islamic banking manual

8/13/2019 Islamic Banking Manual

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LearnIslamic Bankingwith BankIslami

Base Version

January 2006


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BankIslami Pakistan Limited

INTR!"#TIN

This Study pack is about introducing Islamic banking. If this is the first time you are reading about IslamicBanking, then you have arrived at just the right place. Why? It is because in our opinion, this is the mostsimplified tet on Islamic banking ever !ritten so far. It !ill take you through the concepts of IslamicBanking in a seamless manner, so much so that after going through this Study pack, you !ill !onder!hy people al!ays told you Islamic Banking is tough....

Within BankIslami, "## employees are epected to pass the test based on this book before they areallo!ed client contact or confirmation of services. "s it is the $I%ST step in our training process, it isimportant that you grasp the concepts introduced in this book for an effective &roduct level training.

The fundamental precept of the book is that Islamic Banking can be learned by self study, albeit in astructured manner. If you are ne! to Islamic Banking it !ill add to your kno!ledge !hich !ould be

approimately e'ual to () hours of !orkshop training. If you happen to have !orked in Islamic Bankingbefore, !e hope it !ill refresh your kno!ledge.

In !riting this study pack, !e have attempted to adhere to five basic principles !hich sets it apart fromother material that is available. $irstly, the discussion is object focused. We are more interested in tellingyou !hat is a *urabahah, ho! it can be structured and !hat should be avoided instead of telling you theevolution of *urabahah and various opinions about its permissibility in different schools of thoughts.Secondly, the entire discussion is backed up !ith eamples and !here appropriate graphicalillustrations. Thirdly, the accompanied + contains an e-ui based on multiple/choice 'uestions toensure you have actually learned the concepts. $ourthly, !e cut no corners in telling you !hat you needto kno! even at the risk of complicating the discussion. $ifthly, ecept for the first three chapters, !hichmust be read in se'uence, it is modular, i.e. you can pick any chapter and read it. We have also included

*odel "greements so that you can actually see ho! the kno!ledge you have gained is used in thepractical !orld.

$% T "&' T$I& &T"!( P)#*+

This book, as !e eplained earlier, is primarily meant for those !ho are ne! to Islamic banking. It makesno distinction of !hether they are *uslims or not. 0aving said that, !e believe, Islamic Banking can onlybe learned meaningfully if the basic system of Islamic la! and jurisprudence is eplained. This in turnre'uires some discussion about -uran, Sunnah, 0adith and the esteem and contet in !hich they areheld by *uslims. It is only !hen you understand the importance of a commandment in -uran and !hatis subject to interpretation and !hat is not, then you !ill be able to understand the true spirit of IslamicBanking. Importantly, it !ill make your interaction !ith prospects and customers more meaningful.

This Study pack is designed for anyone and everyone !ho is interested in learning about IslamicBanking. To make it easier to grasp, it is divided into nine 123 different +hapters. 4ach chapter is dividedinto different Sessions. We suggest you read one Session at a time. Some of the Sessions are long andyou may split them into t!o or more sittings. 5ou are encouraged to re/!ork the calculations !here theyare provided specially in the *urabahah section. The accompanied + contains e-ui carrying *+-sthat are dra!n from each chapter and tests all vital concepts introduced. *odel agreements do not formpart of the testing material. 4ach chapter can be scored separately in addition to over all score. Wesuggest you take the e-ui after completing each chapter.

I6T%78+TI76I6T%78+TI76


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,"RT$'R )&&I&T)N#'+

Improvement is a continuous process. We need your assistance and suggestions in improving this studypack. &lease send your suggestions to either myself or to Sheba * 9han atshe-a.khan/-ankislami.com.k. Issues relating to Shariah can be referred to either *ufti Irshad"hmad at irshad.ahmed/-ankislami.com.k or *uhammad $aisal Shaikh at1aisal.shaik/-ankislami.com.k.

7ur thanks to the team that produced this Study &ack. Sheba led the team assisted ably by 6aia and"yesha. "n!ar $aroo'ui, $aisal and *ufti Irshad !rote most of the material. "sad !orked on the +.*ohammad Shahad ensured the book is produced in a 'uality manner. To all of them !e epress ourgratitude.

" !ord of ackno!ledgment about our shareholders as !ell !ho have provided us !ith eemplarysupport. +hief :ustice1%3 *ahboob "hmad 1+hairman of the Board, representing :S+#3 for emphasiing

on training and development, *r. "hmed %anderee !hose commitment to Islamic Banking is a source ofinspiration to all of us and ubai Bank for agreeing to share the cost and making valuable suggestions.Thank you very much.

This study pack also makes a statement about !hat BankIslami is / an Islamic Bank !ith very highproduct authenticity, yet very contemporary. 9eep it up at all times;

0asan " Bilgrami+47

I6T%78+TI76I6T%78+TI76
mailto:[email protected]:[email protected]


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#ontents at a lance

#hater 3 Name o1 #hater Page 3

1 Islamic 'conomic &ystem

&ession 4+ %hat is &hariah5

efine Shariah 1

Sources of Shariah 3

efine $i'h 5

&ession 2+ 'ssentials o1 Islamic 'conomics

What are the objectives of Islamic 4conomics? 60o! Islamic economics compares !ith +apitalism Socialism? 6

What is the concept of !ealth in Islam? 7

0o! the !ealth is distributed in Islam? 7

&ession + 'conomic )cti7ities in Islam

The importance of %isk and &rofit sharing 9

Why is trade permissible? 9

Why is investment in business permissible? 9

2 Ri-a and its Prohi-ition 8 )rguments and Rationale 1or its Prohi-ition

&ession 4+ Ri-a

What is %iba? 11

What the 0oly book -uran says about %iba? 11

&rohibition of %iba in 0adith 12

&ession 2+ #ommon arguments in suort o1 commercial interest

"ns!er to the arguments given in support of +ommercial interest 14

&ession + harar

What is

What are the different types of Which businesses are haram? =

#hater 9 Islamic &ales #ontract

&ession 4+ Islamic Law o1 #ontracts

Islamic #a! of +ontracts =2

4ssential element of a valid contract =2

Types of contracts in Islami ((

+ontents at a


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&ession 2+ &ale

What is sale? (@

Basic elements of Islamic sale contract (@

Types of sale (>

&ession + *hiyar

What is 9hiyar? (

Types of 9hiyar (

What is I'ala? (

&ession :+ )gent

+oncept of "gent 1Wakeel3 (2

%ights and 7bligations of the "gent (2

: #hater : 9 ;ura-ahah

&ession 4+ Introduction

efine *urabahah @=

&ayment options in *urabahah @=

&ession 2+ ;ura-aha '


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&ession 2+ $ow to use &alam

&rocess flo! of Salam =

%isks in Salam and ho! they can be mitigated =

What are the common mistakes in eecuting Salam (

6 #hater 6 9 Istisna


What is Istisna'? @

*ain features of Istisna? @

0o! Istisnadiffer from Salam?

&ession 2+ Parallel Istisna

What is parallel Istisna'? >What is the process flo! in Istisna'? >

What is the scope of Istisna'?

> #hater > 9 I?arah @LeasingA

&ession 4+

What is Ijarah? 2

Important features and basic rules of Ijarah. 2

istinguishing factors of Ijarah. 2

&ession 2+

What is the difference bet!een +onventional #ease and Ijarah? >@

ifferent types of leases >

&ession +

What is the process flo! of Ijarah? >>

0o! profit is calculated in Ijarah. >>

What are the risks in Ijarah? >

#hater 9 ;udara-ah


What is Mudarabah? >2

What are the types of Mudarabah? >2

What are the rules of Mudarabah? D

What are some issues in Mudarabah? =

&ession 2+ "ses o1 ;udara-ah

eposits E 0o! does the Bank !ork as a Mudarib? (

Investments E 0o! does the Bank !ork as aRabb-ul-maal? (

+ontents at a


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&rofit and #oss istribution in *udaraba @

&ession + Process 1low o1 Risks

What is the process flo! of Mudarabah? A

What are the risks in Mudarabah? A

Where Mudarabahcan be used by Islamic Banks?

C #hater C 9 ;usharakah


What is Musharakah?

Types of Shirkah

&ession 2+ RulesD security and termination

+haracteristics and rules of Musharakah )D

%ights and obligations of partners inMusharakah )=

Security in *usharakah )=

0o! a *usharakah can be terminated? )=

What are the differences bet!een interest/based financing and*usharaka?

)(

&ession + !iminishing Musharakah

What is iminishing Musharakah? )@

Step/by/step procedure of iminishing Musharakah )A

Where *usharakah can be used as a *ode of $inancing? )

+ontents at a


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#hater 4+

Islamic 'conomic &ystem

1


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#hater 4+ Islamic 'conomic &ystem

&ession 4+ %hat is &hariah5

&ession #hecklist

". efine Shariah

B. Sources of Shariah

+. efine $i'h

). !',INITIN , &$)RI)$

*ost people believe that Shariah and Islamic #a! are similar. This can be misleading asShariah is far more comprehensive. 1see Table " on net page3

Shariah eplains and takes care of all aspects of spiritual, political, social, domesticand private life of an individual.

Shariah is in principle meant for all *uslims, but also applies to a certain etent topeople living inside a *uslim society.

The regulations of Shariah can be divided into t!o groupsF

%egulations on !orship and ritual duties

%egulations of judicial and political nature !hich also include economic activities.

