ISLAMIC

MODES OF
FINANCING
 GROUP MEMBERS

 DR SANAULLAH MAHMOOD
 IQRA UNIVERSITY KARACHI
 INTRODUCTION

 Trading contracts are considered to be the fundamental contracts in Islamic

law.
 Surah al Baqarah verse 275 clearly indicates that sales and trade are
permitted as a general rule of business.
INTRODUCTION
TRADE BASED MODES OF FINANCING-(BAI’-TIJARAAT)

 'Bai‘ (buying/selling) is defined in Shari'ah as:

“the exchange of a thing of value by another thing of value with mutual

consent”

 one thing being the subject matter (Mabi‘) and the other being price
(Thaman).
TRADE BASED MODES OF FINANCING-(BAI’-TIJARAAT)

Basic rules for Bai’

a person cannot sell a commodity unless:
 It has come into existence.
 It is owned by the seller.
 It is in the physical or constructive possession of the seller

 The rules mentioned above are relaxed with respect to two types of sale:
1. Bai' Salam
2. Istisna'
COMPONENTS OF VALID BAI’
 TYPES OF BAI’(WITH RESPECT TO LEGALITY)
1.valid (Sahih),
A sale becomes valid if the following elements are present:
a) Contract (aqd) b) subject matter(Mabe’e) c) price (Thaman)
d) Possession or delivery (Qabza)
2. void (Batil)
A contract in which ownership title is not transferred and, therefore, is not Shar¯ı´ah-
compliant and not enforceable
3. voidable (F¯asid)
A contract that involves any violation of Shar¯ı´ah rules that is not of a severe nature,
and if parties to the contract are agreed and some modifications are made, it is
considered enforceable.
4. suspended (Mawquf)-
If the transfer of title is subject to any specific conditions, it is a Mawquf, or
suspended, sale
 TYPES OF BAI’(WITH RESPECT TO LEGALITY)
5. Bai‘ al Mutlaq
It is exchanging any commodity with money on the spot or at credit
6. Bai‘ al Sarf
The exchange of various kinds of money or goods representing money, e.g.
gold, silver, Dollars, Rupees, etc.
7. Bai‘ al Muq¯ayaza (barter)
The exchange of goods with goods .
8. Bai Mu’ajjal
where the price of the property is deferred to a future but definite time
 KINDS OF BAI’

 Bai Musawamah
 Bai Murabaha
 Bai Salam
 Bai Istisna'
 Bai Urboon
 Bai Touliya
‫ب ی ض‬
 Bai Wadhia ‫ع و ع ی ہ‬
 KINDS OF BAI’
Bai Musawamah:
 it is a negotiated sale,
 the price is bargained between the seller and purchaser
Bai Murabaha:
 it means a sale on mutually agreed profit.
 it is a contract of sale in which the seller declares his cost and the profit.
 adopted by Islamic banks as a mode of financing.
STEPS INVOLVED IN MURABAHA
 APPLICATION OF MURABAHA

 Purchase of raw material; for meeting working capital needs of trade and
industry.
 Medium to long term requirements for purchase of land, building and
equipment.
 Trade finance products including imports, exports and bill purchase
 BAI SALAM/SALAF
 a contract in which advance payment is made for goods to be delivered later on.
 quality of the commodity intended to be purchased must be fully specified
 Salam was allowed by the Holy Prophet (Peace be upon him) to fulfill the needs of
farmers and traders.
 mode of financing for small farmers and traders in agricultural goods
 BAI’ SALAM
 the seller undertakes to supply some specific goods to the buyer at a future
date in exchange for an advance price fully paid on spot.
 The buyer should pay the price in full to the seller at the time of finalizing
the sale.
 applied in commodities whose quality and quantity can be specified exactly.
 It may include:
 raw materials,
 agricultural produce
 manufactured goods.
 PARALLEL SALAM
 A parallel contract of Salam is possible with any third party
 based on two independent Salam contracts whereby the financier will be both the
seller and the buyer in this arrangement
For example:
If a bank has purchased from farmer 'A' 50 tons of wheat by way of Salam to be
delivered on June 30, the bank can contract a parallel Salam with a trader 'B' to
deliver to him 50 tons of wheat on June 30.
But while contracting parallel Salam with 'B', the delivery of wheat to him cannot be
made conditional upon taking delivery from 'A'. Even if 'A' does not deliver wheat
on June 30, bank will be duty bound to deliver 50 tons of wheat to 'B'. Bank can seek
whatever recourse it has against 'A', but he cannot back out from his liability to
deliver the wheat to 'B'.
Similarly, if the farmer delivers poor quality wheat, the bank will be still obligated to
deliver the wheat of stipulated quality to 'B' according to the original Salam contract.
PARALLEL SALAM
 BAI’ SALAM - APPLICATION
 Banks can use this mode to finance the agricultural sector in particular and
other trading activities in general.
 to finance industrial activities
 may be applied in financing handicraftsmen,
 small manufactures, farmers and industrialists
 by providing them with the necessary production needs in the form of tools,
equipment, or raw material
 ‫ن‬
BAI’ ISTISNA‫سص اع‬‫ات‬

