EXECUTIVE SUMMARY

This project was assigned to us by Sir Omer Zaka. The aim of our
assignment was to get knowledge about the Islamic System of banking
Islamic modes of financing and how these systems are used by the
banking sector according to the Islamic principles. The objective was to
get knowledge about these terms and how the banks are following the
Islamic principles in their transactions.

To accomplish this objective we get information from different banks and

from their websites.

We concluded that Islamic system is gaining success more rapidly and its
demand is increasing day by day but still the government should also give
some relaxations to Islamic banks to sustain in the market.

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 TABLE OF CONTENT

 Executive Summary…………………………………………..1

 Introduction……………………………………………………..3

 Islamic modes of financing…………………………………5

 Musharakah……………………………………………………...5

 Mudarabah……………………………………………………….6

 Application of Musharakah & Mudarabah …………..8

 Project financing………………………………………………….8

 Import financing………………………………………………….9

 Export financing………………………………………………….10

 Working capital financing …………………………………….11

 Murabahah……………………………………………………….13

 Export financing………………………………………………….14

 Import financing………………………………………………….14

 Issues in Murabahah…………………………………………….15

 Uses of Murabahah……………………………………………….16

 Ijarah……………………………………………………………….17

 Salam……………………………………………………………….20

 Istisna………………………………………………………………21

 Conclusion……………………………………………………….22

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 INTRODUCTION
Islamic finance has been gaining momentum on a global scale for the last 30 years.
Many Islamic Banks have sprung up over the last few years. These changes are
occurring both in Muslim and in western countries, and are driven by a global trend
amongst Muslims to become more observant of their faith. It might have been the
reason why Islamic Banking emerged; however, today Islamic Banking is sought by
Muslims and non-Muslims due to the benefits it offers. But Islamic bank is an infant
age government must give it some relaxation like reduction in taxes so they can
compete with other conventional banks.

In this assignment Islamic modes of financing is discussed and its implementation

in the banks according to Islamic principles. There are six modes of financing

 Musharakah

 Mudaraba

 Murabahah

 Salam

 Istisna

 Ijarah

The term “Islamic banking” refers to a system of banking or banking activity that is consistent
with Islamic law (Shariah) principles and guided by Islamic economics. In particular, Islamic
law prohibits usury, the collection and payment of interest, also commonly called Riba in Islamic
discourse. In addition, Islamic law prohibits investing in businesses that are considered unlawful,
or haraam (such as businesses that sell alcohol or pork, or businesses that produce media such as
gossip columns or pornography, which are contrary to Islamic values). In the late 20th century, a
number of Islamic banks were created to cater to this particular banking market.

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 Islamic banking has the same purpose as conventional banking except that it operates in
accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions).
The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of
Riba (usury). Common terms used in Islamic banking include profit sharing (Mudharabah), joint
venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah).

Islamic banks and banking institutions that offer Islamic banking products and services (IBS
banks) are required to establish a Shariah Supervisory Board (SSB) to advise them and to ensure
that the operations and activities of the banking institutions comply with Shariah principles.

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 MUSHARAKAH
Musharakah is one of the two ideal modes of Islamic financing. The other one being Mudarabah.
Musharakah is a contractual relationship formed through mutual consent of the parties for
sharing of profits and losses in a joint venture. Assets in the venture are jointly owned in
proportion to each partner’s contribution. The profits are shared in a pre-agreed ratio. Losses,
however, are incurred in proportion to each partner’s investment. Bank representing share of its
depositors invests funds in the joint venture alongside other investor(s).

In this method of financing two or more partners agree through a Musharkah contract to carry
out a specified joint-venture economic activity. The contract specifies the kind, the amount to be
contributed by each of the partners, the partnership period, and the basis for profit distribution.
The conditions for Al-Musharakah are the following:

 Specification of the capital amount of Al-Musharkah.

 Determination of the value of paid up shares for each partner particularly if they are
commodity shares.

 Specification of the ways and means of profit distribution among partners. It is usually a
percentage proportional to the value of shares paid by each partner.

 The partners might delegate one of them to act on behalf of the others for the sake of the
group as a whole.

 It is acceptable for a partner who works more than the others and/or who enjoys more
experience to stipulate to take a percentage in lieu of his extra labor and expertise.

