Center for Islamic Business & Finance

Reading on Islamic
Banking & Finance
Reading Material

Dr. Imam Uddin

Table of Contents
Preface...........................................................................................................................................10
Chapter 1......................................................................................................................................11
The Building Blocks.....................................................................................................................11
1 Sources of Shariah...................................................................................................................12
1.1 Sources of Shariah Defined..........................................................................................................................................12

1.2 Sources of Shariah.......................................................................................................................................................12

1.3 Revelations about Riba in Quran.................................................................................................................................12

1.3.1 First Revelation about Riba.....................................................................................................................................12

1.3.2 Second Revelation about Riba................................................................................................................................13

1.3.3 Third Revelation about Riba....................................................................................................................................13

1.3.4 Fourth Revelation about Riba.................................................................................................................................14

1.4 Riba in Hadith..............................................................................................................................................................15

1.4.1 From Abu Hurayrah : The Prophet, , said: "Riba has seventy segments, the least serious being equivalent to a
man committing adultery with his own mother." (Ibn Majah)............................................................................................15

1.4.2 From Jabir : The Prophet, , may cursed the receiver and the payer of interest, the one who records it and the
two witnesses to the transaction and said: "They are all alike [in guilt]." (Muslim, Kitab al-Musaqat, Bab la'ni akili al-riba
wa mu'kilihi; also in Tirmidhi and Musnad Ahmad).............................................................................................................15

1.4.3 From 'Abdallah ibn Hanzalah : The Prophet, , said: "A dirham of riba which a man receives knowingly is worse
than committing adultery thirty-six times" (Mishkat al-Masabih, Kitab al-Buyu', Bab al-riba, on the authority of Ahmad
and Daraqutni). Bayhaqi has also reported the above hadith in Shu'ab al-iman with the addition that "Hell befits him
whose flesh has been nourished by the unlawful.".............................................................................................................15
1.4.4 From Abu Hurayrah : The Prophet, , said: "God would be justified in not allowing four persons to enter
paradise or to taste its blessings: he who drinks habitually, he who takes riba, he who usurps an orphan's property
without right, and he who is undutiful to his parents." (Mustadrak al-Hakim, Kitab al-Buyu')..........................................15

1.5 Definition of Riba.........................................................................................................................................................15

1.5.1 Types of Riba...........................................................................................................................................................16

1.6 Other Major Prohibitions.............................................................................................................................................16

1.6.1 Gharar......................................................................................................................................................................16

1.6.2 Qimar / Maiser........................................................................................................................................................17

1.7 Prevailing Misperceptions about Islamic Banking......................................................................................................17

1.7.1 General Public mis-perceptions..............................................................................................................................17

1.7.2 Time Value of Money..............................................................................................................................................17

1.7.3 KIBOR as bench Mark..............................................................................................................................................17

Chapter 2......................................................................................................................................19
Sale (Bai’).....................................................................................................................................19
2 Definition of Sale.....................................................................................................................20
2.1 Elements of Sale..........................................................................................................................................................20

2.1.1 Primary Elements....................................................................................................................................................20

2.1.2 Secondary Elements................................................................................................................................................20

2.2 Types of Sale................................................................................................................................................................21

2.2.1 Valid Sale.................................................................................................................................................................21

2.2.2 Void Sale..................................................................................................................................................................21

2.2.3 Voidable Sale...........................................................................................................................................................21

2.3 Examples......................................................................................................................................................................21

Chapter 3......................................................................................................................................22
Murabahah..................................................................................................................................22
3 Definition.........................................................................................................................................................................23

3.1.1 Description..............................................................................................................................................................23

3.2 Types of Murabahah...................................................................................................................................................23

3.2.1 Advance...................................................................................................................................................................23

3.2.2 Spot.........................................................................................................................................................................23

3.2.3 Deferred..................................................................................................................................................................23

3.3 Step by Step Murabahah Transaction.........................................................................................................................23

3.4 Risk Management in Murabahah...............................................................................................................................25

3.5 Shariah Guidelines for Murabahah.............................................................................................................................28

3.5.1 DO’s.........................................................................................................................................................................28

3.6 Profit Calculation in a Murabahah Transaction..........................................................................................................30

3.6.1 Bullet Payment........................................................................................................................................................30

3.6.2 Payment in Equal Installments................................................................................................................................30

3.7 Aitemaad Murabahah Products and underline features............................................................................................30

3.7.1 Tenor for Murabahah Facility..................................................................................................................................30

3.7.2 Payment Mode........................................................................................................................................................30

3.7.3 Pricing Rationale......................................................................................................................................................31

3.7.4 Fee and Expenses....................................................................................................................................................31

3.7.5 Product Overview....................................................................................................................................................31

3.7.6 General Financing Facilities.....................................................................................................................................31

1. Murabahah..................................................................................................................................................................31

2. Murabahah - Spot........................................................................................................................................................31

3. Murabahah – Pledge....................................................................................................................................................31

4. Murabahah – Financing of Imported Merchandize (FIM) Pledge...............................................................................31

 5. Murabahah-Financing of Imported Merchandize (FIM) - Spot...................................................................................31

6. Murabahah – USD / FE 25 Export and Import.............................................................................................................32

3.7.7 IMPORT....................................................................................................................................................................32

7. Sight LC under MMFA..................................................................................................................................................32

8. Usance LC without MMFA...........................................................................................................................................32

9. Usance LC under MMFA (Exception required)............................................................................................................32

3.7.8 LOCAL (INLAND) LCs................................................................................................................................................32

11. Local LC (Sight) under MMFA (Exception required)................................................................................................32

12. Local Usance LC without MMFA..............................................................................................................................33

13. Local Usance LC under MMFA (Exception required)..............................................................................................33

3.7.9 EXPORT (Post Shipment Facilities)..........................................................................................................................33

14. Murabahah against Accepted export Usance Bill (Bank Risk Line).........................................................................33

15. Murabahah against Un-accepted export Clean Usance LC.....................................................................................33

16. Murabahah against Un-Accepted export Discrepant Bills Usance LC Collection Bills............................................33

17. Murabahah against export Usance Contract..........................................................................................................33

3.7.10 LOCAL (INLAND) LCs............................................................................................................................................34

18. Murabahah against Un-accepted Local Usance LC.................................................................................................34

19. Murabahah against Accepted local Usance LC (Bank Risk Line).............................................................................34

3.8 Important Clarifications..............................................................................................................................................34

3.8.1 Direct Payment Procedure......................................................................................................................................34

3.8.2 Indirect Payment Procedure...................................................................................................................................34

3.9 Minimum Inventory Holding Period............................................................................................................................35

3.10 Delivery time of goods from supplier to customer’s premises....................................................................................35

3.11 Identification of Murabahah Assets............................................................................................................................35

3.12 Purchase Evidences.....................................................................................................................................................35

3.13 Invoices to be issued in the format (“Aitemaad-NBP – ABC Customer”)....................................................................35

3.14 Acceptance of Murabahah Contract...........................................................................................................................35

3.15 Percentage of Physical Inspection...............................................................................................................................35

Chapter 4......................................................................................................................................37
4 What is Ijarah..................................................................................................................................................................38

4.1.1 Definition.................................................................................................................................................................38

4.1.2 Description..............................................................................................................................................................38

4.1.3 Ijarah & Ijarah Muntahia Bittamleek.......................................................................................................................38

4.1.4 There are several types of Ijarah Muntahia Bittamleek. These are characterized based on the method by
which the ownership transfers to the user:.........................................................................................................................38
4.2 Essentials of Ijarah......................................................................................................................................................38

4.2.1 A Contract................................................................................................................................................................38

4.2.2 A particular asset.....................................................................................................................................................38

4.2.3 Transfer of usufruct.................................................................................................................................................39

4.2.4 Specified Time Period..............................................................................................................................................39

4.2.5 Agreed Upon Rental................................................................................................................................................39

4.3 Ijarah as a mode of Finance (Conditions of Ijarah).....................................................................................................39

4.3.1 The commencement of lease unlike the contract of sale, the agreement of Ijarah can be effected for a future
date. Hence, it is different from Murabaha.........................................................................................................................39

4.3.2 Rent should be charged after the delivery of the leased asset to the lessee and not from the day the price
has been paid. If the supplier has delayed the delivery after receiving the full price, the lessee should not be liable for
the rent of the period of delay.............................................................................................................................................39

4.3.3 Different relations of the parties.............................................................................................................................39

4.3.4 Expenses consequent to ownership to the lessor..................................................................................................40

4.3.5 Lessee as Ameen.....................................................................................................................................................40

4.3.6 Variable Rentals in Long Term Leases.....................................................................................................................40

4.3.7 Charity for late payment of Rent............................................................................................................................40

4.3.8 Termination of Lease...............................................................................................................................................40

4.3.9 Insurance of the assets/Takaful..............................................................................................................................40

4.3.10 The residual value of the leased asset................................................................................................................40

4.3.11 Ijarah Wa Iqtina...................................................................................................................................................40

4.3.12 Sub-Lease............................................................................................................................................................41

4.4 Difference b/w Islamic Lease & Conventional Lease...................................................................................................41

4.5 Process Flow & documentation...................................................................................................................................41

4.5.1 Step by step Ijarah Financing:.................................................................................................................................41

4.5.2 Documentation........................................................................................................................................................42

4.6 Ijarah risk & its mitigation...........................................................................................................................................43

4.7 General guidelines for Ijarah Financing......................................................................................................................44

4.7.1 Asset Description of the Ijarah Asset......................................................................................................................45

4.7.2 Determination of Total Cost of the Asset...............................................................................................................45

4.7.3 Timing of signing of Lease Agreement....................................................................................................................45

4.7.4 Defining Floor & Cap in the Payment Agreement...................................................................................................45

4.7.5 Treatment of Takaful premium...............................................................................................................................46

4.7.6 Timing of signing of Undertaking to Purchase........................................................................................................46

4.7.7 Signing of ‘Gift Deed’ / Sale Deed at the time of maturity.....................................................................................46

4.7.8 Signing of Asset Purchase Agreement in SLB transaction.......................................................................................46

 4.7.9 Checking Encumbrance on Ijarah Asset is SLB transaction.....................................................................................46

4.7.10 Recording of Ijarah asset....................................................................................................................................46

4.8 Scope of the Product...................................................................................................................................................46

4.8.1 Product Overview....................................................................................................................................................46

4.8.2 Tenor for Ijarah Financing.......................................................................................................................................47

4.8.3 Pricing Rationale......................................................................................................................................................47

4.8.4 Fee and Expenses....................................................................................................................................................47

4.8.5 Payment Mode........................................................................................................................................................47

4.8.6 Simple Illustration...................................................................................................................................................47

4.9 Application of Ijarah..................................................................................................................................................0

Chapter 5........................................................................................................................................1
5 Definition...........................................................................................................................................................................2

5.1 Main Features...............................................................................................................................................................2

5.1.1 Mudharabah Capital.....................................................................................................................................................2

5.1.2 Profit / Loss Distribution................................................................................................................................................2

5.2 Types of Mudharabah...................................................................................................................................................2

5.3 Capacities of Mudharib.................................................................................................................................................3

5.4 Participation from Mudharib.........................................................................................................................................3

5.5 More than one Rabb-ul-Maal........................................................................................................................................4

5.6 Termination of Mudharabah.........................................................................................................................................4

5.7 Banking application.......................................................................................................................................................4

5.8 Step by Step Profit Distribution.....................................................................................................................................5

5.9 Early Redemption (Pre mature encashment)................................................................................................................8

Chapter 6......................................................................................................................................10
6.1 Musharakah.........................................................................................................................11
6.1.1 Definition.................................................................................................................................................................11

6.1.2 Terminology of Musharaka.....................................................................................................................................11

6.1.3 Types of Musharaka................................................................................................................................................11

6.1.5 Structure of Musharaka..........................................................................................................................................13

6.1.6 Rules of Musharaka.................................................................................................................................................13

6.1.7 Concept of limited liability......................................................................................................................................16

6.1.8 Modern partnerships..............................................................................................................................................17

6.1.9 Banking application.................................................................................................................................................17

6.2 Diminishing Musharakah.....................................................................................................18

6.2.1 Definition.................................................................................................................................................................18
 6.2.2 Description..............................................................................................................................................................18

6.2.3 TYPES AND STRUCTURE OF DIMINISHING MUSHARAKAH......................................................................................18

6.2.4 RULES OF DIMINISHING MUSHARAKAH..................................................................................................................19

6.2.5 AITEMAAD’S DM PRODUCT FEATURES...................................................................................................................20

6.2.5.1 PRODUCT OVERVIEW..........................................................................................................................................20

6.2.5.2 TENOR FOR DM FINANCE...................................................................................................................................20

6.2.5.3 PRICING OF UNIT SHARES AND RENTALS...........................................................................................................20

6.2.5.4 FEES AND EXPENSES...........................................................................................................................................20

6.2.5.5 TAKAFUL..............................................................................................................................................................21

6.2.6 SHARI’AH GUIDELINES.............................................................................................................................................21

6.2.6.1 GENERAL RULES TO DIMINISHING MUSHARAKAH.............................................................................................21

6.2.7 STEP BY STEP DM PROCESS.....................................................................................................................................22

6.2.8 DOCUMENTATION REQUIRED.................................................................................................................................23

6.2.9 RISK MANAGEMENT................................................................................................................................................23

6.2.10 DIMINISHING MUSHARAKAH CALCULATION......................................................................................................25

Chapter 7......................................................................................................................................28
7 Istisna......................................................................................................................................29
7.1 Definition.............................................................................................................................29
7.2 Description...........................................................................................................................29
7.2.1 Conditions of Istisna..........................................................................................................29
7.2.2 Price of Istisna..................................................................................................................29
7.2.3 Revoking of Istisna contract..............................................................................................30
7.2.4 Time of Delivery................................................................................................................30
7.2.5 Delivery of Goods..............................................................................................................30
7.3 Parallel Istisna’.....................................................................................................................30
7.4 Difference between Istisna & Salam.....................................................................................31
Chapter 8......................................................................................................................................32
8 Definition.................................................................................................................................33
8.1 Description...........................................................................................................................33
8.2 Basic Rules of the Salam.......................................................................................................33
8.2.1 Capital of Salam................................................................................................................33
8.2.2 Specification of Commodity...............................................................................................33
8.2.3 Delivery Conditions...........................................................................................................34
8.2.4 Khiyar (Option) in Salam...................................................................................................34
8.2.5 Revoking Salam Contract..................................................................................................34
8.2.6 Parallel Salam...................................................................................................................35
8.2.7 Buy Back...........................................................................................................................35
8.2.8 Agency Contract...............................................................................................................35
8.2.9 In case of Default..............................................................................................................35
Preface
Chapter 1
The Building Blocks
 1 Sources of Shariah
1.1 Sources of Shariah Defined
As the name implies, sources from where the principles of Shariah are either directly received or derived are
known as Sources of Shariah

1.2 Sources of Shariah

There are two (2) types of sources categorized as primary and secondary. Primary Sources of Shariah includes
Quran and Sunnah whereas secondary sources include Ijma (consensus) and Qiyas (analogy).

The Quran is the sayings of Allah Rabbulizzat. The Qur’an is the last revealed book from the Almighty,
free from any tampering until the Hereafter (Qur’an; 15: 9); obedience to the injunctions contained
in it is considered necessary by all Muslims, at least conceptually.

The Sunnah, which consists of the sayings of and the actions done and/or approved by the holy Prophet
(pbuh), is an equally important source of information in Islamic law. The importance of sticking to the Sunnah is
obvious from the following verse of the Holy Quran: Allah says, “Indeed you have in the Messenger of Allah an
excellent example for the one who hopes in Allah and looks to the Last Day” (33: 21). The Exalted also says: “So
if you obey him (i.e. Muhammad, pbuh), only then you will be guided” (24: 54). Almost all Muslims believe that
obedience to the orders of the holy Prophet is necessary for being a Muslim.

1.3 Revelations about Riba in Quran

In Holy Quran there are 4 sets of Ayahs that are revealed about Riba and its prohibitions:

• 1st Revelation – Surah-al-Rum, verse 39

• 2nd Revelation – Surah al-Nisa, verse 161

• 3rd Revelation – Surah al-Imran, verses 130-132

• 4th Revelation – Surah al-Baqarah, verses 275-281

Besides, there are also around 40 different Ahadiths on RIBA and its prohibition from our Holy Prophet.

