DEBT FINANCING

(Vol. 2)
 CONTENT:
SALAM &
PARALLEL
SALAM
IJARAH &
BAI’ AL-IJARAH
ISTISNA’ THUMMA
AL-BAI
(AITAB)

AL-
QARDHUL
HASSAN
SALAM & PARALLEL
SALAM

(DEFERRED DELIVERY
SALES)
 INTRODUCTION
The word Salam is also
known as Salaf (advance).

DEFINITION
It can be defined as a purchase or sale of
a commodity for a deferred delivery in
exchange for immediate payment.

The contract of Al-Salam occurs when

the purchaser pay the price of the goods
in cash, whereas, delivery of the goods
is postponed to a fixed time specified in
the contract.
 EVIDENCE OF LEGALITY

Salam comes from the word

salima means to deliver.
In this transaction, the buyer pays the seller the
full-negotiated price of a specific product.
The seller promises to deliver at a specified
future date.
This transaction is limited to products whose
quality and quantity can be fully specified at the
time the contract is made.
When the Prophet migrated to Medina, he has
witnessed the public transacted using Bay al-
Salam in selling fruits and Prophet had not
forbade them.
 EVIDENCE OF LEGALITY

Sayyid Saabiq in Fiqh al-

Sunnah quoted the words
of Ibn al-Munzir (‫)ابن المنذر‬
said: "There was a
consensus of those that
we take (knowledge)
among the members of
scholars, that al-Salam is
permissible."
 PILLARS

SELLER

BUYER

PRICE

GOODS OR SERVICE

CONTRACT OR AGREEMENT
 CONDITIONS

PRICE = The price must be in advance in cash

GOODS = The sale is permissible if the good to be sold

can be accurately determined in shape, quantity, quality,
weight, measures, etc. This in turn will determine the
price of the goods.
- the times and method of submission must be decided
- the place of submission must be decided

AGREEMENT = The contract must use the word al-Salam

when making an offer and acceptance.
 SALAM
Salam contract can be developed
between a farmer and IFIs.

PARALLEL SALAM
Parallel Salam contract can be developed
between IFIs and a wholesaler/
distributor, whom in turn will generate
retail income from the consumer.
 Modus Operandi for Salam Financing

(G) Wholesaler sells

Farmer/Supplier the corn to retails
market/customers
(A) Buy (B) Delivers
1,000 kg 1,000 kg
corn at corn on
RM3.00/ kg 07.01.14 (C) IFIs sells 1,000 kg
& pay cash corn at RM3.20/kg
on 01.01.14 on 07.01.14

Islamic Financial Corn Wholesaler

Institutions (IFIs)
(D) IFIs delivers
1,000 kg corn on
07.01.14 (E) Wholesaler pays
cash RM3,200 on
07.01.14
 Modus Operandi for Salam Financing (cont.)
The salam financing mechanism as follows:
a) The farmer agrees to deliver 1000 kg of corn at RM3 per kg to
Islamic banks. The agreement is dated on 1st January 2014
b) However, under the salam contract, the farmer will only deliver
1000 kg of corn to the IFIs on 7th July 2014.
c) On 7th July 2007, the IFIs makes an agreement to sell the corn to
the wholesaler.
d) On the same date as 7th July 2014, the IFIs will deliver the corn
to the wholesaler and makes a transaction on the same date to
mitigate the inventory risk.
e) Then wholesalers sells the corn to retails market or direct
consumers with market price.
Modus operandi of salam financing involves two inter-related salam
contract (known as parallel salam) between two independent client
(i.e. farmer and wholesaler) and the Islamic banks.
 It involves two separated contract.
 Conclusion
•Salam financing is recognized when capital is paid
by buyer to the seller.
•Parallel Salam transaction is recognized when the
IFIs receives the capital of Salam.
•Salam asset is measured at the time of execution
of the contract.
•If the value of commodity declines, a provision for
the estimated deficit has to be provided.
 AL- IJARAH
& AL-IJARAH THUMMA
AL-BAI(AITAB)
(LEASING AND HIRE PURCHASE)
 INTRODUCTION
• Ijarah means a lease contract as well as a hire
contract. (sale of usufruct: a right of enjoyment)
• It is like someone who is selling to someone else a
right to be benefit or as a payment for services with
a certain price to be paid for it.
• The meaning of right to benefit is like to stay at
house rented or to drive a vehicle hired.
• The lessee earns the use of services of the asset
and makes rental payment to the owner of the
asset.
 Ijarah Financing
It is a leasing contract whereby the benefits of an
asset is transferred by the owner (lessor) to the lessee
at an agreed price/rental amount for an agreed
period of time or lease period. The total lease rental,
which is fixed throughout the tenure, comprises the
original cost of equipment and the bank’s profit
margin. The lessor retain ownership of the equipment
and seeks to recover the capital cost of the
equipment plus a profit margin out of the lease
rentals receivables during the period of the lease.
 Ijarah Financing
Scope of financing:

1. Capital goods: fixed assets, building,

offices etc.
2. Production goods: Machinery, equipment
3. Consumer goods
4. Motor vehicles
5. Other suitable and acceptable assets
IJARAH FINANCING
-PILLARS-

LESSOR

LESSEE

PROPERTY ON LEASE

THE BENEFIT/USUFRUCT/MANFAAT

PAYMENT FOR LEASE / UJRAH

CONTRACT OF LEASE / SIGHAH

 IJARAH FINANCING
-CONDITIONS
FOR LESSOR & LESSEE-
Condition for lessor and lessee are the
same as the conditions for the seller and
buyer.
 IJARAH FINANCING -CONDITIONS
FOR THE PROPERTY ON LEASE-
The property must belong to lessor .