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Certificate of Musharakah

It is on the basis of this expertise and know-how that bank presents a prime investment
opportunity in the form of Certificate of Musharaka (COM) and promises best possible returns to
investors with complete security.

 COM is available in various tenures with flexible profit payment plans to meet your
requirements.

 We offer best possible return on COM for different tenures, the bank have competent and
experienced fund managers who are fully aware of investor's concern for their investment
i.e. to get best returns with maximum security .

 COM can be purchased by individuals as well as corporate and other concerns.

MUDARABAHA
“Mudarabah” is a special kind of partnership where one partner gives money to another for
investing it in a commercial enterprise. The investment comes from the first partner who is called
“rabb-ul-mal”, while the management and work is an exclusive responsibility of the other, who is
called “mudarib”. The difference between Musharakah and Mudarabah can be summarized in the
following points:

1. The investment in Musharakah comes from all the partners, while in Mudarabah; investment is
the sole responsibility of the rabb-ul-mal.
2. In Musharakah, all the partners can participate in the management of the business and can
work for it, while in the Mudarabah; the rabb-ul-mal has no right to participate in the
management which is carried out by the mudarib only.
3. In Musharakah all the partners share the loss to the extent of the ratio of their investment while
in Mudarabah the loss, if any, is suffered by the rabb-ul-mal only, because the mudarib does not
invest anything. His loss is restricted to the fact that his labor has gone in vain and his work has
not brought any fruit to him.

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4. The liability of the partners in Musharakah is normally unlimited. Therefore, if the liabilities
of the business exceed its assets and the business goes in liquidation, all the exceeding liabilities
shall be borne pro rata by all the partners. However, if all the partners have agreed that no partner
shall incur any debt during the course of business, then the exceeding liabilities shall be borne by
the partner alone who has incurred a debt on the business in violation of the aforesaid condition.
Contrary to this is the case of Mudarabah. Here the liability of rabb-ul-mal is limited to his
investment, unless he has permitted the mudarib to incur debts on his behalf.
5. In Musharakah, as soon as the partners mix up their capital in a joint pool, all the assets of the
Musharakah become jointly owned by all of them according to the proportion of their respective
investment. Therefore, each of them can benefit from the appreciation in the value of the assets,
even if the profit has not accrued through sales.
The case of Mudarabah is different. Here all the goods purchased by the mudarib are solely
owned by the rabb-ul-mal, and the mudarib can earn his share in the profit only in case he sells
the goods profitably. Therefore, he is not entitled to claim his share in the assets themselves,
even if their value has increased.

COMBINATION OF MUSHARAKAH AND MUDARBAHA

A contract of Mudarabah normally presumes that the mudarib has not invested anything to the
Mudarabah. He is responsible for the management only, while all the investment comes from
rabb-ul-mal. But there may be situations where the mudarib also wants to invest some of his
money into the business of Mudarabah. In such cases Musharakah and Mudarabah are combined
together. For example, A gave to B Rs.100000/- in a contract of Mudarabah. B added Rs.50000/-
from his own pocket with the permission of A. This type of partnership will be treated as a
combination of Musharakah and Mudarabah.

TERMINATION OF MUDARABAHA
The contract of the Mudarabah can be terminated at any time by either of the two parties. The
only condition is to give a notice to the other party. If all assets of the Mudarabah are in cash
form at the time of termination, and some profit has been earned on the principle amount, it shall
be distributed between the parties according to the agreed ratio. However, if the assets of the

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Mudarabah are not in the cash form, the mudarib shall be given an opportunity to sell or liquidate
them, so that the actual profit may be determined.

APPLICATION OF ISLAMIC FINANCING

The application of Musharakah and Mudarabah is based on some principles. As long as these
principles are complied with, their details of application may vary from time to time. These
principles are as follows:

 Financing through Musharakah and Mudarabah does not mean advancing of money but it
mean participation in the business and in the case of Musharakah participation in the
assets of the business.
 The financier must bear the losses of the business to the proportion of his investment.
 The partners are free to determine the ratio of profit allocated to each partner and it may
different from the ratio of investment a=but in the case that the partner does not take part
in the operations of the business his profit sharing ration should not exceed to his
investment ratio.
 The loss suffered by each partner must be in proportion to his investment.

Project Financing

In the case of project financing, if the financier wants to finance the whole project the
Mudarabah can be adopted. If the finance comes from the both parties then Musharakah can b
adopted but if the investment comes from the both sides but the management responsibility
remains with one party then combination of Musharakah and Mudarabah can be adopted
according to the rules defined above.

