Islamic Modes of Financing

PRODUCTS – Murabahah, Salam

and Istisna
Mirpur, Azad Kashmir
11 – 12 June, 2008
Al – Huda Training Programme

Muhammad Khaleequzzaman
Head Islamic banking Department
Int’l Islamic University Islamabad
 Islamic Modes –

Sale Modes:
1. Murabahah to the purchase orderer
2. Salam as financing mode of Islamic banks
3. Istisna’ and parallel Istisna’
Participatory Modes:
1. Mudarabah (asset and liabilities side)
2. Musharakah as a mode for house finance
Rent based Modes:
1. Operating lease (Ijarah)
2. Ijarah wa Iqtina’
 Islamic Modes – Murabahah

Contents:
1. Murabahah – Historical perspective
2. Spot and Deferred Murabahah
3. Banking Murabahah/Murabahah to the
Purchase Orderer
4. Why Unilateral Promise?
5. Why Security Deposit?
6. Why Agency?
7. Issue of default / penalty
8. Pricing of Murabahah
 Islamic Modes – Murabahah

Murabahah:
Murabahah is simply a sale contract which fixes
the price in terms of the sellers cost plus a
specified percentage markup. The seller must
disclose all items of expense which are included
in the cost ie. All direct expenses incurred in
acquiring that goods – trust relationship
between bank and the clkient.
Uses of Murabaha
• Sale of raw material
• Sale of equipment
• Sale of agricultural inputs
• Sale of real estate and vehicles
 Islamic Modes – Murabahah

Process Flow:
Approval of Credit Facility
– Negotiation/Approval of overall limit
– MOU/Murabahah Facility Agreement
– Requisition + Undertaking + Security Deposit
2

MOU/Facility
Bank Client
Agreement

Approval of Limit 1

Requisition, Undertaking, Sec. Dep. 3

 Islamic Modes – Murabahah

Process Flow:
Agency/Payment to Supplier
– Client appointed as agent [Optional] – When the
option to be used?
– Payment to the Supplier – Direct

Bank
Bank Client

Agency Agreement 2
1
Supplier
Payment 3
2
 Islamic Modes – Murabahah

Process Flow:
Acquiring / Possession /First sale
– Physical Possession / Constructive Possession
• Payment to supplier
• Discount of supplier
• Title of goods
• Transfer of risk and responsibilites

Agent
Bank Title Supplier Goods (Client)
 Islamic Modes – Murabahah

Process Flow:
Execution of Murabahah / second Sale
– Receipt / Possession report / Offer of client
– Acceptance of offer by the bank
– Return of security deposit
– Delivery of goods / Transfer of Risk & responsibility
– Ownership changes
– Payment of earnest money (Urboun)
Payment of Murabahah Price
– Client pays Murabaha price as per agreed schedule
– Collateral released
– Murabahah terminates
 Islamic Modes – Murabahah
• Execution of Murabahah Urboun/Securities 4

Offer to Purchase 2
IB Client
Acceptance of Offer 3

Receipt , Possession Report 1

Hamish jiddiyah 3

 Payment of Murabahah Price

Murabahah Price 1
IB Client

Murabahah Terminates 2
 Islamic Modes – Murabahah

Purchase of poultry feed stock

• Murabahah transaction: Rs. 100,000
• Murabahah Facility: 90 Days
• Payment: Lump sum
• Rate of Profit: Six months
KIBOR+2%
• Freight: 5% of cost of
goods
• Securities: Pledge of feed stock,
post dated cheques
 Islamic Modes – Murabahah
Pricing of Murabahah [Example]:

Particulars Amount (Rs.)

Cost of goods Rs. 100,000
Rate of Profit Kibor + 2%

Six monthly KIBOR 10% p.a.

