Modes of Financing Sale

Istisna

Islamic Modes/Instruments - Sale Contracts:

Istisna:
Introduction

Istisna is a sale transaction where commodity is transacted before it

comes into existence.

It is an order from purchaser to the manufacture to manufacture a

specific commodity or goods for the purchaser

Istisnas Contract: Contract of sale of specified items to be

manufactured or constructed, with an obligation on the part of the
manufacturer or builder to deliver them to the customer upon
completion.
Potential of Istisna:

Manufacturing of high tech. goods, building, roads, manufacturing, etc.

Micro enterprise financing
Pre-shipment financing for exports

Islamic Modes/Instruments - Sale Contracts:

Istisna:Shariah Legitimacy

The Prophet (PBUH) required that a pulpit

(platform) be built for preaching [Bukhari
2/908]
The Prophet (PBUH) required that a finger
ring be manufactured for Him [Bukhari 5/220
and Muslim 3/1655]

Islamic Modes/Instruments - Sale Contracts:

Istisna: Conditions

The subject of Istisna always requires manufacturing.

The manufacturer uses his own material to

manufacture a good to differentiate from Ijarah

Different from Murabahah as no offer and acceptance

is required. The contract reflects the same.
Kind, Quality and Quantity of subject matter must be
known and agreed in absolute term

If goods manufactured conform to the specifications

agreed upon, the purchaser cannot decline to accept
them unless there is defect in these goods [Option of
defect benefits the purchaser]

Buyer can refuse to accept goods if delivery is not made

within agreed time period (stipulated in the contract).

Islamic Modes/Instruments - Sale Contracts:

Istisna: Conditions

In parallel Istisna (sub-contracting), both contracts

have to be independent from each other
Istisna contract is applied to subject matter with
specification and not with designation
The subject matter has to be unique (ie. With no
substitute available in the market) or homogeneous.
Uniqueness differentiates from salam
Purchasing subject matter from the manufacturer and
again selling to him equals bai Innah, which is not
allowed. Purchaser has to take the goods from
manufacurer
It is not necessary that the seller himself manufactures
the product

Islamic Modes/Instruments - Sale Contracts:

Istisna: Price of Istisna

Price of good to be fixed in absolute and un-ambiguous

terms.
This can be cash, tangible goods, or usufruct
Price can also be usufruct of the asset related or not
related to subject matter [Building and renting house to
the manufacturer]
Bank can negotiate with various parties for placing order
to manufacture, ie. Bidding is allowed. However, only one
offer is eventually selected for conclusion of contract
Price of Istisna may be spot and deffered (installments)
therefore Istisna is applicable where Salam is not
applicable.

Islamic Modes/Instruments - Sale Contracts:

Istisna: Price of Istisna

Price once settled cannot be changed, however, huge

projects demand variation due to subsequent
modifications, etc. which is allowed by mutual consent.
The installments can be tied up with different stages of
manufacturing.
Bank may be paying or receiving urboun which is
allowed.
Price can be tied up with the time of delivery. FIs can
start paying with an advanced installment.
Price may also reduce if the delay in delivery is caused.

Islamic Modes/Instruments - Sale Contracts:

Istisna:

Revoking of Istisna

Istisna is a binding contract, unlike promise in

Murabahah
The contract of Istisna can be cancelled unilaterally
before the manufacturer starts the work.
Once the work has been started, Istisna cannot be
cancelled unilaterally.

Islamic Modes/Instruments - Sale Contracts:

Istisna:Delivery of Manufactured goods

Before delivery, goods will remain at the risk of seller

Possession of goods can be physical or constructive
When FI does not want to carry the risk of holding and
selling the manufactured goods, it can enter into
parallel Istisna
FI can also appoint the client its agent to sell the
manufactured goods.

Payment of Istisna Price

FI

Istisna Sale
Transaction

Client

Deferred Delivery of Manufactured Goods

Istisna Price lumpsum or 5 Jun, 1 Jul , 1 Aug 06

Delivery of
Building
1 Aug 06

Bank

2
6

Delivery of
Commodity
1 Aug 06

Make corrections in dates

Client

1st June 06

Parallel Istisna
Or
Sub Contracting

Istisna Contract

Builder

Purchaser/
Seller

Pays 15Jun 1 Jul 1 Aug

Istisna Sale Contract 5 June 06

Islamic Modes/Instruments - Sale Contracts:

Istisna: Security/Collateral

Guarantee, mortgage or hypothecation to ensure the

delivery of good on agreed date
in the case of default in delivery, the guarantor (third
party) may be asked to deliver the same commodity
The buyer can sell the mortgaged property and use the
sale proceed to purchase the required good from the
market or to recover the price advanced by him.
Urboun can be obtained as down payment

Islamic Modes/Instruments - Sale Contracts:

Istisna: Case of Government project

Government wants to build a road and enters into an
Istisna contract under which bank has agreed to build
the road. By the end of December 2007 for Rs. 1200
million, payable in installments over 10 years.
Bank enters into a parallel Istisna contract with a contractor
building the road upto 31 December 2007 for Rs. 100 million
and pays the amount in four equal installments
Contractor hands over the road to bank on 31 December 2007.
Use of the road starts against payment of the toll
Government assign the toll receipts to the bank, and in case of
any short fall pays the difference amount
This can also be operated by the contractor on Build Operate
and Transfer (BOT) basis directly even if the financial
intermediary is not involved.

Islamic Modes/Instruments - Sale Contracts:

Istisna:

Difference Between Istina & Salam

ISTISNA
The subject of istisna is always a
thing to be manufactured.

SALAM
The subject can be any thing.

The price in istisna does not

necessarily need to be paid in full in
advance.

The price has to be paid in full in

advance.

Time of Delivery can be flexible

with reduction in price.

Fixed time of delivery is an

essential part of the sale

The contract can be cancelled

before the manufacturer starts
working.

The contract cannot be cancelled

unilaterally.

Islamic Modes/Instruments - Sale Contracts:

Istisna:

Risks in Istisna and their solutions

RISKS
Delivery Risk
Delay in manufacturing and
delivery of goods. Bank may be
sued by the orderer
Sale not permissible before
delivery
Sale of Istisna goods is not
allowed before taking
possession.

SOLUTIONS

MFI can reduce the Istisna price

as per Istisna agreement by
stipulating condition in the
contract

Bank can take promise to

purchase from the third party.
Also can make arrangement for
sale through agency.

Islamic Modes/Instruments - Sale Contracts:

Istisna:

Price Risk
Reduction in price of the
commodity by the customer on
delayed delivery.
Storage Risk
Istisna contracts end up in
deliveries and ownership of
commodities. These leads to
storage costs and associated risks.
Legal risk Defective legal documentation

Reduction in price clause can

be stipulated in the parallel Istisna

Storage cost may be recovered in

parallel transaction and risk can
be minimized by minimizing of
duration between two
transactions.

Written contract, compliance of

Shariah rules.