Throughout this document, !e !ill be referring to Shariah regulations governing theeconomic activities !ith a specific reference to Islamic Banking and $inance

Chapter 1: Islamic Economic System 2


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Ta-le )


ISLAM a panoramic view


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B. &"R#'& , &$)RI)$

There are t!o sources of Shariah.

=3 &rimary sources(3 erived Sources

4A PRI;)R( &"R#'&

@aA EurFanD The -ook o1 )llah

The


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"llah, the "lmighty, has taken upon 0imself the duty of preserving the -urGanforever in its entirety. It has been preserved so !ell, both in memory and in!riting. The "rabic tet !e have today is identical to the tet that !as revealedto the &rophet 1peace and blessings be upon him3 dot to dot and dash to dash.

6ot even a single letter has yielded to corruption during the passage ofcenturies, and so it !ill remain for ever, by the order of "llah.

@-A &unnah G )hadith

The -urGan is the !ord of "llah !hich !as revealed to &rophet *uhammad 1peaceand blessings be upon him3 and preserved both verbally and in !riting by his+ompanions. "part from the -urGan, !hatever the &rophet uttered or did !as alsopreserved by the +ompanions. The !ord JSunnahK includes the sayings of the&rophet 1peace and blessings be upon him3 kno!n commonly as J0adithsK 1i.e.,sayings3, his practices, and actions of his companions !hich gained his approval.Both the -urGan and the Sunnah fall under a common title JWahyK 1revelation orinspiration3L the difference bet!een the t!o is that the -urGan is a direct revelation

so the !ords are of "llah, !hich are recited 1*atlu!3 in the formal prayer 1Salah3!hile the Sunnah is indirect revelation in the sense that the !ords are not from"llah. 0oly prophet 1Sall/"llahu alayhi !a Sallam3 said many directions he receivedfrom "llah in his o!n !ords, these are not recited 1J


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#. %$)T I& ,IE$5

J$i'hK is utiliation of both primary and derived sources of Shariah to get to a decision. Itcovers every aspect of life. It gives the final and binding rulings on any matter arising out

of our daily lives.

The comprehensive nature of Shariah is due to the belief that a complete and perfectlegislation la! must provide all that is necessary for a personMs spiritual and physical!ell/being. Thus, Shariah provides a complete code of life and as any complete code oflife, Shariah covers all possible actions of a *uslim. "ll directives of Shariah are divided1in principle3 into five categoriesF obligatory, meritorious, permissible, reprehensible, andforbidden. The verdict of -urGan on a fe! topics has been discussed in different places init, hence it is difficult for a common *uslim to kno! and understand the eact status of aparticular issue. It is here !here the role of $i'h starts.

J$i'hK means Munderstanding of detailsM and refers to the inferences dra!n by scholars.Shariah has certain la!s !hich are regarded as divinely ordained, concrete and timeless

for all relevant situations 1for eample, the ban against drinking li'uor as an intoicant3. Italso has certain la!s !hich are etracted based on principles established by Islamic

jurists 1Mujtahiun3. So Minterpretation of an Islamic rule and collecting all the directivesand injunctions about it in one place and deciding itMs statusM is !hat $i'h adds.Therefore, it is easy to say that $i'h is !hat jurists have attempted for to interpret divineprinciples.

With a fast progressing !orld and innumerable steps taken by mankind since theadvent of Islam, ne! problems are cropping up every day and the Islamic Scholarshave to supply ans!ers to these 'uestions. In this connection, mention must bemade of an entity called JIslamic $i'h "cademyK based in :eddah, Saudi "rabia. Thisacademy comprises of prominent Islamic scholars from all *uslim countries andrelating to all Islamic schools of thought. They meet regularly and give rulings on the

matters referred to them from all over the !orld. *ost of the practices prevalent inIslamic banking today have the approval of Islamic $i'h "cademy, :eddah.1httpFNN!!!.fi'hacademy.org3.

http://en.wikipedia.org/wiki/Mujtahidhttp://www.fiqhacademy.org/http://en.wikipedia.org/wiki/Mujtahidhttp://www.fiqhacademy.org/


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&ession 2+ 'ssentials o1 Islamic 'conomics

&ession #hecklist

". What are the objectives of Islamic 4conomics?

B. 0o! Islamic economics compares !ith +apitalism O Socialism?

+. +oncept of Wealth in Islam

. 0o! the !ealth is distributed in Islam?

). %$)T )R' T$' BJ'#TIV'& , I&L);I# '#N;I#&5

Islam considers economic activities of man as la!ful, meritorious and at times obligatoryand necessary. 0o!ever, economic activities are not the basic problem and thereforeeconomic progress is not the primary reason for human eistence. This sentence is theshortest differentiating point bet!een Islamic economic objectives and those in+apitalism O Socialism.

4conomic activities therefore should be conducted, keeping in vie! all the time thatF

These are la!ful and the !ealth is earned in MhalalM !ays, as prescribed by Shariah

The !ealth is fairly distributed in all sectors of the society and not concentrated in afe! hands.

B. #;P)RI&N %IT$ #)PIT)LI&; )N! I)LI&;

#et us briefly talk about the three economic models to better understand the Islamicsystem of economics.

4. +apitalism2. Socialism. Islamic system

4. #aitalism

"s you may be a!are that this model encourages private o!nership and believes that aman is free to accumulate !ealth !ithout any restriction. *arket forces are the primedrivers of an economy. 4ven humanly/established la!s are not applicable.

2. &ocialism

7n the other hand, Socialism model lays do!n that everything belongs to the State andprivate o!nership is prohibited. 0ence, no one is allo!ed to accumulate !ealth for his o!n.

Both capitalism and socialism in their purest form do not eist any !here in the !orld.With the demise of the former 8SS%, socialism has faced a serious set back, though itsdiluted principles are practiced !orld over. +apitalism again in its diluted form is present

around the !orld.



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. Islamic &ystem

Islam says that all !ealth primarily belongs to "llah and it is given to man in trust. 0e hasto earn it under certain rules and share it !ith others through Pakat, Sada'at etc. &rivate

o!nership is allo!ed as long as other tenants i.e. Pakat, Sada'at and prohibition of %ibaare follo!ed.

#. #N#'PT , %')LT$ IN I&L);

"ccording to IslamF

Wealth in all its possible forms is created by "llah.

Therefore, primarily !ealth is the property of "llah.

The right of property !hich a man possesses, has been delegated to him by "llah.

It should be used in such a !ay that it ensures success in the !orld and hereafter.

Since !ealth has been received from "llah, itMs use by man should also be subject tothe commandment of "llah.

"llah may command man to give a specified part of his !ealth to others.

"llah may forbid use of !ealth in a particular !ay.

!. !I&TRIB"TIN , %')LT$ IN I&L);

#et us revie! the objectives of distribution of !ealth in Islam.

4. 'sta-lishment o1 a ractica-le 'conomic &ystem

By practicable economic system !e mean a system that does not deny privateo!nership and deprive human being from their basic rights nor it supports control of fe!!ho have resources to maimie their !ealth. Islam provides a system that hasbalanced economic instructions !hich do not deprive anyone from his rights nor it leavessome of them enjoying !ith resources in their hands.

Islam accepts the follo!ing !ithin certain limitsF

#a!s of demand and supply *otive of personal profit *arket forces 6atural relation of employer and employee

2. 'na-ling e7ery one to get what is right1ully due to him

Islamic concept of deserving !ealth is that both, those !ho have participated ingenerating !ealth and those !ho could not participate in the generation, have rights in!ealth.-urGan Says in Surah "l *aMarijIn their wealth there is known right for those who ask for it and those who have need forit (70; !-"#



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. 'radicating the concentration o1 wealth

&rohibition of hoarding, interest, gambling, , 8'ood $asidh 18nla!ful contracts3 and


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&ession + 'conomic )cti7ities in Islam

&ession #hecklist

". The Importance of %isk and &rofit Sharing.

B. Why is Trade permissible?

+. Why is investment in business permissible?

"s in +apitalism and Socialism 1!here individuals or the state are left free to pursue economic

activities !ithout any restriction3 Islam dra!s a clear line bet!een !hat is allo!ed orpermissible 10alal3 and !hat is not allo!ed or impermissible 10aram3. In this section, !e !illhighlight both sets of these activities i.e. 0alal as !ell as 0aram

). T$' I;PRT)N#' , RI&* )N! PR,IT &$)RIN @essential element o1Islamic economyA

Islam lays great stress on the fact that anybody !ho seeks a re!ard or earning from anyactivity must also bear the risk relating to that activity. Islam abhors that one party enjoys allbenefits !hereas other takes on all the risks. It is for this reason that *odarabah 1Centure+apital3 and *usharakah 1&rofit O loss sharing3 are the primary financing modes.

The aspect of risk sharing is actually the corner/stone of all economic activities in Islam.

The absence of this element in any undertaking makes it not according to the tenets ofIslam. "t the same time, only presence of risk does not make a transaction Shariahcompliant. The underlying reason, rationale and motive has got be in accordance !ith theprinciples of Shariah.

$or eample putting money in $ied eposits at fied rate of interest does not involve anyrisk sharing as return to depositor is almost guaranteed.

B. TR)!'

Trading is the most favoured economic activity in Islam as the elements of risk taking andprofit sharing are prominently present. &lease bear in mind that care is to be taken indoing trade based activities as !ell because hoarding, eorbitant profits and cornering of

market by a fe! are again undesirable.