Freight 5% of cost
Total cost 100000 x 5% 100000 + 5000
=105000
Profit 10%+2% = 12% p.a. 105000 x 12% x
90/365 = 3107
Murabahah Price 105000+3107= 108107
 Islamic Modes – Murabahah

Book Keeping of Murabahah:

 Funds are advanced to supplier for purchase
of goods and F&I paid
 On arrival of goods Murabahah purchase
account effected [bank becomes owner]
 Murabahah Facility A/C and Murabahah Profit
Receivable A/C are effected against
Murabahah Sale A/C [goods sold]
 Client’s A/C is effected against Murabahah
Facility A/C and Murabahah Profit Receivable
A/C (Murabahah price recovered]
Islamic Modes – Agricultural Financing

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Salam
 Islamic Modes – Salam

Salam: Forward Purchase

A salam transaction is the purchase of a
commodity for deferred delivery in exchange for
immediate payment. It is a type of sale in which
the price, known as the salam capital, is paid at
the time of contracting while delivery of the item
to be sold, known as subject matter of salam, is
deferred. Salam is also known as Salaf (lit:
borrowing)
Uses:
– Purchase of commodities (financing for
production of agricultural commodities/
minerals)
– Liquidity requirements of sugar mills, etc.
 Islamic Modes – Salam

Salam: Shariah Legitimacy

 Allh says “O ye who believe when you deal with
each other, in transactions involving future
obligations in a fixed period time, reduce them to
writing” [Al Baqara Verse 282]
 Ibn Abbas reported, the Prophet (PBUH) came to
Medina and found that people were selling dates
for deferred delivery (salam) after a duration of
one or two years. The Prophet (PBUH) said:
“whoever pays for dates on a deferred delivery
basis (salam) should do so on the basis of
specified scale and weight” [Bukhari and Muslim]
 Islamic Modes – Salam

 Wisdom of allowing Salam

 Beneficial for both seller and
purchaser
Three major problems
1. Risk of default by seller
2. Bank’s need to liquidate goods
after delivery
3. Seller’s inabillity to produce or
procure commodity
 Islamic Modes – Salam

Principles/conditions
 An exception to the possession
 A contract opposite to Murabahah
 Payment of full price at spot - otherwise selling
debt for debt
 Allowed in fungible commodities
 Product of a particular origin cannot be specified
 Quality and quantity decided in un ambiguous
terms
 Allowed in fungible commodities
 Product of a particular origin cannot be specified
 Quality and quantity decided in un ambiguous
terms
 Islamic Modes – Salam

Principles/conditions
 Allowed in fungible commodities
 Product of a particular origin cannot be specified
 Quality and quantity decided in un ambiguous terms
 Certain date and place of delivery
 The commodity should remain in the market throughout the
period of contract [Different opinions]
 The time of delivery should be sufficient to allow use of
salam capital conveniently and effect prices, preferably be
at least 15-30 days from the date of contract [Different
opinions]
 A security/guarantee or is preferred as safeguard to the risk
of default
 Only commodity is delivered and not the money
 Islamic Modes – Salam

Parallel Salam:
The disposal of commodity at the end of Bank
can be through:
– Parallel Salam:MFI may sell commodity, before the
date of delivery, to some other
purchaser for the date of original
delivery. The period in second
contract will be shorter than the
original contract, but price higher
than the original contract.
– Unilateral Promise: Promise of purchase can be
obtained from third party for
delivery on the date of original
contract. Price in this promise is
set higher than parallel salam
because the promisor has to
pay nothing.
 Islamic Modes – Salam

Rules of Parallel Salam and Third party

promise
 Both the contracts viz. salam and parallel
salam must be independent of each other
 Parallel salam is allowed only with third
parties [Agency allowed]
 The third party giving unilateral promise
should not pay the price as this is not
allowed in Shariah
 Islamic Modes – Salam – Example

Bank transacts purchase of wheat

 Contract against payment of certain price
 Commodity to be delivered in six months
 Bank apprehends trend of depressed prices
in the prospect OR requires liquidity
 Bank’s position at disadvantage as compared
to other purchasers contracting lower spot
price but cannot undo the contractual
obligation –
 Bank can keep the original contract and enter
another salam contract with a buyer
expecting trend otherwise… can lower the
price risk
Islamic Modes – Salam

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