Since Musharakah or Mudarabah would have been affected from the very inception of the
project, no problem with regard to the valuation of capital should arise. Similarly, the
distribution of profits according to the normal accounting standards should not be difficult.
However, if the financier wants to withdraw from the Musharakah, while the other party wants to

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continue the business, the latter can purchase the share of the former at an agreed price. In this
way the financier may get back the amount he has invested along with a profit, if the business
has earned a profit.

On the other hand, the businessman can continue with his project, either on his own or by selling
the first financier's share to some other person who can substitute the financier. Since financial
institutions do not normally want to remain partner of a specific project for good, they can sell
their share to other partners of the project as aforesaid. If the sale of the share on one time basis
is not feasible for the lack of liquidity in the project, the share of the financier can be divided into
smaller units and each unit can be sold after a suitable interval. Whenever a unit is sold, the share
of the financier in the project is reduced to that extent, and when all the units are sold, the
financier totally comes out of the project.

Import Financing
Musharakah can be used for Import Financing as well. There are two types of bank charges on
the letter of credit provided to the importer:
1. Service charges for opening an LC
2. Interest charged on LCs, which are not opened on full margin.

Collecting service charges for this purpose is allowed, but as interest cannot be charged in any
case, experts have proposed two methods for financing LCs:
1. Based on Musharakah / Mudarabah
2. Based on Murabahah

Musharakah /Mudarabah:
This is the best substitute for opening the LC. The bank and the importer can make an agreement
of Mudarabah or Musharakah before opening the LC.
If the LC is being opened at zero margin then an agreement of Mudarabah can be made, in which
the bank will become Rab-ul-Maal and the importer Mudarib. The bank will own the goods that
are being imported and the profit will be distributed according to the agreement.

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If the LC is being opened with a margin then a Musharakah agreement can be made. The bank
will pay the remaining amount and the goods that are being imported will be owned by both of
them according to their share of investment.

The bank and the importer, with their mutual consent can also include a condition in the
agreement, whereby; Musharakah or Mudarabah will end after a certain time period even if the
goods are not sold. In such a case, the importer will purchase the bank’s share at the market
price.

Export Financing
A bank plays two very important roles in Exports. It acts as a negotiating bank and charge a fee
for this purpose, which is allowed in Shariah. Secondly it provides export-financing facility to
the exporters and charge interest on this service. These services are of two types
 Pre shipment financing
 Post shipment financing

As interest cannot be charged in any case, experts have proposed certain methods for financing
exports.
Pre Shipment Financing:

Pre shipment financing needs can be fulfilled by two methods

 Musharakah / Mudarabah
 Murabahah

Musharakah / Mudarabah:

The most appropriate method for financing exports is Musharakah or Mudarabah. Bank and
exporter can make an agreement of Mudarabah provided that the exporter is not investing; other
wise Musharakah agreement can be made. Agreement in such case will be easy, as cost and
expected profit is known.
The exporter will manufacture or purchase goods and the profit obtained by exporting it will be
distributed between them according to the predefined ratio.
A problem that can be encountered by the bank is that if the exporter is not able to deliver the
goods according to the terms and conditions of the importer, then the importer can refuse to
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accept the goods, and in this case exporter’s bank will ultimately suffer. This problem can be
rectified by including a condition in Mudarabah or Musharakah agreement that, if exporter
violates the terms and conditions of import agreement then the Bank will not be responsible for
any loss which arises due to this negligence. This condition is allowed in Shariah as the Rabb-ul-
mal is not responsible for any loss that arises due to the negligence of Mudarib.

Working Capital Financing

Where finances are required for the working capital of a running business, the instrument of
Musharakah may be used in the following manner:
The capital of the running business may be evaluated with mutual consent: The value of the
business can be treated as the investment of the person who seeks finance, while the amount
given by the financier can be treated as his share of investment. The Musharakah may be
affected for a particular period, like one year or six months or less. Both the parties agree on a
certain percentage of the profit to be given to the financier, which should not exceed the
percentage of his investment, because he shall not work for the business. On the expiry of the
term, all liquid and non-liquid assets of the business are again evaluated, and the profit may be
distributed on the basis of this evaluation.