#. INV'&T;'NT IN B"&IN'&&

This is a desirable activity but it should be noted that Islam re'uires that all suchinvestments should be backed by assets.


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11


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#hater 2+

Ri-a and its rohi-ition

9)rguments and rationale 1or itsrohi-ition

12


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#hater 2 + Ri-a and its rohi-ition 9 )rguments and rationale1or its rohi-ition

&ession 4+ Ri-a

&ession #hecklist

". What is %iba?

B. What the 0oly Book -urMan says about %iba?

+. &rohibition of %iba in 0adith

). RIB) @INT'R'&TA

5ou must have often !ondered !hat the !ord M%ibaM actually means.

%iba means any ecess compensation over and above the principal !hich is !ithout dueconsideration. It is a premium paid to the lender in return for his !aiting as a condition forthe loan. In the !ords of &rophet 1S"WS3 J4very loan that dra!s interest is %ibaK.

This is the biggest M0aramM element in Islam !hich relates to any economic activity.

B. %$)T T$' $L( B* E"RH)N &)(& )B"T RIB)5

It is essential for you to kno! that %iba has strictly been prohibited in the 0oly -urMan.Belo!, !e have given verses from the -urMan !hich are revelations about %iba.

4. ,irst Re7elation a-out Ri-a in EurHan

)*hat whi$h %ou give as interest to in$rease the +eo+les' wealth in$reases not with,od; but that whi$h %ou give in $harit% seeking the goodwill of ,od multi+liesmanifold. 1Surah %ome, Cerse @23

2. &econd Re7elation a-out Ri-a in EurHan

)/nd for their taking interest even though it was forbidden for them and theirwrongful a++ro+riation of other +eo+les mone% and e have +re+ared for thoseamong them who re1e$t faith a grievous +unishment .1Surah al/6isaM, verse =>=3

. Third Re7elation a-out Ri-a in EurHan

)2elievers3 4o not swallow riba doubled and redoubled and be mindful of /llah sothat %ou ma% attain true su$$ess. 1 "l Imran, "yat =@D3

5ou may have heard the argument that only compounding is 0aram 1prohibited3 inIslam. This verse directly rejects this argument.

Chapter 2 : .i,a an its prohi,ition 0 -r(uments an rationale 'or its prohi,ition 13


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:. ,ourth Re7elation a-out Ri-a in EurHan

)*hose who devour Riba shall rise u+ before /llah like men whom Shaitan hasdemented b% his tou$h; for the% $laim that trading is like usur% 2ut /llah has

+ermitted trading and forbidden usur% 5e that re$eives an admonition from hisRabb and mends his wa%s ma% kee+ what he has alread% earned; his faith is in thehand of /llah 2ut he that +a%s no heed shall be among the +eo+le of fire and shallremain in it forever.

)/llah destro%s riba and nourishes $harities /nd /llah does not like an% sinfuldisbeliever Surel% those who believe and do good deeds establish Salah and6akah have their reward with their ord and there is no fear for themnor shall the%grieve.

)8 %ou who believe 9ear /llah and give u+ what remains of %our demand forInterest if %ou are indeed a believer If %ou do not then %ou are warned of thede$laration of war from /llah and 5is Messenger; 2ut if %ou turn ba$k %ou shall

have %our +rin$i+al 4eal not un1ustl% and %ou shall not be dealt with un1ustl%.

)/nd if there be one in miser% then deferment till ease /nd that %ou leave it asalms is far better for %ou if %ou reall% know /nd be fearful of a da% when %ou shallbe returned to /llah then ever%bod% shall be +aid in full what he has earned /ndthe% shall not be wronged. 1Cerses of Surah "l Ba'arahF (/()=3

#. PR$IBITIN , RIB) IN $)!IT$

The 0oly &rophet 1S"W3 has also laid severe emphasis on avoiding %iba. Some of 0issayings, i.e. M0adithsM, are given belo!L

$rom 0arat :abir Ibn/e/"bdullah 1%"3F The &rophet, 1S"WS3 cursed the receiverand the payer of interest, the one !ho records it and the !itnesses to thetransaction and saidF HThey are all alike Qin guiltRK. 1*uslim, Tirmidhi and *usnad"hmad3

$rom 0arat "bu 0urayrah 1%"3F The &rophet, 1S"WS3, saidF H%iba has seventysegments, the least serious being e'uivalent to a man committing adultery !ith hiso!n mother.H 1Ibn *ajah3

$rom 0arat "mr bin "l "as 1%"3F JWhen interest based dealing becomescommon among people, they !ill start facing draught and shortage of food. "nd!hen bribery becomes norm among people they !ill live under constant fear oftheir enemyK.

$rom 0arat "bu 0urayrah 1%"3 F The &rophet 1S"WS3, saidF HThere !ill certainlycome a time for mankind !hen everyone !ill take %iba and if he does not do so,its dust !ill reach him.H 1"bu a!ud, Ibn *ajah3

To sum up, In the !ords of &rophet 1S"WS3

J4very loan that dra!s any premium is %ibaK. 1This 0adith is reported by 0arat 0arith

ibn "bi 8samah in his *usnad3.



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+onventional interest based transactions directly assist in concentration of !ealth in afe! hands. +onsider the follo!ing transactionF

=. 7ur friend 7mar happily places %s =DD !ith Bank "B+ at interest per annum,

!hich means at the end of one year he gets an amount of %s. .

(. Bank "B+ gives the same %s =DD to $ancy industries on loan at = per annumand earns %s = on that money, out of !hich only %s. goes to 7mar 1thedepositor3 and bank keeps %s =D.

@ 6o! $ancy Industries manufactures goods !orth %s =DD. Then it adds %s =1!hich is the interest paid to the bank3 plus %s =D as its o!n profit. Thus the saleprice jumps to %s. =( and !hen 7mar purchases the goods from the shop,he has to pay %s =(. So against %s received as interest from the bank he hasto pay %s. ( for the same %s. =DD. 0e is a loser by %s. (D.

5ou must no! compare that if the same transaction !ould have taken place on the basis

of an Islamic mode of finance such as *udarabah N *usharakah. The scenario !ill be asfollo!sF

=. 7mar puts %s. =DD !ith BankIslami on *udarabah basis. They agree to shareprofits on )DF(D basis, i.e. )D of the earned profit goes to 7mar and (D goesto BankIslami.

(. BankIslami invests the %s. =DD received from 7mar !ith $ancy Industries on*udarabah basis. They agree to share profits on )DF(D basis !hich means )Dof the profit goes to BankIslami and (D to $ancy Industries.

@. Since there is no cost of capital provided by the BankIslami to $ancy Industries, itdoes not have to pay any fied amount in the form of interest to the bank. $ancy

Industries !ill only add their profit of =D to the cost of goods and sell it at %s.==D. 5ou must have noticed that this reduces the cost to 7mar.

A. $ancy Industries makes a profit of %s. =D. &lease recall that they agreed to pay)D of the profit to BankIslami . 0ence they pay %s. ) to the Bank !hich is )Dof the profit.

. 5ou !ould remember that BankIslami had also agreed to pay )D of the profit to7mar. 0ence BankIslami pays %s. >.AD to 7mar as his profit on investment.

>. Since $ancy Industries sells the goods at %s. ==D in this case, !hen 7marpurchases the goods from the shop, he has to pay %s. ==D. 0e received %s. >.ADas profit on investment from BankIslami and he has to pay %s. =D as profit of

$ancy Industries. 0e is out of pocket by only %s. @.>D, as against %s. (D in theother eample.

We can say in short that 7mar has spent less and at the same time has avoided theevils of %iba 1Interest3.



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&ession 2+ #ommon arguments in suort o1#ommercial interest

&ession #hecklist

". "ns!ers to the arguments given in support of +ommercial interest.

). )R";'NT& IN &"PPRT , #;;'R#I)L INT'R'&T

6o!, !e are going to discuss some of these arguments belo! and !e are also givingrebuttals of these arguments. Believe us, you !ill be coming across these argumentsevery no! and then.


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)rgument 3 +

In a commercial loan the -orrower and the lender are -oth getting ro1it 9 the-orrower 1rom the amount he in7ests in the -usinessD and the lender in the shae

o1 interest he recei7es 1rom the -orrower. There1oreD there is no in?ustice which isthe -asis o1 rohi-ition o1 Ri-a

)nswer

This is again a misconception about prohibition of interest. There is injustice in %ibabecause it means that profit of one party 1lender3 is confirmed !hereas profit of theother party 1borro!er3 is uncertain.

Suppose a person borro!s money from a lender and invests in a business. #ater, theborro!er faces loss in the business due to some reason but he has to pay a fied andagreed amount of interest to the lender. The lender does not face any loss as he stillreceived interest from the borro!er. This situation is unfair as the preferred Islamic

principle of Jprofit and loss sharingK !as not practiced here.

5ou may also like to kno! that mere MconsentM or Mmutual benefitM of the parties does notmake any transaction acceptable. $or a transaction to be !ithin four corner of Shariah, ithas to be acceptable according to the principles of Shariah.

)rgument 3 :+

In a commercial loan arrangementD there is 1ree consent o1 -othD the -orrower andthe lender. In Ri-aD consent o1 the -orrower is not there since it is only the lenderwho is getting the e


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&ession + harar

&ession #hecklist

". What is ,harar?