The property is known to both parties and is specified .

The property can be acquired by the lessee for his use until the
end of tenancy or lease.

Ijarah is valid only with consent of both parties to the contract.

Lessee cannot lease the property to another tenant and the
second contract is considered as illegal.

It is the liability of the lessor to repair damages of the property

in order to make it possible for leasing.

The rent, period and the purpose of the lease must be clearly
specified.
 IJARAH FINANCING
-CONDITIONS
FOR THE BENEFIT/USUFRUCT-
The use of the service (usufruct) can be valued with money

The usufruct must be valid according to Islamic commercial law.

The lessee should be able to make use of the property on lease

 IJARAH FINANCING
-CONDITIONS
FOR THE PAYMENT / RENTAL-
Should be fixed & determined

Include profit, administration charges, penalty (?) etc.

Default payment – adherence to BNM’s guideline on

compensation clause
OPTIONS AVAILABLE TO THE LESSEE
OVER THE LEASED ASSET AT THE
END OF THE LEASE TENURE
THE LESSEE CAN:
Purchase the leased asset in exchange for the rental
payment made using the contract of AITAB.

Renew the rental term.

Return the leased asset to the lessor.

 Ijarah Financing Computation
- The method used for computation is flat rate
whereby the customer have to pay rental on a
monthly basis or on an agreed time period.
i) Profit (P) = CF x i x D
CF= cost of financing (purchase price)
i = rate of return per annum
D= period of financing in years
Ijarah Financing Computation
ii) Total Lease Rental (TLR) = CF + P

iii) Monthly rental = TLR/n

TLR = Total lease rental
n= number of months
 IJARAH VS CONVENTIONAL LEASING
ITEMS IJARAH CONVENTIONAL LEASING
Commencement of the The rent will be charged after The day price been paid to
leasing the lessee has taken or delivered supplier although the asset
not the day price has been paid has not been delivered.
Expenses during process Lessor to bear all expenses & To bear by lessee i.e
acquiring allow to factor in cost registration and others
Liability in the case of Lessee is responsible for the case Does not differentiate
losses of negligence but not in the case between negligence or
of beyond his control beyond the control
Penalty for late payment Normally been charged 1% on Charged based on
outstanding installment to cover compounding interest and
cost of late payment treated as income
Termination of the lease In the even of contravenes by Lessor has full right to
lessee, the lessor has a right to terminate
terminate the contract. If not
cannot.
Insurance Insured under takaful Bear by lessee with
conventional insurance
AL IJARAH THUMMA AL-BAI
(AITAB) FINANCING

It is a leasing contract that ends up with

purchase.

The legal title of the leased asset will be

passed to the lessee on the basis of a new
contract through an option to buy-back in
which the legal title at the end of the lease
term.
 AL IJARAH THUMMA AL-BAI
(AITAB) FINANCING
AITAB comprise of 2 contracts
1) Al-ijarah: A contract whereby the lessor (Islamic
bank) will rent the asset(s) to the lessee (customer)
over a certain period and a monthly rental amount as
agreed by both parties.

2) Al-bai: upon completion of the rental period or upon

early settlement, the lessor will the enter into the sale
contract with the lessee to sell the asset at a pre-
agreed selling price.

Al-Ijarah and al-bai are both categorized under the

contract of exchange.
 AL IJARAH THUMMA AL-BAI
(AITAB) FINANCING-
Computation
i) Profit (P) = CF x i x T

CF= cost of financing (purchase price)

i = rate of return per annum
T= period of financing in years

ii) Monthly Installment Amount (MIA)= CF + P

N
N= total number of periodic payments

iii) Final Instalment Amount (FIA)

= CF + P – [MIA x (N-1)]
 AL IJARAH THUMMA AL-BAI
(AITAB) FINANCING-
Computation
iv) Income Recognition = P – n(n + 1) x P
N(N+1)

P= profit
n = the number of months remaining
N= total number of periodic payments

v) Penalty in the event of default =

UIA x PR x OP/360
UIA= Unpaid Installment amount
PR= penalty rate
OP = outstanding period
 ISLAMIC HIRE PURCHASE

In Malaysia, two major contracts of hire purchase

were formed as a new modes of financing:
1) Al-Ijarah Thumma Al-Bai
– a contract of leasing ending with sale
- widely adopted to be used in motor vehicles
financing
- first introduce by BIMB