Although, according to the traditional concept, the profit cannot be determined unless all the
assets of the business are liquidated, yet the valuation of the assets can be treated as "constructive
liquidation" with mutual consent of the parties, because there is no specific prohibition in
Shariah against it. It can also mean that the working partner has purchased the share of the
financier in the assets of the business, and the price of his share has been determined on the basis
of valuation, keeping in view the ratio of profit allocated for him according to the terms of
Musharakah.

For example, the total value of the business of ‘A’ is 30 units. ‘B’ finances another 20 units,
raising the total worth to 50 units; 40% having been contributed by ‘B’, and 60% by ‘A’. It is
agreed that ‘B’ shall get 20% of the actual profit. At the end of the term, the total worth of the
business has increased to 100 units. Now, if the share of ‘B’ is purchased by ‘A’, he should have
paid to him 40 units, because he owns 40% of the assets of the business. But in order to reflect
the agreed ratio of profit in the price of his share, the formula of pricing will be different. Any

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increase in the value of the business shall be divided between the parties in the ratio of 20% and
80%, because this ratio was determined in the contract for the purpose of distribution of profit.
Since the increase in the value of the business is 50 units, these 50 units are divided at the ratio
of 20:80, meaning thereby that ‘B’ will have earned 10 units. These 10 units will be added to his
original 20 units, and the price of his share will be 30 units.

In the case of loss, however, any decrease in the total value of the assets should be divided
between them exactly in the ratio of their investment, i.e., in the ratio of 40/60. Therefore, if the
value of the business has decreased, in the above example, by 10 units reducing the total number
of units to 40, the loss of 4 units shall be borne by ‘B’ (being 40% of the loss). These 4 units
shall be deducted from his original 20 units, and the price of his share shall be determined as 16
units.

Sharing in the gross profit only: Financing on the basis of Musharakah according to the above
procedure may be difficult in a business having a large number of fixed assets, particularly in a
running industry, because the valuation of all its assets and their depreciation or appreciation
may create accounting problems giving rise to disputes. In such cases, Musharakah may be
applied in another way.

The major difficulties in these cases arises in the calculation of indirect expenses like
depreciation for the solution of that problem the parties may decide to allocate the profit from the
gross profit rather than net profit.

Running Musharakah account on the basis of daily products: many financial institutions
finance the working capital of an enterprise by opening a running account for that enterprise
from which an enterprise can draw money according to its need at different intervals but at the
same time they keep on returning the surplus to the account. Thus the process of debit and credit
goes on up to the date of maturity, and the interest is calculated on the basis of daily products.

Keeping in view the basic principles of Musharakah the following procedure may be suggested
for this purpose:

 A certain percentage for profit should be allocated for the management.

 The remaining percentage of profit should be allocated to the investors.

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  The loss, if any, should be borne by the investors.
 The average balance of the contributions made to the Musharakah account calculated on
the basis of daily products shall be treated as the share capital of the financier.
 The profit accruing at the end of the term shall be calculated on daily product basis, and
shall be distributed accordingly.

MURABAHAH
Murabahah is a non-participatory mode of Islamic financing where the bank sells the asset
required by its client to the client on cost-plus profit basis. The asset is purchased by the bank
and carries the risk of any loss or damage to the asset as long as the asset remains under its
ownership. Upon sale of the asset, the bank is obligated to inform the client of the exact cost
incurred in the purchase of the asset and the margin of profit incorporated in the sale price.
Payment against the purchase of assets by the client may be deferred in which case it would
become Muajjal. The selling price once agreed cannot be changed even when the client fails
to pay on the agreed date.

BASIC RULES AND PRINCIPLES

1. Murabahah is a particular kind of sale where the seller expressly mentions the cost of the
sold commodity he has incurred, and sells it to another person by adding some profit or
mark-up thereon.

2. The profit in Murabahah can be determined by mutual consent, either in lump sum or
through an agreed ratio of profit to be charged over the cost.

3. All the expenses incurred by the seller in acquiring the commodity like freight, custom
duty etc. shall be included in the cost price and the mark-up can be applied on the
aggregate cost. However, recurring expenses of the business like salaries of the staff, the
rent of the premises etc. cannot be included in the cost of an individual transaction. In
fact, the profit claimed over the cost takes care of these expenses.