B. What are the different types of ,harar?

+. Which businesses are haram?

). %$)T I& GHARAR5

#et us take a look at another element that Islam does no allo! to be practiced at all. It iscalled ,harar;

,hararsimply means JriskK or Junnecessary ambiguityK or Jecessive uncertaintyK !hichmakes a transaction a matter of dispute bet!een counter parties. $or eample, thetransaction of probable items !hose eistence or characteristics are not certain, therebymaking the transaction similar to gambling.

*any classical eamples of ,hararare provided eplicitly in the "hadith.

They include the sale of fish in the pond N river N lake N sea, birds in the sky, an unborncalf in its motherMs !omb, a runa!ay animal, un/ripened fruits on the tree, etc. "ll suchcases involve the sale of an item !hich may or may not eist as !e cannot predict the

future. In such circumstances, to mention but a fe!, the fish in the sea may never becaught, the calf may be still/born, and the fruits may never ripen. In all such cases, it is inthe best interest of the trading parties to be very specific about !hat is being sold and for!hat price.

We used the !ords JunnecessaryK and JecessiveK to eplain an important concept.8ncertainty and ambiguity are part of human life and because one can not be sure of anincident happening in future, so elimination of these elements completely from economictransactions is not possible but they can be minimied up to a acceptable level as perShariah. 5ou all must have faced some eperience some!here in your life that !heneverecessive element of uncertainty arose, it results in dispute bet!een parties. That is !hysuch transaction are not allo!ed in Islam due to possible injustice !ith one of the parties.

B. T(P'& , GHARAR

There are t!o types of ,hararL

4. Jahalah

This type of ,harar means non/specification of a subject matter being sold e.g.selling of a !atch kept !ith other !atches, in such a !ay that the buyer does noteactly kno! the subject matter !hich means he does not kno! !hich specific!atch is being sold to him. "nother eample could be selling of something in a bag.

We are sure you !ill remember no! that any transaction that has an element of,hararis not valid in Shariah.



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&lease take note of the 0adith !hich is narrated by many books on the authority ofM"bu 0urayra 1%"3 1translation of the version in Sahih *uslim3 thatF

The Prohet @&)%&A rohi-ited the e--le sale and the Ghararsale.

,hararis strictly prohibited in Islam because of inherent injustice.

2. am-ling @EimarA+

Surely you must be kno!ing that gambling is another prohibited activity and iscondemned in -urMan. It is considered haram because of huge element of ,harar.In this study pack !e are not going to deal !ith it.

In present day society, the pries scheme e.g. &rie Bonds, lotteries, speculationsetc. also fall under this category.

#. %$I#$ B"&IN'&&'& )R' $)R);5

5ou !ould recall that !e talked about the fact that the importance of underlyingbusiness bing in compliance !ith Shariah. $ollo!ing is a brief list of activities that areconsidered not in compliance !ith ShariahF

a3 *anufacturing and trading of any thing considered 0aram by Islam like li'uor,drugs, pork products.

b3 "ny business that involves obscenity like casinos, night clubs, pornography etc.

c3 Business dealing in money lending on interest.

d3 Business promoting indecency like prostitution, film making, dance and musicpromoting institutions etc. etc.

We emphasie again that any kind of involvement in the above mentioned businesses isprohibited by all means.4ven employment in such businesses is not allo!ed.



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#hater +

Islamic &ales #ontract

21


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#hater 9 Islamic &ales #ontract

&ession 4+ Islamic law o1 contracts

&ession #hecklist

". Islamic la!s of +ontracts

B. 4ssential elements of a Calid +ontract

+. Types of +ontracts in Islam

). I&L);I# L)%& ,R #NTR)#T&

Islamic commercial la!, kno!n as 9i:h Muammalat in Islamic legal term, !hichconstitutes an important branch of la!, dealing !ith issues of contracts and the legaleffects arising from a contract. +ontract in Islamic la! is a comple legal discipline inboth its jurisprudential and practical function. "lso contract covers a variety of dealingsand transactions to meet the needs of the society.

Issues of commercial transactions, unlike devotional issues i.e. MIbadatM, are bound tochange due to the changing circumstances and situations of both the object and subjectof the transactions.

B. '&&'NTI)L 'L';'NT& , ) V)LI! #NTR)#T

=. +ontractors E &arties to a +ontract(. Subject *atter E


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2. &u-?ect ;atter

Islamic la! stresses about the Subject matter of a contract in the follo!ing mattersF

a. )-ility to !eli7er+elivery, on the other hand, indicates that the object must be capable ofcertain delivery. The classical jurists therefore prohibit the sale of a camel!hich has fled, a bird in the air or a fish in !ater.

There are t!o kinds of eliveryF

&hysical delivery N &hysical &ossessionF&hysically delivering a thing means giving it to other party by hand so thathe has the asset !ith him physically.

+onstructive possessionFelivery of goods in a manner !here other party 1to !hom the goods are

delivered3 takes no physical delivery of the commodity. Instead, thecommodity has come into his control and all the rights and liabilities ofthe commodity are passed on to him including the risk of its destruction.

-. Law1ulness+#a!fulness re'uires that the object should be la!ful, that is something !hichis legally permissible to be traded in. "lso inherent in the la!fulness of theobject is the condition that the object should be legally o!ned by the parties toa contract.

c. '


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c. )-ility to deli7er+elivery, on the other hand, indicates that the object should be capable ofcertain delivery. $or eample selling against a currency that is not used in themarket is not acceptable unless other!ise agreed.

:. %ordings o1 #ontract 8 11er )ccetance

" contract is completed !hen offer from one party and acceptance from othermatch. 4pression of both offer and acceptance could be, according to Islamic la!of contract, verbally epressed like in Mepress contractsM or implied epression!hich has been described as Mcontract by conductM or Mimplied contractM.

0o!ever, Islamic la! of contract re'uires that the offer and acceptance should bejointly connected !ith no unnatural gap bet!een offer and acceptance. We mean byunnatural gap, any delay that does not usually occur bet!een offer and acceptancein such types of transactions. The session in !hich offer and acceptance takesplace is called *ajlis "l/"'d in Islamic la!.

To clarify the concept, assume that "li 1buyer3 and 8mair 1seller3 are bargaining fora cell phone at =DFDD "*. "fter all discussions and bargaining 8mair 1seller3 offeredthat the price of the cellphone !ould not be less than %s ,DDD "li 1buyer3 leavesthe shop and does not buy the cellphone. "fter @ hours he comes back and asks8mair 1seller3 to give him the cellphone. The seller 18mair3 has the right of notselling the cellphone on the price he had demanded reason being the fact that nocontract !as made in the morning and by his conduct "li had !ithdra!n from thenegotiations.

The re'uirements for !ordings of a contract are given belo!F

a. "se o1 resent tense+

This means that the !ords should reflect a contract that is being contracted inpresent not in future.

-. Non8contingent+The effectiveness of a contract is not contingent upon any event in future. Thisis also true for the compensation of the contract. The follo!ing eample ismade to illustrate the conceptF7n =Dth :anuary 9halid 1seller3 sells a &+ to 0ammad 1buyer3 !ith thecondition that the sale !ould be completed if he 19halid3 !ins the tennis matchon =th:anuary. "s sale has been attributed to an event in future it !ould notbe allo!ed.

c. "nconditional+

This is another re'uirement that should be kept in mind. "s discussed,according to Islamic la!, a contract should not be conditional. The basicpurpose of the prohibition of conditional clauses is to avoid any conflict thatmay occur bet!een parties to a contract by clearly specifying every detail of atransaction as !ell as the responsibilities of the parties to the transaction.Such rules are normally violated through conditions !hich are kno!n asJconditions !hich are against the contractK. 9eeping in vie! modern businesspractices, the issue needs to be understood in detail. It is hoped the follo!ingrules !ill help clarify the concept.

Rule No. 4+" condition, !hich is not against the basic objective of the transaction i.e sale, isa valid condition. $or eample a condition of free delivery to buyerGs premises.

Chapter 3 0 Islamic Sales Contract 24


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Rule No. 2+" condition, !hich seems to be against the basic objective of the contract, butit is in the market practice and its voidness is not proved !ith the clearinjunctions of the 0oly -uran and Sunnah is a valid condition. $or eample, a

condition that the seller !ill provide five/year guarantee and one year freeservice.

Rule No. +" condition that is against the basic objective of the contract and not in marketpractice and in favor of one of the contractors or subject matter, is a voidcondition. $or eample if "hmed sells a car to Basheer !ith a condition that he!ill use it on a fied date every month.

Rule No. :+" condition !hich is against the basic objective of the contract, not in themarket practice and not in favor of any contractor is not a void condition. $oreample if both "hmed and Basheer decide to give to charity a certain

percentage of both subject matter and consideration upon completion of sale.

#. T(P'& , #NTR)#T& IN I&L);

+ontracts can be categoried under t!o broad headingsF

=. +ompensation +ontract 18'ood *ua!adha3(. 6on compensatory or voluntary contracts 18'ood


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&ession 2+ &ale

&ession #hecklist

". What is a Sale?

B. Basic elements of Islamic Sale contract

+. Types of Sale

). %$)T I& &)L' @B)IA5

Sale is also a kind of contract. #et us start !ith the definition of sale 1Bai3F

JSaleK is defined in Shariah as the echange of a thing of value 1the asset3 !ith anotherthing of value 1money3 !ith mutual consent.

