding amount in case of
total loss, the customer is liable
to pay the balance. 63
 Commencement of Rentals
Conventional Leasing Car Ijarah

In case of Booking of In case of Car Ijarah, the

Leased Asset, recovery of recovery of rentals is
Lease installment associated with delivery
commence after the of Leased Asset.
payment of cost of Asset
to manufacturer/dealer.
Rental recovery should
not be commenced before
the delivery of Asset.

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 Insurance premium and Registration
Charges
Conventional Leasing
Insurance is independent of the
lease contract. The insurance
expense of the asset is directly
borne by the lessee.
The registration cost of Asset is
borne by the Lessee.
Car Ijarah
Takaful / Insurance and
Registration charges should be at
the expense of the Lessor and not
at the expense of the lessee.
The Lessor may increase the lease
rent to recover any costs incurred
by him in connection with the
asset. However, as a matter of
principal, the cost should be paid
for by the Lessor.
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 WHAT IS DIMINISHING
MUSHARAKA?

Types of Shirkah

Shirka-tul-Aqd Shirka-tul-Milk

SHIRKAT-UL-’AQD
Which means “a partnership effected by a mutual contract”.
SHIRKAT-UL-MILK
It means joint ownership of two or more persons in a
particular property.
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WHAT IS DIMINISHING
MUSHARAKA?

Diminishing Musharaka is Based on Shirkat-ul-Milk.

Diminishing Musharaka refers to a contract where share

of one party in a particular jointly owned property
diminishes over time.
Three Major Steps in Diminishing Musharaka

 Joint ownership of the Bank and customer

 Customer as a lessee uses the share of the bank
 Redemption of the share of the Bank by the customer
and payment of rentals.
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 Diminishing Musharaka Finance
Vs House Loan
Diminishing Musharaka House Loan

Bank and Customers are joint The property is solely owned by

owners of the property and all the Customer and pledged in
ownership related expenses are favour of Bank as collateral
proportionately borne by both.
Lease Agreement between Bank The Bank only charge interest on
and the Customer for use of money borrowed.
Bank’s share in jointly owned
property.
Bank proportionally share all Bank does not participate in case
losses in property as joint owner. of loss of property.

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JAZAKUM UALLAH

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