1.3.1 First Revelation about Riba

– “That which you give as interest to increase the peoples' wealth increases not with God; but
that which you give in charity, seeking the goodwill of God, multiplies manifold.” (Surah
Rome, Verse 39)

1.3.2 Second Revelation about Riba

 – “And for their taking interest even though it was forbidden for them, and their wrongful
appropriation of other peoples' property. We have prepared for those among them who
reject faith a grievous punishment ” (Surah al-Nisa', verse 161)

1.3.3 Third Revelation about Riba

– “Believers! Do not swallow riba, doubled and redoubled, and be mindful of Allah so that you
may attain true success” ( Al Imran, Ayat 130)
1.3.4 Fourth Revelation about Riba

Surah Al
Baqarah
Verses 275-281

• "Those who benefit from interest shall be raised like those who have been driven to madness by the
touch of the Devil; this is because they say: "Trade is like interest" while God has permitted trade and
forbidden interest. Hence those who have received the admonition from their Lord and desist, may
keep their previous gains, their case being entrusted to God; but those who revert shall be the
inhabitants of the fire and abide therein for ever." (275)

• "God deprives interest of all blessing but blesses charity; He loves not the ungrateful sinner." (276)

• "Those who believe, perform good deeds, establish prayer and pay the zakat, their reward is with
their Lord; neither should they have any fear, nor shall they grieve." (277)

• "0, believers, fear Allah, and give up what is still due to you from the interest (usury), if you are true
believers." (278)

• "If you do not do so, then take notice of war from Allah and His Messenger. But, if you repent, you
can have your principal. Neither should you commit injustice nor should you be subjected to it." (279)
 • "If the debtor is in difficulty, let him have respite until it is easier, but if you forego out of charity, it is
better for you if you realize." (280)

• "And fear the Day when you shall be returned to the Lord and every soul shall be paid in full what it
has earned and no one shall be wronged. " (281).

1.4 Riba in Hadith

1.4.1 From Abu Hurayrah : The Prophet, , said: "Riba has seventy segments, the least serious being
equivalent to a man committing adultery with his own mother." (Ibn Majah)

1.4.2 From Jabir : The Prophet, , may cursed the receiver and the payer of interest, the one who records it
and the two witnesses to the transaction and said: "They are all alike [in guilt]." (Muslim, Kitab al-
Musaqat, Bab la'ni akili al-riba wa mu'kilihi; also in Tirmidhi and Musnad Ahmad)

1.4.3 From 'Abdallah ibn Hanzalah : The Prophet, , said: "A dirham of riba which a man receives knowingly is
worse than committing adultery thirty-six times" (Mishkat al-Masabih, Kitab al-Buyu', Bab al-riba, on
the authority of Ahmad and Daraqutni). Bayhaqi has also reported the above hadith in Shu'ab al-iman
with the addition that "Hell befits him whose flesh has been nourished by the unlawful."

1.4.4 From Abu Hurayrah : The Prophet, , said: "God would be justified in not allowing four persons to enter
paradise or to taste its blessings: he who drinks habitually, he who takes riba, he who usurps an
orphan's property without right, and he who is undutiful to his parents." (Mustadrak al-Hakim, Kitab al-
Buyu')

In the 17th century, two new technical terms of interest emerged after the establishment of banking system,
namely:

1. Tijarti Sood (Commercial Interest): Interest paid on loan taken for productive & profitable purposes.

2. Sarfi Sood (Usury): Interest paid on loan taken for personal need and expenses

1.5 Definition of Riba

“Anything over and above the principle without any due consideration already stipulated as a condition in the
contract.”

The above underlined phrases are needed to be further elaborated for clarifying the above definition:

- Anything: It means anything including money, services etc. It is to be noted that this does not restricts
to the money only.
- Over and above the principle: It means more than the face value. (needs clarification)
- Due Consideration: If you show consideration, you pay attention to the needs, wishes or feelings other
people. Or relevant to what is being done.
- Stipulated as a condition: It means without its completion/fulfillment, the contract will not be
concluded or considered executed.

1.5.1 Types of Riba

There are following two main types of Riba:
1.5.1.1 Riba An Nasiyah
Also known as Riba al Quran / Riba Al Jahiliya is defined as excess, which results from predetermined interest
(sood) which a lender receives over and above the principle (Ras ul Maal).

1.5.1.2 Riba Al Fadl

Also known as Riba in Trade / Riba ul Hadith is defined as excess compensation without any consideration
resulting from a sale of goods. ‘Riba Al Fadl’ will be covered in greater detail later.

The Prophet (SAW) said, "Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver,
sell dates in exchange of equivalent dates, sell wheat in exchange of equivalent wheat, sell salt in exchange of
equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury
(Riba). However, sell gold for silver anyway you please on the condition it is hand-to- hand (spot) and sell
barley for date anyway you please on the condition it is hand-to-hand (spot).”

The above hadith discuss six commodities that enabled the scholars to extract law of transactions as follows:
1. If the genus (type of product) and scale of measure (like Kilogram, Littre, counting) both are same:
a) Spot transaction and equal quantity
2. If the genus differs but scale of measure is same:
a) Spot transaction and un equal quantity
3. If the genus and measure both differ:
a) Deferred transaction and un equal quantity.

* genus (type of product)

** scale of measure (like Kilogram, Littre, counting)

1.6 Other Major Prohibitions

1.6.1 Gharar
The uncertainty about the elements of sale or other clauses in the main contract as a result of which the
transaction may become void or voidable and leads to conflict among the parties is known as Gharar that is
prohibited in the Shariah.

Example:

a) Person ‘A’ sells his smart phone to person ‘B’ on telephonic conversation for PKR 20K. In this
transaction, specification of smart phone is missing that is required to be mentioned before the sale is
concluded.
b) But if a person invest PKR. 10 (M) in a departmental store business with an uncertainly whether he will
make profit or not, it will not be considered as Gharar because making profit is not and cannot be a
condition in the main contract.

1.6.2 Qimar / Maiser

Qimar means gambling. Technically, it is an arrangement in which possession of a property is contingent upon
the happening of an uncertain event. By implication it applies to a situation in which there is a loss for one
party and a gain for the other without specifying which party will lose and which will gain.

Example:

a) If Pakistan cricket team loses match, person ‘A’ will give PKR.1000 to person ‘B’ and vice versa.
1.7 Prevailing Misperceptions about Islamic Banking
1.7.1 General Public mis-perceptions
a) Is it same as interest based and is just a renaming of banking as the result is same as of conventional
banks?
Deciding permissibility of transactions based on the results is not fair rather analyzing the mechanism
involved in achieving the results is the accurate measuring tool to decide the permissibility status. The
mechanism of Islamic Banking transactions are very different with that of conventional banking as the
same will be covered in the upcoming chapters.
b) How it is possible for the Islamic banks to execute islamic transactions as the central bank for both
Conventional and Islamic Banks are same?
State Bank of Pakistan runs a separate Islamic Banking Division and Islamic Banking Shariah Board that
monitors and regulate the whole islamic Banking Industry. Similarly the reserves placed by the Islamic
Banks in SBP are managed under the supervision of SBP’s Shariah Board.

1.7.2 Time Value of Money

In Islamic Shariah, the time value of money is permissible when a commodity is involved in the transaction. In
Islamic Shariah it is not permissible that 1 dollar today worth 10 dollars tomorrow but a Car/any product/asset
worth 500 dollars can be sold in 600 dollars tomorrow with no change in its features. It means that the value of
the asset can be increase but not the currency.

1.7.3 KIBOR as bench Mark

Utilizing KIBOR as a bench mark does not means that the Islamic Bank are earning interest. This is just a
measure for setting targets for rate of return. For example, a bottle with the capacity of 1 liter can be used to
measure alcoholic bear or water. Therefore the using something for bench mark purpose does not make any
thing permissible or non-permissible.
Chapter 2
Sale (Bai’)

2 Definition of Sale
“Exchange of a commodity of value with another commodity of value with mutual consent.”
2.1 Elements of Sale
There are four elements of sale that are further categorized as primary (absence of which will make the sale
void) and secondary (absence of which will make the sale voidable).

2.1.1 Primary Elements

2.1.1.1 Offer & Acceptance

Offer & acceptance (Ijab-o-Qubool) is one of the primary element without which the sale transaction will be
considered as void. It is a point at which the seller and buyer agrees that a specific commodity/product is sold
against specific value.

The offer and acceptance can be in written, oral and implied forms.

Example:

a) As evident O&A that is executed in writing is the written form like Sale Deed, Murabahah O&A etc.
b) If the seller/buyer offer & accepts a sale verbally then this will be considered as verbal or oral.
c) There are certain conditions or points in a sale transaction where the buyer/seller neither execute offer
nor accept in writing nor verbally. The best example can be shopping in a departmental store. As the
shopper reaches the counter, it just placed its product(s) on the transaction counter before the
shopkeeper without negotiation. The shopkeeper on the other hand, without asking anything scan the
code of the products and handover the bill to the shopper. Now it is implied that the shopper will pay
the billed amount.

2.1.1.2 Subject Matter

Subject matter is the products/services/goodwill that are being sold or given on rent. Subject matter to be
qualified must fulfill the following conditions:

a) It must be existing (except for Istisna and salam mode of financing)

b) It must be owned by the seller at the time of sale execution.
c) It must be in possession (either in directly possession or constructive of the seller)
d) The SM must be specified and quantified

Examples:

2.1.2 Secondary Elements

2.1.2.1 Price / Consideration

As the name implies it is the price / consideration of the product sold / services delivered. The price must be:

a) Quantified
b) Specific & certain

2.1.2.2 Parties
Parties includes seller(s) and the buyer(s) that must fulfill the following conditions:

a) Must be prudent – means able to take decision with respect to the level of transaction

2.2 Types of Sale

Types of sales are segregated with respect to their validity status.
2.2.1 Valid Sale
A sale is valid if all elements together with their conditions are present as discussed above.

2.2.1.1 Types of Valid Sales

a) Bai Musawamah: It refers to normal sale in which cost price is not known.
b) Bai Murabaha: It refers to a sale in which cost and sale price is known to the buyer.
c) Bai Muqayada: It refers to barter sale excluding currency sale.
d) Bai Surf: It refers to the sale of gold, silver and currency.
e) Bai Salam: It is a kind of sale in which payment is spot while the delivery of the good is deferred.
f) Bai Istisna: It refers to such sale in which commodity is transacted before it comes into existence. It is
basically an order to manufacture.
Bai Muajjal: It refers to such sale in which delivery is spot while payment is deferred but cost is not known.

2.2.2 Void Sale

A sale wherein the primary elements that includes the Offer & Acceptance and the Subject Matter are missing
stands as void ab-initio.

Shariah Status

a) Transaction is completely null and void.

b) Ownership doesn't transfer.
c) For Seller taking price is not Halal.
d) Transaction is haram from its inception.

2.2.3 Voidable Sale

Sale will be on the verge of becoming void due the deficiencies in the secondary elements including the
price/consideration and parties. If the conditions for secondary elements are fulfilled then the sale will become
valid.

2.3 Examples
Chapter 3
Murabahah
 3 Definition
Murabahah is a particular kind of sale in which the seller discloses the cost to the buyer and adds a certain
profit to it to determine the selling price.

1.1.1 Description
Murabahah is an asset trading transaction; hence, Murabahah must be considered a trade transaction and not
a loan. Using Murabahah as a financing instrument, the Bank purchases certain goods (as required by the
client) and sells them to the client on a cost plus profit basis. The Bank’s cost includes all direct expenses
incurred in the acquisition of goods such as invoice price, transportation, LC charges, marine/in transit
insurance, sales tax and other Govt. levies etc. The risk of the asset remains with the bank from the time the
bank purchases the asset and takes the possession until the bank sells it to the customer, handing over the
possession also.

3.1 Types of Murabahah

3.1.1 Advance
A Type of Murabahah wherein the price is paid in advance and the product is delivered afterwards on a certain
date.

3.1.2 Spot
Here the payment and the delivery of the price is done simultaneously.

3.1.3 Deferred
Deferred Murabahah is a sale transaction where in the seller the delivers the product on a certain date and the
price is paid by the buyer on deferred basis.

3.2 Step by Step Murabahah Transaction

1. After necessary Credit and Shariah approvals, AITEMAAD-NBP and the customer will enter into MMFA
Agreement, Version 2.0 (listing the assets to be procured) and Agency Agreement.
2. The Relationship Manager will educate customer about the Murabahah process and especially about the
importance of placing Order Form to AITEMAAD-NBP before / along with finalizing order with supplier,
signing of Declaration and Murabahah Contract before consumption and storing the purchased stock of
goods separately from the stock already present in the warehouse for proper identification.
3. Upon the requirement for purchase of asset, the customer will submit the Order Form to the Branch along
with the name of the supplier and the nature of the goods to be purchased.
4. As per the Order Form, AITEMAAD-NBP will disburse funds in the Current Account / Escrow Account
(preferable) of the customer for onward EITHER DIRECT PAYMENT to the supplier through AITEMAAD-
NBP Pay Order / AITEMAAD-NBP Cross Cheque / /Online Fund Transfer/ AITEMAAD-NBP Demand Draft
OR INDIRECT Payment to the supplier through Other Banks Pay Order / Cross Cheque / Demand Draft /
Cash Payments.
5. At this stage Advance Against Murabahah will be booked
6. In case of Direct Payment sub-Murabahah transactions, branch will hold copy of Cross Cheques / Pay
Orders / Demand Drafts for 100% of the disbursed amount with each sub-Murabahah transaction.
7. In case of Indirect Payment sub-Murabahah transactions, Customer will provide copy of Crossed
 Cheques / Pay Orders / Demand Draft / Cash Receipts (along with sign and stamp of the supplier) as
payment evidence to AITEMAAD-NBP for 100% of the disbursed amount in each sub-Murabahah
transaction.
8. It should be made sure by the related RM that the customer should make payment to suppliers (i.e. issue
payment instrument to supplier) on the same day disbursement is made
9. The customer makes purchases on (spot/advance) basis and store and the minimum inventory holding
period of the client is (X) days.
10. The goods are delivered to customer premises within (Y) days after finalizing order with suppliers.
11. AITEMAAD-NBP goods can be easily identified by Lot Number / Batch Number / Expiry Dates
12. Upon receipt of goods, customer will declare and certify the possession of goods (via signing of
Declaration) and will provide purchase evidences in the shape of INVOICES and Truck Receipts etc. to
AITEMAAD-NBP and will give an offer to AITEMAAD-NBP to purchase the goods via Murabahah Contract
immediately (not later than 2 days after receipt of goods).
13. In cases where INVOICES are not available at the time of signing of Murabahah Contract, customer will
provide purchase evidences in the shape of TRUCK RECEIPTS along with customer confirmation regarding
purchase price (carrying sign and stamp of the customer). In these cases customer will send the Invoices to
AITEMAAD-NBP upon receipt from the supplier for 100% of the disbursed amount within 30 days of
signing of Murabahah Contract.
14. It should be made sure by the customer that supplier should issue Invoices in the format (“Aitemaad-NBP –
ABC Customer”)
15. To ensure that goods are not consumed before signing of declaration, the related Relationship Officer
/Relationship Manager will also perform random physical inspections of purchased stock in
10% of the Direct Payment Sub-Murabahah transactions and in 50% of the Indirect Payment sub-
Murabahah transactions Physical inspection is mandatory in initial 02 sub-Murabahah transactions;
however Shariah Advisor may relax for physical inspection of initial 2 sub-Murabaha cases. Telephonic
confirmation shall be taken in all the remaining cases. Physical Verification Report / Telephonic
confirmation Report will also be enclosed with the declaration.

16. Upon confirmation, AITEMAAD-NBP will accept the offer by signing the Murabahah Contract and the
ownership of assets will transfer. At this stage the tenor of sub-Murabahah, contact price and payment
schedule will be finalized through Payment Schedule.
17. Customer will be informed about the acceptance of the offer by AITEMAAD-NBP. At this stage Murabahah
Facility will be booked by AITEMAAD-NBP.
18. The Customer would settle Sub-Murabahah on or before the maturity date from its own sources
19. The Bank is authorized to conduct supplier verification and confirm the genuineness of purchase
evidences provided by the customer as and when required and in case of any misrepresentation bank
reserves the right to call back the facilities.
20. All transactions must comply AAOIFI standard "Murabahah to Purchase Orderer", related SBP guidelines
and SCD policies for Murabahah.
Note:
 • RM & branch should submit the CTC of Order Form, Murabahah Contract and Declaration to CAD on
the same day the said document is received from customer and will keep the original in branch.
• The submission of CTC of Order Form to CAD should not be delayed till the disbursement date
All the above conditions are necessary to affect a valid Murabahah.