2) Al-Ijarah Muntahiya Bittamlik

– a contract of leasing ending with ownership
-applied some bank in corporate financing
 ITAB VS CONVENTIONAL HIRE PURCHASE
ITEMS ITAB HP
Number of Comprises 2 separate contracts : ijarah and Used single contract
contract bai’
Contract term a. Contract consider financing to customer a. HP is consider loan to customer
b. Profit on the cost of asset b. Bank charged interest on the entire cost
c. Expenses to acquire asset borne by the of acquiring asset
lessor c. Cost incurred during acquiring the asset
d. Late payment charges only maximum of d. Interest late charges payment will be
1% on unpaid ijarah charged
Sources of Sources from halal funds Unlimited with various sources
funds
Acceptance Lessee has to sign the aqad to denote offer No such letter of acceptance
letter and acceptance
Eligible asset Only the asset with the shariah compliance No restriction
Purchase price Determined at the end of the period based on Based on annual rate of return and decide
the current market value upfront
Responsibility Lessor bears all basic & structural Lessee bears all cost incurred
maintenance including acquiring asset
Penalty for Normally been charged 1% on outstanding Charged based on compounding interest and
late payment installment to cover cost of late payment treated as income
Insurance Bear by lessee with takaful by lessee with conventional insurance
Qardhul
Hassan
(BENEVOLENT LOAN)
 In Islam, Qardhul Hassan or benevolent loan
is not a loan for commercial use.
It is strictly a loan for personal use.
This is the essence of loan contract in Islam.

QARD means loan

HASSAN implies good or benevolent

A QARDUL HASSAN loan therefore expresses the

spirit of cooperation and brotherhood between
debtors and creditors.
Creditors expects nothing in return for the
use of the loan. All the needs are the
repayment of the loan in full.

Debtor holds obligation to return the

principle loan.

Debtor also can place a collateral (rahn) to

support the loan.
Debtor may grant gift (hibah) when the debt
matures but the hibah cannot be mentioned
in the loan contract.

Debtor is expected to give the creditor a

hibah for the following reasons;
I. The debtor is thankful for the loan given by
the public
II. The debtor is concern that inflation may cut
real value of principle loan
III. The debtor understands that the creditor
suffers loss of opportunity to earn alternative
income if money is invested elsewhere.
 Istisna’ comes from the word sana’a means to produce or to
ISTISNA’ make.

Is a contract of sale and purchase whereby the buyer place an

DEFINITION order with the seller requesting him to make a product within
a certain period at a price according to an agreed term of
payment. A request to produce or manufacture a product.

Sani’ Mustasni’ Masnu’

The person who The person who causes it to
The thing made
makes the thing be made

The emphasis in istisna’ is the specificity of subject matter to avoid gharar

(uncertainty) ensuring that the seller cannot transact with something that
cannot be accurately described: one can describe equipment, a factory or an
industrial plant, but not fish in the sea prior catching them since their type and
volume is unknown.
 MechanisM FOR Bai’
An investment
isTisna’
company enters Developer The
However, it is
into an construct buildings investment
not the interest
agreement with in stages beginning company will
of the
a developer with the leveling of pay for the
investment
company in the identified land purchase of
company to
which the on which the the bungalows
ultimately own
investment buildings are to be on a staggered
the houses.
company located and its basis according
Then, it will
requires 10 units foundation work to the stages
immediately
of bungalows to until the of completion
sell them back
be completely commissioning of on upon
to the
erected by the the installation of delivery of the
developer
developer telecommunication bungalows.
company at a
company. lines, water &
higher price.
electricity.
 Each party has the option to withdraw from the contract before it is implemented but binding once it has been constituted.
Once constituted, if the Al-Masnoo does not conform to specifications, the Mustasni has the right to revoke the contract.

Al-Sani’ – Subject matter of

Payment in: certain
a. Spot (current) Developer specification:
b. Installment Company a. Kind
c. Bullet (the ultimate seller) b. Type
c. Quantity
d. Quality
Buy-back

Sell to
Price:
a. Known
b. Cannot be increased Delivery:
or decreased on
account of increases Al-Mustasni’- a. Fixing delivery date
or decreases in price Investment is not necessary
of inputs. Company
(the ultimate
buyer)
• To enable an individual to own a certain property
of his interest without having to pay for it
immediately or at the time of execution of the
contract.
• The seller is able to work on the project or ordered
item until its completion.
• At the same time, he is assured of the working
capital needed to cover the financial requirements
of completing the ordered item.
 PILLARS

PERSON WHO PLACE THE ORDER

(PURCHASER)/ (MUSTASNI’)

PERSON WHO RECEIVES THE ORDER

(SELLER)/ (SANI’)

ORDERED ITEM (MUSTASNI’)

PRICE

OFFER & ACCEPTANCE

Pay the total price at the time of execution of
the contract

Pay the total price at the time of delivery of

the product
Make part payment at the time of execution of
the contract and pay the remaining balance at
the point of delivery of the product
Pay on an installment basis as agreed between
the seller and the buyer.
The End