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 4. Murabahah is valid only where the exact cost of a commodity can be ascertained. If the
exact cost cannot be ascertained, the commodity cannot be sold on Murabahah basis. In
this case the commodity must be sold on Musawamah (bargaining) basis i.e. without any
reference to the cost or to the ratio of profit / mark-up. The price of the commodity in
such cases shall be determined in lump sum by mutual consent.

Example (2) A purchased a ready - made suit with a pair of shoes in a single transaction, for a
lump sum price of Rs. 500/-. A can sell the suit including shoes on Murabahah. But he cannot
sell the shoes separately on Murabahah, because the individual cost of the shoes is unknown. If
he wants to sell the shoes separately, he must sell it at a lump sum price without reference to the
cost or to the mark-up.

APPLICATION OF ISLAMIC MODES IN FIANNCING

Export financing

Murabahah is used by many banks for the purpose of export financing. Bank purchases goods
that are to be exported at the price less than the price agreed between exporter and importer It
then exports goods at the original price and thus earns profit.
Murabahah financing requires bank and exporter to sign at least two agreements separately, one
for the purchase of goods and the other for appointing the exporter as the agent of the bank (that
is agency agreement). Once these two agreements are signed, the exporter can negotiate and
finalize all the terms and conditions with the importer on behalf of the bank.
Post Shipment Financing:

Post shipment finance is similar to the discounting of the bill of exchange. Its alternate Shariah
compliant procedure is discussed below:
The exporter with the bill of exchange can appoint the bank as his agent to collect receivable on
his behalf. The bank can charge a fee for this service and can provide interest free loan to the
exporter, which is equal to the amount of the bill, and the exporter will give his consent to the
bank that it can keep the amount received from the bill as a payment of the loan.
Here two processes are separated, and thus two agreements will be made. One will authorize the
bank to collect the loan on his behalf as an agent, for which he will charge a particular fee. The

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second agreement will provide interest free loan to the exporter, and authorize the bank for
keeping the amount received through bill as a payment for loan.

Import financing
At present Islamic banks are using Murabahah, to finance LC. These banks themselves import
the required goods and then sell these goods to the importer on Murabahah agreement.
Murabahah financing requires the bank and the importer to sign at least two agreements
separately; one for the purchase of the goods, and the other for appointing the importer as the
agent of the bank (agency agreement). Once these two agreements are signed, the importer can
negotiate and finalize all terms and conditions with the exporter on behalf of the bank.

Issues in Murabahah:
Following are issues in Murabahah

Payments are coming from the sale and are receivables so the client may ask for the securities.

The seller can ask a client for third party guarantee. In case of default on payment the seller may
have recourse to the guarantor who will be liable to pay the amount guaranteed to him.

Another issue with Murabahah is that if the client defaults in payment of the price at the due
date, the price cannot be changed nor can penalty fees be charged.

Murabahah transaction cannot be rolled over for a further period as the old contract ends. It
should be understood that Murabahah is not a loan rather the sale of a commodity, which is
deferred to a specific date.

The Murabahah can only be affected when the seller can ascertain the exact cost he has incurred
in acquiring the commodity he wants to sell.

Basic mistakes in Murabahah financing

Some basic mistakes that can be made in practical implications of the concept are as follows:
1. The most common mistake is to assume that Murabahah can be used for all types of
transactions and financing. This mode can only be used when a commodity is to be

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 purchased by the customer. If funds are required for some other purpose Murabahah cannot
be used.
2. The document is signed for obtaining funds for a specific commodity and therefore it is
important to study the subject matter of the Murabahah.
3. In some cases, the sale of commodity to the client is affected before the commodity is
acquired from the supplier. This occurs when the various stages of the Murabahah are skipped
and the documents are signed all together. It is to be remembered that Murabahah is a package of
different contracts and they come into play one after another at their respective stages.
4. It is observed in some financial institutions that Murabahah is applied on already purchased
commodities, which is not allowed in Shariah and can be affected on not yet purchased
commodities.
Uses of Murabahah:
Murabahah can be used in following conditions:

Short / Medium / Long Term Finance for:

• Raw material

• Inventory

• Equipment

• Asset financing

• Import financing

• Export financing (Pre-shipment)

• Consumer goods financing

• House financing

• Vehicle financing

• Land financing

• Shop financing

• PC financing

• Tour package financing

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• Education package financing

• All other services that can be sold in the form of package (i.e. services like education, medical
etc. as a package)

• Securitization of Murabahah agreement (certificate) is allowed at par value only. Other wise
certain rules of Islamic Finance must be met.