 A contractual agreement for manufacturing goods and commodities,

 cash payment in advance and future delivery or a future payment and
future delivery
 Price can be paid in installments

used for:
 financing the manufacture
 construction of houses, projects
 building of bridges, roads & highways.
 BAI’ ISTISNA-APPLICATION
 used in the ‫ن‬field of manufacturing
 Al-Saanie ‫( ا لص ا ع‬manufacturer) would arrange both the raw material and the
labor.
 (If material is supplied by the purchaser and the manufacturer is required to
use his labor and skill only, it will be the contract of Ujrah and not of
Istisna.)
 subject of Istisna must be known and specified
 price should be known in advance
 price once settled, cannot be increased or decreased.
 not necessary in Istisna that the price is paid in advance
 Price can be paid in installments within a fixed time period.
 KINDS OF BAI’
Bai Arbun:
 A sale of down payment
 with the condition that if the buyer takes the commodity, the down
payment will become part of the selling price
 if buyer does not purchase the commodity, the advance money will be
forfeited

Bai Wadiah:
 safe-keeping/resale of goods with a discount on the original stated cost.
 sale of goods at a discounted price.
 OPTIONS IN SALES (KHIYAR)
 the doctrine of option or the right of cancellation (Khiyar)
 Khiyar al-Shart:
-a stipulation that any of the parties has the option to rescind the sale within so many
(specified) days
• Khiyar al Ro’yat - an option to be exercised on inspecting the goods
– goods, if not according to the contract, can be returned after inspection
• Khiyar al ‘Aib - an option with regard to defect
– goods can be returned if found to be defective
• Khiyar al Wasf: the option of quality
– where goods are sold by specified quality, but that quality is absent, the goods can be
returned.
• Khiyar-e-Ghaban: the option relating to price
-where goods are sold at a price far higher than the market price, and the client is told
or given the impression that he has been charged the market price.
 RENTAL-BASED MODES OF FINANCING

IJARAH (leasing)
 The term Ijarah (Leasing) in Arabic literally means to give something on rent.
 an agreement where a lessor (mu’ajjir) leases physical asset or property to a lessee
(musta’jir) who receives the benefits associated with ownership of the asset against
payment of predetermined rentals (ujrah).
 Ijara is for a known time period called ijara period.
IJARAH - ELEMENTS
 FEATURES OF IJARAH CONTRACT

 Asset to be leased must have a valuable use that is compliant with Shari’a.
 Asset to be leased must not be consumable.
 Ownership of the asset remains with the lessor and only the usufruct is transferred to the
lessee.
 Usufruct - the right of using another’s property for profit, without spoiling its substance
 Liabilities and risks incidental to ownership will reside with the lessor.
 Period of the ijarah arrangement must be clearly specified
 Purpose and mode of usage should be agreed upfront
 Lessee liable for damage to leased asset only to the extent of the lessee’s negligence.
 TYPES OF IJARAH ARRANGEMENTS

 In conventional leasing, there are two types of leases

o Operating lease – the lessor owns the asset and bears maintenance costs as well as
ownership risks
o Financial lease – the lessor only “technically” owns the asset, maintenance costs
and ownership risks are borne by the lessee

 In Islamic finance, there are many types of Ijarah financing arrangements

I. Simple Ijarah (Operating Lease)
II. Ijarah-thumma-al-Bay' (Lease-sale) or (Financial Lease)
III. Ijarah with Musharaka or Mudharaba
IV. Sale-and lease back
 SIMPLE IJARAH (OPERATING LEASE)

Simple ijarah that is:

 not tied with a purchase agreement.

 suitable for expensive assets such as ships, aircraft, heavy-duty industrial & agricultural
equipment.
 also called a service lease, or a true lease.