Islamic Sales +ontracts are a type of +ompensation +ontract 18'ood *ua!adha3.

B. Basic 'lements o1 Islamic &ales #ontract

We have discussed earlier the basic rules of contract. 6o! coming to the application of

these rules to a sale contract, it is essential for you to remember that there are fourelements !hich should be present in an Islamic sales contract. These areF

=. +ontract E offer from one and acceptance from other 1"'d3(. Subject matter E goods N commodities to be sold 1*abeMe3@. &rice E any thing given as consideration 1Thaman3A. &ossession or delivery 1-aba3

5ou may learn them as +S&&.

#et us discuss these elements in detailF

4. #ontract or transaction" sale contract must have the follo!ing three essentialsF

a. 11er and )ccetance @oral or imliedAIn simple !ords, one person proposes to either sell his commodity to anotherperson or buy from him. J"cceptanceK means that the person !ho has beenoffered gives his approval of the proposal.

"s discussed above, if buyer takes goods from the seller !ith an impliedunderstanding that payment !ould be according to !hat is !ritten on thegoods it !ould be an Mimplied saleM since there is no oral communicationbet!een them.Implied sale can be of t!o typesF

i. Implied +redit Sale E in !hich buyer takes goods from the seller !ith animplied understanding that payment !ould be made later e.g. settlement

of the bill at the end of the month. 1milk, ne!spaper etc.3.



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ii. 0and/to/0and Sale/4change of money !ith goods !ithout uttering I1ab-o-=oboolas per procedure adopted in our daily life. $or eample taking apacket of biscuits that has a tag of price of %s. (D from a shelf and givingshopkeeper %s. (D.

-. #ounter arties @Buyer and &ellerAIn order, for a contract to be valid, it is important that the Buyer and Seller arelegally eligible for conducting such transactions, hence, they should beF

i. SaneF They are mentally sound at the time of contract.

ii. *atureF Should be adult. *inors can only enter into an agreement if theyunderstand the nature of the transaction.

c. #onditions o1 contract+

i. 6on/contingent saleF

The contract of Sale should be non/contingent !hich means it is notdependent on any condition or event in future.

ii. 8nconditional saleF"s !e discussed, being a contract, a sale transaction should be unconditional." conditional sale can only be allo!ed according to the criteria discussedabove i.e. the conditions !hich are not against the contract.

iii. Sale should be immediateFSale must be instant and absolute. " sale attributed to a future date or a salecontingent on a future event is void. This is one of the reasons !hy futurecontracts are not acceptable in Shariah.

2. &u-?ect ;atter or &old ood

&lease recall the re'uirements of subject matter of a contract. In a sale transactionthe follo!ing conditions should be presentF

a. '


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e. &eci1ic Kuanti1ied+It means the subject matter should specifically be kno!n and identified eitherby pointing or by detailed specification that can distinguish it from other things!hich are not sold. $or eample, pointing one car among hundred of cars, or

specifying its color, make, engine number and other details.

1. Title and risk o1 seller to the goods+The subject matter of sale should be in the o!nership of the seller at the timeof sale. The meaning of o!nership is to have rights to the goods as !ell asbearing the risk. Therefore selling something before ac'uiring its o!nershipand risk is not allo!ed. This particular condition makes short saleunacceptable in Islam.

. Price

The detailed discussion on the issue may give you some rules for price. The priceof the goods should beF

a. Euanti1iedThe measuring unit of the price should be kno!n e.g !eight, currency etc.

-. &eci1ied certain$or a sale to be valid, the price should be ascertained and specified e.g. thetotal amount. If the price is uncertain, the sale is void.

:. !eli7ery or ossession

4arly discussion on o!nership of the subject matter dra!s some clear guidelinesregarding the possession by seller and delivery to the buyer. The subject matter1goods N commodity3 of sale should be in the physical or constructive possession of

the seller !hen he sells it to another person. &ossession can be held in t!o !aysF

a. Physical Possession+It means the seller has the asset !ith him physically.

-. #onstructi7e ossession+This refers to a situation !here the buyer has not taken the physical deliveryof the commodity, yet the commodity has come into his control and all therights and liabilities of the commodity are passed on to him including the riskof its destruction.

#. T(P'& , &)L'

iscussed above !as a procedure for a valid sale transaction. "ccording to thisdiscussion a sale can be valid or invalid in nature. 0ence, there are four kinds of saleF

4. Valid @&ahihA" valid sale is in !hich all the four follo!ing elements of sale contract are presentF +ontract Subject *atter &rice &ossession N elivery



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2. Void @BaatilASale !ill be void if any one of the conditions of Moffer and acceptanceM, Mconditions ofBuyer O SellerM, and Msold goods conditionsM are not complied !ith. In a void sale,the buyer does not have title to subject matter and seller does not have title to price.

Both subject matter and price cannot be used la!fully. The produce of both shall beunla!ful.

. !e1ecti7e @,asidASale remain intact but !ill be void due to defect if the Mconditions of contractM, Msoldgood conditionsM and Mconditions of priceM are not complied !ith. 0o!ever, if thedefect is rectified the sale !ill become valid. In a $asid sale, the buyer should notpossess the subject matter. If possessed !ith the consent of the seller, title oro!nership !ill pass to the buyer but usage of subject matter !ill be impermissible.0e must return it to the seller if the defect is not removed.

:. Valid -ut disliked @;akroohASale is valid but not liked in Shariah. " fe! eamples areF

Sale after :uma "an E violation of commandment of "llah to attend :umahprayer !ithout delay. Sale of hoarded goods E unethical and prohibited business practice.Sale by intervention of a third party !hile t!o parties are negotiating.



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&ession + *hiyar

#hecklist

". What is 9hiyar?

B. Types of 9hiyar

+. What is I'ala?

). %$)T I& *$I()R 5

The term khi%arrefers to the option or right of the buyer or seller to cancel a contract of sale.

B. T(P'& , *$I()R

There are five types of khi%ars or options available in a sale contract !hich are asfollo!sF

=. >hi%ar-e-Shart 17ptional condition3F "t the time of sale Buyer or Seller can put acondition that the buyer has an option to cancel the sale !ithin specified days.e.g. money back guarantee !ithin one month of Sale.

Specification of the days is necessary for this >hi%ar. Within this period, thebuyer has the right to cancel N dissolve the sale !ithout any reason or as perspecified condition.

(. >hi%ar-e-Roi%%at 17ption of canceling contract after inspecting goods3F In this,the buyer has the option that the goods can be returned after inspection if foundcontrary to !hat !as specified in the contract.

@. 9hiyar/e/"ib 17ption of canceling contract if a defect is found3F In this type, thegoods can be returned if found defective. It is the responsibility of the seller tosupply goods free of error N defect or point out the defect to the buyer. In no !ayis he allo!ed to cover the defect of the goods !hich !ill constitute a fraud.

A. >hi%ar-e-asf @7ption of canceling contract if goods are not of specified 'uality3FWhere the goods are sold by specifying a certain 'uality by the seller and that isabsent in the goods.

. >hi%ar-e-,haban 17ption of canceling contract if price is more or less than themarket price3F Where the seller sells the goods at a price !hich is far epensivethan the market price, the buyer has the right to return it to the seller.



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#. IE)L) @#)N#'LL)TIN , &)L' #NTR)#TA

I:alaF Is act of cancellation of a sale contract !here both parties freely consent to cancel

the contract i.e. each party !ill give back the consideration 1money and subject matter3received by them.

&rincipally speaking, neither the buyer nor the seller has the sole right to cancel thecontract after its eecution. 0o!ever !e often see that the buyer !ants to cancel thecontract after buying goodsL similarly, seller sometime !ishes to reverse the saletransaction. In such cases it is necessary that any one !ho !ants to cancel the contractshould get the consent of the other. This mutual agreement bet!een buyer and seller tocancel the contract is called I'ala.

The price of the goods being returned under I:ala!ill remain unchanged.



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&ession+ : )gent

&ession #hecklist

". +oncept of "gent 1Wakeel3

B. %ights and 7bligations of the "gent

). #N#'PT , )'NT @%)*''LA

5ou must have noted in earlier sessions that the Islamic sale contract is valid only!hen the goods to be sold are in possession of the seller, i.e. these have been

purchased or produced by him first.

Ideally the financier or the Bank should purchase the goods itself directly from thesupplier or through a third person appointed by it as employee before selling it to thecustomer. 0o!ever, in eceptional cases, !here direct purchase from the supplier isnot practical, the Bank makes the customer its "gent to buy the goods on its behalf.

In all such situations a formal "gency "greement must be signed bet!een the t!oparties outlining the rights and obligations of the agent.

B. RI$T& )N! BLI)TIN& , T$' )'NT

4. The "gent is bound to act and perform as per specifications and guidelines given

by the &rincipal or financier.

2. "s long as the "gent complies !ith the instructions of the &rincipal, all his actions!ill be construed as coming from the &rincipal himself and the latter cannot diso!nthese actions. 0o!ever if the "gent eceeds or breaks the mandate given to him,he is fully accountable for his actions and may have to compensate the &rincipalfor any damage caused by such unauthoried action.

. "gent can be any person capable of eecuting a transaction including the customerhimself.

:. The "gent may receive funds in advance from the &rincipal for making purchases.

=. In case the "gent fails to purchase the goods, he is bound to refund the amount tothe principal if received in advance.