IJARAH
Ijarah means lease, rent or wage. Generally, Ijarah concept means selling the benefit of use or
service for a fixed price or wage. Under this concept, the Bank makes available to the customer
the use of service of assets / equipments such as plant, office automation, motor vehicle for a
fixed period and price.

Basic Rules of Ijarah/Leasing

1. Ijarah/Leasing is a contract whereby the owner of something transfers its usufruct to

another person for an agreed period, at an agreed consideration.
2. The subject of Ijarah must have a valuable use. Therefore, things having no usufruct at all
cannot be given on Ijarah.
3. It is necessary for a valid contract of Ijarah that the corpus of the Ijarah property remains
in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus,
anything which cannot be used without consuming cannot be given on Ijarah basis.
Therefore, the Ijarah facility cannot be affected in respect of money, eatables, fuel and
ammunition etc. because their use is not possible unless they are consumed. If anything
of this nature is given on Ijarah basis, it will be deemed to be a loan and all the rules
concerning the transaction of loan shall accordingly apply. Any rent charged on this
invalid Ijarah transaction shall be an interest charged on a loan.
4. As the corpus of the Ijarah Assets remains in the ownership of the lessor, all the liabilities
emerging from the ownership shall be borne by the lessor, but the liabilities referable to
the use of the property shall be borne by the lessee.
5. The period of Ijarah must be determined in clear terms.

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 6. Lessees cannot use the Ijarah asset for any purpose other than the purpose specified in the
Ijarah agreement. If no such purpose is specified in the agreement, the lessee can use it
for whatever purpose it is used in the normal course. However if he wishes to use it for an
abnormal purpose, he cannot do so unless the lessor allows him in express terms.
7. The lessee is liable to compensate the lessor for every harm to the Ijarah asset caused by
any misuse or negligence on the part of the lessee.
8. The Ijarah asset shall remain in the risk of the lessor throughout the Ijarah period in the
sense that any harm or loss caused by the factors beyond the control of the lessee shall be
borne by the lessor.
9. A property jointly owned by two or more persons can be given on Ijarah basis, and the
rental shall be distributed between all the joint owners according to the proportion of their
respective shares in the property.
10. A joint owner of an Asset can given on Ijarah basis his proportionate share to his co-
sharer only, and not to any other person.
11. It is necessary for a valid Ijarah that the Ijarah asset is fully identified by the parties.

Advantages of Ijarah
Ijarah provides the following advantages to the Lessee: Ijarah conserves the Lessee' capital since
it allows up to 100% financing. Ijarah gives the Lessee the right to access the equipmenton
payment of the first installment. This is important as itis the access and use (and not ownership)
of equipmentthat generates income. Ijarah arrangements aid corporate planning and budgeting by
allowing the negotiation of flexible terms Ijarah is not considered Debt Financing so it does not
appear on the Lessee' Balance Sheet as a Liability. This method of "off-balance-sheet" financing
means that it is not included in the Debt Ratios used by bankers to determine financing limits.
This allows the Lessee to enter into other lease financing arrangements without impacting his
overall debt rating. All payments towards Ijarah contracts are treated as operating expenses and
are therefore fully tax-deductible. Leasing thus offers tax-advantages to for-profit operations
many types of equipment (i.e computers) become obsolete before the end of their actual
economic life. Ijarah contracts allow the transfer of risk from the Lesse to the Lessor in exchange
for a higher lease rate. This higher rate can be viewed as insurance against obsolescence. If the
equipment is used for a relatively short period of time, it may be more profitable to lease than to