The most essential element of a Murabahah transaction is that the commodity must remain in the risk and
reward of the institution during the period between the third and the sixth stage explained above.

3.3 Risk Management in Murabahah

Transaction
Leg Name Possible Risk Description Mitigation
Stage
1st Leg - Intimation of 1. Operational Risk In case if client do 1. Customer to agree and sign the
Asset requirement a. Shari’ah Risk not intimate the Shari’ah approved process flow at
Procuremen by the Client / b. Reputational bank before opening the time of signing the offer
t from Timely Risk of LC / placing order, letter.
Supplier / submission of it may become a buy 2. The Branch is required to
Agency PO back transaction. maintain a Murabahah
Period Monitoring Sheet (as provided in
compliance manual), and report
to SCD on a monthly basis.
3. Branch shall immediately report
any instance(s) through initial
incident report (IIR) to the IBG
ORC/Risk Champion.
4. Further Branch need to report
any instance vide monthly loss
data report (MLDR)

Payment to the 1. Operational Risk 1. In case of 1. RM/Branch to ensure that

Supplier a. Utilization indirect customer provides evidence of
(Direct/Indirect Funds Risk payments, payment to the supplier like PO
) 2. Credit Risk customer may copy etc.
a. Liquidity Risk utilize the funds 2. Securities to ensure that bank
for purpose can recover its actual loss.
other than 3. Agency Agreement that makes
purchase of the customer responsible to
asset for e.g. the purchase the asset on Bank’s
customer may behalf and promise to purchase
utilize the funds that bounds the customer to
to settle interest purchase the asset as per LPO.
based loan from 4. Performance Guarantee of the
other bank. customer as an agent of the
2. With the Bank
payment to the
supplier, bank
will be out of
fund that
exposes bank to
credit risk and
then to liquidity
risk.

Supply of Asset 1. Market Risk 1. After the agent 1. Takaful for transit
/ Transit Period a. Equity Risk has purchased 2. Hamish Jidyah/unilateral
b. Profit risk and made the Promise to purchase from
2. Credit Risk payment to the the client to safeguard
3. Operational Risk supplier, the actual loss. In case of
Bank will promise breach, bank
become the carries this risk.
owner of the 3. Securities to ensure that
asset. bank can recover its actual
Subsequently the loss.
bank will bear all
4. Mitigations:
the related risks.
a. Agency
2. There will be a
Agreement/Custo
Market risk for
mer Guarantee for
the Bank if there
Supplier’s
is a total loss
performance.
during transition
b. Takaful, Agency
or if the client
Agreement.
declines to
purchase the
asset / execute
the Murabahah
contract. In the
later case, the
Bank will need to
sell the asset in
the market
where it may
lose the profit or
even may not
recover the
principle.
3. At this stage too,
bank carries the
Credit Risk.
4. Several
Operational Risk
may trigger at
this stage
including the
following:
a. Supplier may
delay the
supply of the
goods.
b. Transit Risk:
Transporter is
exposed to
accidents,
malfunctionin
g of
transport, law
and order etc.

Declaration 1. Market Risk 1. At this stage 1. Market Risk same as above

Stage (Goods a. Equity Risk also, bank will 2. Equity Risk same as above
delivered / 2. Credit Risk carry the equity 3. Operational Risk same as above
possession 3. Operational Risk and Credit Risks 4. RM/Branch to ensure the
taken by the a. Shari’ah Risk being the owner
 Agent) of the asset and following:
2. Credit Risk is a. Get the truck receipts/Gate
same as above Pass etc. on the date of
3. Operational risk declaration as evidence.
includes timing b. Match the product
of the code/Assignment number as
declaration i.e. given on invoice with that of
the agent should provided on truck
purchase goods receipt/gate pass etc.
only after the c. Physical inspection
agency is
awarded. Any
goods purchased
earlier than the
agency, will
become a buy
back transaction.

2nd Leg – Offer & 1. Operational Risk 1. This is the most 1. Operational Risk mitigation:
Sale of Acceptance / a. Shari’ah important and a. Shari’ah Risk:
Asset to the Execution of /Reputational sensitive stage of i. Declaration evidence must
Client Murabahah Risk. the process where contain proper details
/Execution Contract the asset especially date & time.
of O/A ownership Further, it should be a
transfers to the separate document with O/A
client from the or Murabahah Contract. .
Bank. Following Timely exchange of these
are the triggers: documents with proper
a. Shari’ah Risk: asset / goods references.
i. The Bank & ii. Process flow must
The client contains/take care of all
must execute sensitivities of the
offer and procurement and
acceptance / consumption process of the
Murabahah specific business. The
contract only approved process flow must
after the be agreed and signed by the
declaration customer.
made by the iii. The inventory management
client. system must provide some
ii. It must be for evidence like Stock Report
the etc.
invoiced/decla
red purchased
asset/goods.
iii. Most
importantly, it
must be
before
consuming the
goods.

Repayment 1. Credit Risk 1. After offer & 1. Sufficient Securities from the
Period 2. Liquidity Risk acceptance, the Client.
credit risk will 2. Sufficient Securities from the
now be from the Client.
client w.r.t its
 inability to pay
off the
Murabahah
payment to the
bank due to any
reason including
business failures,
operational
breakdown,
energy crisis etc.
2. In case of default
by the customer,
bank’s general
pool will be
exposed to
liquidity risk.

3.4 Shariah Guidelines for Murabahah

3.4.1 DO’s
• The concerned Relationship Manager/Officer shall use Murabahah only for tangible goods/
commodities.
• The subject matter of sale must be existing, owned by the seller and in his physical or constructive
possession. Therefore, it is necessary that the seller must have assumed the risks of ownership before
selling the commodities to the buyer/customer.
• The concerned Relationship Manager/Officer shall execute proper offer & acceptance to conclude the
Murabahah contract as the contract of Murabahah is not automatically concluded by merely taking
possession of the goods.
• The price of the goods and AITEMAAD-NBP’s profit on Murabahah transaction should be fixed and
known to both the parties at the time of contract of Murabahah. The cost and profit element of the
selling price should be separately identified.
• The concerned Relationship Manager/Officer must ensure that the Seller is a third party, and not the
customer himself or his agent.
• The appointment of an agent (if any), the purchase of goods by or for and on behalf of the Bank and
the ultimate sale of such goods to the customer shall all be transactions independent of each other and
shall be so separately documented.
• The Bank shall make the payment for Murabahah subject matter directly to the supplier.
• In cases where customer avails Credit for Payment to be made to the supplier, and where customer
issues Post-Dated cheques against procurement of goods, customer should place Order Form to
AITEMAAD-NBP at the time of finalizing Order with the supplier and well before the dispatch of goods
from customer’s premises.
• If a Customer has suggested any particular source of supply, a guarantee regarding good performance
of supplier can be obtained from the Customer in his personal capacity (and not in the capacity of
agent).
• The concerned Relationship Manager/Officer should ascertain AITEMAAD-NBP’s actual or constructive
possession of the goods before it’s sold to the customer. The Bank receiving the Bill of Lading is a
constructive possession.
 • Providing insurance cover, while acquiring ownership of goods, is the responsibility of AITEMAAD-NBP.
However, the Customer as an agent may carry out the said work. It is also permissible to build the cost
of insurance into the cost of goods being sold
• RM Corporate/Commercial representative interacting with the Customer must ensure that relevant
documents (like Invoices and other payment evidences) are received well in time in order to confirm
execution of sale by the supplier.
• The buyer may be required to furnish security in the form of pledge, hypothecation, lien, mortgage or
any other form of encumbrance on asset.
• In case of late payment or default by the Customer without a valid reason 1, he will become liable to
pay additional amount that will go to the charity fund constituted by the Bank.

3.4.1.1 DON’Ts
• Murabahah cannot be used for paying utility bills, wages, overhead expenses, etc.
• Murabahah transaction cannot be carried out on items of gold, silver or currencies.
• Goods to be traded should be real goods and not credit documents.
• It is also not allowed to buy goods from the company owned by the customer.
• It is not permissible to charge a commitment fee from the customer or a fee for merely providing
credit facility.
• Once the sale transaction has been concluded, the selling price determined cannot be changed
• It is not permissible to extend the date of payment of the Murabahah Price in exchange for an
additional payment in case of rescheduling.
• Buy-back arrangement is prohibited -- In case where customer has already issued a Post-dated cheque
to supplier and risk of the goods is already transferred to customer. Therefore, commodities already
owned by the Customer cannot become the subject of a Murabahah transaction between the
Customer and AITEMAAD-NBP.
• The amount charged due to late payment or default by the Customer cannot be taken as an Income of
the Bank rather it shall be used for charitable purposes.
• Murabahah contract cannot be rolled over because the goods once sold by the Bank become property
of the Customer and, hence, cannot be resold.
• The promissory note or bill of exchange or any evidence of indebtedness cannot be assigned or
transferred on a price different from its face value.
• The mortgagee or the charge-holder shall not derive any financial benefit from security furnished by
the customer.
• The subject matter of Murabahah cannot be treated as security immediately from the time of sale to
the customer. The possession of the goods must be transferred to the customer at the time of
Murabahah and only after that such goods may be pledged as security by asking customer to give
possession to the Bank

3.5 Profit Calculation in a Murabahah Transaction

The profit can be calculated in three ways depending on the repayment of Murabahah Price:

3.5.1 Bullet Payment

In cases where the Murabahah Price is being paid in one bullet payment (Principal + Profit), the Murabahah
price is simply calculated by the following formula:

1
 Murabahah Price= Principal + Principal X Profit Rate X No. of days (between disbursement and
Maturity)
Example:
Financing Amount : Rs. 100,000,000
Profit Rate : 16% p.a.
Tenor : 1 year
Payment of Murabahah Price : Bullet payment
Contract Price : Rs. 116,000,000 at the end of 1st year
(Murabahah Selling Price)

3.5.2 Payment in Equal Installments

In cases where the Murabahah price is being paid in equal periodic installments, where each payment carries a
portion of the principal and profit, the installment will be calculated using an IRR based equal payment formula
as follows:

Installment = Principal X r
[1 – (1/ (1 + r) n]

Murabahah Price = Installment X n

Where,
n = No. of periods
r = Profit Rate / No. of periods
Example:
Financing Amount : Rs 100,000,000
Profit Rate : 16% p.a.
Tenor : 1 year
Payment of Murabahah Price : Four Equal Installments
Amount Due : Rs. 27,550,000.at the end of every quarter
Contract Price : Rs 110,200,000
(Murabahah Selling Price)

3.6 Aitemaad Murabahah Products and underline features

3.6.1 Tenor for Murabahah Facility

Murabahah facility will be offered relatively for small tenors such as 30 days to 180 days; however the
Management Committee has right to reduce or extend the tenor based on the requirement

3.6.2 Payment Mode

The payment of the Murabahah price may be paid:

a. At Spot at the time of sale

b. In Installments
c. In lump sum (bullet) after a certain time at a future date agreed between the parties.

3.6.3 Pricing Rationale

As market practice, IBG will use KIBOR as a benchmark until such time that another pertinent benchmark
exclusive for Islamic Banks is available.

3.6.4 Fee and Expenses

All expenses incurred by the IBG-NBP in acquiring the commodity/ assets like freight, custom duty, Takaful
expenses etc. may be included in cost price of goods/ commodity

3.6.5 Product Overview

IBG may use Murabahah for financing:
 • Working Capital – Murabahah used for working capital needs such as purchase of raw material for
manufacturing concerns.
• Trade finance – Murabahah used to finance imports and exports for the benefit of the industry. An
Islamic alternative to export Usance bill purchase.
• Corporate Finance – Murabahah used for corporate financing such as construction material for
building a warehouse, factory, offices, etc.

3.6.6 General Financing Facilities

1. Murabahah
It is usually a short-term facility in PKR for purchasing raw materials and assets by NBP Aitemaad, the Bank and
its onward sale to the customer on cost plus profit basis usually with deferred payment. This facility also covers
Murabahah for imported goods (for LC opened under MMFA)

2. Murabahah - Spot
A Murabahah facility in PKR in which the subject matter is purchased and held by NBP Aitemaad, the Bank and
is reflected in the inventory of the Bank. The subject matter is then sold by the Bank to the customer against
spot payment, as and when required by the customer.

Note: Risk profile of this facility is higher than the normal Murabahah transaction therefore the Credit
Committee must approve all such Credit Proposals for holding of goods as AITEMAAD-NBP inventory.
AITEMAAD-NBP goods will be stored under the supervision of AITEMAAD-NBP appointed Mucaddam

3. Murabahah – Pledge
A Murabahah facility in PKR in which the subject matter is sold to the customer and then after delivery the
same goods are kept under a pledge arrangement as a security. The goods will be stored under the supervision
of AITEMAAD-NBP appointed Mucaddam

4. Murabahah – Financing of Imported Merchandize (FIM) Pledge

A Murabahah facility in PKR where the subject matter, that is a Merchandize (FIM) imported good, is sold to
the customer. Once the customer takes the delivery of the goods, the same goods are kept under a pledge
arrangement as a security.

5. Murabahah-Financing of Imported Merchandize (FIM) - Spot

A Murabahah facility in PKR in which the subject matter, that is an imported good, is kept under a pledge
arrangement before selling to the customer and the goods are reflected in the inventory of the Bank. The Bank
then sells the subject matter to the customer against spot payment, as and when required by the customer.

Note: Risk profile of this facility is higher than the normal Murabahah transaction therefore, due care must be
exercised such proposals. Process Flow may vary because of the change in Security structure.

6. Murabahah – USD / FE 25 Export and Import

Usually a short-term facility in USD for purchasing raw materials and assets by Bank on
advance/credit/cash/import basis and its onward sale to the customer on cost plus profit basis with deferred
payment. This facility is extended to importers and exporters to facilitate trade business .
3.6.7 IMPORT
7. Sight LC under MMFA
Sight LC facility to the customer for import of raw material and assets as Bank's agent from the foreign buyer
and its Murabahah sale on cost plus profit basis to the customer by the Bank either on deferred or on spot
basis. The Bank can also include the profit for PAD period in this case.

Note: A minimum amount as per the SOC to be charged as profit for spot payment cases.

8. Usance LC without MMFA

A Usance LC facility to the customer for import of raw material and assets in customer's own name. Bank is only providing
services in this case as customer’s agent and no Murabahah will be done. All Trade base facility will be done under
Murabaha with spot and profit equal to service charges

9. Usance LC under MMFA (Exception required)

A Usance LC facility to the customer for import of raw material and assets as Bank's agent from the foreign
buyer and its Murabahah sale on cost plus profit basis to the customer by the Bank.

Note: This facility requires an exception / specific approval from the competent authority about forward cover and
estimated rate view. All Trade base facility will be done under Murabaha with spot and profit equal to service charges

3.6.8 LOCAL (INLAND) LCs

10. Local LC (Sight) without MMFA

Sight LC facility to the customer for local purchase of raw material and assets in customer's own name. Since the assets
are offloaded at client's warehouses, it is difficult for Bank to ensure that the assets are in place at the time of offer /
acceptance. All Trade base facility will be done under Murabaha with spot and profit equal to service charges.

Note: Normally Local Sight LCs should be opened without MMFA.

11. Local LC (Sight) under MMFA (Exception required)

A type of Murabahah given for purchase of raw material and assets as Bank's agent from the local buyer and its
Murabahah sale on cost plus profit basis to the customer by the Bank.

Note: This facility requires specific credit committee and process approvals (with steps like physical inspections) to ensure
that the assets exist at the time of offer/ acceptance (Murabahah Contract) because in local LCs the assets arrive at
customer's premises hence making it difficult for Bank to control and ensure the existence of assets before declaration. All
Trade base facility will be done under Murabaha with spot and profit equal to service charges

12. Local Usance LC without MMFA

Usance LC facility to the customer for local purchases of raw material and assets in customer's own name. Bank is only
providing services in this case and no Murabahah will be done. All Trade base facility will be done under Murabaha with
spot and profit equal to service charges

13. Local Usance LC under MMFA (Exception required)

Usance LC facility for local purchase of raw material and assets as Bank's agent and its Murabahah sale to the
customer by the Bank.

Note: This facility requires specific credit committee and process approvals with physical inspection only to ensure that
the assets exist at the time of offer/ acceptance (Murabahah Contract) because in local LCs the assets arrive at customer's
premises hence making it difficult for Bank to control and ensure the existence of assets before Murabahah Contract. All
Trade base facility will be done under Murabaha with spot and profit equal to service charges
3.6.9 EXPORT (Post Shipment Facilities)
14. Murabahah against Accepted export Usance Bill (Bank Risk Line)
An Islamic alternate for Usance Bill Discounting based on Murabahah. In this case the Bank extends a
Murabahah facility to the customer and receives the accepted export bill (drawn against approved Bank) as a
security under lien. The Bank along with the lien may also take any other security over the Export bill. .