 phase 1- the bank purchases the asset needed by its customer from the vendor.
 phase 2- the bank as owner of the asset leases out the same to its customer against rentals
 ownership of the asset remains with the lessor (bank),

 the asset reverts to the bank at the end of the lease period

 most ideal type of ijarah

 IJARAH-THUMMA-AL-BAY' (LEASE-SALE) OR (FINANCIAL LEASE)

 ijarah-thumma-al-Bay' (lease-sale), or "Ijara-waIktina'a" or “Ijara muntahiea

bitamleek”,
 the lessee is offered the option of ultimately purchasing the asset at the end
of ijarah period at a predetermined price.
 bank finance the purchase of an asset via a leasing arrangement and at the
end of lease period, ownership of the asset is transferred to the customer
 full cost of the asset/property is amortized during the lease period
 "full payment lease“
 bank remains the owner till the very end bearing all the risks and
responsibilities
 customer is responsible for only the rentals
 customer becomes the owner if option to purchase at the end of the period
is used
 IJARAH WITH MUSHARAKA OR MUDHARABA

 bank and its customer enter into a partnership specifically formed to finance the
acquisition of the property that the customer is interested in
 The bank and customer contribute to the equity of the partnership in a certain ratio
 The partnership then purchases the property and leases it to the customer
 proportion of rental accruing to customer is used to redeem part of the bank’s stake in the
property
 the bank’s stake in property reduces to zero and the customer becomes the full owner of
the property.
 common in housing finance
 This mechanism known as diminishing musharaka or mudharaba in combination with
ijarah
 SALE-AND LEASE BACK
 the customer may sell an asset that it owns, to the bank for a price and then take it back on
lease.
 The result is an immediate cash inflow for the customer (in the form of sale price of the
asset).
 The customer continues to use the asset in lieu of periodic ijarah rentals paid to the bank,
which now owns the asset.
1. Customer sells an asset it owns to Bank on cash basis; (Possession of the asset remains
with the Customer while ownership papers are transferred to the Bank)
2. Customer enters into an ijarah contract with Bank for the same asset;
3. Customer pays known rentals over future (known) time period(s).
4. Bank transfers ownership of asset to customer at the end of ijarah period either through
gift or sale.
 IJARAH-APPLICATION

 The contract of ijarah financing can be utilized as:

 a mode of financing to provide the customers with short to medium-term financing to lease
such items which may include:
 real estates,
 buildings
 equipment
 machineries, computers, motor vehicles
 PARTNERSHIP-(SHIRAKAH-SHIRAKAT DARI)
 Shirkah is of two kinds
 
1. Shirkat al- Milk
(Partnership in Ownership)
 
2. Shirkat al uqud
(Partnership by Contract )
PARTNERSHIP-(SHIRAKAH-SHIRAKAT DARI)
 PARTNERSHIP-(SHIRAKAH-SHIRAKAT DARI)

1. Shirkat al- Milk (Partnership in Ownership)

where two or more persons are owners of one thing.
2. Shirkat al uqud (Partnership by Contract )
when two or more persons, by their free consent, enter into contract to do
some business with a view to share its profits and losses.
It is of four kinds which are briefly described as follows:
1.Shirakat al amwal Shirkat-ul-Mufavadha
Shirkat-ul-Anan. 
2. Shirkat ul a‘mal or Shirkat-ul-Sanai.
3.Shirkat-ul-Wujooh
4.Mudarbah
 PARTNERSHIP-(SHIRAKAH-SHIRAKAT DARI)

Shirkat-ul-Mufavadha: 
 Equal shares
 the capital contribution of the partners and their shares in profits and losses are equal.
Shirkat-ul-Anan: 
 the partners neither contribute equally in capital nor do they share the profits and
losses equally.
Shirkat-ul-Sanai (partnership in labour or crafts),
 two persons become partners by agreeing to work jointly
 share their earnings, in partnership.
 also known as Shirkah Taqabbul, or Shirka al Abd¯an.
 partnerships between medical practitioners, teachers, miners, transport owners and
farmers.
 PARTNERSHIP-(SHIRAKAH-SHIRAKAT DARI)

Shirkat-ul-Wujooh (Partnership in Creditworthiness)

 a form of partnership which is started by the person who have neither capital nor skill
 they start the business on credit as partners and share the profits among themselves
Mudarbah
 a contract of partnership in which one party is entitled to profit on account of its M¯al,
 the other party is entitled to profit on account of its labor.
PARTNERSHIP-(SHIRAKAH-SHIRAKAT DARI)