6. $rom the moment the "gent purchases the goods, all risks relating to o!nership!ill be !ith the &rincipal until such time the goods are sold to an outside party. Ifthe customer is also the "gent, he !ill take over the risk !hen the Sale "greementis signed and o!nership transfers to him from the &rincipal. "t that time his role as"gent !ill come to an end.

>. The "gency "greement can be canceled by either party, by giving a notice asspecified in the agreement. Till such time that the notice of cancellation reaches the"gent, all actions taken by him !ill be binding on the &rincipal.



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). "gent is entitled to a fee for his efforts and this must be clearly mentioned inthe "gency "greement. In case the customer himself becomes an "gent, such feeis usually not charged.

"gency contract !ould become more clear to you after you study the net chapter!hich is *urabahah. We recommend that you go through this concept again afterreading *urabahah or !here "gentMs role is discussed.



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#hater :+

;ura-ahah

35


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#hater :+ Murabahah


&ession #hecklist

". efine Murabahah

B. &ayment options in Murabahah

Before beginning, !e !ant you to be clear on the !ord Murabahah itself. *any peoplecall it *urMrabba some call it *arMhaba !hile a fe! call it *uraba. The actual !ord isMurabahahas given above.

). !',INITIN+

Murabahahis a sale in !hich costs and profits are disclosed to the end customer.

$or eample Shahid is selling a car to "li on Murabahah basis for %s. (DD,DDD!hich he has purchased for %s. =)D,DDD. 6o!, if Shahid tells "li the cost heincurred for ac'uiring the car i.e. %s. =)D,DDD, this sale is called Murabahah;

$or more eplanation consider *aria !ho !ent to a je!eller to buy a gold necklacefor her !edding. She selected a beautiful necklace !orth %s. D,DDD. *aria !assurprised and asked the je!eller !hy such a delicate necklace costs %s. D,DDD.The je!eller told her precisely that the actual cost of gold used in making thatnecklace !as %s. @(,DDD. ,DDD !ere used to beautify thenecklace, %s. ,DDD !ere being charged for labour %s. ,DDD !ere the :e!ellerMsprofit. If *aria agrees that a profit of %s. ,DDD !ill be composite of total cost ofnecklace !hich is %s. D,DDD, this transaction !ould be called a Murabahah.

Murabahahis a sale bet!een a Buyer and a Seller in !hich the seller epressly tellsthe purchaser ho! much cost he has incurred and ho! much profit he is taking inaddition to the cost. That is !hy Murabahah is also called Mcost/plusM transaction.

Thus buyer is fully a!are of cost and profit the seller is taking in the sale.

Chapter 4: Mura,ahah 36


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&ession 2+ Murabahahe


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:. Possession o1 goodsThe goods must be in physical or constructive possession of the Bank !hile selling itto another person. +onstructive possession means a situation !here the possessorhas not taken physical delivery of the commodity yet, but it has come into his control.

In such a case, all rights and liabilities of the commodity are passed on to himincluding the risk of its destruction. This means that the Bank being a seller !ill beresponsible for any damages as it is the holder of all rights and liabilities.

=. ,inaliMation o1 sale&lease note that Murabahahmust be instant and absolute and it should not bedependent on anything in future. Thus a Murabahahassociated to a future date i.e. aMurabahahto be finalied on a future date or a Murabahahcontingent on a futureevent is void. $or eample if a person sells a car on Murabahah basis !ith acondition that the sale !ill be finalied if a ne! ta policy is announced, !ill not be anacceptable Murabahahtransaction.

6. Risk o1 goods

Though point @ eplains the obligations of o!nership, there eists a commonmisconception about this aspect. 7ne significant sign of o!nership is that afterpurchase of the goods the Bank must bear risk of goods until those are actually soldand delivered to the customer. In other !ords, after purchase of the goods but beforeselling of those to customer, the Bank shall bear the conse'uences of any damageor defect. $or eample, =DD bales of +otton are purchased by the Bank for acustomer. 8nfortunately the !hole consignment caught fire !hile the consignment!as still under o!nership of the Bank. In this case the Bank !ill bear the loss as theo!nership !as yet not passed on to the customer.

B. %$)T ;)*'& ) MURABAHAH!I,,'R'NT ,R; INT'R'&T8B)&'! ,IN)N#IN5

We !ould like to emphasie on the basic difference before going into details. The

foremost point to remember is that Murabahahis a sale and not merely a loan advancedto a customer. There are some misconceptions about Murabahah that it came intoeistence by merely replacing the !ord of HinterestH by the !ord HprofitH or Hmark/upH.0o!ever, the fact is very different from this, let us repeat, Murabahah is a sale. "nytransaction !hich is not structured as a sale can not be a valid Murabahah. 0ere aresome points that make this clearF

4. Murabahahis only a mode to escape from HinterestH and not an ideal instrument forachieving the real economic Islamic objectives. Islamic economic system aims forproper distribution of !ealth in society, !hich can be best achieved throughMusharakah and Mudarabah. Therefore, this instrument should be used as atransitory step taken in the process of the Islamiation of the economy and shouldonly be used in those cases !here Mudarabahor Musharakahare difficult to be used.

2. The second important point is that, Murabahah as a mode of financing has beenallo!ed by the Shariah scholars !ith some conditions. 8nless these conditions arefully observed, Murabahahis not permissible. In fact, it is the observance of theseconditions 1see rules for Murabahah3 !hich can dra! a clear line of distinctionbet!een conventional and Murabahahtransaction.

. Murabahahis not a loan given on interest. It is the sale of a commodity for a deferredprice !hich includes an agreed profit added to the cost.

:. "s Murabahahis a sale and not a loan, therefore, it should fulfil all the conditionsnecessary for a valid sale, especially those discussed in earlier chapters.



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=. Murabahahcannot be used as a mode of financing ecept !here the client needsfunds to actually purchase some commodities. $or eample, if he !ants funds topurchase cotton as a ra! material for his ginning factory, the Bank can sell him thecotton on the basis of Murabahah. But !here the funds are re'uired for some other

purposes, like paying the price of commodities already purchased by him, or the billsof electricity or other utilities or for paying the salaries of his staff, Murabahahcannotbe effected as Murabahah re'uires a real sale of some asset. In other !ordsMurabahahhas to be asset back.

6. The Bank must have o!ned the commodity before he sells it to the client.

>. The commodity must come into the possession of the Bank, !hether physical orconstructive, in the sense that the commodity must be in his risk, even if it is for ashort period. The table belo! sho!s the se'uence of events in a valid Murabahahtransaction.

Financier (after receiving a financing requestfrom customer3

!ay4

!ay 2 !ay

!ay :

&laced an 7rder for desired commodity / / /

Took the delivery of that commodity / / /

&aid the price / / /

Informed the customer about availability / / /

Sold the commodity to customer / / /

#. $% ) MURABAHAHTR)N&)#TIN I& &TR"#T"R'!

Bilal o!ns a sugar mill. 0e is in need of funds urgently as he suffered some loss in

another business. 0e !ants to buy sugarcane for his mill. $or this, he approaches aBank. The Bank agrees to buy sugarcane for Bilal under Murabahahmode. We !ill seeho! a simple Murabahah transaction takes place bet!een Bilal and the Bank in thefollo!ing stepsF

4. The Bank and Bilal enter into a "greement to Murabahah!hereby the Bank agrees tobuy sugar cane from the market and sell it to Bilal after having added (D over costincurred. The sale is to be effected on an agreed date.

2. 6o! the Bank !ill ac'uires the re'uired sugarcane from market and takes itspossession in a manner that all risk before selling it to Bilal are borned by the Bank.

. The Bank !ill inform Bilal Sugar *ills about the availability of the sugarcane !ith the

Bank and the price.

:. Bilal !ill receive the sugarcane and Murabahah!ould be concluded.

=. &ayment of price of the sugarcane !ould be according to agreed time line and otherterms and conditions.



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. &%"+TI+"# ST4&S I6 +76ST%8+TI6< " *8%"B"0"0 T%"6S"+TI76

4. +lient and Bank sign an agreement to enter into Murabahah

"greement to Murahabah

2. Bank gives money to supplier for purchase of goods

. +lient pays the price of goods purchased under Murabahah

&ayment from client to Bank 1&rompt or deferred in installments3

;ura-ahah under )gency Transaction8 ) rahical Presentation+

5ou must have noticed that !hatever has been discussed so far has relates to a simpleMurabahahtransaction in !hich Bank directly purchases the goods and hands it over to

the customer. &ractically speaking this kind of transaction is rare in Banking. It is noteasy for banks to trade in goods.

In such cases there is a method for Murabahahthat is called JMurabahahunder agencyK.In this method, Bank appoints its "gents to perform trading of goods on behalf of theBank. The agent ac'uires goods from market on BankMs behalf and takes its possessionon behalf of the Bank as !ell. This appointed agent may be any person including theclient himself.

This is graphically illustrated belo!F

4. Bank appoints +lient as an agent to purchase goods on its behalf

"greement to *urahabah

"gency "greement


Bank +lient

Bank +lient

Supplier

-(reement to Murabahah

%isk Transferred

isbursement to the supplier

Bank +lient

+lientBank


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2. The Bank pays the cost of goods purchased directly to the supplier or to the client 1ashe is the agent of the Bank3.