Note: It must be ensured that the facility is extended only if the Customer has genuine need for purchasing raw
materials etc. and the facility cannot be extended merely for liquidity generation.

In addition, if the Murabahah Contract is not received in due course the Bank cannot take the export proceeds
and they will be returned to the customer. However, only the advance against Murabahah will be recovered
from the customer.

15. Murabahah against Un-accepted export Clean Usance LC

Same features as mentioned above in point 14. Except that in this facility the Bank mark lien over unaccepted
Usance Clean export bills sent on Collection basis (Acceptance generally arrives afterwards i.e. within 7 to 10
working days).

Note: Transaction risk profile changes after acceptance, however ‘Murabahah product risk’ remain constant.

16. Murabahah against Un-Accepted export Discrepant Bills Usance LC Collection Bills
Same features as in point 15 except that in this facility the Bank mark lien under over underlying unaccepted
Usance Discrepant export bills sent on Collection Bills. (Acceptance generally arrives afterwards i.e. within
seven to ten working days)

Note: Transaction risk profile changes after acceptance, however ‘Murabahah product risk’ remain constant.

17. Murabahah against export Usance Contract

Same features as in point 15 except in this facility the Bank mark lien over export contract. Additional security
may be taken in these cases.

3.6.10 LOCAL (INLAND) LCs

18. Murabahah against Un-accepted Local Usance LC
An Islamic alternative to Local bill discounting based on Murabahah. In this case the Bank extends a
Murabahah facility to the customer and takes the local Usance bill as a security under lien. The Bank may also
take any other security, along with the lien over the Usance Bill.

Note: the bank must ensure that the Customer has genuine need for purchasing raw materials etc. and the
customer is not availing the facility merely for liquidity generation.

In case the customer does not provide the Murabahah Contract in due course, the Bank will return the amount
of the proceeds of the bill to the customer.

19. Murabahah against Accepted local Usance LC (Bank Risk Line)

An Islamic alternative to Local bill discounting based on Murabahah. In this case, the Bank will extend a
Murabahah facility to the customer and take the accepted local Usance bill as a security under lien. The Bank,
along with the lien over the Usance Bill, may also take any other security.
Note: the Bank must ensure that the Customer has genuine need for purchasing raw materials etc. and the
customer is not availing the facility merely for liquidity generation.

In case the customer does not provide the Murabahah Contract in due course, the Bank will return the amount
of the proceeds of the bill to the customer. The Bank will recover any advance against Murabahah provided to
the customer without any opportunity cost.

3.7 Important Clarifications

3.7.1 Direct Payment Procedure
After the submission of Order Form by the customer, the disbursements as per Order Form shall be made in
customer’s current account maintained at AITEMAAD-NBP. From there on as per customer’s instructions a Pay
Order/Cross Cheque/DD shall be issued in favor of the suppliers and customer’s current account shall be
debited. It should be made sure by the related branch RM that customer should make payment to supplier
within 2 working days after disbursement.

Customer will provide copy of Crossed Cheques / Pay Orders / Demand Draft as payment evidence to
AITEMAAD-NBP for 100% of the disbursed amount in each sub-Murabahah transaction.

3.7.2 Indirect Payment Procedure

After the submission of Order Form by the customer, the disbursements as per Order Form shall be made in
customer’s current account maintained at AITEMAAD-NBP. From there on the customer makes payments to
the supplier himself as an agent of AITEMAAD-NBP through Cash / Non Payees account cheques / other
bank’s Cross Cheque / Pay Orders in favor of suppliers.

It should be made sure by the related branch RM that customer should make payment to supplier within 2
working days after disbursement.

Customer will provide copy of Other Bank’s Crossed Cheques / Pay Orders / Demand Draft / Cash Receipts
(along with sign and stamp of the supplier) as payment evidence to AITEMAAD-NBP for 100% of the disbursed
amount in each sub-Murabahah transaction.

3.8 Minimum Inventory Holding Period

This refers to the minimum number of days the customer holds the goods after receiving the delivery of goods
and before the start of consumption or resale. Actual minimum Inventory holding period for each commodity
(for which Murabahah Facility is allowed) should be mentioned in the Process Flow

3.9 Delivery time of goods from supplier to customer’s premises

This refers to the minimum and maximum number of days the supplier takes to deliver the goods to customer
premises after finalizing order with supplier

3.10 Identification of Murabahah Assets

This refers to the process or means by which AITEMAAD-NBP assets can be identified at the time of physical
inspection and before signing of Murabahah Contract.

3.11 Purchase Evidences

As a proof of purchase, the purchase evidence can be submitted in form invoices/bills/receipts/delivery note/
dispatch note/ inward passes etc. The related RM must clearly know that the Purchase Evidence does not
include purchase invoice only.
In cases where INVOICES are not available at the time of signing of Murabahah Contract, customer should
provide purchase evidences in the shape of Truck Receipt/ Builty/ Delivery Challan/ Gate Pass along with
customer confirmation regarding purchase price ( carrying sign & stamp of the customer) . In these cases
customer will send the Invoices to AITEMAAD-NBP upon receipt from the supplier for 100% of the disbursed
amount within 30 days of signing of Murabahah Contract.

3.12 Invoices to be issued in the format (“Aitemaad-NBP – ABC Customer”)

In cases where customer makes Indirect Payments to supplier, Invoices should be issued in the format
(“Aitemaad-NBP – ABC Customer”). In cases where invoices are not possible in this manner, the exception
should be approved and recorded in the Process Flow.

3.13 Acceptance of Murabahah Contract

RM must get the declaration and Murabahah Contract accepted by the authorized signatory of the Bank. In
case of unavailability of the authorized signatory, the concerned RM should accept the declaration and
Murabahah Contract by signing the declaration & Murabahah Contract himself and subsequently get it
accepted by the authorized signatory.

3.14 Percentage of Physical Inspection

For DIRECT Payment sub-Murabahah Transactions, the related RM / RO / Corporate Representative should
perform random physical inspections of purchased stock in 10% of the Direct payment Sub-Murabahah
transactions. The 10% Physical Inspection means that out of a total number of Sub-Murabahah transactions in
a year Physical Inspection must be conducted in 10% of the transactions i.e. if 30 Sub-Murabahah transactions
have been conducted with a particular customer during a year the physical inspection should have been
conducted in at least 03 Sub-Murabahah.

For INDIRECT Payment sub-Murabahah Transactions, the related RM / RO / Corporate Representative should
perform random physical inspections of purchased stock in 30% of the indirect payment Sub-Murabahah
transactions

Telephonic confirmation shall be taken in all the remaining cases. Physical Verification Report / Telephonic
confirmation Report (will also be enclosed with the declaration).
Chapter 4
Ijarah
 4 What is Ijarah

“Ijarah” is a term of Islamic fiqh. Lexically, it means ‘to give something on rent’.

4.1.1 Definition

Ijarah is a type of sale wherein the seller sells the usufruct of an asset/expertise/specialization for a specific
time period. In such sale the ownership of the asset is not transferred rather the right of utilizing the benefits
(usufruct) for a particular span of time.

4.1.2 Description
In the Islamic jurisprudence, the term ‘Ijarah’ is used for two different situations.

In the first place, it means ‘to employ services of a person on wages given to him as a consideration for his
hired services’. The employer is called ‘musta’jir’ while the employee is called ‘ajir’.

The second type of Ijarah related to the usufructs of assets and properties, and not the services of human
beings. ‘Ijarah’ in this sense means ‘to transfer the usufruct of a particular property to another person in
exchange for a rent claimed from him.’ In this case, the term ‘Ijarah’ is analogous to the English term ‘leasing’.
Here the lessor is called ‘Mu’jir’, the lessee is called ‘musta’jir’ and the rent payable to the lesser is called
‘ujrah’.

4.1.3 Ijarah & Ijarah Muntahia Bittamleek

i. Ijarah is the transfer of ownership of a service for an agreed upon consideration.

ii. Operating Ijarah do not end up with the transfer of ownership of leased assets to the lessee.

iii. Ijarah Muntahia Bittamleek ends up with the transfer of ownership of leased assets to the lessee.

4.1.4 There are several types of Ijarah Muntahia Bittamleek. These are characterized based on
the method by which the ownership transfers to the user:
i. For no consideration (through a gift)
ii. For token consideration
iii. For price specified in the lease
iv. For remaining amount (if lease is terminated before period)
v. Gradual transfer

4.2 Essentials of Ijarah

4.2.1 A Contract
Ijarah is a contract (AQD) just like sale therefore all elements of a valid contract (e.g., offer and acceptance,
qualification of parties etc.) must be present.

4.2.2 A particular asset

A subject matter of lease should be identifiable, existing, valuable, usable, capable of ownership/possession.

4.2.3 Transfer of usufruct

• Only the use of the asset is transferred from the lessor to the Lessee.
 • Ownership & risk of the leased asset remains with the Lessor.

• All rights and liabilities relating to ownership are borne by the Lessor.

• All rights and liabilities relating to use are borne by the Lessee.

Lessee as Ameen:

• Is liable to use the asset only for the purpose specified in the agreement.

• Is liable for loss to the asset due to his negligence

• Cannot be made liable for loss caused by factors beyond his control.

4.2.4 Specified Time Period

For the lease to be valid the period for which the usufruct is transferred should be clearly specified.

4.2.5 Agreed Upon Rental

i. The rent must be determined at the time of contract for the whole period of lease.
ii. Rental for either the entire period of lease should be fixed at the outset or should be fixed for a specific
period, based on bench-mark acceptable to both the Parties.
iii. It is permissible to decide different rent for different phases of lease.
iv. Lessor builds all the procurement expenses of the asset (e.g, freight, transportation etc.) into the cost
of the assets and then determines the lease rentals.
v. The rent or any part thereof may be payable in advance before the delivery of the asset to the lessee.
vi. The lease period shall commence from the date on which the leased asset has been delivered to the
lessee.

4.3 Ijarah as a mode of Finance (Conditions of Ijarah)

Ijarah is an Islamic alternate to leasing & not originally a mode of financing.

Leasing should not be interest-based loan or replacing interest with rent, rather it should comply with all of the
following conditions of Islamic leasing:

4.3.1 The commencement of lease unlike the contract of sale, the agreement of Ijarah can be effected for a
future date. Hence, it is different from Murabaha.

4.3.2 Rent should be charged after the delivery of the leased asset to the lessee and not from the day the
price has been paid. If the supplier has delayed the delivery after receiving the full price, the lessee
should not be liable for the rent of the period of delay.

4.3.3 Different relations of the parties

There are two separate relations between the institution and the client: one of an agent and the other of a
lessee.

4.3.4 Expenses consequent to ownership to the lessor

As the lessor is the owner of the asset, he is liable to pay all the expenses incurred in the process of its
purchase and its import to the country of the lessor for example expenses of freight and customs duty etc.
4.3.5 Lessee as Ameen
The lessee is responsible for any loss caused to the asset by his misuse or negligence. He can also be made
liable to any normally occurring wear and tear.

4.3.6 Variable Rentals in Long Term Leases

In this case the lessor has two options:

• A lease contract can have a condition that the rent shall be increased according to a specified
proportion (e.g. 5%) after a specified period (like one year).

• He can contract lease for a shorter period after which the parties can renew the lease at new terms
and by mutual consent.

4.3.7 Charity for late payment of Rent

The lessor cannot charge an additional amount in case the lessee delays payment of the rent. Penalty of late
payment is given to charity by lessee.

4.3.8 Termination of Lease

If the lessee contravenes any term of the agreement, the lessor has a right to terminate the lease contract
unilaterally. If not then it can be terminated through mutual consent only. However, in such a case he cannot
charge rentals of remaining period. Furthermore, the destruction of the asset also terminates the lease.

4.3.9 Insurance of the assets/Takaful

If the leased property is insured under the Islamic mode of Takaful, it should be at the expense of the lessor
and not at the expense of the lessee.

4.3.10 The residual value of the leased asset

Through a mutual agreement of Lease, after the expiry of the lease period, the corpus of the leased asset
cannot be transferred to the lessee, otherwise it becomes hire purchase.

It is a well-settled rule of Islamic jurisprudence that one transaction cannot be tied up with another transaction
so as to make the former a pre-condition for the other.

However, the lessor may enter into a unilateral undertaking to sell the leased asset to the lessee at the end of
the lease period. This undertaking will be binding on the lessor only.

4.3.11 Ijarah Wa Iqtina

The lessor may sign a separate promise to gift/Sale the leased asset to the lessee at the end of the lease
period, subject to his payment of all amounts of rent. The validity of this arrangement is subject to two basic
conditions:

Firstly, the agreement of Ijarah itself should not be subjected to signing this promise of sale or gift.

Secondly, the promise should be unilateral and binding on the promisor only.

4.3.12 Sub-Lease
If the leased asset is used differently by different users, the lessee cannot sub-lease the leased asset except
with the express permission of the lessor.

4.4 Difference b/w Islamic Lease & Conventional Lease

Islamic Lease Finance Lease
 Rent can only be charged after delivery of leased
assets.
Charity of late payment of rental is given to
charity.
At the end of lease term, security deposit can be
refunded to lessee.
Transfer of asset at the end of lease period to
lessee is not included in the lease agreement.
All risks and rewards of assets will be held with
bank.
Rent charged from the days the price has been
paid even if delivery is delayed.
Penalty of Late payment of rental is taken into
Income.
At the end of lease, down payment is not
refunded to lessee.
Transfer of asset at the end of lease period to
lessee is a part of the lease agreement.
All risks and rewards of assets transferred to
lessee.

4.5 Process Flow & documentation

4.5.1 Step by step Ijarah Financing:
Ijarah Financing scheme has the following basic features:

A. Written Request by the Customer

Upon the requirement for procurement of assets the customer will give a ‘Written Request for Purchase of
Asset to the Bank’ as per AITEMAAD - NBP’s standard Legal Documentation.

B. Execution of Agency Agreement, Undertaking to Lease and Insurance Agency Agreement.

 Subsequent to the Written Request by the Customer; AITEMAAD - NBP execute Agency Agreement with
the Customer for the purchase of the asset.
 Under the Agency Agreement the customer is appointed as an agent (wakeel) of AITEMAAD - NBP to
purchase asset on AITEMAAD - NBP’s behalf.
 At the same time the Customer will also execute Undertaking to Lease under which the Customer will
promise to lease the asset from the Bank after the acquisition of the asset by the Bank.
 After the finalization of cost of the asset, the Customer will request disbursement from Aitemaad -
NBP in writing along with a payment for the amount of ‘Security Deposit’ as agreed in the
Undertaking to Lease
 This amount of Security Deposit will be treated as Amanah (Hamesh Jaddiyah) before the execution of
Lease Agreement and it will be treated as Fixed Rental (advance rental for the entire term of lease)
after the execution of Lease Agreement.
 Insurance Agency Agreement will be executed between the customer and the Bank through which the
bank appoints customer as his agent to acquire Takaful for the asset.
 Aitemaad - NBP will issue a pay order in the name of the supplier of the asset.
 Customer will take possession of the asset on behalf of Aitemaad - NBP.
 Customer will obtain Takaful coverage of the asset from a Takaful Company, acceptable to the Bank;
however if any exception required, Shariah Advisor/SCD will be authorized for approval.

C. Execution of Lease Agreement

 Immediately after taking possession of the asset on behalf of Aitemaad - NBP, Customer would inform
the Bank in writing along with the Takaful Policy.

 Aitemaad - NBP will confirm the Takaful payments of the asset.

 Rental schedule will be prepared keeping in view the Takaful cost.

 Lease Agreement will be executed between the Bank and the customer.
  Aitemaad - NBP’s representative will visit the site of the customer to affix seal of Aitemaad - NBP on
the asset.

D. Undertaking to Purchase

 After the signing of Lease Agreement the customer will provide an Undertaking to purchase the asset
in case of Event of Default and Termination.

 The Undertaking to Purchase will mention a schedule of Purchase prices of assets for different
periods.

E. Completion of Lease

 Upon completion of lease period and payment of all dues Aitemaad - NBP shall gift the asset to the
Customer by signing the Gift Deed with the Customer.

F. Early Termination

 If the Customer wants to terminate the Lease pre-maturely, he shall contact RM with a request for
premature termination.