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buy If the equipment is used for a long period but has a very poor resale value, leasing avoids
having to account for and depreciate the equipment under normal accounting principles.
Ijarah thumma al bai' (hire purchase)
Parties enter into contracts that come into effect serially, to form a complete lease/ buyback
transaction. The first contract is an Ijarah that outlines the terms for leasing or renting over a
fixed period, and the second contract is a Bai that triggers a sale or purchase once the term of the
Ijarah is complete. For example, in a car financing facility, a customer enters into the first
contract and leases the car from the owner (bank) at an agreed amount over a specific period.
When the lease period expires, the second contract comes into effect, which enables the customer
to purchase the car at an agreed to price. The bank generates a profit by determining in advance
the cost of the item, its residual value at the end of the term and the time value or profit margin
for the money being invested in purchasing the product to be leased for the intended term. The
combining of these three figures becomes the basis for the contract between the Bank and the
client for the initial lease contract. This type of transaction is similar to the contractum trinius, a
legal maneuver used by European bankers and merchants during the Middle Ages to sidestep the
Church's prohibition on interest bearing loans. In a contractum, two parties would enter into
three concurrent and interrelated legal contracts, the net effect being the paying of a fee for the
use of money for the term of the loan. The use of concurrent interrelated contracts is also
prohibited under Shariah Law.
Ijarah-wal-iqtina
A contract under which an FHM bank provides equipment, building, or other assets to the client
against an agreed rental together with a unilateral undertaking by the bank or the client that at the
end of the lease period, the ownership in the asset would be transferred to the lessee. The
undertaking or the promise does not become an integral part of the lease contract to make it
conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets
back its principal sum along with profit over the period of lease.

FHM will provides customers with short to medium term financing by way of Ijarah/leasing and
finally acquiring items such as:

• Plant and machinery

• Property

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• Computers and information technology equipment
• Motor vehicles and heavy machinery
• other fixed assets

SALAM
Salam means a contract in which advance payment is made for goods to be delivered later on.
The seller undertakes to supply some specific goods to the buyer at a future date in exchange of
an advance price fully paid at the time of contract. It is necessary that the quality of the
commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute.
The objects of this sale are goods and cannot be gold, silver, or currencies based on these metals.
Barring this, Bai Salam covers almost everything that is capable of being definitely described as
to quantity, quality, and workmanship.

The followings are the conditions governing the conduct of an Al-Salam contract:

(a) The price for the commodity that will be delivered as a repayment must be identified and
known.

(b) The sold commodity must be known by detailed specifications of quantity and quality.

(c) Repayments must be in commodity and not in cash. The cash repayment is prohibited
except for the exact original loan without any added profit.

(d) The repayment must be postponed to a specified future date and a known place of
delivery.

(e) The borrower is free with regard to the source of the commodity for repayment, whether
from his own farm production or bought from the market as long as it is typical to the
specified descriptions.
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 This method of financing is found to be more flexible and preferred by the farmers because it
enables them to get cash lending and be free to do what they like with regard to the finance
allocation. It is also observed that the commodity repayments are usually done from the
harvest of the crops financed.

ISTISNA
Istisna’a is a sale contract between the FHM as Al-Sani (the seller) and the customer as Al-
Mustasni (the ultimate purchaser) whereby the FHM.

It is defined as “a contract with a manufacturer to make something “ or “ a contract on a

commodity on liability with the provision of work.” A more complete and precise definition by
Mustafa Ahmed Zarqa” a contract of selling a manufacturable thing with an undertaking by the
seller to present it manufactured from his own material with specified description at a determined
price.”

The person who manufactured the thing is called “Soni” and the person who ordered its
manufacture

Steps of Istisna’a Transaction:

 based on the order from the customer

 undertakes to have manufactured or otherwise acquire the subject matter (Al-Masnoo) of
the contract
 according to specifications stipulated by the customer and
 sells it to the customer for an agreed upon price and method of settlement whether that be
in advance, by installments or deferred to a specific future date.

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Parallel Istisna’a

Parallel istisna’a is the second sale contract entered into by the FHM with the subcontractor in
order to fulfill its contractual obligations in the first contract to the customer. It is assumed that
the FHM will always enter into a parallel istisna’a contract in order to satisfy its contractual
obligations towards the Istisna’a agreement with the customer. The subcontractor (seller or Al-
Sani) in the parallel Istisna’a contract has no direct legal relationship with the FHM’s customer
in the Istisna’a contract. Parallel Istisna’a is not a contingent transaction on the first Istisna’a
contract.

CONCLUSION

There are ample opportunities for developing the Islamic banking system worldwide. Despite
the thriving growth of the industry, it just captures a small portion of market share of the
banking industry. Currently, the global banking industry is relatively small compared to its
conventional counterpart. It needs to gain critical mass, build worldwide brand recognition
and exceed performance standards set by the conventional banking industry. Thus, Islamic
banking system should strive to increase the market share.

Effective promotional and awareness programs that shows good experiences of Islamic
finance are needed to attract both Muslim and non-Muslim alike to support Islamic banking
industry. The unique features of Islamic products that promote transparency, fairness and

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profit sharing should appeal to all.

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