"greement to Murabahah

"gency "greement

&ayment

. The client purchases the commodity on behalf of the Bank and takes possession as

the agent of the Bank. %emember that the client is performing t!o roles here E he is aclient as !ell as an agent.

Transfer of %isk elivery of


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'. LI;IT)TIN& , ;"R)B)$)$ ;!'

#et us remind you that Murabahah, is a type of saleand not a loan, that is !hy it isimportant that Murabahahfulfills all the conditions necessary for a valid sale.

Murabahahhas certain limitationsF

It cannot be used as a mode of financing ecept !here the client needs funds to actuallypurchase some commodities. $or eample, if a client !ants funds to purchase cotton asa ra! material for his ginning factory, the Bank can sell him the cotton on the basis ofMurabahah. 0o!ever !here the funds are re'uired for some other purposes, like payingthe price of commodities already purchased by him, or running epenses like bills ofelectricity or other utilities or for paying the salaries of his staff, Murabahahcannot beused because Murabahahis al!ays asset based. The o!nership of the subject matter isa etremely essential element of Murabahah, thus financier must o!n the commoditybefore he sells it to his client. The commodity should also come into the possession ofthe financier, !hether physical or constructive. This means that the commodity must be

in his risk, even for a short period. Therefore, if o!nership is not possible !ith its gistthen Murabahahcan not be used.

"s Murabahahis a type of trade, all necessary conditions for trading must be observed init. 9no!ing the specifications is etremely vital. If there is any commodity !herespecification cannot be identified, Murabahahcannot be used. $or eample, if a trader!ants to purchase on Murabahahbasis =DD bales of cotton stored in a !arehouse !ithother bales, the Murabahahcan not be performed unless the sold bales are identifiedproperly through batch number or any other !ay.

Similarly, industries !here ra! material is ac'uired from different sources cannot availMurabahahunless they are able to identify sources and 'uantify the goods. $or eample,a packed milk producing company that purchases milk from different resources cannot

use Murabahah for purchasing milk unless a mechanism is put in place that clearlyidentifies the sources.



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&ession + Pro1it #alculation

&ession #hecklist

". #earn ho! profit is calculated in Murabahah

B. Benchmarking rate to a prevailing benchmark

+. &rocess flo! of a sample Murabahahtransaction

A. HO !"O#I$ IS %AL%&LA$'( I) A MURABAHAH$"A)SA%$IO)

&rofit in Murabahah can be calculated in three !ays depending on the payment ofMurabahahprice by the +ustomer. &lease remember that the payment terms should benegotiated !ith the +ustomer on eecution of Murabahah +ontract. To ensuretransparency in the transaction, it is compulsory for the concerned officer to definepayment period in clear terms. "ny eception made to this rule has to be approved bythe 0ead 7ffice.

We !ould like to dra! your attention to another important point. This is that the paymentof Murabahahprice by the +ustomer is not recorded or !ritten as %4&"5*46T. This isdone because an Islamic Bank is not involved in advancing loan. Murabahahbeing atrading transaction, the +ustomer is only making payments of the goods purchased.

$ollo!ing situations may arise at the time of calculation of Murabahahprice. #etF

*& *urahabah &rice+& +ost &rice% &rofit %ate& &eriod

4. Bullet Payment

In cases the Murabahahprice is being paid in one bullet payment 1+ost &rice U &rofit3,the Murabahahprice is calculated by the follo!ing formulaF

*& +& U +& % &N@>

Exampe!

+& %s. =DDmn

% = p.a.

& @> days

*& =DD U =DD = @>N@> %s ==m



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2. Reayment in eKual Installments

In cases the Murabahahprice is being paid in e'ual periodic installments and eachpayment carries a portion of the +ost &rice and &rofit, the installment !ill be calculated

using an I%% based e'ual payment formula as follo!sF

Installment VVV+& r.......Q= E 1=N 1= U r3&R

WhereF& 6o. of periods% &rofit %ate N 6o. of periods

15ou are not suppose to learn this.3

Murabahah&rice Installment n

Exampe!

+& %s. =DDmn% = p.a.

& @> days

&ayment fre'uency $our 4'ual Installments

Murabahah&rice 1"mount ue3 %s (.@) mn at the end of every 'uarter

+ontract &rice 1MurabahahSelling &rice3 %s =D2.( mn 1(@.@) A3

. Reayment in uneKual Installments

If the Murabahahprice is being paid in une'ual periodic installments in such a !ay thatthe profit portion of the selling price is paid over the life of the transaction e'ually and the+ost &rice is paid at maturity, the Murabahah&rice is calculated as follo!sF

*& +& U +& % &N@>

The profit is calculated as follo!sF

&eriodic profit % =Nfre'uency +&

Interim Installments +ost &rice &rofit %ate 6o. of days 1days per period3 N @>

"ustration!

$inancing "mount %s =DDmn

&rofit %ate = p.a.

Tenor = year

&ayment $our 8ne'ual Installments !ith bulletpayment of cost price

"mount due at the end of first @ 'uarters %s @.mn 1= X =DD3

"mount due at the end of last 'uarters %s [email protected] 1=DD U @.3

+ontract &rice1MurabahahSelling &rice to the customer3

%s ==mn 1=DD U =3



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*. *')%HMA"+I), $O A !"'-AILI), *')%HMA"+

Shariah Scholars allo! using variable profit rate tied to a kno!n benchmark. In other

!ords, any kno!n benchmark can be used in a Murabahahtransaction for calculatingthe profit. This approach helps to manage profit rate in Murabahahtransaction especiallyin cases !here a large and long eposure is intended to be taken. 0o!ever, you mustconsider the follo!ing guidelinesF

=3 7nly a kno!n benchmark should be used.

(3 $loor 1lo!er limit3 and ceiling 1upper limit3 if applicable, are clearly defined.

@3 &rofit %ate of each Murabahah transaction should be fied at the time ofdisbursement !hich !ill not change after the eecution of offer O acceptance. Wehave discussed before, price once fied cannot be changed.

A3 6e! rate !ill only be applicable on each ne! disbursement. &lease remember andclarify to the customer that the rate of the !hole facility !ould be floating but rate!ould be fied for each disbursement of the Murabahahfacility.

3 5ou should also keep this fact in mind that though the Shariah scholars allo! usinginterest based benchmarks. This permission is given only for the interim period in theabsence of an Islamic benchmark. The activity is regarded as permissible but notpreferable. In case an Islamic benchmark is available, it should be used.

%. !"O%'SS #LO #O" A SAM!L' MURABAHAH$"A)SA%$IO)

6o! let us go through the real !orld Murabahah transaction process. This is !hathappens in actual.

=3 +ustomer and Bank agree to do business.

(3 +redit &roposal for the limit clearly specifies the nature of procurement process of thecommoditiesNgoods to be used as a subject matter of Murabahah, normally in aseparate section of proposal. It also discusses the Murabahah&rocess to be follo!ed!hile undertaking Murabahahfinancing !ith the customer.

@3 6ecessary approvals are obtained.

A3 #egal documents are prepared.

3 The Bank and the +ustomer enter into a ;ain Murabahah,inancing )greement1**$"3. 8nder the agreement, the Bank promises to sell and the +ustomer

promises to buy the agreed commoditiesNgoods from time to time as per the terms ofthe **$".

>3 The Bank and +ustomer enter into an )gency )greement. 8nder this agreement,the Bank appoints the +ustomer as its agent to procure the specifiedcommoditiesNgoods on its behalf.

3 Whenever the customer has a purchasing re'uirement he contacts the Bank.

)3 The Bank negotiates tenor, rate and amount as per agreed guidelines !ith thecustomer.



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from credit point of vie!. In such cases the proportionate cost price !ould becalculated as follo!sF

+ost price of the trancheTotal disbursement

*&

"n illustration of the above is follo!sF

BankIslami paid %s. D million to a supplier to purchase cotton for *Ns "B+ O +oon :anuary D=, (DD. The customer is intending to purchase cotton of %s musing %s. (* from o!n sources.

BankIslami plans to sell the cotton to "B+ for a total price of %s. million to bereceived after one year.

"B+ paid %s. ( million from other sources to the supplier.

+otton !as received by *Ns "B+ as per the follo!ing schedule.

+otton valued %s. = million on :anuary D, (DD +otton valued %s. (D million on :anuary D2, (DD +otton valued %s. D million on :anuary ==, (DD +otton valued %s. = million on :anuary =@, (DD

The eclaration of the above !ould be eecuted as follo!sF 7n :anuary D, (DD

+ost &rice %s. = million Murabahah&rice %s. =>. million 1=NDY3 7!nership &ercentage =DD 1=N=Y=DD3

7n :anuary D2, (DD +ost &rice %s. (D million Murabahah&rice %s. (( million 1(DNDY3 7!nership &ercentage =DD 1(DN(DY=DD3

7n :anuary ==, (DD +ost &rice %s. D million Murabahah&rice %s. . million 1DNDY3 7!nership &ercentage =DD 1NY=DD3

:anuary =@, (DD +ost price recovered to date =U(DUADm +ost price remaining D/AD=Dm

Murabahah&rice %s. == million 1=DNDY3 7!nership &ercentage >>.>> 1=DN=Y=DD3 5ou may askF Why cost price !as not recovered proportionately? There

are t!o reason. $irstly, banks like to recover their funds 'uickly. If thecredit is of good 'uality, the Bank may like to defer recovery right uptothe end. Secondly, Sharia scholars prefer recovery of funds underagency 'uickly.