 RM shall intimate the pre-mature termination sale price to the Customer after checking the same
from the Early Termination schedule as per the Undertaking to Purchase.

 If the customer wishes to continue with the early termination, RM shall forward the Customer’s
application to CAD for processing of early termination.

 Subsequently the Customer will make early termination Sale Price amount to the Bank and a Sale
deed will be executed between the bank and the customer to evidence the Sale transaction.

4.5.2 Documentation
i. Letter of Request
ii. Lease Agreement
iii. Letter of Agency
iv. Schedule of lease Rentals
v. Insurance Agency Agreement
vi. Promise to purchase the leased assets
vii. Misc. Undertaking
viii. Promissory Note
ix. Post dated cheques

4.6 Ijarah risk & its mitigation

Transaction Stage Identified Risk Risk Rationale Mitigation

Intimation of c. Shari’ah Risk In case if client do not Customer to agree and sign
requirement by the d. Reputational Risk intimate the bank before the shari’ah approved
Client opening of LC / placement process flow.
of order, it may become a
sale and lease back
transaction.

Agency 1. Credit Risk 1. As the banks retire the 1. Securities

Period/Retirement 2. Equity Risk LC, it will be exposed to
of LC/ Purchase of 3. Market Risk Credit risk.
Asset 2. With the Purchase of the
Asset, all risk pertaining
to the ownership
transfers to the Bank.
3. In case if the clients
default to execute the
undertaking to Ijarah,
the bank would have to
sell the asset in the
market.
Taking Possession of 1. Operational Risk a) After retirement of LC,
the asset a. Clearance from clearance from custom may
Port/Payment of be delayed.
Custom Duty
b. Shari’ah Risk b) Proper possession by the
c. Reputational Risk bank may be compromised.
Delivery of Asset at 1. Operational Risk During transit, the asset may
Client’s Place subject to damages, arsenal
attack etc.
Installation Period 1. 1. The staff responsible to
install the asset may
lacks expertise
2. During Installation the
asset may be damaged.
3. Due to reasons like, law
and order situation,
absence of support
resources, installation
may be delayed.
Operational Period Operational
a. System/Machinery
Breakdown. This risk
may trigger shari’ah risk
as during the repair
period rentals has to be
stopped.
b. Power Breakdown/Load
2. Takaful, proposal
feasibility / good SWOT
analysis while
reviewing the proposal.
3. Promise / Undertaking
to Lease binds the
customer to enter into
lease agreement.
Security Deposit
(Hamish Jiddiyyah/
Advance Rental will be
taken to recover the
actual losses if any,
arising from the
customer’s breach of
promise.
a) Customer as an agent
would be responsible to
manage the retirement of
LC and clearance from the
port.
b) Customer to sign and
agree the shari’ah
approved process flow.
Takaful
1. As an Agent, client will
be responsible to
ensure proper
installation of the asset.
2. Ensure relevant clauses
in takaful policy.
3. Bank has to carry this
risk.
Operational
1. RM/branch to intimate
the relevant
departments including
Finance, accounts and
SCD.
2. Branch to ensure that
rentals are not taken
 Shedding. This will into income account.
trigger the credit risk
because client may not
be able to generate
enough revenues to pay
rentals.
Equity

a. Technology
Obsoleteness Equity
b. Market Risk due to tech.
a. Proper feasibility /
obsoleteness
SWOT is conducted at
Credit Risk
the time of Ijarah
a. Default in rental agreement.
payments. b. Bank carries this risk.
b. Default in rental
payments will effect
Credit Risk
pool’s earning that may
trigger Liquidity Risk to
a. Hamesh
pay off the depositors
Jidiyah/other
Securities to cover
actual loss.

End of Ijarah & Customer may default in Bank carries this risk.
Execution of Asset executing the promise to
Sale Agreement Purchase

4.7 General guidelines for Ijarah Financing

Following points should be taken care of during the implementation of Ijarah Financing:

a. Asset description of the Ijarah Asset

b. Determination of Total Cost of the Asset

c. Timing of signing of Lease Agreement

d. Defining Floor & Cap in the Lease Agreement

e. Treatment of Takaful premium

f. Timing of signing of Undertaking to Purchase

g. Signing of Gift Deed/ Sale Deed at the time of maturity

h. Signing of Asset Purchase Agreement in SLB transaction

i. Checking Encumbrance on Ijarah Asset in SLB transaction

j. Recording of Ijarah Assets

4.7.1 Asset Description of the Ijarah Asset

As Ijarah is done on specific and identified asset of the customer, thus proper description of Ijarah Asset
should be mentioned in the Appendix B of the Lease Agreement and its location in case of immovable
assets.

4.7.2 Determination of Total Cost of the Asset

Total cost of Ijarah asset should be determined at the time of execution of Ijarah Agreement. All direct
costs incurred in procurement should be added up to Invoice Value/ Import Cost to determine the Total
Cost of the Asset. Cost of installation should only be added to the total cost if the asset is being given on
Ijarah by AITEMAAD - NBP along with the installation.

4.7.3 Timing of signing of Lease Agreement

It should be made clear that Lease Agreement can only be signed after the assets come into a usable state.

In case Ijarah is done on an asset such as the whole plant which requires various portions to be constructed
to make the whole plant workable, AITEMAAD - NBP will sign Lease Agreement in such cases with the
customer only when the whole plant comes into a workable condition.

In cases where Ijarah is to be done on an identified machinery of a Plant (and not on whole plant);
AITEMAAD - NBP will sign Lease Agreement with the customer right after the delivery of the machine/asset
to the customer’s premises in usable condition irrespective of whether that part is installed by the
customer or not.

4.7.4 Defining Floor & Cap in the Payment Agreement

As rentals in the Lease Agreement are calculated with reference to a well known benchmark agreed upon at
the time of signing of Lease Agreement; thus following conditions should be met with regard to Rental
calculation:

 The amount of rental for the first period should be specified in Rupees Terms at the beginning of the
First Period at the time of signing of Lease Agreement.

 A balanced Floor & Cap should be defined on the benchmark to avoid uncertainty

4.7.5 Treatment of Takaful premium

AITEMAAD - NBP should bear the Takaful Premium of the asset at any given time. AITEMAAD - NBP should
reimburse the Takaful Premium to the customer, if the customer has taken takaful as an agent of the bank.
Hence, AITEMAAD - NBP should include the premium reimbursable to the customer as part of the First rental
due after payment of Takaful Premium each year.

4.7.6 Timing of signing of Undertaking to Purchase

Undertaking to Purchase (UTP) should be signed after/ along with signing of Lease Agreement by the
customer.
4.7.7 Signing of ‘Gift Deed’ / Sale Deed at the time of maturity

Ijarah Asset is redeemed by customer’s purchase of asset from AITEMAAD - NBP through a Sale Deed in case
of early termination and Gift Deed in case of normal maturity.

4.7.8 Signing of Asset Purchase Agreement in SLB transaction

In SLB transactions, Asset Purchase Agreement should be signed before signing of Ijarah Agreement with the
customer.

4.7.9 Checking Encumbrance on Ijarah Asset is SLB transaction

In Sale and Lease Back (SLB) transactions where assets are already encumbered should be followed for
assessing the requirement of NOC as per shariah guidelines.

4.7.10 Recording of Ijarah asset

As per the Islamic Financial Accounting Standard (IFAS) – 2 the assets financed through Ijarah mode shall be
recorded as asset in the books of the bank. Hence it must be made sure that the assets are recorded in
AITEMAAD - NBP’s books; in case of SLB transactions the assets shall be removed from the customer’s books
and recorded in AITEMAAD - NBP’s books.

4.8 Scope of the Product

IBG shall use Ijarah to facilitate financing requirements of Retail, SME and Corporate customers for their
Short-term to long term needs. If at any point there is a long-term financing need, IBG can use Ijarah for
entertaining such needs if it is a viable proposition.

IBG shall use Ijarah mode for following financing needs:

 Vehicle financing
 House Financing
 Plant & Machinery Financing

4.8.1 Product Overview

In general, terms, we can say that Ijarah is a simple leased (Rent based) transaction, where the customer
acquires the machinery/usufructs of assets on rent. At the end of tenure, the Bank will sell/gift the subject
matter to the customer (depending upon contract). These are the two different contracts, should not be
contingent with each other.

The rules of Ijarah are very much analogous to the rules of sale, because in both cases something is
transferred to another person for a valuable consideration. The only difference between Ijarah and sale is

that in the latter case the Ownership of the property is transferred to the purchaser, while in the case of
Ijarah, the Ownership of the property remains with the lessor, but only its usufruct i.e. the right to use it, is
transferred to the lessee.

4.8.2 Tenor for Ijarah Financing

Ijarah Financing will be offered to the sectors and for the tenors as per *NBP policies and updates thereof,
circulated from time to time.

4.8.3 Pricing Rationale

As market practice, IBG will use KIBOR as a benchmark until such time that another pertinent benchmark
exclusive for Islamic Banks is available.
4.8.4 Fee and Expenses
All expenses incurred by the IBG-NBP in acquiring the machinery/ assets like freight, custom duty, Takaful
expenses etc. may be included in ijarah price of goods/ commodity.

4.8.5 Payment Mode

The Payment in Ijarah mode will be collected as rent on scheduled basis. However at the end of tenure, the
Bank will sell/gift the subject matter to the customer (depending upon contract).

4.8.6 Simple Illustration

Cost of Machine/Plant A Rs.500,000 Takaful Cost D (X% of A) Rs.10,000

Financing require for Tenure 3 Years (36 Registration E Rs.10,000
months)
Security Deposit B (10%) Rs.50,000 Freight F Rs. 2,000
Require Financing Amount C=A-B All above expenses should be borne by lessor and can be
Rs.450,000 amortized/spread over the lease period
Profit rate: 10% Rental calculation will be made on outstanding balance(i.e.450,000)
Monthly Rent to be paid by customer Disclaimer: Pricing of Rental depends upon many factors
approximately Rs.15,300 such as IRR, Takaful, etc.
Factors included in Total Rental Amount = Principal+ Profit+ Takaful Expense+ Misc. expense
*Credit policy for exclusive IBG need to be developed to cater all type of shariah compliant financing facility
4.9 Application of Ijarah

1 Ijarah - Plant & Machinery A medium to long-term Islamic leasing facility for plant and machinery.
The subject matter of Ijarah may be purchased locally or imported by
the customer as an agent of the Bank.

2 Ijarah – Commercial Vehicles A medium to long term Islamic leasing facility for vehicles that are used
for personal/ business/ commercial purposes.

A medium to long term Islamic leasing facility for plant and machinery
3 Ijarah - Sale & Leaseback for
where asset is purchased from the customer and leased back to him.
Plant & Machinery

Note: This is not a regular financing facility and cannot be offered

to Customers merely for liquidity generation. Moreover, in this case
the customer cannot purchase the asset from the Bank in the first
year of Lease. Specific approval from Shariah Advisor is required in
all the cases.
 Chapter 5
Mudharabah

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 5 Definition

“Mudharabah” is a kind of partnership where one partner gives money to another for investing in profitable avenues.

The investor (fund supplier) is called “Rabb-ul-Mal” while the person who utilizes this fund (the fund manager) is called
“Mudharib” who is exclusively responsible for management of the business.

The investor (fund supplier) is called “Rabb-ul-Mal” while the person who utilizes this fund (the fund manager) is called
“Mudharib” who is exclusively responsible for management of the business.

5.1 Main Features

5.1.1 Mudharabah Capital

5.1.1.1 The capital of Mudharabah should be in form of known cash as a matter of principle;

5.1.1.2 The capital should be in hand, therefore, receivables (debt etc.) can not be capital of Mudharabah;

5.1.1.3 The capital should be handed over to Mudharib

5.1.2 Profit / Loss Distribution

5.1.2.1 The Mudharabah contract should mention profit sharing ratio in defined and clear terms;

5.1.2.2 The profit sharing ratio should be specific, of the expected profit

5.1.2.3 Unknown ratio or ratio attributed to future settlement or ratio linked with the capital (in terms of x% of the
capital) is not allowed and the transaction becomes void;

5.1.2.4 A lump sum settlement as profit is not allowed.

5.2 Types of Mudharabah

5.2.1 Restricted Mudharabah
a) Restricted Mudharabah contract is a kind of Mudharabah in which the capital provider restricts the Mudharib to
perform business as per limitation imposed by him;
b) These restrictions may be for place (geographical restriction), particular type of investment (sector wise restriction)
or any other restriction;
c) The condition for such Mudharabah is that the restrictions should not unduly constrain the Mudharib from general
business operations;
d) Real Estate Mudharabah, Oilfield Mudharabah and Rental Mudharabah are examples of this type.
5.2.2 Unrestricted Mudharabah
a) Unrestricted Mudharabah contract is a kind of Mudharabah in which the capital provider (Rabb-ul-Maal) does not
put any restriction the Mudharib;
b) In this type of Mudharabah, Mudharib has more freedom in doing business in different sectors;
c) General Mudharabah and Investment Mudharabah are examples of this type.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 5.3 Capacities of Mudharib
5.3.1 Capacities of Mudharib
Mudharib has different capacities for which rules are different. Listed down are his roles:
Ameen (trustee):
a) Mudharib holds money and assets of Mudharabah as trustee;
b) Therefore, he is responsible for management of assets honestly;
c) In case of actual loss he is responsible for nothing;

Ajeer (employee)

a) Mudharib gets a fee if Mudharabah becomes void due to any reason

Wakeel (Agent):

a) Mudharib manages Mudharabah as an agent of owner;

b) Therefore his actions are considered as of Rabb-ul-Maal;

c) Actual loss is born by Rabb-ul-Maal in case it happens;

Shareek (partner):

a) Mudharib becomes partner in the profit that Mudharabah generates;

Zamin (liable/guarantor):

a) In situation of loss due to misconduct / negligence Mudharib has to bear it;

5.4 Participation from Mudharib

5.4.1 Mixing of funds by Mudharib

i. The basic feature of Mudharabah is that the Mudharib performs only business operations and does not add capital;

ii. The capital is provided by Rabb-ul-Maal and the Mudharib is responsible for the management only;

iii. But the Mudharib may also add capital into the business of Mudharabah with permission of Rabb-ul-Maal ;

iv. In such cases Musharakah and Mudharabah are combined;

v. For example, “A” gave to “B” Rs.100,000/- in a contract of Mudharabah. B added Rs. 50,000/- from his own pocket
with the permission of A;

vi. This type of partnership will be treated as a combination of Musharakah and Mudharabah;

vii. Here the Mudharib may allocate for himself certain percentage of profit as partner (Shareek), and at the same time
he may allocate another percentage for his management and work as a Mudharib.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 5.5 More than one Rabb-ul-Maal
i. Mudharabah can be between two persons: Rabb-ul-Maal and Mudharib;

ii. But Rabb-ul-Maal may also be more than one;

iii. If a Mudharabah starts by provision of funds from one Rabb-ul-Maal and after the start Mudharib wishes to add
some more funds from others, this would be allowed if Rabb-ul-Maal permits;

iv. In such case all funds providers (Arbab-ul-Maal) are partners among themselves;

v. The share for Rabb-ul-Maal will be divided among them as per their contribution ratio;

5.6 Termination of Mudharabah

i. The contract of Mudharabah can be terminated at any time by either of the parties;

ii. This termination should be with consent of concerned parties;

iii. A notice to the other party is also sufficient if it was agreed at the time of inception of Mudharabah;

iv. If all assets are in form of cash and some profit has been earned on the principle amount, it shall be distributed
between the parties according to the agreed ratio;

v. If the assets of the Mudharabah are in other form the Mudharib shall be given an opportunity liquidate them and
the actual profit may be determined after liquidation

5.7 Banking application

5.7.1 Scope of Mudharabah for Banking System:

i. Mudharabah is not a vastly practiced Islamic mode of financing by Islamic banks due to certain reasons;

ii. However, Mudharabah as a mode of financing used by Islamic Banks for the following purpose:

iii. Relationship of Islamic banks with depositors, depositors provide deposits to bank as Rabb-ul-Mal, these
deposits are to be invested by Islamic bank as Mudharib;

5.7.2 Liability side

i. All types of saving / investment accounts;

ii. Inter- bank acceptance and placement;

iii. Term Finance certificates;

iv. Certificate of investment;

v. Special rate deposits;

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 5.8 Step by Step Profit Distribution

Step 1: Calculate the Weighted Average Balances

• Weightages Average Balance Weighted Average Balance 0.7399 x 3,500,000.00 =

2,589,650.00

• Get the relevant share of each slab’s weighted average balance share in total weighted average.

Step 2: Calculate the Total Available Funds for Investment (TAFI)

a. Equity includes the following

• Bank’s Equity

• Current Account

b. Remunerative Deposits

• Total of PLS & TDRs

c. The Aggregate of a & b is TAFI

d. Each category’s share in TAFI should be calculated

Step 3: Profit earned and its Distribution

a. Know the Profit earned on the Asset Pool

b. Distribute the total earned profit among the following as per their share in Total Investment.
– Bank’s Equity
– Current Account
– Total Remunerative Deposit
c. Profit Earned on Total Remunerative Deposits to be further segregated as per Rabbul Maal and Mudarib Profit Sharing
Ratio.
d. Profit on Rabbul Maal to be distributed as per their share in Total weighted Average Balance.
Step 4: Calculating the Daily Average Balance

For example the balance of a depositor have the following variable day end balance:

Date Day End Balance

1 to 09 April 2015 105,000.00
10 to 21 April 2015 150,000.00
22 to 28 April 2015 175,000.00

Now to calculate the daily average balance:

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 1-9 = 9 days >> 105,000 x 9 = 9454,000/-

10-21 = 12 days >> 150,000 x 12 = 180,000/-

22-28 = 7 days >> 175,000 x 7 = 1,225,000/-

Step 5: Calculating the RoI

Divide the profit earned by the Total size of the Deposit Slab (not the weighted average balance of the slab)

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 Illustration: Assume Deposit Pool consist of 6 Depositors and IBG Fund. Profit and loss will be distributed as per flow chart
and diagram:
Investment Proportion Amount In Percentage
Depositors(Rabul Maal) 9,000,000 90%
IBG Fund 1,000,000 10%
Deposit Profit case Loss case
Category Rabul Maal share 495,000 Loss Amount (1,100)
Investment Weightage Loss Proportio
  Amount s Wt. Avg. Investment Profit Amount Weightage n Loss Amount

As per investment Amount on

A 1,000,000 0.5 500,000 29,118 1 1 (90)

the day of loss realization

B 1,000,000 0.75 750,000 43,676 1 1 (90)
C 1,000,000 0.75 750,000 43,676 1 1 (90)
D 2,000,000 1 2,000,000 116,471 1 2 (180)
E 2,000,000 1 2,000,000 116,471 1 2 (180)

F 2,000,000 1.25 2,500,000 145,588 1 2 (180)

IBG
Fund 1,000,000   -     (100)
  10,000,000   8,500,000       (810)
Profit Distribution Loss Distribution
Deposit Pool (10Mn) Deposit Pool (10Mn)

Gross Income 1900

Gross Income 110,000

Less: Direct expenses

Less: Direct expenses
3,000
9,000

Less: PER (if

applicable) Net Loss (1,100)
Net Income 101,000
Add: contributed
from PER Rs. 100

Pool Income Pool share

IB Income IB share
10,000 (100) (900)
90,000
Add: contributed from
IRR (already
maintained) Rs.90
Mudarib Rabul Maal Mudarib Rab-ul-Maal
Less: IRR (if
45% 55%
applicable) 0% 100%

Upto 1% share

Loss will be shared as per actual

Profit will be investment amount and not the weighted
distributed as per Average Balance at the date when loss is
Weightages recognized. Usually no weightages will be
_________________________________________________________________________________________________
announced applicable; however we can say that loss
Institute of Business Management will be shared among depositors by
Korangi Creek Road, Karachi, 75190, Pakistan.
applying weightage 1.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 5.9 Early Redemption (Pre mature encashment)
In Term Deposits, if Rabb-ul Maal would like to redeem his share before maturity the profit will be paid with respect to the
applicable category based on early redemption (pre mature encashment) schedule.
The premature termination before liquidation of the Pool shall be handled as sale and purchase of the depositors’ share in
the respective pool.
In case, where the term deposits is reduced to the lower slab and profit paid earlier at a higher weightage shall also be
adjusted through sale of the share in the asset pool at a discount
In case of Early Redemption (pre mature encashment) of Term Deposits, the applicable weightage on such Term deposit
shall be that of term deposit of nearest completed tenure. For instance, a five-year’s term deposit liquidated after one year
shall be assigned the same weightage applicable on one year term deposit.
Schedule for Premature Encashment
All IPTDC will be redeemed according to the below schedule and Bank has to get signature from the
customer before encashment.

5.10 Risk Management Grid for Liability Products

Before analyzing the risk to which bank is exposed to in Liability Products, it is deemed necessary to briefly discuss the
profiles of both type of account holders.

S. No Current accounts PLS Account

1 The principal amounts deposited are
guaranteed without any rights to share in
profits.
2. A sound repayment capacity is required to
meet full cash withdrawal needs as and when
they arise.
3. Current account holders do not share any risk
borne by the Islamic Bank.
The principal is not guaranteed as the PLS depositor share
the risk of IBI’s business. They share in profit and bear
losses to the extent of their investments.
Withdrawal may subject to lower than expected returns,
Shariah noncompliance and others.
PLS deposit holders do not share in the risks on assets
financed by current accounts, which are borne by
shareholders alone.

Relationship Current /
Possible Risk Description Mitigation
Stage PLS
At Inception 1. Operational Risk Current a. Sources of Funds (for In addition to general KYC
a. Due diligence / KYC Account company accounts only) may requirements, Branch to ensure
Risk be against Shari’ah principles. Shari’ah specific KYC factors,
b. Shari’ah / b. NA including nature of business.
Reputational Risk

PLS a. Sources of Funds (for a. In addition to general KYC

account company accounts only) may requirements, Branch to ensure

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 be against Shari’ah principles.
b. Customer’s unawareness
about Risks he is exposed to as
Rabb ul Maal.
c. Commitment/over
commitment for profit rate.
Operational 1. Liquidity Risk Current 1. Liquidity Risk:
Period 2. Fiduciary Risk Account / a. Liquidity shortfalls w.r.t
3. Rate of Return Risk PLS abnormal cash
a. Displaced inflows/outflows from asset
Commercial Risk and liability side
respectively.
b. Lack of Shari’ah Compliant
Liquidity Management Tools
2. Miscalculation /Misjudgment
of the risk appetite and
resultantly develops
investment policies that
ignore PLS depositor’s
expectations/priorities.
3. Customer(s) may opt for
partial/full withdrawal due to
lower than expected returns,
concerns about financial
condition of the IBI and non-
compliance with Shari’ah
principles.
_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
Shari’ah specific KYC factors,
including nature of business.
b. IB EM / Branch to nominate the
relevant staff for IB training. Further,
IB EM/ Branch to ensure that
customer understands the basics of
the products and underline risks.
c. IB EM / Branch Manager to ensure
that relevant staff shall not over
commit / communicate any facts
that cause the depositor to establish
unreasonable high expectations.
1. IBG EM / Treasury/Finance to
develop liquidity management
framework that should at least
include:
a. Maturity Ladders based on
appropriate time line.
b. Criteria for classifying cash
flows, including behavioral
methods.
c. Effective Net Funding
Requirement (NFR) that shall
also include internal
assessment of PLS depositors’
expectations and incentives.
d. Mechanism of periodical cash
flow analysis under various
market scenarios and
conditions.
e. IBIs shall assume liquidity risk
commensurate with their
ability to have sufficient
recourse to Shariah-compliant
funds to mitigate such risk.
2. IBIs shall establish a
comprehensive risk management
and reporting process to assess
the potential impacts of market
factors affecting rates of return
on assets in comparison with the
expected rates of return for PLS
deposit holders.
 Chapter 6
Musharakah

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 6.1 Musharakah
6.1.1 Definition
A Musharaka contract is an agreement where two or more parties (for example an Islamic bank and its clients) agree to
contribute to the capital - in cash or in kind, no debt is accepted - of the partnership in equal or varying amounts to
establish a new project or share in an existing one.

6.1.2 Terminology of Musharaka

i. Musha means undivided ownership of the asset.

ii. Sharikah or Shirkah ( ‫ ) ﺷرﻛﺔ‬in Arabic means partnership.

iii. Musharakah, commonly used now in Islamic finance, means the act or contract of striking up a partnership;

iv. In classical Islamic law, partnerships are referred to as Shirkah; however, the concept of Musharakah is slightly
limited in relation to the concept of Shirkah, which is used in a wider sense;

v. All modes of “Sharing” or partnership are termed as “Shirkah” in the terminology of Islamic Fiqh, while the term
“Musharakah” is not found in the books of Fiqh. It is more commonly used in commercial context.

6.1.3 Types of Musharaka

The term Musharakah has been introduced recently by those who have written on the subject of Islamic modes of
financing and it generally refers to two particular type of “Shirkah” namely:

6.1.3.1 Shirkat-ul-A'qd (‫) ﺷﺭﻛﺔ ﺍﻠﻌﻘﺪ‬

Shirkat-ul-Aqd is simply a partnership which is executed through a mutual contract for commercial purposes. It can also be
referred to as a joint commercial enterprise or activity.

6.1.3.1.1 Shirkat-ul-Aqd is divided into three types:

i. Shirkat-ul-Amwal – Partnership in capital

ii. Shirkat-ul-Aamal – Partnership in work
iii. Shirkat-ul-Wujooh – Partnership in reputation and goodwill;

6.1.3.2 Shirkat-ul-Milk ( ‫) ﺷﺭﻛﺔ ﺍﻠﻤﻠﻚ‬: A property or asset jointly owned by two or persons for any purpose other
than business.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 6.1.4 Each of these three Shirkah i.e. Amwal, Aamal and Wujooh are further divided into two sub-types:

6.1.4.1 Shirkat-al-Mufawada ( ‫)ﺍﻠﻣﻔﺎوﻀﺔ ﺷﺭﻛﺔ‬: Partners' capital, management, profit, and risk in absolute equal
amount. This types is not common now.

6.1.4.2 Shirkat-ul-Inan (‫)ﺍﻠﻌﻨﺎﻦ ﺷﺭﻛﺔ‬: Partners’ share capital, management, profit and risk are not equal and may
differ for each partner. This is common type of partnership.

SHIRKAH (‫)ﺍﻠﺷﺭﻛﺔ‬

Compul
sory
Shirkat- Optiona Shirkat-
ul-A'qd l ul-Milk

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 6.1.5 Structure of Musharaka
6.1.5.1 Two types of structure Musharakah are possible:

6.1.5.1.1 Permanent Musharakah:

i. It is a Musharakah / partnership of permanent nature;

ii. Partners establish the partnership for retention of their shares in Musharakah i.e. the Musharakah is an ongoing
concern;

6.1.5.1.2 Temporary (Redeemable) Musharakah:

i. It is a Musharakah / partnership for a specified time period;

ii. During or after this specific period it is redeemed by one partner;

iii. Redemption of Musharakah will take place through sale of shares from one partner to other partner or third
person.

iv. Redeemable partnership is also called ‘Diminishing Musharakah’;

6.1.6 Rules of Musharaka

6.1.6.1 Capital of Musharakah:

i. It should in cash or kind form;

ii. The value should be agreed upon in case of kinds;

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

iv. Should be known either in advance or before the time of profit/loss determination;

v. Should be under the disposal of the manager;

vi. Debt alone cannot be contribution in Shirkah;

vii. It can be varying in quantity among the partners;

6.1.6.2 Management of Partnership:

i. In Principle each partner has right in Musharaka management;

ii. The partners may appoint a managing partner by mutual consent;

iii. Some of the partners may decide not to work for the Musharaka and work as sleeping partner;

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 iv. It is not allowed to specify a fixed remuneration to a partner Musharaka who manages funds or provides some form
of other services, such as accounting;

v. However, it is permissible to give him a greater share of profit than he would receive solely on the basis of his share
in the partnership capital;

vi. It is also permissible to appoint him as an employee through separate agreement and giving him remuneration for
his services;

6.1.6.3 Profit Sharing ratio:

i. Ratio or the basis for sharing profit should be decided in the beginning of partnership;

ii. Profit should be allocated in percentages of earning (x% of Net Profit) and not in a sum of money (lump sum) or a
percentage of the capital or investment (x% of participated amount / ROI);

iii. It is not necessary for sharing profit according to proportionate capital contribution;

iv. A sleeping partner cannot share in the profit more than the percentage of his capital;

v. The partner may at the later stage agree to change the profit sharing ratio, and on the date of distribution, a
partner may surrender a part of his profit to another partner;

vi. One partner can cap his share of profit - Tiers profit.

vii. Tiered profit sharing ratios can also be agreed;

viii. Profit ratio can either be fixed or variable according to the tiers;

ix. The final allocation of profit is not allowed to be based on expected profit;

x. However, it is permissible to distribute a provisional profit, subject to final settlement after actual or constructive
liquidation;

xi. It is permissible for partners to decide not to distribute a portion of profit – Creation of various reserves.

6.1.6.4 Sharing of Loss

i. As a matter of principle the loss has to be shared according to the ratio of capital contribution;

ii. Partners are not allowed to adopt any other mechanism except the mechanism that ensure distribution of loss
among partners on pro rata basis;

iii. Any other arrangement, even agreed upon by partners, will be invalid and void;

6.1.6.5 Estimated expenses

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 i. Finalization of expenses through estimation (thereby estimating the profit) in Musharakah is not allowed;
ii. Expenses should be actual;
iii. Therefore, estimation of expenses, based on percentage of the capital or any other basis, are not allowed;
iv. However, projection / estimation on the basis of final settlement is allowed;
v. Any difference in actual and estimation should be adjusted

6.1.6.6 Guarantee

i. Guarantee of capital, part of capital, profit or part of profit from one partner to other is not allowed;

ii. Such guarantee if given becomes invalid;

iii. Guarantee or Security can be asked for only misconduct or negligence of partner(s);

iv. A third party may provide a guarantee to make up losses of one or all partners;

v. This third party should not have stake in guaranteed entity more than 33%;

6.1.6.7 Termination
i. Musharaka terminates in any of the following event:
a. Death of a partner during the Musharaka;
b. Heirs of the deceased partner have option either to draw the share of the deceased from the business, or
to continue with the contract of Musharakah;
c. If any one of the partners becomes insane or otherwise becomes incapable of effecting commercial
transactions, the Musharaka stands terminated.
ii. In normal course of business, every partner has a right to terminate the Musharaka at any time after giving notice
to other partner;
iii. In this case, if all the assets of the Musharaka are in cash form then they will be distributed pro rata between the
partners;
iv. In case they are mixed assets the partners may agree either on:
a. Liquidation of the assets in open market (market price); or
b. Physical distribution of the assets among partners; or
c. Internal liquidation i.e. purchasing from one partner share of other at any agreed price between them;

6.1.6.8 In case of dispute on termination of Musharakah following is the way of resolving the disputes:
i. In case of any dispute between partners on liquidation and distribution of the non-liquid assets, the distribution
shall be preferred;
ii. Any of partition, separation or distribution is right of partners. Every partner can ask for any of these;
iii. However, if the assets are not separable or divisible, such as machinery, then the liquidation is the solution;

6.1.6.9 Termination with One Partner

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 i. In case a partner wishes termination of the Musharaka, while others do not, this can be achieved by mutual
consent;
ii. The partners who wish to run the business may purchase the share of the other partner who wants termination;
iii. The reason is that the termination of Musharaka with one partner does not imply its termination between other
partners;
iv. However, in this case, the price of the share of the leaving partner has to be determined by mutual consent;
v. In case of dispute on the valuation of the share the leaving partner may compel other partners on the distribution
of the assets;
vi. However, if they are not divisible then the partner may an arbitrator to solve the dispute;

6.1.6.10 Security / collateral

i. A security, collateral or guarantee could be asked in a Musharakah / Sharika contract;
ii. But since the partners maintain the assets of the Sharika on a Amanah (trust) basis therefore no partner is held
liable for any loss except in cases of misconduct, negligence or breach of contract;
iii. A third party may provide a guarantee to make up a loss of capital of some or all partners. This guarantee is
bounded with the conditions that:
a. The legal capacity and financial liability of such a third party as a guarantor has to be independent from the
Sharika contract;
b. The guarantee should neither be provided for consideration nor linked in any manner to the Sharika
Contract;
c. The third party guarantor should not own more than a half (33% in a viewpoint) of the capital in the entity;
d. The guaranteed entity should not own more than a half of the capital in the entity that undertakes to
provide a guarantee;

6.1.7 Concept of limited liability

i. In the modern economic and legal terminology it is a condition under which a partner, a shareholder or a group of
shareholder of a business secures himself from bearing a loss greater than the amount he has invested in a
company or partner-ship;

ii. This is called “Limited liability” or “Juridical Entity”;

iii. What is its Shari'ah status?

iv. Scholars have quoted some instances from Islamic Fiqh where the Muslim jurists have affirmed a legal entity,
similar to that of a juridical person;

v. These examples would show that the concept of 'juridical person' is not totally foreign to the Islamic jurisprudence;

vi. A juridical entity of a joint-stock company may be accepted on the basis of these examples;

vii. No any serious Shari'ah objection is likely to be raised against this concept;

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 6.1.8 Modern partnerships
i. In current times many types of partnerships are common;

ii. Scholars are of view that even though these types have no mention in Islamic Fiqh but they are also not violation of
any law of Islam;

iii. Therefore, these types may be accepted is Islam as well;

iv. The condition for acceptability is that these partnerships should follow the law of 'Rewards and responsibilities' of
partners;

v. Capital could not be guaranteed in any of these types;

vi. Loss must be on pro rata basis;

vii. These companies may be of limited liability nature as we discussed in previous slide;

6.1.9 Banking application

i. Musharakah is top preferable mode of financing recommended by Islam;

a. It one of the important factors that help in achieving ‘distribution of wealth’ which is a key feature of
Islamic financial and economic system;

b. As Mudarabah, Musharakah is also not a vastly practiced Islamic mode of financing by Islamic banks due to
certain reasons;

ii. However, Musharakah could easily be used as a vast mode of financing for almost every financial need;

iii. Below are some fields where this mode can easily be applied:

a. Long-term Finance;

b. Running Finance (limited scope);

c. Investment Banking;

d. Project Financing;

e. Private Equity Investment;

f. Redeemable capital investment.

iv. Due to continuous demand Islamic banks are in search of ways and techniques to use Musharakah as a mode of
financing;

v. Some Islamic banks have successfully executed Musharakah with limited use;

vi. Such Musharakah were of limited time period and were executed through specific transactions;
_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 vii. These Musharakah could be classified as ‘transaction based Musharakah’;

viii. Under this way of partnership Islamic banks provided portion of required capital for an order to be manufactured
and delivered during certain period;

6.2 Diminishing Musharakah

6.2.1 Definition

Diminishing Musharakah, also known as Shirkah tul Mutanaqisah is a form of co-ownership in which two or more partners
share the ownership of business or tangible asset(s) in identified proportion where one or more partners undertake to buy
the shares of the partners gradually in instalments until the title of such business or asset(s) is completely owned by the
buying partner(s).