=)3&rofit is accrued at the end of each month.

=23&ayment of Murabahah+ontract &rice is done on the due date by the customer.

(D3In case the customer unnecessarily delays payment, charity may be charged.



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&ession :+ MurabahahRisks

&ession #hecklist

". %isks for banks in Murabahah

B. Securities in Murabahah

A. "IS+S I) A MURABAHAH$"A)SA%$IO)

The most critical point for you to remember is that Murabahahis a sale transaction !hichinvolves taking o!nership of the asset being financed by the Islamic Bank. "ll riskrelated to the o!nership of the asset are borne by the Islamic Bank until the assets are

sold to the +ustomer usually against deferred payment. " Murabahahtransaction !herethe Bank does not assume o!nership risk is not a valid transaction.

Islamic Banks face t!o types of risks !hile undertaking Murabahah financing. 7therrisks such as li'uidity, operational, rate etc. are ignored to keep the discussion focusedon MurabahahF

=. "sset1s3 %isks(. +redit %isks

4. )sset Risks

5ou remember under a Murabahahtransaction, Bank sells the assets to the customer

after purchasing it from a supplier. In case the asset is destroyed before on!ard sale tothe customer, the Bank !ould be responsible for any kind of loss. Therefore, beforeentering into a Murabahah!ith a +ustomer, the Bank should study the procurementprocess of the asset1s3. &roper steps should be taken to cover risks arising in theprocurement process.

Similarly, if the customer fails to purchase or decides not to purchase the asset from theBank due to any reason despite his promise to do so, the Bank !ould be left !ith theasset. In this situation the Bank !ould sell the asset in the market and may recoveractual loss from the customer !ho defaulted on his promise. #et us revie! an eample inthe follo!ing paragraph to clarify the point.

Suppose Saleem O +o approaches "!ami Bank to purchase a generator under a

Murabahahtransaction. "fter eecution of the legal agreements, "!ami Bank purchasesa generator from a supplier at a cost %s. =DD,DDD and contact Saleem O +o. fornecessary actions. ue to some reasons, Saleem O +o fails to purchase the asset from"!ami Bank. "!ami Bank has no choice but to sell the asset in the market. "ny of thefollo!ing three situations may arise no!F

=. "sset is sold at a price greater than %s. =DD,DDD say %s. =D=,DDD(. "sset is sold at a price e'ual to %s. =DD,DDD@. "sset is sold at a price lo!er than %s. =DD,DDD say %s. 22,DDD

In scenario = and ( the Bank !ould not be allo!ed to charge any amount from thecustomer. The Bank is also not allo!ed to charge any li'uidated damages. If charged,the amount should be given to charity. 0o!ever, in the third scenario, the Bank is



57/103


allo!ed to charge %s. =,DDDN/ from Saleem O +o as the Bank has suffered actual lossdue to the default in promise.

$ow to manage )sset Risks5

The assets risk can be avoided if proper steps are taken at the time of credit evaluation." credit proposal should clearly specify the nature of procurement process i.e. the stepsre'uired in procurement of the commoditiesNgoods to be used as a subject matter ofMurabahah, in a separate section of the proposal. It should also discuss the Murabahah&rocess to be follo!ed !hile undertaking Murabahahfinancing !ith the customer.

" good understanding of the process !ould help the Bank to take appropriate measuresto minimie the attached risks !hich !ill vary from transaction to transaction and fromcustomer to customer.

2. #redit Risks

"s in Murabahahthe Bank allo!s the customer to defer the payment of price for a certaintime period, credit risk comes into play. The risk is the same !hich is faced byconventional banks and financial institution and that is !hy it should be managed in thesame manner.

*. $!'S O# S'%&"I$I'S A,AI)S$ MURABAHAH

"s discussed before, the procedure of Murabahahfinancing comprises of different stepscarried out at different stages. In the earlier stages of the process, client does not incur adebt, as he is only acting as agent of the Bank. It is only after the commodity is sold tohim by the Bank on credit that the relationship of a creditor and debtor comes intoeistence.

5ou see in case the commodity is destroyed during the period of agency agreement, theBank can have recourse to the security only if it is proved that the incident took place dueto the negligence of the client. %eason being the fact that the asset !as not sold to thecustomer, therefore the Bank !as the beneficial o!ner.

The above fact re/emphasies the importance of obtaining the 7ffer O "cceptance i.eeclaration along !ith the purchase evidence in Murabahahs booked by the Bank !ithoutunnecessary delay.

It is important to kno! that any kind of security, !hich is acceptable in la! can be taken tosecure Murabahahfinancing. $ollo!ing is the eception list due to Shariah reasonsF

1* Shares of conventional commercial banks, leasing companies, $Is, 6B$Is andshares of companies !hich do not pass the Shariah Screening +riteria. The reasonShariah scholars have not allo!ed to take these instruments as securities is theirimermissi-lenature i.e. the business of these companies is not permissible. 7nlythose commoditiesNproperties can be used as a security, !hich are recognied as*aal/*uta'a!!am=in Shariah.

(3 In case of efense Saving +ertificates, Special Saving +ertificates, +onventionalT$+s and Bonds, #ien cannot be marked on the interest portion. 7nly principalportion can be used to recover any amount outstanding. $inancing against thesesecurities is disliked. "pproval of the Shariah "dvisor !ill be necessary beforeaccepting them as securities.

= " thing !hich has a value according to Islamic Shariah



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51


59/103


#hater =+

&alam

52


60/103


#hater = 9#aam


&ession #hecklist

". What is Salam? Its definition, purpose and rules.

B. %ules of valid Salam contract

+. +omparing Salam and Murabahah?

. &arallel Salam?

INTR!"#TIN

Salam is one of the permissible economic financing modes in Islam compared to others asmost of the other modes are trade based. Salamis a different types of sale that have beendiscussed in early chapters.

"s you have gone through in earlier sections on Islamic +ontract of Sale, there are three basicconditions for validity of a simple saleF

=. The asset 1subject matter of sale transaction3 must eist.(. The seller must o!n the asset.@. The asset must be in the physical or constructive possession of the seller.

These are mandatory conditions, ho!ever, according to 0adith there are t!o sale transactionsthat deviate from the above established rules. They areF

Salam Istisna

Both these sales are of special nature and are allo!ed by Shariah We !ill discuss Salam inthis chapter and Istisna in the net +hapter.

). %$)T IA$AM5

Salam is a sales transaction !here the seller undertakes to supply some specific goodsto the buyer at a future date against an advance price fully paid on spot but the supply isdeferred.

There are three basic elements, in a SalamtransactionF

=. Specified goods(. Supply of goods on future date@. &rice is fully paid in advance

Salam !as allo!ed by the &rophet 1S"WS3 subject to certain conditions.

Chapter 5 0 Salam 53


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"ctually Salam !as allo!ed to meet the needs of small farmers !ho needed money togro! their crops and to feed their families till the time of harvest.

The background is that after the prohibition of Riba in -urMan, they could not borro!

money on interest, hence they !ere allo!ed to sell their agricultural products in advance.

Salam is beneficial to the buyer and seller both E The seller receives the price inadvance and the buyer gains since the Salamprice is generally lo!er than the spot pricein the market.

B. R"L'& , V)LI!#A$AM#NTR)#T

"s discussed earlier, some conditions have been considered necessary for simple sale,to eliminate ambiguity and uncertainty in delivery and possession.

"fter establishing the fact that Salamis an eception to the general rules of sale, onecan think that deferred delivery of goods in Salamremains a factor of ambiguity and


62/103


3* The commodity must be generally available in market at the date of delivery. If thecommodity is not easily available at the time of delivery. Salam!ould not be allo!ed.$or eample, selling of a commodity in off/season. It is obvious that the seller may notbe able to deliver the commodity at the delivery time.

4* In Salamone can not put a condition of buying a particular commodity or product of aparticular field or farm e. g. supply of !heat of a particular field or the fruit of aparticular tree. There is a possibility that the crop is destroyed before delivery andkeeping such possibility in vie! the delivery remains uncertain

3 The eact date and place of delivery by the seller must be specified in the contract.

6* " security in the form of a guarantee, mortgage or hypothecation can be taken in aSalam in order to ensure that the seller delivers.

7* The seller at the time of delivery must hand over the commodity. Sometimes it

happens that the buyer does not !ant to take the delivery, instead, he !ishes amonetary settlement. Scholars are of the vie! that this a hidden !ay of takinginterest, therefore, seller must deliver the subject matter to the buyer and not money.

* The Salam contract once established cannot be canceled unilaterally. +onsent ofboth parties is re'uired. 5ou must note that in no case can a seller hands over moneyin place of commodity on the date of delivery.

Salamcan be done forF

&urchase of homogeneous commodities for !orking capital. $or!ard purchase of manufacturing inputs e.g. +otton.

#. #;P)RIN#A$AM)N! ;"R)B)$)$

#et us take a look at differences bet!een Salamand *urabahah. Though both Salam and*urabahah are sale based transaction, there are distinctive differences bet!een the t!oF

Murabahah #aam

4. The buyer can pay the sale price ondeferred basis or in installments.

2. The subject matter of sales i.e. goodsmust eist before sale is eecuted.

. The goods must be firstly inpossession of the seller.

4. The buyer must pay the full sale pricein advance.

2. The commodity does not eist at thetime of sale.

. he uestion o' possession

islamic banking manual

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