6.2.2 Description

The Diminishing Musharakah is a permissible participatory Shariah compliant mode of finance which is developed near past
extracted from Musharakah mode of finance. This mode of finance complies with Islamic ethics and consideration. It is also
an optional (al-khiyar) contract which tends to reduce or remove Gharar in managing business by making one partner the
sole owner of that business.

In Diminishing Musharakah, the participants (financier and its clients) in either the joint ownership of the asset or joint
commercial enterprise have an agreement that the financier will sell its share to the client which is divided into number of
units to be sold one by one in specific interval. The process of buying the unit shares increases the share of the client until
he becomes the sole owner of that property or commercial enterprise.

6.2.3 TYPES AND STRUCTURE OF DIMINISHING MUSHARAKAH

As in Musharakah, Diminishing Musharakah is also divided into two types:

i Diminishing Musharakah in Shirkat-ul-aqd (joint venture)

ii Diminishing Musharakah in Shirkat-ul-milk (joint ownership)

Diminishing Musharakah in Shirkat-ul-aqd (joint venture), here, two partners start up a business for the purpose of earning
profit whereby one partner undertakes to buy the others shares gradually in specific interval. In this contract, no profit or
principal is guaranteed since the business can go into bankruptcy. In this situation, there should be two different
agreements; one is shirkat-ul-aqd agreement between the two partners with its terms and conditions, agreed profit ratio
and known investment contribution of each partner. The other agreement is that, one partner will purchase the share of

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 the other partner using the market price during the time of purchase and not time of agreement. It should be noted that
this promise should not be a part of Shirkah agreement but if it is not fulfilled, it can be forced by the court of law.

Diminishing Musharakah in shirkat-ul-milk (joint ownership), two partners purchase the property with the purpose of one
or both to use it or rent it to an outsider, one partner undertakes to purchase the share of the other gradually. This contract
will specify the ration of investment of each partner. The independent agreement of one partner promise to purchase the
share of the other partner on the basis of offer and acceptance will be signed. In Shirkat-ul-milk, the principal can be
guaranteed and the unit price can be fixed. If both partners decide to rent out their property to an outsider or one partner
decides to rent out his share to other partner, a separate Ijarah agreement with all the rules related to Ijarah will be signed.
The basic structure of diminishing Musharakah has three main components which are:

i. Joint ownership of the financier and the client

ii. Customer as a lessee of the financier’s share pays rent

iii. Redemption of the share of the financier by the customer

6.2.4 RULES OF DIMINISHING MUSHARAKAH

The following basic rules are to be considered while making arrangement of Diminishing Musharakah:-

i. Apart from applying the concept of halal and haram, Diminishing Musharakah can be formed only in tangible assets
(specified asset) and not the whole business.

ii. Having separate agreements on stages in the process of Diminishing Musharakah, three main stages, creation of
Shirkah agreement, arranging the rent agreement through Ijara basis and agreement for purchasing the shares
gradually, should be treated differently.

iii. The proportion of investment shares should be clearly identified, the expenses regarding ownership shall be borne
jointly by the partners to the proportion of their investment, risk and reward and loss if any, shall be borne to the
proportion of their level of their level of investment shares as well.

iv. The amount of periodic payment would go on diminishing rate with the purchase of ownership units by purchasing
co-owner where each periodic payment shall constitute a separate transaction of sale

v. In case the co-owner fails to honor his undertaking regarding the periodic payment and purchase or sale of units as
the case may be, the asset shall be sold in open market and the co-owner aggrieved by such failure shall be entitled

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 to the loss or gain as the difference between the market price and the price agreed in the undertaking. The co-
owner shall also be entitled to recover the outstanding rental for the whole period that the other owner has
actually used the asset.

6.2.5 AITEMAAD’S DM PRODUCT FEATURES

6.2.5.1 PRODUCT OVERVIEW

Diminishing Musharakah (DM) is a concept, wherein the Bank and its client enter in a joint ownership in an asset. The
Bank after establishing this partnership leases out its portion/share to the client at a rent agreed upon using a
benchmark through a separate Rental Payment Agreement. Further, the client also agrees to purchase the share of
the Bank in small unit at periodical intervals. For this purpose, the share of the bank is divided into small units. The
customer over an agreed tenor purchases all the units of the Bank’s share through independent sale contract
ultimately taking the complete ownership of the said asset.

Thus, DM Diminishing Musharakah is a hybrid arrangement of multiple mode; Partnership, Ijarah and sale contracts.
While using DM as a long-term financing product the customer and the Bank enters into a joint ownership in a
particular asset. The Bank later leases its share to the customer on rent. The customer also agrees to purchaser the
share of the Bank periodically until the share of the Bank is completely transferred.

6.2.5.2 TENOR FOR DM FINANCE

DM facility will be offered to the sectors and for the tenors as mentioned in the NBP Credit Policy Manual and
updates of the same, circulate from time to time but not contradicting to Shari’ah Principle.

6.2.5.3 PRICING OF UNIT SHARES AND RENTALS

The unit price shall be the principle outstanding and any expenses that is part of the cost. The customer with the
consent of the Bank shall have an option to buy multiple units as balloon payments.

As market practice, the bank will use KIBOR as a benchmark to determine the rent, until such time that another
pertinent benchmark exclusive for Islamic Banks is available. The mechanism used will be the outstanding amount
multiplied by the sum of benchmark and bank’s spread.

Further Ijarah’s salient features will be adhered along with admissible of fixation of rentals for specified period with
the provision that rentals are agreed and fixed in advance and in absolute terms for periodical intervals.

6.2.5.4 FEES AND EXPENSES

 All the expenses/fee relating to documentation, routine maintenance of asset shall be borne by the customer.
 All the expenses relating to the registration and taxes of the ownership and major maintenance of the asset will be
first capitalized and then will be shared according to the ownership ratio of the asset between the partners.

6.2.5.5 TAKAFUL

 Takaful will be as per the Bank’s Insurance policy until a Takaful policy is formulated and implemented.
_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 Takaful will be in the joint name of IBG, NBP and the client and the cost of Takaful must be borne by both as per
remaining proportionate share of investment.

6.2.6 SHARI’AH GUIDELINES

6.2.6.1 GENERAL RULES TO DIMINISHING MUSHARAKAH

1. The general rules of Shirkat-ul-Milk are applicable to Diminishing Musharakah.

2. The formation of Shirkat-ul-Milk be it optional or mandatory should be documented/registered officially and
legally.
3. In Shirkat-ul-Milk the share of each partner shall be determine at the time of commencement of partnership at the
value as evaluated by the evaluator or by mutual consent of the partners.
4. An undertaking (unilateral promise) to purchase/sell of shares of partners at face value, book value, agreed value or
market value shall be obtained.
5. The joint owner in a Shirkat-ul-Milk shall indemnify loss of the other owner, in case of misconduct, negligence and
breach of contract.
6. It is permissible for the joint owners to assign the management of the joint asset/property to any partner or
appoint any manager to other than the joint partner.
7. The remuneration for managing shall be included in the expenses of the Shirkat-ul-Milk.
8. The joint owner in Shirkat-ul-Milk shall provide personal guarantee and/or pledge in order to cover in case of
misconduct, negligence or breach of contract.
9. Expenses such as Taxes, levies, fees related to the joint ownership shall be borne by all joint owners in proportion
of ownership.
10. The Bank as a joint owner shall rent out (Ijarah) its share to the customer for a specific amount and duration.
11. The general rules of Ijarah shall be applicable to the arrangement of renting out the share in joint ownership.
12. Various contracts and undertaking/promises in the DM arrangement must be independent of each other and must
be executed sequentially as per procedure.
13. In case, the purchaser fails to honor his promise with regard to periodic rental payment and/or purchase of unit of
joint owned property it will be dealt as per the Bank’s rules and policy nothing contradictory to Shariah.

6.2.7 STEP BY STEP DM PROCESS

1. The Customer approaches the Islamic Banking Branch (IBB) with the request (on prescribed form) for availing long-
term financing for their business /commercial operations with an understanding that he will also invest some
amount towards this investment.
2. The IBB/Relationship Manager will evaluate the request. If the request is satisfactory, he will send it to the Shari’ah
Compliance Department (SCD) along with all requisite documents
3. The SCD reviews the request, if it is unsatisfactory; the application/proposal will declined. The RM will inform the
customer subsequently.
_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 4. In case of any discrepancy/observation identified by SCD, the application will be send back to RM for removal.
5. If approved, RM start processing
6. RM to provide detail of used asset to appraiser as received from Customer for evaluation and for the share of
capital to be invested in DM by the Customer.
7. If the asset is new RM compile the /valuation report and other requisite documents and submit the same to BLA.
8. The IBB/RM prepare/finalize the CAM and move it to sign off.
9. The Credit Department at IBG evaluates the proposal/CAM.
10. Any discrepancy/observation found will be send back to IBB/RM for its removal.
11. The proposal/CAM with no discrepancies/observation is forwarded to Head IBG for review.
12. Any observation by the Head IBG is send back to IBB/RM for removal.
13. The proposal/CAM with the approval of Head of IBG is send to SCD and Shari’ah Board (SB) for reviews. Any
discrepancy/observation by SCD/SB sends back to IBB/RM for removal.
14. The proposal/CAM approved by Head IBG, SCD and SB is forwarded to CMG for reviews and to further gets
approval from competent authority as per Bank’s policy and rules. Any deviation/observation by CMG is send back
to IBB/RM for removal.
15. In case the competent authority for any reason rejects the proposal/CAM, RM at IBB informs the customer.
16. Approved proposal/CAM is forwarded to RM. The RM prepare/compiles the offer letter, legal and other requisite
documents for signoff of customer.
17. BLA provide legal opinion to IBB/RM.
18. The customer provides IBB/RM signoff offer letter and other agreements/ undertakings.
19. DM Finance Account is created at IBB.
20. Customer deposits its share of investment in the DM Finance Account created at IBB.
21. IBG inject funds into DM Finance Account at IBB.
22. Payment order is prepared/issued in the name of the vendor/supplier of DM asset.
23. The vendor/supplier delivers the asset to customer.
24. The customer confirms the delivery of asset.
25. The customer signs Ijarah Agreement at IB.
26. The customer pays periodical rent and the unit share price to IBG as per its agreed terms and condition.
27. The rental received from the customer is taken in income account.
28. The unit share price received from the customer is taken in DM account.
29. The IBG sells the unit as per terms and conditions.
30. The customer purchases IBG’s Share in asset.
31. Once all the share are purchased, the DM agreements ends.
32. As all the shares of IBG is sold out to customer, therefore Ijarah also ends.
33. The above process is in general, however it may differ from case to case basis which will be dealt according during
proposal review and approval by Shari’ah Board/SCD.

6.2.8 DOCUMENTATION REQUIRED

All the agreements required will be developed as per the guidelines of State Bank of Pakistan and will also be duly vet by
the Bank’s approved BLA before extending the DM facilities to each customer.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 1. Musharakah Agreement
2. Payment Agreement (Rental/Principal)
3. Undertaking to purchase Musharakah Units
4. Unit Sale receipt
5. Power of Attorney
6. Any other Document deemed necessary by the competent authority.

The client's obligations to make payments of rent, IBG may require any additional security as per CPM to secure its interest,
particularly in view of the financial position of the client which may also be stipulated in the DMA.

6.2.9 RISK MANAGEMENT

The compliance of Basel accord upon Islamic banks is equally vital like the conventional financial institutions in order to
address the risk of modern and diversified financial management. Islamic financial contracts due to the changing
relationship between the contracting parties during the lifetime of the contracts directly affects the risk exposures. As
majority of risks in Islamic Banking remain the same (Credit Risk, Market Risk, Liquidity Risk, Rate of Return Risk,
Operational Risk, etc.), it is critical for them to recognize and evaluate the overlapping nature and transformation of risks
that exist between and amongst the categories of risks. Adverse changes in the Islamic banking market, counterparties, or
products, as well as changes in the economic and political environments in which they operate are examples of Business
Risks; in this regard, Islamic banks are expected to view the management of these risks from a holistic perspective.

Similarly, Islamic Banks face REPUTATIONAL RISK arising from failure in governance, business strategy, process and practice
with respect to Shari’ah non-Compliance in product and services that leaves negative image on the institution resulting in
low profitability or losses, thus losing position in the market.

Main Risk
Phase Description Risk Description Proposed Mitigations
Head
1 - Phase I Credit Risk 1 - Supplier Default Performance Guarantee (only in case of Advance
payments)
Market Risk 1 - Equity Risk: Price of Undertaking to Purchase / rental agreement under
machinery/equipment/ Musharakah agreement. MODTD, property with margin as
Property/other asset partner share.
supplied declines
2 - Profit Rate Bench Mark with KIBOR
3 - Forex Risk Forward Cover through Islamic mode.

Operational 1 - Supplier in unable to Performance Guarantee

Risk deliver the machinery
2 - Transit Risk Takaful

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 3 - Delayed Shipment / 1. Clauses to be inbuilt in the Agreements with the supplier
Delay in importing the for discounts in case of delayed shipment.
machinery 2. LC clause having an expiry..

4 - Substandard TQM standards to be documented properly in the relevant

Machinery/equipment/ documentation by IB/Customer.
asset supplied Agent to ensure proper Quality management
6 - Appraiser 1. Appraiser to be on Bank's Approved Panel
Competency 2. Bank Official may evaluate the asset independently

2 - Phase II Credit Risk 1- Defaults on 1 - RM to visit the business facility regularly / to be vigilant
Profits/rental Payments with possible cash flow problems CM may face.
2 – Other Securities
2 - Default on Unit 1 - RM to visit the business facility regularly / to be vigilant
Purchase with possible cash flow problems CM may face.
2 - Securities: Exclusive charge / UTP / MODTD

Market Risk 1 - Profit Rate Risk Bench mark against KIBOR, floating rental rates
2 - After the facility Covered with extra margin taken.
becomes non
performing, the resale
value of the machine
declines.
Operational 1 - Delay in If the machinery / equipment is not in operational
Risk installation / condition, rentals cannot be taken into income account. In
deployment of asset to order not to disturb the regular stream of cash flows, the
be in working position rental shall be received from the customer but would not
be taken into income account rather would be parked in
un-earned income account until the respective equipment
is not in operational condition. profit will be clubbed with
subsequent rent
2 - Power breakdowns RM shall ensure while proposing the casethat business
holding operation of facility must have appropriate power back-up.
the machine
3 - Break down during 1. Insurance / Takaful - ensure operational breakdown are
operation insured.
2. Breakdown period profit will be clubbed with
subsequent rent

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 4 - Model Becomes Undertaking to Purchase, securities etc.
obsolete

4 - Over all Tenor Shari'ah Risk Non-compliance of Review of Process/CAM by the Shari’ah Compliance
of DM Shari’ah Principles Department and adherence to the principles
Liquidity Risk In case of default Securities: Charge on equipment/ machinery
Liquidity Risk

6.2.10 DIMINISHING MUSHARAKAH CALCULATION

ABC Firm is engaged in Renting and Operation & Maintenance of Caterpillar equipment (i.e. Power Generation,
Construction and Material Handling equipment). The Firm requested NBP-IBG to provide the Diminishing Musharaka facility
limit of Rs.200 Million for procurement of Caterpillar gensets between the range of 250 KVA and 2250 KVA along with
necessary accessories. Diminishing Musharaka (DM) Facility of Rs.200 million @ Respective KIBOR (Avg. Ask side) + 100 bps
to procure Caterpillar Gensets along with necessary accessories.

Musharaka Ratio:

Musharaka Ratio i.e. the share of investment of each partner will be as follows:

Parties Ratio Amount

NBP IBG 90% 200.00
ARM 10% 22.22
Total 100% 222.22

Factors

i. DM Amount = Bank’s Participating Amount = PKR 200,000,000/-

ii. Rent Rate = 11% = 11%/12 = 0.92% per month
iii. Tenor = 5 years = 60 months
iv. Per month Principal deduction = unit purchase price = 3,333,333 per month for 60 month tenor
v. It is not to be noted that the monthly rent will be on declining basis as the share of the Bank will diminishes every
month upon timely payment by the customer.

Pmnt
No. Unit Purchased amount Rent Total Monthly Payment Remaining Outstanding
200,000,000.00
1 3,333,333 1,833,333 5,166,666.67 196,666,666.67
2 3,333,333 1,802,778 5,136,111.11 193,333,333.33
_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 3 3,333,333 1,772,222 5,105,555.56 190,000,000.00
4 3,333,333 1,741,667 5,075,000.00 186,666,666.67
5 3,333,333 1,711,111 5,044,444.44 183,333,333.33
6 3,333,333 1,680,556 5,013,888.89 180,000,000.00
7 3,333,333 1,650,000 4,983,333.33 176,666,666.67
8 3,333,333 1,619,444 4,952,777.78 173,333,333.33
9 3,333,333 1,588,889 4,922,222.22 170,000,000.00
10 3,333,333 1,558,333 4,891,666.67 166,666,666.67
11 3,333,333 1,527,778 4,861,111.11 163,333,333.33
12 3,333,333 1,497,222 4,830,555.56 160,000,000.00
13 3,333,333 1,466,667 4,800,000.00 156,666,666.67
14 3,333,333 1,436,111 4,769,444.44 153,333,333.33
15 3,333,333 1,405,556 4,738,888.89 150,000,000.00
16 3,333,333 1,375,000 4,708,333.33 146,666,666.67
17 3,333,333 1,344,444 4,677,777.78 143,333,333.33
18 3,333,333 1,313,889 4,647,222.22 140,000,000.00
19 3,333,333 1,283,333 4,616,666.67 136,666,666.67
20 3,333,333 1,252,778 4,586,111.11 133,333,333.33
21 3,333,333 1,222,222 4,555,555.56 130,000,000.00
22 3,333,333 1,191,667 4,525,000.00 126,666,666.67
23 3,333,333 1,161,111 4,494,444.44 123,333,333.33
24 3,333,333 1,130,556 4,463,888.89 120,000,000.00
25 3,333,333 1,100,000 4,433,333.33 116,666,666.67
26 3,333,333 1,069,444 4,402,777.78 113,333,333.33
27 3,333,333 1,038,889 4,372,222.22 110,000,000.00
28 3,333,333 1,008,333 4,341,666.67 106,666,666.67
29 3,333,333 977,778 4,311,111.11 103,333,333.33
30 3,333,333 947,222 4,280,555.56 100,000,000.00
31 3,333,333 916,667 4,250,000.00 96,666,666.67
32 3,333,333 886,111 4,219,444.44 93,333,333.33
33 3,333,333 855,556 4,188,888.89 90,000,000.00
34 3,333,333 825,000 4,158,333.33 86,666,666.67
35 3,333,333 794,444 4,127,777.78 83,333,333.33
36 3,333,333 763,889 4,097,222.22 80,000,000.00
37 3,333,333 733,333 4,066,666.67 76,666,666.67
38 3,333,333 702,778 4,036,111.11 73,333,333.33
39 3,333,333 672,222 4,005,555.56 70,000,000.00
40 3,333,333 641,667 3,975,000.00 66,666,666.67
41 3,333,333 611,111 3,944,444.44 63,333,333.33
42 3,333,333 580,556 3,913,888.89 60,000,000.00
43 3,333,333 550,000 3,883,333.33 56,666,666.67
44 3,333,333 519,444 3,852,777.78 53,333,333.33
_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 45 3,333,333 488,889 3,822,222.22 50,000,000.00
46 3,333,333 458,333 3,791,666.67 46,666,666.67
47 3,333,333 427,778 3,761,111.11 43,333,333.33
48 3,333,333 397,222 3,730,555.56 40,000,000.00
49 3,333,333 366,667 3,700,000.00 36,666,666.67
50 3,333,333 336,111 3,669,444.44 33,333,333.33
51 3,333,333 305,556 3,638,888.89 30,000,000.00
52 3,333,333 275,000 3,608,333.33 26,666,666.67
53 3,333,333 244,444 3,577,777.78 23,333,333.33
54 3,333,333 213,889 3,547,222.22 20,000,000.00
55 3,333,333 183,333 3,516,666.67 16,666,666.67
56 3,333,333 152,778 3,486,111.11 13,333,333.33
57 3,333,333 122,222 3,455,555.56 10,000,000.00
58 3,333,333 91,667 3,425,000.00 6,666,666.67
59 3,333,333 61,111 3,394,444.44 3,333,333.33
60 3,333,333 30,556 3,363,888.89 (0.00)
Total 200,000,000 55,916,667 255,916,666.67

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 Chapter 7
Istisna

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 7 Istisna

7.1 Definition
Istisna' is a sale transaction where a commodity is transacted before it comes into existence. It is an order to a
manufacturer to manufacture a specific commodity for the purchaser. The manufacturer uses his own material to
manufacture the required goods.

7.2 Description

Unlike other sales, Istisna is a sale contracts wherein the subject matter is transacted before they come into existence.

As a financing mode it has been legalized on the basis of the principle of Istihsan (public interest).Istisna‘a is an agreement
culminating in a sale at an agreed price whereby the purchaser places an order to manufacture, assemble or construct (or
cause so to do) anything to be delivered at a future date. It becomes an obligation of the manufacturer or the builder to
deliver the asset with agreed specifications at the agreed period of time. As the sale is executed at the time of entering into
the Istisna‘a contract, the contracting parties need not renew an exchange of offer and acceptance after the subject matter
is prepared. This is different from the promise in a contract of Murabaha to Purchase Orderer, which requires formal offer
and acceptance by the parties when possession of the items to be sold is taken by the bank. Istisna‘a can be used for
providing the facility of financing the manufacture/construction of houses, plant, projects, building of bridges, roads and
highways, etc. The price must be fixed with the consent of the parties involved.

In Istisna‘a, the manufacturer arranges both the raw material and the labour. If material is supplied by the purchaser and
the manufacturer is required to use his labour and skill only, this is the contract of Ujrah (doing any job against an agreed
wage/remuneration) and not of Istisna‘a. In the following sections we discuss elements of Istisna‘a in detail. An Istisna‘a
contract is binding on the contracting parties; the manufacturer is obliged to supply the subject matter with the agreed
specifications and the orderer or buyer is obliged to accept the asset of stipulated type, quality and quantity and make the
agreed payment. The parties may agree to a period during which the manufacturer will be responsible for any defects or
the maintenance of the subject matter.

7.2.1 Conditions of Istisna

i. The subject of Istisna’ is always a thing which needs manufacturing.

ii. Manufacturer uses his own material.

iii. Quality & Quantity should be agreed in absolute terms.

iv. Purchase price should be fixed with mutual consent.

7.2.2 Price of Istisna

i. Price of Istisna’ may be in the form of money, commodity and usufruct.
_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 ii. Price of Istisna’ may be SPOT and DEFERRED, therefore Istisna’ is applicable where Salam is not applicable.

iii. Price of Istisna’ can be paid in installments.

iv. The installments may be tied up with different stages of projects.

7.2.3 Revoking of Istisna contract

i. The Contract of Istisna’ can be cancelled unilaterally before the manufacturer starts working.

ii. Once the works starts, Istisna cannot be cancelled unilaterally.

7.2.4 Time of Delivery

i. It is not necessary in Istisna that the time of delivery is fixed. However, the purchaser my fix a maximum time for
delivery after the appointed time, he will not be bound to accept the goods and pay the price.

ii. In order to ensure that the goods will be delivered within the specified period, some modern agreement of this
nature contain a clause to the effect that in case the manufacturer delays the delivery after the appointed time,
the price shall be reduced by a specified amount per day.

7.2.5 Delivery of Goods

i. Before delivery, goods will remain at the risk of seller.

ii. After delivery, risk will be transferred to the purchaser.

iii. Possession of goods can be physical or constructive.

iv. Transferring of risk and authority of use and utilization/consumption are the basic ingredients of constructive
possession.

v. If manufactured goods are delivered before agreed date, purchaser can refuse to accept the goods.

7.3 Parallel Istisna’

i. After the execution of Istisna agreement with one party, buyer or seller executes another Istisna agreement with
third party,

Conditions For Parallel ISTISNA’

ii. There must be two different and independent contracts, these two contracts cannot be tied up and performance of
one should not be contingent on the other.

iii. Parallel Istisna is allowed with third party only.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 7.4 Difference between Istisna & Salam
ISTISNA’ SALAM
The subject of Istisna’ is always a thing which needs The subject can be anything but mostly used for
manufacturing. Agricultural Product.
The price in Istisna does not necessarily need to be paid
The price has to be paid in full in advance.
in full in advance.
Time of Delivery does not have to be fixed Time of delivery is an essential part of the sale

The contract can be cancelled before the manufacturer The contract cannot be cancelled unilaterally.
starts working.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 Chapter 8
Salam

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 8 Definition

Bai‘ Salam is an ancient form of forward contract wherein the price was paid in advance at the time of making the contract
for prescribed goods to be delivered later.

8.1 Description

The two terms “Salam” and “Salaf” have been used interchangeably in Hadith literature to describe the contract for future
delivery of specified goods with up-front payment of the price. The parties stipulate a certain time for supply of goods of
specified quantity and quality. This is contrary to Bai‘ Mu’ajjal, in which goods are delivered to the purchaser in advance
and the agreed price is paid at a stipulated date in the future. As the commodity to be delivered in future against prompt
payment becomes a debt on the part of the seller, the transaction is termed Salaf and implies a loan without any benefit.

In the emerging Islamic finance movement, Salam is normally used to denote a forward transaction of a defined nature.
Salam has been permitted by the holy Prophet (pbuh) himself, without any difference of opinion among the early or the
contemporary jurists, notwithstanding the general principle of the Shar¯ı´ah that the sale of a commodity which is not in
the possession of the seller is not permitted. Upon migration from Makkah, the Prophet came to Madinah, where the
people used to pay in advance the price of fruit (or dates) to be delivered within one, two and three years. But such a sale
was carried out without specifying the quality, measure or weight of the commodity or the time of delivery. The holy
Prophet ordained: “Whoever pays money in advance (for fruit) (to be delivered later) should pay it for a known quality,
specified measure and weight (of dates or fruit) of course along with the price and time of delivery”.

The rationale for this permission, as described by S.M. Hasanuz Zaman, is the concept of “necessity”. He adds: “It is stated
that the practice, as qualified by the Prophet (pbuh), continued during his life and subsequently. The later jurists
unanimously treated it as a permissible mode of business. The list of items covered by Bai‘ Salam suggests that it benefited
the owners of farms and orchards. For example, the Madinan list of cultivation covered wheat, barley, dates and grapes.
The conquest of Syria added to it such items as olives and dried large grapes. Barring a few exceptions, the jurists have
expanded the list of items, in regard to which Salam is permissible, to cover all the commodities that could be precisely
determined in terms of quality and quantity.

8.2 Basic Rules of the Salam

8.2.1 Capital of Salam

i. The capital of Salam should be known to all the parties. It may be in form of fungible goods, livestock and
usufruct of an asset. Generally it should be fixed in terms of cash.

ii. Purchase price in Salam must be fully advanced to the seller at the commencement of the contract.

8.2.2 Specification of Commodity

i. The commodity should be known. It must be monitored by specifications to the maximum possible degree, only
negligible variation is tolerated.

ii. It must also be ensured that the commodity is possible to be delivered when it is due.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 iii. Only those goods can be sold through Salam contract in which the quality and quantity can be exactly specified.
In other words it can be done only in such items which can be weighed, measured or counted.

iv. Salam can only be carried out in the items in which variations in numbers make no difference.

v. Salam is not permitted for anything specific like “this car”. Nor it is permitted for anything for which he seller
may not be held responsible, like land, buildings or trees or for articles whose values change according to
subjective assessment, like jewelry and antiques.

vi. Salam sale is impermissible on existing commodities or on land and real estates because the description of the
land or the real estate entails the location.

8.2.3 Delivery Conditions

i. Due date of delivery must be agreed at the commencement of the contract.

ii. The place of delivery should also be known. If it is not known, the place where the contract took place shall be
considered to be the place of delivery, unless it is impracticable. In such a case, the place of delivery shall be
decided according to customary practices.

iii. Before delivery, goods will remain at the risk of seller.

iv. After delivery, risk will be transferred to the purchaser.

v. Possession of goods can be physical or constructive.

vi. Transferring of risk and authority of use and utilization / consumption are the basic ingredients of constructive
possession.

8.2.4 Khiyar (Option) in Salam

i. The jurists disallow the operation of the Islamic law of option (Khiyar al Shart) in the case of Bai‘ Salam
because this disturbs or delays the seller’s right of ownership over the priceof the goods.
ii. The purchaser also does not have the “option of seeing” (Khiyar al Ro’yat), which is available in the case of
normal sales.
iii. However, after taking delivery, the purchaser has the “option of defect” (Khiyar al‘Aib) and the option of
specified quality.
iv. This means that if the commodity is defective or it does not have the quality or specification as agreed at the
time of contract, the purchaser can rescind the sale. But in that case, only the paid amount of price can be
recovered without any increase.

8.2.5 Revoking Salam Contract

i. Once agreed upon, a Salam contract cannot be revoked unilaterally by any party.

ii. It can be cancelled or partially cancelled with mutual consent by returning the actual or proportionate
amount of price paid.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk
 8.2.6 Parallel Salam
i. There must be two separate and independent contracts, one where the Bank acts as buyer and other in
which it is a seller.

ii. The two contracts cannot be tied up and performance of one should not be contingent on other.

8.2.7 Buy Back

i. Salam arrangement cannot be used as a buy back facility where the seller in the first contract is also the
purchaser in the second.

ii. Even if the purchaser in the second contract is a separate legal entity but owned by the seller in the first
contract, it would not tantamount to a valid Parallel Salam agreement.

8.2.8 Agency Contract

i. If the bank has no expertise to sell the commodities received under Salam contract, then the bank can appoint
the customer as its agent to sell the commodity in the market / third party, subject to Salam agreement and
Agency agreement are separate from each other.

ii. A price must be determined in agency agreement on which the agent will sell the commodity but if the price is
increased, the benefit can be given to the agent.

8.2.9 In case of Default

i. No penalty can be stipulated in the contract.

ii. If the seller fails to perform his obligation, due to insolvency or genuine reasons, he should be given an
extension in the delivery time.

iii. If the total or partial quantity is not available on due date, the customer has an option to wait for the time
when the commodity becomes available or he can get his money back.

iv. Replacement of commodity may also be mutually agreed.

_________________________________________________________________________________________________
Institute of Business Management
Korangi Creek Road, Karachi, 75190, Pakistan.
Telephone: (92-21) 111 002 004, Fax: (92-21) 35090968 Email: imamuddin@iobm.edu.pk